SHERMAN, Texas — The Securities and Exchange Commission’s fraud case against Texas Attorney General Ken Paxton could be dismissed within the next 30 days, after a federal judge subjected the commission’s attorneys to harsh questioning Friday morning.
“You’re basically asking me to create a new general rule” requiring disclosure of compensation, Federal District Judge Amos L. Mazzant, III told SEC attorney Matt Gulde.
The SEC’s lawsuit against Paxton is based on its contention such a requirement already exists somewhere in federal law, but the commission had a hard time pointing out to Mazzant just where that might be.
The SEC argues Paxton had a duty to disclose to potential investors in a company called Servergy he would receive a commission if they bought stock. The basic argument is that omitting that information amounts to fraud because it misleads investors, who might make another decision if they knew.
That is “the major issue here,” Gulde told the court. “The bottom line is when you’re selling a stock, you’ve got to disclose you’re making a commission.”
However, registered securities brokers face no such requirement, all sides agreed, and rarely disclose commissions. The question is whether there’s anything in statutory or case law that would impose such a requirement on Paxton, who is an attorney and politician, not a stockbroker by trade.
The best case the SEC could cite for support was from a New York district court in 1938, which clearly underwhelmed Mazzant.
Paxton’s attorney Matt Martens cited a host of cases involving brokers from the Supreme Court on down that established a general rule there is no positive duty to disclose one’s compensation.
But neither side had a case directly on point matching Paxton’s situation.
Martens argued that demonstrated nobody has ever considered this conduct illegal before.
That didn’t seem to sway Mazzant, but he did wonder aloud if the SEC wasn’t trying to fit a “square peg in a round hole.”
“Are we stretching the securities law to cover something it wasn’t meant to?” Mazzant asked.
Despite the rule explained by Martens that there is no general duty to disclose sales commissions, there are specific circumstances where such a duty could exist.
A fiduciary relationship is one; you can’t profit off somebody whose affairs have been entrusted to you.
But Mazzant was unimpressed by Gulde’s argument that Paxton was a fiduciary for any of the people he’d told about Servergy.
“The only thing that even comes close is the investment club” Paxton had formed with Byron Cook, a politician and former friend who is now Paxton’s accuser, along with others. “I’m not sure even that creates a fiduciary duty.”
The SEC doesn’t allege at all that Paxton ever said anything untrue. The commission is basing its case on a prohibition in securities law on telling half-truths. The law in this area requires one to clear up any misleading “half-true” statements one has made by speaking completely on the subject.
But the SEC doesn’t identify any specific “half-true” statements.
It’s arguing that Paxton not disclosing a compensation agreement made everything else he said half-true. For example, when he told people Servergy was “a great company,” that statement is somehow rendered half-true.
Mazzant recognized that such an interpretation amounted to a new general rule with vast reach.
“That would apply to anybody who receives compensation,” Mazzant said.
Gulde argued it was somehow specific to Paxton’s circumstances, and the fact he knew the potential investors personally.
“I can’t conceive of where there’d be an exception to that, because everyone you’d go to is somebody you know,” Mazzant said.
Afterwards, Martens said he was “pleased the judge asked all the right questions.”
Mazzant promised a ruling within 30 days. A dismissal at this stage would be extraordinary.
Mazzant noted at the outset he typically denies this sort of preliminary request to dismiss.
So do most judges. That’s because it requires the defendant to concede every single fact to the plaintiff, and argue that even if he did everything the plaintiff says he did, none of the accusations amount to anything illegal.
Success on this sort of motion would mean the SEC screwed up royally. It could also influence the proceedings against Paxton in state court, as state and federal securities law follow similar contours.
Contact Jon Cassidy at [email protected] or @jpcassidy000.
Correction: An earlier version of this article mistakenly referred to the SEC as both the “prosecution” and the “plaintiff” in the same sentence; the SEC is the plaintiff in this civil action.
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