U n i t e d S t a t e s D i s t r i c t C o u r t

N O R T H E R N D I S T R I C T O F T E X A S

D A L L A S D I V I S I O N

S E C U R I T I E S A N D E X C H A N G E

COMISSION

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V . § C I V I L A C T I O N N O . 3 : 2 2 - C V - 1 4 1 5 - S

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MICHAEL BOWEN and CHOL KIM a/k/a §

B R A N D O N K I M §

M E M O R A N D U M O P I N I O N A N D O R D E R

This Memorandum Opinion and Order addresses Defendant Michael Bowen’s Partial

Motion to Dismiss (“Motion”) [ECF No. 15]. The Court has considered the Motion, Bowen’s Brief

in Support of His Partial Motion to Dismiss (“Bowen’s Brief’) [ECF No. 16], Plaintiff Securities

and Exchange Commission’s (“SEC”) Response to Defendant’s Partial Motion to Dismiss

(“Response”) [ECF No. 19], Bowen’s Reply in Support of His Partial Motion to Dismiss [ECF

No. 20], and the applicable law. For the following reasons, the Court GRANTS the Motion.

I . B A C K G R O U N D

This is asecurities fraud and unregistered sales of securities case brought by the SEC

against Defendants William Glen Baker, Bowen, Cannon Operating Company EEC, North Texas

Minerals EEC, and Choi Kim a/k/a Brandon Kim.‘ In the Complaint, the SEC alleges that Baker,

Bowen, and Cannon raised approximately $2,182,687 from at least 140 investors between

January 2018 and September 2020 through the fraudulent and unregistered offer and sale of

securities. Compl. [ECF No. 1] H1- The securities at issue are four offerings of working interests

'Plaintiff voluntarily dismissed Cannon and North Texas Minerals. See ECF No. 24. The Court entered an

agreed Final Judgment as to Baker. See ECF No. 32. And the Clerk entered default against Kim. See ECF

No. 29. Bowen is the only remaining Defendant who has made an appearance in this case.

Case 3:22-cv-01415-S Document 38 Filed 09/21/23 Page 1 of 20 PageID 370
in Oklahoma oil and gas wells. Id. Bowen was the Chief Operating Officer and sales manager of

Cannon until his departure in September 2018. M]| 9.

In January 2018, Carmon and Baker began raising money for the four well offerings;

Mustang 2, Shawnee 1, Shawnee 3, and Shawnee 5. Id. 14. Cannon’s salespeople solicited

prospective investors for the Mustang 2and Shawnee 5projects, which were new wells to be

drilled in the Shawnee Field, where Cannon already operated several wells. Id. 14, 16. Baker

and Bowen, both officers of Cannon, also directly solicited investors. Id. 117. The salespeople.

Baker, and Bowen all received commissions when they successfully closed asale. Id. T| 40. Bowen

determined the commission amount for each sale. Id. ^41. Neither the salespeople nor Baker and

Bowen were registered as brokers. Id. *|f 40.

The Mustang 2offering began in April 2018. Id. T| 23. Baker and Bowen allegedly prepared

the written offering materials for Mustang 2, “with Baker drafting and Bowen reviewing and

editing them.” Id. T| 19. The materials included aPrivate Placement Memorandum and amarketing

brochure called the “Prospect Book” (collectively, “Mustang 2Offering Materials”). Id. Bowen

and others sent the Mustang 2Offering Materials to prospective investors. Id. The SEC alleges

that the Mustang 2Offering Materials were misleading. Specifically, the SEC claims that the

Prospect Book “contained misleading information about the actual production of oil and gas from

three of Cannon’s prior wells,” which were in the same field as the Mustang 2well’s proposed

location. Id. ^22. The Prospect Book claimed that the prior wells “continued to produce at massive

rates”; however, the SEC claims that actual production had declined dramatically and that the wells

had been offline in March and April 2018. Id. 22-23.

The SEC also alleges that Cannon’s, Baker’s, and Bowen’s subsequent actions did not

comport with the statements made in the Mustang 2Offering Materials. The Private Placement

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Memorandum promised investors that proceeds would be deposited into asegregated bank

account, but Baker never opened aseparate account and instead deposited investor funds into

Cannon’s general operating account. Id. T| 24. Further, the Private Placement Memorandum stated

that Caimon would use 85% of investor funds for “Program Costs” and 15% for a“Management

Fee,” but Cannon did not spend investor funds as promised. Id. 25-26. Cannon’s offering.

overhead, and management expenses allegedly “vastly exceeded” the 15% limit. Id. ^26. And

Bowen allegedly misused investor funds by using them to pay commissions to salespeople, even

though commissions were not authorized or disclosed to investors and exceeded the cap on

offering, overhead, and management expenses. Id. ^28.

