Securities And Exchange Commission v. Lester et al

BRIEF in Opposition to 64 Renewed MOTION to Dismiss

D. Colo.April 20, 2017

1 IN THE UNITED STATES DISTRICT COURT DISTRICT OF COLORADO Civil Action No. 15-cv-02301-CMA-CBS SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. DONALD J. LESTER, RUBICON ALLIANCE, LLC, CFI FUND, LLC, and NUPOWER, LLC, Defendants, EQUITY EDGE PREFERRED INCOME FUND I, LLC, EQUITY EDGE, LLC, and EQUITY EDGE COMPANIES, LLC, Relief Defendants. PLAINTIFF SECURITIES AND EXCHANGE COMMISSION’S OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS Plaintiff Securities and Exchange Commission (“SEC”) submits this Response in Opposition to Defendants’ and Relief Defendants’ (collectively, “Defendants”) Motion to Dismiss (ECF No. 20) (“Motion”). As outlined herein, the Motion should be denied. INTRODUCTION The SEC has more than adequately pleaded each element of each violation for each Defendant and, for the claims that sound in fraud, the SEC has complied with Rule 9(b) by alleging fraud with particularity. Defendants attempt to debate the merits of the claims by encouraging the Court to delve into the Defendants’ view of the facts, while ignoring the specific, detailed facts pleaded by the SEC, should be rejected because Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 1 of 22 2 such arguments are inappropriate in a motion to dismiss pursuant to Rule 12(b)(6). The SEC has plausibly pleaded all seventeen claims and the Defendants can comprehend the basis of each claim and formulate a response. The Motion should be denied in its entirety. LEGAL STANDARD When ruling on a motion to dismiss under Rule 12(b)(6),1 the Court must determine whether the allegations of the Complaint are sufficient to state a claim within the meaning of Rule 8(a), which requires “a short and plain statement of the claim showing that the pleader is entitled to relief in order to give the defendant fair notice what the claim is and the grounds upon which it rests.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (internal quotations and citations omitted). The plaintiff’s “[f]actual allegations must be enough to raise a right to relief above the speculative level[.]” Id. The Court must accept all well-pleaded allegations of the complaint as true. McDonald v. Kinder-Morgan, Inc., 287 F.3d 992, 997 (10th Cir. 2002). The standard is a liberal one, and “a well-pleaded complaint may proceed even if it strikes a savvy judge that actual proof of those facts is improbable, and that a recovery is very remote and unlikely.” Dias v. City & Cty. of Denver, 567 F.3d 1169, 1178 (10th Cir. 2009) (internal quotation marks omitted) (quoting Twombly, 550 U.S. at 556). Rule 9(b) provides, in part, “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b). 1 The SEC agrees that Exhibits A and B to the Motion are central to the SEC’s claims and that their consideration does not convert the Motion to one for summary judgment. See Mot. at 3 n.1. The SEC does not believe that Exhibit C is necessary to consideration of the Motion; nonetheless, even if it is considered, the Motion is still properly analyzed under Rule 12(b)(6). Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 2 of 22 3 However, “[m]alice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” Id. “The requirements of Rule 9(b) must be read in conjunction with the principles of Rule 8, which calls for pleadings to be ‘simple, concise, and direct . . . and to be construed as to do substantial justice.’” Schwartz v. Celestial Seasonings, Inc., 124 F.3d 1246, 1252 (10th Cir. 1997) (quoting Fed. R. Civ. P. 8(e) and (f)). Securities claims that are “not premised on fraud [] do[] not trigger Rule 9(b) scrutiny.” Id. (addressing Section 11 of the Securities Act). ARGUMENT I. The Complaint Is Not A “Shotgun Pleading” Defendants claim to be confused by the SEC’s seventeen claims as articulated in the Claims For Relief portion of the Complaint. Mot. at 6. Defendants’ argument requires the first twenty-two pages of the Complaint to be ignored, however, because the first several sections of the Complaint include detailed factual assertions accompanied by clear, focused headings. Unlike the situation in Int'l Acad. of Bus. & Fin. Mgmt., Ltd. v. Mentz, No. 12-CV-00463-CMA-BNB, 2013 WL 212640, at *7 (D. Colo. Jan. 18, 2013), the SEC has gone well beyond “the mere invocation of a statute,” and has pleaded - in detail - each element of each claim. Defendants’ “shotgun pleading” argument essentially boils down to a request that the SEC repeat pages of facts in the Claims For Relief section of the Complaint, which itself is approximately ten pages long and provides the elements of each claim and specifies each relevant Defendant. Such repetition is unnecessary and unreasonable. “If the plaintiff had to repeat every paragraph in every count, a lengthy complaint already would become unreasonably too long, elevating form over substance.” SEC v. