Securities & Exchange Commission v. Unique Financial Concepts, Inc. , 196 F.3d 1195 ( 1999 )

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee,
v.
UNIQUE FINANCIAL CONCEPTS, INC., Ernest J. Patti, et al., Defendants-Appellants.
No. 99-4033.
United States Court of Appeals,
Eleventh Circuit.
Nov. 18, 1999.
Appeal from the United States District Court for the Southern District of Florida. (No. 98-7147-CV-SH),
Shelby Highsmith, Judge.
Before BLACK, HULL and MARCUS, Circuit Judges.
BLACK, Circuit Judge:
Appellants Unique Financial Concepts, Inc. (Unique), Ernest J. Patti (Patti), Frederick N. Hollander
(Hollander), and Nicholas D. DeAngelis (DeAngelis), appeal a preliminary injunction enjoining Appellants
from violating the anti-fraud and securities registration provisions of Section 17(a) of the Securities Act of
1933, 15 U.S.C. § 77q(a). The district court found that Appellants' activities were subject to the Securities
Act because Appellants were offering investment contracts in which investor funds were to be pooled. The
district court also found that the Commodity Exchange Act (CEA), 7 U.S.C. §§ 1-25, did not preclude
Appellee Securities and Exchange Commission (SEC) from regulating the investment opportunity offered
by Appellants. We affirm.
I. BACKGROUND
Hollander and Patti established Unique in October 1997. At its inception, Unique purported to offer
the sale of foreign currency options. Unique advertised heavily on television, newspaper, and the Internet,
promising large returns on small investments. These promises were not based on actual investments made
by Unique. Prospective investors were sent a packet containing an offering document that described the
foreign exchange market, a customer agreement, and a disclosure of risk statement.
The original customer agreement explained that the investments would be pooled together and that
Unique had sole discretion over the investments. In August 1998, Unique modified its customer agreement
by removing the language concerning the pooling of investments and Unique's sole discretion over these
investments.
After receiving initial investments from investors, Unique deposited the funds into its bank account
at Southern Bank in Fort Lauderdale, Florida. Unique sales representatives advised the investors as to which
currencies they should invest in and how many puts and calls they should buy. The investor then spoke to
a compliance officer, who explained the details of the investment and requested the investors' assent to the
purchase.
A portion of the investors' funds then purportedly was wired to Capital Management International
(CMI) and Asset Management Funding (AMF) in the Bahamas. According to Patti and other representatives
of Unique, AMF was a holding company for clearing houses, while CMI was the clearing house responsible
for carrying out Unique's option trades. Unique also claims it later contracted with two other Bahamian
clearing houses, Forex International (Forex) and Nassau Bay Clearing, Ltd.
After the initial investment, Unique aggressively solicited the investors for additional investments.
Eventually, however, Unique representatives were extremely hard to reach and often failed to return phone
calls. The investors lost significant amounts of money on their investments.
From October 1997 until October 22, 1998, Unique raised just over $6.5 million from investors using
the above scheme. Of this amount, only $2,489,801 (38%) was wired to the Bahamas to the alleged clearing
houses. The remainder of the investors' money was divided as follows: approximately $700,000 was paid
to Unique sales representatives; approximately $1.2 million was paid for advertising (including $760,786.32
paid to DRE consulting, a company co-owned by Patti from which he received a substantial salary);
approximately $300,000 was paid to Patti, Hollander, and DeAngelis, the lead sales representative; and
approximately $1.6 million was paid for business and personal expenses, including checks made payable for
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car rentals and personal loans. In addition, approximately $644,000 of the investors' funds was distributed
to new investors.
II. THE PRELIMINARY INJUNCTION
The district court found that Appellants' activities were subject to the Securities Act and granted the
SEC a preliminary injunction enjoining Appellants from violating anti-fraud and securities registration
provisions of the Securities Act, 15 U.S.C. § 77q(a). Significantly, the district court found that no credible
evidence existed to show that Appellants' "clearinghouses" ever placed trades on behalf of investors. The
court emphasized that Appellants failed to introduce any written agreements showing a relationship between
Unique and the Bahamian clearing houses (Nassau Bay, CMI, or Forex). Patti claimed that Appellants did
not have any copies of the contracts between the parties, and asserted, without citing any authority, that
Bahamian law prevented Appellants from obtaining copies of the agreements from the Bahamas. The district
court found that Patti lacked credibility and that the absence of any written agreements was "highly suspect."
