Kunz v. Securities & Exchange Commission , 64 F. App'x 659 ( 2003 )


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  •                                                                         F I L E D
    United States Court of Appeals
    Tenth Circuit
    UNITED STATES COURT OF APPEALS
    MAR 28 2003
    TENTH CIRCUIT
    PATRICK FISHER
    Clerk
    KEVIN D. KUNZ, KUNZ & CLINE
    INVESTMENT MANAGEMENT,
    INC.,
    Petitioners,
    v.                                          No. 02-9514
    (Admin. Proc. File No. 3-9960)
    SECURITIES & EXCHANGE                                   (SEC)
    COMMISSION,
    Respondent.
    ORDER AND JUDGMENT *
    Before TACHA, Chief Circuit Judge, McKAY, and HENRY, Circuit Judges.
    Petitioners, Kevin Kunz and Kunz & Cline Investment Management (“Kunz
    & Cline”), appeal from an order of the Securities and Exchange Commission (“the
    Commission” or “SEC”) sustaining disciplinary action taken by the National
    Association of Securities Dealers (“NASD”). 1 For the reasons set forth below, we
    *
    This order and judgment is not binding precedent, except under the
    doctrines of law of the case, res judicata, and collateral estoppel. This court
    generally disfavors the citation of orders and judgments; nevertheless, an order
    and judgment may be cited under the terms and conditions of 10th Cir. R. 36.3.
    1
    The NASD is a self-regulatory agency, registered with the Commission as
    a securities association under the Securities and Exchange Act of 1934 and
    (continued...)
    AFFIRM.
    I. Background
    A.    VesCor
    VesCor was in the business of originating, purchasing, and selling loans
    secured by real property. VesCor financed its business by selling to the public
    certain investment products, including Wholesale Accrual Notes (“Accrual
    Notes”), Wholesale Monthly Income Notes (“Monthly Notes”), and Wholesale
    Mortgage Loan Participation Interests (“MLP Interests”) (collectively, “the
    VesCor investment products”). Val E. Southwick (“Southwick”) was VesCor’s
    President, Chief Executive Officer, Corporate Secretary, Chairman, and the sole
    member of its Board of Directors. Petitioner Kunz worked for VesCor from
    August 1994 through December 1994. Prior to 1994, VesCor sold the VesCor
    investment products without registering them under the Securities Act.
    B.    The Nevada Investigation
    In early 1994, Nevada began investigating VesCor’s activities. Nevada
    concluded that the Accrual Notes, Monthly Notes, and MLP Interests were
    “securities.” Nevada and VesCor entered into a settlement agreement, requiring
    VesCor to make rescission offers to current holders of the VesCor investment
    1
    (...continued)
    subject to Commission oversight. General Bond & Share Co. v. SEC, 
    39 F.3d 1451
    , 1453 (10th Cir. 1994).
    -2-
    products in the state of Nevada.
    In conjunction with the rescission offers, VesCor planned to simultaneously
    offer investors the opportunity to reinvest in the Accrual Notes, Monthly Notes,
    and MLP Interests. VesCor also decided to send the simultaneous rescission-
    reinvestment offers to investors in other states. In late 1994, Southwick decided
    that these transactions should be handled by a broker-dealer registered with the
    Commission. Accordingly, Southwick encouraged Kunz to leave VesCor to form
    his own brokerage firm.
    C.    The Formation of Kunz & Cline
    In December 1994, Kunz left VesCor and formed Kunz & Cline with
    Jeffrey Cline (“Cline”). Southwick, through VesCor, agreed to furnish the
    required start-up funds. According to Kunz’s testimony, Southwick expected
    Kunz & Cline to be VesCor’s “captured broker.” The NASD approved Kunz &
    Cline’s application on December 13, 1994.
    D.    The Simultaneous Rescission-Reinvestment Offers
    VesCor created six Private Placement Memoranda (“PPMs”) to accompany
    the simultaneous rescission-reinvestment offers, providing two different PPMs for
    each of the three investment products. VesCor used one set of three for residents
    of Nevada, and the other set of three for non-Nevada residents.
