Ak's Daks Communications, Inc. v. Maryland Securities Division

DEBORAH S. EYLER, J. On April 4, 1995, the Maryland Securities Division (“the Division”), appellee, issued a summary cease and desist order and initiated formal proceedings against Express Communications, Inc., Pendleton Waugh, Patricia T. Phipps, Charlie Mae Lewis, Ak’s Daks Communications, Inc., SMR Advisory Group, Albert Koenigsberg, Warren Blanck, Puma Communication, Inc., David Meredith, Communication Consultants, Jerry Calloway, Manning Communications Consultants, David Evans, and David Smith. 1 On October 3, 1996, the Division issued a show cause order against Ak’s Dak’s Communications, Inc., SMR Advisory Group, L.C., Albert Koenigsberg, ³¹⁹ and new respondent Jimmy Evans, charging them with violations of the original summary order to cease and desist. The two cases were consolidated and a hearing was held before an Administrative Law Judge (the “ALJ”) on November 18, 19, and 20, 1996, and January 27, 28, 29, 80, and 31, 1997. The ALJ issued findings and submitted them to the Maryland Securities Commissioner (“Commissioner”). 2 The Commissioner held a hearing and thereafter determined that Ak’s Daks Communications, Inc., SMR Advisory Group, L.C., Albert Koenigsberg, Jimmy Evans, Warren Blanck, Puma Communication, Inc., David Meredith, and Manning Communications Consultants, appellants, violated Maryland securities laws. He imposed a fine of $178,000.

Appellants filed an action for judicial review of the Commissioner’s decision in the Circuit Court for Baltimore City. The circuit court (Berger, J.) affirmed the Commissioner’s decision. The appellants now appeal to this Court, presenting the following questions for review, which we have rephrased: I. Was the Commissioner legally correct in deciding that limited liability company interests sold to Maryland investors were investment contracts and, therefore, securities?

II

Was the evidence legally sufficient to support the Commissioner’s decision that the appellants violated sections 11-301, 11 — 401, 11-402, and 11-501 of the Maryland Securities Act? For the following reasons, we answer yes to both questions. Accordingly, we shall affirm the judgment of the circuit court. FACTS AND PROCEEDINGS The Appellants Ak’s Daks Communications, Inc. (“Ak’s Daks”) is a Florida corporation that was organized on April 9, 1992.

Albert ³²⁰ Koenigsberg is its president and sole shareholder. Ak’s Daks entered into contracts with each of the 55 limited liability companies (“the LLC’s”) involved in this case (as discussed below) to serve as their administrative agent. Pursuant to the contracts, Ak’s Daks was responsible for the administrative and record-keeping needs of each of the LLCs. SMR Advisory Group (“SMR Advisory”) is a Florida limited liability company that was organized on March 10, 1994, by Koenigsberg, Warren Blanck, and Bobbi Chubirka.

SMR Advisory is a founding member of each of the LLCs. SMR Advisory is a telecommunications strategic planning, engineering, and construction enterprise that was formed to operate specialized mobile radio (“SMR”) systems in the 220-222 MHZ spectrum. It contracted with Ak’s Daks to construct and manage 220-222MHz radio dispatch systems for the LLCs. Warren Blanck is president of Unicall Communications, a membership recruiting organization for various of the LLCs.

Unicall was founded by SMR Advisory. Puma Communications, Inc. (“Puma Communications”) is a membership recruiting organization for various of the LLCs. It was founded by SMR Advisory and is a Florida corporation. David Meredith is the president, sole shareholder, and employee of Puma Communications.

Meredith also is a member of SMR Advisory. Jimmy Evans is a member and employee of SMR Advisory. The LLCs & Their Formation Each LLC was formed to offer SMR dispatch services from a particular location. The SMR dispatch services consist of a two-way radio system that allows one person to speak at a time.

Forty-two of the LLCs are located on the west coast of the United States and are intended participants in the proposed Western Regional Network. If created, that network would provide uninterrupted SMR service to clients throughout the western range of the LLCs. Thirteen of the LLCs are located 6n the east coast. ³²¹ The 220-222 MHZ SMR systems have limited capacity for general use in communications. This is because the technology necessary to permit a SMR system to operate as a two-way communications device has not yet been developed.

