Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-casd-3_12-cv-02164/USCOURTS-casd-3_12-cv-02164-23/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:0077 Securities Fraud

---

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF CALIFORNIA

SECURITIES AND EXCHANGE

COMMISSION,

Plaintiff,

CASE NO. 3:12-cv-2164-GPC-JMA

ORDER GRANTING IN PART AND

DENYING IN PART THE SEC’S

MOTION FOR PARTIAL

SUMMARY JUDGMENT ON ITS

FIRST AND SECOND CLAIMS

FOR RELIEF

[ECF No. 1015]

v.

LOUIS V. SCHOOLER and FIRST

FINANCIAL PLANNING

CORPORATION, dba Western

Financial Planning Corporation,

Defendants.

I. INTRODUCTION

Before the Court is Plaintiff Securities and Exchange Commission’s (the “SEC”)

Motion for Partial Summary Judgment on its First and Second Claims for Relief. (ECF

No. 1015.) Defendants Louis V. Schooler (“Schooler”) and First Financial Planning

Corporation d/b/a Western Financial Planning Corporation (“Western”) (collectively,

“Defendants”) oppose. (ECF No. 1063.)

The parties have fully briefed the motion. (ECF Nos. 1015, 1063, 1067.) A

hearing on the SEC’s motion was held on May 19, 2015. (ECF No. 1073.) Upon review

of the moving papers, admissible evidence, oral argument, and applicable law, the

Court GRANTS IN PART AND DENIES IN PART the SEC’s motion for partial

- 1 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 1 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

summary judgment.

II. BACKGROUND

This is an enforcement action brought by the SEC. (See ECF No. 1.) The SEC

alleges that Defendants defrauded investors in the sale of general partnership (“GP”)

units which were, as a matter of law, unregistered securities. (Id.) On September 4,

2012, the SEC filed its complaint. (Id.) On October 22, 2012, this case was transferred

to the undersigned judge. (ECF No. 52.) On July 15, 2013, Defendants filed an answer

to the SEC’s complaint. (ECF No. 255.) On March 28, 2014, the SEC filed a motion

for partial summary judgment with regards to whether the GP units were securities.

(ECF No. 563.) On April 25, 2014, the Court granted the SEC’s motion for partial

summary judgment and found that the GP units at issue in this case were securities as

a matter of law (the “Securities Order”). (ECF No. 583.) The facts of this case are set

forth in further detail in the Securities Order. (Id. at 1–11.)

On March 13, 2015, the SEC filed the present motion for partial summary

judgment on its first and second claims for relief. (ECF No. 1015.) On April 24, 2015

Defendants filed an opposition to the SEC’s motion. (ECF No. 1063.) On May 8, 2015,

the SEC filed a response to Defendants’ opposition. (ECF Nos. 1067.) The SEC moves

for summary judgment on its first and second claims for relief: that Defendants violated

Section 17(a) of the Securities Act of 1933 (“Section 17(a)”), 15 U.S.C. § 77q(a),

Section 10(b) of the Exchange Act of 1934 (“Section 10(b)”), 15 U.S.C. § 78j(b), and

Rule 10b-5 promulgated under the Exchange Act of 1934 (“Rule 10b-5”), 17 C.F.R.

§ 240.10b-5. (ECF No. 1 ¶¶ 67–74; ECF No. 1015.)

III. LEGAL STANDARD

Federal Rule of Civil Procedure 56 empowers the Court to enter summary

judgment on factually unsupported claims or defenses, and thereby “secure the just,

speedy and inexpensive determination of every action.” Celotex Corp. v. Catrett, 477

U.S. 317, 325, 327 (1986); FED.R.CIV. P. 56. Summary judgment is appropriate if the

“pleadings, depositions, answers to interrogatories, and admissions on file, together

- 2 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 2 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

with the affidavits, if any, show that there is no genuine issue as to any material fact

and that the moving party is entitled to judgment as a matter of law.” FED. R. CIV. P.

56(c). A fact is material when it affects the outcome of the case. Anderson v. Liberty

Lobby, Inc., 477 U.S. 242, 248 (1986).

The moving party bears the initial burden of demonstrating the absence of any

genuine issues of material fact. Celotex, 477 U.S. at 323. The moving party can satisfy

this burden by demonstrating that the nonmoving party failed to make a showing

sufficient to establish an element of his or her claim on which that party will bear the

burden of proof at trial. Id. at 322–23. If the moving party fails to bear the initial

burden, summary judgment must be denied and the Court need not consider the

nonmoving party’s evidence. Adickes v. S.H. Kress & Co., 398 U.S. 144, 159–60

(1970).

