SEC v. Faulkner: Court Grants SEC’s Motion for Preliminary Injunction, Asset Freeze, Appointment of a Receiver, and Other Relief
In SEC v. Faulkner, No. 3:16-CV-1735-D, 2017 BL 337822 (N.D. Tex. Sept. 25, 2017), the District Court of the Northern District of Texas granted the Securities and Exchange Commission’s (“SEC”) request to enjoin Christopher Faulkner (“Faulkner”), Breitling Oil & Gas Corporation (“BOG”), and Breitling Energy Corporation (“BECC”) ( collectively, “Defendants”) from future violations of the antifraud provisions of the federal securities law, instituted an asset freeze upon Defendants, and appointed a receiver due to the alleged violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”), Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), and Rule 10b-5 promulgated thereunder.
The SEC alleged that Defendants had, for at least seven years, engaged in a scheme of over-selling the available units for oil and gas prospects. According to the SEC, Defendant Faulkner oversold “working investments” for oil and gas prospects, while also inflating the estimated costs incurred for each project. Additionally, Defendants allegedly misappropriated millions of dollars in cash disbursements, and reimbursements, for personal expenses incurred by Faulkner. In total, the SEC estimated Defendants defrauded investors of $80 million, with Faulkner having personally received at least $23.8 million. Faulkner responded by arguing that: (1) the scope of receivership should be limited to the assets of BOG and BECC, as the appointment of a receiver to control his assets was excessive since the assets of BOG and BECC would sufficiently secure any proceeds owed to investors; and (2) Faulkner and other insured parties should have access to the directors’ and officers’ insurance policy (“D&O Policy”) issued to BECC. The other Defendants did not respond to the SEC’s motion.
Section 17(a) of the Securities Act promotes honesty and fair dealing by requiring companies to provide full disclosure of material information concerning securities offered to the public. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit any act or omission that results in fraud or deceit, in connection with the purchase or sale of any security. Further, pursuant to Section 20(b) of the Securities Act and Section 21(d) of the Exchange Act the SEC can obtain injunctive relief upon showing a reasonable likelihood that the defendants are, or are about to, engage in practices that violate federal securities laws. The SEC can adequately show this likelihood with proof, by a preponderance of the evidence, of past substantive violations that indicate a reasonable likelihood of future violations.
The court determined the SEC made an adequate showing to support a reasonable likelihood that Defendants had, or were about to, violate federal securities law and granted the preliminary injunction requested by the SEC without addressing the uncontested merits of the request. The court also determined that a receivership covering Faulkner’s assets was appropriate, as Faulkner obtained at least $23.8 million of investors’ assets and Faulkner’s continual misappropriation of investor’s assets, even after the SEC filed suit, instilled little confidence the management of assets would improve in the absence of supervision.
The court also concluded the D&O Policy was subject to the freeze order by looking to who owned the proceeds of the policy. The court determined that while the policy insured BECC, and its directors and officers, from claims made against them alleging wrongful acts, it was within the scope of the Defendants assets, and subject to the freeze order, as proceeds from the policy would be used to pay damages, judgments, settlements, and pre-judgment and post-judgment interest. The court noted, however, that Faulkner could file for an advancement of defense costs from this policy, as without such funds he faced a real and immediate harm of not being able to mount a defense in the present suit.
For the reasons above, the court held that a preliminary injunction, asset freeze, receivership, and other ancillary relief was appropriate against the Defendants.
The primary materials for this case are available on the DU Corporate Governance website.