The SEC further alleges that the Mustang 2Offering Materials omitted material

information, which Bowen knew or should have known because he reviewed, edited, and helped

prepare the documents. Id. 19, 30-31. First, the Mustang 2Offering Materials did not mention

Bowen or name him as Cannon’s Chief Operating Officer. Id. ^31. The SEC claims that “[t]his

omission was designed to prevent investors from learning about Bowen’s prior securities

violations.” Id. In 2018 and 2019, the SEC sanctioned Bowen for selling securities in unregistered

offerings and for selling securities without being registered as abroker. Id. ^9. The SEC issued an

order barring Bowen from selling securities on March 18, 2018. Id. 142. According to the SEC,

from March 18, 2018, to September 2018, Bowen solieited investors for Cannon in violation of

this order. Id. Second, the Mustang 2Offering Materials failed to disclose negative information

about Cannon and Baker.^ Id. 132. Third, the Mustang 2Offering Materials did not disclose the

payment of sales commissions. Id. 33. Bowen left Cannon in September 2018. Id. T| 9. Ultimately,

Cannon never drilled the Mustang 2well. Id. f37.

^The SEC does not attempt to tie the omission of negative information about Cannon and Baker to Bowen;

therefore, the Court does not analyze this omission below.

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Based on the foregoing allegations, the SEC asserts four claims against Bowen. First, the

SEC alleges that Bowen and others violated Section 10(b) of the Securities Exchange Act of 1934

(“Exchange Act”), 15 U.S.C. §78j(b), and Rule lOb-5 thereunder, 17 C.F.R. §240.10b-5, by

engaging in fraud in connection with the purchase or sale of securities. Compl. 48-51. Second,

the SEC alleges that Bowen and others violated Section 17(a) of the Securities Act of 1933

(“Securities Act”), 15 U.S.C. §77q(a), by engaging in fraud in the offer or sale of securities.

Compl. 52-55. Third, the SEC alleges that Bowen and others violated Sections 5(a) and 5(c) of

the Securities Act, 15 U.S.C. §77e(a), (c), by engaging in the unregistered offer and sale of

securities. Compl. 56-58. Fourth, the SEC alleges that Bowen and others violated Section 15(a)

of the Exchange Act, 15 U.S.C. §78o(a), by offering and selling securities as unregistered brokers.

Compl. 59-61. Bowen moves to dismiss only the two fraud claims. Bowen’s Br. 2n.l.

I I . L E G A L S T A N D A R D

A. Rule 12(b)(6)

To defeat amotion to dismiss filed pursuant to Federal Rule of Civil Procedure 12(b)(6), a

plaintiff must plead “enough facts to state aclaim to relief that is plausible on its face.” Bell Atl.

Corp. V. Twombly, 550 U.S. 544, 570 (2007); Reliable Consultants, Inc. v. Earle, 517 F.3d 738,

742 (5th Cir. 2008). To meet this “facial plausibility” standard, aplaintiff must “plead[] factual

content that allows the court to draw the reasonable inference that the defendant is liable for the

misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Plausibility does not require

probability, but aplaintiff must establish “more than asheer possibility that adefendant has acted

unlawfully.” Id. The Court must accept well-pleaded facts as true and view them in the light most

favorable to the plaintiff. Sonnier v. State Farm Mut. Auto. Ins. Co., 509 F.3d 673, 675 (5th Cir.

2007). However, the Court does not accept as true “conclusory allegations, unwarranted factual

inferences, or legal conclusions.” Ferrer v. Chevron Corp., 484 F.3d 776, 780 (5th Cir. 2007)

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(citation omitted). Aplaintiff must provide “more than labels and conclusions, and aformulaic

recitation of the elements of acause of action will not do.” Twombly, 550 U.S. at 555 (citation

omitted). “Factual allegations must be enough to raise aright to relief above the speculative

level... on the assumption that all the allegations in the complaint are true (even if doubtful in

fact).” Id. (citations omitted).

In ruling on aRule 12(b)(6) motion, the Court limits its review to the face of the pleadings.

See Spivey v. Robertson, 197 F.3d 772, 774 (5th Cir. 1999). The pleadings include the complaint

and any documents attached to it. Collins v. Morgan Stanley Dean Witter, 224 F.3d 496, 498

(5th Cir. 2000). The ultimate question is whether the complaint states avalid claim when viewed

in the light most favorable to the plaintiff Great Plains Tr. Co. v. Morgan Stanley Dean Witter &

Co., 313 F.3d 305, 312 (5th Cir. 2002). At the motion to dismiss stage, the Court does not evaluate

the plaintiffs likelihood of success; rather, it only determines whether the plaintiff has stated a

claim upon which relief can be granted. See Mann v. Adams Realty Co., 556 F.2d 288,293 (5th Cir.

1977).

B. Rule 9(b)

The two claims Bowen moves to dismiss are fraud claims, which are subject to aheightened

pleading standard. “In alleging fraud or mistake, aparty must state with particularity the

circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b). “Malice, intent, knowledge, and

other conditions of aperson’s mind may be alleged generally.” Id. “At aminimum. Rule 9(b)

requires allegations of the particulars of time, place, and contents of the false representations, as

well as the identity of the person making the misrepresentation and what he obtained thereby.'

