Colorado Securities Commisioner Files Suit Against Oil and Gas Promoters for Fraudulent Investment Scheme
Thursday, 13 August 2009 16:54

Colorado Securities Commissioner Files Suit Against Oil and Gas Promoters for Fraudulent Investment Scheme

0in; margin-bottom: .0001pt; margin-left: .1in;">Civil complaint filed in District Court in the city and county of Denver, Colorado alleging violations of § 11-51-301 C.R.S. for the offer or sale of unregistered securities; violation of § 11-51-401(2) C.R.S. for unlicensed sales representative activity; violations of §§ 11-51-501(1) C.R.S. and 11-51-604(4) for fraud and deceit related to the sale of securities; and, as to the attorney defendants, violation of § 11-51-604(5)(c) for joint and several liability.

Underlying Facts:

According to a complaint filed by the Colorado Securities Commissioner in Denver District Court on July 22, 2009, four businesses, their lawyer, and eight individuals violated the anti-fraud, registration, and licensing provisions of the Colorado Securities Act in connection with their marketing and promotion of investments in oil and gas well-drilling operations. Named in the complaint are

  1. (1) the “Heartland defendants:” The corporate defendants include HEI Resources, Inc., a Texas corporation that previously did business as Heartland Energy, Inc., Heartland Energy Development Corp., a Delaware corporation, Bedrock Energy Development, Inc., a Delaware corporation, and Gulf Coast Western, a Texas corporation. The named individual defendants include Charles Reed Cagle (President and CEO of HEI and Co-CEO of Gulf), Joseph D. Kinlaw, both of Colorado Springs, Brandon Davis of Castle Rock (President of Heartland Energy), and Matthew Fleeger of Dallas, Texas (Co-CEO of Gulf);
  2. (2) the “Sales defendants:” John Schiffner of Parker, Nicholas Troyer of Colorado Springs, Steve Ziemke of Monument, Dale Phillips of Colorado Springs, and James Pollak of Denver, Colorado; and,
  3. (3) the “Attorney defendants:” Joel Held, a Dallas, Texas attorney, and his firm, Baker & McKenzie, LLP, also of Dallas.

 

None of the defendants are licensed in any capacity with the Securities Commissioner.

Allegations:

The Commissioner alleges that, since 1997, the defendants perpetrated a scheme to defraud investors by operating “boiler room” call centers in Colorado that made cold-call solicitations to potential investors nationwide for oil and gas investments, and raised millions of dollars through the sale of “joint venture” securities. Boiler rooms typically feature numerous salesmen, each making hundreds of cold calls per day to unsuspecting individuals, using scripted sales pitches and high-pressure tactics to push investment opportunities.

Cagle and Kinlaw allegedly orchestrated the scheme. Under their guidance, sales agents in the Colorado “boiler rooms” cold-called potential investors nationwide, including elderly, infirm, and unsophisticated investors, offering joint venture interests in oil and gas drilling projects, representing that they were in the business of developing wells on land known to have produced oil and gas. The coldcallers promised that investments in the wells had a high success rate and would provide a return within a short period of time with very low risk, that the technology employed by the consulting geologist “ensured productive wells,” that lease operating costs for drilling operations are substantially tax deductible, that the offering was available “only for a limited time,” and that investors could contact references regarding the investment opportunity, including Cagle and Held. They failed to disclose the actual financial track records associated with the prior wells. When investors questioned the risk of the investment, the sales agents utilized pre-scripted responses that carefully steered investors away from the concern and back to potential profits.

Interested investors were provided with an “offering packet” containing a private offering memorandum, a “confidential information memorandum” describing a particular joint venture, a memo from a geological consultant containing the results of 3-D seismic historical production data, maps showing the general location of the drill site, and a letter from one of the Sales defendants promising “tremendous potential” for the site. Investors also received a “Monthly Conversion Table” which provided hypothetical calculations of the monthly return on their investment, ranging from 14-140% if the well produced. Once interested investors were identified by the cold-calling sales agent, a “closer” sales agent—someone with more experience to “close” the deal—would make the final investment arrangements. Both the cold-calling and the closer sales agents received a percentage of the investment, and any subsequent investments by the same investor, as commission.

