IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY
April 21, 1999
MATA SERVICES, INC., KI DIGITAL, INC., CHARLES AND NANCY MCCORMICK, WILLIAM AND KATHY SCHROEDER, MACROPHAGE, INC., KI DIGITAL, LLC, MATA SERVICES, LLC, IRIDIUM INTERSTSTE, LLC, FILM EAST, LLC, SCREEN WORKS, LLC, KI MANAGEMENT, LLC, ET AL.,
The opinion of the court was delivered by: Robert B. Kugler United States Magistrate Judge
HONORABLE STANLEY S. BROTMAN
O P I N I O N
KUGLER, United States Magistrate Judge
This matter is before the Court pursuant to 28 U.S.C. § 636(c)(1), Fed. R. Civ. P. 73(b) and Rule 73.1 of the Local Civil Rules for the United States District Court for the District of New Jersey on the consent of the parties to have this matter decided by a United States Magistrate Judge. Presently before the Court is Plaintiff Geoffrey Steiert's motion for a preliminary injunction. This Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1331. For the reasons discussed below, Plaintiff's motion is denied. Facts and Procedural History
This action arose from a series of loans made by Plaintiff Geoffrey Steiert to Defendant Mata Services, Inc., ("Mata Services") and its affiliates. See Declaration of Geoffrey Steiert submitted in support of Plaintiff's Motion for a Preliminary Injunction at ¶ 3. In his complaint, Plaintiff alleges that he was induced to make these loans by certain misrepresentations made by Defendant Mata Services and its agents. See id. at ¶ 4. Among the misrepresentations that Plaintiff alleges are i) that Mata Services was well-capitalized and had no debt; ii) that his loans were secured; iii) that his loans would be converted to stock upon Securities and Exchange Commission ("SEC") approval of Mata Services' stock offering; and iv) that Mata Services had enough cash to repay the loans on demand at any time before the SEC approval of Mata Services' offering. See id. Plaintiff alleges that when he demanded repayment of the loans in April and May of 1998, "Defendants claimed they were unable to pay [him] due to an ongoing SEC `audit' of [Defendants'] bank accounts." Id. at ¶ 7.
On or about June 19, 1998, the Attorney General of the State of New Jersey filed a civil action against Mata Services, Ki Digital, Inc. ("Ki Digital") and Charles McCormick seeking injunctive and monetary relief. See Brief of Mata Services, Inc., Ki Digital, Inc., Mata Services, LLC, Ki Digital, LLC, Iridium, LLC, Film East, LLC, Screenworks, LLC, and Ki Management, LLC, (collectively the "Corporate Defendants") filed in Opposition to Plaintiff's Motion for a Preliminary Injunction ("Corporate Defendants' Brief") at 1; see also Exhibit N to Exhibits to Plaintiff's Motion for a Temporary Restraining Order, Preliminary Injunctive Relief and Other Equitable Relief ("Plaintiff's Exhibits").
The complaint in the state court action alleges that Mata Services changed its name to Ki Digital in September, 1997 and operates through a number of subsidiaries including Mata Services, LLC, Ki Digital, LLC, Iridium, LLC, Film East, LLC, Screenworks, LLC, and Ki Management, LLC. See Plaintiff's Exhibit N at ¶ 2. The state court complaint also alleges that Mata Services and Ki Digital, through its officers, directors, employees and agents, including Defendant Charles McCormick, issued securities as defined by New Jersey law. See id. at ¶¶ 4-11. The state court complaint also alleges that the defendants' offering materials did not disclose or otherwise materially misstated i) "the intended uses for the invested funds"; ii) "the nature and extent of any risks associated with the investments"; iii) "Mata and Ki Digital's financial statements"; iv) "Mata and Ki Digital's financial condition, access to capital, operating results and outlook"; and v) "the ability of Mata and Ki Digital to repay the principal of and interest on the promissory notes." Id. at ¶ 12. The state court complaint further alleges that in or about June 1997, Mata Services and Ki Digital issued more than 500 promissory notes with a face value of more than $11,000,000.00. See id. at ¶ 13. Ki Digital and the New Jersey Bureau of Securities entered into a consent order on June 19, 1999. See Plaintiff's Exhibit O. The consent order enjoined Ki Digital, its successors, affiliates and agents from issuing securities in New Jersey. See id. at ¶ 1. The consent order further enjoined Ki Digital, its successors, affiliates and agents from disposing of assets except as approved by the court-appointed receiver. See id. at ¶ 3. By the consent order, the court appointed Robert G. Stevens, Esquire, as a receiver of Ki Digital and vested in him broad authority over Ki Digital, its successors and affiliates. See id. at ¶¶ 5-10.
As part of his court-ordered duties, Mr. Stevens filed with the court a report titled "Report of Robert G. Stevens, Receiver, to the Honorable Harry A. Margolis," in which Mr. Stevens reported on the general financial condition of the Corporate Defendants. See Plaintiff's Exhibit T. In his report, Mr. Steven found, among other things, that certain promissory notes issued by the Corporate Defendants "were not registered [securities] nor were they exempt from registration and, with the other violations of the New Jersey Securities Law, resulted in the entering of the Consent Order." Id. at 8-9. Mr. Stevens further found that certain notes issued in connection with Mata Services' factoring transactions also violated New Jersey securities laws and ordered that Ki Digital issue no additional promissory notes of any kind. See id. at 9-10.