Benchmark Elecs., Inc. v. J.M. Huber Corp., 343 F.3d 719, 724 (5th Cir. 2003) (quoting TelPhonic Servs., Inc. v. TBS Inti, Inc., 975 F.2d 1134,1139 (5th Cir. 1992)). “Put simply. Rule 9(b)

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requires ‘the who, what, when, where, and how”’ of the fraud. Id. (quoting Williams v. WMX

Techs., Inc., 112 F.3d 175, 179 (5th Cir. 1997)).

I I I . A N A L Y S I S

Section 10(b) and Rule lOb-5 of the Exchange Act and Section 17(a) of the Securities Act

make it unlawful to “employ any device, scheme, or artifice to defraud”; make any untrue

statement of amaterial fact or omit “a material fact necessary in order to make the statements

made, in the light of the circumstances under which they were made, not misleading” (or, for

purposes of Section 17(a)(2), to obtain money or property by means of any such misstatement or

omission); or engage in any act, transaction, practice, or course of business that “operates or would

operate as afraud or deceit.” 15 U.S.C. §77q(a); 17 C.F.R. §240.10b-5.

Here, the SEC alleges that Bowen’s fraud falls into three general categories: (1) failing to

correct misstatements and omissions in the Mustang 2Offering Materials; (2) distributing the

misleading materials to investors; and (3) misusing investor funds by paying sales commissions.

Resp. 2, 7. Although neither party clearly delineates which conduct allegedly violates which

statutory provisions, the SEC generally alleges that Bowen made and/or used material

misrepresentations and omissions in violation of Rule 1Ob-5 (b) and Section 17(a)(2) and

participated in afraudulent scheme in violation of Rule 10b-5(a), Rule 10b-5(c), Section 17(a)(1),

and Section 17(a)(3). The Court will analyze each claim in turn.

A. Rule 10b-5(b) and Section 17(a)(2)

To state aclaim under Section 10(b) and Rule 10b-5(b), the SEC must allege that Bowen:

(1) made amaterial misrepresentation or omission; (2) in cormection with the purchase or sale of

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securities; and (3) acted with scienter.^ S.E.C. v. Hopper, No. H-04-1054, 2006 WL 778640, at *9

(S.D. Tex. Mar. 24, 2006) (citing, among other sources, S.E.C. v. Monarch Funding Corp.,

192 F.3d 295, 308 (2d Cir. 1999)); also S.E.C. v. Reynolds, No. 3-08-CV-0384-B, 2008 WL

3850550, at *4 (N.D. Tex. Aug. 19, 2008) (citations omitted) (same). Section 17(a)(2), by

comparison, prohibits, in the offer or sale of securities,'* obtaining money “by means of any untrue

statement of amaterial fact or any omission to state amaterial fact necessary in order to make the

statements made, in light of the circumstances under which they were made, not misleading.

15 U.S.C. §77q(a)(2). Though the rule and the statute are similar, there are two key differences.

First, Section 17(a)(2) does not include the word “make.” Compare 17 C.F.R. 240.10b-5(b)

(making it unlawful "'[t]o make any untrue statement of amaterial fact or to omit to state amaterial

fact necessary in order to make the statements made .. .not misleading” (emphasis added)) with

15 U.S.C. §77q(a)(2) (prohibiting “obtain[ing] money or property by means of any untrue

statement ... or any omission” (emphasis added)). Second, “[sjcienter is not an element of a

§17(a)(2) ...cause of action.” Meadows v. S.E.C, 119 F.3d 1219, 1226 n.l5 (5th Cir. 1997)

(citation omitted). “To show that adefendant has violated §17(a)(2) ..., the [SEC] need only

show that the defendant acted with negligence.” S.E. C. v. Seghers, 298 F. App’x 319, 327 (5th Cir.

2008) (citation omitted).

The Court turns first to the question of whether the SEC has adequately tied Bowen to the

alleged misstatements and omissions for purposes of Rule 10b-5(b) and Section 17(a)(2) liability.

Next, the Court analyzes whether the SEC has plausibly alleged material misstatements or

^Bowen does not challenge whether the alleged statements were made in connection with the purchase or

sale of securities. Therefore, the Court will not consider this element.

^Bowen does not challenge whether alleged statements were made in the offer or sale of securities.

Therefore, the Court will not consider this element.

