In re Blue Flame Energy Corp.

• Decision Date: 26 December 2006
• Docket Number: No. 05AP-1053.,05AP-1053.
• Citation: 871 N.E.2d 1227,171 Ohio App.3d 514,2006 Ohio 6892
• Parties: In re BLUE FLAME ENERGY CORPORATION, et al.
• Court: Ohio Court of Appeals

871 N.E.2d 1227

171 Ohio App.3d 514

2006-Ohio-6892

In re BLUE FLAME ENERGY CORPORATION, et al.

No. 05AP-1053.

Court of Appeals of Ohio, Tenth District, Franklin County.

Decided December 26, 2006.

Carlile, Patchen & Murphy, L.L.P., Dennis J. Concilla, and Douglas R. Jennings, Columbus; Howard Z. Gopman & Assoc., Ltd., and Howard Z. Gopman, for appellees and cross-appellants, Blue Flame Energy Corporation et al.

Jim Petro, Attorney General, and Daniel P. Jones, Assistant Attorney General, for appellant and cross-appellee, Ohio Department of Commerce, Division of Securities.

Rex A. Staples, Stephen W. Hall, and Joseph Brady; Schottenstein, Zox & Dunn and Matthew L. Fornshell, Columbus, for amicus curiae North American Securities Administrators Association, Inc.

KLATT, Presiding Judge.

{¶ 1} Appellant, the Ohio Department of Commerce, Division of Securities ("Division"), appeals from a judgment of the Franklin County Court of Common Pleas that reversed and vacated a cease-and-desist order that the Division issued against appellees, Blue Flame Energy Corporation ("Blue Flame"), The Energy Group, Inc. ("Energy Group"), Pine Mountain 2002, Ltd. ("Pine"), Pike 2002, Ltd. ("Pike"), and Lawrence R. Buettner. For the following reasons, we affirm in part and reverse in part.

{¶ 2} Blue Flame, a Kentucky corporation, and Energy Group, an Illinois corporation, are engaged in the business of oil and natural gas exploration, development, and operations. Blue Flame is the managing general partner of Pine and Pike, both Kentucky limited partnerships. Blue Flame formed Pine and Pike to finance natural-gas drilling and operations in Eastern Kentucky's Appalachian Basin. Buettner, a security salesman licensed by Ohio, is the president of Blue Flame and Energy Group, as well as a promoter of Pine and Pike.

{¶ 3} In 2002, Blue Flame, on behalf of Pine and Pike, filed with the Division a Form D¹ for each limited partnership. Each Form D notified the Division that the respective limited partnership was offering partnership interests for sale and claiming an exemption from federal security-registration requirements pursuant to Rule 506² of Regulation D. According to the forms, one Ohio investor had already purchased a partnership interest in Pine, and another Ohio investor had purchased an interest in Pike.

{¶ 4} On January 24, 2003, the Division issued to appellees a Notice of Opportunity for Hearing in which the Division alleged that appellees had violated R.C. 1707.44(C)(1) by offering to sell nonexempt, nonregistered securities. R.C. 1707.44(C)(1) provides that "[n]o person shall knowingly sell, cause to be sold, offer for sale, or cause to be offered for sale, any security which * * * [i]s not * * * the subject matter of one of the transactions exempted in section 1707.03." One type of transaction exempted in R.C. 1707.03 is "[a]ny offer or sale of securities made in reliance on the exemption provided in Rule 506 of Regulation D under the Securities Act of 1933, and in accordance with Rules 501 to 503 of Regulation D." R.C. 1707.03(X).

{¶ 5} In the Notice of Opportunity, the Division recognized that Blue Flame had filed with the Division a Form D for Pine and another for Pike, both of which manifested appellees' reliance upon the Rule 506 and R.C. 1707.03(X) exemptions. However, the Division alleged that appellees could not rely upon those exemptions because appellees failed to satisfy the Regulation D conditions, namely, the condition that appellees refrain from engaging in general solicitation and general advertising. See Section 230.502(c), Title 17, C.F.R. The Division maintained that appellees had generally solicited and advertised for investors on a website that Blue Flame maintained, a second website that Energy Group maintained, and in an article that "The Bull and Bear Financial Report" posted on its website.

{¶ 6} Appellees requested a hearing and stipulated to facts submitted to the hearing examiner. After reviewing the joint stipulations and the parties' briefs, the hearing examiner issued a report and recommendation finding that appellees had violated R.C. 1707.44(C)(1) and recommending that the Commissioner of Securities ("Commissioner") issue a cease-and-desist order. On January 26, 2004, the Commissioner followed the hearing examiner's recommendation and issued the order.

