The opinion of the court was delivered by: HOGAN
THOMAS F. HOGAN, UNITED STATES DISTRICT JUDGE
On May 15, 1991, the plaintiff Securities and Exchange Commission (SEC) applied to this Court for an ex parte temporary restraining order enjoining defendants from committing federal securities violations and freezing defendants' assets, among other things. The Court granted the requested temporary relief upon the SEC's showing that there was a justifiable basis for believing that defendants had sold securities in violation of the registration provisions of the Securities Act of 1933, 15 U.S.C. § 77a et seq., (the 1933 Act), and of the antifraud provisions of the 1933 Act and the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., (the 1934 Act).
On May 30, 1991, defendants International Loan Network, Inc., and Melvin Ford sought and received a modification of the temporary restraining order and asset freeze to permit defendants to retain counsel on their behalf and to enable them to meet necessary business and living expenses, among other things. Defendant Odell Mundey subsequently sought and was granted minor modifications of this Order. After an expedited discovery period, the SEC filed a Motion for a Preliminary Injunction, Order Freezing Assets, Appointment of a Receiver and Other Ancillary Relief on June 21, 1991. After the Oppositions and Reply were filed, this Court conducted a three-day evidentiary hearing from July 1, 1991 to July 3, 1991. Counsel for all parties delivered lengthy closing arguments on July 8, 1991.
After three days of live testimony and one full day of argument, there is, unfortunately, much that remains unclear about the operation of ILN and its programs. What appears in ILN documents has been directly contradicted by witness testimony and by transcripts of ILN meetings and video presentations. Programs as described in testimony and in written material are frequently incomprehensible. Questions propounded by the Court to both witnesses and counsel have been left unanswered. In short, because of significant gaps in the evidence presented, the Court's own findings are necessarily limited. When in doubt, however, the Court has relied on the words of the ILN's founder and president, Melvin Ford, whose oral presentations have been preserved on video and audio tapes introduced as evidence in this case.
According to Ford, "ILN is a financial distribution network whose members believe that through the control of money and through the control of real estate you can accumulate wealth and become financially independent." Plaintiff's Exhibit 101 at 12 (Transcript of Melvin Ford's presentation at the Los Angeles, California "President's Night" on April 18, 1991) (hereinafter President's Night Transcript). This concept boils down to one essential phrase, which is repeatedly referred to by Ford and other ILN representatives in the numerous exhibits filed in this case: "The movement of money creates wealth." President's Night Transcript at 37.
To become a member of the ILN and gain the opportunity to achieve the organization's stated goal of financial independence, a person must, at a minimum, pay a $ 125 "basic" membership fee. This fee, which is retained in its entirety by the organization, entitles a basic member to a variety of "benefits and services" including discount shopping, discount travel and car rental, and other similar discounts. These benefits are provided by Consumer Benefit Services, Inc., by virtue of a contract with the ILN.
Beyond the basic membership, a person may become a "club member" in ILN's $ 100, $ 500, or $ 1,000 clubs. Each of these clubs requires an investment of these respective additional amounts, plus the $ 125 basic membership fee. Club memberships entitle members to the benefits provided to basic members plus newsletters and various seminars on money management and other topics. In addition, as a member of the $ 500 or $ 1,000 club, a person becomes eligible to participate in the ILN's Property Rights Acquisition program (PRA), which offers real estate training courses and videotapes, among other things.
The PRA program, along with the Capital Fund Bonus System and the Maximum Consideration program, are the primary programs alleged by the SEC to violate the federal securities laws and will be discussed in detail below. All are marketed through a network of ILN marketing representatives and independent representatives. These representatives invite potential members to local ILN meetings and "President's Nights," where the sales pitches for the organization are made. Melvin Ford is the central speaker at the President's Nights, which are held in hotels throughout the country and draw large crowds of members and potential members. At these meetings, Ford has been known to enter with his family down a central aisle to the soundtrack from the movie "Flashdance." He then delivers a lengthy presentation that is part motivational and part financial evangelism. He rouses the crowd with chants such as "I will not accept defeat" and "I'm the captain of my ship." He is both engaging and persuasive. The highlight of his presentation is his "reward" to the audience members by showing them "how you make money in ILN" through the three programs that are the focus of this lawsuit. President's Night Transcript at 31.
A. The Capital Fund Bonus System
According to Melvin Ford, the Capital Fund Bonus System (the Capital Fund) "is the most powerful financial system since banking." President's Night Transcript at 31. This is the system by which ILN members earn income by recruiting others to join the ILN. Although the ILN's written material makes it clear that a person need not be a member of the ILN in order to solicit new members, it is equally clear that the Capital Fund is marketed so that a person will first join the organization himself and then recruit others to join. The process is repeatedly explained at ILN meetings and President's Nights with the chant: "You come in, then you bring in your wife and your kids." President's Night Transcript, passim.