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omissions. Finally, the Court considers whether the SEC has adequately pleaded scienter for

purposes of its Rule 10b-5(b) claim and negligence for purposes of its Section 17(a)(2) claim.

i. Made or Used aMisrepresentation or Omission

The Court first examines whether the SEC has adequately tied Bowen to the challenged

misstatements and omissions in the Mustang 2Offering Materials. Though the SEC concedes that

Baker drafted the Mustang 2Offering Materials, the SEC claims that Bowen “review[ed] and

edit[ed]” and “helped prepare” the materials. See Compl. 19, 31. Bowen argues that “neither

statute nor precedent imposes fraud liability on an employee because he reviewed and edited a

company document,” Bowen’s Br. 1, and that “there is no allegation that Bowen ...had any

control over ... the contents of the Mustang 2[Offering Materials].” Reply 6. Without citing any

case law in support of its position, the SEC responds that “[t]he allegations in this case that Bowen

prepared, reviewed, and edited the [Mustang 2Offering Materials]... connect[] Bowen’s actions

to the fraud.” Resp. 7.

a. Rule 10b-5(b)

The Supreme Court has held that “[t]o be held liable for amisstatement or omission under

Section 10(b) and Rule 1Ob-5, the defendant must be the ‘maker’ of the statement, i.e., ‘the person

or entity with ultimate authority over the statement, including its content and whether and how to

communicate it.’” In re SolarWinds Corp. Sec. Litig., 595 F. Supp. 3d 573, 586 (W.D. Tex. 2022)

(quoting Cap. Grp., Inc. v. First Derivative Traders, 564 U.S. 135, 142 (2011)). However,

courts are split regarding whether Janus applies to enforcement actions brought by the SEC. See,

e. g., Lorenzo v. 5. £. C., 13 9S. Ct. 1094,1100 (2019) (assuming without deciding that the defendant

was not a‘maker’ under subsection (b) of Rule lOb-5” where the defendant was involved in

drafting but the defendant’s boss had “ultimate authority over the content, form, and

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commmication of the challenged statement); U.S. S.E.C. v. Benger, 931 F. Supp. 2d 908, 911 n.l,

912-13 (N.D. 111. 2013) (citing cases on both sides of the split and cases in which the SEC conceded

that Janus applied); S.E.C. v. Killian, No. H-16-621,2017 WL 7052310, at *6 (S.D. Tex. Mar. 24,

2017) (applying Janus and stating that an executive may he held accountable if he had ultimate

authority over the statement, signed the statement, or ratified and approved the statement, or if the

statement is attributed to him (citation omitted)). For the reasons stated below, the Court finds that

the SEC has not adequately pleaded its claim regardless of whether Janus applies to this action;

therefore, the Court need not decide the issue at this time. Because the Court grants the SEC leave

to amend its Complaint, as discussed below, the parties may address the applicability of Janus in

briefing on any future dispositive motions.

Even if Janus does not apply, the Court concludes that the SEC has not plausibly alleged

that Bowen “made” the challenged statements under any definition of the term. “Mere knowledge

of another’s violation of §10(b), or even aiding and abetting aviolation, is not enough to establish

[primary] liability under the Exchange Act.” S.E.C. v. Felton, No. 3:20-CV-0822-G, 2020 WL

7056333, at *6 (N.D. Tex. Dec. 2, 2020) (internal quotation marks and citation omitted). To

establish primary liability, vague allegations that adefendant reviewed and edited adocument.

without more, are insufficient. See, e.g., S.E. C. v. Fraser, No. CV-09-00443-PHX-GMS, 2009 WL

2450508, at *8 (D. Ariz. Aug. 11,2009) (“[WJhile the Complaint does allege that Fraser had some

level of involvement in reviewing and discussing the Forms 10-K, there are no allegations of the

nature of those reviews and discussions, that Fraser suggested what the forms should state, or that

any such suggestion, if it occurred, was heeded.”); S.E.C. v. Berry, 580 F. Supp. 2d 911, 922 (N.D.

Cal. 2008) (“The SEC’s conclusory pleadings that Ms. Berry ‘reviewed’ and ‘discussed’ various

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filings is insufficient to plead (with particularity) Ms. Berry’s role in the purported fraud.”).

Therefore, the SEC has failed to state aclaim for aviolation of Rule 10b-5(b).

b. Section 17(a)(2)

T h e C o u r t ’ s c o n c l u s i o n t h a t B o w e n w a s n o t t h e m a k e r o f t h e s t a t e m e n t s a t i s s u e f o r

purposes of Rule 10b-5(b) liability does not necessarily preclude Section 17(a)(2) liability. As

noted above, Section 17(a)(2) does not include the key term “make.” See 15 U.S.C. §77q(a)(2).

Many courts applying Janus to SEC enforcement actions have highlighted this distinction.

concluding that ""Janus's definition of‘maker’ does not extend to claims under Section 17(a)(2).

S.E.C. V. Farmer, No. 4:14-CV-2345, 2015 WL 5838867, at *1 (S.D. Tex. Oct. 7, 2015)

(collecting cases), appeal dismissed, No. 15-20620 (5th Cir. Feb. 25, 2016); see also US. S.E.C.

