[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT FILED
_____________________________
U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
Nos. 01-10107 & 02-11393 May 5, 2005
_____________________________ THOMAS K. KAHN
CLERK
D. C. Docket No. 00-02532-CV-JTC-1
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff-Appellee,
versus
ETS PAYPHONES, INC.,
Defendant,
CHARLES E. EDWARDS,
Defendant-Appellant.
_________________
Appeal from the United States District Court
for the Northern District of Georgia
__________________
(May 5, 2005)
ON REMAND FROM THE SUPREME COURT
OF THE UNITED STATES
Before EDMONDSON, Chief Judge, HILL and LAY*, Circuit Judges.
_______________
* Honorable Donald P. Lay, United States Circuit Judge for the Eigth Circuit, sitting by
designation.
PER CURIAM:
In 2002, we decided Charles E. Edwards’s (Edwards) appeal from the
district court’s grant of the Securities and Exchange Commission’s (SEC) motion
for preliminary injunction and asset freeze against Edwards. The asset freeze
included the assets of Edwards’s wholly-owned corporation, Twinleaf, Inc.
(Twinleaf). We determined that the district court lacked subject matter
jurisdiction because the investments offered by Edwards were not “securities”
under federal securities laws. SEC v. ETS Payphones, Inc., 300 F.3d 1281, 1285
(11th Cir. 2002). On review, the Supreme Court clarified that investments with a
fixed rate of return could constitute an “investment contract” under the Securities
Acts of 1933 and 1934. SEC v. Edwards, 124 S.Ct. 892, 898-99 (2004).
Edwards’s original appeal, by remand from the Supreme Court, is before us
again. In the interim, Edwards moved the district court for a modification of the
asset freeze to permit Twinleaf to pay its attorneys fees. The district court denied
Edwards’s motion, and he appealed.
We now consider both appeals. We must decide, specifically, whether (1)
the transactions offered by Edwards were securities under the Securities Acts of
1933 and 1934; (2) the district court clearly erred when it found Edwards was
likely to violate securities laws in the future; (3) Edwards can be personally liable
2
for violations of federal securities acts; and (4) the district court erred by denying
Twinleaf, Inc., use of its funds to pay attorneys fees for this action.
FACTS
We adopt the statement of facts from our earlier opinion reported in 300
F.3d 1281.
STANDARD OF REVIEW
We review a trial court’s decision to grant injunction under the abuse of
discretion standard. Klay v. United Healthcare Group, Inc., 376 F.3d 1092, 1096
(11th Cir. 2004). Determinations of law are reviewed de novo, while the findings
of fact that support an injunction are reviewed for clear error. SEC v. Unique Fin.
Concepts, Inc., 196 F.3d 1195, 1198 (11th Cir. 1999). To reverse the injunction
on a question of jurisdiction, the plaintiff (here, the SEC) must “only establish a
‘reasonable probability of ultimate success upon the question of jurisdiction when
the action is tried on the merits.’” Id. (citations and quotation omitted). We review
an asset freeze for an abuse of discretion, though we do not defer to the district
3
court’s legal analysis. Levi Strauss & Co. v. Sunrise Int’l Trading Inc., 51 F.3d
982, 986-87 (11th Cir. 1995).
JURISDICTION
The Securities Acts of 1933 and 1934 define a “security” as including
“investment contract.” 15 U.S.C. §§ 77b(a)(1), 78c(a)(10). The Supreme Court
has set out the test for determining whether a transaction qualifies as an
“investment contract” in SEC v. W.J. Howey Co., 66 S.Ct. 1100 (1946). Under
Howey, a security must include four components: (1) an investment of money, (2)
a common enterprise, (3) the expectation of profits, and (4) the expectation of
profits to be derived solely from the efforts of others. Unique Fin. Concepts, 196
F.3d at 1198.1
Our prior decision in this case concluded that the transactions involved an
investment of money. 300 F.3d at 1283. The Supreme Court said the fixed rate of
return offered by Edwards could constitute an “expectation of profits.” Edwards,
1
In Unique Fin. Concepts, this Court derived a three-element test from Howey. 196 F.3d at 1198
((1) an investment of money, (2) a common enterprise, and (3) the expectation of profits to be
derived solely from the efforts of others). For the purposes of this appeal, we examine separately
the two aspects of the third element: the expectation of profits and whether those profits are derived
solely from Edwards’s efforts.
