Pending before the Court is plaintiff's motion for summary judgment against defendants Better Life Club of America, Inc., and Robert N. Taylor and against the relief defendants. After considering the numerous submissions of each party, the Court will grant summary judgment for plaintiff on all counts and will dismiss defendants' counterclaims with prejudice. The Court will also grant summary judgment for plaintiff on Count Four of the Second Amended Complaint, which asserts a claim against the relief defendants.
The defendants in this case are the Better Life Club of America ("BLC") and Robert N. Taylor, its president. The substance of the case is plaintiff's allegation that defendants ran a "Ponzi"
or pyramid scheme which produced little or no profit through legitimate means, but which instead obtained profits solely through the sale of memberships and the attraction of new investors to the scheme. Plaintiff Securities and Exchange Commission ("SEC") alleges that defendants have committed three violations of federal securities laws: (1) the sale of unregistered securities in violation of 15 U.S.C. § 77e; (2) securities fraud in violation of 15 U.S.C. § 77(q)(a); and (3) securities fraud in violation of 15 U.S.C. § 77(j)(b) and 17 C.F.R. 240.10b-5. Plaintiff seeks a permanent injunction against future violations and seeks restitution and disgorgement of funds from defendants. Plaintiff also seeks disgorgement of funds transferred to relief defendants Elizabeth Lawson and Wilkins McNair, Jr.
Defendants assert three counterclaims. These claims are for (1) tortious interference with contracts, (2) intentional infliction of emotional distress, and (3) willful invasion in violation of the Right to Financial Privacy Act of 1978. For these counterclaims defendants request $ 52 million in compensatory damages and $ 10 million in punitive damages.
Defendant Robert Taylor founded the Better Life Club of America in early 1993. The price of membership in the BLC was $ 39 per year, which entitled the member to a subscription to the "Better Life News," plus perks such as "free financial counseling," a one-third discount on seminars, guidebooks, and tapes, and the opportunity to participate in BLC "wealth building projects." The largest of these wealth-building projects was the "Advertising Pool." Investors in the Advertising Pool were promised that their investment would be "doubled" within 60 to 90 days.
Ostensibly, the invested funds were to be used to "advertise Better Life Club 900-Lines and to promote other profit-making business activities." These profitable ventures were supposed to generate sufficient returns to pay investors.
At no time did defendants attempt to register these Advertising Pool "contracts" as securities under any federal or state laws. The Advertising Pool investment opportunity was promoted in a variety of publications, fliers, letters, and other media. Most of these promotions contained references to past performance and to the Club's optimism for the future, but each also stated, unequivocally and without reference to risk or uncertainty, that each investor would receive double his investment in either 60 or 90 days.
Between January 1, 1993 and August 31, 1995, the effective life of the operation, the BLC received over $ 45 million in funds invested through the Advertising Pool.
The Special Administrator estimates that approximately $ 41 million of the collected funds were paid out to investors before August 31, 1995, and that those investors received a full, 100% return on their investments. However, on September 1, 1995, when the SEC brought this action and obtained an asset freeze on BLC accounts, the Advertising Pool was on the verge of collapse. According to both the Special Administrator and BLC's own accountant, relief defendant McNair, the Club had only $ 2.7 million in its accounts
and had investor obligations in excess of $ 51.6 million that were to come due over the next 90 days. Thus, it was apparent at that time that defendants could not have provided their promised investment payments.
The BLC "profit-making" ventures never managed to turn a profit. Although the "Better Life News" may have made modest strides as a subscription paper, other ventures--including the vaunted "900 Number" services-- were consistent financial losers. Even defendants admit to the Court that the "900-number" services failed to generate any income. Therefore, almost all funds that were coming into BLC accounts were made up of new investments, not of profits from Club activities.
Defendant Taylor received substantial sums of money from BLC accounts during his two and a half year reign at the helm of the Club. The Special Administrator estimates that defendant Taylor received in excess of $ 800,000-- perhaps as much as $ 1.2 million.
Defendant Taylor claims that much of that $ 800,000 was spent on Club-related business expenses, but admits to receiving at least $ 544,000 as "compensation" from Club accounts. In reality, the figure is likely much higher, since defendant Taylor has documented no more than $ 158,000 in expenses, many of which are highly questionable.