Big Apple Consulting USA, Inc., 783 F.3d 786, 797 (11th Cir. 2015) (“[T]he [Supreme] Court’s V .

definition of ‘to make’ in Rule lOb-5 does not apply to §17(a)(2).”). Cf. Lorenzo v. S.E.C.,

872 F.3d 578, 589 (D.C. Cir. 2017), affd, 139 S. Ct. 1094 (“Indeed, ‘to make any statement’ was

the critical language construed in Janus: what the Court described as the ‘phrase at issue. 99?

(cleaned up)).

Because “obtaining money by means of any untrue statement' i n v i o l a t i o n o f

Section 17(a)(2) “encompasses abroader range of conduct than making such astatemenf’ under

Rule 1Ob-5, the SEC’s Section 17(a)(2) claim survives the first step of the analysis. Farmer, 2015

WL 5838867, at *1 (cleaned up); see also S.E.C. v. Tambone, 597 F.3d 436, 444 (1st Cir. 2010)

(“[AJlthough [SJection 17(a)(2) may fairly be read to cover the ‘use’ of an untrue statement. ..

Rule 10b-5(b) is more narrowly crafted and its reach does not extend that far.”). The SEC has

plausibly alleged that Bowen obtained money by means of untrue or misleading statements.

Specifically, the SEC alleges that Bowen “sent [the Mustang 2Offering Materials] to prospective

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investors.” Compl. ^19; see also Resp. 7(arguing that Bowen “disseminated and used the

materially false or misleading offering materials to sell the oil and gas interests”). And those

materials allegedly contained material misrepresentations and omissions.

The SEC further alleges that Bowen received commissions when he successfully closed a

sale and thus obtained money. Compl. ^40. According to the SEC, “[hjetween January 2018 and

September 2020, Baker, Bowen, and Carmon raised approximately $2,182,687 from at least

140 investors through the fraudulent ...offer and sale of securities.” Id. ^1; see also id. ^15

(alleging that Cannon raised $1,538,152 in connection with the Mustang 2well). “[CJourts allow

liability under Section 17(a)(2) even where the defendant obtains money only as the indirect result

of the fraud, such as through increased compensation from his or her employer.” Farmer, 2015

WL 5838867, at *8 (citation omitted). Therefore, the SEC has plausibly alleged that Bowen

obtained money by means of the alleged untrue statements in the Mustang 2Offering Materials.

See S.E.C. v. Moleski, No. 2:21-CV-01065-SVW-E, 2021 WL 6752254, at *3 (C.D. Cal. Oct. 21,

2021) (finding that the SEC stated aclaim under Section 17(a)(2) where it alleged “that the

individual Defendants received money or property from their frauds by virtue of the commissions

they received from Heartland ....”).

Accordingly, the SEC has plausibly alleged conduct that falls within the ambit of

Section 17(a)(2).

ii. Material Misrepresentation or Omission

The Court turns next to the question of whether the SEC has plausibly alleged material

misstatements and omissions.^ To be actionable, statements or omissions must be both: (1) untrue

^Bowen identifies an additional alleged misrepresentation that is not addressed below; namely, the

statement that investor funds would be placed in asegregated bank account. See Bowen’s Br. 7. However,

it does not appear that the SEC attempted to tie this misrepresentation to Bowen, and the SEC does not

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or misleading and (2) material. See 15 U.S.C. §77q(a)(2); 17 C.F.R. §240.10b-5(b). “[T]he

standard for misrepresentation is whether the information disclosed, understood as awhole, would

mislead areasonable potential investor.” Seghers, 298 F. App’x at 328 (citation omitted). As to

materiality, “[a] statement or omitted fact is ‘material’ if there is asubstantial likelihood that a

reasonable investor would consider the information important in making adecision to invest.” Id.

(quoting ABC Arbitrage Plaintiffs Grp. v. Tchuruk, 291 F.3d 336, 359 (5th Cir. 2002)); see also

Basic Inc. v. Levinson, 485 U.S. 224,231-32 (1988) (stating that materiality requires “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.” (citation

omitted)). The Court will first consider Bowen’s challenges to whether the statements and

omissions were untrue or misleading and material and then will turn to whether the SEC has

pleaded its claims with particularity.

First, the SEC alleges that the Mustang 2Prospect Book misrepresented the prior wells’

production history by stating that they “continued to produce at massive rates,” Compl. 122, even

though actual production “declined dramatically after the initial production,” id. ^23. Bowen does

not contest the assertion that this statement was false, and the Court concludes that the SEC

plausibly alleges that the statement was untrue. Further, the SEC plausibly alleges that the

statement was material. The prior wells were in the same field as the proposed Mustang 2well.

meaning the misrepresentation “misled investors into believing that production from the

Mustang 2[well] would also be high.” Id. 122. When making the decision to invest in anew well.

areasonable investor would consider the production history of prior wells in the same field to be

important.

address it in its Response. See Compl. ^24 (“Baker ...never opened aseparate account for Mustang 2

investor funds.” (emphasis added)). Therefore, the Court does not consider this allegation at this time.

