Securities and ex. Com. v. Rubera

• Decision Date: 05 December 2003
• Docket Number: No. 02-35886.,No. 02-35907.,02-35886.,02-35907.
• Citation: 350 F.3d 1084
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. Paul S. RUBERA, Defendant-Appellee. Securities And Exchange Commission, Plaintiff-Appellee, v. Paul S. Rubera, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

350 F.3d 1084

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. Paul S. RUBERA, Defendant-Appellee.

Securities And Exchange Commission, Plaintiff-Appellee, v. Paul S. Rubera, Defendant-Appellant.

No. 02-35886.

No. 02-35907.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted November 5, 2003 — Portland, Oregon.

Filed December 5, 2003.

COPYRIGHT MATERIAL OMITTED

Leslie E. Smith and Eric Summergrad, Securities and Exchange Commission, Washington, DC, for the plaintiff-appellant-cross-appellee.

Douglas A. Stringer, Robert C. Weaver, Jr. and Adam R. Kelly, Garvey Schubert Barer, Portland, OR, for the defendant-appellee-cross-appellant.

Appeal from the United States District Court for the District of Oregon, Owen M. Panner, Senior District Judge, Presiding.

Before: Arthur L. ALARCÓN, Johnnie B. RAWLINSON, and Jay S. BYBEE, Circuit Judges.

OPINION

ALARCÓN, Circuit Judge.

In this civil enforcement action filed by the Securities and Exchange Commission pursuant to Sections 20(d)(1) and 22(a) of the Securities Act of 1933, 15 U.S.C. §§ 77t(d)(1), 77v(a), and Sections 21(d)(3)(A), 21(e), and 27 of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78u(d)(3)(A), 78u(e), 78aa, (collectively "Securities Acts"), the district court entered judgment against Paul S. Rubera for violation of the registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933. 15 U.S.C. §§ 77e(a), (c). The district court entered judgment in favor of Mr. Rubera on the second and third claims of the complaint which alleged that Mr. Rubera used interstate commerce in the offer or sale of securities for purposes of committing fraud in violation of Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), and Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder. 17 C.F.R. § 240.10b-5. Each party has appealed.

Mr. Rubera seeks reversal of the judgment that he violated the registration provisions of the Securities Acts. He contends that the district court erred as a matter of law in determining that his pay telephone investment program, in which individuals were sold pay telephones and service agreements in one transaction, was a "security," and that he violated federal securities law by not registering his telephone investment program with the SEC.

The SEC argues that the district court erred in finding that Mr. Rubera lacked scienter with regard to the false and misleading statements made to persons who purchased pay telephones and service agreements from Alpha Telcom, Inc. ("Alpha"), Mr. Rubera's solely owned corporation.

We affirm because we conclude that Mr. Rubera's telephone investment program was a "security" under the Securities Acts. We also hold that the district court's finding that Mr. Rubera lacked scienter as to false statements made to investors was not clearly erroneous.

We will analyze the merits of these appeals in separate parts. In Part One we consider whether the pay telephone investment program was a security under the Securities Acts. In Part Two we review the district court's finding that the SEC failed to meet its burden to demonstrate that Mr. Rubera acted with scienter.

Part One

I

In 1986, Mr. Rubera and a friend incorporated Alpha. Alpha was in the business of selling, installing, and maintaining pay telephones and business systems. Mr. Rubera became the sole owner of Alpha in 1989.

In 1997, Charles Tummino approached Mr. Rubera with a business proposal for selling pay telephones to individuals and simultaneously entering into service agreements with those individuals to install, service, and maintain the telephones ("telephone investment program"). Dan Lacy, Alpha's attorney, concluded that this proposal would not constitute a security. Mr. Lacy obtained an opinion from an outside attorney specializing in securities law who also opined that the proposal would not constitute a security. Thereafter, Alpha commenced selling telephones along with service contracts to individual investors. The telephone investment program was never registered with the SEC.