    -3-
    1.    Material not included in the PPMs
    At the time VesCor issued the PPMs, $1.8 million in civil judgments were
    outstanding against Southwick, stemming from previous business activities. The
    Nevada PPMs contained five paragraphs concerning Southwick’s litigation
    history, 2 but the non-Nevada PPMs did not disclose this information. Further,
    none of the PPMs disclosed the relationship between VesCor and Kunz & Cline. 3
    All six PPMs included the same financial statement, which Kunz testified
    that he saw for the first time in November 1994. According to Kunz’s testimony,
    he was surprised by the sizeable net operating loss that VesCor had accumulated
    since 1991. Although Kunz questioned Southwick about the losses, he conducted
    no investigation of the information contained in the financial statements.
    The financial statements contained a balance sheet dated September 30,
    1994, listing VesCor’s assets. Included in the “Assets” information was an entry
    for “Investments” valued at $12,265,322. The balance sheet indicated that, of this
    amount, $9,191,509 was attributable to a single asset — 20,000 acres in Cannon
    2
    The Nevada settlement agreement required this disclosure.
    3
    Kunz testified that he relied on VesCor’s counsel concerning these
    omissions. Concerning the relationship between VesCor and Kunz & Cline, Kunz
    testified that he assumed disclosure was not necessary since VesCor’s counsel
    never raised the issue during the drafting of the PPMs. Regarding Southwick’s
    litigation history, Kunz testified that he did inquire whether disclosure of
    Southwick’s litigation history was legally required and VesCor’s counsel
    informed him that inclusion was not required.
    -4-
    County, Tennessee — acquired in exchange for 750 shares of VesCor stock four
    days prior to the closing date of the balance sheet. The financial statement also
    contained a “Statement of Shareholders’ Equity” showing that (1) on September
    26, 1994, 750 shares of stock were issued for the Tennessee land, with each share
    valued at $12,177.85; (2) on September 15, 1994, 250 shares of stock were issued
    “for services,” with each share valued at $63.80; and (3) on December 31, 1993,
    the remaining outstanding shares were valued at $1,250.92 per share. The
    balance sheet and accompanying notes documented that, without the inclusion of
    the Tennessee land, VesCor had assets of $5,671,761 and liabilities of
    $6,454,673, resulting in a negative net worth of $782,912.
    Kunz testified that he understood the purpose of the Tennessee land deal to
    be a “balance sheet enhancement, meaning that [Southwick] would acquire the
    property for a short period of time to make [the] private placement look good and
    sellable.” Kunz also testified that he sought confirmation from VesCor’s counsel
    that VesCor had proper title to the Tennessee land. VesCor’s counsel responded
    only that a deed was recorded. Kunz conducted no further investigation. 4
    4
    Apparently, the Tennessee land was comprised of numerous land grants
    dating from the 1820’s, when the North Carolina legislature issued the grants to
    encourage westward settlement. In many instances, the land grants had not been
    converted to actual locations, tax maps, or legal descriptions. Rather, the deed
    merely referenced land-grant numbers in describing the property and contained no
    language typical of a contemporary land description.
    -5-
    E.    Kunz & Cline’s Dealings with Bruce Anderson
    In 1994, Kunz met Bruce Anderson (“Anderson”) through Southwick. Prior
    to entering into two consulting agreements with Kunz & Cline 5 in 1994, Anderson
    had sold VesCor securities to numerous customers. Anderson was not properly
    registered under NASD rules to offer the VesCor securities for sale.
    Since Anderson could not present the simultaneous rescission-reinvestment
    offers to his clients, Kunz met with Anderson and then personally or by mail
    furnished Anderson’s clients with the PPMs. Approximately eighty of Anderson’s
    clients reinvested their funds in the VesCor investment products. Kunz paid
    Anderson a “consulting fee” of $88,936. At the NASD hearing, Kunz conceded
    that this was the same amount Anderson would have received as a commission for
    sales of the VesCor securities. Specifically, Kunz testified that “[t]he reason we
    formalized the consulting agreement was to compensate [Anderson] in a manner
    that would have been consistent with commissions that he would have earned had
    he been licensed.”
    5
    Originally, Kunz and Anderson had intended that Anderson would register
    and become a principal of Kunz & Cline. These plans were abandoned after Kunz
    and Anderson discovered that Anderson could not participate in the VesCor
    investment product offerings because he was not properly registered in
    accordance with NASD rules.