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Second, the SEC argues that the Mustang 2Offering Materials omitted the fact that investor

funds would be used to pay commissions to salespeople. Id. Tf 33. Bowen challenges this allegation

on the grounds that the statement was not fraudulent when made. Bowen’s Br. 8. Instead, Bowen

argues either that the statement was “just an unfulfilled promise on the part of Baker and Cannon,

id. at 8, or that the Mustang 2Offering Materials’ disclosure that 15% of investor funds would go

to offering expenses encompassed the use of such funds for sales commissions, Reply 4-5.

The Court finds that the SEC has plausibly alleged amaterial omission. Omitting the fact

that investor funds would be used to pay commissions renders the statements made regarding the

use of investor funds misleading because it suggests that commission payments will not come out

of investor funds. This omission also is material because it “concealed Carmon’s improper use of

investor funds.” Resp. 6. Therefore, the SEC has plausibly alleged amaterial omission. See S.E.C.

V. Montgomery, No. SA-20-CA-598-FB, 2021 WL 210749, at *4 (W.D. Tex. Jan. 20, 2021)

(finding violation of Section 17(a)(2) where private placement memorandum “detailed the use of

investor proceeds” but “failed to disclose that approximately one-third of investor funds would be

used to pay commissions to salespeople who offered and sold the investments”); S.E.C. v.

Reynolds, No. 1:06-CV-1801-RWS, 2010 WL 3943729, at *1 (N.D. Ga. Oct. 5, 2010)

(“Defendants also failed to disclose several material facts to investors, including ...that investor

funds were used to pay commissions to Independent Representatives[.]”); S.E.C. v. US. Funding

Corp., No. 02-2089(WJM), 2006 WL 995499, at *4 (D.N.J. Apr. 11, 2006) (finding amaterial

misrepresentation or omission where investment materials “did not disclose that investor funds

would be used to pay ... telemarketers’ commissions”).

Third, the SEC points to the omission of any reference to Bowen in the Mustang 2Offering

Materials. Compl. f31. Bowen argues that the omission was not misleading when it occurred and

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that the omission is not material. Bowen’s Br. 8n.27; Reply 6. The SEC responds that the omission

is misleading because it concealed the fact that Bowen previously had been sanctioned by the SEC

and material because it prevented investors from discovering Bowen’s previous securities

violations. Compl. f31; Resp. 10. The Court concludes that the SEC has not plausibly alleged a

material omission. The SEC notes that Bowen was barred from selling securities in March 2018,

Compl. f42, and that the Mustang 2offering began in April 2018, id. T| 23. But the SEC does not

specify when Bowen allegedly helped prepare the Mustang 2Offering Materials. If the SEC’s

theory is that Bowen failed to edit the Mustang 2Offering Materials to include his identity, the

date he reviewed the materials, rather than the date the offering began, is relevant. Further, the

Court determined above that the SEC’s only viable theory is that Bowen used the misstatements

and omissions in the Mustang 2Offering Materials to obtain money by soliciting investors.

Presumably, the investors would be on notice of Bowen’s involvement in the offering due to his

solicitation. However, as discussed below, due to the lack of information about the solicitations.

the Court cannot advance this line of reasoning any further. Suffice to say that, at this time, the

SEC has not adequately alleged afraud claim based on the omission of Bowen’s identity and

position from the Mustang 2Offering Materials.

Although the SEC adequately alleges two material misstatements or omissions, the SEC

has not pleaded its claims based on these statements with particularity. As stated above, the Court

finds that the SEC has not plausibly alleged that Bowen made the statements in the Mustang 2

Offering Materials at all, much less with the particularity required by Rule 9(b). And the SEC

omits critical details regarding Bowen’s alleged use of such materials to solicit investors. See, e.g.,

Felton, 2020 WL 7056333, at *7 (“The SEC provides no details on [defendant’s] specific

activities, when they may have occurred, or how any activities are tied to fraud.”). The SEC alleges

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in conclusory fashion that Bowen sent the materials to potential investors. See, e.g., Compl. *[| 19.

And presumably this happened sometime between April 2018 (when the Mustang 2offering

began) and September 2018 (when Bowen left Cannon). See id. 9,23. But the SEC omits critical

information such as “who [Bowen] sold interests to, as well as when, where, and how he sold

them.” Reply 8.

The Court recognizes that “[wjhen the complaint details the defendants’ scheme and

apprises them of the basic transaction(s) upon which fraud is alleged, an enforcement action may

be less specific with respect to when and where the alleged fraud occurred.” S.E.C. v. Haarman,

No. A-21-CV-00235-LY, 2022 WL 2782648, at *5 (W.D. Tex. Jan. 25, 2022) (citation omitted).

report and recommendation adopted by 2022 WL 2763163 (W.D. Tex. Mar. 11, 2022). In this

case, however, the SEC has not sufficiently apprised Bowen of the basic transactions upon which

fraud is alleged. In sum, the SEC fails to provide the who, what, when, where, and how of the

fraud that is required by Rule 9(b).

