Securities & Exchange Comm'n v. Unique Fin.

Decision Date18 November 1999
Docket NumberNo. 99-4033,99-4033
Parties(11th Cir. 1999) SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. UNIQUE FINANCIAL CONCEPTS, INC., ERNEST J. PATTI, et al., Defendants-Appellants
CourtU.S. Court of Appeals — Eleventh Circuit

Before BLACK, HULL and MARCUS, Circuit Judges.

BLACK, Circuit Judge:

Appellants Unique Financial Concepts, Inc. (Unique), Ernest J. Patti (Patti), Frederick N. Hollander (Hollander), and Nicholas D. DeAngelis (DeAngelis), appeal a preliminary injunction enjoining Appellants from violating the anti-fraud and securities registration provisions of Section 17(a) of the Securities Act of 1933, 15 U.S.C. 77q(a). The district court found that Appellants' activities were subject to the Securities Act because Appellants were offering investment contracts in which investor funds were to be pooled. The district court also found that the Commodity Exchange Act (CEA), 7 U.S.C. 1- 25 , did not preclude Appellee Securities and Exchange Commission (SEC) from regulating the investment opportunity offered by Appellants. We affirm.

I. BACKGROUND

Hollander and Patti established Unique in October 1997. At its inception, Unique purported to offer the sale of foreign currency options. Unique advertised heavily on television, newspaper, and the Internet, promising large returns on small investments. These promises were not based on actual investments made by Unique. Prospective investors were sent a packet containing an offering document that described the foreign exchange market, a customer agreement, and a disclosure of risk statement.

The original customer agreement explained that the investments would be pooled together and that Unique had sole discretion over the investments. In August 1998, Unique modified its customer agreement by removing the language concerning the pooling of investments and Unique's sole discretion over these investments.

After receiving initial investments from investors, Unique deposited the funds into its bank account at Southern Bank in Fort Lauderdale, Florida. Unique sales representatives advised the investors as to which currencies they should invest in and how many puts and calls they should buy. The investor then spoke to a compliance officer, who explained the details of the investment and requested the investors' assent to the purchase.

A portion of the investors' funds then purportedly was wired to Capital Management International (CMI) and Asset Management Funding (AMF) in the Bahamas. According to Patti and other representatives of Unique, AMF was a holding company for clearing houses, while CMI was the clearing house responsible for carrying out Unique's option trades. Unique also claims it later contracted with two other Bahamian clearing houses, Forex International (Forex) and Nassau Bay Clearing, Ltd.

After the initial investment, Unique aggressively solicited the investors for additional investments. Eventually, however, Unique representatives were extremely hard to reach and often failed to return phone calls. The investors lost significant amounts of money on their investments.

From October 1997 until October 22, 1998, Unique raised just over $6.5 million from investors using the above scheme. Of this amount, only $2,489,801 (38%) was wired to the Bahamas to the alleged clearing houses. The remainder of the investors' money was divided as follows: approximately $700,000 was paid to Unique sales representatives; approximately $1.2 million was paid for advertising (including $760,786.32 paid to DRE consulting, a company co-owned by Patti from which he received a substantial salary); approximately $300,000 was paid to Patti, Hollander, and DeAngelis, the lead sales representative; and approximately $1.6 million was paid for business and personal expenses, including checks made payable for car rentals and personal loans. In addition, approximately $644,000 of the investors' funds was distributed to new investors.

II. THE PRELIMINARY INJUNCTION

The district court found that Appellants' activities were subject to the Securities Act and granted the SEC a preliminary injunction enjoining Appellants from violating anti-fraud and securities registration provisions of the Securities Act, 15 U.S.C. 77q(a). Significantly, the district court found that no credible evidence existed to show that Appellants' "clearinghouses" ever placed trades on behalf of investors. The court emphasized that Appellants failed to introduce any written agreements showing a relationship between Unique and the Bahamian clearing houses (Nassau Bay, CMI, or Forex). Patti claimed that Appellants did not have any copies of the contracts between the parties, and asserted, without citing any authority, that Bahamian law prevented Appellants from obtaining copies of the agreements from the Bahamas. The district court found that Patti lacked credibility and that the absence of any written agreements was "highly suspect." As a result, the court concluded that "the contract may be damaging to the [Appellants] and that they may be purposefully avoiding its production."