On April 8, 1999, Plaintiff filed an emergent application for a Temporary Restraining Order, Preliminary Injunction and Expedited Discovery in this Court. See Plaintiff's Motion for Temporary Restraining Order and Preliminary Injunction and Expedited Discovery ("Plaintiff's Motion") at 2. In his moving papers, Plaintiff alleges that "Defendants are still engaged in a fraudulent scheme to manipulate and disburse funds to the individual Defendants and various third parties, to the detriment of Plaintiff." Id. at ¶ 5. Plaintiff further alleges that he "was made privy to a telephone message left by Defendant Kathy Schroeder with Dennis Taylor wherein she specifically indicated that `funds' had cleared in Chuck McCormick's bank accounts and would shortly be disbursed." Id. Plaintiff further alleges that the defendants were engaged in a scheme to move "`millions' of funds throughout the United States." Id. Plaintiff claims that absent temporary restraints he would be irreparably harmed by the defendants' conduct because he would not be able to locate the defendants' corporate assets to enforce any judgment he might receive in this Court. See id.
Plaintiff sought through his application a temporary restraining order "freezing each and every account owned or controlled by any of the Defendants named herein (except to the extent controlled by the State Court receiver); freezing such accounts until further disposition of these proceedings by this Court, including a K.A.M. Enterprises, Inc. account located at Commerce Bank, Account No. 3679197; and further restricting the Defendants from disbursing to themselves or any third party any funds, and that the defendants notify all of their agents and brokers that their accounts have been frozen and that such agents should no longer distribute any further monies distributed to them by the Defendants until further order by this Court." Plaintiff's Motion at 4- 5. Plaintiff further sought expedited discovery through a court order requiring the defendants to appear for deposition and produce documents regarding the defendants' ongoing business activity and bank accounts. See id. at 5.
On April 8, 1999, the Court instructed Plaintiff's counsel, Thomas S. Harty, to inform all parties in this action by telephone that the Court will conduct a hearing on Plaintiff's application for a Temporary Restraining Order that same day at 3:00 p.m. Mr. Harty appeared at the hearing on behalf of Plaintiff and Kevin M. Hart, Esquire, appeared by telephone on behalf of the receiver and the corporate defendants. No other parties appeared for the hearing in person or by telephone.
After considering the papers submitted with Plaintiff's application and hearing the arguments of Mr. Harty and Mr. Hart, the Court denied Plaintiff's application for a Temporary Restraining Order because, among other things, Plaintiff had not demonstrated to the Court with sufficient particularity how he would suffer irreparable harm if the Court denied his application, Plaintiff failed to satisfy his obligation to post a bond pursuant to Fed. R. Civ. P. 65(c) before the Court issued temporary restraints, and Plaintiff had not demonstrated to the Court that the scope of the order was narrowly tailored to encumber those assets Plaintiff might recover after judgment. The Court further ordered the parties to appear for a hearing on Plaintiff's application for a Preliminary Injunction on April 13, 1999 at 2:00 p.m., and ordered Plaintiff's counsel to fax a copy of the Court's order to all counsel of record. The Court further ordered that any written opposition to Plaintiff's application must be received by the Court no later than April 12, 1999 at 5:00 p.m. Submissions of the Parties
Plaintiff's moving papers consisted of a document entitled "Motion for Temporary Restraining Order and Preliminary Injunction and Expedited Discovery," which appears to be in substance a short memorandum of law in support of Plaintiff's motion, a Declaration of Geoffrey L. Steiert, Esquire, a Declaration of Thomas Yarnall, a Declaration of Dennis Taylor, a Declaration of Thomas S. Harty, Esquire, and a bound volume of exhibits A through V. The exhibit volume contains, among other things, letters and newsletters from the defendants soliciting investors' money and purporting to inform investors of various business enterprises, see Exhibits A, C1, C2, C3, C4, D, F, H, I, L and U, promissory notes signed by certain defendants evidencing loans made to Plaintiff and other investors, see Exhibits B, E, G, J, K and M, the complaint filed by the Attorney General of New Jersey in the state court action, see Exhibit N, the consent order appointing the receiver, see Exhibit O, a report of an audit performed by an accounting firm at he behest of the receiver of Ki Digital and its subsidiaries' consolidated balance sheets, see Exhibit S, the Report of Robert G. Stevens, Receiver, to the Honorable Harry A. Margolis, see Exhibit T.
The thrust of Plaintiff's argument in support of his application for a preliminary injunction is that the defendants are secreting away or otherwise transferring assets that are in various defendants' control and which will be subject to execution if Plaintiff prevails on his claims. See Plaintiff's Motion at ¶ 5. As factual support for his allegations, Plaintiff submits to the Court the declaration of Plaintiff himself, as well as the declarations of two non-parties, Thomas Yarnall and Dennis Taylor.
Plaintiff's declaration recounts the allegedly fraudulent investment scheme and the circumstances surrounding his discovery that he had been defrauded. See Steiert Declaration at ¶¶ 1-54. Plaintiff then discusses in his declaration second-hand accounts he has received about the defendants alleged movement of funds from various bank accounts that are outside the reach of the court-appointed receiver. See id. at ¶¶ 57-63. Many of the allegations contained in Plaintiff's declaration are first and second level hearsay that is offered for the truth of the matter asserted. For example Plaintiff states "Dennis Taylor told me this past week that he has been told by Chuck McCormick and Bill and Kathy Schroeder, that Chuck McCormick is in the process of closing some of the bank accounts he controls, and moving funds into new accounts, for the express purpose of evading discovery of the accounts and monies." Id. at ¶ 62. Finally, Plaintiff alleges that on April 6, 1999 he listened to a message left on Dennis Taylor's answering machine by Kathy Schroeder on which Ms. Schroeder stated that funds would be moved out of a McCormick bank account on either April 8 or April 9. See id. at 63.
