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From Securities Regulation Daily, May 21, 2015

Perpetrator of Saudi oil Ponzi scheme loses appeal

By Amanda Maine, J.D.

A district court did not err in granting summary judgment against a defendant who allegedly sold promissory notes to fund investments in Saudi oil but instead used the money for lavish personal expenses, an appellate panel concluded. The panel found that the notes at issue were indeed securities under the federal securities laws and that the SEC had made an adequate showing that the defendant made misrepresentations in furtherance of the Ponzi scheme. The panel also rejected the defendant’s appeal of the civil penalty the district court imposed (SEC v. Zada, May 21, 2015, Kethledge, R.).

Background. In November 2010, the SEC charged Joseph Zada with securities fraud and registration violations, alleging that he ran a $60 million Ponzi scheme. According to the SEC, Zada told investors that he had connections to royalty in Saudi Arabia and would use his connections to combine their money with his to purchase oil at low prices and sell at higher prices. Investors were promised returns of up to 40 percent. Zada raised $60 million from investors, who in return received promissory notes that only said that Zada would pay principal amount plus a much lower rate of interest. However, Zada never bought any oil. He instead used the investors’ money to fund his lavish lifestyle. Any investors who were actually paid only received money raised from other investors, the SEC alleged.

The district court granted the SEC’s motion for summary judgment on all charges. The court also granted the SEC’s request for civil penalties and disgorgement totaling nearly $121 million. Zada appealed.

Securities. Zada first argued that the promissory notes sold to investors were not “securities” under the Securities Act and the Exchange Act (Securities Acts). A panel of the Sixth Circuit Court of Appeals outlined four factors that must be considered when determining if a particular instrument bears a “family resemblance” to a list of instruments that are not securities (such as consumer debt and home mortgage loans): (1) the motivation prompting the transaction; (2) the plan of distribution; (3) the reasonable expectations of the investing public; and (4) whether a risk-reducing factor such as another regulatory scheme makes application of the Securities Acts unnecessary.

Regarding the motivation factor, the SEC presented testimony from several investors who said Zada gave them notes as part of a scheme to invest in Saudi oil. Zada contended that some of the investors referred to the transactions as loans, but the court pointed it out that it was doubtful that 60 investors would make personal loans to a self-styled millionaire with connections to Saudi royalty.

The plan of distribution factor also favors the SEC, the panel held, noting that the notes were sold to a wide range of unsophisticated investors, not to a handful of institutional investors. In addition, the panel determined that a reasonable person who gave Zada money to invest in Saudi oil would expect that the federal securities laws would apply. Finally, the panel rejected Zada’s argument that his naming of some investors as beneficiaries of his life insurance policy was a risk-reducing factor, noting it would only help the investors upon Zada’s death.  With all four factors favoring the SEC, the panel determined that the notes were securities and subject to the Securities Acts.

Fraud. Zada also challenged the district court’s order finding him liable for securities fraud because the SEC did not prove that he lied to each of the 60 investors, and only provided testimony from ten investors. The court stated that this disparity might be relevant to the scope of Zada’s ill-gotten gains, but under the Securities Acts, the SEC is only required to show that Zada made misrepresentations in furtherance of his scheme, not to provide testimony from each and every victim.

Penalty. The SEC offered evidence to support their contention that Zada received $56 million in ill-gotten gains through his scheme, which Zada did not contest. He did argue, however, that the imposition of a $56 million penalty in addition to $56 million in disgorgement was an abuse of discretion by the district court. Zada pointed out that one of the factors the court cited in imposing such a stiff penalty was Zada’s “lack of acceptance of responsibility” for the scheme. According to Zada, this punished him for invoking his Fifth Amendment privilege against self-incrimination because he was facing possible criminal charges in addition to the SEC’s civil charges.

The panel agreed with Zada that his decision not to testify did not reflect a denial of responsibility, but rather a desire to preserve his options in a possible criminal case against him. However, the panel said that other factors cited by the court—including the egregiousness of the offenses, the large amount of stolen money, and a high degree of scienter—make it clear that the “lack of responsibility” factor was not essential to the penalty imposed.  The district court’s judgment was accordingly affirmed.

The case is No. 14-1346.

Attorneys: Deday LaRene (LaRene & Kriger PLC) for Joseph Paul Zada and Zada Enterprises, LLC. Christopher Paik for the SEC.

Companies: Zada Enterprises, LLC

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