Memorandum Opinion and Order Dismissing SEC Case Against Texas AG Paxton | Sec Rule 10b 5

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Memorandum Opinion and Order Dismissing SEC Case Against Texas AG Paxton
  United States District Court EASTERN DISTRICT OF TEXAS SHERMAN DIVISION SECURITIES AND EXCHANGE COMMISSION v. WILLIAM E. MAPP, III, WARREN K. PAXTON, JR., CALEB J. WHITE, and SERVERGY, INC. § § § § § § §§§ CIVIL ACTION NO. 4:16-CV-246 JUDGE MAZZANT MEMORANDUM OPINION AND ORDER  Pending before the Court is Warren K. Paxton, Jr.’s Motion to Dismiss Under Federal Rules of Civil Procedure 12(b)(6) and 9(b) (Dkt. #44). Having considered the relevant pleadings, the Court finds that the motion should be granted. I. BACKGROUND  This motion comes before the Court following the Court’s conditional dismissal of Warren K. Paxton, Jr. (“Paxton”) from the underlying action (Dkt. #39). The Court granted the Securities and Exchange Commission (the “Commission”) leave to allege additional facts that might support a claim under the statutes alleged in its srcinal complaint (the “Original Complaint”). The facts alleged in the new complaint (the “Amended Complaint”), which the Court must accept as true, are as follows: Servergy, Inc. (“Servergy”) is a computer hardware company that develops secure, cloud- based data storage servers. From November 2009 to September 2013, Servergy raised approximately $26 million in private securities offerings to develop what it claimed was a revolutionary new server. William E. Mapp, III (“Mapp”), Servergy’s co-founder and then-CEO, was responsible for the fundraising campaign and had signatory authority over Servergy’s bank Case 4:16-cv-00246-ALM Document 96 Filed 03/02/17 Page 1 of 37 PageID #: 1995  2 accounts. As Servergy’s primary fundraiser, Mapp identified prospective investors through word-of-mouth referrals and offered compensation to individuals for introducing new investors to the company. Paxton became involved in Servergy’s fundraising campaign in the summer of 2011. Paxton currently serves as the Attorney General of Texas. Before serving as Texas’s Attorney General, Paxton was a Texas state senator from January 2013 to December 2014 and a Texas state representative from January 2003 to December 2012. Paxton was previously an investment adviser representative of Mowery Capital Management (“MCM”). Paxton at times solicited clients on MCM’s behalf and collected asset management fees. In 2011, Paxton reported legal services income from MCM. Paxton was also registered as an investment adviser representative from July 2003 to December 2004 and from December 2013 to November 2014. On July 12, 2011, Mapp met Paxton—then a member of the Texas House of Representatives—at Paxton’s law office in McKinney, Texas, to discuss Servergy. During their meeting, Mapp offered to pay Paxton a 10% commission for any investors Paxton recruited to invest with Servergy. Following the meeting, Mapp emailed Paxton and reiterated his offer to pay Paxton either with Servergy common stock or a combination of cash and stock. Paxton responded to Mapp’s offer via email, stating, “I will get to work.” Paxton actively recruited investors for Servergy between July 11, 2011, and July 31, 2011. Throughout Paxton’s recruiting efforts, Paxton raised $840,000 for Servergy—32% of all investment funds raised by Servergy in 2011—by promoting the company and soliciting investors for an undisclosed transaction-based compensation in the form of 100,000 shares of Servergy common stock. Paxton told prospective investors that he had met with Servergy’s management and determined it was a great company and the investment presented an interesting opportunity. Case 4:16-cv-00246-ALM Document 96 Filed 03/02/17 Page 2 of 37 PageID #: 1996  3 Paxton did not conduct any due diligence into Servergy or reveal to potential investors that he was  being compensated to promote Servergy’s stock. On July 22, 2011, Paxton organized and invited at least seven prospective investors to an investment pitch at Servergy’s office. Paxton attended that meeting and also introduced Mapp to at least five additional prospective investors by telephone and email the same day. Among the  people Paxton recruited were his friends, business associates, law firm clients, and members of an investment group (the “Investment Group”) of which he belonged. The Investment Group consisted of four members (“Investors 1, 2, 3, and 4”) not including Paxton. Based on prior dealings in the Investment Group, members trusted each other to consider the interest of the group as a whole and not exploit one another for a member’s personal benefit. Typically, the member who recommended the investment would monitor the investment going forward and represent the group’s interest. Paxton did not inform the Investment Group of his compensation arrangement with Servergy. Following the initial pitch to the Investment Group, Paxton followed up with one of its members (“Investor 1”), a fellow state representative, to further encourage his investment in Servergy. Investor 1 has been involved in the Investment Group for 25 years along with Investors 2, 3, and 4. These four investors have operated under the established policy and expectation that members participating in an investment deal do so on what Investor 1 calls an “equal dollar-for-dollar basis,” in which everyone takes the same risk and receives the same benefit. No one member makes money or otherwise benefits from the investment of another member. There was an expectation that if one member of the group was to benefit from a deal, he would disclose that  benefit. The group had a known and established pattern of conduct in which the member who recommends an investment typically monitors the deal going forward and represents the interests Case 4:16-cv-00246-ALM Document 96 Filed 03/02/17 Page 3 of 37 PageID #: 1997  4 of the members who have invested. The Amended Complaint alleges Paxton knowingly or recklessly violated his duty to disclose his compensation based on his formal and informal fiduciary relationship with the Investment Group members. Investor 1 and Paxton have a personal and professional relationship dating back to 2003. Paxton lived in Investor 1’s apartment while in Austin on House business. Paxton served as Investor 1’s attorney, setting up entities for Investor 1’s family and certain business ventures. Paxton began to participate in investments with the Investment Group before soliciting its members to invest in Servergy in 2011. Investor 1 informed Paxton of the Investment Group’s established purpose, policies, and practices. Paxton had previously brought other investment opportunities to the Investment Group. To Investors 1, 2, 3, and 4’s knowledge, Paxton did not receive any compensation for investments he brought to the Investment Group before Servergy. Paxton agreed to provide legal services in exchange for shares of at least one investment made through the Investment Group, which Paxton disclosed to the Investment Group members. Paxton also performed legal services for members of the Investment Group and some of the entities in which the Investment Group invested. Investor 1 believed Paxton was investing in the Servergy Investment. Paxton told Mapp that he intended to act as a point person for the Investment Group. Paxton testified that the other three investors would likely invest if Investor 1 were to invest. All four of the Investment Group members invested in Servergy. Investor 2 initially missed the investment deadline. Paxton placed an unsolicited late night phone call to Investor 2 to change his mind, stating that the offering price would double if he did not invest within the next week. Following the phone call, Investor 2 invested $150,000 with Servergy. Both Investor 1 and Investor 2 stated they would not have invested in Servergy had they known Paxton was being paid to promote the company. Investor 3 Case 4:16-cv-00246-ALM Document 96 Filed 03/02/17 Page 4 of 37 PageID #: 1998
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