Hi. Scienter or Negligence

To establish aviolation of Rule 10b-5(b), the SEC must show that Bowen acted with

scienter. Seghers, 298 F. App’x at 327 (citation omitted). “Scienter is amental state that embraces

an intent to deceive, manipulate or defraud, and includes severe recklessness.” Id. at 333 (citation

omitted). Severe recklessness is:

limited to those highly unreasonable omissions or misrepresentations that involve

not merely simple or even inexcusable negligence, but an extreme departure from

the standards of ordinary care, and that present adanger of misleading buyers or

sellers which is either known to the defendant or is so obvious that the defendant

must have been aware of it.

Id. (quoting Fine v. Am. Solar King Corp., 919 F.2d 290, 296-97 (5th Cir. 1990)). “The factual

background adequate for an inference of fraudulent intent can be satisfied by alleging facts that

show adefendant’s motive to commit securities fraud.” Tuchman v. DSC Commc’ns Corp.,

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14 F.3d 1061, 1068 (5th Cir. 1994). The SEC also may plead scienter “by identifying

circumstances that indicate conscious behavior on the part of the defendant, though the strength of

the circumstantial allegations must be correspondingly greater.” Id. (citation omitted). To establish

aviolation of Section 17(a)(2), the SEC need only show that Bowen acted negligently. Seghers,

298 F. App’x at 327 (citation omitted).

Because the SEC has provided few details on how Bowen used the misstatements and

omissions discussed above to solicit investors, it is difficult to analyze scienter and negligence. As

to scienter, the SEC has presented some facts supporting amotive to commit securities fraud, as

Bowen received commissions on sales and determined the amount of commissions paid on each

sale. Compl. 133; see also S.E.C. v. Ramirez, No. 15-2365 (PAD), 2018 WE 2021464, at *11

(D.P.R. Apr. 30, 2018) (citation omitted) (finding the fact that the defendant earned commissions

on customer purchases, among other things, weighed in favor of an inference of scienter). But on

the other hand, “[ijncentive compensation can hardly be the basis on which an allegation of fraud

is predicated.” Tuchman, 14 F.3d at 1068 (citation omitted).

The Court finds that the SEC has not adequately alleged that Bowen knew or must have

been aware of the danger of misleading investors. As to the first alleged misstatement, the SEC

alleges that Bowen knew that actual production from the prior wells had declined because that

information was contained in offering materials for a2016 project. Compl. 23. But the SEC does

not allege that Bowen reviewed or otherwise was aware of those 2016 offering materials. And the

SEC’s vague claim that Bowen reviewed and edited the Mustang 2Offering Materials does not

plausibly allege that Bowen ever saw the misstated production numbers. The Court finds, however.

that the SEC has adequately alleged negligence with respect to the production history statement.

If, as Bowen claims, “he made no substantive review of ...the Mustang 2Prospect Book,

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Reply 4, he was at least negligent in soliciting investors without reviewing the materials he was

using to do so.

As to the second alleged misstatement, the SEC alleges that Bowen knew the payment of

commissions was omitted because he was the sales manager and determined the amount of

commissions paid. Compl. ^33. Bowen argues that the SEC cannot predicate afraud claim on his

title or position^ and that paying commissions as directed by one’s employer does not constitute

fraud. Bowen’s Br. 7-8. The Court finds that scienter is lacking. To analyze this issue, the Court

must separate two acts: (1) omitting the fact that commissions would be paid out of investor funds

and (2) improperly paying commissions or improperly paying sales commissions that exceeded

the 15% cap. For purposes of Rule 10b-5(b) or Section 17(a)(2) liability, only the former is at

issue.

There are several issues with the SEC’s contention that Bowen “knew, or [was] reckless in

not knowing, that [the Mustang 2Offering Materials] failed to disclose to investors the payment

o f s a l e s c o m m i s s i o n s ' because Bowen determined the amount of commissions paid and

prepared” the Mustang 2Offering Materials. Compl. ^33. The SEC alleges in one breath that the

commissions were not disclosed but claims in the next that they exceeded the 15% cap on offering,

overhead, and management expenses. Id. 28. Since it is unclear to the Court and to the SEC

whether commissions were part of the offering, overhead, and management expenses, the Court

cannot conclude that Bowen knew or was reckless in not knowing that the sales commissions were

not disclosed. Further, as with the production history misrepresentation, the SEC’s vague

^Although irrelevant to the analysis below, the Court rejects this argument. While other pleading defects

preclude liability, the Court does not agree that the SEC attempts to establish liability based solely on

Bowen’s position as sales manager. The SEC factually alleges that Bowen, in his role as sales manager,

“was in charge of paying commissions,” Compl. 128, and “determined the amount of commission paid on

each sale,” id. f33.

