Court Opinion

ID: 74166
Source: CourtListenerOpinion
Date Created: 2010-04-26 08:41:05+00
Date Added: 2024-06-11T12:40:26.855452
License: Public Domain

[PUBLISH]

             IN THE UNITED STATES COURT OF APPEALS
                                                                  FILED
                        FOR THE ELEVENTH CIRCUIT
                                                  U.S. COURT OF APPEALS
                         ________________________   ELEVENTH CIRCUIT
                                                             11/18/99
                                No. 99-4033               THOMAS K. KAHN
                         ________________________             CLERK

                     D. C. Docket No. 98-07147-CV–SH

SECURITIES AND EXCHANGE COMMISSION,

                                                                Plaintiff-Appellee,

                                   versus

UNIQUE FINANCIAL CONCEPTS, INC.,
ERNEST J. PATTI, et al.,

                                                        Defendants-Appellants.

                         ________________________

                 Appeal from the United States District Court
                     for the Southern District of Florida
                       _________________________
                            (November 18, 1999)

Before BLACK, HULL and MARCUS, Circuit Judges.

BLACK, Circuit Judge:
      Appellants Unique Financial Concepts, Inc. (Unique), Ernest J. Patti (Patti),

Frederick N. Hollander (Hollander), and Nicholas D. DeAngelis (DeAngelis), appeal

a preliminary injunction enjoining Appellants from violating the anti-fraud and

securities registration provisions of Section 17(a) of the Securities Act of 1933, 15

U.S.C. § 77q(a). The district court found that Appellants’ activities were subject to

the Securities Act because Appellants were offering investment contracts in which

investor funds were to be pooled. The district court also found that the Commodity

Exchange Act (CEA), 7 U.S.C. §§ 1- _ , did not preclude Appellee Securities and

Exchange Commission (SEC) from regulating the investment opportunity offered by

Appellants. We affirm.

                          I. BACKGROUND

      Hollander and Patti established Unique in October 1997. At its inception,

Unique purported to offer the sale of foreign currency options. Unique advertised

heavily on television, newspaper, and the Internet, promising large returns on small

investments. These promises were not based on actual investments made by Unique.

Prospective investors were sent a packet containing an offering document that

described the foreign exchange market, a customer agreement, and a disclosure of risk

statement.

                                         2
       The original customer agreement explained that the investments would be

pooled together and that Unique had sole discretion over the investments. In August

1998, Unique modified its customer agreement by removing the language concerning

the pooling of investments and Unique’s sole discretion over these investments.

      After receiving initial investments from investors, Unique deposited the funds

into its bank account at Southern Bank in Fort Lauderdale, Florida. Unique sales

representatives advised the investors as to which currencies they should invest in and

how many puts and calls they should buy. The investor then spoke to a compliance

officer, who explained the details of the investment and requested the investors’ assent

to the purchase.

       A portion of the investors’ funds then purportedly was wired to Capital

Management International (CMI) and Asset Management Funding (AMF) in the

Bahamas. According to Patti and other representatives of Unique, AMF was a holding

company for clearing houses, while CMI was the clearing house responsible for

carrying out Unique’s option trades. Unique also claims it later contracted with two

other Bahamian clearing houses, Forex International (Forex) and Nassau Bay

Clearing, Ltd.

      After the initial investment, Unique aggressively solicited the investors for

additional investments. Eventually, however, Unique representatives were extremely

                                           3
hard to reach and often failed to return phone calls. The investors lost significant

amounts of money on their investments.

      From October 1997 until October 22, 1998, Unique raised just over $6.5 million

from investors using the above scheme. Of this amount, only $2,489,801 (38%) was

wired to the Bahamas to the alleged clearing houses. The remainder of the investors’

money was divided as follows: approximately $700,000 was paid to Unique sales

representatives; approximately $1.2 million was paid for advertising (including

$760,786.32 paid to DRE consulting, a company co-owned by Patti from which he

received a substantial salary); approximately $300,000 was paid to Patti, Hollander,

and DeAngelis, the lead sales representative; and approximately $1.6 million was paid

for business and personal expenses, including checks made payable for car rentals and

personal loans. In addition, approximately $644,000 of the investors’ funds was

distributed to new investors.

