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Securities and Exchange Commission v. Arcturus Corp.

United States Court of Appeals, Fifth Circuit

June 27, 2019


          Appeals from the United States District Court for the Northern District of Texas

          Before STEWART, Chief Judge, and DENNIS and WILLETT, Circuit Judges.

          CARL E. STEWART, Chief Judge:

         IT IS ORDERED that our prior panel opinion, Securities and Exchange Commission v. Arcturus Corporation, 912 F.3d 786 (5th Cir. 2019), is WITHDRAWN and the following opinion is SUBSTITUTED therefor.

         The Defendants-Leon Ali Parvizian, Alfredo Gonzalez, Robert J. Balunus, Arcturus Corp., Aschere Energy, LLC, R. Thomas & Co., LLC, and AMG Energy, LLC-sold interests in several oil and gas drilling projects to investors. They never registered the interests as securities. The SEC called foul and filed this civil enforcement action. Because the Defendants failed to register interests in their drilling projects as securities, the SEC alleged that they violated Sections 10(b) and 15(a) of the Securities Exchange Act ("Exchange Act"), 15 U.S.C. §§ 78j(b), 78o(a), Rule 10b-5, 17 C.F.R. § 240.10b-5, and Sections 5(a), 5(c), and 17(a) of the Securities Act ("Securities Act"), 15 U.S.C. §§ 77e(a), 77e(c), 77q(a). After roughly a year and a half of discovery, both parties filed motions for summary judgment. The district court granted the SEC's motion, holding that the oil and gas interests qualified as securities. The Defendants now appeal. Because the Defendants raised significant issues of material fact, we reverse the district court's decision and remand for trial.



         This case involves seven defendants, three individuals-Leon Ali Parvizian, Alfredo Gonzalez, and Robert J. Balunus-and four companies- Arcturus Corp., Aschere Energy, LLC, R. Thomas & Co., LLC, and AMG Energy, LLC. Parvizian started three of the companies-Arcturus, Aschere, and AMG. He was also primarily responsible for running Arcturus and Aschere. Parvizian also founded AMG, but passed management on to Gonzalez, who has served as president since 2010. Balunus started and managed R. Thomas.

         The Defendants offered and sold interests in six oil and gas drilling projects-Hillock, Piwonka, Conlee, Fraley-Nelson, Chips, and Wied Field. Each project had a managing venturer that supervised and managed the day-to-day operations. The managing venturer also earned management fees paid by the project. Together, Arcturus and Aschere were the managing venturers of all six projects-Arcturus managed four, and Aschere managed two. (We refer to Arcturus and Aschere, collectively, as the "Managers.")

         While Arcturus and Aschere managed the drilling projects, R. Thomas and AMG were primarily responsible for marketing and selling interests in the projects. Neither company controlled or operated the drilling projects beyond marketing, and neither company registered as a broker.

         R. Thomas entered into a consulting agreement with Aschere. Under the agreement, R. Thomas earned a 12% commission on each new investor it introduced to the drilling projects.[1] AMG had a similar consulting agreement with Aschere, under which it offered and sold interests in all six joint ventures in exchange for $500 per week for each AMG employee and a 12% commission on each venture unit sold.

         1. The Sales Process

         When the Defendants were selling interests in the drilling projects, they sought investors through a nationwide cold-calling campaign from 2007 to 2011.[2] Potential investors came from a lead list that Parvizian purchased.[3]The Defendants also called previous investors about the drilling projects.

         The record indicates that the full cold-call process involved multiple conversations and multiple calls. (According to Alfredo Gonzalez, a former Amerest salesperson, the process "might take 5 phone calls or it might take 15 phone calls.") In the initial call, the salesperson would give a "short and sweet" statement, introducing himself and noting that he works for "a firm involved in [sic] oil and gas exploration." The salesperson would then ask if the prospective investor had experience in oil and gas investing. If the investor did, the salesperson would ask if the prospective investor was interested in information about a potential investment opportunity. If so, the salesperson would transfer the prospective investor to a "registered broker."[4] Or if the salesperson was also a registered broker, then he would continue speaking with the prospective investor. If the prospective investor expressed further interest to the broker, the broker would have a receptionist send out information.

