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Securities and Exchange Commission v. Louis Schooler and First Financial Planning Corporation D/B/A Western Financial Planning Corporation


September 12, 2012


The opinion of the court was delivered by: Honorable Larry Alan Burns United States District Judge


The Court granted the SEC's ex parte motion for a temporary restraining order on September 6, 2012. According to the SEC, Defendants are violating the registration and antifraud provisions of the federal securities laws by, among other things, selling partnership interests in undeveloped land at a huge markup.

On September 11, Defendants filed an emergency motion to dissolve or modify the TRO pursuant to Fed. R. Civ. P. 65(b)(4). The motion makes, in essence, three arguments, which the Court summarized as follows in an order setting a briefing schedule that it entered the same day:

The first is that, by its own admission, the SEC didn't show that irreparable injury would result before Defendants could be heard. In fact, the SEC took the position, mistaken in Defendants' view, that "[u]nlike private litigants, if the government can show a probability of success on the merits, the courts presume irreparable injury in Commission enforcement actions where injunctive relief is sought." (Doc. No. 3-1 at 13.) The Defendants' second argument cuts to the heart of the SEC's jurisdiction to bring claims against them: the general partnership investments at issue simply are not securities. Here, the Defendants take issue with the SEC's claim in its moving papers that "[a]lthough some courts have found that investments in land solely for the purpose of obtaining profits from appreciation of property value on resale are not securities, and some general partnership interests are not investment contracts, the GP units at issue in this case are securities." (Doc. No. 3-1 at 14.)

And the Defendants' third argument is that the TRO threatens to do their business irreparable harm by its requirement that the appointed receiver notify each and every investor of the SEC's allegations and the TRO itself. Related to this, the Defendants argue that the TRO places the receiver in the conflicted position of serving the General Partnerships alongside Western: "Wearing his hat as receiver to the General Partnerships, he is required to send out notices to all of Western's investors. Wearing his hat as receiver to Western, it would be gross negligence or worse to send out a mass mailing to every past customer spreading inaccurate statements and allegations and would irreparably harm Western." (Doc. No. 14 at 3.)

(Doc. No. 17 at 1--2.)

The SEC has now responded to Defendants' arguments, and the Court will address them in sequence.

I. Irreparable Harm

A TRO is simply a preliminary injunction issued on short notice or no notice at all, and with a quick expiration date. The standards governing their issuance are "substantially identical." Stuhlbarg Int'l Sales Co. v. John D. Brush & Co., 240 F.3d 832, 839 n.7 (9th Cir. 2001). A plaintiff must show, among other things, that it "is likely to suffer irreparable harm in the absence of preliminary relief." Winter v. Natural Res. Def. Council, Inc., 555 U.S. 7, 20 (2008).

The TRO sought by the SEC, however, was issued without written notice to Defendants, and that requires a heightened showing of irreparable harm under Federal Rule of Civil Procedure 65:

(1) Issuing Without Notice. The court may issue a temporary restraining order without written or oral notice to the adverse party or its attorney only if:

(A) specific facts in an affidavit or a verified complaint clearly show that immediate and irreparable injury, loss, or damage will result to the movant before the adverse party can be heard in opposition; and

(B) the movant's attorney certifies in writing any efforts made to give notice and the reasons why it should not be required.

Fed. R. Civ. P. 65(b). In other words, while a standard-issue preliminary injunction must find a likelihood of irreparable harm, a secret-issue TRO must find a certainty of it. This higher hurdle "reflect[s] the fact that our entire jurisprudence runs counter to the notion of court action taken before reasonable notice and an opportunity to be heard has been granted both sides of a dispute." Granny Goose Foods, Inc. v. Bhd. of Teamsters, 415 U.S. 423, 438 (1974).

Defendants accuse the SEC of "giv[ing] itself a pass on the irreparable injury requirement," and indeed it does. But it does so on good authority-and, critically, only with respect to the basic standard for issuance of a preliminary injunction or temporary restraining order, not with respect to the notice requirement. (See Doc. No. 3-1 at 12--13.) The SEC may obtain a preliminary injunction simply by establishing "(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. Unique Fin. Concepts, Inc., 196 F.3d 1195, 1199 n.2 (11th Cir. 1999). The irreparable harm requirement is waived, as it were, because "[i]n statutory enforcement cases where the government has met the 'probability of success' prong of the preliminary injunction test . . . the passage of the statute is itself an implied finding by Congress that violations will harm the public," United States v. Nutri-Cology, Inc., 982 F.2d 394, 398 (9th Cir. 1992). See also SEC v. Mgmt. Dynamics, Inc., 515 F.2d 801, 808 (2d Cir. 1975) ("But the statutory imprimatur given SEC enforcement proceedings is sufficient to obviate the need for a finding of irreparable injury at least where the statutory prerequisite the likelihood of future violation of the securities laws has been clearly demonstrated.")