                          II. THE PRELIMINARY INJUNCTION

      The district court found that Appellants’ activities were subject to the Securities

Act and granted the SEC a preliminary injunction enjoining Appellants from violating

anti-fraud and securities registration provisions of the Securities Act, 15 U.S.C.

§ 77q(a). Significantly, the district court found that no credible evidence existed to

show that Appellants’ "clearinghouses" ever placed trades on behalf of investors.

                                           4
The court emphasized that Appellants failed to introduce any written agreements

showing a relationship between Unique and the Bahamian clearing houses (Nassau

Bay, CMI, or Forex). Patti claimed that Appellants did not have any copies of the

contracts between the parties, and asserted, without citing any authority, that

Bahamian law prevented Appellants from obtaining copies of the agreements from

the Bahamas. The district court found that Patti lacked credibility and that the absence

of any written agreements was “highly suspect.” As a result, the court concluded that

“the contract may be damaging to the [Appellants] and that they may be purposefully

avoiding its production.”

      Although Appellants did produce option reports and monitoring sheets detailing

the purported trades and client accounts, the district court noted that Appellants failed

to authenticate any of these reports. Specifically, the court pointed to the fact that

there were no transaction or wire verifications indicating that the clearing houses

executed any trades. Although Appellants did produce alleged trade confirmations,

these confirmations were sent from Appellants’ office, not from the Bahamian

clearing houses.

        In addition, Patti testified that Appellants never received any bank records

indicating the occurrence of the alleged trades, that he did not know how the

Bahamian clearing houses executed the trades, and that he did not know how the

                                           5
clearing houses were compensated for their services. Furthermore, Appellants’

compliance officer testified that she did not know what the clearing houses did and

did not even know what the term clearing house meant. Finally, Appellants’

accountant, Morris Berger, stated that the “only thing we had to deal with is really the

Unique data. And we don’t have the Bahamian trading data . . . . Do I know that

there was actual trading in the Bahamas? The answer is, no, I don’t.”

       Thus, the court concluded, “at this juncture Unique has failed to produce one

scintilla of independent evidence in support of its contention that investors’ funds

were invested in foreign currency options by clearinghouses in the Bahamas.” In

addition, the court stated that “at this stage of the litigation, it appears as though

Unique either misused or converted investors’ funds and have used an artifice to

defraud.”1

       The district court nevertheless found that the “investments” offered by

Appellants should be considered investment contracts, and thus concluded that the

SEC did have jurisdiction to bring this claim. The court also held that the SEC had

established a prima facie case of violations of the anti-fraud and registration

       1
        In essence, the district court found that Appellants were operating a “Ponzi scheme.” See,
e.g., SEC v. Lauer, 52 F.3d 667, 670 (7th Cir. 1995). That is, rather than executing currency trades,
Appellants were keeping over 60% of the money. Appellants paid the rest of the money back to the
investors “to fool them into thinking they were making money and should therefore invest more.”
Lauer, 52 F.3d at 670.

                                                 6
provisions of Section 17(a) of the Securities Act and issued a preliminary injunction

enjoining Appellants from committing further violations.

                           III. STANDARD OF REVIEW

      A district court's grant of a preliminary injunction order involves a mixed

standard of review. The decision to grant the injunction is reviewed for abuse of

discretion. See Haitian Refugee Ctr., Inc. v. Baker, 953 F.2d 1498, 1505 (11th Cir.