         Initially, Arcturus would send a one-page introduction letter, giving basic information about the company and ways to seek out additional information.[5] This letter did not include any other materials. This process was designed to form a "substantive relationship" with the new client. If the new client expressed interest after additional calls, then Arcturus would send out a group of signing documents. The Defendants distributed five primary signing documents: (1) a Confidential Information Memorandum ("CIM"), which gave a detailed overview of the drilling project; (2) a copy of the Joint Venture Agreement ("JVA"), which laid out the contractual rights and duties of each party; (3) a screening questionnaire, which asked various questions about the investor's education, investing history, and experience; (4) a Private Placement Memorandum ("PPM"), which was an advertising brochure for each drilling project with geological information, pricing, and potential returns; and (5) a subscription agreement, which served as the investor's application. After sending these documents, a broker would make a follow-up call to ensure the materials arrived and were all in order.

         If the prospective investor decided to invest, then he would fill out "paperwork that was included" in the materials, including the questionnaire. Arcturus would review the questionnaire to ensure that (1) the investor was accredited and (2) the investment was suitable for the particular investor. This review included looking at the investor's net worth and employment. According to Balunas, the Defendants would also check on the potential investor's experience with oil and gas investing.

         After reviewing these documents, the Defendants would sometimes call prospective investors for additional information, though this would happen less often for "repeat clients." The Defendants would then request that each prospective investor reverify their suitability information. Bull also suggested that they would seek other updates on each investor's suitability from "time-to-time." If the investor did not qualify as an accredited investor, the Defendants would reject the investor.[6] Both Bull and Billy Cooper, a former Arcturus employee, stated that the Defendants would reject non-accredited investors, but Bull could not remember any specific rejections. Cooper also believed that some of the projects may have had non-accredited investors. Parvizian disagreed and maintained that every investor was accredited.

         2. The Investors

         Spread over the six projects, there were over 340 investors.[7] The record does not contain much information about these investors. The record only contains direct evidence about the qualifications of roughly 25 investors, leaving nearly 315 unaccounted for. But of the 25 investors about whom we have information, many had experience in the oil and gas field, direct experience with the Defendants, or both. One investor has prior experience with Orbit Energy. Another stated that he has "an engineering background" and "participated in other energy ventures with Escondido and Patriot Energy." Another stated that he has "done 83 of these projects over the last ten years." Another stated that he has "extensive experience in investing in domestic energy and often defer[s] to the advice of [his] energy advisors and petroleum engineers." Another has "past experience in oil and gas with various partial investment projects." Another has "past experience in oil and gas with Cocoal and British Petroleum." Another has "previous oil & gas experience with OG-7 Jay Pisquro." Another "previously invested in three different oil drilling and exploration projects." Another "previously invested in at least seven different oil and gas drilling, exploration, and/or production projects," some of which "were joint ventures which, like Arcturus, required active participation and voting." Another invested in two other drilling joint ventures. And another has "past experience in oil and gas with Choice Exploration."

         Besides those with oil and gas experience, at least five other investors have prior experience with the Defendants. Other investors had more general business experience. For example, one investor is a senior vice president at Capitol One and manages an operating budget of $500, 000, 000. Another has invested millions in publicly traded stocks and "numerous" joint venture investments.

         Beyond these investors, the record contained information about five investors who seemed to lack specialized experience.

         Outside of this direct information about investors, the Defendants made a few global statements about the investors. Parvizian stated that every investor was accredited. Balunas discussed the investors at length. He repeatedly emphasized that the investors were "sophisticated people." Balunas stated that many investors "had their CPAs or attorneys call" the Defendants. And others personally visited the well or spoke with the drilling operator or onsite drilling engineers. Bull assumed that some investors were new to oil and gas investment. But Cooper stated that "most of the people [he] spoke to [had] invested in oil and gas before."