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 3 of 22 4 Goldstone, 952 F. Supp. 2d 1060, 1222 (D.N.M. 2013).2 In fact, “[t]he Tenth Circuit has specifically approved of incorporating paragraphs of a complaint into securities allegations against defendants.” Id. (internal quotation marks omitted) (citing Schwartz, 124 F.3d at 1253). The SEC’s Complaint is detailed, clear, and in-line with Rules 8(a), 10(c), and relevant Tenth Circuit authority and should not be dismissed. II. The SEC Sufficiently Pleaded Every Claim3 A. The Complaint Pleads a Fraudulent Scheme by Mr. Lester and Rubicon (Claims 1, 2, 8, and 10) Defendants argue that the SEC’s scheme liability claims should be dismissed because the SEC “merely reiterate[s]” the misrepresentation and omission claims. Mot. at 13. This is incorrect. The SEC has pleaded significant conduct beyond the misstatements and omissions. For example, Paragraph 1 of the Complaint opens with a description of the fraudulent scheme pursuant to which Rubicon and Mr. Lester engaged in a series of fraudulent transactions and improperly used investor funds without any discussion of the material misstatements and omissions that are also present in this case. Throughout the Complaint, the SEC continued to plead the comprehensive, lengthy scheme and the conduct in furtherance of the scheme, including a series of illegitimate transactions and the fraudulent diversion of investor 2 Because the flawed “shotgun pleading” assertion is Defendants’ sole argument in support of dismissal of the SEC’s claims asserting violations of Section 5(a) and 5(c) of the Securities Act (Claim 12), and Section 7(a) of the Investment Company Act, (Claim 13), those claims are sufficiently pleaded and should not be dismissed. 3 Defendants request that the SEC’s Complaint be dismissed with prejudice. Mot. at 20. As detailed herein, the entire Motion should be denied; however, should the Court determine that the Complaint should be dismissed in whole or in part, the SEC respectfully requests that the dismissal be without prejudice and that the SEC be granted leave to amend. The SEC is no different than any other litigant and leave to amend should be given “freely … when justice so requires.” Fed. R. Civ. P. 15(a)(2). Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 4 of 22 5 funds, 4 and the failure to disclose inherent conflicts of interest implicated by favoring one fund over another. See Compl. ¶¶ 1, 4, 42-79. This case is distinguishable from SEC v. Kelly in which the Complaint defined the scheme “by explicit reference to the alleged public misrepresentations” and the conduct “became deceptive only thorough AOL’s misstatements in its public filings.” 817 F. Supp. 2d 340, 344 (S.D.N.Y. 2011) (emphasis in original). The SEC’s allegations go far beyond the misrepresentations and omissions that were also pleaded, the fraudulent conduct was deceptive when it occurred, and the SEC has sufficiently stated a claim for scheme liability. Defendants also contend that the SEC has failed to allege “inherently deceptive” conduct related to the Equity Edge transactions. Mot. at 13-14. However, the scheme conduct described as such throughout the Complaint is unquestionably inherently deceptive. For example, it was inappropriate and inherently deceptive for Rubicon and Mr. Lester to prop up Equity Edge by directing cash from CFI to Equity Edge. See Compl. ¶ 44. Among other things, such conduct relied upon valuing NuPower as worthless in a transaction between Rubicon and Equity Edge, but then turning around and valuing NuPower at $5.6 million in a transaction involving CFI, thereby creating a false appearance regarding NuPower’s value. See Compl. ¶ 52 (transaction was 4 Defendants’ allegation that the Complaint “pleads that this [part of the] scheme was fraudulent solely because the actions were allegedly ‘contrary to CFI’s stated investment strategy’ and ‘contrary to the language of the CFI offering memorandum’” is disingenuous. Mot. at 14. Reviewed in their entirety, the cited sentences clearly allege inherently deceptive conduct that is both inherently deceptive on its own and contrary to the CFI offering memorandum. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 5 of 22 6 devised “to improperly move funds”); id. ¶ 78 (describing “faulty valuation method to create a faulty valuation”). Similarly, the fraudulent diversion of funds from one set of investors to another is inherently deceptive, as is favoring one fund (and, thereby, one set of investors) over another. See id. ¶ 53 (describing “a clear conflict of interest”). It was also inherently deceptive for Rubicon and Mr. Lester to continue to fundraise for CFI while knowing that that CFI’s investment in NuPower was contrary to CFI’s stated investment strategy and that new investor funds were used to pay interest to earlier stage investors. Id. ¶ 78. See also SEC v. St. Anselm Expl. Co., No. 11-cv-00668-REB-MJW, 2012 WL 1045707, at *6 (D. Colo. Mar. 28, 2012) (denying 12(b)(6) motion on scheme claim and citing as deceptive conduct the continued sale of promissory notes after defendant became aware of company’s dire financial condition);5 SEC v. China Ne. Petroleum Holdings Ltd., 27 F. Supp. 3d 379, 392 (S.D.N.Y. 2014) (denying 12(b)(6) motion on scheme claim when SEC pleaded, in addition to misstatements, that defendants enriched themselves and their families at shareholders expense). Finally, “[t]he three main subdivisions of Section 17 and Rule 10b-5 have been considered to be mutually supporting rather than mutually exclusive.” In the Matter of Cady, Roberts & Co., 40 S.E.C. 907, Exchange Act Rel. No. 6668, 1961 WL 60638, *4 (Nov. 8, 1961). As a result, misrepresentations and omissions may constitute devices, schemes, or artifices to defraud. See, e.g., Chadbourne & Parke LLP v. Troice, 134 S. 5 The St. Anselm decision relied upon by Defendants is not instructive here. See Mot. at 14. That opinion was decided under Rule 52(c) of the Federal Rules of Civil Procedure and is the result of a trial to the Court. 