S.E.C. v. Current Financial Services, Inc.

• Decision Date: 18 May 2000
• Docket Number: No. Civ.A. 91-3089 SSH.,Civ.A. 91-3089 SSH.
• Citation: 100 F.Supp.2d 1
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. CURRENT FINANCIAL SERVICES, INC., et al., Defendants.
• Court: U.S. District Court — District of Columbia

Page 1

100 F.Supp.2d 1

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. CURRENT FINANCIAL SERVICES, INC., et al., Defendants.

No. Civ.A. 91-3089 SSH.

United States District Court, District of Columbia.

May 18, 2000.

COPYRIGHT MATERIAL OMITTED

Mark Adler, SEC, Washington, DC, for plaintiff.

John D. Wogan, (Receiver), Current Financial Services, Inc., New Orleans, LA, for defendants.

David W. Banner, American Equity Financial Group, Latrobe, PA, defendant pro se.

Douglas R. Rayburn, Current Financial Services of Mississippi, Inc., Jayess, MS, defendant pro se.

OPINION

STANLEY S. HARRIS, District Judge.

Before the Court is the Securities and Exchange Commission's ("SEC") motion for summary judgment and a permanent injunction against defendants Current Financial Services of Mississippi, Inc. ("CFSM") and CFSM's president Douglas R. Rayburn.¹ Upon consideration of the parties' submissions and the entire record, the Court grants the SEC's motion.² "Findings of fact and conclusions of law are unnecessary on decisions of motions under Rule 12 or 56." Fed.R.Civ.P. 52(a); Summers v. Department of Justice, 140 F.3d 1077, 1079-80 (D.C.Cir.1998). Nonetheless, the Court sets forth its reasoning.

I. Background

Richard and Ray Hope founded Current Financial Services, Inc. ("Current") in 1988, to engage in the business of factoring medical receivables; they purchased receivables from various health care providers at a discounted price with the expectation of collecting and retaining all or most of the full face value of the receivables. The primary risks were that a patient's health insurance did not fully cover the claim upon which a receivable was based and the possible insolvency of the insurer.

To raise capital and to finance its business operations, Current began entering into "investment agreements" with the general public; these "investment agreements" essentially were debt securities. Current offered a high rate of interest for these debt securities, ranging from 18% to 60% per year. Current used different forms of the debt security agreement, including the "Subordinated Debenture Agreement," which subordinated the investor to other company debt, and the "Investment Agreement," which had no subordination clause.

To raise even more capital, the Hope brothers enlisted other individuals, such as Rayburn, who formed their own corporations and became "sub-issuers." The sub-issuers purchased debt securities from Current and financed the purchases by selling their own debt securities to the public. Selling debt securities was the sole or primary business of the sub-issuers. To pay interest to the sub-issuers and investors on the debt securities, Current relied on the success of its factoring operation. The sub-issuers obtained funds to pay their investors from the spread in interest rates between what they received from Current and what they paid to their investors.

Current and the sub-issuers solicited investors widely, marketing the debt securities to the public as "investments." Rayburn initially solicited investors to invest directly in Current, and later used CFSM to solicit investors. His initial investors were widows from his church who withdrew money from certificates of deposit to invest in Current. He also placed an ad in a local newspaper to solicit investors for CFSM. By September 1991, CFSM had sold debt securities with an aggregate face value of approximately $500,000 to about 37 investors in five states.

When offering the debt securities to investors, Current and the sub-issuers made several misrepresentations and misleading omissions, including emphasizing a high rate of return without a reasonable factual basis for such an assertion, and omitting information regarding the risks involved. None of these instruments were registered with the SEC. Current and the sub-issuers, however, had notice that selling the investment agreements raised legal problems, as various attorneys told Current and some of the sub-issuers on different occasions that Current was offering and selling "securities." Current's business records also contained a copy of an article discussing the Supreme Court's decision in Reves v. Ernst & Young, 494 U.S. 56, 110 S.Ct. 945, 108 L.Ed.2d 47 (1990), holding that promissory notes are presumed to be securities. Richard and Ray Hope, however, assured the sub-issuers that their activities were legitimate.