Once the moving party has satisfied this burden, the nonmoving party cannot rest

on the mere allegations or denials of his or hear pleading, but must “go beyond the

pleadings and by her own affidavits, or by the ‘depositions, answersto interrogatories,

and admissions on file’ designate ‘specific facts showing that there is a genuine issue

for trial.’” Celotex, 477 U.S. at 324 (citing FED. R. CIV. P. 56 (1963)). If the

non-moving party fails to make a sufficient showing of an element of its case, the

moving party is entitled to judgment as a matter of law. Id. at 325. “Where the record

taken as a whole could not lead a rational trier of fact to find for the nonmoving party,

there is no ‘genuine issue for trial.’” Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,

475 U.S. 574, 587 (1986) (citing FED. R. CIV. P. 56 (1963)). In making this

determination, the Court must “view [] the evidence in the light most favorable to the

nonmoving party.” Fontana v. Haskin, 262 F.3d 871, 876 (9th Cir. 2001). The Court

does not engage in credibility determinations, weighing of evidence, or drawing of

legitimate inferences from the facts; these functions are for the trier of fact. Anderson,

477 U.S. at 255.

/ /

- 3 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 3 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

IV. DISCUSSION

A. Evidentiary Disputes

1. Judicial Admissions

First, the statements made by Defendants, (ECF No. 571-1 ¶¶ 9–10), are not, as

the SEC argues, “conclusively binding.” (See ECF No. 1067, at 2–3 (citation omitted).)

Federal Rule of Civil Procedure 7 generally allows for two types of filings by the

parties: (1) “pleadings,” and (2) “motions and other papers.” FED. R. CIV. P. 7. Rule 7

further specifies that there are exactly seven types of pleadings, primarily complaints,

answers to complaints, and replies to answers to complaints. Id. Ignoring this

distinction, the SEC misinterprets American Title Insurance Co. v. Lacelaw Corp., 861

F.2d 224 (9th Cir. 1988), and Ferguson v. Neighborhood Housing Services, 780 F.2d

549 (6th Cir. 1986). With regards to pleadings, those cases do hold that “stipulations

and admissions in the pleadings are generally binding on the parties and the Court.”

Am. Title, 861 F.2d at 224 (citation and quotation marks omitted); Ferguson, 780 F.2d

at 551. But Defendants’ statements at issue are not contained in the pleadings, they are

contained within a response to a statement of facts submitted in conjunction with an

opposition to a motion. (See ECF No. 571-1 ¶¶ 9–10.) This is, of course, not a

“pleading” but an “other paper[],” FED. R. CIV. P. 7, and thus not governed by

Ferguson. 780 F.2d at 550 (“The primary issue presented by this appeal is the

significance and effect of NHS’ admission in its answer . . . .”) (emphasis added).

Statements contained in non-pleadings, such as briefs, are governed by the Ninth

Circuit’s holding in American Title: “statements of fact contained in a brief may be

considered admissions of the party in the discretion of the district court.” 861 F.2d at

226–27 (emphasis in original). To the extent that Defendants now dispute a statement

contained in an earlier non-pleading filing, (compare ECF No. 1063-1 ¶¶ 8–9 with ECF

No. 571-1 ¶¶ 9–10 ), the Court exercises its discretion and does not consider the earlier

statement to be a judicial admission. (Cf. ECF No. 1029, at 11.)

/ /

- 4 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 4 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

2. Schooler’s 2015 Deposition

Second, Defendants argue that statements from Schooler’s 2015 deposition are

inadmissible because Schooler was unable to review the transcript pursuant to Federal

Rule of Civil Procedure 30(e). (ECF No. 1063-1 ¶ 13.) Though one of Schooler’s

attorneys, Philip Dyson, declares that Mr. Dyson was not “notified by the certified

court reporter that Mr. Schooler’s transcript was ready for review,” (ECF No. 1063-2

¶ 13), the SEC has submitted a letter indicating that another of Schooler’s attorneys,

Eric Hougen, was notified that Schooler’s transcript was available for review, (ECF

No. 1067-2, Ex. 4). Ultimately, Rule 30(e) permits introduction of Schooler’s original

deposition testimony. See Podell v. Citicorp Diners Club, Inc., 112 F.3d 98, 103 (2d

Cir. 1997) (original answer admissible even when deponent amends deposition

transcript). Furthermore, to the extent that Schooler believed his deposition statements

were in error, he could have stated so in his declaration, which he did not directly do.

(See ECF No. 1063-3.) Though he alleges that he never obtained a copy from the court

reporter pursuant to Rule 30(e), (id. ¶ 17), his counsel was in possession of at least the

portions of the transcript that the SEC submitted in support of its present motion and

his counsel could have shared those portions with him. (See ECF Nos. 1015-5, 1015-6.)

Accordingly, the Court finds that the statements contained in Schooler’s 2015

deposition can be considered by the Court for purposes of the present motion.

B. Fraud

The SEC alleges that Defendants violated three antifraud provisions: (1) Section

17(a), (2) Section 10(b), and (3) Rule 10b-5. (ECF No. 1 ¶¶ 67–74.) There are four

elements to violations of all three provisions: “[1] a material misstatement or omission

[2] in connection with the offer orsale ofsecurity [3] by means of interstate commerce”

[4] made with the requisite intent. Sec. and Exch. Comm’n v. Phan, 500 F.3d 895,

907–08 (9thCir. 2007) (citation omitted). For “[v]iolations ofSection 17(a)(1), Section

10(b), and Rule 10b-5,” scienter is satisfied by a showing of recklessness. Sec. and

Exch. Comm’n v. Dain Rauscher, Inc., 254 F.3d 852, 856 (9th Cir. 2001) (emphasis

- 5 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 5 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

and citation omitted). For “[v]iolations of Sections 17(a)(2) and (3),” intent is satisfied

by a showing of negligence. Id. (citation omitted).