4
124 S. Ct. at 898-99. We now examine whether the SEC sufficiently demonstrated
the second and fourth elements of the Howey test.
In our earlier ruling, we reaffirmed this Circuit’s adherence to the “broad
vertical commonality” test for determining whether investors operated under a
common enterprise. ETS Payphones, Inc., 300 F.3d at 1284. That test requires
the movant to “show that the investors are dependent upon the expertise or efforts
of the investment promoter for their returns.” Id. at 1284.
The district court found that “ETS had to attract an ever expanding number
of investors to meet its obligation to existing investors.” ETS Payphones, Inc.,
123 F. Supp.2d 1349, 1352 (N.D. Ga. 2000). Investors were dependent upon
Edwards’s ability to attract new business to realize profits. Ninety-nine percent of
investors leased back the phones they bought from one of Edwards’s companies to
another company of his. Thus, investors evidently had no desire “to perform the
chores necessary for a return” on their investment. Eberhardt v. Waters, 901 F.2d
1578, 1580-81 (11th Cir. 1990) (defining the “thrust of the common enterprise
test”). Given the factual findings of the district court and our review of the record,
we conclude the SEC made, at this preliminary stage, a sufficient showing on the
second element: a common enterprise.
5
The fourth element of the Howey test asks the “amount of control that the
investors retain[ed] under their written agreements.” Albanese v. Fla. Nat’l Bank
of Orlando, 823 F.2d 408, 410 (11th Cir. 1987). The more control investors retain,
the less likely it becomes that the contract qualifies as a security. ETS investors
retained minimal control over the telephones. Once an investor leased the phone
back to ETS (which ninety-nine percent did), that investor relied on ETS (and
Edwards) for profits. See Eberhardt, 901 F.2d at 1581 (considering that the
average investor relied on defendants for success). In addition, through his
companies, Edwards provided the “essential managerial efforts” of phone
placement, collection and maintenance. SEC v. Koscot Interplanetary, Inc., 497
F.2d 473, 483 (5th Cir. 1974).2 And, this fact is important: these managerial
efforts included the sole discretion over where to place telephones. See SEC v.
Unique Fin. Concepts, Inc., 196 F.3d 1195, 1201 (11th Cir. 1999) (considering
defendant’s sole discretion over investment funds).3 We see no abuse of discretion
in the district court’s conclusion that the SEC met its burden of showing a
reasonable probability of success on the jurisdictional question.
2
In Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir. 1981) (en banc), this Court adopted as
precedent all decisions of the former Fifth Circuit Court of Appeals decided prior to October 1, 1981.
3
In making this determination, we often look to the actual relationship between the parties. See
Albanese, 823 F.2d at 412 (reasoning that any control retained by investors was “illusory” despite
contractual terms).
6
REASONABLE LIKELIHOOD OF CONTINUING VIOLATIONS
To grant a preliminary injunction in a securities case, a plaintiff must
provide, among other elements, “positive proof” that the defendant will likely
violate securities laws in the future. SEC v. Caterinicchia, 613 F.2d 102, 105 (5th
Cir. 1980) (citing SEC v. Blatt, 583 F.2d 1325, 1334 (5th Cir. 1978)).
The district court concluded that the SEC met this burden. ETS Payphones,
Inc., 123 F. Supp.2d at 1355. We review that determination for an abuse of
discretion. Unique Fin. Concepts, Inc., 196 F.3d at 1198. That Edwards has
complied with the SEC since the inception of the SEC suit is undisputed. Yet, we
must weigh this compliance against the magnitude of the alleged fraud and
examples of potential malfeasance, including a finding of scienter, and allegations
of state law violations by ETS committed before the SEC’s involvement. SEC v.
Carriba Air, Inc., 681 F.2d 1318, 1322 (11th Cir. 1982) (considering “the
egregiousness of the defendant’s actions, the isolated or recurrent nature of the
infraction, the degree of scienter involved, the sincerity of the defendant’s
assurances against future violations, the defendant’s recognition of the wrongful
nature of his conduct, and the likelihood that the defendant’s occupation will
present opportunities for future violations”).
