Sec. & Exch. Comm'n v. Torchia

• Decision Date: 25 April 2016
• Docket Number: 1:15-cv-3904-WSD
• Citation: 183 F.Supp.3d 1291
• Parties: Securities and Exchange Commission, Plaintiff, v. James A. Torchia, Credit Nation Capital, LLC, Credit Nation Acceptance, LLC, Credit Nation Auto Sales, LLC, American Motor Credit, LLC, and Spaghetti Junction, LLC, Defendants.
• Court: U.S. District Court — Northern District of Georgia

183 F.Supp.3d 1291

Securities and Exchange Commission, Plaintiff,

v.James A. Torchia, Credit Nation Capital, LLC, Credit Nation Acceptance, LLC, Credit Nation Auto Sales, LLC, American Motor Credit, LLC, and Spaghetti Junction, LLC, Defendants.

1:15-cv-3904-WSD

United States District Court, N.D. Georgia, Atlanta Division.

Signed April 25, 2016

Joshua A. Mayes, Madison Graham Loomis, Walter E. Jospin, Kristin Wilhelm Murnahan, U.S. Securities and Exchange Commission, Atlanta, GA, for Plaintiff.

Katherine S. Addleman, Timothy A. Newman, Haynes & Boone, Dallas, TX, Stephen L. Corso, Houston, TX, James Johnson, Knight Johnson, LLC, Atlanta, GA, for Defendants.

OPINION AND ORDER

WILLIAM S. DUFFEY, JR., UNITED STATES DISTRICT JUDGE

This matter is before the Court on Plaintiff United States Securities and Exchange Commission's ("SEC") Second Motion for Preliminary Injunction [20] ("Preliminary Injunction Motion") and Emergency Motion for Temporary Restraining Order, Asset Freeze, Receiver, and Other Equitable Relief [2] ("TRO Motion"). Also before the Court is Defendants James A. Torchia, Credit Nation Capital, LLC ("CN Capital"), Credit Nation Acceptance, LLC ("CN Acceptance"), Credit Nation Auto Sales, LLC ("CN Auto"), American Motor Credit, LLC ("AMC"), and Spaghetti Junction, LLC's ("Spaghetti Junction") (collectively, "Defendants") Motion to Dismiss [21].

I. BACKGROUND AND FINDINGS OF FACT

A. Introduction

This action involves alleged fraudulent schemes operated by Mr. Torchia and the Defendant entities he controls. The alleged fraud involves two separate investment schemes. In the first, CN Capital raises money to invest in sub-prime auto loans and life insurance settlements. ( [20.1] at 4). CN Capital raises the funds by selling unregistered promissory notes to investors, who are told that they will receive a 9% "fixed" return and that their promissory notes are "100% asset backed." (Compl. ¶ 2). CN Capital tells promissory note investors that it expects to generate returns from its investments in excess of the 9% interest payable on the notes. ( [20.1] at 5). The second involves CN Acceptance, which sells unregistered fractional interests in life settlement contracts ("LS Interests") to investors. (Compl. ¶ 4).

The SEC contends that Defendants' own forensic accounting analysis reveals that their financial situation is dire, CN Capital is insolvent and has been for years, and that Defendants are attempting to obscure CN Capital's financial condition. The SEC argues that Defendants did not disclose CN Capital's insolvency to investors, in violation of federal securities laws. (See Compl. ¶¶ 10-12). The Complaint alleges that Defendants violated Sections 5(a), 5(c), 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act of 1933, 15 U.S.C. §§ 77a, et seq. ("Securities Act"), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq. ("Exchange Act"), and subsections (a), (b), and (c) of Rule 10b-5 under the Exchange Act, 17 C.F.R. § 240.10b–5 ("Rule 10b-5"). (Id.¶¶ 10-12). The SEC asks the Court to "shut down this fraudulent scheme and appoint a receiver to marshal and liquidate the assets to prevent investors from losing any more money than they already have as a result of the Defendants['] fraud." ( [20.1] at 18-19).

Defendants argue that the SEC's allegations are based on a misunderstanding of Defendants' business model and operations. ( [61] at 6). They argue that the SEC's allegation that CN Capital is insolvent relies on a "non-GAAP,¹ preliminary, cash flow analysis[.]" ( [26] at 2). Defendants claim that the fair market value of life settlements owned by Credit Nation exceeds $40 million, (Defs.' Initial Disclosures [19] at 4), and that taking the fair market value of these assets into account shows that CN Capital is solvent. Defendants seek dismissal of this action and oppose an injunction, including because the life insurance settlements it sells to investors are not securities, the SEC has not made a prima facie case that Defendants violated registration requirements or the antifraud provisions of the federal securities laws, and the SEC failed to provide evidence of scienter or intent to defraud. (See, e.g., [26] at 4-13).

