S.E.C. v. Kenton Capital, Ltd.

• Decision Date: 30 September 1998
• Docket Number: Civil Action No. 95-0829(CKK).
• Citation: 69 F.Supp.2d 1
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. KENTON CAPITAL, LTD., Donald C. Wallace, Jeffrey E. Carter, Deltaur Partners, Harry Watson, Tracy L. French, and Terry Plack, Defendants, and Atlantic Pacific Guarantee Corporation and Charles Smith, Relief Defendants.
• Court: U.S. District Court — District of Columbia

Page 1

69 F.Supp.2d 1

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. KENTON CAPITAL, LTD., Donald C. Wallace, Jeffrey E. Carter, Deltaur Partners, Harry Watson, Tracy L. French, and Terry Plack, Defendants and Atlantic Pacific Guarantee Corporation and Charles Smith, Relief Defendants.

Civil Action No. 95-0829(CKK).

United States District Court, District of Columbia.

September 30, 1998.

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Larry P. Ellsworth, I, Securities & Exchange Commission, Division of Enforcement, Washington, DC, for Plaintiff.

Brian E. Maas, Ronald C. Minkoff, Beldock Levine & Hoffman, LLP, New York City, for Defendants.

Charles Smith, Santa Monica, CA, for Relief Defendants.

MEMORANDUM OPINION

KOLLAR-KOTELLY, District Judge.

This case involves alleged violations of the anti-fraud, securities registration, broker registration, and investment adviser registration provisions of the federal securities laws. The Securities and Exchange Commission ("SEC") filed an Amended Complaint stating five claims against Defendants Donald Wallace and Kenton Capital, LTD ("Kenton").¹ The First Claim charges Defendants Wallace and Kenton with violating section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. The Second Claim charges Defendants with violating section 17(a) of the Securities Act of 1933, ("Securities Act"), 15 U.S.C. § 77q(a). The Third Claim charges Defendants with violating sections 5(a) and 5(c) of the Securities Act, 15 U.S.C. §§ 77e(a) and 77e(c). The Fourth Claim charges Defendants with violating section 15(a) of the Exchange Act, 15 U.S.C. § 77o(a). The Fifth Claim charges Defendants with violating section 203(a) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-3(a). Currently pending before the Court is the SEC's Motion for Summary Judgment against Wallace and Kenton on all five claims.² Upon consideration of the entire record, and for the reasons outlined below, the Court will grant the SEC's motion as to all five claims.

I. BACKGROUND

Kenton Capital, LTD ("Kenton") is an entity incorporated in the Cayman Islands, British West Indies. Wallace Dep. at 52-54.³ Donald Wallace is Kenton's president. Id. at 62-63. Prior to his involvement with Kenton, Wallace worked for many years as a registered securities professional. Id. at 33-35.

In 1994, Wallace was interested in raising money through short term bank instruments. In February 1995, Wallace met Jeffrey Carter, who claimed to have experience with such programs. Id. at 73-78. After Carter introduced Wallace to some investors in the Cayman Islands, Wallace established Kenton and arranged for Carter to act as a consultant for the company. Id. at 99. As president of Kenton, Wallace was a signatory on Kenton's bank account and signed contracts on Kenton's behalf. Id. at 67, 69. According to Carter, Wallace made all of Kenton's decisions. Pl.'s Mot. Summ. J. Ex. 2 (Carter Dep. at 208).

On behalf of Kenton, Wallace and Carter began to search for trading programs and investors. From a hotel room in Little Rock, Arkansas, Carter contacted prospective investors about providing capital to Kenton. Id. at 151-52, 177, 271. Carter sent agreements to three investors, which described trading programs with projected returns of 3750% per week for forty weeks ("the Carter program"). Id. at 331-33; Carter Dep. at 74-76; Def.'s Opp. Ex. 17 ("Investment Agreement"). The agreements that Carter sent also ensured that the investment would be "returned to the investor no later than the end of the investment period" of one year and one day. Def.'s Opp. Ex. 17. Wallace signed these agreements, but he did not monitor Carter's representations to investors. Wallace Dep. at 271-72. Wallace has since stated that the projected profits were "not achievable," and that he had "no basis" for representing that they were achievable. Id. at 333-34.

During initial negotiations to raise capital, Carter arranged with Atlantic Pacific Guarantee Corporation ("AP") that AP would provide bonds as insurance for investments. Wallace Dep. at 112. Joseph Silvestri, a broker, gave Wallace a form of the bond and a copy of AP's financial statement. Id. at 114-15. Wallace also spoke to Charles Smith, AP's President, who provided Wallace with some additional information about AP's financial status. Id. at 117. Wallace reviewed AP's financial statements, which demonstrated that AP had sufficient assets to back the bonds. Id. at 118-19. Kenton did not determine whether AP was licensed to issue surety bonds, and, in fact, AP was not so licensed. Pl.'s Mot. Summ. J. Ex. 0 (McNamara Decl. ¶ 15). AP's financial statement, which Wallace reviewed, was not completed in accordance with accepted accounting standards, and reflected assets of only $176,057,931, not the "300 MILLION +" that Wallace represented to investors. Pl.'s Reply Exs. 22, AA (Atlantic Pacific Balance Sheet as of January 30, 1995; Barrett Decl. ¶ 4). AP and Smith are now without funds and cannot return money to investors. Pl.'s Reply Ex. 24 (Letter from Charles Smith).