Although Appellants did produce option reports and monitoring sheets detailing the purported trades and client accounts, the district court noted that Appellants failed to authenticate any of these reports. Specifically, the court pointed to the fact that there were no transaction or wire verifications indicating that the clearing houses executed any trades. Although Appellants did produce alleged trade confirmations, these confirmations were sent from Appellants' office, not from the Bahamian clearing houses.

In addition, Patti testified that Appellants never received any bank records indicating the occurrence of the alleged trades, that he did not know how the Bahamian clearing houses executed the trades, and that he did not know how the clearing houses were compensated for their services. Furthermore, Appellants' compliance officer testified that she did not know what the clearing houses did and did not even know what the term clearing house meant. Finally, Appellants' accountant, Morris Berger, stated that the "only thing we had to deal with is really the Unique data. And we don't have the Bahamian trading data . . . . Do I know that there was actual trading in the Bahamas? The answer is, no, I don't."

Thus, the court concluded, "at this juncture Unique has failed to produce one scintilla of independent evidence in support of its contention that investors' funds were invested in foreign currency options by clearinghouses in the Bahamas." In addition, the court stated that "at this stage of the litigation, it appears as though Unique either misused or converted investors' funds and have used an artifice to defraud."1

The district court nevertheless found that the "investments" offered by Appellants should be considered investment contracts, and thus concluded that the SEC did have jurisdiction to bring this claim. The court also held that the SEC had established a prima facie case of violations of the anti-fraud and registration provisions of Section 17(a) of the Securities Act and issued a preliminary injunction enjoining Appellants from committing further violations.

III. STANDARD OF REVIEW

A district court's grant of a preliminary injunction order involves a mixed standard of review. The decision to grant the injunction is reviewed for abuse of discretion. See Haitian Refugee Ctr., Inc. v. Baker, 953 F.2d 1498, 1505 (11th Cir. 1992). Questions of law supporting the injunction are reviewed de novo. See Tefel v. Reno, 180 F.3d 1286, 1295 (11th Cir. 1999). Findings of fact are reviewed for clear error. See SEC v. Carriba, 681 F.2d 1318, 1323 (11th Cir. 1982). When a preliminary injunction is challenged on the basis of jurisdiction, a plaintiff need only establish "a reasonable probability of ultimate success upon the question of jurisdiction when the action is tried on the merits." Majd-Pour v. Georgiana Community Hospital, Inc., 724 F.2d 901, 902 (11th Cir. 1984) (quoting Industrial Electronics Corp. v. Cline, 330 F.2d 480, 482 (3d Cir. 1964)).

IV. ANALYSIS

The central issue in this case is whether the district court abused its discretion in finding that Appellee has shown a reasonable probability of ultimate success upon the question of the SEC's jurisdiction over Appellants' conduct.2 The determinative question within this issue is whether the contracts offered and sold by Appellants were investment contracts, and thus securities, under federal securities law.3 If the contracts were investment contracts, then, contrary to Appellants' assertion, the SEC had jurisdiction under the federal securities laws to bring this suit.

A. Three Prong Howey Test

In S.E.C. v. W.J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100 (1946), the Supreme Court established the classic test for determining whether a transaction is an "investment contract" within the meaning of Section 2(a)(1) of the Securities Act, 15 U.S.C. 77b(a)(1). In Howey, the Court explained that for the purposes of the Securities Act, an investment contract is "a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party...." Howey, 328 U.S. at 298-99, 66 S. Ct at 1103. This Court has divided the Howey test into the three elements: "(1) an investment of money, (2) a common enterprise, and (3) the expectation of profits to be derived solely from the efforts of others." Villeneuve v. Advanced Business Concepts Corp., 698 F.2d 1121, 1124 (11th Cir. 1983), aff'd en banc, 730 F.2d 1403 (11th Cir. 1984). Both parties agree the first prong of this test has been satisfied. There is distinct disagreement, however, as to the second and third prongs.

1. Common Enterprise Prong

With respect to the second...

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