Also, the narrow band width of the 220-222 MHZ frequency restricts the amount of information that can be transmitted and radio signals in the 220-222 MHZ range cannot penetrate buildings as effectively as 800 MHZ systems. The LLCs all were organized by SMR Advisory and either one member of the public, an affiliate, or a holder of a 220 MHZ license from the Federal Communications Commission (“FCC”). For the LLCs in which Maryland residents invested, the other founding member either was an employee or owner of SMR Advisory, or was otherwise related to SMR Advisory or Koenigsberg. SMR Advisory received an 8% equity ownership interest in the “Class B” LLC interests.

The holder of the FCC license received a 20% interest in the LLC and was required to transfer his license to the LLC. These original members entered into agreements to start the build-out of the SMR facility and then sought out other members “to provide additional capital and whatever other participation each additional LLC member deemed appropriate.” The additional members were “Class A” members; upon completion of the build-out of the 220 MHZ operating system, the Class A members became Class B members, and the Class A interests ceased to exist. New members from the public also became Class B members. Each LLC has, on average, 38 investors and each LLC has raised approximately $275,000 from those investors.

Twenty-one Maryland residents invested a total of more than $161,000 in various of the LLCs. Nationwide, over 1100 people invested in the LLCs. Investor funds from all of the LLCs were pooled in a single bank account. Offering Materials Investors were solicited through a variety of means, including radio commercials.

Membership recruiters also solicited investors who previously had invested in wireless communica ³²² tions. Members were not sought on the basis of their technical or business expertise in the field, even though operating the 220-222 MHZ SMRs requires a technical understanding of the mobile radio field. Membership recruiters promised potential investors a profitable outcome, telling one potential investor that a $7,500 investment could produce revenues of $50,000 to $60,000 in five years. The membership recruiters did not inform potential investors of the characteristics of the market, the site, or the projected earnings for the particular LLC involved.

The recruiters arranged for Ak’s Daks or SMR Advisory to send promotional material to the potential investors. The offering materials prepared by Ak’s Daks stated that Koenigsberg had 15 years of experience in FCC license and filing programs. It did not reveal that his experience was gained with a company whose president was convicted of federal crimes. The material also highlighted SMR Advisory as a major player in the wireless communications field.

Potential investors were advised that SMR Advisory was to be the administrator of the offering and would provide various services, including: formation of the LLC, negotiation with 220/222 MHZ license holders, coordination and execution of legal documents, provision of monthly newsletters to members and quarterly performance statements to clients, and compliance with FCC rules and regulations. The materials stated that SMR Advisory had operating company profit margins in excess of 28 percent. The offering materials included a forecasted financial statement for the Western Regional Network. It projected that the LLCs on the west coast would have a combined net income of $10,181,100 in 1999 and a total net income for a five year period of $28,965,700.

These figures average out to a net income of $18,148 on a $8,500 investment over a five year period. The offering materials also projected over $4,939,000 in interconnect revenues and over $1,600,000 in revenue from data transmission services for the Western Regional Network. The interconnect revenue projections contained in the materi ³²³ als were fifteen times the projections made by the appellants’ expert witness, Stephan Virostek, and were based upon estimations of rates and percentage of subscribers for interconnect services that were well-above industry averages. The offering material included a document depicting the Western Regional Network as an interlocking network of SMR stations from north of Los Angeles to Seattle.

The material described this as “a project underway to develop the largest seamless narrowband wireless network in the United States.” The offering material did not mention the existence of the “forty mile rule,” an FCC regulation that restricts common ownership of SMR systems in the same community. This regulation would thwart the appellants’ plans for the Western Regional Network. The representations concerning this network and of the potential for high profit were important factors in some Maryland residents’ decisions to invest. The offering material also failed to inform investors of the characteristics of the market or projected earning for specific LLCs.