Carter also contacted Harry Watson, who agreed to raise capital for Kenton through his company, Deltaur Partners. Watson Dep. at 248; Def.'s Mot. Summ. J. Ex. G (Agreement between Kenton and Deltaur). Watson and his partner, Tracy French, succeeded in bringing investors to Kenton. Watson Dep. at 248; Wallace Dep. at 160. Although Watson and French contacted investors for Kenton, Wallace did not monitor their representations. Wallace Dep. at 273-74.

In April 1995, Wallace and Carter met with Watson to discuss possible trading programs. Watson informed them that he believed Carter's program offering a 3750% return was "absolutely impossible" and would lose money. Watson Dep. at 167-70. Wallace then asked Watson to recommend a "safe program" for Kenton to use instead. Id. Watson suggested that Kenton contact John Silver, a trader that he knew in Germany. Wallace Dep. at 136. Wallace and Watson called Silver, and Silver proposed the following program ("the Silver program"): for $2 million, Silver would rent $100 million in U.S. Treasury bills, paying Kenton 7% per week and providing a bank guarantee on the principal. Id. at 138; Watson Dep. at 178-81. Silver would take the rented securities to a bank, borrow 90% of the face vale, and then trade the borrowed amount in offshore investments. Watson Dep. at 179-80; Wallace Dep. at 138-41. Wallace decided to use the Silver program, without making any due diligence inquiries into Silver or his company. Wallace Dep. at 139-45. Instead, Wallace relied on Watson's recommendation. Id. at 136-45. Watson had agreed to review Kenton's trading program, Watson Dep. at 119-21, 125, and Smith was also supposed to approve of any program or final investment decisions, Silvestri Dep. at 65-66; Wallace Dep. at 287-91.

After this meeting with Watson, Wallace revised the investment agreement that Carter had been sending to investors. Wallace Dep. at 227. Wallace sent investors a replacement contract, titled "Investment Advisor's Agreement." Pl.'s Mot. Summ. J. Ex. 12. Soon afterward, a third contract was sent to investors, which was identical to the Investment Advisor's Agreement except that the title had been changed to "Joint Venture Agreement," and instead of offering "specialist investment advice" the Joint Venture Agreement offers "specialist investment information." Pl.'s Mot. Summ. J. Exs. 12 and 13. These contracts did not specify a rate of return, and gave Kenton complete discretion as to how to invest the funds it collected. Id.

These new contracts were accompanied by a document describing the Silver program, titled "Asset Leveraging Opportunity." Pl.'s Mot. Summ. J. Ex. 10. The Asset Leveraging Opportunity proposed that Kenton would pool investments in order to invest $100 million or more in "Bank Instrument Trading Programs." Id. This would be accomplished when a "facilitator" leased U.S. treasuries at 2% per month, established an account with a brokerage house, and hypothecated the treasuries for 90% of their value. Id. Through this program, the facilitator could generate 7% profits per week, provided that investors pledged at least $100,000 in cash. Id. For every $100,000 invested, investors were promised $110,000 in profits per week for forty weeks. Id. Wallace has stated that, to the best of his knowledge, such profits have never been achieved by any trading program. Id. at 333-39.

The Asset Leveraging Opportunity did not mention any risks to investors. Pl.'s Mot. Summ. J. Ex. 10. The Joint Venture Agreement had a paragraph labeled "Risk," that acknowledged that programs offering high rates of return "must be balanced by the prospects that such returns may not be achieved." Pl.'s Mot. Summ. J. Ex. 13. The contract goes on to state that "The Joint Venture will ensure that all Investment contracts which are entered into in respect of an investment will contain provisions assuring that there will be no financial risk to the Investor over and above the Investment Amount." Id. The agreement authorized Kenton to purchase an AP guarantee bond for the investor in order to ensure repayment within a year and a day. The contract relieved Kenton of responsibility for the performance of the bond and required the investor to investigate the bond company. Id.

The Joint Venture Agreement also provided that investors pay fees and costs to Kenton "from the Investment Amount." Pl.'s Mot. Summ. J. Ex. 13. These included a 10% finders fee, a 15% administrative fee, and costs for arranging leveraging. Id. Kenton also requested 50% of "any profits earned on the investment of the net proceeds of the Investment Amount." Id.

On the basis of these representations, over forty investors pledged to invest in Kenton's trading program. Pl.'s Mot. Summ. J. Ex. 3. The SEC claims that the Defendants actually collected $1,745,000 from twelve...