1

As the Court previously found that the GP units at issue in this case are securities

and that Defendants advertised or sold the GP units through telephone and mail, (ECF

No. 583, at 3, 20; see also ECF No. 4-25), the Court finds that the SEC has satisfied

its burden with regards to the security and interstate commerce elements and thus

GRANTS the SEC summary judgment on these elements. See Sec. and Exch. Comm’n

v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) (“We have said that the ‘in

connection with’ requirement is met if the fraud alleged ‘somehow touches upon’ or

has ‘some nexus’ with ‘any securities transaction.’”) (quoting Sec. and Exch. Comm’n

v. Clark, 915 F.2d 439, 449 (9th Cir. 1990)). The Court now turns to whether the

statements or omissions were material and whether Defendants acted with the requisite

intent.

1. Materiality

Materiality is defined as “a substantial likelihood that the disclosure of the

omitted fact would have been viewed by the reasonable investor as having significantly

altered the ‘total mix’ of information made available.” TSC Indus., Inc. v. Northway,

Inc., 426 U.S. 438, 449 (1976). The Ninth Circuit has cautioned that “[d]etermining

materiality in securities fraud cases ‘should ordinarily be left to the trier of fact.’”

Phan, 500 F.3d at 908 (quoting In re Apple Computer Secs. Litig., 886 F.2d 1109, 1113

(9th Cir. 1989)). “[E]ven when there is no dispute as to the facts, it usually is for the

jury to decide whether the conduct in question meets the reasonable-person standard.”

Phan, 500 F.3d at 908 (citations and emphasis omitted). Thus a misstatement or

omission must be “so obviously important to an investor, that reasonable minds cannot

The SEC notes that “[t]he Supreme Court has never addressed whether 1

negligence is necessary to prove a violation of Sections 17(a)(2) and (a)(3),” and

argues that negligence may not be required to prove a violation of Sections 17(a)(2) or

(3). (ECF No. 1015-1, at 12, 24–25.) However, the Ninth Circuit has unequivocally

stated that negligence is an element of Section 17(a)(2) and (a)(3) violations. Phan, 500

F.3d at 907; Dain Rauscher, 254 F.3d at 856.

- 6 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 6 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

differ on the question of materiality,” for the Court to decide the issue of materiality

on summary judgment. TSC Indus., 426 U.S. at 450 (quoting Johns Hopkins Univ. v.

Hutton, 422 F.2d 1124, 1129 (4th Cir. 1970)).

The SEC argues three bases for materiality: (1) failure to disclose the price that

Western’s initial purchase price on the properties it resold to the GPs at nearly 500%

that initial price, (2) the inclusion of purportedly comparable properties that were not

actually comparable, and (3) failure to disclose that the GPs’ properties were subject

to mortgages. (ECF No. 1015-1, at 14–22.)

a. Land Value

It is undisputed that Defendants omitted Western’s purchase price for the GP

properties from the information disclosed to the investors. (ECF No. 4-1, 139:3–14,

177:20–178:5.) Defendants respond that this omission is immaterial for four reasons:

(1) Defendants disclosed their conflict ofinterest to the investors, (2) Defendants’ prior

GP investments had been successful, (3) Defendants disclosed the speculative nature

of the investments, and (4) Western’s purchase price was “readily and publicly

available.” (ECF No. 1063, at 6–11.) First, the partnership representations do state that

there is a conflict of interest between Defendants and the investors. (ECF No. 14-3 ¶

74.) Second, while some prior GP investments may have been successful, the Court is

not convinced that the evidence provided by Defendants undisputedly proves that

alleged success. (See ECF No. 1003, at 13 (discussing the weaknesses in Defendants’

evidence of alleged success).) Third, the partnership representations do state that the

GP units are speculative investments. (ECF No. 14-3 ¶ 6.) Fourth, while Schooler

declares that the price Defendants “paid for the land . . . [is] public information

available in county records and title reports,” Defendants previously stated that they

“have not been able to obtain the final closing statements for all of the properties

acquired before 2004.” (ECF No. 1063-3 ¶ 15; ECF No. 981, at 36 n.7.) Receiver

Thomas C. Hebrank, who acts asfederal equity receiver in this case, has also indicated

that, even after title report searches, he was unable to find Western’s purchase price for

- 7 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 7 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

land held by approximately 26 GPs. (ECF No. 852-1, Ex. A.)

As an initial matter, the case cited by the SEC for the proposition that

information relevant to fair market value can be material to a securities purchaser, SEC

v. Cochran, 214 F.3d 1261 (10th Cir. 2000), is inapposite. (ECF No. 1015-1, at 14.)

Because Cochran was an appeal from a grant of summary judgment in favor of the

defendant, the Tenth Circuit viewed the facts in the light most favorable to the SEC in

that case. 214 F.3d at 1262–63 (citation omitted). Thus, while Cochran stands for the

proposition that information relevant to fair market value can be material in certain

situations, itsays nothing about whether an omission ofsuch information issufficiently

obvious to make its materiality appropriately resolved on summary judgment. See TSC

Indus., 426 U.S. at 450. The SEC’s reliance on SEC v. Fehn, 97 F.3d 1276 (9th Cir.