Contrary to the Defendants' argument, the SEC doesn't ignore Rule 65 or read into it the legal standard for issuance of a preliminary injunction discussed in Unique Fin. Concepts, Nutri-Cology, and Mgmt. Dynamics. The notice page of its TRO application explicitly "seeks waiver of the notice requirements of Rule 65(b)" on the ground that "it is clear from specific facts set forth in the evidence that the Commission has submitted with the Application that immediate and irreparable injury, loss or damage will result if the defendants are notified of the Commission's Application before it is heard." (Doc. No. 3 at 1.) The Court, considering the supporting memo and evidentiary record, was satisfied with this argument, and that is why it agreed to accept the SEC's TRO application on an ex parte basis, depriving Defendants of the opportunity to be heard up front. The Defendants' first objection to the TRO is therefore OVERRULED.

II. Likelihood of Success on the Merits

Defendants' second argument is that the SEC failed to show a likelihood of success on the merits by failing to show that the general partnership interests at issue in this case are in fact securities.

The securities laws regulate securities, which are defined to include "investment contracts." 15 U.S.C. § 78c(a)(10). The Supreme Court, in SEC v. W.J. Howey Co., defined an investment contract as "a contract, transaction or scheme whereby a person (1) invests his money in (2) a common enterprise and is led to (3) expect profits solely from the efforts of the promoter or a third party." 328 U.S. 293, 298--99 (1946). The Ninth Circuit has held, moreover, that "solely" in the third prong isn't to be read literally. Rather, the question is 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 Enters., Inc., 474 F.2d 476, 482 (9th Cir. 1973).

In this case, as in most, the determinative prong is the third: Do the investors who purchase the general partnership interests expect profits solely from Defendants' efforts? The leading case on this issue, followed by the Ninth Circuit, is Williamson v. Tucker. See Koch v. Hawkins, 928 F.2d 1471, 1476--78 (9th Cir. 1991). In Williamson, the Fifth Circuit held that a general partnership interest can be designated a security if the investor can establish, for example, that (1) an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership; or (2) the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or (3) the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers. 645 F.2d at 424.

The SEC addressed the Williamson factors at length in its TRO memo, with substantial reference to a thick evidentiary record. (Doc. No. 3-1 at 14--17.) The Court found it likely that the SEC could show the general partnership interests at issue in this case are securities, and therefore subject to the SEC's regulatory and enforcement powers. The Court isn't moved from that finding after having read and considered Defendants' motion to dissolve the TRO. For example, Defendants' first substantive move is to reference the General Partnership Agreement to claim that, in fact, "[t]here are no limited partners" and "[a]ll partners are general partners." Doc. No. 14 at 9. But that technical point misses the first principle that the term "investment contract," as defined by the Supreme Court in W.J. Howey Co., "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." 328 U.S. at 299. Thus, the formal structure or label of the general partnerships doesn't determine whether they're securities; the Court has to consider "the economic realities of the transactions." Considering that, Defendants' second objection to the TRO is OVERRULED.

III. Irreparable Harm to Defendants

Defendants take the position that alerting all of their investors of the SEC's allegations and the TRO would likely end their business. (Doc. No. 14 at 16--17.) They don't explain exactly how this would happen, however, which the SEC is eager to point out. (Doc. No. at 6.) Indeed, as the SEC is also eager to point out, Defendants avoid in their motion to dissolve the TRO the SEC's core charge, namely that the price the general partnerships pay for the undeveloped land far exceeds its fair market value. As far as the Court can tell, the Defendants sole come-back to this is that Western did in fact provide detailed disclosures to all investors: "Western provides extremely detailed Partner Representations (attached as Exhibit 3) that fully describe the full extent of the nature and character of the investment, its speculative nature, the unknown time horizon and risks inherent in the investment." (Doc. No. 14 at 15.) One of these representations, on the Court's reading of the document, is that Defendants "will be making a very substantial profit in the sale of the real property to the Partnership. Therefore, as between [Defendants] and [the investor] there exists a conflict of interest and no fiduciary relationship." (Doc. No. 14-3 ¶ 74.)

This objection is OVERRULED, although, out of an abundance of caution for Defendants' interests, the Court will not lift the stay on the receiver's notification obligation until it hears from the parties at the September 17 hearing. The Court remains, it should say, extremely skeptical of Defendants' position-basically, that their investors should not be notified of a public proceeding and public documents that are a part of that proceeding. On the other hand, the SEC's suggestion notwithstanding, the Court doubts that between the time this Order is issued and the time of the September 17 hearing the investors could even be properly notified and make plans to appear in court. This issue, apparently the highest of Defendants' concerns, can wait until Monday.

IV. Conclusion

Defendants' motion to dissolve the TRO is DENIED. This denial is WITHOUT PREJUDICE, of course, to their ability to argue on September 17 that the temporary restraining order should expire without the issuance of a preliminary injunction. The Court has received Defendants' opposition brief and will give the issues full and fresh consideration.



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