7
When weighing these issues, we must also recognize “that for the matter in
question there is a range of choice for the district court and so long as its decision
does not amount to a clear error of judgment we will not reverse even if we would
have gone the other way had the choice been ours to make.” McMahan v. Toto,
256 F.3d 1120, 1128 (11th Cir. 2001). As such, we see no abuse of discretion in
the district court’s decision to grant the preliminary injunction.
INDIVIDUAL LIABILITY
Edwards argues that, if the investments were securities, they were issued by
ETS, not by him. This argument is without merit. United States v. Rachal, 473
F.2d 1338, 1341-42 (5th Cir. 1973) (exempting individuals from the reach of the
Securities Act would “eviscerate” it).
Edwards also challenges the court’s finding of scienter, a necessary element
of fraud under the securities laws. The district court found that ETS “always lost
money on its payphone operations.” SEC v. ETS Payphones, Inc., 123 F. Supp.
2nd 1349, 1352 (N.D. Ga. 2000). The district court also specifically found that
Edwards was aware of ETS’s financial condition. Id. at 1355. Edwards contends
8
that because ETS used non-standard accounting methods, he lacked an intent to
defraud investors.4
We review findings of scienter for clear error. Lucas v. Fla. Power & Light
Co., 765 F.2d 1039, 1040 (11th Cir. 1985). The SEC provided evidence that
neither ETS nor its representatives, including Edwards, disclosed to investors that
ETS would be unable to buy back phones if a substantial number of investors so
requested. Edwards admits that ETS relied on new investors to sustain operations.
This reliance was also not conveyed to investors. Instead, Edwards sent a letter to
“leaseholders” on 1 June 2000 stating that ETS remained profitable, even though
ETS declared bankruptcy on 11 September 2000. Given the other facts, we see no
clear error in the district court’s additional finding of scienter. Accordingly, we
see no error in the district court’s decision to grant the preliminary injunction
against Edwards personally.
EDWARDS’S ASSET FREEZE
4
Edwards admittedly did not employ the Generally Accepted Accounting Principles (GAAP).
The SEC demonstrated that when GAAP methods are employed, ETS’s financial losses are
undeniable. The Government expert conceded, however, that under the methods used by ETS, no
loss was apparent. The trial court considered this testimony when ruling and rejected Edwards’s
purported reliance on the non-standard methods.
9
The district court ordered that Edwards’s assets be frozen to preserve
sufficient funds for potential disgorgment. ETS Payphones Inc., 123 F. Supp.2d at
1356. On the initial appeal, Edwards challenged this freeze, arguing it was
facially invalid and that it failed to show assets were acquired by fraud.5 We
conclude that the district court did not abuse its discretion when ordering a freeze
of Edwards’s assets.
We reject Edwards’s facial challenges. Edwards argues that the Supreme
Court decision of Grupo Mexicano de Desarrollo, S.A. v. Alliance Bond Fund,
Inc., 119 S. Ct. 1961 (1999) (“Grupo Mexicano”) prevents a pre-judgment freeze
of his assets. Grupo Mexicano addressed the issue of whether “in an action for
money damages, a United States District Court has the power to issue a
preliminary injunction” amounting to a freeze of assets. 119 S. Ct. at 1964
(emphasis added). The Court answered the question “no,” but it distinguished
those cases where the ultimate relief sought is equitable. Id. at 1971 (discussing
Deckert v. Independence Shares Corp., 61 S. Ct. 229 (1940) and United States v.
First Nat. City Bank, 85 S. Ct. 528 (1965)).
5
The SEC argues that Edwards did not preserve his appeal on the scope of the asset freeze. See
Federal Trade Comm’n v. Alantex Assoc’s, 872 F.2d 966, 970 (11th Cir. 1989) (concluding
appellant waived right to challenge asset freeze because it did not request the release of funds for
specific purpose). We disagree. Edwards challenged the reach of the asset freeze, including the
affect on Twinleaf.
10
The Fourth Circuit recently addressed this issue and said that in cases
involving equitable relief, even where money damages are also claimed, Deckert
controls. United States v. Oncology Assoc’s, P.C., 198 F.3d 489, 498 (4th Cir.
