State Ex Rel. Miller v. Pace

• Decision Date: 07 April 2004
• Docket Number: No. 02-1726.,02-1726.
• Parties: STATE of Iowa, ex rel. Thomas J. MILLER, Attorney General of Iowa, and Craig A. Goettsch, Iowa Superintendent of Securities, Appellees, v. Edwin PACE, an Individual, Appellant.
• Court: Iowa Supreme Court

677 N.W.2d 761

STATE of Iowa, ex rel. Thomas J. MILLER, Attorney General of Iowa, and Craig A. Goettsch, Iowa Superintendent of Securities, Appellees, v. Edwin PACE, an Individual, Appellant.

No. 02-1726.

Supreme Court of Iowa.

April 7, 2004.

Dennis M. Lawyer of The Lawyer Law Firm, Indianola, for appellant.

Thomas J. Miller, Attorney General, and Chantelle Smith and Benjamin E. Bellus, Assistant Attorneys General, for appellees.

TERNUS, Justice.

The defendant, Edwin Pace, appeals a district court judgment finding he had violated various state laws in his marketing and sale of payphones, awarding monetary remedies and penalties, and granting injunctive relief. He contends the district court erred (1) in ruling the program he sold—the sale and leaseback of payphones—was a security, and (2) in finding he was not entitled to the lack-of-knowledge defense available to "affiliates" under Iowa securities law. Pace also asserts the State failed to prove he committed unlawful practices under Iowa's consumer fraud law. Finally, he claims his due process rights were violated, as well as the constitutional prohibition against ex post facto laws. On our de novo review, we find no error in the trial court's decision and, accordingly, we affirm.

I. Background Facts and Proceedings.

The defendant has been a licensed insurance agent for over twenty years. He was also licensed to sell securities for several years but his license had lapsed prior to the sales at issue in this case. During the period giving rise to this litigation, Pace marketed products primarily to the elderly and frequently represented himself as a "senior advisor."

Beginning in 1997, but primarily in 1999 and continuing through June of 2000, the defendant sold payphones, known as customer-owned, coin-operated telephones (COCOTS), in Iowa. Three ownership options were available to Pace's clients. Under the first option, the investor would own the payphone and be totally responsible for its placement and operation. Once a location was determined, however, a management company would provide services relating to installation, maintenance, and repair of the COCOT for $40-$50 per month. The investor assumed the risk of profit or loss under this plan. Under the second option, the investor paid the management company a monthly fee of $75-$82 to provide all the required services, including finding a location for the phone. As with the first option, the investor experienced any profits or losses generated by the COCOT. Under the third plan, the investor entered into an agreement to purchase a payphone and then simultaneously leased the payphone to a management company. The payphone was then delivered directly to the management company for placement and operation. During the three to five year term of the lease, the investor had no involvement in the day-to-day operation of the payphone; all management rights rested in the management company in exchange for a monthly payment of $75-$82 to the investor.

Although all three options were theoretically available to Pace's clients, as a practical matter, investors were only interested in the sale/leaseback plan because they had no expertise in operating or ability to manage a payphone. Thus, Pace focused his sales presentations on the third option and, in fact, the only COCOTS actually sold by the defendant were under the sale/leaseback plan.

Pace worked with a number of marketing companies, including Tri-Financial Group, BEE Communications, and ATC, Inc. Each company selling payphones was associated or affiliated with a particular management company. Although Pace claimed only to sell payphones and to have no relationship with the management companies, he would forward a request for lease information directly to the management company upon an investor's decision to go with the sale/leaseback option. Each payphone was sold for $5000 to $7000, and Pace earned a commission of between 10-12% on each sale.

On September 24, 1999, the Iowa Securities Commission issued a cease and desist order to Tri-Financial Group and its management company, Phoenix Telecom. In this order the Commission asserted COCOTS were securities as defined in Iowa Code section 502.102(19) (1999), and they were not registered as required by Iowa Code section 502.206. Tri-Financial and Phoenix Telecom were alleged to have violated Iowa Code section 502.201 through their offer and sale of unregistered, nonexempt securities. They were ordered to cease and desist.