The Declaration of Thomas Yarnall, a non-party, also recounts his involvement in the allegedly fraudulent investment scheme conducted by the defendants, and then discusses his discovery of the movement of funds from various bank accounts. Specifically, Mr. Yarnall alleges that "[a]s recently as this past November or December, Bill Schroeder told me that he had just received a check in the approximate amount of $200,000.00, which had been written on a non-Ki Digital account controlled by Chuck McCormick." Yarnall Declaration at ¶ 28. Additionally, Mr. Yarnall alleges that "[m]ore recently, Bill Schroeder told me that Chuck McCormick has been moving millions of dollars through an account not on the books of Ki Digital or its divisions, and that he [Bill Schroeder] is anticipating receiving payment of millions of dollars any day now, either from Chuck McCormick or Kevin McCormick." See id. at ¶ 29.
The declaration of Dennis Taylor, another non-party, similarly recounts his involvement in the defendants' fraudulent investment scheme. The most relevant portion of Mr. Taylor's declaration alleges that he received a payment on a loan he made to Ki Digital from Kevin McCormick, Charles McCormick's brother, in the form of checks drawn on a Commerce Bank account in the name of K.A.M. Enterprises, Inc. See Taylor Declaration at ¶ 29-31. Additionally, Mr. Taylor alleges that McCormick and the Schroeders told him within the past two months "that millions of dollars received in connection with the sale of computer equipment are being cleared by Chuck McCormick through his bank accounts -- one of which is the `K.M.A. Enterprises, Inc.' account." Id. at ¶ 33. *fn1 Mr. Taylor further alleges that "Chuck McCormick and Bill Schroeder have also told [him] that Chuck McCormick is in the process of closing accounts and moving funds to new bank accounts, of concern that the accounts might be discovered." Id. at 34. Curiously, there is no mention in Taylor's declaration of the phone message that Kathy Schroeder left on his answering machine that Plaintiff claims to have listened to on April 6, although Taylor did testify at the April 13 hearing about at least one, and possibly more, phone messages left by Ms. Schroeder.
On April 12, 1999, the Corporate Defendants submitted an opposition brief to the Court through their counsel, Kevin M. Hart and Scott I. Unger. The Corporate Defendants also submitted to the Court a Certification of Robert G. Stevens, Esquire. The Corporate Defendants argue in opposition first that the Court does not have subject matter jurisdiction over this matter because the promissory notes between Plaintiff and certain defendants are not "securities" as defined by federal law. See Brief in Opposition to Plaintiff's Motion for Temporary Restraining Order, Preliminary Injunction and Expedited Discovery ("Opposition Brief") at 4-10. The Corporate Defendants further argue that the Court should not grant Plaintiff's application for preliminary injunctive relief because Plaintiff cannot satisfy the four-pronged analysis that would entitle him to the relief he seeks. See id. at 4-15. Finally, the Corporate Defendants argue that the affidavits Plaintiff submitted in support of his motion violate Rule 7.2(a) of the Local Civil Rules of the United States District Court for the District of New Jersey ("Local Rules") and Fed R. Civ. P. 56(e). See id. at 15-16. The Corporate Defendants claim that Plaintiff's affidavits contain facts outside the personal knowledge of the affaint as well as impermissible factual and legal argument. See id.
Charles McCormick submitted a letter to the Court through his counsel Christopher Porrino, Esquire, in opposition to Plaintiff's application. See Letter from Christopher Porrino, Esquire, to the Court dated April 12, 1999 ("Porrino Letter"). In that letter McCormick states that he joins in the opposition arguments made in the Corporate Defendants' Brief. See id. at 1. McCormick also asserts an objection to the subpoena Plaintiff's counsel served on him requiring him to appear at the April 13 hearing and to produce documents. See id. at 1- 2. McCormick seeks in this letter to quash the subpoena pursuant to Fed. R. Civ. P. 45(c)(3)(A) on the grounds that the subpoena did not allow a reasonable amount of time to comply and that the subpoena subjected McCormick to an undue burden. Notwithstanding McCormick's objections to Plaintiff's subpoena, McCormick appeared at the April 13 hearing through his counsel. At the April 13, 1999 hearing, McCormick, through his attorney, Christopher Porrino, invoked his Fifth Amendment right to remain silent and refused to testify.
On April 12, 1999, William Schroeder, Kathleen Schroeder and Macrophage, Inc., (collectively the "Schroeders") submitted a letter in opposition to Plaintiff's application, and an Affidavit of Defendants William Schroeder, Kathleen Schroeder and Macrophage, Inc. ("Schroeder Affidavit"). In their opposition letter, the Schroeders also join in the Corporate Defendants' opposition brief. See Letter from William N. Levy, Esquire, to the Court dated April 12, 1999 ("Levy Letter") at 2. The Schroeders also object to Plaintiff's subpoena pursuant to Fed. R. Civ. P. 45(c) on the grounds that the subpoena did not provide them with a reasonable amount of time to respond and is unduly burdensome. See Schroeder Affidavit at ¶ 2. Additionally, the Schroeders state in their opposition that they will not attend the April 13 hearing or produce any responsive documents on April 13 because they have planned a trip to Jamaica and will be departing on the morning of April 13. See id. at ¶ 3; Levy Letter at 1-2.