As a result, the court concluded that "the contract may be damaging to the [Appellants] and that they may be
purposefully avoiding its production."
Although Appellants did produce option reports and monitoring sheets detailing the purported trades
and client accounts, the district court noted that Appellants failed to authenticate any of these reports.
Specifically, the court pointed to the fact that there were no transaction or wire verifications indicating that
the clearing houses executed any trades. Although Appellants did produce alleged trade confirmations, these
confirmations were sent from Appellants' office, not from the Bahamian clearing houses.
In addition, Patti testified that Appellants never received any bank records indicating the occurrence
of the alleged trades, that he did not know how the Bahamian clearing houses executed the trades, and that
he did not know how the clearing houses were compensated for their services. Furthermore, Appellants'
compliance officer testified that she did not know what the clearing houses did and did not even know what
the term clearing house meant. Finally, Appellants' accountant, Morris Berger, stated that the "only thing we
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had to deal with is really the Unique data. And we don't have the Bahamian trading data.... Do I know that
there was actual trading in the Bahamas? The answer is, no, I don't."
Thus, the court concluded, "at this juncture Unique has failed to produce one scintilla of independent
evidence in support of its contention that investors' funds were invested in foreign currency options by
clearinghouses in the Bahamas." In addition, the court stated that "at this stage of the litigation, it appears
as though Unique either misused or converted investors' funds and have used an artifice to defraud."1
The district court nevertheless found that the "investments" offered by Appellants should be
considered investment contracts, and thus concluded that the SEC did have jurisdiction to bring this claim.
The court also held that the SEC had established a prima facie case of violations of the anti-fraud and
registration provisions of Section 17(a) of the Securities Act and issued a preliminary injunction enjoining
Appellants from committing further violations.
III. STANDARD OF REVIEW
A district court's grant of a preliminary injunction order involves a mixed standard of review. The
decision to grant the injunction is reviewed for abuse of discretion. See Haitian Refugee Ctr., Inc. v. Baker,
953 F.2d 1498, 1505 (11th Cir.1992). Questions of law supporting the injunction are reviewed de novo. See
Tefel v. Reno, 180 F.3d 1286, 1295 (11th Cir.1999). Findings of fact are reviewed for clear error. See SEC
v. Carriba, 681 F.2d 1318, 1323 (11th Cir.1982). When a preliminary injunction is challenged on the basis
of jurisdiction, a plaintiff need only establish "a reasonable probability of ultimate success upon the question
of jurisdiction when the action is tried on the merits." Majd-Pour v. Georgiana Community Hospital, Inc.,
724 F.2d 901, 902 (11th Cir.1984) (quoting Industrial Electronics Corp. v. Cline, 330 F.2d 480, 482 (3d
Cir.1964)).
1
In essence, the district court found that Appellants were operating a "Ponzi scheme." See, e.g., SEC v.
Lauer, 52 F.3d 667, 670 (7th Cir.1995). That is, rather than executing currency trades, Appellants were
keeping over 60% of the money. Appellants paid the rest of the money back to the investors "to fool them
into thinking they were making money and should therefore invest more." Lauer, 52 F.3d at 670.
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IV. ANALYSIS
The central issue in this case is whether the district court abused its discretion in finding that Appellee
has shown a reasonable probability of ultimate success upon the question of the SEC's jurisdiction over
Appellants' conduct.2 The determinative question within this issue is whether the contracts offered and sold
by Appellants were investment contracts, and thus securities, under federal securities law.3 If the contracts
were investment contracts, then, contrary to Appellants' assertion, the SEC had jurisdiction under the federal
securities laws to bring this suit.
A. Three Prong Howey Test
In S.E.C. v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), the Supreme Court
established the classic test for determining whether a transaction is an "investment contract" within the
meaning of Section 2(a)(1) of the Securities Act, 15 U.S.C. § 77b(a)(1). In Howey, the Court explained that
for the purposes of the Securities Act, an investment contract is "a contract, transaction, or scheme whereby
a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the
2
Under Section 20(b) of the Securities Act of 1933, 15 U.S.C. § 77t(b), and Section 21(d) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78u(d), the SEC is entitled to a preliminary injunction when it establishes
the following: (1) a prima facie case of previous violations of federal securities laws, and (2) a reasonable
likelihood that the wrong will be repeated. SEC v. Management Dynamics, Inc., 515 F.2d 801, 806-07 (2d
Cir.1975); SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1100 (2d Cir.1972). On appeal, Appellants
challenge only the SEC's jurisdiction over this matter. Thus, we need not address whether the injunction
granted in this case meets the above requirements.