To earn money through the recruitment of others, a person must apply to become an "Independent Representative" of the ILN and must sign an "Independent Representative Agreement." This agreement specifies that as an Independent Representative, the person must abide by all federal, state, county, and local laws and regulations and must not engage in "deceptive, misleading, or unethical practices." ILN's Exhibit 2 at 10 ("Income Opportunity" brochure describing ILN's Capital Fund Bonus System) (hereinafter Income Opportunity brochure). For each new member recruited, an Independent Representative receives 50 percent of the new member's club membership fee.
Each new member represents a "Capital Fund" for the Independent Representative, from which additional income may derive. Through these Capital Funds, an Independent Representative receives descending percentages of the club membership fees paid by new members recruited "downline" through the fifth level of recruitment. ILN explains this in its materials by referring to "Daddy Tom" recruiting "Sister Sue," "Cousin Bob," "Aunt Mary," and "Uncle Joe." Each person recruited by Daddy Tom becomes a Capital Fund for Daddy Tom. He then gets 50 percent of the club membership fees paid by these new recruits. Additionally, Daddy Tom receives 15 percent of the club fees paid by anyone recruited by the people he recruited. He also receives 15 percent of the third level of recruits, and 10 percent of the fourth and fifth levels of recruits. See Income Opportunity brochure at 5-6.
The opportunity to earn income through the ILN Capital Fund program is substantial. At the evidentiary hearing conducted in this case, Lee Steverson, the director of membership for the ILN, testified that he had earned over $ 68,000 since 1989 through the Capital Fund. Mr. Steverson had only directly sponsored 12 people into the ILN. The Court also heard testimony that H.L. Barner, an associate marketing representative for the ILN, had 250 people in his "downline" and had earned substantial income by recruiting new ILN members.
The success of those like Barner and Steverson was highlighted by Melvin Ford at President's Nights throughout the country. At an April 1991 President's Night in Los Angeles, California, Ford told the audience that a member's downline could grow to over 3,000 Capital Funds and that there were people in California making over $ 30,000 in one month through the Capital Fund. "It's too simple, isn't it," he said, "You come in, then you bring in your wife and your kids." President's Night Transcript at 40.
B. The Property Rights Acquisition Program (PRA)
1. The Property Acquisition Certificate (PAC) Program
Instituted in the fall of 1989, this was the first in the series of programs leading up to the current PRA program. This program was marketed as an opportunity for every ILN member to achieve a "guaranteed lifetime income." See Plaintiff's Exhibit 24 at 29 (Video Tape "Common Ground" and Transcript) (hereinafter Common Ground Transcript).
Under the PAC program, investors of $ 10,000 were told they would receive either $ 100,000 of equity in real estate within 90 days or $ 100,000 in income payable in monthly installments of approximately $ 1,500 starting within 180 days (the Standard PAC). ILN guaranteed investors that if the monthly checks fell below $ 1,000 per month, ILN would refund the $ 10,000 investment plus 50 percent interest. See Common Ground Transcript at 31. Investors of $ 25,000 were told they would receive either $ 250,000 worth of equity in real property within 90 days or income of $ 50,000 per year for their lifetimes, payable in monthly installments of just over $ 4,000 (the Super PAC). ILN guaranteed investors in the Super PAC that if their monthly payments fell below $ 2,500, ILN would refund the entire $ 25,000 investment plus 50 percent interest. See Common Ground Transcript at 33.
The PAC program was discontinued in mid-1990 after an investigation and settlement with securities regulators in North Carolina. Much of the money taken in through the PAC program was returned to investors. Significantly, counsel for the ILN admitted during closing arguments that the PAC program "quite possibly" involved the offer and sale of a security.
This transitional program took the place of the PAC program after its discontinuance in early 1990. Under this program, investors of $ 1,000, $ 5,000, or $ 10,000 allegedly were promised the rights to real property or, the evidence indicates, large cash "settlements" within 180 days. The duration of this program is unclear from the evidence, but the program operated in all material respects like the Property Rights Assignment program that took its place within a very short period of time.
3. The Property Rights Assignment (PRA) Program
The PRA program was initiated in May 1990. Written materials describing the program promised investors "an opportunity to acquire property below market value." Plaintiff's Exhibit 39 at 1 (Property Rights Assignment brochure). ILN offered this opportunity through the assignment of tax lien sale certificates or rights to property acquired by ILN through foreclosures or government-assisted programs. According to the PRA brochure, purchasers of $ 1,000 PRAs would be assigned property rights assessed at $ 10,000; purchasers of $ 5,000 PRAs would be assigned property rights assessed at $ 50,000; and purchasers of $ 10,000 PRAs would be assigned property rights assessed at $ 100,000. The assignments were to be made within 180 days of the purchase of a PRA.