The Commission's order was a public record, but Pace claimed to have no knowledge of it. Nonetheless, Pace made no further sales through Tri-Financial after this order was issued. He did, however, continue to sell COCOTS through other marketing companies.

On May 31, 2000, the Iowa Securities Bureau wrote to Pace informing him it had information he was selling COCOTS through BEE Communications and its management company, ETS Payphones, Inc., neither of which was registered to sell securities in the State of Iowa. The Bureau told the defendant it believed the sale/leaseback program he sold was an investment contract and subject to registration under Iowa Code chapter 502. Pace was informed that the broker-dealer and agent licensing requirements of section 502.301 may also have been violated, which could result in civil and criminal penalties. The letter ended by stating that Pace may be involved in activity that violates Iowa law and that if he had any questions about the legality of his activities, he may wish to consult an attorney. Shortly after Pace received this letter, he was notified by BEE Communications that it would not be selling COCOTS in Iowa until the questions raised by the Bureau had been resolved, even though no cease and desist order had been issued.

Pace contended at trial that based on these communications, he thought only payphones sold through BEE Communications did not comply with Iowa law and that the noncompliance was due to the company's failure to make the required filings with the Bureau. He testified he thought other COCOTS were not affected by the Bureau's inquiries, and therefore he continued to sell COCOTS through other marketing companies.

On July 10, 2000, Pace received a second letter from the Bureau, which was very similar to the first letter. The second letter, however, also made specific reference to ATC, Inc. and its management company, Alpha Telecom. Pace was again informed that these companies were not registered with the State of Iowa to sell securities; that sale/leasebacks of payphones were securities requiring registration of the security and the selling agent; and that by selling COCOTS, Pace may be in violation of Iowa law. The defendant stopped selling payphones after he received this letter.

Within several weeks two management companies, ETS and Alpha Telecom, declared bankruptcy. ETS claimed that it, not the investors, owned the payphones. (In fact, the bankruptcy court made a determination that the payphones were owned by ETS.) After the bankruptcy proceedings were filed, the investors no longer received their monthly lease payments.

On September 17, 2001, the State filed a petition charging Pace with violations of the Iowa Uniform Security Act, Iowa Code chapter 502, the Iowa Business Opportunity Act, Iowa Code chapter 523B, and the Iowa Consumer Fraud Act, Iowa Code section 714.16. At trial, the facts previously reviewed were brought out. In addition, several investors testified about the information given to them by Pace. They said Pace told them they would own the payphones; they could cancel the lease at any time and receive a refund of all or some portion of the purchase price; the management companies were financially strong; there was little risk in this investment and the investors would receive a return of 13-14%; and that COCOTS were legal in Iowa. One witness testified that Pace even told an elderly investor that COCOTS were fully insured by Lloyds of London.

The State also called a financial expert who had reviewed the financial statements of ETS. He testified that it was "obvious" the phone program could not be maintained without the continuous sale of payphones because the only way the lease payments could be made was through proceeds from future payphone sales.

In its subsequent decision, the district court made factual findings consistent with our review of the pertinent facts. The court found that even though material was available to Pace indicating significant legal issues with COCOTS across the country, he continued to represent to prospective purchasers that there were no concerns with selling the product in Iowa. He also repeatedly represented to potential investors that they would realize immediate and significant income from the ownership of a COCOT, that the COCOT was a liquid and safe investment, and that the COCOT was recession proof.

With respect to the allegations of securities law violations, the district court concluded: (1) the sale/leaseback program was an investment contract subject to regulation under chapter 502, see Iowa Code § 502.102(19) (including an investment contract in the definition of a "security"); (2) Pace violated the statutory prohibition against the offer and sale of an unregistered security, see id. § 502.201(1); and (3) Pace violated the statutory prohibition against the sale of a security by an unregistered agent, see id. § 502.301(1). The district court also held that all three options offered by Pace constituted a "business opportunity" as defined in section 523B.1(3)(a). Because option three—the sale/leaseback option—violated the more stringent securities law, the court ruled only offers of options one and two violated section 523B.2, prohibiting the sale of unregistered business opportunities in Iowa.

The court also held Pace committed securities fraud and business opportunities fraud by making false representations and failing to disclose facts key to an investor's...