1992). Questions of law supporting the injunction are reviewed de novo. See Tefel

v. Reno, 180 F.3d 1286, 1295 (11th Cir. 1999). Findings of fact are reviewed for clear

error. See SEC v. Carriba, 681 F.2d 1318, 1323 (11th Cir. 1982). When a

preliminary injunction is challenged on the basis of jurisdiction, a plaintiff need only

establish “a reasonable probability of ultimate success upon the question of

jurisdiction when the action is tried on the merits.” Majd-Pour v. Georgiana

Community Hospital, Inc., 724 F.2d 901, 902 (11th Cir. 1984) (quoting Industrial

Electronics Corp. v. Cline, 330 F.2d 480, 482 (3d Cir. 1964)).

                                 IV. ANALYSIS

       The central issue in this case is whether the district court abused its discretion

in finding that Appellee has shown a reasonable probability of ultimate success upon

                                           7
the question of the SEC’s jurisdiction over Appellants’ conduct.2 The determinative

question within this issue is whether the contracts offered and sold by Appellants were

investment contracts, and thus securities, under federal securities law.3 If the contracts

were investment contracts, then, contrary to Appellants’ assertion, the SEC had

jurisdiction under the federal securities laws to bring this suit.

A. Three Prong Howey Test

        In S.E.C. v. W.J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100 (1946), the Supreme

Court established the classic test for determining whether a transaction is an

“investment contract” within the meaning of Section 2(a)(1) of the Securities Act,

15 U.S.C. § 77b(a)(1). In Howey, the Court explained that for the purposes of the

        2
         Under Section 20(b) of the Securities Act of 1933, 15 U.S.C. § 77t(b), and Section 21(d)
of the Securities Exchange Act of 1934, 15 U.S.C. § 78u(d), the SEC is entitled to a preliminary
injunction when it establishes the following: (1) a prima facie case of previous violations of federal
securities laws, and (2) a reasonable likelihood that the wrong will be repeated. SEC v. Management
Dynamics, Inc., 515 F.2d 801, 806-07 (2d Cir. 1975); SEC v. Manor Nursing Centers, Inc., 458 F.2d
1082, 1100 (2d Cir. 1972). On appeal, Appellants challenge only the SEC’s jurisdiction over this
matter. Thus, we need not address whether the injunction granted in this case meets the above
requirements.
        3
        Under the Securities Act of 1933, a "security" is defined as:
       [A]ny note, stock, treasury stock, bond, debenture, evidence of indebtedness,
       certificate of interest or participation in any profit-sharing agreement, collateral-trust
       certificate, reorganization certificate or subscription, transferable share, investment
       contract, voting-trust certificate, certificate of deposit for a security, fractional
       undivided interest in oil, gas, or other mineral rights, or, in general, an interest or
       instrument commonly known as a "security," or any certificate of interest or
       participation in, temporary or interim certificate for, receipt for, guarantee of, or
       warranty or right to subscribe to or purchase, any of the foregoing.
15 U.S.C. § 77b(a)(1) (emphasis added).

                                                   8
Securities Act, an investment contract is “a contract, transaction, or scheme whereby

a person invests his money in a common enterprise and is led to expect profits solely

from the efforts of the promoter or a third party....” Howey, 328 U.S. at 298-99, 66

S. Ct at 1103. This Court has divided the Howey test into the three elements: “(1) an

investment of money, (2) a common enterprise, and (3) the expectation of profits to

be derived solely from the efforts of others.” Villeneuve v. Advanced Business

Concepts Corp., 698 F.2d 1121, 1124 (11th Cir. 1983), aff’d en banc, 730 F.2d 1403

(11th Cir. 1984). Both parties agree the first prong of this test has been satisfied.

There is distinct disagreement, however, as to the second and third prongs.

       1. Common Enterprise Prong

       With respect to the second prong, we have adopted the concept of vertical

commonality, holding that a common enterprise exists where “the fortunes of the

investor are interwoven with and dependent on the efforts and success of those

seeking the investment or of third parties.” Villeneuve, 698 F.2d at 1124 (quoting

SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 n.7 (9th Cir. 1973)).4

We previously had observed that “the fact that an investor’s return is independent of

that of other investors in the scheme is not decisive.                     Rather, the requisite

       4
        Unlike the more stringent concept of horizontal commonality, utilized by the Second, Third,
Sixth, and Seventh Circuits, see, e.g., Stenger v. R.H. Love Galleries, 741 F.2d 144, 146 (7th Cir.
1984), this flexible standard does not require investor funds to be pooled nor does it require profits
to be shared on a pro rata basis.

