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Five things to know about the SEC’s lawsuit against Texas AG Paxton

By   /   April 11, 2016  /   News  /   No Comments

Part 7 of 17 in the series The Problematic Paxton Prosecution
AP file photo

HOLD UP: Texas Attorney General Ken Paxton named in a new lawsuit filed by the SEC.

The Securities and Exchange Commission added to Attorney General Ken Paxton’s stack of legal problems Monday, filing a lawsuit against him, a company called Servergy, its former CEO Bill Mapp and another employee.

The SEC accuses Paxton of fraud, based on the same events that led to his indictment in Tarrant County last year. The SEC complaint provides the first detailed account that anyone has given the public regarding a July 2011 pitch meeting that Paxton arranged and $100,000 worth of stock he received afterward.

The most potentially damaging information in the SEC complaint was already publicly known: Mapp allegedly lied to investors more than a year after the pitch meeting involving Paxton, telling them that the company had pre-orders from large corporate clients such as Amazon and Freescale.

The worst part for Paxton is simply the fact that he was named; that means another credible authority shares the opinion of the special prosecutors that his actions in setting up a pitch meeting and accepting free stock in the company amounted to fraud.

However, the federal complaint is just like the state case in that there is no bright legal line that Paxton is accused of crossing. It is the opinion of these officials that the stock Paxton received was compensation for bringing in investors, and that alleged compensation was a material fact that would have affected the choice that investors made to put their money into Servergy.

“People recruiting investors have a legal obligation to disclose any compensation they are receiving to promote a stock,” Shamoil Shipchandler, the head of the SEC’s Fort Worth office, said in a prepared statement. The SEC’s complaint cites no legal authority supporting that specific opinion.

RELATED: Paxton indicted on ‘strange’ legal theory

At least five key facts emerge from the SEC’s account of the July 2011 investor meeting Paxton arranged.

1) The SEC has found no evidence of hucksterism by Paxton. The strongest claim of this sort is that Paxton “forwarded, and was included on, correspondence advancing materially false claims regarding the nature of Servergy’s technology and business prospects. While Paxton possessed no technical expertise and did not know whether any of Servergy’s claims were true, he conducted no due diligence to confirm, clarify, or correct Servergy’s claims.” The SEC doesn’t state what false technical claims were in the literature Paxton forwarded, but elsewhere the agency argues that Servergy’s comparisons to other products were misleading. Servergy’s product, the CTS-1000, was marketed on a claim of “consuming up to 80% less power” than other servers, a claim that depends on what servers you compare it to – high-performance machines or power sippers. There’s demand for both. At the risk of oversimplifying a mass of technical information, you could compare Servergy’s comparisons to a comparison of a fuel-efficient subcompact with an Italian sports cars. In short, the SEC thinks Servergy was pretending to make an Italian sports car with the fuel efficiency of a subcompact when it was really just making a subcompact. But whether that would be clear to Paxton, the investors, or an eventual jury depends on whether they’d understand Mapp’s claims at the time, such as, “To be clear, Cleantech Servers are not another ‘microserver for microjobs’ – these are true industrial grade brawny core servers.”

2) Paxton approached a dozen potential investors to a July pitch meeting with Mapp. Apparently, five of them decided to invest $840,000 in Servergy. The SEC cites complaints from just two of them, who are not named, but are apparently state Rep. Byron Cook and Cook’s friend, Joel Hochberg. There are no complaints or allegations from the others cited. Their accounts could prove important to resolving the case.

3) It’s unclear whether Paxton had a specific compensation agreement for bringing in new investors. After one meeting, “Mapp emailed Paxton and reiterated his offer to pay Paxton either with Servergy common stock or a combination of cash and stock. In his email response to Mapp’s offer, Paxton confirmed ‘I will get to work.’” Paxton says his shares were a gift. “According to Paxton, he met Mapp at a Dairy Queen restaurant in McKinney, Texas, in July or August 2011, intending to invest $100,000 of his own money in Servergy. But, according to Paxton, Mapp refused his investment and stated, ‘I can’t take your money. God doesn’t want me to take your money.’ Consequently, Paxton claims, he later accepted the shares as a gift.” At some point, “Mapp asked Paxton to sign a subscription agreement indicating that the shares were given in exchange for services” but that agreement was “never executed.”

4) The SEC conflates its account of the pitch meeting with events from a year and a half later, when Cook began to doubt his investment decision. “In early 2013, Paxton organized and attended a meeting with (Cook) and Mapp, at which Mapp lulled (Cook) with false claims that the company was flush with purchase orders. Paxton did nothing to determine whether Mapp’s claims were true. (Cook) would not have invested in Servergy had he known Paxton was being paid to promote the company.”

5) The SEC appears to be basing its central claim on a supposed understanding shared by members of an investment club that included Paxton and Cook. “Based on prior dealings in the group, members trusted each other to consider the interests of the group as a whole and not exploit one another for a member’s personal benefit. Similarly, prior experiences in the group established that the member who recommended an investment would monitor the investment going forward and represent the group’s interests. Despite a duty to do so, Paxton knowingly or recklessly failed to inform any member of the investment group that he was being compensated by Servergy for recruiting investors.”

Contact Jon Cassidy at [email protected] or @jpcassidy000.

Part of 17 in the series The Problematic Paxton Prosecution

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Jon Cassidy was a former Houston-based reporter for Watchdog.org.