Investment fraud is booming along with oil and gas drilling, SEC says by James Osborne, January 4, 2013, Dallas News Business
But with the oil and gas boom on and news reports of big discoveries in Texas and North Dakota proliferating, securities fraud cases are increasing, the Securities and Exchange Commission warns. What eight years ago might have been a few cases a year now amounts to more than 20 fraud lawsuits brought by the agency a year. But putting a stop to fraud has proved tricky.
Court rulings have brought into question the agency’s jurisdiction over investment offerings presented as joint ventures. Unlike shareholders in a company like Apple, the investors in such deals have been found by state and federal judges to be partners who essentially stake money at their own risk. David Peavler, associate director of the SEC’s Fort Worth office, said the legal precedent gave some firms incentive to take advantage.
“It’s an illusion. They set them up like joint ventures, but the investors don’t have any real power,” he said. “What the investor doesn’t know is the promoter is getting most of the money. There’s little incentive to find good prospects because the promoter is getting paid whether the well hits or not.”
The agency’s difficulty in establishing jurisdiction over such investments is evidenced by a series of cases brought over the last two decades involving a now-closed Dallas investment firm. In 1998, the SEC cut a deal with a young investment broker and amateur bodybuilder named Bret Boteler.
A number of associates from the Dallas firm Kinlaw Securities were facing millions of dollars in penalties after being accused of selling worthless stakes in oil fields using the hard-sell, boiler-room-style tactics that were sweeping the investment world in the 1990s. In exchange for getting out from under the federal suit, Boteler, a relatively junior member of the firm, agreed to stop selling the securities. But Boteler, now 49, resurfaced this summer when the SEC brought new allegations against him and the company he founded in 2001, EnerMax. Between 2007 and 2011, the firm raised $17.3 million from 260 investors across the country, according to an SEC lawsuit filed in July. Of the 45 wells EnerMax contracted to drill, more than half were abandoned. Only three actually made any money. As investors watched their money disappear, Boteler pocketed $1.3 million in salary, bonuses and expenses, including $65,000 to pay his children’s private school fees.
Standing outside his home in Bedford last week, Boteler described EnerMax as a company that “was going pretty well until some things went wrong.” He referred questions about the case to his attorney, Randy Foret, who disputed the SEC charges. He said his client was an honest businessman who had drilled some bad wells, a fact of life in the oil business. “This is a not garden variety securities fraud case,” Foret said. “Most of the wells are producing some oil. It’s not the sort of case where he took the money and never drilled anything. I’ve worked on the opposite side, going after those companies.” Foret said they are considering challenging the agency’s jurisdiction.
On its website, which has now been taken down, EnerMax described itself as an independent oil and gas company under the motto “Exploring today for a better tomorrow.” Until last year, the company operated out of a small office park in Hurst, occupying a ground floor office in the same building as a Realtor and construction firm. In 2005, Boteler was profiled in the Fort Worth Star-Telegram as a homegrown entrepreneur who started EnerMax out of his house. In the article, he cites his company’s use of 3-D seismic technology, a technique pioneered by Exxon Mobil Corp. that allows drillers to digitally map underground oil deposits. A quick online search would have taken prospective investors to a video of Boteler being interviewed by the late Gen. Norman Schwarzkopf on the infomercial series World Business Review. Dressed in a navy suit under which his bodybuilder’s physique was apparent, Boteler predicted that advancements in horizontal drilling techniques would revolutionize the oil industry. “In the old days, your target reservoir was located directly beneath your drill site,” he told Schwarzkopf. “Today it doesn’t matter where your drill site is.” Boteler was right about horizontal drilling revolutionizing the oil industry. But behind the hype, EnerMax was struggling.
The SEC declined to comment on the Boteler case. But in its suit, the agency alleges that EnerMax misled investors regarding its expertise and “omitted material information regarding the speculative, unproven nature of the prospects.” Art Rice, who owns an electronics supply company in North Carolina with contracts with the likes of Intel, says he invested close to $1 million with Boteler after a phone call around 2006. At one point, he even flew to Texas to see one of the wells he helped finance. Boteler picked him up from the airport and drove him out to the drilling rig. “Early on, I think he tried very hard. But at the end I don’t think he was so honorable or truthful. He was just trying to survive,” said Rice, who is now suing Boteler.
Five years after graduating from Southwest Texas State University, Boteler got a job at Kinlaw Securities through a friend. The firm was founded by Joe D. Kinlaw, who created a hardball culture where brokers employed call lists and scripted pitches to draw in wealthy investors, according to the SEC. … In 1993, the SEC filed a suit claiming that the company had defrauded investors of more than $125 million. Kinlaw and Boteler settled. But the vice president of the firm, Charles Cagle, challenged the SEC’s authority to regulate its business, arguing that Kinlaw Securities sold partnerships in a business venture, not securities. In 1999, a Dallas federal judge dismissed the SEC’s case. The judge ruled that Kinlaw’s investors had enough power and information to be deemed partners.
The distinction between partner and shareholder is a meaningful one for companies seeking outside investment, said Henry Hu, a law professor at the University of Texas at Austin. Not only is registering a security with the SEC a rigorous and costly process, but anti-fraud laws are far more stringent for investments deemed securities. “The issue of whether a general partnership or joint venture interest is a security for federal securities law purposes has been around forever,” he said in an email. “Although courts do not generally find general partnership interests to involve securities, courts may well consider such matters as how much power the investors have under the partnership agreement and whether they are able to intelligently exercise those powers.”
Cagle and Kinlaw eventually left Texas for Colorado Springs, where they founded an oil and gas investment firm named HEI Resources, according to the Denver Post. In 2009, the Colorado Securities Commission sued to shut down the company on allegations that it had fraudulently raised more than $300 million from investors on hyped drilling projects. But again, a judge found in October that the investments were partnerships and dismissed the regulators’ case.
In 2007, Boteler entered into a deal with Florida-based businessman Justin Solomon to sell shares in oil ventures in Texas to 400 foreign investors from Denmark to Australia, according to court documents. Three years later, the SEC sued Solomon for fraud. Solomon ultimately agreed in 2011 to cease operations and to pay out almost $8 million in restitution and fines. But that money has not been repaid, said Lori Hood, a Houston attorney hired by the investors to track down the money. She filed suit against Solomon and Boteler in 2011. “I’m fairly certain most of this money is in Aruba,” she said. The SEC “does the cease and desist, but they don’t go after the assets. … They tell me, ‘We’re happy to go after them if you can prove they have assets.’”
When federal agents went through EnerMax’s books this summer, they found little trace of any remaining cash. There were records of a series of bad investments, including $191,000 in a company selling medicinal water as a cancer cure that is now out of business. For Rice, coming to grips with what was happening was not easy. As the losses piled up, there was always the promise from Boteler that the next well was the one, Rice said. “You know what? The whole thing is greed,” he said. “You get so far in, you get in trouble. I never put myself in a hole I couldn’t survive. But I didn’t do the due diligence I should have. If you’re not a crook yourself, it’s very hard to figure out how somebody would lie like that.” [Emphasis added]