1996), is misplaced for similar reasons. (See ECF No.1015-1, at 15.) Fehn was an

appeal of a final judgment after a bench trial. 97 F.3d at 1282. Thus, the issue of

materiality was submitted to the finder of fact in Fehn, which the SEC argues against

in this case. Just as in Cochran, Fehn does not say whether an omission is sufficiently

obvious where a disclosure of the omitted fact could remedy an otherwise misleading

statement. See id. at 1290 n.12. However, the Ninth Circuit has stated that “the

materiality of information relating to financial condition, solvency and profitability is

not subject to serious challenge.” Sec. and Exch. Comm’n v. Murphy, 626 F.2d 633,

653 (9th Cir. 1980).

The Court notes that this is an extremely close call. The pertinent facts— that

Western marked up the GP properties by upwards of 500% and that Western did

disclose to at least some investors that it would make a “very substantial profit”—are

not in dispute. Other courts have found that failures to disclose far smaller markups

were material omissions even when accompanied by disclosures that there was some

sort of markup. See, e.g., Sec. and Exch. Comm’n v. Alliance Leasing Corp., No. 3:98-

cv-1810-J-CGA, 2000 WL 35612001 (S.D. Cal. Mar. 20, 2000), aff’d 28 F. App’x 648

(9th Cir. 2002). For example, in Alliance Leasing, the defendants made a general

- 8 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 8 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

disclosure that they would receive “commissions,” but failed to disclose that those

commissions amounted to 30%. 2000 WL 35612001, *10. On summary judgment, the

district court found that “[r]easonable minds could not differ that a general disclosure

of ‘commissions’ is not the equivalent of a disclosure of 30% commissions.” Id. The

district court thus granted summary judgment for the SEC, finding that “large

commissions amounting to 30 cents on every dollar invested are patently material”

because “large commissions impact the profitability of an investment and as such are

material to an investor’s informed decision.” Id. While the reasoning of Alliance

Leasing is quite persuasive, the Court finds that the materiality of the land value

omissions should be submitted to the finder of fact.

On one hand, Western’s initial purchase price may have been material to an

investor because it affected the likelihood that the investor would realize a return on

his or her investment, and, if so, how much that return could be. On the other hand,

Defendants did represent that they would make a “very substantial profit” by selling

the property to the investors, (ECF No. 14-3 ¶ 74), and thus the specific amount paid

by Westernmay have been immaterial because the investors were already informed that

that amount was substantially less than what the investors paid for the property. That

said, this disclosure was buried on the tenth page of an eleven page document in the

middle of a series of disclaimers. (See id.) While it is a close call, based on the

disclosure of what Defendants stood to gain, the Court cannot say that Western’s

purchase price is “so obviously important, that reasonable minds cannot differ on the

question of materiality.” TSC Indus., 426 U.S. at 450 (citation omitted); see also Sec.

and Exch. Comm’n v. Meltzer, 440 F. Supp. 2d 179, 194 (E.D.N.Y. 2006) (“[T]he

difference in compensation may or may not be material to a reasonable investor; it may

be that simply being alerted to the fact that some significant amount was paid is

significant, but that the actual amount is immaterial.”). Accordingly, the Court finds

that the materiality of Defendants’ alleged omission of the price Western paid for the

properties is a question to be decided by the finder of fact.

- 9 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 9 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

b. Comparable Properties

The SEC cites three alleged misrepresentations regarding allegedly comparable

properties (“comps”): (1) comps provided to Western’s sales representatives to help

market the Pyramid Highway property to investors, (ECF No. 4-24); (2) a brochure

provided to investors regarding the Stead property, (ECF No. 7-1, Ex. 1); and (3) the

use of land purchased by Wal-Mart as a comp for the Stead property in an email sent

by Western employee John Naviaux, (ECF No. 4-25, Ex. 25; ECF No. 7 ¶ 9). (ECF No.

1015-1, at 4–5, 8–10, 19–20.)

In response, Defendants argue that: (1) the investors represented that theydid not

rely on Defendants’ representations, (ECF No. 14-3 ¶ 19); and (2) the comps “were 2

merely puffery, and not actionable misrepresentations or omissions of material fact.”

(ECF No. 1063, at 12.) As an initial matter, whether the investors actually relied on the

representations is irrelevant to the SEC’s fraud causes of action. See Sec. and Exch.

Comm’n v. True N. Fin. Corp., 909 F. Supp. 2d 1073, 1097 (D. Minn. 2012)

(explaining that reliance is not an element of Section 17(a), Section 10(b), or

Rule10b-5 causes of action brought by the SEC); see also Sec. and Exch. Comm’n v. 

Rana Research, Inc., 8 F.3d 1358, 1364 (9th Cir. 1993) (“The SEC need not prove

reliance in its action . . . on the basis of violations of section 10(b) and Rule 10b-5.”);

Sec. and Exch. Comm’n v. Credit Bancorp, Ltd., 195 F. Supp. 2d 475, 490–91

(S.D.N.Y. 2002) (“The SEC does not need to prove investor reliance, loss causation,

or damages in an action under Section 10(b) of the Exchange Act, Rule 10b–5, or

Section 17(a) of the Securities Act.”) (citations omitted). The Court now turns to the

alleged misrepresentations cited by the SEC.

i. The Pyramid Highway Property

The evidence shows that the comps provided to Western’s sales representatives

At oral argument, the vast majority of Defendants’ argument with regards to the

2

comps wasthat the investors stated that they did not rely on Western’s representations.