3
Under the Securities Act of 1933, a "security" is defined as:
[A]ny note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of
interest or participation in any profit-sharing agreement, collateral-trust certificate,
reorganization certificate or subscription, transferable share, investment contract, voting-trust
certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or
other mineral rights, or, in general, an interest or instrument commonly known as a
"security," or any certificate of interest or participation in, temporary or interim certificate
for, receipt for, guarantee of, or warranty or right to subscribe to or purchase, any of the
foregoing.
15 U.S.C. § 77b(a)(1) (emphasis added).
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promoter or a third party...." Howey, 328 U.S. at 298-99, 66 S.Ct. at 1103. This Court has divided the Howey
test into the three elements: "(1) an investment of money, (2) a common enterprise, and (3) the expectation
of profits to be derived solely from the efforts of others." Villeneuve v. Advanced Business Concepts Corp.,
698 F.2d 1121, 1124 (11th Cir.1983), aff'd en banc, 730 F.2d 1403 (11th Cir.1984). Both parties agree the
first prong of this test has been satisfied. There is distinct disagreement, however, as to the second and third
prongs.
1. Common Enterprise Prong
With respect to the second prong, we have adopted the concept of vertical commonality, holding that
a common enterprise exists where "the fortunes of the investor are interwoven with and dependent on the
efforts and success of those seeking the investment or of third parties." Villeneuve, 698 F.2d at 1124 (quoting
SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 n. 7 (9th Cir.1973)).4 We previously had
observed that "the fact that an investor's return is independent of that of other investors in the scheme is not
decisive. Rather, the requisite commonality is evidenced by the fact that the fortunes of all investors are
inextricably tied to the efficacy of the [promoter]." SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 479
(5th Cir.1974).5 More recently, we have affirmed the formulations of Villeneuve and Koscot, instructing that
"[t]he thrust of the common enterprise test is that the investors have no desire to perform the chores necessary
for a return." Eberhardt v. Waters, 901 F.2d 1578, 1580-81 (11th Cir.1990).
Significantly, the fact that an investment company's operations are a sham and thus might not actually
satisfy the common enterprise prong of the Howey test does not mean that the investment company can avoid
4
Unlike the more stringent concept of horizontal commonality, utilized by the Second, Third, Sixth, and
Seventh Circuits, see, e.g., Stenger v. R.H. Love Galleries, 741 F.2d 144, 146 (7th Cir.1984), this flexible
standard does not require investor funds to be pooled nor does it require profits to be shared on a pro rata
basis.
5
In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir.1981) (en banc), this Court adopted as
binding precedent all decisions of the former Fifth Circuit handed down prior to close of business on
September 30, 1981.
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the Securities Act. As the Seventh Circuit has noted, "[i]t would be a considerable paradox if the worse the
securities fraud, the less applicable the securities laws." SEC v. Lauer, 52 F.3d 667, 670 (7th Cir.1995); see
also First National Bank v. Estate of Russell, 657 F.2d 668, 673 n. 16 (5th Cir.1981) (noting that the SEC
has jurisdiction even the "security purportedly traded is nonexistent or fictitious.... A contrary result would
encourage rather than curb fraud.") (internal citation omitted).
Thus, in order to qualify as an investment contract, "it is enough that the [parties] merely offer the
essential ingredients of an investment contract." Howey, 328 U.S. at 301, 66 S.Ct. at 1104. After all, "[t]he
Securities Act prohibits the offer as well as the sale of unregistered non-exempt securities." Id; see also SEC
v. C.M. Joiner Leasing Corp., 320 U.S. 344, 352-53, 64 S.Ct. 120, 88 L.Ed. 88 (1943) (noting that "[i]n the
enforcement of [the Securities Act,] it is not inappropriate that promoters' offerings be judged as being what
they were represented to be").
At trial, the district court found that the language of the original customer agreement, in conjunction
with its conclusion that Appellants' operations were a sham, supported the existence of a common enterprise.