The solicitation material contained some information on the promoters’ financial interest in the investments, but did not reveal that 35% of the investment fund went to the membership recruiter and 12% of the investment fund went to Ak’s Daks, and 25% of the gross income went to SMR Advisory. The offering materials further did not disclose that there were proceedings pending against these parties in South Dakota and Arizona. Potential investors were told that the LLCs were member-managed companies operated under the control of a majority vote of the members. Upon receipt of the offering material, a potential investor would send a reservation form and money to Ak’s Daks, thereby holding an investment in a particular LLC for the investor.

Potential investors then were contacted by a compliance interviewing company that ran through a series of questions designed to elicit an acknowledgment by the investor that he was aware that the LLCs were member-managed companies, that his money was totally at risk, and that his liability was limited to the amount invested. The compliance ³²⁴ interview conducted with one Maryland investor contained approximately 25 questions and lasted between three and five minutes. Approximately 1% of potential investors were rejected as a result of the compliance interview process. Membership summaries were sent to investors; the summaries contained copies of contracts that already had been entered into on behalf of the LLCs.

The appellants gave the investor the right to rescind the investment up until seven days after the receipt of these summaries. If the investor chose to retain the investment, he or she was required to ratify the previously negotiated contracts. No investment opportunity offerings in the LLCs were registered in Maryland as securities under the Securities Act. None of the appellants have registered in Maryland as a broker dealer or a broker dealer agent under the Securities Act.

After the Commissioner issued the cease and desist order of April 4, 1995, the appellants continued to solicit Maryland residents to invest in the LLCs. Operation of the LLCs Koenigsberg, SMR Advisory, and Ak’s Daks negotiated all of the contracts for the LLCs. Koenigsberg signed all of the subscription agreements for the new members; he did not consult current members before accepting the new members. Koenigsberg signed nearly all of the contracts on behalf of the LLCs.

He signed some of the contracts on behalf of both parties. On various occasions, Koenigsberg signed as “founding member,” “officer” and “PresidenVfounder.” Yet, he is not the founding member, president, or officer of any of the LLCs. Many of the contracts involving LLCs in which Marylanders invested were signed before the Maryland investors became members of the LLC; the Maryland investors had no input into the terms of these contracts. Eleven contracts were signed, after Maryland residents invested, between the LLCs that had Maryland members and Ak’s Daks, SMR Advisory, the FCC licensee, or radio tower site owner.

The investors had no say in the terms of these contracts. ³²⁵ SMR Advisory’s contracts with the LLCs give it a broad range of authority. The contracts have five-year terms. Many provide that renewal of the contracts may not be unreasonably withheld, except for gross negligence or fraud. Other of the contracts with SMR Advisory and with Ak’s Daks provide that renewal may not be unreasonably withheld.

SMR Advisory sent proxies to investors on various issues, requiring the investors to make business decisions for the LLCs. The proxies did not contain important technical and cost information, however, and some proxies asked the members to ratify decisions that already had been made. 3 DISCUSSION I The appellants first contend that the Commissioner erred as a matter of law in determining that the interests in the LLCs that they offered and sold to investors were securities. Specifically, they argue that in analyzing the issue the Commissioner should have applied a presumption that interests in limited liability companies are not securities. The Division responds that the Commissioner was legally correct in its analysis and in concluding that the LLC interests were securities. 4 ³²⁶ We apply a de novo standard of review to legal determinations made by an administrative agency.

See Young v. Board of Physician Quality Assurance, 111 Md.App. 721, 726 , 684 A.2d 17 (1996), cert. granted, 344 Md. 568 , 688 A.2d 447 , cert. dismissed, 346 Md. 314 , 697 A.2d 82 (1997). In ascertaining the propriety of an agency’s legal conclusions, we must consider whether the agency recognized and applied the correct principles of law governing the case. Id. Our review is limited to the conclusions of law actually made by the agency, and we will affirm the agency’s decision only if it is sustainable on the grounds given.