         3. The Drilling Projects

         The drilling projects were split into multiple stages. First, in the capitalization stage, the Defendants sought investors for each individual drilling project. According to the signing documents, investors collectively would pay a fixed price for a "Turnkey Drilling Contract." The Manager of the drilling project would then use those funds to purchase a working interest in a prospect well, which would entitle it to drill, test, and complete the well. The working interest also entitled the project to a share of the well's net revenue.

         After capitalization, the drilling project would begin initial operations. Initial operations included the drilling and testing of the prospect well. The Manager of each drilling project was responsible for the initial operations. Aschere, for example, was responsible for managing the initial operations of the Conlee well. To complete the initial operations, the Manager would take the investors' funds and subcontract with a drilling operator who would drill and test the well. The operator for each project was identified in the corresponding CIM.

         After drilling and testing the well, the Managers would recommend whether or not to complete the well.[8] The investors would then vote on the recommendation. If the investors voted in favor, then they would all be required to pay a completion assessment, which covered the cost of entering into a "Turnkey Completion Contract." If an investor did not pay the completion assessment, he abandoned his interest in the well, did not pay any further assessments, and had no right to any revenue.

         After completion, the investors could elect, at the Manager's recommendation, to engage in special operations. Special operations could include drilling deeper, fracking, or completing additional zones in the well. These operations were subject to special assessments. The investors could also choose to engage in additional operations, which were subject to additional assessments.


         In December 2013, the SEC filed this civil enforcement action, alleging that the Defendants violated Section 5(a) and (c) of the Securities Act and Section 17(a) of the Exchange Act. The SEC argued that interests in these drilling projects qualified as securities, and the Defendants tried to avoid federal securities laws by calling the projects joint ventures and labeling the investors as partners. The Defendants argued that the projects were joint ventures because the investors had powers, rights, and management obligations. Both parties filed motions for summary judgment, and the district court granted the SEC's motion.

         The district court held that interests in the drilling projects were sold as securities pursuant to SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The parties agreed that only one factor from Howey was in dispute-whether the investors expected to profit "solely from the efforts of" the Defendants. This factor is governed by Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981), which sets out three factors for determining whether investors expect to profit solely from third-party efforts. The drilling interests qualified as securities for three main reasons, which correspond to the three factors in Williamson. First, the district court held that the investors had no real power to control the venture. Despite having some powers in the JVAs, the court held that these powers were illusory because the investors had no way of contacting each other, and the Defendants would not provide contact information. Without the ability to communicate, they could not amass the votes they needed to control the drilling projects.

         Second, the court held that the investors were inexperienced and lacked expertise in the oil and gas field. The investors lacked experience, according to the district court, because the Defendants marketed their drilling interests through a broad cold-calling campaign. The investors were also forced to rely on the Defendants to acquire all of their information.

         Third, the court held that the investors were reliant on the Defendants. The Defendants controlled all of the investors' assets, and a replacement manager could not access those assets-only the Defendants could. The investors also relied on the Defendants for all of their information.


         This court reviews a district court's grant of summary judgment de novo, using the same legal standard as the district court. Turner v. Baylor Richardson Med. Ctr., 476 F.3d 337, 343 (5th Cir. 2007). Summary judgment is appropriate where there is no genuine issue of material fact and the parties are entitled to judgment as a matter of law. Id. All reasonable inferences must be drawn in favor of the nonmovant, but "a party cannot defeat summary judgment with conclusory allegations, unsubstantiated assertions, or only a scintilla of evidence." Id. (internal quotation marks omitted).

