There are four Defendants in this action. Two Defendants, SBMCC and SBMIC, are face amount certificate companies registered with the SEC pursuant to section 8(a) of the Investment Company Act, 15 U.S.C. §80a-8(a). The two other Defendants are a corporate parent of the face amount certificate companies, Geneva, and an individual, Westbury, who controls each of the entity-Defendants. SBMCC is a Maryland corporation that is wholly owned by SBM Financial, LLC. SBM Financial, LLC is, in turn, wholly owned by Geneva. Geneva is wholly owned by Geneva Financial Holdings, LLC, which is wholly owned by Westbury. Westbury is also the Chairman of the Board of Directors, Chief Executive Officer, and President of SBMIC.
Andrea Dittert, a Supervisory Staff Accountant for the SEC who worked on the investigation in this case, explains that:
[f]ace-amount certificate companies issue fixed-income debt securities; these companies agree to pay the principal amount of the instruments (the "face amount") plus accrued interest on maturity. Their profitability is dependent upon the difference between the return they generate on their investment portfolio and the expenses incurred from selling and satisfying certificate obligations.In 2002, the SEC began investigating fraud by John Lawbaugh, a former executive of SBMCC and SBMIC, involving misappropriation of millions of dollars from these companies and from investors. The SEC ultimately filed a civil enforcement action based on that fraud that resulted in disgorgement against Lawbaugh and final injunctive relief against Lawbaugh and the face amount certificate companies. Sec. & Exch. Comm’n v. Lawbaugh. Lawbaugh, formerly the majority shareholder in both SBMCC and SBMIC, filed bankruptcy and his estate was liquidated. The SEC supported Westbury and Geneva in their effort to take control of SBMCC and SBMIC, which succeeded when the bankruptcy court approved their purchase of the stock of both companies from Lawbaugh's bankruptcy estate in December 2003.
The SEC conducted a follow-up examination of SBMCC and SBMIC, which was concluded in September 2005, and as a result of that examination opened a formal investigation of these companies. The SEC filed its complaint in this case on April 4, 2006. The complaint asserts three claims for relief. First, it alleges that SBMCC and SBMIC violated the qualified reserve requirements for face amount certificate companies required by section 28 of the Investment Company Act of 1940, 15 U.S.C. §80a-28. Second, the SEC alleges securities fraud, in violation of section 17a of the Securities Act of 1933, 15 U.S.C. §77q(a); section 10b of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b); and rule 10b-5 under the Securities Exchange Act, 17 C.F.R. §240.10b-5. The SEC alleges that SBMCC, SBMIC, and Westbury committed fraud against investors who hold SBMCC and SBMIC face amount certificates. The SEC also alleges that Geneva and Westbury committed fraud against the District of Columbia. Finally, the SEC alleges that Westbury and Geneva violated fiduciary duties imposed by section 206(1)&(2) of the Investment Advisors Act of 1940, 15 U.S.C. §80b-6(1)&(2), through the alleged fraud upon the District of Columbia.
The same day that the SEC filed its complaint, it also moved for preliminary relief. (Paper 2). In this motion, the SEC seeks a temporary restraining order and a preliminary injunction against future violations of the securities laws, a preliminary injunction freezing Defendants’ assets, appointment of a receiver for the entity-Defendants, an order requiring a full accounting, a preliminary injunction against destruction of evidence, and orders providing for expedited discovery and alternative means of service.
1. The SEC has offered sufficient evidence to conclude at this stage that SBMCC and SBMIC have likely violated the qualified reserve requirements and will likely continue to be in violation during the pendency of this action. Although it is not clear that a showing of irreparable harm is required, the low levels of qualified reserve assets at SBMCC and SBMIC indicate a risk of irreparable harm. If Defendants are not enjoined from further depleting reserve levels, the remaining reserve assets may be insufficient to satisfy the demands of all investors, causing irreparable harm to investors who otherwise could have been more fully compensated. Nevertheless, an injunction requiring Defendants to come into compliance with the reserve requirements is not appropriate relief at this time, because it is not clear that Defendants would have the ability to comply with such an order. The asset freeze restrictions that have been and will be imposed as ancillary injunctive relief are adequate to address this risk of irreparable harm.
2. The SEC's request for a preliminary injunction was denied because the Court concluded that there was an an insufficient showing of fact to support the issuance of a preliminary injunction. and the SEC has not shown that Westbury or Geneva are likely to commit future securities fraud.
3. Geneva and Westbury moved for summary judgment on the securities fraud issue under section 10(b), section 17(a), and rule 10b-5. The Court concluded that various statements in their private offering memoranda were sufficiently explicit, despite qualifying statements contained in the private offering memoranda, that a jury could conclude that a reasonable investor would rely on them and it denied the motions for summary judgment.
4. The the SEC has not made a sufficient showing on the merits as to past and likely future violations by Geneva and Westbury to justify a preliminary injunction based on the alleged violations of the Investment Advisers Act. However, Geneva's and Westbury's motions to dismiss and for summary judgment were denied because the Court concluded that the SEC has pled and produced adequate evidence of material misstatements and omissions with the requisite mental state, which is negligence under the Investment Advisers Act to create material questions of fact for trial.
5. The Court maintained in place a freeze on the assets of SBMIC and SBMCC, but denied a request for a freeze on the assets of Geneva.
6. The Court denied the request of the SEC for the appointment of a receiver for the Defendants because under the circumstances of this case, appointment of a receiver to provide an accounting of Defendants' affairs is not necessary to preserve the status quo.
7. Various other requests by the SEC for preliminary relief were denied as being unnecessary to maintain the status quo.
8. The Court agreed to amend the scheduling order. This portion of the opinion contained a lengthy discussion of the requirements necessary to be shown to allow a court to amend a scheduling order.
9. The Court granted the SEC's motion for a protective order and blocked a request for deposition notice by Westbury, holding that Westbury has other means of discovery available to procure much of the information he seeks through the disputed deposition, and the burden on the court and the SEC in considering the work product issue as to an inevitable array of issues raised at the deposition are not warranted.
A copy of the Memorandum Opinion is available in PDF.