The oral descriptions of the PRA program, as testified to by several SEC witnesses who had purchased PRAs, differed significantly. These witnesses testified that at meetings conducted by ILN representatives, potential purchasers were promised the option of cash payments of five times their investments in lieu of the property rights assignments. In other words, for a $ 1,000 PRA, a purchaser had the option of $ 10,000 worth of property rights or $ 5,000 in cash. At least two of the witnesses testifying for the SEC stated that they had no interest in acquiring property and they had been persuaded to purchase PRAs solely because of the promise of a large cash return through no effort of their own. These witnesses specifically asked the people recruiting them whether they would have to recruit others in order to receive their money. They were told that if they were not interested in recruiting, then the PRA program was the program for them. Each of these witnesses was shown checks made out to others who had purchased PRAs. The checks were for amounts of five times the amounts originally invested and were dated within 30 days of the dates of the original investments. One witness testified that she and others at the ILN meeting she attended specifically inquired about why ILN's written documents did not mention the five-to-one cash option. She was told that the Internal Revenue Service (IRS) was investigating the program and that because of this, even though the program was legal, the cash option could only be mentioned in private. This witness and others also testified that they were promised a full refund if they were dissatisfied with the program. At least two of the SEC's witnesses testified that they had submitted written requests for refunds as early as February 1991, but still had not received any money back.
None of these witnesses were impeached at the hearing and the Court thus accepts their testimony as credible.
Several witnesses for defendants testified that they had never heard Ford or Mundey guarantee a five-to-one cash return to PRA purchasers. Moreover, ILN's director of membership, Lee Steverson, testified that Independent Representatives were repeatedly reminded through memoranda and other written documentation not to make such unauthorized offers. Nevertheless, the unrebutted testimony of Lewis Goolsby, a former consultant for ILN who was involved in designing software for the PRA program, revealed that in May 1990, Odell Mundey directed him to print "settlement" checks for all PRA members at five times their initial investment. Goolsby testified that $ 22 million in checks were printed and delivered to Mundey. The checks were not subsequently distributed through a single mass mailing, but were held back so that they could be distributed either shortly before or actually at the President's Nights and other ILN meetings in various cities throughout the country. The evidence before the Court indicates that some of the checks were never distributed.
Steverson's explanation for the five-to-one checks was that they were settlements for the company's inability to assign property to PRA purchasers within the 180-day time period promised. According to Steverson, the property that ILN had acquired at the time was too overvalued to assign, therefore, the company offered PRA purchasers cash settlements of 50 percent of the assessed value of the property rights they had expected, which, the Court notes, equals five times the initial PRA investment. Steverson acknowledged that some cash settlements were made within one month of the initial PRA purchase, rather than at the end of 180 days, and that settlement checks were distributed at President's Nights. This testimony was corroborated by the testimony of H.L. Barner, an associate marketing representative for ILN, who received such a cash settlement of $ 50,000 in June 1990 for a $ 10,000 PRA he purchased in May 1990. Barner acknowledged that he had shown his check to potential PRA purchasers, although he claims he only did this in the privacy of his home and not at public meetings. Despite Steverson's and Barner's consistent testimony that no guarantees about cash returns were ever made, both had family members who received five-to-one cash payments. Steverson's fiancee received a $ 5,000 payment for her $ 1,000 PRA. Barner's wife, mother, mother-in-law, brother, and uncle all purchased PRAs and received checks in amounts equalling five times their investments. Most, if not all, received their checks within 30 days of their investments. None received property rights assignments. In fact, defendants have presented no evidence that anyone ever received a property rights assignment under the former PRA program.
Although the Court accepts the testimony of Steverson and Barner that the word "guarantee" was not used in connection with the PRA program, the Court finds incredible any testimony that potential recruits were not led to believe they could expect cash returns on their PRA investments.
The Court makes this determination based upon inconsistencies in Steverson's and Barner's testimony, their inability to explain details of the programs, and their demeanor on the witness stand. Additionally, if the PRA program had not been marketed as providing five-to-one cash payments, there would have been no reason for the ILN to make these payments other than for display to potential investors. ILN was only otherwise obligated to provide a refund if it could not provide the promised property rights assignments.
4. The Property Rights Acquisition Program (PRA)
In March 1991, the PRA program was revised yet again.
The name was changed from Property Rights Assignment program to Property Rights Acquisition program. Under this program, a $ 1,000 PRA entitled the purchaser to three real estate training courses. Purchasers of $ 5,000 PRAs were entitled to seven courses and five videotapes with accompanying workbooks. Purchasers of $ 10,000 PRAs were entitled to 12 real estate courses and 12 videotapes with accompanying workbooks. In addition, purchasers of any of these PRAs receive the right to use the PRA Selection Service to acquire tax lien certificates or real property, based on availability. As it has been described to the Court, this service consists of a listing of available properties and tax lien certificates that PRA members may review and make selections from. If a PRA member chooses to acquire any of the property ...