Although defendants claim that this compensation was derived solely from membership payments, BLC bank records--submitted by defendants themselves-- indicate that membership dues amounted to less than $ 200,000 over the course of two and a half years. Furthermore, since BLC's activities were not producing significant profits, defendant Taylor's compensation must have derived from investor funds. Defendant Taylor received cash, and also used funds drawn from BLC accounts to finance a house, a 40 foot swimming pool, at least three automobiles,
and trust funds in excess of $ 120,000 for his two sons. In addition, defendant Taylor gave relief defendant Lawson a cashier's check for $ 7500, joint ownership of the house, a 1992 Jaguar, and a $ 50,000 "loan" made to payable Lawson's business, Ruby Communications. There is no evidence that defendant Taylor ever disclosed to investors that he would take "compensation" from BLC accounts, which were made up almost entirely from investor funds and membership fees, nor did he ever disclose the extent of those "compensation" payments.
II Summary Judgment
Summary judgment is appropriate only if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56; Celotex Corp. v. Catrett, 477 U.S. 317, 322, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986). In considering a motion for summary judgment, the "evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in his favor." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986).
Plaintiff's Complaint contains three counts for relief: for the sale of unregistered securities, in violation of 15 U.S.C. § 77e (Count One); for securities fraud, in violation of 15 U.S.C. § 77(q)(a) (Count Two); and for securities fraud, in violation of 15 U.S.C. § 77(j)(b) and 17 C.F.R. 240.10b-5 (Count Three). Defendants assert three counterclaims, for tortious interference with contracts, for intentional infliction of emotional distress, and for willful invasion in violation of the Right to Financial Privacy Act of 1978.
Plaintiff moves for summary judgment on all three counts of the complaint. Plaintiff also moves for summary judgment on defendants' three counterclaims.
III Sale of Unlicenced Securities
Count One of the Amended Complaint asserts that defendants violated § 5 of the Securities Acts. That statute makes it unlawful for anyone
"to make use of any means of interstate commerce or of the mails to offer to sell or offer to buy...any security, unless a registration statement has been filed as to such security."
15 U.S.C. § 77e(c). The statute also makes it illegal to actually sell such securities. 15 U.S.C. § 77e(a). Plaintiff asserts that defendants' marketing of the Advertising Pool investment violates this statute.
There are no material factual disputes underlying this count. It is undisputed that defendants offered the opportunity to invest in the Advertising Pool and that persons accepted that offer and conveyed funds to defendants for investment in the Pool. It is undisputed that the Advertising Pool transactions involved the mails and other instrumentalities of interstate commerce. It is further undisputed that defendants never filed any registration statements regarding the Advertising Pool.
Rather than raise factual defenses, defendants argue that their Advertising Pool activities were not subject to regulation under the Securities Acts, and therefore that they do not create liability under § 77e. Defendants first argue that the notes given in exchange for the Advertising Pool investment funds were not securities. They then argue that, even if the Advertising Pool notes were securities, they were exempted from the registration requirements, because they had a maturity of less than nine months.
Defendants first argue that the BLC did not sell sold securities, but merely executed promissory notes in exchange for loan agreements. Such loan agreements are not literally covered by the Securities Act; however, in keeping with the flexible, remedial nature of securities laws, courts distinguish between traditional, commercial promissory notes, which are outside the Securities Acts, and "investment contracts," which are subject to regulation. See SEC v. W.J. Howey Co., 328 U.S. 293, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946), rehearing denied, 329 U.S. 819, 91 L. Ed. 697, 67 S. Ct. 27; Baurer v. Planning Group, Inc., 215 U.S. App. D.C. 384, 669 F.2d 770 (D.C. Cir. 1981); Securities and Exchange Commission v. International Loan Network, Inc., 770 F. Supp. 678, 688-92 (D.D.C. 1991), aff'd, 968 F.2d 1304, 297 U.S. App. D.C. 22 (D.C. Cir. 1992). Under a test developed by the Supreme Court, a transaction is an "investment contract" if persons invest or loan money to a common enterprise with a promise or expectation of profits to come solely from the efforts of others (generally the promoter or a third party). Howey, 328 U.S. at 299. Courts have applied this definition to many situations, including pyramid schemes. See International Loan, 770 F. Supp. at 692.
Even the language of BLC's own promotional literature demonstrates that these "loans" were investment contracts under Howey. The transactions involved several individual investors who contributed substantial funds to a common enterprise (the Ad Pool), and who were promised profits (a doubling of money) that would result entirely from the efforts of others (defendants' use of funds on 900-number and other "profit-making business activities"). These were not loans for commercial purposes, but were investment payouts disguised beneath the facade of promissory notes. It is hard to imagine a more perfect example of the Howey investment contract. Therefore, these Advertising Pool notes were securities, and they are subject to regulation under federal law.