936 F. Supp. 2d at 1284. As cited above, that Court had previously denied a Rule 12(b)(6) motion on scheme liability. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 6 of 22 7 Ct. 1058, 1063 (2014) (Rule 10b-5 “forbids the use of any ‘device, scheme, or artifice to defraud’ (including the making of ‘any untrue statement of a material fact’ or any similar ‘omi[ssion]’) ‘in connection with the purchase or sale of any security’”) (alternations in original).6 Regardless, as detailed above, the SEC has sufficiently alleged deceptive conduct beyond the misstatements and omissions. As a result, the SEC has appropriately asserted claims for both a fraudulent scheme and material misstatements and omissions, as is appropriate in a case such as this one in which the Defendants’ unlawful conduct violates all provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. B. The Complaint Pleads the Fraudulent, Material Misstatements and Omissions of CFI, Rubicon, and Mr. Lester (Claims 3, 6, and 10) The Court should deny Defendants’ request to dismiss misstatement and omission claims because the Complaint sufficiently “set[s] forth an explanation as to why the statement[s] or omission[s] complained of w[ere] false or misleading.” Grossman v. Novell, Inc., 120 F.3d 1112, 1124 (10th Cir. 1997) (quoting In re GlenFed Sec. Litig., 42 F.3d 1541, 1548 (9th Cir.1994) (en banc)). Nothing more is required, as a 6 See In the Matter of Francis V. Lorenzo, Securities Act Rel. No. 9762, at 16 (April 29, 2015) (Commission opinion) (By “knowingly sen[ding] materially misleading language from his own email account to prospective investors[,]” Lorenzo “employ[ed] a deceptive ‘device,’ ‘act,’ or ‘artifice to defraud’ for purposes of liability under Section 10(b), Rule 10b-5(a) and (c), and Section 17(a)(1)”) (footnote omitted). See also In the Matter of Raymond J. Lucia Companies, Inc., Securities Exchange Act Rel. No. 75837, at 16-17 (Sept. 3, 2015) (Commission opinion) (Advisers Act sections 206(1) and 206(2) encompass the making of fraudulent misstatements of material fact and omissions of material fact necessary to make statements made not misleading); Warwick Capital Mgmt., Inc., Advisers Act Rel. No. 2694, at 14-15, 2008 WL 149127, at *8-9 (Jan. 16, 2008) (Commission opinion) (concluding that an investment adviser violated, inter alia, Advisers Act Sections 206(1) and (2) by making false and misleading statements about its assets and performance). Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 7 of 22 8 complaint need only articulate “what is false or misleading about a statement, and why it is false.” Id. Here, the Complaint specifically alleges particular statements and representations that not only demonstrate the respective defendant “made an untrue statement of material fact, or failed to state a material fact necessary to make the statements that were made not misleading,” Goldstone, 952 F. Supp. 2d at 1196, but also details the statements, particularizes why they are alleged to be false, and explains what information should have been disclosed, but was not. Although defendants aver that the Complaint alleges “conclusory allegations,” 7 Mot. at 7, most, if not all, of their arguments merely raise defenses to the claims. Defendants essentially argue that disclosures were sufficient. Such arguments should be addressed on a motion for summary judgment, not a motion to dismiss because courts must accept all well-pleaded allegations in the complaint as true and to draw all reasonable inferences in favor of the non-moving party. Scheuer v. Rhodes, 416 U.S. 232, 236 (1974), overruled on other grounds, Harlow v. Fitzgerald, 457 U.S. 800 (1982). The question is not whether plaintiffs will ultimately prevail in a trial on the merits, but whether they should be given an opportunity to offer evidence in support of their claims. 7 Far from conclusory allegations, the Complaint properly articulates “what is false or misleading about a statement, and why it is false.” Grossman, 120 F.3d at 1124. Specifically, the Complaint alleges the POM “represented that Rubicon had ‘not identified a particular operating business in which to invest,’” which “was false because by approximately October 26, 2010, CFI had purchased from Equity Edge a 50% ‘investment’ in NuPower for $2.8 million,” Compl. ¶ 67, and the POM “represented that CFI would invest in ‘cash flow-producing assets,’” which was “false because by approximately October 26, 2010, CFI had purchased from Equity Edge a 50% ‘investment’ in NuPower, which held only one asset: an investment in Company A, a development stage company with no revenues or operating history. Neither NuPower nor Company A was a ‘cash flow-producing asset.’” Compl. ¶ 69. “In addition, new CFI investor funds were frequently used to make payments to early stage investors rather than to make investments in ‘cash flow-producing assets.’” Id. at ¶ 70. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 8 of 22 9 Id. To the extent the Court decides to address the merits of 3, 6 and 10, the Court should nonetheless deny the Motion because the proffered defenses are without merit. 1. The Complaint sufficiently alleges falsities for the statements that Rubicon had “not identified a particular operating business in which to invest” and that CFI would invest in “cash flow-producing assets.” Defendants argue Paragraph 67 of the Complaint “lacks particular facts alleging that this statement was untrue or misleading when made,” and similarly argue that Paragraphs 69 and 70 of the Complaint are insufficient because the statements are “forward-looking.” Mot. at 7-9. Defendants’ argument is essentially that because the CFI Private Offering Memorandum (“POM”) was dated January 1, 2010, it can only contain false statements if such statements were false as of January 1st, despite the fact that the POM continued to be distributed to potential investors after the October 2010 NuPower transaction. According to Defendants’ reasoning, any allegation that a statement becomes false after the January 1, 2010, is an impermissible “fraud by hindsight” claim. Id. at 7-8. Defendants are mistaken. First, courts have squarely rejected attempts to disclaim responsibility for false statements at the time of an investment merely because the offering materials were dated earlier (which is always the case unless the investment is somehow made on the same day the offering memorandum is written). As explained by the Seventh Circuit: The duty to correct statements so long as the offering continues snaps into place. Offering materials must be correct and non-misleading at the time of the sale, and not just as of the time they were written. . . . If as the investors submit [defendant] came to doubt the representations in his letter but continued to allow its circulation, this may be powerful evidence of recklessness, and so establish liability under § 10(b) and Rule 10b-5. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 9 of 22 10 Ackerman v. Schwartz, 947 F.2d 841, 848-49 (7th Cir. 1991) (internal citation omitted) (emphasis added); see also United States v. Gordon, 710 F.3d 1124, 1142 (10th Cir. 2013) (“[O]nce a statement of fact ... has been made, the person making the statement is then under a duty to correct any misstatements....” (quoting Thomas Lee Hazen, The Law of Securities Regulation § 12.9[10], at 471-72 (6th ed. 2009) (alterations in original)); Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir.2000) (holding that an affirmative duty to disclose exists when there has been an “inaccurate, incomplete or misleading prior disclosure”); In re Phillips Petroleum Sec. Litig., 881 F.2d 1236, 1245 (3d Cir. 1989) (“There can be no doubt that a duty exists to correct prior statements, if the prior statements were true when made but misleading if left unrevised.”); Tabby's Int'l, Inc. v. SEC, 479 F.2d 1080, 1082 (5th Cir. 1973) (“Where events occur or actions are taken in the course of an offering which render statements in the offering circular materially false or misleading, it is clearly improper to continue the offering without appropriate amendment of the circular.”). SEC v. Manor Nursing Ctrs., Inc. is analogous to the instant case. 458 F.2d 1082 (2d Cir.1972). There, defendants engaged in conduct directly contrary to certain representations made in the prospectus soon after the effective date of the prospectus and during the period of the offering. Id. at 1095. The court found certain developments need be disclosed to investors because the effect of the antifraud provisions of the 1933 and 1934 Acts “is to require that the prospectus reflect post-effective developments which make the prospectus misleading in any material respect.” Id. at 1099. Here, the date on the CFI POM does not provide a defense to Defendants’ subsequent actions that contradicted statements made in the CFI POM regarding the use of investor funds, Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 10 of 22 11 nor does the POM date permit Defendants to continue its distribution while it contained statements that were (or had become) indisputably false.8 Moreover, Defendants overstate the disclaimers contained in the CFI POM. See Mot. at 8 (quoting Ex. A at iii). The POM does not state that the POM contains falsities or may be inaccurate at the time of investment, and even if such disclaimers were made, they would not foreclose liability. See Krim v. BancTexas Grp., Inc., 989 F.2d 1435, 1448-49 (5th Cir. 1993) (“This is not to say that an issuer cooking up a prospectus may evade liability for a material misrepresentation or omission by liberally sprinkling the document with boilerplate warnings and disclaimers