(See ECF No. 1073.) As the Court notes below, reliance is not an element of the

antifraud provisions in an SEC enforcement action.

- 10 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 10 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

regarding the Pyramid Highway property were not comparable at the time of

investment. (Compare ECF No. 182-1, Ex. 13, at 97 (Pyramid Highway property

purchased by Schooler for approximately $3,000 per acre, sold to Western for

approximately $5,700 per acre, and then sold to investors for approximately $15,000

per acre) with ECF No. 4-24 (compsfor the Pyramid Highway property valued between

approximately $130,000 per acre and $700,000 per acre).) Indeed, Schooler himself has

admitted as much. (ECF No. 4-1, Ex. 1, at 164:1–25; ECF No. 4-2, Ex. 2, at

311:4–315:25.) However, the SEC does not cite what representations were made to

investors regarding the Pyramid Highway property. Though these “comps” were

provided to Western’s sales representatives, that does not show what those sales

representatives actually said to investors. Even if these comps were advertised to

investors, the investors may have viewed them as what the property “could become”

rather than what it was currently worth. (ECF No. 4-2, Ex. 2, at 314:19.) This is

consistent with an investor’s declaration that Western provided both “true comps,” i.e.,

properties that allegedly were comparable at the time of the investment, and “future

comps,” i.e. properties that allegedly showed what the property could be valued at in

the future, (ECF No. 563-4 ¶ 5), and the SEC’s evidence does not indicate whether the

Pyramid Highway compsit cites as alleged misrepresentations were advertised as “true

comps” or “future comps.” Accordingly, the SEC has failed to carry its burden to show

that a the Pyramid Highway comps were material.

ii. The Stead Property

3

The SEC makes two arguments with regards to the Stead property: (1) that the

comps given in Western’s brochure and in an email sent by Western employee John

Naviaux “were not, in fact, comparable” to the Stead property, (ECF No. 1015-1, at

19); and (2) the fair market value representation of the Stead property in Western’s

brochure was “less than 1/25th” of the actual fair market value, (ECF No. 1015-1, at

The Stead property is comprised of two primary parcels: (1) the North Stead 3

property containing approximately 39.8 acres, and (2) the South Stead property

contained approximately 76 acres. (See ECF No. 7-1, Ex. 1, at 5.)

- 11 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 11 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

10). The parties do not dispute that Western’s brochure on the Stead property,

displayed to potential investors (see ECF No. 1015-7, Ex. 4, at 39:9–41:7), stated that

the South Stead property “would, under current market conditions, be evaluated at

approximately $2.50 per sq foot” and that, “[i]n the past, similar commercial property

in the Reno area has been valued between $6.00 and $15.00 per sq foot, with some

small commercial pads approaching a price of $20.00 per square foot.” (ECF No. 7-1,

Ex. 1, at 5–6.) Similarly, the parties do not dispute that Mr. Naviaux sent an email to

an investor stating that “[w]e paid $2.50 a Sq. Ft.” for the Stead property and that WalMart paid “$8.78 per sq. ft.” “for their new site in Stead, NV.” (ECF No. 4-25, Ex. 25.)4

First, the Court finds that the alleged comps to the Stead property—$6.00 to

$15.00 per square foot in Western’s brochure and $8.78 per square foot in Mr.

Naviaux’s email—may have been “future comps” and thus not necessarily material

misrepresentations. This is consistent with the fact that Western’s brochure stated that

the $6.00 to $15.00 per square foot comps were from “the past” and that “[t]here is no

way to predict whether higher values would return.” (ECF No. 7-1, Ex. 1, at 5.) As with

the Pyramid Highway comps, a hypothetical reasonable investor could arguably have

viewed these comps as what the marketed property “could become,” (ECF No. 4-2, Ex.

2, at 314:19), and not considered the misrepresentation to be material. Accordingly, the

Court findsthat the materiality of Defendants’ alleged misrepresentation regarding the

purportedly comparable properties is a question to be decided by the finder of fact. See

TSC Indus., 426 U.S. at 450.

Second, the Court finds that the statement by Western—that, “under current

market conditions,” the South Stead property would “be evaluated at approximately

$2.50 per sq foot,” (ECF No. 7-1, Ex. 1, at 5)—was a material misrepresentation. The

appraisal obtained by the SEC which states that the fair market value of the Stead

The Court notes that this email appears to have been sent after the sale of GP 4

units in that instance because it states “[w]e paid” and thus would not necessarily be

a representation made in connection with the offer orsale of a security. (ECF No. 4-25,

Ex. 25 (emphasis added).) Though not entirely clear, “[w]e” appears to refer the

investor herself. (See ECF No. 1015-7, Ex. 4, at 42:3–22.)

