Securities Regulation Daily Appellate panel affirms securities fraud findings in the sale of oil and gas joint venture agreements
Wednesday, December 5, 2018

Appellate panel affirms securities fraud findings in the sale of oil and gas joint venture agreements

By Joseph Arshawsky, J.D.

The investment contracts sold by defendant Sameer P. Sethi, interests in an oil and gas joint venture, were securities, the United States Court of Appeals for the Fifth Circuit held, affirming the district court’s decision. Moreover, the district court correctly found that Sethi knowingly made material misrepresentations to investors regarding his relationships with major oil companies (SEC v. Sethi, December 4, 2018, per curiam).

Sethi sold interests in an oil and gas drilling joint venture. He sold these interests through his company, Sethi Petroleum, which he founded in 2003 and manages alone. Sethi would make cold calls and once he found an "accredited investor," he would promote the venture using two main documents: a private placement memorandum ("PPM") and a copy of the joint venture agreement ("JVA"). The PPM specified that Sethi would use the funds to purchase a 62.5 percent net working interest in at least twenty wells, all of which would be operated "by publicly traded and/or major oil and gas companies," such as ExxonMobil, Hess Corporation, and ConocoPhillips. As a result of his sales efforts, Sethi ended up raising over $4 million from ninety investors, which he used to purchase a fractional working interest in eight wells from Irish Oil & Gas, with the interests ranging from 0.15 percent to 2.5 percent. Three different operators worked on the wells—Crescent Point Energy U.S. Corp., Oxy USA Inc., and Slawson Exploration Co. Six of the wells produced oil, and the operators voluntarily cancelled two other wells. Over the course of the investments, no evidence shows that a vote or investor meeting ever occurred.

On appeal, Sethi challenged two of the district court’s decisions. First, he argues that the district court erred when it held that interests in his drilling projects qualified as securities. Second, he argues that the district court erred in granting summary judgment on the SEC’s securities fraud claims. The Fifth Circuit affirmed the district court.

Securities. 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." Here, the parties dispute the third factor. Under the Williamson factors, a partner is dependent solely on the efforts of a third-party manager when: "(1) an agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership; or (2) the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or (3) the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers." The first Williamson factor is whether the drilling projects left the investors so little power "that the arrangement in fact distribute[d] power as would a limited partnership."

Here, the governing venture documents gave investors some theoretical power to control the drilling projects. Importantly, they had the power to remove Sethi as manager. They also could call meetings and propose amendments with a 20 percent vote, develop rules for meetings with a 50 percent vote, and veto Sethi’s decisions. "These powers, however, were illusory in practice. Sethi blocked investors from using their powers on numerous occasions. First, and most tellingly, Sethi was responsible for calling meetings and soliciting votes. He never did." The investors never held a meeting and did not vote on any matter. A receiver appointed by the district court also found no evidence that Sethi ever "organized a vote or solicited input of any kind from investors."

While Sethi contends that the project was in its early stages, the SEC provided evidence that Sethi took several actions without informing investors. When he purchased well interests for the venture, he did not inform the investors or solicit any investor approval, even though this approval was required by the JVA. He did not notify investors when he sued to rescind this interest. Nor did Sethi ask for any investor input when he drilled eight of twenty wells promised in the PPM.

Second, Sethi gave the investors little to no information. The investors did not have access to the project’s books. Sethi does not provide any evidence to the contrary. Meanwhile, the SEC provided summary judgment evidence that investors did seek to use their powers but could not. The SEC provided unrebutted evidence showing that the investors could not use their legal powers. As a result, the district court correctly concluded that Sethi’s drilling projects distributed power as if they were limited partnerships. "Because we agree that the first Williamson factor was met, we do not address the second and third factors."

Misrepresentations. The Fifth Circuit was not persuaded by Sethi’s argument that he did not make any misrepresentations at all. Sethi’s brief cited no summary judgment evidence to support his conclusory arguments. Meanwhile, the district court, relying on unrebutted evidence, held that Sethi misstated his relationships with major oil companies when offering interests in his drilling venture and, as a result, misled investors. The record supports the district court’s findings. Taken together, Sethi’s statements suggest that Sethi Petroleum had preexisting relationships with some of the largest oil companies in the world— relationships that Sethi would leverage in the venture’s favor.

In reality, these relationships did not exist. No evidence in the record indicates that Sethi Petroleum had any preexisting relationship with any of the listed companies or ones that are similar. Nor does the record show that the venture ever partnered with Exxon Mobil, Conoco Phillips, or a similar company. In fact, Sethi acquired the venture’s only well interests from Irish Oil & Gas, Inc.—a small, private oil company. The district court correctly concluded that these facts constitute a misstatement.

Scienter. These facts also establish scienter. Sethi knew that he did not have relationships with the listed companies, and Sethi does not dispute that the venture never partnered with a major oil company. The district court correctly found that Sethi made material misstatements to investors when he knowingly misrepresented his relationships with major oil companies.

The case is No. 17-41022.

Attorneys: Daniel Matro for the SEC. Sameer P. Sethi, pro se.

MainStory: TopStory Enforcement FraudManipulation SecuritiesOfferings LouisianaNews MississippiNews TexasNews

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