1999). Under Deckert, equitable remedies employed to “preserve the status quo”
are proper in actions arising under the Securities Act. 61 S. Ct. at 234. We accept
the reasoning of the Fourth Circuit and conclude that Grupo Mexicano does not
control the outcome of this case, because the SEC seeks equitable relief
(disgorgment), not just money damages.6
We acknowledge that the SEC also seeks the legal remedy of civil damages.
But, the asset freeze is justified as a means of preserving funds for the equitable
remedy of disgorgment. We do not believe that the inclusion of a claim for civil
penalty damages makes the remedies sought wholly legal and not equitable.
Edwards’s second facial challenge is based on the SEC’s decision not to
follow the procedures set forth in the Federal Debt Collection Act (“FDCA”). 28
U.S.C. § 3001 et. seq. The FDCA applies to situations where the government
6
Contrary to Edwards’s assertions, disgorgment is an equitable remedy. See, e.g., SEC v. Yun,
327 F.3d 1263, 1268 n.10 (11th Cir. 2003) (distinguishing between legal damages and equitable
disgorgement); SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978). See also Tull v. United States,
107 S. Ct. 1831, 1839 (1987).
11
seeks “to recover a judgment on a debt; or to obtain, before judgment on a claim
for a debt, a remedy in connection with such claim.” 28 U.S.C. § 3001(a).
The FDCA is inapplicable to this case for two reasons. First, the SEC is not
now seeking to recover for a judgment or “obtain” any assets. At this point, the
SEC is attempting to freeze assets to prevent their disbursement; no money is
being transferred to the federal treasury or registry of the court. Second, the
statutory definition of “prejudgment remedy” does not include disgorgement. 28
U.S.C. § 3002(11). Accordingly, even if we assume, without deciding, that a
claim for disgorgement seeks collection of a “debt” as defined by the FDCA, the
means the SEC employed to secure that debt in this case (disgorgement) is not one
of the prejudgment remedies covered by the FDCA.7 The asset freeze, as it applies
to funds potentially subject to disgorgement, is facially sound. We reserve
judgment on the applicability of the FDCA to the SEC’s claim for civil penalties.
Edwards also challenges the scope of the asset freeze. The SEC’s burden
for showing the amount of assets subject to disgorgement (and, therefore available
for freeze) is light: “a reasonable approximation of a defendant’s ill-gotten gains
7
Edwards also argues that Rule 64 of the Federal Rules of Civil Procedure should have controlled
the lower court’s disposition of his assets. We disagree. Rule 64 applies in cases of “arrest,
attachment, garnishment, replevin, sequestration, and other corresponding or equivalent remedies.”
Fed. R. Civ. P. 64. Disgorgement is unlike these remedies. See generally, Blatt, 583 F.2d at 1335.
12
[is required] . . . Exactitude is not a requirement.” SEC v. Calvo, 378 F.3d 1211,
1217 (11th Cir. 2004). But, the “power to order disgorgement extends only to the
amount with interest by which the defendant profited from his wrongdoing. Any
further sum would constitute a penalty assessment.” SEC v. Blatt, 583 F.2d 1325,
1335 (5th Cir. 1978).
Given our other conclusions, we can presume gains from ETS were acquired
through fraud. Accordingly, any money distributed from ETS to Twinleaf or
Edwards would be subject to a disgorgement order. “The purpose of disgorgement
is . . . to deprive the wrongdoer of his ill-gotten gain.” Blatt, 583 F.2d at 1335.
The SEC continually cites $300 million as the total amount of ill-gotten
gains by ETS, but neither the record before us nor a finding of the district court
sufficiently establishes that amount. The record is consistent with the SEC’s
appellate brief: the SEC suggests, without a specific rebuttal from Edwards, that
from 1996 through 2000, Edwards personally received at least $3.04 million in
compensation from ETS and Twinleaf.8 Twinleaf obtained at least $18.4 million
in payments and interest free loans from ETS. Accordingly, approximately $21
million should be subject to disgorgement.