of responsibility.”). Further, “fraud by hindsight” is irrelevant to this action, as the concept holds “corporate officials should be liable for failing to reveal only those material facts reasonably available to them,” and allegations a defendant should have anticipated future events does “not suffice to make out a claim of securities fraud.” City of Philadelphia v. Fleming Companies, Inc., 264 F.3d 1245, 1260 (10th Cir. 2001) (internal quotations omitted). Here, the Complaint does not allege that any defendant should have anticipated future events, rather it specifically alleges they engaged in conduct that 8 Defendants argue “the Complaint lacks particular facts alleging that NuPower, and its underlying holding Company A, was not a cash flow-producing asset.” Mot. at 9 (emphasis in original). This is incorrect, as the Complaint specifically states Company A was “a development stage company with no revenues or operating history” and that “[n]either NuPower nor Company A was a ‘cash flow-producing asset.’” Compl. at ¶ 69. The Court should similarly reject Defendants’ argument the investment was cash flow producing merely because “Company A contracted to pay NuPower a 9 percent annual dividend on the share shares, payable quarterly, in cash.” Mot. at 9. Of course, NuPower’s contract does not (and did not) make Company A cash flow, nor did it transform CFI’s investment in NuPower into a “cash flow-producing asset.” Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 11 of 22 12 was contrary to certain representations made in the CFI POM, and that the POM continued to be distributed while containing false and misleading statements.9 2. The Complaint sufficiently alleges falsity for the statement “[a]ny transaction between [CFI] and any Affiliate will be conducted on an arms-length basis, at fair market value.” Defendants similarly argue that Paragraph 72 of the Complaint “fails to allege particular facts explaining why the NuPower transaction was not on an “arms’ length basis,” Mot. at 10, or “why the NuPower transaction was not at ‘fair market value.’” Mot. at 11. These arguments are without merit, as the two succeeding paragraphs specifically allege particular facts explaining both why the NuPower transaction was neither at fair market value nor on an arms’ length basis. Compl. ¶¶ 73 - 74. The Court should also reject Defendants’ subsequent argument that because the CFI offering memorandum “’plainly stated’ the actual and potential conflict of interest, they cannot support the Complaint’s claims of fraud.” Mot. at 11. Defendants ask this Court to accept their proffered defense on the adequacy of disclosure and ignore “well- pleaded allegations of the complaint as true”, McDonald, 287 F.3d at 997. Moreover, Defendants’ proffered defense is unavailing, as Defendants merely point to language disclosing that CFI may do business with certain Affiliates, and ignore that the conduct 9 Defendants aver that “the Tenth Circuit has declined to adopt” a “duty to update the POM.” Mot. at 8. A “duty to update” is distinct from a “duty to correct,” as the former “arises when a company makes a forward-looking statement-a projection-that because of subsequent events becomes untrue.” Stransky v. Cummins Engine Co., Inc., 51 F.3d 1329, 1331-32 (7th Cir. 1995). The instant action does not deal with forward looking projections. To the extent that Defendants argue the Tenth Circuit has declined to adopt a “duty to correct,” they are mistaken. See Grossman, 120 F.3d at 1125 (Recognizing that “if a defendant makes a statement on a particular issue, and that statement is false or later turns out to be false, the defendant may be under a duty to correct any misleading impression left by the statement.”). Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 12 of 22 13 alleged specifically refer to the statement that any affiliated transactions would be “conducted on an arms-length basis, at fair market value.” Compl. ¶ 72. The Court should similarly reject Defendants’ argument that “the Complaint is devoid of particular facts demonstrating that the price derived by Lester’s practices was not a plausible fair market value.” Mot. at 12. As an initial matter, the Complaint specifically alleges Mr. Lester and Rubicon used “a faulty valuation method to create a faulty valuation for NuPower.” (Compl. ¶ 78(a)) (emphasis added). The Complaint similarly alleges that the price was “unilaterally determined…based on back-of-the- envelope calculations and erroneous personal beliefs regarding Company A’s possible success, which did not follow any accepted valuation methodology.” Compl. ¶ 73 (emphasis added). A price based on erroneous personal beliefs is not fair market value, especially after Rubicon’s interest in NuPower was transferred to Equity Edge for “no money,” Compl. at ¶ 4, just prior to Lester manufacturing the NuPower valuation. To the extent Defendants argue they fraudulently stumbled onto an accurate figure, the Court should reject this contention. See Stransky v. Cummins Engine Co., 51 F.3d 1329, 1332 (7th Cir. 1995) (“[A] statement materially false when made does not become acceptable because it happens to come true.”) (internal quotations omitted).10 10 Further, even if the valuation had been accurate, the failure to disclose the transfer and sale of NuPower - and the conflicts created by the transaction - constituted a breach of the fiduciary duties owned by Rubicon and Mr. Lester to CFI investors due to Rubicon’s and Mr. Lester’s status as investment advisers. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92 (1963) (Section 206 of the Advisers Act reflects a congressional recognition that investment advisers owe their clients a fiduciary duty and an "intent to eliminate, or at least expose, all conflicts of interest which might incline [an] investment adviser - consciously or unconsciously - to render advice which was not disinterested."). As a result, even an accurate valuation Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 13 of 22 14 3. The SEC Sufficiently Pleaded Violations Of 17(a)(2) Of The Securities Act Against Rubicon And Mr. Lester. Defendants assert that the SEC’s Section 17(a)(2) claim should also be dismissed with respect to Mr. Lester and Rubicon because they are not “makers” of the false statements. Mot. at 12 n.5. Defendants’ reliance on Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2296 (2011) is misplaced. As noted by numerous courts, the Supreme Court’s ruling in Janus is limited to subsection (b) of Rule 10b-5, and has no impact on Section 17(a) of the Securities Act.11 See, e.g., SEC v. Big Apple Consulting USA, Inc., 783 F.3d 786, 795-98 (11th Cir. 2015); SEC v. Farmer, No. 4:14- CV-2345, 2015 WL 5838867, *7 (S.D. Tex. Oct. 7, 2015) (compiling cases), appeal filed, (5th Cir. Oct. 28, 2015); SEC v. Benger, 931 F. Supp.2d 904, 905-06 (N.D.Ill.2013); SEC v. Stoker, 865 F. Supp.2d 457, 465-66 (S.D.N.Y. 2012); SEC v. Daifotis, No. C 11-00137 WHA, 2011 WL 3295139, at *5 - *6 (N.D. Cal. Aug. 1, 2011). Defendants further attack the Section 17(a)(2) claim by arguing that the SEC fails to plead that Rubicon or Mr. Lester received money from CFI due to the alleged fraud. The complaint does allege, however, that, Rubicon indirectly compensated itself from CFI through the diversion of CFI funds to Equity Edge. Compl. ¶¶ 32, 49-51. These funds - obtained indirectly from CFI - are sufficient to trigger liability under Section involving an appropriate transfer of interest in NuPower remains relevant to the SEC’s Advisers Act claims. 11 In support of the claim that Janus is applicable to Section 17(a)(2) of the Securities Act, Defendants’ cite SEC v. Kelly, 817 F.Supp.2d 340 (S.D.N.Y. 2011). Kelly is not persuasive on this point. Kelly was decided within a year of Janus, is one of a few outliers on the application of Janus to Section 17(a) of the Securities Act, and has been rejected by other district courts. See, e.g., Benger, 931 F.Supp.2d at 906 (“Kelly is clearly an outlier, even in its own district. It ignored the policy considerations that were important to the Court in Janus, and it has not been followed.”) Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 14 of 22 15 17(a)(2) of the Securities Act. See Stoker, 865 F. Supp. 2d at 463 (noting “all three prongs of liability under Section 17(a) are preceded by the common modifier “directly or indirectly”). Further, the SEC pleaded that Mr. Lester managed, controlled, and partially owned Rubicon. See Compl. ¶¶ 12, 18, 24, 38. The SEC’s allegations that Mr. Lester, as an agent of Rubicon, facilitated the fraud that led to Rubicon’s indirect receipt of funds from CFI is sufficient to plead a violation of Section 17(a)(2) against Mr. Lester. See Stoker, 865 F. Supp. 2d at 463-464. See also Compl. ¶1 (describing Mr. Lester as orchestrating the fraudulent scheme); id. ¶ 86 (Mr. Lester personally participated in the drafting, review, and approval of the CFI offering materials). In sum, the Court should decline to dismiss Claims 3, 6, and 10. C. The Complaint Pleads that Mr. Lester and Rubicon Were Investment Advisers (Claims 8, 9, 10, and 11) Section 202(a)(11) of the Advisers Act defines an “investment adviser” to include, “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities[.]” Defendants argue that Claims 8, 9, 10, and 11 should be dismissed because the SEC fails to sufficiently allege that Rubicon and Mr. Lester acted as investment advisers. However, the SEC pleaded Rubicon’s and Mr. Lester’s status as investment advisers based on their advising CFI for compensation. Specifically, Paragraph 29 explains, “Rubicon manages CFI and is vested with the sole authority to oversee its investments. Investors have no right to participate in the management of CFI, leaving Rubicon and its manager, Lester, with control over investment decisions. Through Lester, Rubicon determines what securities CFI purchases and at what price.” The SEC Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 15 of 22 16 also pleaded that, pursuant to the CFI offering memorandum, up to 10% of investor funds may be used to compensate Rubicon and that Rubicon also profits if CFI generates a return of greater than 7%. Compl. ¶¶ 30-31.12 Further, the Complaint detailed how Rubicon indirectly compensated itself from CFI by the diversion of CFI funds to Equity