S.E.C. v. Alpha Telcom, Inc.
| Decision Date | 07 February 2002 |
| Docket Number | Civil Action No. CV 01-1283 PA. |
| Citation | 187 F.Supp.2d 1250 |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. ALPHA TELCOM, INC., an Oregon Corporation; American Telecommunications Company, Inc., a Nevada Corporation; Strategic Partnership Alliance, LLC, a Nevada Limited Liability Company; SPA Marketing, LLC, a Nevada Limited Liability Company; Paul S. Rubera; Robert A. McDonald; Ross S. Rambach; and Mark E. Kennison, Defendants. |
| Court | U.S. District Court — District of Oregon |
Karen Matteson, Securities and Exchange Commission, Los Angeles, CA, for Plaintiff.
Christian A. Hatfield, Robert C. Weaver, Jr., Garvey Schubert & Barer, Portland, OR, for Defendant Paul S. Rubera.
David R. Zaro, Allen Matkins Leck Gamble & Mallory LLP, Los Angeles, CA, for Receiver.
Plaintiff Securities and Exchange Commission (SEC) brings this action against Paul S. Rubera (Rubera), alleging he violated the securities registration provisions and antifraud provisions of the Securities Act of 1933, and the antifraud provisions of the Securities and Exchange Act of 1934. Following a bench trial on the merits of this case, I now issue my findings of fact and conclusions of law in accordance with Federal Rule of Civil Procedure 52(a).1
Rubera is the sole owner of Alpha Telcom, Inc. (Alpha). Alpha started in 1986 as a company that sold, installed and maintained telephones and business systems in Grants Pass, Oregon. Sometime in 1997, Rubera was approached by Charles Tummino about a business idea. Tummino's idea was to sell payphones to individuals who would then enter into a service agreement with Alpha to install, service, and maintain the payphones.
Rubera consulted with Alpha's attorney Dan Lacy about the idea. In particular, Rubera wanted to know whether the arrangement would constitute a security. Lacy issued an opinion letter concluding the arrangement was not a security. Lacy also sought an outside legal opinion from Florida attorney Jim Leone who specialized in securities. Leone also concluded the business idea would not constitute the sale of a security. Rubera was given the green light from his attorneys to go forward with the deal. With that advice, Alpha began selling pay telephones, along with service contracts, to individual investors (the "payphone program").
To invest in the payphone program, investors would enter into two agreements: (1) a $5,0002 per phone purchase agreement; and (2) a service agreement with Alpha to manage the phone. The two agreements were presented and promoted simultaneously. Although investors were given the choice of using a company other than Alpha to manage the phone, approximately ninety percent of investors picked Alpha to service their phones.
Alpha offered four levels of service contracts. Most investors did not have the experience or knowledge necessary to operate and maintain the phones, so they selected the Level Four Service Agreement that required Alpha to perform all necessary services. Investors who selected the Level Four agreement had no involvement in the operation of the payphone. Alpha selected the location of the phone, installed the phone, obtained all certifications from regulatory bodies, maintained and cleaned the phone, paid all monthly telephone and utility bills, and collected the revenue.
With the Level Four service agreement, investors were allowed to sell the phones back at the original price after thirty-six months (or with a penalty before thirty-six months). This is referred to as the "buy-back" provision. Beginning sometime after May 2000, investors were also given the option of purchasing buyback insurance. The insurance would cover the investor's purchase price if for some reason the company became unable to repurchase the phones.
The Level Four service agreement also provided that investors were to receive thirty percent of the net revenue from the phone, while Alpha was to receive seventy percent as a monthly fee. However, if revenues from the phone did not generate a base amount of $58.34 in any given month (which amounts to a fourteen percent return on a $5,000 investment), Alpha agreed to waive a portion of its seventy percent fee to maintain that monthly base payment. If Alpha waived its entire fee and the base amount still was not met, Alpha made up the difference. Indeed, Alpha created a computer program that automatically paid each investor the base amount each month, regardless of whether the investor's particular phone generated enough revenue to pay that amount.
Initially, Tummino was in charge of marketing and sales for the payphone program. Tummino hired and oversaw a small sales force of independent contractors to solicit buyers for the program. Tummino created the marketing materials used by sales agents, and he also prepared the sales agreement and Alpha service agreement that the agents presented to buyers. These materials were reviewed and approved by Lacy, and Rubera had little understanding or knowledge about the materials.