    -6-
    F.    The Commission’s Decision 6
    On January 16, 2002, the Commission concluded that petitioners had
    violated Rule 2110 of the NASD’s Conduct Rules, finding that petitioners: (1)
    created offering documents for the sale of securities that contained material
    misstatements and omissions, (2) failed to comply with the Securities Act of
    1933’s registration requirements, and (3) compensated a person not properly
    registered pursuant to NASD requirements, in connection with the sale of
    securities. The Commission also sustained the sanctions imposed by the NASD.
    This appeal followed.
    6
    The Commission reached this conclusion in the posture of reviewing de
    novo the NASD’s earlier findings of violations and sanctions. In 1996, the
    NASD’s District Business Conduct Committee (“DBCC”) filed a complaint
    against petitioners, alleging that petitioners committed the following wrongful
    conduct: (1) selling securities through PPMs containing material
    misrepresentations and omissions, in violation of NASD Conduct Rule 2110 and
    2120; (2) selling securities that were neither registered pursuant to Section 5 of
    the Securities Act of 1933, nor exempt from registration, in violation of Section 5
    and Conduct Rule 2110; (3) making unsuitable recommendations of VesCor
    securities in light of customers’ financial situations and needs, in violation of
    Conduct Rules 2310 and 2110; and (4) paying brokerage commissions to
    Anderson, who was not properly registered under NASD regulations, in violation
    of Conduct Rule 2110.
    On November 3, 1997, the DBCC entered its final decision, finding for
    complainant on all counts (with the exception of the Conduct Rule 2120
    allegation) and imposing sanctions. Petitioners then appealed the DBCC’s
    decision to the National Adjudicatory Council of the NASD (“NAC”). The NAC
    affirmed on all counts, with the exception of the unsuitable recommendations
    count, and reduced the fine by $10,000.
    -7-
    II. Discussion
    A.     Standard of Review
    “Our review of the SEC’s factual findings is limited to determining whether
    those findings are supported by substantial evidence.” C.E. Carlson, Inc. v. SEC,
    
    859 F.2d 1429
    , 1433 (10th Cir. 1988) (citations omitted). Although substantial
    evidence requires more than a “scintilla” of evidentiary support, in general, “[i]f
    the evidence is capable of rational interpretation that would favor either side, the
    SEC’s findings will not be overturned on appeal.” 
    Id.
     (citation omitted). In other
    words, substantial evidence “‘means such relevant evidence as a reasonable mind
    might accept as adequate to support a conclusion.’” 
    Id.
     (citation omitted). In
    reviewing the Commission’s conclusions of law, our review is de novo. Lehl v.
    SEC, 
    90 F.3d 1483
    , 1486 (10th Cir. 1996). We review the sanctions imposed in
    this case for an abuse of discretion. C.E. Carlson, 
    859 F.2d at 1438
    .
    B.     Whether the Commission Erred in Concluding That Petitioners
    Violated NASD Rule of Conduct 2110.
    Under NASD Rule of Conduct 2110, “[a] member, in conduct of his
    business, shall observe high standards of commercial honor and just and equitable
    principles of trade.” In this case, the Commission concluded that petitioners
    violated Rule 2110 by (1) creating offering documents for the sale of securities
    that contained material misstatements and omissions, (2) failing to comply with
    -8-
    the Securities Act of 1933’s registration requirements, and (3) compensating
    Anderson, who was not registered in accordance with NASD requirements, for the
    sale of securities. We consider these three findings in turn.
    1.     Material misrepresentations and omissions
    a.     Overview of applicable law
    In general, “‘[a] statement or omission is only material if a reasonable
    investor would consider it important in determining whether to buy or sell stock,’
    and if it would have ‘significantly altered the total mix of information available’
    to current and potential investors.” City of Philadelphia v. Fleming Co., 
    264 F.3d 1245
    , 1265 (10th Cir. 2001); Basic Inc. v. Levinson, 
    485 U.S. 224
    , 240 (1988)
    (“[M]ateriality depends on the significance the reasonable investor would place
    on the withheld or misrepresented information.”). “Although in general
    materiality is primarily a factual inquiry, the question of materiality is to be
    resolved as a matter of law when the information is so obviously important [or
    unimportant] to an investor, that reasonable minds cannot differ on the question
    of materiality.” SEC v. Cochran, 
    214 F.3d 1261
    , 1267 (10th Cir. 2000) (internal
    quotation marks omitted) (citing Connett v. Justus Enters. of Kan., Inc., 
    68 F.3d 382
    , 384 (10th Cir. 1995)).