The SEC initiated this action against 17 defendants, alleging that the defendants (1) offered and sold unregistered securities in violation of Section 5 of the Securities Act of 1933, 15 U.S.C. § 77e ("Section 5"), and (2) made material misstatements and omissions of material facts when selling the securities to investors in violation of the anti-fraud provisions in Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) ("Section 17(a)"), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) ("Section 10(b)"), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 ("Rule 10b-5"). The SEC now brings this summary judgment motion and seeks a permanent injunction against future violations as well as a judgment for disgorgement.

II. Summary judgment

Summary judgment may be granted only "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). In considering a summary judgment motion, all evidence and the inferences to be drawn from it must be considered in a light most favorable to the nonmoving party. See Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 106 S.Ct. 1348, 1356, 89 L.Ed.2d 538 (1986). Summary judgment cannot be granted "if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 106 S.Ct. 2505, 2510, 91 L.Ed.2d 202 (1986).

As a threshold matter, the Court must determine whether the "Subordinated Debenture Agreements" offered by CFSM and Rayburn are "securities." A security includes a "note," "bond," "debenture," "certificate of interest or participation in any profit-sharing agreement," or "investment contract." 15 U.S.C. § 77b(a)(1). To decide whether a transaction is a security, the Supreme Court has determined that every note is presumed to be a security; a court must then determine whether any factors exist to rebut that presumption. Reves, 494 U.S. at 66-69, 110 S.Ct. 945. In Reves, the Supreme Court outlined the steps that a court should follow. First, a court must assess the motivations of the buyer and seller in entering into the transaction. "If the seller's purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a `security.'" Id. at 66, 110 S.Ct. 945. Second, a court must examine how the instrument was distributed to determine whether there is "common trading for speculation or investment"; offering and selling the instrument to a broad segment of the public satisfies this factor. Id. Third, a court should examine whether the investing public reasonably expected that the investments were securities. Id. Finally, a court should examine whether some factor such as the existence of another regulatory scheme significantly reduced the risk of the instruments. Id. at 67, 110 S.Ct. 945.

Based upon the evidence presented, the Court concludes that the instrument that CFSM and Rayburn sold is a security. CFSM and Rayburn offered the instruments to the public to raise capital to finance its purchases of the instruments Current offered (which the Court also concludes are securities). The investors who bought them earned profits in the form of interest. CFSM and Rayburn sold these instruments to the public, even advertising in a newspaper; collectively, Current and the sub-issuers sold the instruments to over 570 investors in 15 states, with Current raising $10 million and the sub-issuers raising in excess of $8 million. The instruments were also held out to the public as investment agreements. Finally, the Court sees no factor that significantly reduces the risk of the instrument. The Court next determines whether summary judgment should be entered against each defendant.

A. CFSM

Rayburn is proceeding pro se. He filed an opposition to the SEC's summary judgment motion on behalf of himself and CFSM. The Court, however, informed him that corporations may not proceed pro se and directed CFSM to obtain counsel within 28 days, or the SEC's motion would be deemed conceded. Instead of obtaining counsel, Rayburn filed a motion requesting a release of frozen funds to obtain counsel, which the Court denied. In that same Order, the Court advised CFSM that failure to obtain legal counsel and respond within 28 days would result in the SEC's motion being treated as conceded and judgment being entered in the SEC's favor. To date, CFSM has not obtained counsel or properly filed an opposition; accordingly, the Court treats the motion as conceded. Without any evidence to the contrary, the Court finds that the SEC has demonstrated that summary judgment should be entered in its favor as to CFSM.

B. Rayburn

(1) Selling unregistered securities

The SEC contends that Rayburn violated Section 5 of the Securities Act of 1933. Section 5 prohibits the sale or delivery after sale of unregistered securities. 15 U.S.C. § 77e(a). In its supporting memorandum, the SEC documents Rayburn's offer and sale of unregistered securities to the investing public. Rather than disputing that he offered and sold unregistered securities, Rayburn argues that he did not know that what he was selling was considered a security, and that he was led to believe he was selling a legitimate instrument. H...