8
The SEC stresses that Edwards’s own testimony at the preliminary hearing revealed the $2.24
million figure. Edwards’s accounting, however, shows him receiving over $2.7 million in
compensation from ETS and Twinleaf for the same period.
13
Against this potential equitable liability of $21 million, the district court
found that Edwards possesses $7 million in personal real estate assets. 123 F.
Supp.2d at 1356. In 2000, Edwards estimated in his deposition that Twinleaf’s
actual value at $13 to $15 million. In 2001, he revised that number to $2.09
million in cash. But, we use the 2000 calculation to examine whether, at the time
the district court made the decision to freeze all assets, the court abused its
discretion. Cf. Dallas Cowboys Cheerleaders, Inc. v. Scoreboard Posters, Inc.,
600 F.2d 1184, 1887 (5th Cir. 1979) (acknowledging that appellate review may
consider the “posture of the proceedings at the time of entry”).
When totaling Twinleaf’s value with Edwards’s personal assets, it appears
that the most Edwards possessed in 2000 was $22 million; the least he controlled
was $20 million. Accordingly, Edwards failed to meet his burden of showing the
SEC’s fallback number of $19 million for potential liability is an unreasonable
approximation. SEC v. Calvo, 378 F.3d 1211, 1217 (11th Cir. 2004).9 Edwards’s
arguments about the asset freeze are not based on Twinleaf’s actual value in 2000.
Thus, if Twinleaf’s value in 2000 was as low as the $13 million estimated by
Edwards, a full asset freeze would be necessary to preserve such funds for
9
This number, cited by the SEC in its brief, is exclusive of prejudgment interest.
14
potential disgorgment. Given these facts, the district court did not abuse its
discretion when it froze all of Edwards’s assets.
MODIFICATION OF ASSET FREEZE FOR ATTORNEYS FEES
Edwards also appeals the district court’s denial of his request to permit
Twinleaf to use its assets to pay its attorneys fees. These fees accrued during
attempted settlement negotiations with the SEC and as a result of submitting
accountings and weekly financial reports.
In addition to the challenges discussed above, Edwards argues that the asset
freeze violates Twinleaf’s rights under the Due Process Clause of the Fifth
Amendment to the United States Constitution. Edwards also argues that, under
Georgia law of corporations, he cannot be responsible for Twinleaf’s legal fees.
The standing and mootness doctrines bar us from deciding whether
Twinleaf should be permitted to pay its own legal expenses. Edwards concedes
that Twinleaf is a nonparty to this litigation. Therefore, to achieve standing,
Edwards must show that he and Twinleaf have a close relationship, and that “some
obstacle” prevents Twinleaf from asserting its rights. See Planned Parenthood
Ass’n of Atlanta Area, Inc. v. Miller, 934 F.2d 1462, 1465 n.2 (11th Cir. 1991).
15
Edwards made no such showing. In addition, the argument is moot. Edwards
acknowledges that Twinleaf is no longer subject to an asset freeze, but he fears it
may be subject to one later. Edwards has not convincingly demonstrated why his
fear is likely to be realized.
We also reject Edwards’s argument that Twinleaf should pay for the weekly
reports of revenues earned by it. Edwards personally agreed, by consent order, to
provide such reports. The consent order is interpreted as a contract, and he is
bound by it. See Robinson v. Collert, 602 F.2d 87, 92 (5th Cir. 1979).10
Thus, in all matters, the district court’s orders are affirmed.
AFFIRMED.
10
Edwards also argues that the district court erroneously relied on two cases from the Seventh
Circuit. SEC v. Quinn, 997 F.2d 287 (7th Cir. 1993); SEC v. Cherif, 933 F.2d 403 (7th Cir. 1991).
We review district court judgments; we do not grade the opinions. We agree with Edwards that the
decisions are not on point. Quinn involved the asset freeze of one person, and that person violated
the preliminary injunction. 997 F.2d at 289. Cherif involved persons who did not submit to an
accounting. 933 F.2d at 403. Edwards has been far more cooperative than the defendants in those
cases. Still, we may affirm the district court’s judgment, even if we do not agree its reasoning. See
Rosen v. Cascade Int’l, Inc., 21 F.3d 1520, 1527 n.13 (11th Cir. 1994).
16