    b.     The Commission’s conclusions
    The Commission concluded that petitioners made three material
    -9-
    misrepresentations or omissions. Specifically, the Commission found that: (1)
    petitioners’ statements regarding VesCor’s Tennessee land holdings and the
    financial statements in VesCor’s PPMs were material misrepresentations; (2)
    petitioners’ failure to disclose the financial relationship between VesCor and
    Kunz & Cline in all of the PPMs was a material omission; and (3) petitioners’
    failure to disclose Southwick’s litigation history in the non-Nevada PPMs was a
    material omission. We consider each finding in turn.
    c.    Misrepresentation regarding the Tennessee land
    We have no doubt that information regarding the Tennessee land would be
    “material” to an investor, insofar as “‘a reasonable investor would consider it
    important in determining whether to buy or sell [the securities],’ and . . . it would
    have ‘significantly altered the total mix of information available’ to current and
    potential investors.” Fleming, 
    264 F.3d at 1265
     (citation omitted). As the Ninth
    Circuit has stated, “[s]urely the materiality of information relating to financial
    condition, solvency and profitability is not subject to serious challenge.” SEC v.
    Murphy, 
    626 F.2d 633
    , 653 (9th Cir. 1980) (citing cases). Even if, as petitioners
    maintain, holders did not acquire an “ownership” interest in VesCor, they were
    still “creditors of the company,” and as such, VesCor’s financial condition was
    highly relevant to their decision to purchase the VesCor investment products.
    Further, the Commission appears correct in its conclusion that both the Accrual
    - 10 -
    Notes and the Monthly Notes were secured, to some extent, by VesCor’s assets.
    Comm. Order at 9. Specifically, the PPMs defined the investors’ security as
    follows: “Note holders . . . will be creditors of the company to be secured by a
    partial assignment of the company’s interest in a trust account at a financial
    institution and/or in certain first trust deeds.”
    Petitioners stress that an independent auditor had inspected the financial
    statements. However, petitioners’ awareness of numerous “red flags” warranted
    further investigation. First, the Tennessee land had a substantial effect on
    VesCor’s balance sheet. As the Commission found, “[w]ith it, VesCor appeared
    to have a positive net worth of approximately $8 million, when in reality the
    company had a negative net worth of approximately $800,000.” Comm. Order at
    9. Second, the amount and valuation of the stock exchanged for the Tennessee
    land should also have raised questions. “The PPMs indicated that VesCor
    acquired [the Tennessee land] in exchange for stock that was valued on a per
    share basis at approximately 200 times the value assigned just weeks earlier in
    another transaction involving the issuance of stock for services, and
    approximately 10 times the value assigned to shares owned by Southwick, the
    only other shareholder.” 7 Comm. Order at 11 (emphasis added). Third, VesCor
    7
    The financial statements noted that, on September 26, 1994, VesCor
    issued 750 shares of stock for the Tennessee land, with each share valued at
    (continued...)
    - 11 -
    acquired the Tennessee land only four days prior to the balance sheet’s closing
    date. Fourth, Kunz was aware of VesCor’s dubious intention with respect to the
    Tennessee land deal. Kunz testified that he understood the purpose of the
    Tennessee land deal to be a “balance sheet enhancement, meaning that
    [Southwick] would acquire the property for a short period of time to make [the]
    private placement look good and sellable.”
    Despite these red flags, Kunz conducted no investigation of the Tennessee
    land asset, other than to ask VesCor’s counsel whether VesCor had proper title to
    the Tennessee land. Thus, substantial evidence supports the Commission’s
    finding of a material misstatement with respect to the information provided in the
    PPMs concerning the Tennessee land asset.
    d.    Omissions regarding (1) the financial relationship
    between VesCor and Kunz & Cline in all of the PPMs
    and (2) Southwick’s litigation history in the non-Nevada
    PPMs
    The fact that Kunz & Cline might be operating under a conflict of interest,
    due to its relationship with VesCor, would no doubt be important to any of
    VesCor’s offerees in their decision to purchase VesCor investment products. See
    7
    (...continued)
    $12,177.85. Only eleven days earlier, on September 15, 1994, VesCor had issued
    250 shares of stock “for services,” with each share valued at $63.80.