The Schroeders refused to appear at the April 13, 1999 hearing because of their pre-planned vacation in Jamaica, but were represented at the hearing by their attorney William Levy, Esquire. The Court ordered the Schroeders to appear before it for a hearing on April 19, 1999 at 1:30.
On April 13, hours before the hearing scheduled for 2:00 p.m., Plaintiff submitted a written reply to the defendants' opposition. See Letter from Thomas S. Harty, Esquire, to the Court dated April 13, 1999 ("Plaintiff's Reply"). In his reply papers, Plaintiff points out that the defendants' opposition is devoid of any facts that rebut Plaintiff's claims that the Schroeders and Charles McCormick are moving funds in and out of various bank accounts. See id. at 2. The remainder of Plaintiff's reply addresses the substance of the defendants' legal argument that Plaintiff is not likely to succeed on the merits in this matter.
On April 19, 1999, Plaintiff submitted to the Court a Supplemental Declaration of Geoffrey L. Steiert. Plaintiff's supplemental declaration explains a transaction he entered into in 1998 that permitted him to convert his IRA into a Roth IRA, and further sets forth the amount of damages he claims. The April 13, 1999 Hearing
The Court convened the hearing on April 13, 1999. In attendance at the hearing were Plaintiff's counsel, Thomas Harty, Plaintiff Geoffrey Steiert, counsel for Charles McCormick, Christopher Porrino, counsel for the Schroeders, William Levy, counsel for the Corporate Defendants and the court-appointed receiver, Kevin Hart, the court-appointed receiver, Robert Stevens, and John Eastlack, counsel for Kevin McCormick and K.A.M. Enterprises, Inc., upon whom Plaintiff's counsel served subpoenas to appear.
The Court admitted into evidence the declarations of Geoffrey Steiert, Thomas Yarnall, Dennis Taylor and Robert Stevens pursuant to Fed. R. Civ. P. 43(e). Additionally, the Court heard the sworn testimony of Dennis Taylor and permitted all counsel to cross-examine Mr. Taylor.
On direct examination, Mr. Taylor testified that subsequent to the April 8, 1999 hearing on Plaintiff's application for a Temporary Restraining Order, he received several telephone calls from the Schroeders. In one telephone call Kathy Schroeder told Taylor that McCormick was wiring money to the Schroeders that was to be used to repay Mr. Taylor for promissory notes that had come due. In a subsequent telephone conversation, Mr. Taylor claims that William Schroeder told him that, upon the advice of counsel, Schroeder was not going to speak to Mr. Taylor in the future. Mr. Taylor also testified that William Schroeder told him that if certain accounts were frozen, Taylor and other investors would not be paid monies owed them under certain promissory notes.
On cross-examination, Mr. Taylor testified that he was only generally familiar with the facts contained in his sworn declaration. Mr. Taylor further testified that the declaration was prepared by Plaintiff Geoffrey Steiert and that Steiert asked Taylor to sign the declaration. Mr. Taylor claimed that he read the declaration quickly before signing it and generally relied on Mr. Steiert's recollection of the facts contained in the declaration. Upon questioning by the Court, Mr. Taylor admitted that paragraph 34 of his declaration was not true. Paragraph 34 states that "Chuck McCormick and Bill Schroeder have also told me that Chuck McCormick is in the process of closing accounts and moving funds to new bank accounts, out of concern that the accounts might be discovered." This allegation is critical to Plaintiff's application and Mr. Taylor testified under oath at the April 13 hearing that Mr. McCormick never actually spoke to him about moving money in and out of accounts. For all these reasons, the Court found that Mr. Taylor was not a credible witness. Additionally, Mr. Taylor often seemed confused on the witness stand about facts contained in his declaration and was able to answer key questions only after being asked leading questions.
The April 19, 1999 Hearing
The parties appeared again before the Court for a hearing on April 19, 1999. At that hearing Plaintiff presented evidence in the form of testimony from a Mr. Mazer that McCormick was still engaged in a scheme of borrowing money from investors in exchange for promissory notes with a short maturity date and high interest rate. Mr. Mazer testified that he received a promissory note signed by McCormick on behalf of Mata Services that was to mature on Friday, April 23, 1999. Apparently, McCormick is still borrowing money and signing promissory notes on behalf of the companies without the knowledge and consent Mr. Stevens, contrary to the express directives in the state court consent order. Despite the fact that this hearing was held to accommodate the vacation schedules of the Schroeders, the Schroeders neither testified at the hearing, nor introduced into evidence any documents.
"[T]he grant of injunctive relief is an extraordinary remedy . . . which should be granted only in limited circumstances." American Telephone and Telegraph Co. v. Winback and Conserve Program, Inc., 42 F.3d 1421, 1426-27 (3d Cir. 1994) (citing Frank's GMC Truck Center, Inc. v. General Motors Corp., 847 F.2d 100, 102 (3d Cir. 1988) (citing United States v. City of Philadelphia, 644 F.2d 187, 191 n. 1 (3d Cir.1980)) (internal quotations omitted). "This proposition is particularly apt in motions for preliminary injunctions, when the motion comes before the facts are developed to a full extent through the normal course of discovery." Id. at 1427. In order to obtain preliminary injunctive relief, "the moving party must . . . show: (1) a reasonable probability of eventual success in the litigation, and (2) that it will be irreparably injured pendente lite if relief is not granted to prevent a change in the status quo." Acierno v. New Castle County, 40 F.3d 645, 652 (3d Cir. 1994) (citations and internal quotations omitted). "Moreover, while the burden rests upon the moving party to make these two requisite showings, the district court `should take into account . . . (3) the possibility of harm to other interested persons from the grant or denial of the injunction, and (4) the public interest.'" Id. (quoting Delaware River Port Auth. v. Transamerican Trailer Transp., Inc., 501 F.2d 917, 920 (3d Cir. 1974)). "[D]istrict [C]courts should award preliminary injunctive relief only upon weighing all four factors." Winback, 42 F.3d at 1427.