Defendants next argue that, even if these promissory notes were securities, they were exempted from registration requirements by Section 3(a)(3) of the 1933 Act. That section exempts from coverage certain commercial paper that has a maturity of less than nine months. 15 U.S.C. § 78c(a)(10). Defendants argue that since the Ad Pool notes had a maturity of 60 to 90 days, they are within this "commercial paper exemption." Therefore, defendants contend, they could not sell unregistered securities in violation of 15 U.S.C. § 77e, because the notes were exempted from registration requirements.
Defendants are correct that § 78c contains a commercial paper exemption; however, courts have interpreted this provision very loosely, and have held that a short maturity period does not automatically exempt a security from the registration requirement. In re NBW Commercial Paper, 813 F. Supp. 7 (D.D.C. 1992). See also Holloway v. Peat, Marwick, & Mitchell, 900 F.2d 1485 (10th Cir. 1990), cert. denied, 498 U.S. 958, 112 L. Ed. 2d 396, 111 S. Ct. 386; SEC v. American Board of Trade, 751 F.2d 529 (2d Cir. 1984). In fact, the commercial paper exemption is available only for true commercial paper-- short-term, high quality instruments issued to fund operations, and sold only to sophisticated investors. NBW, 813 F. Supp. at 18. Therefore, while the statute creates a presumption that commercial paper is exempted, this presumption can be rebutted by evidence that sales are made available to the general, unsophisticated public, or that the investments are of less than prime quality. Id.
The Advertising Pool notes are clearly not commercial paper that is exempted from the registration requirement. These notes were offered to small-scale investors in the general public, not to typical, sophisticated, experienced purchasers of commercial paper.
In addition, plaintiff has demonstrated that the notes were not of prime quality.
Therefore, these securities were not exempt from the registration requirement, even though they carried maturity periods of less than nine months.
Finally, defendants argue that the provisions of 15 U.S.C. § 77(d) exempt the Advertising Pool notes from the regulations of § 77e, because the notes were not offered to the public and because they were offered only to accredited investors.
There is no support whatsoever for defendants' arguments. The offers to participate in the BLC and in the Advertising Pool were promoted in public newspapers and at public "wealth building" seminars, and members of the BLC were encouraged to promote the Club and its ventures to their friends, acquaintances, and other members of the general public. Therefore, it is ridiculous to assert that the Advertising Pool investment was not offered to the public.
It is equally absurd to suggest that the bulk of the Advertising Pool investors were in any way "accredited" under the meaning of 15 U.S.C. § 77(d)(6). Defendants sought to tap the savings and income of middle and working class people, not of sophisticated investors. The Advertising Pool investors were precisely the type of people whom the Securities Acts were designed to protect by "promoting full disclosure of information thought necessary to informed investment decisions." SEC v. Ralston Purina Co., 346 U.S. 119, 124, 97 L. Ed. 1494, 73 S. Ct. 981 (1953); SEC v. Murphy, 626 F.2d 633, 642 (9th Cir. 1980). Furthermore, the Advertising Pool notes were certainly promoted by "advertising" and "public solicitation," so the § 77e exemption is inapplicable. 15 U.S.C. § 77(d)(6).
The Advertising Pool notes offered by defendants were securities and were not exempt from regulation under 15 U.S.C. § 77e. Because defendants offered and sold these securities, and because these securities were not registered, defendants were in clear violation of the statute.
Therefore, plaintiff is entitled to summary judgment on Count I of the Second Amended Complaint.
IV Securities Fraud
Counts Two and Three of the Amended Complaint allege that defendants engaged in securities fraud in violation of § 17(a) of the Securities Act of 1933 and § 10(b) and Rule 10b-5 of the Securities Act of 1934. Section 17(a)(2) makes it unlawful for any person engaged in the offer or sale of securities through interstate commerce
to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
15 U.S.C. § 77q(a). Section 10(b) makes it unlawful to "use or employ, in connection with the purchase or sale of any security...any manipulative or deceptive device or contrivance in contravention of such rules or regulations as the Commission may prescribe." 15 U.S.C. § 78j(b). Pursuant to the rulemaking power delegated by this section, the Commission promulgated Rule 10b-5, which makes it unlawful for any person
to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.