    - 12 -
    Fleming, 
    264 F.3d at 1265
    . The same goes for Southwick’s litigation history,
    insofar as Southwick was VesCor’s “alter ego.” 8
    Petitioners do not seriously dispute this, but point to their reliance on the
    advice of VesCor’s counsel. However, VesCor’s counsel cannot be properly
    characterized as disinterested. See C.E. Carlson, 859 F.3d at 1436 (citing cases).
    Accordingly, petitioners’ reliance on the advice of VesCor’s counsel cannot
    excuse their omission of material facts from the PPMs.
    2.   Sale of non-registered, non-exempt securities
    There is no dispute that the VesCor securities at issue were not registered.
    Rather, petitioners contend that the VesCor investment products were exempt
    from the registration requirements of sections 4 and 5 of the Securities Act, 15
    U.S.C. §§ 77d & 77e, under either (1) “Regulation D,” 
    17 C.F.R. § 230.506
    , or
    (2) the Securities Act of 1933 § 4(2), 15 U.S.C. § 77d(2). 9 We reject both
    contentions.
    a.    Regulation D
    Under Regulation D, 
    17 C.F.R. § 230.506
    , certain “limited offers” are
    exempt from registration. Section D’s exemption is not available, however,
    8
    Southwick was VesCor’s President, Chief Executive Officer, Corporate
    Secretary, Chairman, and the sole member of its Board of Directors.
    9
    Although petitioners do not reassert this argument on appeal, we briefly
    review the Commission’s findings under section 4(2).
    - 13 -
    where there are “more than 35 [non-accredited] purchasers of securities from the
    issuer in any offering.” 
    17 C.F.R. § 230.506
    (b)(2)(i)-(ii). As sellers of
    unregistered securities, petitioners had the burden of proving entitlement to
    exemption. Andrews v. Blue, 
    489 F.2d 367
    , 374 (10th Cir. 1973).
    In this case, the Commission found that 138 non-accredited investors
    purchased Accrual Notes, Monthly Notes, and MLP Interests. Comm. Order at
    14. Thus, if the VesCor investment products are “integrated,” Regulation D’s
    exemption would clearly be inapplicable. 10 The Commission concluded that the
    Accrual Notes, Monthly Notes, and MLP Interests were one “integrated” offering,
    and substantial evidence supports this conclusion. 11
    First, the three rescission-reinvestment offerings were made
    simultaneously. Second, the VesCor investment products were all offered for the
    same general purpose. The PPMs make this purpose clear:
    The Company intends to provide general funding for the operations
    10
    The Commission alternatively noted that VesCor had 58 non-accredited
    investors in Accrual Notes and 45 non-accredited investors in Monthly Notes,
    taking both offerings outside Regulation D’s ambit even in the absence of
    integration.
    11
    In reaching this conclusion, the Commission applied a five-factor test, set
    forth in SEC Rule 502(a). Comm. Order at 14. These factors include: (1)
    whether the offerings are part of a single plan of financing; (2) whether the
    offerings involve issuance of the same class of securities; (3) whether the
    offerings have been made at or about the same time; (4) whether the same type of
    consideration is received; and (5) whether the offerings are made for the same
    general purpose.
    - 14 -
    of the Company’s expansion activities with respect to a series of
    mortgages made or purchased at a discount. The source of such
    funds would be the proceeds from the sale of [the particular
    securities] and the sale of [the two other securities] pursuant to other
    simultaneous private offering memoranda.
    Third, as the Commission noted, “the consideration for the securities was the
    same: the rejection of the right to rescind a prior investment and the election to
    credit accumulated interest to principal . . . [and for any] new or additional
    investment . . . the consideration was cash.” Comm. Order at 15.
    Based on the above, we conclude that substantial evidence supported the
    Commission’s conclusion rejecting VesCor’s argument under Regulation D.
    b.    Section 4(2) of the Securities Act
    Section 4(2) of the Securities Act of 1933 exempts from registration
    “transactions by an issuer not involving any public offering.” 15 U.S.C. § 77d(2).