In this context, where the Plaintiff seeks to encumber assets to ensure that the defendants do not thwart any future money judgment against them by secreting away their funds, the plaintiff must show that he is "likely to become entitled to the encumbered funds upon final judgment" and that "without the preliminary injunction, plaintiff will probably be unable to recover those funds." Hoxworth v. Blinder, Robinson & Co., Inc., 903 F.2d 186, 197 (3d Cir. 1990). Moreover, "[i]f a court imposes a preliminary injunction encumbering a defendant's assets to protect a future money judgment, the court must make some attempt reasonably to relate the value of the assets encumbered to the likely value of the expected judgment." Id. at 198.
A. Subject Matter Jurisdiction
The defendants argue that the Court does not have subject matter jurisdiction over this action. *fn2 Therefore, the Court must first determine whether it has subject matter jurisdiction over Plaintiff's claims. See 11A Wright, Miller & Kane, Federal Practice and Procedure: Civil 2d § 2941 at 35 (West 1995). The defendants argue both here and in their motion to dismiss pursuant to Fed. R. Civ. P. 12(b) that this Court is without subject matter jurisdiction because the promissory notes that defendants signed in favor of Plaintiff are not "securities" within the meaning of 15 U.S.C. § 77a, et seq., 15 U.S.C. § 78a, et seq., and the Supreme Court's holding in Securities and Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946).
First, the defendants reliance on Howey is misplaced. In Reves v. Ernst & Young, 494 U.S. 56, 64 (1990), the Supreme Court held that the Howey test was not applicable to deciding whether notes are securities within the meaning of the Securities Acts. The Court noted: "We reject the approaches of those courts that have applied the Howey test to notes; Howey provides a mechanism for determining whether an instrument is an `investment contract.' The demand notes here may well not be `investment contracts, but that does not mean they are not `notes.' To hold that a `note' is not a `security' unless it meets a test designed for an entirely different variety of instrument `would make the Acts' enumeration of many types of instruments superfluous.'" Reeves, 494 U.S. at 64 (quoting Landreth Timber Co. v. Landreth, 471 U.S. 681, 692 (1985)).
Both the Securities Act of 1933 and the Securities Exchange Act of 1934 broadly define the term security. See Reves, 494 U.S. at 60-61 (citations omitted). Under the Securities Act of 1933, a security is: any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting- trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. 15 U.S.C. § 77b(a)(1).
The Securities Exchange Act of 1934 similarly provides: The term "security" means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a "security"; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited. 15 U.S.C. § 78c(a)(10).
By their express terms, both the 1933 Act and the 1934 Act (collectively the "Securities Acts") govern the purchase and sale of "notes." However, the term "note" in the statutes does not mean any note, rather, the term must be considered "against the backdrop of what Congress was attempting to accomplish in enacting the Securities Acts." See Reves, 494 U.S. at 63. When determining whether a note is a security, the Court must look to four factors. See id. at 66 (citation omitted).
First, the Court must "examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into it." Id. (citation omitted). "If the seller's purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a `security.'" Id. (citation omitted). Here, the uncontroverted evidence contained in Plaintiff's Declaration and Supplemental Declaration indicates that he loaned money to the Corporate Defendants and Macrophage, Inc., for the purpose of earning a profit on the interest paid pursuant to the promissory notes. Additionally, documents submitted to the Court by Plaintiff's counsel repeatedly refer to the lenders, including Plaintiff, as "investors," and purport to inform the "investors" of the uses to which the Corporate Defendants are putting the invested money. See, e.g., Plaintiff's Exhibit C2, C3, C4 and D.
Second, the Court must examine the plan of distribution for the instrument. See Reeves, 494 U.S. at 66 (citation omitted). Here, there was testimony presented at both the April 13 hearing and the April 19 hearing that investors were solicited to loan money to the Corporate Defendants by other investors, who in turn received a percentage of the loan as a commission. The Court finds that this method of distribution whereby the seller of the instruments earns a commission on sales also suggests that the notes issued to investors were securities.
Third, the Court must consider the "reasonable expectations of the investing public." Reeves, 494 U.S. at 66-67 (citation omitted). Here, the Court finds that the investing public would assume that these notes were securities. The Corporate Defendants issued notes with a declared interest rate to investors and paid commissions to the sellers of those notes. Additionally, the uncontroverted testimony at the hearings indicated that the defendants represented to the investors that some of the "six-percent notes" could be converted to common stock after SEC approval of Ki Digital's private offering of stock. This representation and the defendants' references to the SEC would lead the investing public reasonably to believe that the notes sold here were securities and were subject to federal regulation.
Finally, the Court "must examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary." Reeves, 494 U.S. at 67 (citation omitted). No regulatory scheme protected investors from the risks associated with these notes, and it is these types of investments that are among the evils from which Congress sought to protect the investing public through the Securities Acts.