                                                  9
commonality is evidenced by the fact that the fortunes of all investors are inextricably

tied to the efficacy of the [promoter].” SEC v. Koscot Interplanetary, Inc., 497 F.2d

473, 479 (5th Cir. 1974).5 More recently, we have affirmed the formulations of

Villeneuve and Koscot, instructing that “[t]he thrust of the common enterprise test is

that the investors have no desire to perform the chores necessary for a return.”

Eberhardt v. Waters, 901 F.2d 1578, 1580-81 (11th Cir. 1990).

       Significantly, the fact that an investment company’s operations are a sham and

thus might not actually satisfy the common enterprise prong of the Howey test does

not mean that the investment company can avoid the Securities Act. As the Seventh

Circuit has noted, “[i]t would be a considerable paradox if the worse the securities

fraud, the less applicable the securities laws.” SEC v. Lauer, 52 F.3d 667, 670 (7th

Cir. 1995); see also First National Bank v. Russell, 657 F.2d 668, 673 n.16 (5th Cir.

1981) (noting that the SEC has jurisdiction even the “security purportedly traded is

nonexistent or fictitious . . . . A contrary result would encourage rather than curb

fraud.”) (internal citation omitted).

       Thus, in order to qualify as an investment contract, “it is enough that the

[parties] merely offer the essential ingredients of an investment contract.” Howey, 328

       5
        In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir. 1981) (en banc), this Court
adopted as binding precedent all decisions of the former Fifth Circuit handed down prior to close
of business on September 30, 1981.

                                               10
U.S. at 301, 66 S. Ct. at 1104. After all, “[t]he Securities Act prohibits the offer as

well as the sale of unregistered non-exempt securities.” Id; see also SEC v. C.M.

Joiner Leasing Corp., 320 U.S. 344, 352-53 (1943) (noting that “[i]n the enforcement

of [the Securities Act,] it is not inappropriate that promoters’ offerings be judged as

being what they were represented to be”).

      At trial, the district court found that the language of the original customer

agreement, in conjunction with its conclusion that Appellants’ operations were a

sham, supported the existence of a common enterprise. The agreement, in relevant

part, reads as follows:

      By executing this agreement, Client authorized [Unique] in its sole
      discretion to use the total funds on deposit in the omnibus account which
      includes the funds of the undersigned to execute single trades or
      transactions and to apportion the gains, losses, commissions, and
      clearing expenses proportionally to each account. The results of each
      trade will be apportioned and applied proportionately (per unit) to all
      accounts open on the trade and rounded down to the nearest US dollar.
      (emphasis added).

      On appeal, Appellants contend that, despite the language of the original

agreement, in actual practice it did not operate a horizontal investment pool but rather

maintained individual, independent investment accounts.          As support for this

contention, Appellants point to cash flows between Appellants and the Bahamian

clearing houses, the alleged trade reports, as well as testimony regarding the trades

and trade reports. Appellants claim we should rely on the actual operation of its

                                          11
investment contracts, rather than the language of the original agreement, to hold that

Appellants’ investment accounts do not meet the common enterprise prong.

       However, given the absence of any credible documentation of trades, the

absence of any persuasive testimony concerning these trades, as well as the fact that

Appellants invested less than 40% of investors’ money, we conclude the record

supports the district court’s finding that Appellants’ operations were a sham.