B. Defendants' Business

1. Overview

Defendant James Torchia is the CEO of CN Capital, CN Acceptance, and AMC (collectively, "Credit Nation"). ( [21.1] at 2). Although the Credit Nation entities are separate, they function as a unit. (Id. at 4). Mr. Torchia is also the CEO of CN Auto, a used car dealership that is no longer in operation. (Id.). Mr. Torchia owns Spaghetti Junction, through which he loaned Credit Nation millions of dollars in start-up capital between 2008 and 2011. (Id. at 3). The ownership structure of the various entities under Mr. Torchia's control is depicted in the following chart provided by the SEC:

( [20.1] at 23).

Credit Nation raises money to invest in (i) sub-prime auto loans and (ii) life insurance settlements. ( [20.1] at 4; [21.1] at 3). Credit Nation raises the investment capital by selling three- and five-year promissory notes to investors. ( [21.1] at 3). Credit Nation tells promissory note investors that they will receive a 9% fixed return and that their promissory notes are "100% asset backed." ( [20.1] at 4-5). Credit Nation tells promissory note investors that Credit Nation expects to generate returns from its investments in excess of the 9% interest payable on the notes. (Id. at 5). Credit Nation's advertisements for its promissory notes included the following newspaper advertisements:

( [2.10] at CN-SEC-000550, -000553).²

Defendants' sub-prime auto loan and life insurance settlement operations are represented in the following chart provided by the SEC:

( [20.1] at 24). These operations are explained in further detail below.

2. Defendants' Investments in Sub-Prime Auto Loans

Credit Nation provides automobile loans (the "Sub-Prime Auto Loans") at high interest rates to individuals with credit problems. (Id. at 5). The Sub-Prime Auto Loans are secured by the automobiles purchased with the loan proceeds. (Id.). Credit Nation's offering materials and advertising circulars describe the steps that it takes to ensure that its Sub-Prime Auto Loans are profitable, such as requiring high down payments and attaching a GPS tracker to each vehicle. (See, e.g., [2.13] at CN-SEC-000599-560). Credit Nation tells investors that, in its discretion, it will keep the Sub-Prime Auto Loans and profit from the interest or that it will resell the loans at a profit. ( [20.1] at 5).

AMC, a subsidiary of CN Capital, makes the investments in Sub-Prime Auto Loans. (Id.). AMC originates loans directly from automobile dealerships and also purchases loans. (Id.). Many of the Sub-Prime Auto Loans that AMC purchased were from the now-defunct CN Auto, a car dealership controlled by Mr. Torchia. (Id. at 5-6).

The SEC contends that Credit Nation's investments in Sub-Prime Auto Loans "have never been profitable," (id. at 6), and that it never disclosed its millions of dollars in losses to promissory note investors, (id.).

3. Defendants' Investments in Life Insurance Settlements

Credit Nation also invests in life insurance settlements at a discount to their maturity value—that is, the death benefit of the underlying policy. Credit Nation buys life insurance policies, either from an insured or from a settlement company that acts as a broker, hoping that the combination of the purchase price and the premiums paid over time will be less than the death benefits that Credit Nation ultimately receives upon the death of the insured. (Id. at 6-7).

Credit Nation told buyers of its promissory notes that it planned to focus on buying policies with life expectancies in the three-to-four year range, ( [2.13] at CN-SEC-000561), and that it expects to receive a 15% return on its portfolio of life insurance settlements, ( [2.12] at CN-SEC-042943).

After it purchases a life insurance policy, CN Capital either holds the policy or sells it, in whole or in part, at a markup. It sells LS Interests through its affiliate, CN Acceptance. CN Acceptance tells LS Interest investors that it will pay premiums for the life expectancy of the insured, plus two years if the insured lives that long. (Compl. ¶ 4). In return, LS Interest investors receive a portion of the death benefit when the insured dies. (Id.).

The SEC contends that Credit Nation's investments in life insurance settlements have not been profitable, and that Credit Nation has suffered multi-million dollar operating losses. (Id.¶¶ 72, 77). The SEC alleges that Defendants are insolvent and have liabilities that greatly exceed their assets, and that this financial situation has never been disclosed to investors. (Id.¶ 77). The SEC also alleges that Mr. Torchia has misappropriated and misused investor money through "loans" and transfers between him and the Defendant entities. (Id.¶¶ 88-112).

Defendants argue that the fair market value of life settlements owned by Credit Nation exceeds $40 million, (Defs.' Initial Disclosures [19] at 4), and that their life settlement business is profitable. Their theory is that when an insurance policy is purchased, its value is its face value minus the premiums it expects to pay until the insured dies. Put another way, if a policy with a face value of $1 million is purchased for $600,000, its value is $1 million minus estimated premiums required to be paid to keep the policy in force. They reject that the value is what they paid or what a willing purchaser would pay for the policy in an arm's length purchase.

C. Procedural History

On November 10, 2015, the SEC filed its TRO Motion. On November 13, 2015, the Court held a hearing on the motion. (Minute Entry [13] ). Counsel for both the SEC and Defendants participated in the hearing. (Nov. 13, 2016, Hr'g Tr. [16] ). At the hearing, the Court determined that it required more information from the parties—and more time—to decide whether injunctive relief and a receiver were...