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allegations that Bowen reviewed and edited the Mustang 2Offering Materials do not plausibly

allege that Bowen knew the payment of commissions was omitted. For the same reasons, the Court

also finds that the SEC has not plausibly alleged that Bowen was negligent in omitting the payment

of commissions from the Mustang 2Offering Materials.

Because the Court has already found that the SEC failed to state aclaim with respect to the

third alleged misstatement—the omission of Bowen’s name and position from the Mustang 2

Offering Materials—the Court will not analyze scienter or negligence at this time. In sum, the

Court finds that the SEC’s Complaint fails to state aclaim for violations of Rule 10b-5(b) and

Section 17(a)(2).

B. Scheme Liability

Even if Bowen did not make or use any false statements for purposes of Rule 10b-5(b) or

Section 17(a)(2) liability, he may still be subject to scheme liability under Rule 10b-5(a) and (c)

and Section 17(a)(1) and (3). See, e.g., Lorenzo, 872 F.3d at 592 (collecting cases standing for the

proposition that “securities-fraud allegations involving misstatements can give rise to liability

under related provisions even if the conduct in question does not amount to ‘making’ astatement

under Janus'’’). Rule 10b-5(a) and (c) and Section 17(a)(1) and (3) “prohibit, in the offer or sale of

securities, the employment of any device, scheme, or artifice to defraud; and the engaging in any

act, practice, or course of business that operates or would operate as afraud or deceit on any

person.” S.E.C. v. Narayan, No. 3:16-CV-1417-M, 2017 WL 4652063, at *3 (N.D. Tex. Aug. 28,

2017). “These provisions ... are described as creating ‘scheme liability. Id. (citation omitted). 999

Three of the four scheme liability provisions require proof of scienter, but “the language of

§17(a)” does not require scienter “under ... §17(a)(3).” Aaron v. S.E.C., 446 U.S. 680, 697

(1980).

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Here, the SEC arguably alleges abasis for scheme liability. First, the SEC alleges that

Bowen misused investor funds by paying commissions to salespeople. Compl. 128. Those

commission payments either were not disclosed or exceeded the 15% cap on offering, overhead,

and management expenses. Id.-, see, e.g., Montgomery, 2021 WL 210749, at *4 (finding basis for

scheme liability where the defendant “misused investor funds by using offering proceeds contrary

to disclosures about how such proceeds would be used”). Moreover, the salespeople receiving

commissions, including Bowen himself, allegedly were not registered as brokers. Compl. 40.

Second, the SEC alleges that Bowen disseminated the misleading and untrue Mustang 2Offering

Materials to prospective investors. Id. ]| 19. “Those who disseminate false statements with intent

to defraud are primarily liable under Rules 10b-5(a) and (c), §10(b), and §17(a)(1), even if they

are secondarily liable under Rule 10b-5(b).” Lorenzo, 139 S. Ct. at 1104; see also Yoshikawa v.

Exxon Mobil Corp., No. 3:21-CV-00194-N, 2023 WL 5489054, at *9 (N.D. Tex. Aug. 24, 2023)

(“Dissemination is aform of conduct, and ‘the scheme subsections can cover conduct that involves

amisstatement even if the defendant was not the maker of it.’” (citation omitted)).

But, as Bowen notes, the SEC merely alleges that Bowen engaged in afraudulent scheme,

made afraudulent misrepresentation, or engaged in afraudulent transaction or course of business

[b]y engaging in the conduct described above.” Bowen’s Br. 4-5 (quoting Compl. 49, 53).

Bowen himself fails to address scheme liability in his briefing on the Motion, focusing instead on

whether he made any misstatements or omissions. See Reply 1(“The SEC’s fraud claims are all

based on statements contained in (or omissions that allegedly should have been contained in) the

Mustang 2[Offering Materials] ....”); Berry, 580 F. Supp. 2d at 923 (“[Defendant] fails to

differentiate between these different bases for imposing liability under Rule lOb-5 when she argues

that she did not make any false statements. To be liable under Rule lOb-5 ... [s]he need only have

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made an intentionally deceptive contribution to an overall fraudulent scheme.”)- Because the

parties neither meaningfully address scheme liability nor cite any case law supporting their

respective positions, the Court will not attempt to guess at what their arguments might be. Instead,

the Court will address this issue, if necessary, after the SEC amends its Complaint.

I V . C O N C L U S I O N

For the reasons discussed above, the Court GRANTS Defendant Michael Bowen’s Partial

Motion to Dismiss [ECF No. 15]. Because the SEC has requested leave to amend its Complaint,

see Resp. 10, and given the Federal Rules of Civil Procedure’s liberal policy of allowing

amendments to pleadings, the Court GRANTS the SEC leave to amend its Complaint. The SEC

must file an amended complaint by October 12, 2023. If an amended complaint is not filed within

such time, the SEC’s claims will be dismissed with prejudice.

S O O R D E R E D .

SIGNED September 21, 2023.

K A R E N G R E N S C H O L E R

U N I T E D S T A T E S D I S T R I C T J U D G E

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