{¶ 7} Appellees filed a timely administrative appeal to the trial court pursuant to R.C. 119.12. The trial court referred the matter to a magistrate, who recommended that the trial court reverse and vacate the Commissioner's order. The magistrate based this recommendation on three separate and independent reasons. First, the magistrate held that federal law expressly preempted the Division from regulating the issuance and sale of appellees' securities because appellees relied upon the Rule 506 exemption in offering them for sale. Second, the magistrate concluded that the Division lacked personal jurisdiction over appellees. Third, the magistrate found that Ohio Adm.Code 1301:6-3-03(E)(8), which sets forth another exemption to Ohio's registration requirements, applied and provided a successful defense to appellees' violation of R.C. 1707.44(C)(1).

{¶ 8} The magistrate did make one finding in the Division's favor—that reliable, probative, and substantial evidence supported the hearing examiner's conclusion that the offer and sale of appellees' securities failed to qualify for the Rule 506 and R.C. 1707.03(X) exemptions. However, because federal law preempted the application of R.C. 1707.44(C)(1) to appellees' securities, this finding was irrelevant to the magistrate's ultimate recommendation.

{¶ 9} The trial court considered both parties' objections to the magistrate's report and recommendation, rejected all the objections, and adopted the magistrate's decision. On September 9, 2005, the trial court issued a judgment entry in which it reversed and vacated the cease-and-desist order. The Division now appeals from that judgment.

{¶ 10} On appeal, the Division assigns the following errors:

[1.] The lower court erred in failing to apply the appropriate standard of review to the factual findings made by the administrative hearing officer and affirmed by the Commissioner of Securities.

[2.] The lower court erred in ruling that the Ohio Division of Securities was preempted by federal law from enforcing Ohio's blue sky laws against offerors of securities who claimed an invalid exemption from Ohio's registration requirements while in fact making a general solicitation offer by the internet.

[3.] The lower court erred in failing to consider all facts when ruling that the Ohio Division of Securities lacked jurisdiction to protect Ohio investors who were solicited to buy securities by Blue Flame, et al.

[4.] The lower court erred in misinterpreting the Ohio Division of Securities administrative rule on internet offerings.

[5.] The lower court erred in assigning a criminal burden of proof to the Ohio Division of Securities in a civil administrative proceeding.

[6.] The lower court erred in rejecting the Ohio Division of Securities' objections to the Magistrate Judge's Recommendations on the basis that the objections were "immaterial" in light of the federal preemption defense.

{¶ 11} Also, appellees assign the following conditional cross-assignment of error:

The lower court erred in failing to reverse the administrative hearing officer's finding that the websites violated SEC Regulation D.

{¶ 12} Because the Division's third assignment of error relates to jurisdiction, we will address it first. By this assignment of error, the Division maintains that the trial court erred in holding that the Division lacked personal jurisdiction over appellees. While we agree that the trial court erred with regard to Blue Flame, Pine, Pike, and Buettner, we conclude that the trial court was correct in finding that it did not have personal jurisdiction over Energy Group.

{¶ 13} Whether a forum can claim jurisdiction over an individual is a question of law, which this court reviews under the de novo standard. Joffe v. Cable Tech, Inc., 163 Ohio App.3d 479, 2005-Ohio-4930, 839 N.E.2d 67, at ¶ 10. See, also, AmCare, Inc. v. Ohio Dept. of Job & Family Servs., 161 Ohio App.3d 350, 2005-Ohio-2714, 830 N.E.2d 406, at ¶ 10 (appellate review of an administrative decision presenting a question of law is de novo). The party who asserts the existence of personal jurisdiction has the burden of establishing that jurisdiction once the opposing party challenges it. Klug v. Trivison (2000), 137 Ohio App.3d 838, 842, 739 N.E.2d 1243.

{¶ 14} None of appellees reside in Ohio. In deciding whether Ohio has jurisdiction over nonresident defendants, a court must engage in a two-step analysis. U.S. Sprint Communications Co. Ltd. Partnership v. Mr. K's Foods, Inc. (1994), 68 Ohio St.3d 181, 183, 624 N.E.2d 1048; Kentucky Oaks Mall Co. v. Mitchell's Formal Wear, Inc. (1990), 53 Ohio St.3d 73, 75, 559 N.E.2d 477. The court must first determine whether Ohio's long-arm statute, R.C. 2307.382, and the applicable Rule of Civil Procedure, Civ.R. 4.3(A), confer jurisdiction. U.S. Sprint Communications at 184, 624 N.E.2d 1048; Kentucky Oaks Mall Co. at 75, 559 N.E.2d 477. Second, the court must determine whether granting jurisdiction would deprive the nonresident of due process of law under the Fourteenth Amendment to the United States Constitution. Id.

{¶ 15} In the case at bar, we need not engage in the first step of the analysis because neither the long-arm statute nor the Rules of Civil Procedure apply to regulatory actions. The long-arm statute designates when "[a] court may exercise personal jurisdiction over a person * * * as to a cause of action." (Emphasis added.) R.C. 2307.382(A). As this matter neither originated in a court nor through a cause of action, the long-arm statute, by its very terms, is inapplicable. The Rules of Civil Procedure also apply to courts, not...