The agreement, in relevant part, reads as follows:
By executing this agreement, Client authorized [Unique] in its sole discretion to use the total funds
on deposit in the omnibus account which includes the funds of the undersigned to execute single
trades or transactions and to apportion the gains, losses, commissions, and clearing expenses
proportionally to each account. The results of each trade will be apportioned and applied
proportionately (per unit) to all accounts open on the trade and rounded down to the nearest U.S.
dollar. (emphasis added).
On appeal, Appellants contend that, despite the language of the original agreement, in actual practice
it did not operate a horizontal investment pool but rather maintained individual, independent investment
accounts. As support for this contention, Appellants point to cash flows between Appellants and the
Bahamian clearing houses, the alleged trade reports, as well as testimony regarding the trades and trade
reports. Appellants claim we should rely on the actual operation of its investment contracts, rather than the
language of the original agreement, to hold that Appellants' investment accounts do not meet the common
enterprise prong.
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However, given the absence of any credible documentation of trades, the absence of any persuasive
testimony concerning these trades, as well as the fact that Appellants invested less than 40% of investors'
money, we conclude the record supports the district court's finding that Appellants' operations were a sham.
Consequently, we look, as did the district court, to the terms of the offer to determine whether Appellants'
activities are covered by the Securities Act. As noted above, the terms of the offer explicitly state that
investors' funds will be pooled and apportioned proportionately by Appellants to each account. This language
clearly presents an offer for an investment in a common enterprise and thus supports the common enterprise
prong of the Howey test.6
2. Expectation of Profits Prong
There is also distinct disagreement over whether Appellants' operations meet the "expectation of
profits" element of the Howey test. In Howey, the Supreme Court explained that this prong requires that
investors expect their "profits to come solely from the efforts of others." Howey, 328 U.S. at 301, 66 S.Ct.
at 1104. The courts have suggested several interpretations of the word "solely," with the disagreement
centered on whether "solely" means all or merely predominant. The view this Court adopted in Koscot, 497
F.2d at 483, asks "whether the efforts made by those other than the investor are the undeniably significant
ones, those essential managerial efforts which affect the failure or success of the enterprise." SEC v. Glenn
W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir.1973). One year after Koscot, the Supreme Court
reaffirmed Howey and revisited this question in United Housing Foundation, Inc. v. Forman, 421 U.S. 837,
95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). In Forman, the Supreme Court held that "the touchstone" of an
investment contract for purposes of the Securities Acts is "the presence of an investment in a common venture
premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts
6
Appellants claim that the language of the original agreement was a mistake, and that the language was
changed to accurately reflect Unique's operations. The district court, however, made a factual finding that
Appellants switched their customer agreement in August 1998 specifically to avoid liability under the federal
securities laws.
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of others." Id. at 852, 95 S.Ct. at 2060. We subsequently explicitly embraced the Forman test.7 See
Villeneuve v. Advanced Business Concepts, Corp., 730 F.2d 1403, 1404 (11th Cir.1984) (en banc).
In addition, this Court has clearly stated that "the crucial inquiry [for the third prong] is the amount
of control that the investors retain under their written agreements." Albanese v. Florida Nat'l Bank, 823 F.2d
408, 410 (11th Cir.1987) (citing Williamson v. Tucker, 645 F.2d 404, 423-24 (5th Cir.1981)). While we have
yet to resolve the precise level of control dictated by Forman (and refrain from doing so here), we conclude
Appellants' operation meets any reasonable interpretation of "solely."
First, contrary to Appellants' assertion, Appellants did not manage non-discretionary investment
accounts in which individual investors made all key strategic decisions. Rather, as noted above, the record
supports the district court's finding that Appellants did not engage in any actual trading, but instead operated
a fraudulent scheme which misappropriated investors's funds. Thus, the investors retained no control over
their investments, since there were no investments to control. Second, the original customer agreement
specifically gave Appellants the "sole discretion to use the total funds" deposited by the investors. (emphasis
added). Consequently, both the language of the agreement and Appellants' actual operations support the
district court's finding that Appellants' operations met the third prong of the Howey test.
Because a review of the record indicates that all three prongs of the Howey test have been met, we
conclude Appellee did establish a reasonable probability of ultimate success upon the question of jurisdiction.
The district court therefore did not abuse its discretion in granting the preliminary injunction.
B. The Commodities Exchange Act
Appellants also argue that the Commodity Futures Trading Commission (CFTC), through the
Commodities Exchange Act (CEA), 7 U.S.C. §§ 1-25, divests the SEC of authority to bring this action. The
essential issue is whether the trading of futures of investment contracts is a securities transaction subject to
7
In Villeneuve, we refrained from deciding whether Forman and Koscot are consonant. We refrain from
resolving this issue here as well.
