By Jon Cassidy | Watchdog.org
The two charges of fraud against Paxton don’t involve misrepresentation on Paxton’s part, or any other violation of a clear principle. Rather, the prosecutors think Paxton should have volunteered more information about his own investments in the course of selling stock in a company, and that his not doing so amounts to fraud.
While the mainstream media covered the issue by running predictable quotes from Democrats and Republicans, the legal industry press zeroed in on the peculiar nature of the charges against Paxton.
Under a headline reading “Lawyers question Paxton’s felony indictments,” Texas Lawyer led with the following paragraph:
“Attorneys with experience prosecuting and defending criminal securities matters are questioning what they say is strange wording and surprising allegations in three felony indictments against Texas Attorney General Ken Paxton.”
One expert the trade paper consulted called the prosecution’s theory “strange.”
The first of the three indictments is simple enough: It’s a third-degree felony charge for rendering “services as an investor investment advisor” in 2012 to James and Freddie Henry without being registered with the state.
James Henry was one of three clients Paxton referred to investment adviser Fritz Mowery, and he testified at a 2014 hearing before the Texas State Securities Board, which fined Paxton $1,000 and ordered him to tell anyone else he referred about any finder’s fees he would receive.
As the Dallas ABC affiliate reported the testimony, “James Allen Henry of Corinth said he went to Paxton for help with long-term estate planning. He testified that while visiting with Paxton, he asked if Paxton had any recommendations for a financial adviser to manage his funds. Paxton suggested Mowery.
“Henry said he did not recall being told about the fee-sharing arrangement, but indicated that he was not bothered by it. He said he would trust Paxton and Mowery without reservation.”
Former federal prosecutor and securities lawyer Bill Mateja told Texas Lawyer that failure to register is usually considered a “de minimus” violation and handled as a civil matter.
The two felony fraud counts are serious, though, each carrying a potential sentence of 99 years in prison. However, they’re not nearly so simple as they’ve been presented to the public.
Under state securities law, it’s fraud to “knowingly make any untrue statement of a material fact,” or to mislead a potential investor by “omit(ing) to state a material fact” that would affect his investment decision.
Paxton isn’t being accused of telling a lie, which is a factual question. He’s being accused of the much more subjective charge of misleading investors by failing to state a material fact. Actually, the indictments just allege the failure to state a fact; they don’t explain how anyone was misled.
Mateja told Texas Lawyer he had expected Paxton would be accused of making a fraudulent misrepresentation, and that he was surprised by the actual indictment.
“They are saying that it was unlawful for him to fail to mention that he had not personally invested (in a tech company called Servergy) and he would be receiving compensation,” Mateja said.
If that by itself were found to be a crime, securities traders across the state could be facing criminal exposure every time they make a sale, unless they take the unusual step of telling clients that they hadn’t purchased the stock for their own portfolios.
Paxton did have stock in Servergy, though: 100,000 shares that he’s been reporting on his annual disclosure forms since 2011.
The prosecutors are apparently unclear about whether Paxton already held those shares when he solicited investors, or whether he got them later, as they accuse him of failing to disclose to them that he “would be compensated, and had, in fact, received compensation from SERVERGY, INC., in the form of 100,000 shares.”
So either he would be or he had been. What the newspapers miss is that this isn’t an explicit violation of any law. It’s the special prosecutors’ opinion that Paxton should have volunteered this information.
“The question is: Would these investors — would they have changed their minds based on knowing that information,” Mateja told Texas Lawyer. “This case is going to boil down to materiality.”
San Antonio attorney Cynthia Orr, who defends people accused of securities violations, told the trade publication she found the allegation “strange.”
“How would it be material to an investor that (Paxton) had not invested,” said Orr. “I would attack it. … How would it make someone invest, where they would not invest had they known?”
In a case from 2000, a Texas appellate court upheld a verdict of fraud in a civil case that involved undisclosed sales commissions. In Duperier v. Texas State Bank, the issue was that the secret commission was so large it could have been “an indication of undisclosed problems with the notes” being sold, but the commission itself wasn’t a problem.
The stage was set for the public to believe Paxton had been misleading investors by stories published last month about a Securities and Exchange Commission investigation into Servergy.
It’s Servergy stock at issue: Paxton is supposed to have turned his former friend, Rep. Byron Cook, and a Florida businessman named Joel Hochberg on to the company.
The SEC has been investigating Servergy’s claim to have built a server that uses 80 percent less energy than its rivals. Investigators suspect the company’s president, William Mapp, had ginned up investor interest by claiming it had pre-orders from Amazon and Freescale.
According to court records filed by the SEC, the kernel of truth to those claims was that Freescale had agreed to test the servers in mid-2012, and at the end of the year, an Amazon employee expressed interest in testing out one of Servergy’s servers for his personal use.
In early 2013, Mapp apparently emailed Paxton, among other people who solicited investors, bragging that he was about to ship his first order from Amazon.
One might assume Paxton then went and told investors about a pending Amazon contract that would send the stock value through the roof, only one would be wrong.
The two fraud indictments against Paxton are over solicitations made in July 2011, long before Mapp got the idea to talk up Freescale or Amazon.
Paxton’s name shows up once in the middle of a 143-page court filing in an otherwise obscure case, leading savvy observers to recognize that an operator somewhere put that item out. That, and the involvement of Cook, who’s closely allied with Speaker Joe Straus, a Paxton antagonist, is one of the factors suggesting forces at work behind the scenes.
Whether that’s the case, the prosecution is going to have to prove Paxton misled Cook and Hochberg into buying stock through truthful statements, and that the trick depended on him not saying that he hadn’t bought stock himself.
Contact Jon Cassidy at [email protected] or @jpcassidy000.
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