The Court finds that it has subject matter jurisdiction over this matter under 28 U.S.C. § 1331 because the notes issued by the defendants are securities within the meaning of 15 U.S.C. 77b(a)(1) and 15 U.S.C. § 78c(a)(10).
At oral arguments, some of the defendants seemed to make an argument that the Court should abstain from exercising jurisdiction over this matter notwithstanding the fact that it has jurisdiction under 28 U.S.C. § 1331 because of the pending state court receivership and action.
Under the abstention doctrine a federal court may abstain from exercising jurisdiction over a matter even though a federal statute or constitutional provision permits federal jurisdiction. See Railroad Commission of Texas v. Pullman, 312 U.S. 496 (1941). The abstention doctrine "reflect[s] a complex consideration designed to soften the tensions inherent in a system that contemplates parallel judicial process." Chiropractic America v. Lavecchia, No. 99-5560, __ F.3d __, 1999 WL 213073, *3 (3d Cir., April 14, 1999) (internal quotations omitted) (quoting Penzoil Co. v. Texaco, Inc., 481 U.S. 1, 11, n.9 (1987)).
Several reasons are assigned for withholding the exercise of jurisdiction. Abstention is recognized to avoid deciding a federal constitutional question when the case may be disposed on questions of state law, Pullman; to avoid needless conflict with the administration by a state of its own affairs, Burford; to leave to the states the resolution of unsettled questions of state law, Louisiana Power & Light Co. v. City of Thibodaux, 360 U.S. 25, 79 S. Ct. 1070, 3 L. Ed.2d 1058 (1959); to avoid duplicative litigation, Colorado River. In addition, the doctrine of "Our Federalism" teaches that federal courts must refrain from hearing constitutional challenges to state action under certain circumstances in which federal action is regarded as an improper intrusion on the right of a state to enforce its own laws in its own courts, Younger v. Harris, 401 U.S. 37 (1971). Id.
The defendants have failed to present the Court with any reasons why the Court should abstain from exercising jurisdiction over this matter. First, Plaintiff does not raise any question of constitutional dimension that would require the Court to abstain in favor of a state law determination in order to avoid the premature adjudication of a constitutional question. Second, this action in no way interferes with the state's ability to govern its own affairs. The state is free to proceed with its action against the defendants and the receiver is free to oversee the affairs of the Corporate Defendants notwithstanding Plaintiff's claims here. Third, neither the plaintiff nor the defendants have presented the Court with an unsettled question of state law. Finally, while this action and the state court action may be duplicative litigation, the Court is not convinced that the state is acting directly for the protection of the note holders, such as Plaintiff. As discussed more fully below, the state court appointed receiver is only tangentially protecting the interests of the note holders in that action.
In Lac D'Amiate Di Quebec, Ltee v. American Home Assurance Co., 864 F.2d 1033 (3d Cir. 1988), the Third Circuit addressed the abstention doctrine in a fact situation where the defendant insurer was involved in a New York state court liquidation proceeding. The court held that "where a state creates a complex regulatory scheme, supervised by the state courts and central to state interests, abstention will be appropriate if federal jurisdiction deals primarily with state law issues and will disrupt a state's efforts `to establish a coherent policy with respect to a matter of substantial public concern.'" Id. at 1043 (quoting Colorado River Water Conservation District v. United States, 424 U.S. 800, 814 (1976)). The Court further noted that "federal courts more readily abstain from a case that contains no issue of federal law." Id. at 1044 (citations omitted). In this case the defendants have presented the Court with no proof whatsoever that the Corporate Defendants are subject to a complex state regulatory proceeding that will be impacted adversely if this federal action proceeds. Moreover, there a substantial questions of federal law present here that are not being addressed in the state court action. Finally, both federal and state governments are charged with the regulation of securities. The Court in Lac D'Amiante was at least partially persuaded by the McCarran-Ferguson Act, which "specifically provides that it is in the public interest for states to continue serving their traditional role as the preeminent regulators of insurance in the federal system and indicates the special status if insurance in the realm of state sovereignty." Id. (citation omitted). The Court finds that the facts of Lac D'Amiante are inapposite to the case at bar, which deals with the issuance of securities as opposed to insurance.
The Court further finds that it should not abstain from exercising jurisdiction over this matter.
B. Irreparable Harm
Before this Court will issue preliminary injunctive relief, Plaintiff must demonstrate that he will suffer irreparable harm without such relief. To show irreparable harm a plaintiff must demonstrate real harm that cannot be redressed by a legal or equitable remedy following trial. Hoxworth, 903 F.2d at 205 (quoting ECRI v. McGraw-Hill, Inc., 809 F.2d 223, 225 (3d Cir. 1987)). The injury created by "a failure to issue the requested injunction must be of a peculiar nature, so that compensation in money cannot atone for it." Orson, Inc. v. Miramax Film Corp., 836 F. Supp. 309, 312 (E.D. Pa. 1993) (citing Ecri v. McGraw- Hill, Inc., 809 F.2d 223, 226 (3d Cir. 1987)). "The Third Circuit has consistently held that preliminary injunctive relief is not available where money damages are adequate to compensate the injured party." Bascom Food Products Corp. v. Reese Finer Foods, Inc., 715 F. Supp. 616, 636 (D.N.J. 1989) (citing Frank's GMC Truck Center, Inc. v. General Motors Corp., 847 F.2d 100, 102-03 (3d Cir. 1988)). Where the plaintiff is confronted with inestimable injury in terms of monetary damages, a District Court may find irreparable harm. See id. (noting that "not all things in life can be reduced to a dollar price"); but see Acierno, 40 F.3d at 655 (stating that "[a]n inability to precisely measure financial harm does not make that harm irreparable or immeasurable").
