Last month the Supreme Court of Mississippi handed down its 6-3 split opinion in the matter of Harrington v. Mississippi Secretary of State. The appellants in this case were officers in a real estate investment company. The officers solicited and sold over $1,500,000 of membership interests in the investment company through a private placement memorandum (PPM). The solicitation projected $60,000,000 in revenue and $20,000,000 in earnings over five years. Finally, the PPM provided that full and complete “records and books of accounts would be maintained and available to the investors.”
The Secretary of State's Securities and Charities Division ultimately issued a summary Cease and Desist Order against the company—SteadiVest, LLC. Among other things, the Division alleged that StediVest was a Ponzi scheme and that the PPM misled investors. The Division charged the two officers with five violations of the Mississippi Securities Act.
An administrative hearing was held on the allegations after which the hearing officer recommended that a penalty of $1,585,000 be imposed—the amount raised by the offering. Regardless, the Secretary of State issued a Final Order fining one officer $850,000 and the other $170,000. The officers appealed to the court system. The lower court upheld the Secretary of State's Order, and the officers appealed once again.
The Supreme Court dispensed with ease the officers' challenge to the sufficiency of the evidence against them. It also rejected their claims that the warnings in the PPM were sufficient and that the Division should have been required to prove scienter (knowing or intentional conduct). The Court's scienter analysis was grounded in the parallel between the Model Securities Act and Section 17 of the Federal Securities Act of 1933, as well as the variant scienter requirements within 17(a)(b) and (c). Perhaps more on this aspect of the opinion in a future blog.
This blog is intended to draw the reader's attention to one specific portion of the Supreme Court's analysis that deals with the calculation of fines for the two officers. Why is this important? In my experience, regulators frequently seek to ratchet up the total potential statutory fine by dissecting a single violation into a multitude of violations in order to achieve a drastic multiplier of the statutory fine exposure.
The Supreme Court's analysis in this regard can be found on pp.18-19 of the opinion. The Supreme Court upheld the Secretary of State's determination that two separate violations occurred, segregating the PPM violation from the books and records violation, but it rejected the Secretary of State's subsequent application of a multiplier of 17 for each affected investor.
Finally, anyone who has defended an agent or investment adviser representative before a state securities regulator might take some comfort in the Presiding Justice's dissenting opinion in this case. To give you just a taste:
If the majority intends to say that the Legislature has given the Secretary of State the power and authority to find a violation for ever representation in a securities offering that the Secretary of State subjectively believes might (as opposed to did or, unless abated, is going to) operate as a fraud, then it is enough for me to say that I simply reject that tortured interpretation of the statute. In my view, some proof is required that someone actually did detrimentally rely, or actually would have detrimentally relied, on the representations.
The word fraud is understood by nearly everyone who can spell it (including my esteemed colleagues in the majority), to mean an intentional material, less than truthful, representation upon which the speaker intends the victim to rely, and upon which the victim does actually, detrimentally, rely1. This Court has applied that meaning since before Mississippi became a state, and the English were employing it in the Common Law when Henry VIII schemed a way to marry Anne Boleyn. Law students must know and apply that meaning on law school and bar exams.
Food for thought.
1Hobbs Auto, Inc. v. Dorsey, 914 So.2d 148, 153 (Miss.2005)