- 12 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 12 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

property was $0.077 per square foot as of August 2010 and $0.053 per square foot as

of July 2012. (ECF No. 5-1, Ex. 1, at 4.) Citing the “Expert-Opinion Rebuttal Report 5

of Louis V. Schooler,” Defendants dispute the appraised values, arguing that the SEC’s

appraiser “used properties that are completely dissimilar.” (ECF No. 1063-1, at 26

(quoting ECF No. 862-9, Ex. 8, at 12–14).) However, the cited report by Schooler does

not attempt to rebut the Stead appraisal, but rather attempts to rebut the appraisals of

the Dayton IV and Washoe 5 properties. (See ECF No. 862-9, Ex. 8, at 4–5.) Thus,

Defendants cite no evidence that in any way disputes the Stead appraisal as nothing in

Schooler’s report indicates an issue with the SEC’s appraisals other than for the Dayton

IV and Washoe 5 properties.

However, the Court does note that Western’s brochure assumed that the Stead

property’s surface water rights were worth “$40,000 per acre foot,” (ECF No. 7-1, Ex.

1, at 5), but the SEC’s appraiser does not appear to have valued the water rights in his

appraisals because he stated that the water rights were either limited, potentially

inadequate for development, or potentially lost due to non-use. (See ECF No. 5-2, Ex.

1, at 69–70). Viewing the evidence in the light most favorable to Defendants, the Court

finds it appropriate to add the water rights valuation assumed by Western to appraised

value obtained by the SEC.

The Stead propertywas purchased with approximately 104.895 acre feet of water

rights, (ECF No. 5-1, Ex. 1, at 28; ECF No. 5-2, Ex. 1, at 69), which comes out to

approximately $4,195,800 based on the $40,000 per acre foot assumption in Western’s

brochure. Divided by the approximately 4,596,407.64 square feet in the Stead property,

this would increase the SEC’s appraised values by $0.913 per square foot had

Western’s assumption been used. This results in values of $0.99 per square foot for

August 2010 and $0.966 per square for July 2012.

The Stead property is approximately 105.519 acres, which is approximately

5

4,596,407.64 square feet. (See ECF No. 5-1, Ex. 1, at 3–4.) The appraiser valued the

property at $355,000 as of August 2010 and $244,500 as ofJuly 2012. (Id.) This results

in approximately $0.077 per square foot and $0.053 per square foot appraisals,

respectively.

- 13 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 13 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

As discussed above, the undisputed evidence indicatesthat the fair market value

of the Stead property was, using Western’s assumptions regarding water rights,

approximately one dollar per square foot in August 2010 and July 2012. By

representing that the fair market value of the South Stead property was $2.50 per

square foot, Western’s representation was 150% greater than the actual market value.

In the mind of a hypothetical reasonable investor, this misrepresentation would have

significantly changed the “total mix” of information, TSC Indus., Inc. v. Northway,

Inc., 426 U.S. at 449, because he or she was led to believe that the property was worth

more than double what the true fair market value was. Cf. Johnston v. Bumba, 764 F.

Supp. 1263 (N.D. Ill. 1991), aff’d 983 F.2d 1072 (7th Cir. 1992) (“We find this

disclosure [of ‘substantial profit’] too vague to satisfy the requirements of disclosure,

particularly where the fair market value of the systems was misrepresented.”). Due to

the magnitude of difference between the actual fair market value and Western’s

statements, summary judgment on the misrepresentation of the South Stead property’s

fair market value is appropriate because it is “so obviously important, that reasonable

minds cannot differ on the question of materiality.” TSC Indus., 426 U.S. at 450

(citation omitted). Accordingly, the Court finds that the fair market value

representation in Western’s brochure on the Stead property was material.

c. Mortgages

There is no evidence that Defendants directly told the investors that the GP

properties were encumbered by mortgages owed by Western. (See ECF No. 4-2, Ex.

2, at 289:14–15, 330:9– 25; ECF No. 4-5, Ex. 5, at 53:13–54:18.) Defendants respond

that the investors had notice of the mortgages because: (1) the partnership

representations specifically authorized the execution of deeds of trust, (ECF No. 14-3

¶ 23); (2) the all inclusive trust deeds (“AITDs”) executed by the GPs in relation to

each property specifically mentioned the mortgages (see, e.g., ECF No. 1063-2, Exs.

6–8); and (3) the underlying mortgages were publicly “available in county records and

title reports,” (ECF No. 1063-3 ¶ 15). (ECF No. 1063, at 12–14.)

- 14 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 14 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

As an initial matter, the AITDs appear to have been executed after the investors

made the decision to hand over their money to Western and thus, at the time the

investors purchased the security, the AITDs would not have informed the investors of

the underlying mortgages. (Compare ECF No. 182-1, Ex. 13, at 102 (escrow close date

for Pyramid Highway 177 Partners was May 6, 2010) with ECF No. 1063-2, Ex. 6

(AITD for Pyramid Highway 177, LLC executed on May 6, 2010).) However, as

Western, not the GPs or the investors, owed the mortgages, the mortgages were

essentially a “contingent liability” that Western might fail to pay the mortgages,

causing either the GP to pay the mortgage or the property to be foreclosed upon. Fehn,

97 F.3d at 1291. The materiality of a contingent liability depends “upon a balancing of

both the indicated probability that the event will occur and the anticipated magnitude

of the event in light of the totality of the company activity.” Basic Inc. v. Levinson, 485

U.S. 224, 238 (1988) (quoting Sec. and Exch. Comm’n v. Tex. Gulf Sulphur Co., 401

F.2d 833, 849 (2d Cir. 1968)). While the magnitude of the event is significant—either

foreclosure and loss of the investment property or the payment of potentially over a

million dollars, (see, e.g., ECF No. 182, at 5 (Dayton Valley II property secured by $1.5

million mortgage))—there is no evidence of the probability that Western would fail to

pay the mortgages. The SEC merely argues that “the magnitude of the event . . .

represents such a significant financial loss, that the mortgage information was clearly

material.” (ECF No. 1015-1, at 21.)