Edge. Compl. ¶ 32; see also id. ¶¶ 49-51. Finally, the SEC pleaded that Mr. Lester controlled Rubicon and its decision making. See id. ¶ 29. As a result, Mr. Lester “is also properly labeled an investment adviser within the meaning of the Advisers Act.” SEC v. Berger, 244 F. Supp. 2d 180, 193 (S.D.N.Y. 2001).13 This case presents facts that are significantly and materially different than Zinn v. Parrish, 644 F. 2d 360 (7th Cir. 1981). First, unlike the situation presented by Zinn, both Rubicon and Lester were “financially interested in the securities recommendations [they] passed along.” Id. at 364; Compl. ¶¶ 30-32, 49-50 (regarding Rubicon); id. ¶¶ 12, 53 (regarding Mr. Lester). Further, both Rubicon and Mr. Lester “hold [themselves] out as being engaged in the business of giving advice to others as to securities.” Zinn, 644 F. 2d at 364; Compl. ¶¶ 11, 17 (regarding Rubicon); id. ¶ 12, 18 (regarding Mr. Lester); see also Ex. A to Mot. (ECF No. 20-1) at 12. Finally, Mr. Lester’s advisory interactions 12 It is not necessary for the SEC to plead that Rubicon had received this compensation. See SEC v. Fife, 311 F.3d 1, 11 (1st Cir. 2002) (SEC met preliminary injunction burden of demonstrating that defendant was an investment adviser when defendant understood that he would be compensated for his efforts by a commission based on a percentage of profits from the investments if successful, despite the fact that compensation had not yet been received). 13 As detailed above, the SEC has adequately pleaded its claims under Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act; therefore, it has also adequately pleaded its claims under Section 206 of the Advisers Act. Berger, 244 F. Supp. 2d at 192. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 16 of 22 17 with clients were not “isolated;” Zinn, 644 F. 2d at 364; rather, Mr. Lester has been selling securities since at least 2002. Compl. ¶ 2. The SEC has pleaded that both Rubicon and Mr. Lester are investment advisers; therefore, Claims 8, 9, 10, and 11 are sufficiently pleaded and should not be dismissed. D. The Complaint Pleads Scienter. Rule 9(b) provides that “[m]alice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” Scienter is an element of claims under Section 17(a)(1) of the Securities Act, Sections 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) of the Advisers Act, and recklessness is sufficient to establish scienter. Negligence is sufficient to satisfy the requirements of Sections 17(a)(2) and (3) of the Securities Act and Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. See SEC v. Coddington, No. 13-cv-03363- CMA-KMT, 2015 WL 1401679, at *4 (D. Colo. Mar. 23, 2015) (addressing the Securities Act and Exchange Act); SEC v. Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992) (addressing the Advisers Act). The SEC has repeatedly pleaded that Rubicon, Mr. Lester, and CFI knew, or were reckless in not knowing that their conduct was improper, including the transfer and sale of NuPower, Compl. ¶ 56, their payments to early-stage CFI investors from later investments, id. ¶65, the false and misleading representations and omissions to investors, id. ¶¶ 68, 71, 76, 77, and the scheme conduct detailed above, id. ¶ 78(b). See also id. at pp. 23-32 (claims for relief). This is sufficient. See Coddington, 2015 WL 1401679, at *7. Further, while the SEC did plead negligence, see Compl. ¶¶ 7, 56, 65, 68, 71, 76, “because the Complaint adequately pleads scienter against the defendant[s] under the more rigorous scienter standards, Defendant’s argument that the SEC fails to Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 17 of 22 18 plead the lesser negligence requirement is without merit.” Coddington, 2015 WL 1401679 at *7 (citing SEC v. Nacchio, 438 F. Supp. 2d 1266, 1283 (D. Colo. 2006)). Defendants claim that the SEC has failed to plead scienter “or even negligence” because Defendants believe that their theory of the case “is far more plausible” than Defendants incorrect, sarcastic, and simplified view of the SEC’s case. This argument has no merit. At this stage, the Court is to “assume the truth of all well-pleaded facts in the complaint, and draw all reasonable inferences therefrom in the light most favorable to the plaintiffs,” Dias, 567 F.3d at 1178, and “not to weigh potential evidence that the parties might present at trial, but to assess whether the plaintiff’s complaint alone is legally sufficient to state a claim for which relief may be granted,” Dubbs v. Head Start, Inc., 336 F. 3d 1194, 1201 (10th Cir. 2003). E. The Complaint Pleads That Mr. Lester And Rubicon Acted As Unregistered Brokers (Claim 15) Section 15(a)(1) of the Exchange Act prohibits a broker or dealer from effecting transactions in securities without registering with the SEC. Scienter is not an element of a violation of Section 15(a)(1).14 SEC v. Parrish, No. 11-CV-00558-WJM-MJW, 2012 WL 4378114, at *4 (D. Colo. Sept. 25, 2012). Section 3(a)(4) of the Exchange Act defines a “broker” as “any person engaged in the business of effecting transactions in securities for the account of others.” In determining whether a person is a broker, the Court should apply a fact-intensive, multi-factor test that includes inquires as to: [W]hether the person works as an employee of the securities' issuer; (ii) whether he receives a commission rather than a salary; (iii) whether he sells or has sold the 14 Claim 15 is not grounded in fraud, which renders Rule 9(b) inapplicable. See, e.g., Schwartz, 124 F.3d at 1252. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 18 of 22 19 securities of another issuer; (iv) whether he participates in negotiations between the issuer and investor; (v) whether he provides advice or a valuation as to the merit of an investment; and (vi) whether he actively, rather than passively, finds investors. Landegger v. Cohen, No. 11-cv-01760-WJM-CBS, 2013 WL 5444052, at *5 (D. Colo. Sept. 30, 2013) (internal citations omitted). As noted in Landegger, “some courts have also held that the transaction-based compensation factor[] is one of the hallmarks of broker status,” but “[o]ther courts have also held that regularity of participation ‘is the primary indicia of being ‘engaged in the business’ for the purposes of the broker definition.” Id. (internal citations omitted) (determining that both factors should be afforded heightened weight, but noting that they “must not be weighted so heavily as to subsume the others in the analysis”). Defendants assert that the SEC has failed to plead that Rubicon and Mr. Lester violated Section 15(a)(1) of the Exchange Act because the Complaint fails to allege that they received transaction-based compensation or that Mr. Lester personally received any part of Company A’s payments. Mot. at 19-20. Defendants’ arguments are factually and legally flawed. First, Defendants improperly ignore the multi-prong, fact-intensive inquiry necessary to determine a violation of Section 15(a)(1) and the SEC’s specific factual allegations addressing these factors. See Compl. ¶¶ 91-93; see also id. ¶¶ 13-14 (CFI and NuPower have no employees); ¶ 2 (from 2002 to 2009, Mr. Lester sold securities to numerous investors in unregistered transactions); ¶ 3 (from approximately January 2010 to December 2014 Mr. Lester and Rubicon sold securities in CFI and NuPower); ¶¶ 21-22 (describing Mr. Lester’s participation in the preparation offering memoranda and interactions and with investors). These allegations are more than sufficient to allege that both Rubicon and Mr. Lester acted as unregistered brokers. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 19 of 22 20 It is not necessary for the SEC to plead - or even prove - that Rubicon or Mr. Lester received compensation. See SEC v. Imperiali, Inc., 594 F. App'x 957, 961 (11th Cir. 2014) cert. denied sub nom. Imperato v. S.E.C., 136 S. Ct. 346 (2015) reh'g denied, 136 S. Ct. 529 (2015) (SEC presented sufficient evidence to establish defendant was a broker, even if he did not receive proceeds from sales). Nonetheless, the SEC did plead that Rubicon obtained compensation from both CFI and NuPower. Compl. ¶¶ 38, 93. Defendants improperly attempt to delve into the merits by explaining their view of the services performed by Rubicon in connection with the agreement between Rubicon and Company A, Mot. at 19-20; however, such an argument is inappropriate because Defendants are not entitled to a presumption in their favor, nor can they ask the court to weigh potential evidence that might be presented at trial. Dias, 567 F.3d at 1178; Dubbs, 336 F. 3d at 1201. Regarding its claim that Rubicon and Mr. Lester were unregistered brokers, the SEC pleaded “sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (internal quotation marks omitted).15 CONCLUSION The SEC has complied with Rules 8(a) and 9(b) of the Federal Rules of Civil Procedure and has more than adequately placed the Defendants on notice of all of the claims against them. The Motion to Dismiss should be denied. 15 Defendants’ only argument in favor of dismissal of the aiding and abetting and control person liability claims and the equitable disgorgement claim is that the primary violations warrant dismissal. Mot. at 16-18. As detailed above, all of the primary violations were adequately pleaded; therefore, Claims 4, 5, 7, 9, 11, 16, and 17 should also survive the Motion. Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 20 of 22 21 Respectfully submitted April 20, 2017. s/ Danielle Voorhees Mark Williams, Esq. Danielle Voorhees, Esq. Securities and Exchange Commission 1961 Stout Street, Suite 1700 Denver, CO 80294 Ph. (303) 844-1000 Email: williamsm@sec.gov; voorheesd@sec.gov Counsel for Plaintiff Securities and Exchange Commission Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 21 of 22 22 CERTIFICATE OF SERVICE I hereby certify that on April 20, 2017, a copy of the foregoing Response In Opposition To Motion To Dismiss was filed with the CM/ECF filing system which will send notification of such filing to the following: Matthew J. Smith, Esq. Brian Neil Hoffman, Esq. Jessica J. Smith, Esq. Holland & Hart LLP 555 17th Street, Ste. 3200 Denver, CO 80202 Email: MJSmith@hollandhart.com; BNHoffman@hollandhart.com jjsmith@hollandhart.com s/ Danielle Voorhees Case 1:15-cv-02301-CMA-CBS Document 65 Filed 04/20/17 USDC Colorado Page 22 of 22