Consequently, we look, as did the district court, to the terms of the offer to determine

whether Appellants’ activities are covered by the Securities Act. As noted above, the

terms of the offer explicitly state that investors’ funds will be pooled and apportioned

proportionately by Appellants to each account. This language clearly presents an offer

for an investment in a common enterprise and thus supports the common enterprise

prong of the Howey test.6

       2. Expectation of Profits Prong

       There is also distinct disagreement over whether Appellants’ operations meet

the “expectation of profits” element of the Howey test. In Howey, the Supreme Court

explained that this prong requires that investors expect their “profits to come solely

from the efforts of others.” Howey, 328 U.S. at 301, 66 S. Ct. at 1104. The courts

       6
           Appellants claim that the language of the original agreement was a mistake, and that the
language was changed to accurately reflect Unique’s operations. The district court, however, made
a factual finding that Appellants switched their customer agreement in August 1998 specifically to
avoid liability under the federal securities laws.

                                                12
have suggested several interpretations of the word “solely,” with the disagreement

centered on whether “solely” means all or merely predominant. The view this Court

adopted in Koscot, 479 F.2d at 483, asks “whether the efforts made by those other

than the investor are the undeniably significant ones, those essential managerial efforts

which affect the failure or success of the enterprise.” SEC v. Glenn W. Turner

Enterprises, Inc., 474 F.2d 476, 482 (9th Cir. 1973). One year after Koscot, the

Supreme Court reaffirmed Howey and revisited this question in United Housing

Foundation, Inc. v. Forman, 421 U.S. 837, 95 S. Ct. 2051 (1975). In Forman, the

Supreme Court held that “the touchstone” of an investment contract for purposes of

the Securities Acts is “the presence of an investment in a common venture premised

on a reasonable expectation of profits to be derived from the entrepreneurial or

managerial efforts of others.” Id. at 852, 95 S. Ct. at 2060. We subsequently

explicitly embraced the Forman test.7 See Villeneuve v. Advanced Business Concepts,

Co., 730 F.2d 1403, 1404 (11th Cir. 1984) (en banc).

       In addition, this Court has clearly stated that “the crucial inquiry [for the third

prong] is the amount of control that the investors retain under their written

agreements.” Albanese v. Florida Nat’l Bank, 823 F.3d 408, 410 (11th Cir. 1987)

       7
         In Villeneuve, we refrained from deciding whether Forman and Koscot are consonant. We
refrain from resolving this issue here as well.

                                             13
(citing Williamson v. Tucker, 645 F.2d 404, 423-24 (5th Cir. 1981)). While we have

yet to resolve the precise level of control dictated by Forman (and refrain from doing

so here), we conclude Appellants’ operation meets any reasonable interpretation of

“solely.”

      First, contrary to Appellants’ assertion, Appellants did not manage non-

discretionary investment accounts in which individual investors made all key strategic

decisions. Rather, as noted above, the record supports the district court’s finding that

Appellants did not engage in any actual trading, but instead operated a fraudulent

scheme which misappropriated investors’s funds. Thus, the investors retained no

control over their investments, since there were no investments to control. Second,

the original customer agreement specifically gave Appellants the “sole discretion to

use the total funds” deposited by the investors. (emphasis added). Consequently, both

the language of the agreement and Appellants’ actual operations support the district

court’s finding that Appellants’ operations met the third prong of the Howey test.

      Because a review of the record indicates that all three prongs of the Howey test

have been met, we conclude Appellee did establish a reasonable probability of

ultimate success upon the question of jurisdiction. The district court therefore did not

abuse its discretion in granting the preliminary injunction.

B. The Commodities Exchange Act

                                          14
      Appellants also argues that the Commodities Trading & Futures Commission

(CFTC),through the Commodities Exchange Act (CEA), 7 U.S.C. §§ 1- _, divests the

SEC of authority to bring this action. The essential issue is whether the trading of

futures of investment contracts is a securities transaction subject to the SEC’s

jurisdiction, a futures transaction subject to the CFTC’s jurisdiction, or both. Thus,

this case “requires an inquiry into the relative boundaries of jurisdiction between the

CFTC and the SEC as intended by Congress.” Messer v. E.F. Hutton & Co., 847 F.2d

673, 674-75 (11th Cir. 1988).