In October 1998, American Telecommunications Company, Inc. (ATC) was created.3 Tummino operated ATC as the marketing and sales arm of the payphone program, while Alpha's focus was on obtaining phone sites, installation, service and management of the phones.
Tummino retired in late 1998. Before doing so, he introduced Rubera and Lacy to Ross Rambach and Mark Kennison. Rambach and Kennison owned a company called Strategic Partnership Alliance, LLC (SPA), which was in the business of selling programs like that offered by ATC and Alpha. Both Rambach and Kennison had a history of disciplinary actions taken against them by federal and state securities regulators. Rubera was unaware of that history.
Based on Tummino's recommendation, SPA was hired in early 1999 as an independent marketing and sales firm for ATC. Thereafter, SPA was responsible for hiring, training and supervising the sales agents who were marketing the payphone program. SPA also modified the sales materials that were initially prepared by Tummino. Although all modifications to the sales materials were supposed to be approved by Alpha and ATC's counsel before use, SPA did not always follow that direction. After SPA came on board, ATC remained as a processing center for the payphone program while Alpha continued to perform the service and maintenance of the pay phones.
By all accounts, Alpha was a poorly run business. Inventory and accounting systems were inferior and key personnel were inexperienced or incompetent. In 2000 and 2001, the company experienced cash flow problems, and Alpha borrowed money from ATC to pay its expenses.
Despite Alpha's inefficiencies, the business was rapidly growing. By early Fall 2000, Alpha could not keep up with the demand for acquiring new phone sites. Rambach suggested to Alpha that it hire an outside company to acquire new sites so Alpha could focus on installation, service, and maintenance. Rambach recommended a company called ATMN/EMI to acquire the new phone sites. Rubera took Rambach's advice and hired ATMN/EMI. Rubera did not know that Rambach and Kennison were principals of ATMN/EMI.
ATMN/EMI did acquire new phone sites for Alpha. However, within a few months Alpha discovered that many of the sites were worthless. They obtained sites in burned out buildings or in locations not suitable for pay telephones. In some instances, the locations did not even exist. Alpha terminated its relationship with ATMN/EMI in December 2000 when it discovered these problems.
At the same time ATMN/EMI was procuring worthless sites, SPA salespersons were encouraging existing investors to cash-in on their buy-back options, then in turn reselling new phones to these existing investors. The incentive was particularly appealing to investors who purchased their phones before buyback insurance was available. The investors would exercise their buyback option, then some would immediately reinvest in new phones with buyback insurance. The result was extra commissions to SPA, but it created an overwhelming administrative and financial burden on Alpha.
The buyback insurance was the brainchild of Rambach and Kennison. In early 2000, Rambach and Kennison began trying to persuade Alpha or ATC to fund an insurance policy to sell to investors. Kennison believed the insurance policy would greatly increase sales because investors would have an extra sense of security in their purchase. After much prodding by Rambach and Kennison, the buyback insurance was added to the program, and was funded by ATC.
Robert Harrison is an acquaintance of Rambach and Kennison. Harrison is an insurance salesman in Richmond, Texas. Harrison created Northern & Western Insurance Company (N&W) to insure the first two million dollars in claims. ATC was to maintain an account, known as the "sinking fund," with two million dollars for the initial claims. ATC also paid premiums to Harrison so he could procure excess insurance.
Harrison procured excess insurance to cover claims in excess of the initial two million dollars. Harrison led the parties to believe that Lloyd's of London was the excess insurer, when it was not. Based on Harrison's representations, Alpha or ATC advertising had indicated that the excess insurer was Lloyd's of London. The excess insurers were in fact British A-plus rated carriers. Once the mistake was discovered, Alpha immediately sent a letter to investors acknowledging and correcting the mistake.
Harrison, his wife, and Rubera were each one-third owners of N&W. However, Rubera never met Harrison, and the two have only spoken on the phone twice as participants in conference calls. Harrison's directions came primarily from Rambach, Kennison, their attorney Walter Theis, and ATC's attorney Michael Cougar. No claims have...
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