While the possibility of such an event could be material to a hypothetical

reasonable investor, if the event’s likelihood was low then the mortgage information

may not have been material. Because the SEC has not presented evidence that Western

ever failed to meet its obligations on these mortgages, let alone that such an event had

a more than marginal chance of occurring, the Court cannot say that the disclosure of

underlying mortgages is “so obviously important, that reasonable minds cannot differ

on the question of materiality.” TSC Indus., 426 U.S. at 450 (citation omitted).

Accordingly, the Court findsthat the materiality of Defendants’ alleged omission ofthe

- 15 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 15 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

underlying mortgages is a question to be decided by the finder of fact.

As the Court has found that only one of the SEC’s alleged bases for materiality

is properly decided on summary judgment, the Court GRANTS IN PART AND

DENIES N PART the SEC’s motion for summary judgment asto materiality. The SEC

requests “that the Court grant summary judgment as to the elements of its claims that

[the Court] deems have been established.” (ECF No. 1015-1, at 25.) Accordingly, the

Court turns to whether Defendants acted with scienter or negligence.

2. Intent

Generally, intent in securities fraud cases “should not be resolved by summary

judgment.” Provenz v. Miller, 102 F.3d 1478, 1489 (9th Cir. 1996) (emphasis in

original). Because of this, “the moving party bears a heavier burden of showing that

there exists no genuine issue of material fact.” Sec. and Exch. Comm’n v. Seaboard

Corp., 677 F.2d 1289, 1295 (9th Cir. 1982). Section 17(a)(1), Section 10(b), and Rule

10b-5 require a showing ofrecklessness; Sections 17(a)(2) and (a)(3)require a showing

of negligence. Dain Rauscher, 254 F.3d at 856. Reckless conduct is “defined as a

highly unreasonable omission, involving not merely simple, or even inexcusable

negligence, but an extreme departure from the standards of ordinary care, and which

presents a danger of misleading buyers or sellers that is either known to the defendant

or is so obvious that the actor must have been aware of it.” See Hollinger v. Titan Cap.

Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (quoting Sundstrand Corp. v. Sun Chem.

Corp., 553 F.2d 1033, 1045 (7th Cir.) cert. denied, 434 U.S. 875 (1977)). Negligent

conduct is defined as a “fail[ure] to use the degree of care and skill that a reasonable

person of ordinary prudence and intelligence would be expected to exercise in the

situation.” True N. Fin., 909 F. Supp. 2d at 1122 (citations omitted). Defendants

respond to the SEC’s allegations by arguing that: (1) they relied on the advice of

counsel, and (2) intent should be decided by the finder of fact. (ECF No. 1063, at

14–16.)

/ /

- 16 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 16 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

a. Reliance on Counsel

There are four elements that Defendants must prove to show reliance on the

advice of counsel: they “(1) made a complete disclosure to counsel; (2) requested

counsel’s advice as to the legality of the contemplated action; (3) received advice that

it was legal; and (4) relied in good faith on that advice.” Sec. and Exch. Comm’n v.

Goldfield Deep Mines Co. of Nev., 785 F.2d 459, 467 (9th Cir. 1985) (citing Sec. and

Exch. Comm’n v. Savoy Indus., Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir. 1981).

However, “such reliance does not operate as an automatic defense, but is only one

factor to be considered.” Id. (citation omitted). Though the SEC argues that “Schooler

never sought legal advice regarding his disclosures” prior to 2010, (ECF No. 1067, at

9), the Court is not so convinced. Schooler specifically asked his counsel whether the

GP units were securities, to which the response was, essentially, “probably not.” (See

ECF No. 1063-3, Exs. 1–4.) Because the antifraud provisions operate only in

connection with the offer or sale of a security, Phan, 500 F.3d 895 at 907–08, by

asking whether the GP units were securities and being advised that they were not,

Schooler was also asking whether he was in compliance with the antifraud provisions.

However, with regards to the Stead property brochure, the Court finds that

Defendants have not shown that they “made a complete disclosure to counsel” and thus

have failed to carry their burden. Goldfield, 785 F.2d at 467. Specifically, Defendants

never told counsel that they represented a property’s alleged fair market value to

investors, instead merely disclosing that they would use “sales videos, aerial

photographs, and the basic property description to sell the partnership interest.” (ECF

No. 1063-3, Ex. 2.) With regards to all other alleged misrepresentations and omissions,

the Court does not reach Defendants’ reliance on counsel argument because, as

discussed below, the Court finds that the SEC has failed to carry its burden on the

element of intent.

b. Stead Property Brochure

With regards to the material misrepresentation regarding the fair market value

- 17 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 17 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

of the South Stead property in Western’s brochure noted above, the Court finds that

Defendants acted with scienter. It is undisputed that Defendants purchased the Stead

property for approximately $1.85 million, or approximately $0.40 per square foot, on

April 1, 2010. (ECF No. 5-1, Ex. 1, at 28–29; ECF No. 1063-1, at 26.) Because

Defendants’ purchase of the Stead property was an arm’s length transaction,

Defendants must have been aware that their purchase price represented, at most,

approximately the fair market value of the land. (See ECF No. 5-1, Ex. 1, at 28–29.)