"Establishing a risk of irreparable harm is not enough. A plaintiff has the burden of proving a clear showing of immediate irreparable injury." Ecri, 809 F.2d at 226 (quoting Continental Group, Inc. v. Amoco Chemicals Corp., 614 F.2d 351, 359 (3d Cir. 1980)) (internal quotations omitted); see also Hoxworth, 903 F.2d at 205; Apollo Technologies Corp. v. Centrosphere Industrial Corp., 805 F. Supp. 1157, 1208 (D.N.J. 1992) (Lechner, J.).
A plaintiff may not delay in seeking relief, such that it is apparent that "speedy action [by the court] is not required." Skehan v. Board of Trustees of Bloomsburg State College, 353 F. Supp. 542, 543 (M.D. Pa. 1973); see also Quince Orchard Valley Citizens Assoc., Inc. v. Hodel, 872 F.2d 75, 80 (4th Cir. 1989); Lydo Enterprises, Inc. v. City of Las Vegas, 745 F.2d 1211, 1213 (9th Cir. 1984). Regarding delay, the Second Circuit has stated:
Preliminary injunctions are generally granted under the theory that there is an urgent need for speedy action to protect the plaintiff's rights[;] [d]elay in seeking enforcement of those rights, however, tends to indicate at least a reduced need for such drastic, speedy action. . . . Although a particular period of delay may not rise to the level of laches and thereby bar a permanent injunction, it may still indicate an absence of the kind of irreparable harm required to support a preliminary injunction. Citibank, N.A. v. Citytrust, 756 F.2d 273, 276 (2d Cir. 1985) (citations omitted).
Here, Plaintiff has demonstrated to the Court that he will suffer irreparable harm if the defendants secrete money from assets to which he may become entitled upon a final judgment in this matter. In other words, if Plaintiff receives a judgment against some or all of the defendants in this action and has a right to enforce that judgment against the assets he seeks to encumber here, Plaintiff would suffer irreparable injury now if the defendants were permitted to disburse those assets so that Plaintiff could not reach them to execute his judgment.
The Court further finds that Plaintiff has demonstrated that he will suffer irreparable harm if the defendants secrete away assets to which he may become entitled.
C. Reasonable Probability of Success on the Merits
To obtain a preliminary injunction, Plaintiff must demonstrate "a reasonable probability of eventual success in the litigation." Acierno, 40 F.3d at 653.
To satisfy the success on the merits requirement in this context where the plaintiff seeks to encumber funds to satisfy a future money judgment, the plaintiff must show that he is "likely to become entitled to the encumbered funds upon final judgment and [show] that without the preliminary injunction, plaintiff will probably be unable to recover those funds." Hoxworth, 903 F.2d at 197.
Plaintiff has failed to make that showing. The evidence that Plaintiff has presented to the Court merely shows that the Schroeders and possibly William McCormick are moving money among several bank accounts, including an account controlled by a non-party, K.A.M. Enterprises. Plaintiff has not shown the Court how he may become entitled to those funds to satisfy a judgment on the notes signed by William McCormick on behalf of Mata Services and by William Schroeder on behalf of Macrophage, Inc. Even assuming that Plaintiff ultimately will succeed on the merits of this action and recover a judgment for the full value of the notes plus interest, Plaintiff has not demonstrated how the money allegedly being moved among the accounts of the Schroeders, McCormick and K.A.M. Enterprises, the funds Plaintiff seeks to encumber, would be subject to a levy by Plaintiff to enforce that judgment.
It should be noted, however, that the Court is satisfied that Plaintiff ultimately will succeed on the merits of his claims at least as to the entities that issued promissory notes to him. Plaintiff has presented the Court with uncontroverted evidence that several defendants issued promissory notes to him and that those notes are now due and owing. The defendants have not presented any evidence challenging the validity of the securities they issued, nor have they presented the Court with any evidence that the notes have been satisfied. The Court will draw an adverse inference from the defendants' invocation of their Fifth Amendment right to remain silent and assume that the notes are valid and the debt due and owing. But the Third Circuit's decision in Hoxworth requires more before the Court can encumber assets to satisfy a future money judgment. Plaintiff must draw a nexus between the assets he seeks to encumber and his claims in this case. Plaintiff has failed to draw that nexus.
The Court further finds that he has not satisfied his burden of proving that he will become entitled to the assets he seeks to encumber by his application for injunctive relief.
D. Injury to Other Interested Parties
The Court must also determine whether granting the requested preliminary injunctive relief will injure any interested parties. Winback, 42 F.3d at 1427.
The potential injury to the interested parties almost goes without saying. If the Court were to grant Plaintiff's application, the Schroeders, William McCormick and K.A.M. Enterprises would be denied access to money in the accounts Plaintiff seeks to freeze for the duration of this litigation and, as discussed above, Plaintiff may never be entitled to those funds even after a final judgment in his favor.
The Court further finds that the defendants and K.A.M. Enterprises would suffer injury if the Court granted the relief Plaintiff seeks.