         Under Section 5 of the Securities Act, it is "unlawful for any person, directly or indirectly" to use interstate commerce to offer to sell "any security" unless the person has filed a "registration statement" for the security.[9] 15 U.S.C. § 77e(c). The Securities Act broadly defines the term security to include a long list of financial instruments, including "investment contracts," the type of security at issue here. See 15 U.S.C. § 77b(a)(1). While Congress defined the term "security," it left it to the courts to define the term "investment contract." In Howey, the Supreme Court did exactly that and developed a "flexible" test for determining whether an investment contract qualifies as a security:

[A]n investment contract for purposes of the Securities Act means 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. Distilled to its elements, an investment contract qualifies as a security if it meets three requirements: "(1) an investment of money; (2) in a common enterprise; and (3) on an expectation of profits to be derived solely from the efforts of individuals other than the investor." Williamson, 645 F.2d at 417-18 (citing SEC v. Koskot Int'l, Inc., 497 F.2d 473 (5th Cir. 1974)).

         When applying this test, courts should disregard "legal formalisms" and, instead, focus on the substance of the deal-"the economics of the transaction under investigation." Reves v. Ernst & Young, 494 U.S. 56, 61 (1990). Even though certain contracts might "superficially resemble private commercial transactions" and lack "the formal attributes of a security," they still can qualify as securities. Youmans v. Simon, 791 F.2d 341, 345 (5th Cir. 1986)

         Here, the parties do not contest that the drilling interests met the first two Howey factors.[10] The primary issue is whether the drilling interests satisfied the third factor-whether the investors expected to profit "solely from the efforts of" the Managers.

         When determining whether investors expect to rely "solely on the efforts of others," courts construe the term "solely" "in a flexible manner, not in a literal sense." Youmans, 791 F.2d at 345. And for good reason. If courts interpreted "solely" in a literal way, a party could "evade liability" merely by parceling "out [minor] duties to investors." Id. at 345-46. To prevent this possibility, courts find the third Howey factor met if "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." Williamson, 645 F.2d at 418. Even though an investor might retain "substantial theoretical control," courts look beyond formalities and examine whether investors, in fact, can and do utilize their powers. Affco Invs. 2001, LLC v. Proskauer Rose, L.L.P., 625 F.3d 185, 190 (5th Cir. 2010).

         Here, the court must apply these general principles to a partnership.[11]Interests in a partnership can satisfy the third Howey factor and qualify as an "investment contract." But not all partnerships qualify. For example, partners in a general partnership can guard "their own interests" with their "inherent powers" and do not need protection from securities laws-they can "act on behalf of the partnership"; "bind their partners by their actions"; "dissolve the partnership"; and "are personally liable for all liabilities of the partnership." Youmans, 791 F.2d at 346. General partners are, in short, "entrepreneurs, not investors." Id. Accordingly, general partnership interests typically do not qualify as securities. Id. And a litigant trying to prove otherwise must overcome the "strong presumption" that "a general partnership . . . is not a security." Nunez v. Robin, 415 Fed.Appx. 586, 589 (5th Cir. 2011) (per curiam) (unpublished) (quoting Youmans, 791 F.2d at 346); see also Youmans, 791 F.2d at 346 ("A party seeking to prove the contrary must bear a heavy burden of proof.").

         Limited partners are different. Unlike general partners, limited partners lack significant powers-their "liability for the partnership is limited to the amount of their investment"; "[t]hey cannot ordinarily dissolve the partnership . . . [or] bind other partners"; and "they have little or no authority to take an active part in the management of the partnership." Youmans, 791 F.2d at 346. Without any significant powers, a limited partner is like "a stockholder in a corporation." Id. As a result, "limited partnership interests may be considered a security." Id. (citing Sibel v. Scott, 725 F.2d 995, 998 (5th Cir.), cert. denied, 467 U.S. 1242 (1984)).

         While we typically employ a "strong presumption" that "a general partnership . . . is not a security," Nunez, 415 Fed.Appx. at 589 (quoting Youmans, 791 F.2d at 346), we have noted that even general partners can lack managerial powers. Labeling a partnership as general or limited does not always reflect what really matters: the division of power among the partners. While general partners usually have an array of ways to influence the partnership, partnership documents or other barriers ...

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