    Again, petitioners had the burden of proof. Andrews, 
    489 F.2d at 374
    .
    In determining whether an offering is “public,” we have previously
    construed section 4(2) as providing for exemption from “registration only when
    an offeree has had sufficient access to information similar to that made available
    to the offeree in a registration statement.” 
    Id. at 373
    . Thus, “the exemption
    question turns on the knowledge of the offerees.” SEC v. Ralston Purina Co., 
    346 U.S. 119
    , 126 (1953) (emphasis added). In other words, “an offering is private
    when made ‘to those who are shown to be able to fend for themselves.’” Andrews,
    - 15 -
    
    489 F.2d at
    373 (citing Ralston Purina, 
    346 U.S. at 124
    ).
    In conducting this analysis several factors are relevant, including: “(1) the
    number of offerees, (2) the sophistication of the offerees, (3) the size and manner
    of the offering, and (4) the relationship of the offerees to the issuer.” Murphy,
    
    626 F.2d at 644-45
     (internal citations omitted).
    Petitioners point to no evidence in the record concerning the actual number
    of offerees, or the offerees’ particular characteristics. “That failure by itself may
    be fatal to [petitioners’] claimed exemption under § 4(2).” Mark v. FSC
    Securities Corp., 
    870 F.2d 331
    , 334 (6th Cir. 1989). Further, petitioners made
    offerings to a large number of diverse investors. Finally, petitioners point to no
    evidence of a relationship between VesCor and the numerous offerees.
    Based on the above, we conclude that substantial evidence supported the
    Commissioner’s determination that VesCor’s offering of its investment products
    was not exempt from registration under section 4(2) of the Securities Act of 1933.
    3.     Compensation to Anderson, a non-registered broker, for the
    solicitation or sale of securities
    Petitioners do not dispute that Anderson was not properly registered under
    NASD regulations. Rather, petitioners attack the Commission’s conclusion
    regarding the connection between Kunz & Cline’s compensation to Anderson and
    the sale of VesCor securities to Anderson’s clients.
    - 16 -
    In his testimony before the NASD, Kunz admitted that “[t]he reason we
    formalized the consulting agreement was to compensate [Anderson] in a manner
    that would have been consistent with commissions that he would have earned had
    he been licensed.” In addition, Kunz acknowledged that the actual amounts paid
    to Anderson were consistent with the amounts that would be paid as commissions
    for sales of VesCor securities. Further, several VesCor investment product
    purchasers indicated that Anderson sold them the securities during the period in
    question. In fact, Anderson notarized several of the purchase agreements,
    indicating that the agreements were executed in his presence. Thus, there was
    substantial evidence supporting the Commission’s conclusion that Kunz & Cline’s
    payments to Anderson were compensation for the sale of securities.
    C.     Whether the Commission Erred in Upholding the Sanction Imposed.
    We review the sanction in this case for an abuse of discretion. C.E.
    Carlson, 
    859 F.2d at 1438
    . In this case, the NASD: (1) suspended Kunz from
    associating with any NASD member firm in a representative capacity for thirty
    calendar days and in a principal capacity for one year, to run concurrently; (2)
    required Kunz to requalify as a representative within ninety days of the
    conclusion of his suspension as a representative or cease to function in that
    capacity until he requalified, and to requalify as a principal before functioning in
    such a capacity; (3) ordered Kunz & Cline to retain an independent consultant; (4)
    - 17 -
    fined Kunz and Kunz & Cline $20,000, jointly and severally; (5) fined Kunz
    $5,000, individually; and (6) imposed hearing costs on Kunz and Kunz & Cline,
    jointly and severally. The Commission upheld the NASD’s actions, concluding
    they were not “excessive, oppressive or an undue burden on competition,” and
    further noting the sanctions fell within the applicable range under the NASD’s
    sanction guidelines. 12 Comm. Order at 19. We cannot conclude that this
    constituted an abuse of discretion.
    III. Conclusion
    Based on the foregoing, we AFFIRM.
    ENTERED FOR THE COURT,
    Deanell Reece Tacha
    Chief Circuit Judge
    12
    See NASD Sanction Guidelines.
    - 18 -