E. The Public Interest
The Court also must consider what effect the grant or denial of the preliminary injunction will have on the public interest. "As a practical matter, if a plaintiff demonstrates both a likelihood of success on the merits and irreparable injury, it almost always will be the case that the public interest will favor the plaintiff. Nonetheless, district courts should award preliminary injunctive relief only upon weighing all four factors." Winback, 42 F.3d at 1427, n. 8 (citing Duraco Prods., Inc. v. Joy Plastic Enter., Ltd., 40 F.3d 1431, 1438 (3d Cir. 1994)). "The injunction should issue only if the plaintiff produces evidence sufficient to convince the district court that all four factors favor preliminary relief." Duraco Products, Inc. v. Joy Plastics Enter., Ltd., 40 F.3d 1431, 1438 (3d Cir. 1994) (citing Opticians Ass'n v. Independent Opticians, 920 F.2d 187, 192 (3d Cir.1990)). "Focusing on this factor is another way of inquiring whether there are policy considerations that bear on whether the [preliminary injunction] should issue." 11A Wright, Miller & Kane, Federal Practice and Procedure: Civil 2d, § 2948.4 at 200-01 (West 1995).
As a general proposition, preventing a party from secreting away assets otherwise subject to execution after final judgment serves the public interest. See, e.g., In re Uranium Antitrust Litigation, 617 F.2d 1248, 1261 (7th Cir. 1980) (holding that district court's order enjoining defaulting defendants from transferring finds out of the country served the public interest by providing enforcement of antitrust laws).
Defendants devote much of their opposition to an argument that this Court should abstain from encumbering any of the defendants assets because the note holders' interests are being protected by the state court receiver. However, the Court finds that the receiver in the state court is only tangentially protecting the Plaintiff's interests. According to the express terms of the consent order, the receiver generally is charged with the authority to preserve the assets of Ki Digital and its subsidiaries, and to review the business affairs of Ki Digital and issue a report with his recommendations. See Plaintiff's Exhibit O. To the extent that the note holders may be entitled to assets controlled by entities other than Ki Digital, the receiver presently has no authority to bring suit to secure those assets for the benefit of the note holders.
Additionally, the defendants elicited some testimony at the April 13, 199 hearing indicating that Ki Digital may be entering into a contract to provide computer and electronic equipment to the Ivory Coast as a subcontractor on an unspecified general contract. The Court finds that the potential Ivory Coast contract is far too speculative a proposition to have any effect on he Court's analysis whatsoever. According to the testimony at the April 13 hearing, Ki Digital had not yet entered into a subcontract with the general contractor, a South Jersey construction company allegedly bidding on a large construction contract in Africa, and the general contractor had not even entered into a final contract with the Ivory Coast. The defendants claimed that if the contractor enters into a contract with the Ivory Coast, and the contractor enters into a subcontract with Ki Digital, then the contractor may take an equity interest in Ki Digital that may provide up to $8,000,000.00 in cash to satisfy a portion of the approximately $15,000,000.00 in outstanding notes. The Court finds that the possibility of all of these contingencies occurring would have no impact at all on the Court's analysis of Plaintiff's claims. Plaintiff has every right to assert his claims here regardless of potential deals that may or may not materialize during the pendency of this action.
F. Scope of the Injunction
The Court must narrowly tailor the scope of any injunction to encumber only those assets belonging to the defendants as are necessary to protect any future money judgment. See Hoxworth, 903 F.2d at 198. Accordingly, the Court must first determine the amount Plaintiff is reasonably likely to be awarded in a judgment here, and compare that amount with the amount of money in the accounts that Plaintiff seeks to encumber.
While Plaintiff has presented to the Court evidence of the total amount owed to him under the promissory notes, he has not shown how much money is in each of the accounts he seeks to encumber, or even identified the accounts other than an account at Commerce Bank in the name of K.A.M. Enterprises, Inc. Therefore there is no way the Court can determine if the amount Plaintiff seeks to encumber bears any relation to the amount of money Plaintiff may recover in this action. The Court appreciates that the defendants invoked their right to remain silent in this matter and refused to testify. Plaintiff argued that the Court should draw an adverse inference from the defendants' silence. However, the Court cannot infer from the defendants' silence that the defendants are in possession of bank accounts and further infer that the amount of money in those accounts is equal to the amount of money Plaintiff is likely to recover in this action.
The Court also is aware of the fact that Plaintiff has not received discovery from the defendants, and may have been precluded from discovering admissible evidence. During the course of the hearings, the Court repeatedly invited Plaintiff's counsel to make an application to compel the defendants to produce documents, but counsel never made such an application. Without a proper motion, the Court's hands are tied are as to the defendants' unwillingness to produce documents in this matter.
The Court further finds that Plaintiff has not met his burden of showing that the scope of the injunction he seeks is proportional to his claims in this case.
For the reasons discussed above, Plaintiff has not demonstrated to the Court that he likely will become entitled to the funds he seeks to encumber through this application. The Court further finds that Plaintiff has not demonstrated to the Court that the scope of the injunction he seeks is proportional to the amount of money he might recover from the defendants upon final judgment. Accordingly, Plaintiff's application for a preliminary injunction is denied.
THIS MATTER having been brought upon motion before the Court by Kevin S. Harty, Esquire, attorney for Plaintiff Geoffrey Steiert, for a preliminary injunction; and the Court having considered the moving papers, the opposition thereto, and Plaintiff's reply papers; and the Court having convened hearings on April 9, April 13, and April 19, 1999; and for the reasons stated in the Opinion accompanying this Order;
IT IS ON THIS 20th day of April, 1999 hereby ORDERED that the Plaintiff's motion for a preliminary injunction is DENIED.
ROBERT B. KUGLER United States Magistrate Judge
cc: Honorable Stanley S. Brotman