Just because a business fails does not mean fraud was committed, a U.S. District Court judge ruled recently--even though the SEC and the 11th Circuit disagree in this case.
In June, Senior Judge Marvin H. Shoob of the Northern District of Georgia again dismissed a securities fraud case brought by the SEC. The commission alleged that the principals in Merchant Capital defrauded 350 investors of more than $20 million. Judge Shoob's ruling came despite the 11th Circuit's strong suggestion that the defendants deserved punishment when it reversed part of Judge Shoob's original decision, vacated other parts and remanded part back to him to reconsider.
In his latest ruling in SEC v. Merchant Capital, Judge Shoob said, "Notwithstanding the court of appeals' findings, the Court believes that the evidence still shows that defendants acted at all times in good faith, and that it was their intention to operate the [limited liability partnerships] as viable, albeit risky, businesses for the benefit of all the partners as well as themselves."
According to several local attorneys, it may be unusual for a District Court judge to set aside the clear intentions of the court of appeals--but when it comes to Judge Shoob, it is not completely unexpected.
"It is surprising to see a District Court judge push aside an 11th Circuit decision," says John R. Bielema, a partner at Powell Goldstein. Bielema focuses on securities and corporate litigation. "Judge Shoob heard the evidence, was able to assess the witnesses and saw there was no fraud."
The case began in 2002, when the Atlanta office of the SEC alleged that Merchant Capital, a Tennessee investment company, and its principals Steven C. Wyer and Kurt V. Beasley developed a fraudulent scheme that involved the sale of interests in registered limited liability partnerships (RLLPs). The RLLPs purchased and collected debt pools consisting of charged-off consumer debt from banks and credit card companies.
Among other charges, the SEC claimed Merchant's sales materials misrepresented the fees charged in connection with operating these partnerships and misrepresented the independent nature of the partnerships. Alleging violations of the registration and antifraud provisions of the federal securities laws, the SEC sought injunctive relief, disgorgement and penalties.
In January 2005, Judge Shoob heard the case in a bench trial. In November 2005, he found in favor of the defendants. According to Judge Shoob, the partnership interests were not investment contracts and, therefore, not securities. He also concluded that the defendants had not committed securities fraud.
The SEC appealed, and in its April 2007 ruling, the 11th Circuit ruled that the investment partnerships were indeed covered by securities laws. The court faulted Judge Shoob's original ruling: "We also hold that the defendants made material misrepresentations and omissions in the marketing of those interests as enumerated above; we hold that the District Court committed clear error in concluding otherwise."
Deciding that Judge Shoob was in the best position to determine scienter--whether the defendants had knowledge or intent of wrongdoing--the appeals court sent the case back to him. "We believe the District Court is in the best position to decide the scienter and remedies issues on remand; however, in light of our holdings above, we vacate the District Court's holdings with respect to scienter and remedies, and remand for reconsideration in light of this opinion."
Despite this 11th Circuit admonishment, Judge Shoob again found for the defendants. In one of several references to the defendants' good faith efforts in managing the partnerships, he wrote, "Defendants attempted in good faith to structure the RLLPs so that the partnership interests would not be deemed securities.
"Even though the court of appeals determined that they failed in this regard, as discussed above, the evidence shows that defendants were not acting with an intent to deceive or with severe recklessness."
In his latest ruling, Judge Shoob stressed that he had heard extensive testimony from both Wyer, who was formerly a principal in a securities firm, and Beasley, an attorney and CPA. "Based on its observations of the demeanor of both individual defendants, the Court is convinced of their credibility," he wrote. At press time, the SEC was considering whether to appeal. "The matter is still under consideration," says John Heine, a spokesperson with the SEC.
Gregory Bartko, who represented the defendants, says the judge showed appropriate deference to the 11th Circuit but was "unusually emphatic" in his latest ruling. "We hoped he would stand strong, and he did," Bartko says.
"These were good businesspeople who took every step they could to tow the line," says Bartko, of the Law Office of Gregory Bartko in Atlanta.
It is a ruling that should provide comfort to other companies facing lawsuits after a business fails, he says. "Just because a business is started and isn't successful, doesn't mean it is fraud."