      The “exclusive jurisdiction” provision of the CEA defines the ambit of the

CFTC’s exclusive jurisdiction over the commodities market. It reads, in relevant

part, as follows:

             [T]he CFTC shall have exclusive jurisdiction with respect
             to accounts, agreements (including any transaction which
             is of the character of, or is commonly known to the trade as,
             an “option,” “privilege,” “indemnity,” “bid,” “offer,” “put,”
             “call,” “advance guarantee,” or “defined guarantee,”) and
             transactions involving contracts of sale of a commodity for
             future delivery, traded or executed on a contract market
             designated pursuant to section 7 of this title or any other
             board of trade, exchange or market . . . .

7 U.S.C. § 2 (emphasis added). In contrast, the “SEC savings clause” preserves SEC

authority over its traditional regulatory functions despite the CFTC’s jurisdiction. It

reads, in relevant part, as follows:

                                          15
       [E]xcept as hereinabove provided, nothing contained in this section shall:

             (i) supersede or limit the jurisdiction at any time conferred on the
       Securities and Exchange Commission or other regulatory authorities
       under the laws of the United States or any State, or

             (ii) restrict the Securities and Exchange Commission and such
       other authorities from carrying out their duties and responsibilities in
       accordance with such laws.

7 U.S.C. § 2.

       Appellants note that this Court, in Messer, has upheld the exclusive jurisdiction

of the CFTC over certain future trades. See Messer, 847 F.2d at 675. Appellants then

claim the transactions in this case involved commodities futures, in the form of

individual foreign currency options, and thus fall within the exclusive jurisdiction of

the CFTC. We disagree.

       While the exclusive jurisdiction provision applies to the offer and sale of a

commodity for future delivery, Appellants concede that the SEC savings clause

preserves the SEC’s jurisdiction over the offer and sale of investment interests in a

commodity pool.8 Thus, if we conclude Appellants offered investment interests in a

commodity pool, we also must conclude the SEC has jurisdiction over this case.

       8
        Although, given Appellants’ concession, we need not address this issue, there is extensive
evidence that Congress intended the SEC to have concurrent jurisdiction over commodity pools.
See, e.g., 7 U.S.C. § 6m(2); H.R. Rep. No. 97-565 (Part I) at 82 (1982), reprinted in 1982
U.S.C.C.A.N. 3871, 3931.

                                               16
      This Court has not defined the term commodity pool, but the CFTC regulations

define “pool” as “any investment trust, syndicate or similar form of enterprise

operated for the purpose of trading commodity interests.” 17 C.F.R. § 4.10(d)(1)

(1998). This definition encapsulates Appellants’ investor scheme. As discussed

above, the district court explicitly found that the investors’ funds were to be pooled

and distributed on a pro rata basis for the (alleged) purpose of trading commodity

interests. Appellants thus were offering an investment opportunity in a commodity

pool which even Appellants admit is subject to the SEC’s jurisdiction.

      Appellants’ reliance on Messer for the claim that the CFTC has exclusive

jurisdiction over this case is misplaced. In Messer, this Court concluded that T-bond

futures, a type of commodity, were under the exclusive jurisdiction of the CFTC. The

T-bond futures at issue in Messer were traded in individual discretionary accounts.

See Messer, 847 F.2d at 674, 679. In this case, however, as discussed above, the

foreign currency options (allegedly) were traded in an investment or commodity pool.

This distinction is critical. Commodities, such as the T-bond futures in Messer, are

within the exclusive jurisdiction of the CFTC. Commodity pools, such as the foreign

currency options pool in this case, are within the concurrent jurisdiction of the CFTC

and the SEC.

                                         17
       We therefore conclude the CEA did not divest the SEC of authority to bring

this action.

                          IV. CONCLUSION

       The district court did not abuse its discretion in granting the preliminary

injunction. Appellants’ activities were investment contracts covered under the

Securities Act. The SEC thus established a reasonable probability of success on the

question of jurisdiction. In addition, the CEA did not divest the SEC of authority to

bring this action.

       AFFIRMED.

                                         18