After investors agreed to the terms and funded their investment, they were “accepted” by the joint venture and asked to ratify that one of the Heartland defendants was the “Initial Managing Venturer” and that Attorney defendants were legal counsel for the joint venture. Also, conference calls were scheduled with investors during which Cagle or other Heartland defendants presented issues to be voted upon, such as whether and how the drilling of a well should be completed, often at additional cost, or plugged and abandoned. The Heartland defendants used the conference calls as a vehicle for touting the success and potential of the venture, answering investors’ questions and influencing how investors would vote. Most investors lacked expertise and sophistication regarding the joint venture and were therefore dependent upon these representations, voting as the Heartland defendants wished them to. Aside from these few ratification votes, which were significantly influenced by the Heartland defendants, investors did not participate in the day-to-day management of the joint venture.

The Commissioner charges that the Attorney defendants are jointly and severally liable in this action because, in the course of their legal representation of Heartland defendants, Held and Baker & McKenzie reviewed and drafted various confidential information memorandums for the joint ventures, which created the illusion of a “general partnership,” not subject to securities regulations, with investors maintaining actual control over the joint venture. In reality, the Attorney defendants were aware that the “general partner” votes were illusory and intended to ratify the “Initial Managing Venturer’s” decisions. Also, Held served as a reference for the Heartland defendants in soliciting investors, vouching for their credibility but failing to mention in his communications with potential investors that he would ultimately be “ratified” as the joint venture’s attorney and would draft the confidential information memorandum.

Interestingly, Cagle and Kinlaw have a joint history of state and SEC enforcement actions and litigation against them spanning across Virginia, Texas, Colorado, Alabama, and Illinois:

(1) In 1989, Cagle entered into a consent settlement order with the Virginia Corporation Commission, permanently enjoining him and Kinlaw Oil Corp. from offering or selling securities in Virginia in violation of state law.

(2) The SEC filed suit against Kinlaw, Cagle, and others in the District Court for the Northern District of Texas alleging the defendants participated in a scheme that raised $177 million from several thousand investors nationwide through fraudulent sales of interests in oil and gas drilling joint ventures managed by Kinlaw Securities and Kinlaw. In 1995, Kinlaw entered into a settlement agreement with the SEC by consenting to a permanent injunction prohibiting him from violating antifraud and registration provisions of federal securities laws. Following the SEC action, Cagle and Kinlaw moved their main offices to Colorado.

(3) In 2002, the Alabama Securities Commission issued a cease and desist order, concluding that joint venture interests sold by Cagle and Heartland Energy were securities; however, in 2003 the Commission vacated its order, stating it “is not rendering an opinion as to whether or not the joint venture interests . . . are or are not securities . . .”

(4) In 2002, the Colorado Division of Securities brought an administrative action against Heartland Energy, Cagle, and a third party, Stanley Rose, in connection with the offer and sale of securities in Colorado. The Attorney Defendants represented Cagle in the action. The Commissioner concluded that insufficient evidence existed to determine whether a security existed.

(5) In 2007, the Alabama Securities Commission entered a second cease and desist order against Heartland Energy, Cagle, Schiffner, and Davis, concluding that the defendants had sold unregistered investment contract securities in Alabama. The Commission later vacated as to defendant Cagle as he lacked an actual ownership interest in Heartland Energy.

(6) In 2008, two separate private plaintiff actions were filed against Cagle, Kinlaw, and others in Colorado, alleging violations of the registration, licensing and antifraud provisions of the Colorado Securities Act.

(7) In 2009, the Illinois Secretary of State entered a temporary order of prohibition against HEI Resources, Cagle, and Schiffner, stating that Illinois residents had been cold-called by Schiffner and purchased interests in a joint venture called Heartland Energy, Los Ojuelos #1 Joint Venture, and had received the same offering documents sent to every prospective investor by the Heartland defendants. The order states that this constituted a sale of unregistered securities in violation of the Illinois Securities Act and prohibited HEI Resources, Cagle, and Schiffner from offering or selling securities in Illinois until further order from the State.

The Commissioner has charged the defendants for the fraudulent offer and sale of unregistered securities, in the form of interests in oil and gas drilling operations, through the use of unlicensed sales representatives, to investors nationwide, and seeks damages, rescission, interest, costs, attorneys’ fees, restitution, disgorgement, temporary and permanent injunctive relief, and a constructive trust on the fraudulently obtained funds.

 

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