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the SEC's jurisdiction, a futures transaction subject to the CFTC's jurisdiction, or both. Thus, this case
"requires an inquiry into the relative boundaries of jurisdiction between the CFTC and the SEC as intended
by Congress." Messer v. E.F. Hutton & Co., 847 F.2d 673, 674-75 (11th Cir.1988).
The "exclusive jurisdiction" provision of the CEA defines the ambit of the CFTC's exclusive
jurisdiction over the commodities market. It reads, in relevant part, as follows:
[T]he CFTC shall have exclusive jurisdiction with respect to accounts, agreements (including any
transaction which is of the character of, or is commonly known to the trade as, an "option,"
"privilege," "indemnity," "bid," "offer," "put," "call," "advance guarantee," or "defined guarantee,")
and transactions involving contracts of sale of a commodity for future delivery, traded or executed
on a contract market designated pursuant to section 7 of this title or any other board of trade,
exchange or market....
7 U.S.C. § 2 (emphasis added). In contrast, the "SEC savings clause" preserves SEC authority over its
traditional regulatory functions despite the CFTC's jurisdiction. It reads, in relevant part, as follows:
[E]xcept as hereinabove provided, nothing contained in this section shall:
(i) supersede or limit the jurisdiction at any time conferred on the Securities and Exchange
Commission or other regulatory authorities under the laws of the United States or any State, or
(ii) restrict the Securities and Exchange Commission and such other authorities from carrying
out their duties and responsibilities in accordance with such laws.
7 U.S.C. § 2.
Appellants note that this Court, in Messer, has upheld the exclusive jurisdiction of the CFTC over
certain future trades. See Messer, 847 F.2d at 675. Appellants then claim the transactions in this case
involved commodities futures, in the form of individual foreign currency options, and thus fall within the
exclusive jurisdiction of the CFTC. We disagree.
While the exclusive jurisdiction provision applies to the offer and sale of a commodity for future
delivery, Appellants concede that the SEC savings clause preserves the SEC's jurisdiction over the offer and
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sale of investment interests in a commodity pool.8 Thus, if we conclude Appellants offered investment
interests in a commodity pool, we also must conclude the SEC has jurisdiction over this case.
This Court has not defined the term commodity pool, but the CFTC regulations define "pool" as "any
investment trust, syndicate or similar form of enterprise operated for the purpose of trading commodity
interests." 17 C.F.R. § 4.10(d)(1) (1998). This definition encapsulates Appellants' investor scheme. As
discussed above, the district court explicitly found that the investors' funds were to be pooled and distributed
on a pro rata basis for the (alleged) purpose of trading commodity interests. Appellants thus were offering
an investment opportunity in a commodity pool which even Appellants admit is subject to the SEC's
jurisdiction.
Appellants' reliance on Messer for the claim that the CFTC has exclusive jurisdiction over this case
is misplaced. In Messer, this Court concluded that T-bond futures, a type of commodity, were under the
exclusive jurisdiction of the CFTC. The T-bond futures at issue in Messer were traded in individual
discretionary accounts. See Messer, 847 F.2d at 674, 679. In this case, however, as discussed above, the
foreign currency options (allegedly) were traded in an investment or commodity pool. This distinction is
critical. Commodities, such as the T-bond futures in Messer, are within the exclusive jurisdiction of the
CFTC. Commodity pools, such as the foreign currency options pool in this case, are within the concurrent
jurisdiction of the CFTC and the SEC.
We therefore conclude the CEA did not divest the SEC of authority to bring this action.
V. CONCLUSION
The district court did not abuse its discretion in granting the preliminary injunction. Appellants'
activities were investment contracts covered under the Securities Act. The SEC thus established a reasonable
8
Although, given Appellants' concession, we need not address this issue, there is extensive evidence that
Congress intended the SEC to have concurrent jurisdiction over commodity pools. See, e.g., 7 U.S.C. §
6m(2); H.R.Rep. No. 97-565 (Part I) at 82 (1982), reprinted in 1982 U.S.C.C.A.N. 3871, 3931.
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probability of success on the question of jurisdiction. In addition, the CEA did not divest the SEC of
authority to bring this action.
AFFIRMED.
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