The telephone investment program functioned in the following manner: Investors would purchase a telephone for $5,000 from Alpha or its affiliates and, at the same time, enter into a service agreement with Alpha whereby the latter would manage and maintain the telephone. Sales agents promoted the two agreements together as a package. Alpha offered four levels of service with the service agreements. Although investors were not obligated to select Alpha to manage their telephones, approximately 90 percent of investors selected Level Four, the highest level of service, while the remaining 10 percent selected Levels One, Two, or Three. Under Level Four, investors were passive, leaving operation of the telephones solely in Alpha's hands. Alpha selected the location of the telephones, installed the telephones, maintained the telephones, paid all monthly telephone and utility bills, and obtained all regulatory certifications. Also, with Level Four, investors were given a buyback option allowing them to resell their telephones to Alpha at the purchase price for an indefinite period of time. In exchange, Alpha was entitled to a 70 percent share of any revenue received from the pay telephones. Under the Level Four service agreement, the investor was entitled to receive the balance. If, however, 30 percent of the telephone's monthly revenue was not equal to or greater than a base amount set at $58.34, or approximately an annualized return of 14 percent on the $5,000 investment, Alpha agreed to waive a sufficient portion of its 70 percent share to meet the base amount.

Mr. Tummino oversaw marketing and sales for the telephone investment program. He created the marketing materials, supervised the sales agents, and prepared the sales and service agreements. In October 1998, Mr. Rubera created American Telecommunications Company, Inc. ("ATC") as a wholly owned subsidiary of Alpha to be the marketing and sales arm of the telephone investment program.

In the same year, Mr. Rubera retained Perkins & Co., an accounting firm, to review Alpha's financial statements. Perkins & Co. concluded that under Generally Accepted Accounting Principles ("GAAP"), Alpha could not categorize the sale of telephones to investors as revenue due to the buyback options. Applying GAAP and treating the telephone sales as liabilities, Alpha's financial status as of October 31, 1998 would have reflected a net loss of approximately $2,600,000 rather than a marginal net gain. Mr. Rubera did not believe the telephone sales should be considered liabilities since he reported them as income for tax purposes. He decided instead to treat telephone sales as revenue in Alpha's financial report, and to insert a note in the report stating that its methodology departed from GAAP.

In late 1998, Mr. Tummino retired and introduced Mr. Lacy and Mr. Rubera to Ross Rambach and Mark Kennison who operated Strategic Partnership Alliance, LLC ("SPA"). SPA supervised and trained sales agents in marketing pay telephones to investors. Mr. Rubera hired SPA to oversee hiring, training, and supervision of sales agents for the telephone investment program.

Mr. Rambach suggested that Mr. Rubera hire a company named ATMN/EMI to acquire new pay telephone sites. Later, Mr. Rubera learned that Mr. Rambach and Mr. Kennison were ATMN/EMI's principals and that the sites they acquired were oftentimes unsuitable for pay telephone use or were nonexistent. Alpha terminated its relationship with ATMN/EMI when it discovered these problems.

In early 2000, Mr. Rambach and Mr. Kennison persuaded Mr. Rubera to acquire an insurance policy to guarantee the availability of funds to finance the buyback option. They introduced Mr. Rubera to Robert Harrison, a Texas-based insurance agent with whom they were familiar. Mr. Harrison created Northern & Western Insurance Company ("N & W") to insure the buyback claims, with Mr. Rubera as a co-signatory. ATC paid significant premiums to Mr. Harrison to supply excess insurance. Mr. Harrison led the parties to believe that Lloyd's of London was the excess insurer, a falsity which was advertised in the marketing materials. Once this mistake was discovered, Alpha sent a letter to investors informing them that Lloyd's of London was not the excess insurer.

Meanwhile, SPA agents encouraged investors who had bought telephones before buyback insurance was offered to exercise their buyback options and then repurchase telephones with SPA. In this way, investors would, at no cost to themselves, acquire telephones that carried buyback insurance. By April 2001, there was a sharp increase in investor buyback requests. This resulted in extra sales commissions for SPA and financial losses for ATC and Alpha.

Throughout this time, Mr. Rubera did not pay investors in accordance with the revenue generated from their pay telephones, but instead paid all investors at least $58.34 a month, regardless of the amount of revenue generated by each telephone. To fund these monthly payments to investors, Alpha borrowed from ATC. Mr. Rubera thus paid existing investors from funds ATC had obtained from telephone sales to new investors.

The pay telephone business was not profitable. Most of Alpha's revenue derived from telephone sales. The sales materials, however, stated that pay telephones produce substantial profits. One of ATC's sales brochures stated that the telephone investments were low risk and "virtually recession-proof," guaranteed an annual return of 14 percent to be paid monthly, and claimed that the telephone business overall was highly profitable ("ATC sales brochure"). It is unclear from the record who compiled the ATC sales brochure. By August 2001, Alpha was operating at a significant loss and filed for bankruptcy.

On August 27, 2001, the SEC filed its complaint in the United States District Court for the District...