Yet in spite of the knowledge of their own purchase price, Defendants represented to

investors that the fair market value of the South Stead property was $2.50 per square

foot, (ECF No. 7-1, Ex. 1, at 5), which was over six times greater than what they paid

for it. This affirmative misrepresentation was an “extreme departure fromthe standards

of ordinary care” that Defendants knew, or should have known, presented a danger of

misleading investors. Hollinger, 914 F.2d at 1569 (citation omitted). On this specific

misrepresentation, the Court finds the SEC has carried its burden with regard to intent,

and thus with regards to all elements. Accordingly, the Court GRANTS the SEC’s

motion for summary judgment with regards to this misrepresentation.

c. Other Alleged Misrepresentations and Omissions

With regards to the other misrepresentations and omissions , the SEC argues that

three things show scienter: (1) Defendants’ “fail[ure] to disclose Western’s purchase

price or an appraisal to investors,” (2) Defendants “provid[ing] ‘comps’ to the sales

force that were not truly comparable to the properties Western was offering,” and (3)

Defendants’ “fail[ure] to disclose that significant third-party mortgages encumbered

the properties being offered to investors.” (ECF No. 1015-1, at 22–23.)

Summary judgment on intent is “inappropriate . . . unless all reasonable

inferencesthat could be drawn fromthe evidence defeat the plaintiff’s claims.” Vaughn

v. Teledyne, Inc., 628 F.2d 1214, 1220 (9th Cir. 1980) (citation omitted); Provenz, 102

F.3d at 1489–90 (“Thus, summary judgment on the scienter issue is appropriate only

where ‘there is no rational basis in the record for concluding that any of the challenged

- 18 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 18 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

statements was made with requisite scienter.’”) (emphasis in original) (quoting In re

Software Toolworks, 38 F.3d 1078, 1088 (9th Cir. 1994)). A reasonable inference that

Defendants’ actions were consistent with the ordinary standard of care can be drawn

with regards to all three of the alleged misrepresentations and omissions cited by the

SEC above. First, a reasonable person in Defendants’ position may have omitted

Western’s purchase because Defendants did disclose that they stood to make a “very

substantial profit.” (ECF No. 14-3 ¶ 74.) Second, a reasonable person in Defendants’

position may have represented the purportedly comparable properties as comparable

because Defendants could have believed that investors would view these comps as

what the property “could become” and not what it was worth at the time of investment.

(ECF No. 4-2, Ex. 2, at 314:19.) Third, a reasonable person in Defendants’ position

may have omitted the existence ofthe underlying mortgages because Defendants could

have believed that there was an extremely high likelihood that Western would meet its

payment obligations under the mortgage. See Basic, 485 U.S. at 238. Accordingly, the

Court finds that the SEC has not carried its burden with regards to the intent element

of the antifraud provisions and thus DENIES the SEC’s motion for summary judgment

with regards to intent on all other alleged misrepresentations and omissions.6

V. CONCLUSION AND ORDER

For the reasons stated above, IT IS HEREBY ORDERED that the SEC’s

Motion for Partial Summary Judgment on its First and Second Claims for Relief, (ECF

No. 1015), is GRANTED IN PART AND DENIED IN PART:

At oral argument, the SEC argued that “one misrepresentation to one investor 6

issufficient to find a violation.” (ECF No. 1079.) While the SEC istechnically correct,

the Court does note that, in determining the appropriate civil penalties in SEC

enforcement actions, each separate violation is relevant. See Sec. and Exch. Comm’n

v. Tourre, 4 F. Supp. 3d 579, 583 (S.D.N.Y. 2014) (“Courts assess civil penalties on

a per-violation basis.”). As the SEC has indicated that it may seek civil penalties in this

case, (ECF No. 685-1, at 14–15), the Court believes it appropriate to submit the

materiality and intent of the other alleged misrepresentations and omissions to the

finder of fact to determine whether Defendants did, in fact, commit any other

violations. Were the SEC to abandon its first and second causes of action based on the

other alleged misrepresentations and omissions and decide not to seek penalties based

on those alleged misrepresentations and omissions, the issue would not need to be

resolved by the finder of fact.

- 19 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 19 of

20
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

1. With regards to the Stead property fair market value representation in

Western’s brochure, the SEC’s first and second causes of action are

GRANTED as to all elements; and

2. With regards to all other alleged misrepresentations and omissions, the

SEC’s first and second causes of action are GRANTED as to an offer or

sale of a security, GRANTED as to interstate commerce, DENIED as to

materiality, and DENIED as to intent.

DATED: June 3, 2015

HON. GONZALO P. CURIEL

United States District Judge

- 20 - 3:12-cv-2164-GPC-JMA

Case 3:12-cv-02164-GPC-LL Document 1081 Filed 06/03/15 PageID.<pageID> Page 20 of

20