RIA Compliance Blog
On December 13, 2016, the Arizona Court of Appeals (“Court of Appeals”) affirmed an Arizona Superior Court’s decision finding that Patrick Shudak, an investment adviser, violated the Arizona Securities Act by acting as an unregistered securities salesperson or dealer in connection with the sale of interests in a real estate venture.
From January 2008 through July 2009, Shudak sold membership units in a company known as Parker Skylar & Associates, LLC (PSA). Neither Shudak nor PSA was registered as a securities salesperson or dealer under the Arizona Securities Act. Shudak stated in PSA’s promotional materials that the money invested in PSA would “be used to purchase and develop real property.” In reality, however, Shudak placed the money that investors put into PSA into his personal account, the personal accounts of others such as his girlfriend, and business accounts of other business that Shudak owned or had some affiliation with.
In December 2009, investors started to grow worried when Shudak stopped returning phone calls and replying to the investors’ demands for information. As a result, Shudak was obligated to stop serving as PSA manager and to give up his PSA membership. He subsequently filed for bankruptcy in April 2010.
In September 2012, the Securities Division of the Arizona Corporation Commission (ACC) brought a notice of opportunity for hearing against Shudak and PSA. The notice claimed that Shudak and PSA had violated the Arizona Securities Act. Subsequently, in June 2013, an administrative law judge (ALJ) conducted a three-day evidentiary hearing. While Shudak did have attorneys to represent him, he did not come to the hearing, give testimony, or produce any witnesses to give testimony. The hearing resulted in a recommended opinion and order (ROO) that determined that the PSA membership units were securities and that Shudak “acted as a dealer and/or salesman of securities,” resulting in a conclusion that Shudak had sold unregistered securities in violation of the Arizona Securities Act. The ROO also determined that Shudak had engaged in fraudulent conduct when he sold the securities. The ACC adopted the ROO and demanded that Shudak pay about $2 million in restitution and a $150,000 administrative penalty. Shudak appealed to the Court of Appeals.
Shudak’s first argument on appeal was that the PSA membership units did not have to be registered because they constituted a private offering. This argument did not succeed because Shudak did not give testimony, and he did not present any evidence that would have satisfied his burden of showing that the membership units met the criteria for a private offering. Shudak also disputed the ROO’s finding that he was liable as a control person. This argument also failed because it was determined that PSA engaged in fraud, and PSA did not dispute that finding. As a result, Shudak had to be liable as a control person of PSA.
Shudak also disputed the ROO’s finding of fraud. According to the Court of Appeals, the ACC claimed that Shudak and PSA engaged in four types of fraud. First, Shudak oversubscribed the offering by allocating 132.5 percent of the membership units to a specified group of individuals and entities. Second, Shudak managed investor funds poorly. Third, he did not inform investors that a perfected security interest was attached to PSA’s assets. Fourth, Shudak did not inform investors that a number of lawsuits and default judgments had been filed against him and other businesses that he owned.
Shudak argued that the ACC did not produce adequate evidence that he committed any the four frauds outlined above. The Court of Appeals, however, found that the evidence that the ACC presented was adequate to support a finding of fraud. Moreover, the Court of Appeals noted that Shudak did not produce any records or other evidence that would have put the reliability of the ACC’s evidence into question.
Next, Shudak challenged the propriety of the restitution and administrative penalties imposed against him. According to Shudak, the restitution award should not have been granted because no violations were confirmed, he was not given due process, and evidence did not warrant the restitution amount. However, as discussed above, the Court of Appeals found that the ACC had provided adequate evidence of fraud.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.