United Parcel Serv., Inc., v. People’s Counsel, 336 Md. 569, 585 , 650 A.2d 226 (1994); United Steelworkers v. Bethlehem Steel Corp., 298 Md. 665, 679-80 , 472 A.2d 62 (1984). Maryland Code (1999 RepLVoL), § ll-101(r) of the Corporations and Associations Article (“CA”) defines a “security” as any (i) note; (ii) stock; (iii) treasury stock; (iv) bond; (v) debenture; (vi) evidence of indebtedness; (vii) certificate of interest or participation in any profit-sharing agreement; (viii) collateral-trust certificate; (ix) preorganization certificate or subscription; (x) transferable share; (xi) investment contract; (xii) voting-trust certificate; (xiii) certificate of deposit for a security; (xiv) certificate of interest or participation in an oil, gas, or mining title or lease or in payments out of production under the title or lease; (xv) in general, any interest or instrument commonly known as a “security”; or (xvi) Certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or war ³²⁷ rant or right to subscribe to or purchase any of the preceding. This definition is substantially the same as the federal definition of a “security” under the Securities Act of 1933 § 2(1), 15 U.S.C. § 77b (a)(1) (1997), and is to be interpreted in a manner that is consistent with the federal definition. CA § 11-804.

See also O’Neil v. Marriott Corp., 538 F.Supp. 1026, 1032 (D.Md.1982); Caucus Distribs., Inc. v. Maryland Sec. Comm’r, 320 Md. 313, 324 , 577 A.2d 783 (1990). For that reason, we will rely in large part on federal case law in interpreting the term “security.” The Commissioner found that the LLC interests met the “investment contract” definition of a security. Although an “investment contract” is not further defined by Maryland or federal securities law or regulations, its meaning has been explained by the United States Supreme Court in the seminal case of Securities and Exchange Commission v. Howey, 328 U.S. 293 , 66 S.Ct. 1100 , 90 L.Ed. 1244 (1946). There, the Court held that an investment contract, within the meaning of the federal securities laws, is an investment of money in a common enterprise with an expectation of profits derived solely from the efforts of others.

The Court explained: The term “investment contract” is undefined by the Securities Act or by relevant legislative reports. But the term was common in many state “blue sky” laws in existence prior to the adoption of the federal statute and, although the term was also undefined by the state laws, it had been broadly construed by state courts so as to afford the investing public a full measure of protection. Form was disregarded for substance and emphasis was placed upon economic reality. An investment contract thus came to mean a contract or scheme for “the placing of capital or laying out of money in a way intended to secure income or profit from its employment.” State v. Gopher Tire & Rubber Co., 146 Minn. 52, 56 , 177 N.W. 937, 938 .

This definition was uniformly applied by state courts to a variety of situations where individuals were led to invest money in a common enterprise with the expectation that they would earn a ³²⁸ profit solely through the efforts of the promoter or of some one other than themselves. By including an investment contract within the scope of § 2(1) of the Securities Act, Congress was using a term the meaning of which had been crystallized by this prior judicial interpretation.... It embodies a flexible rather than a static principle, one that is capable of adaption to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits. Id. at 298-99, 66 S.Ct. 1100 (footnote omitted) (emphasis added).

See also Reves v. Ernst and Young, 494 U.S. 56, 64 , 110 S.Ct. 945 , 108 L.Ed.2d 47 (1990) (stating that Howey provides the method for determining if an instrument is an “investment contract”); Teague v. Bakker, 35 F.3d 978, 986 (4th Cir.1994), cert. denied, 513 U.S. 1153 , 115 S.Ct. 1107 , 130 L.Ed.2d 1073 (1995) (stating that an investment contract exists when there has been (1) an investment of money in (2) a common enterprise with (3) an expectation of profits derived solely from the efforts of others). The parties do not dispute that the sale of an interest in a limited liability company satisfies the first two factors of the Howey definition of an investment contract. The only issue in this case is whether, under the final Howey factor, the investors in the LLCs expected profits to be derived solely from the efforts of others. 5 There is a long line of factual cases interpreting this prong of the Howey definition of an investment contract. In determining if an investor expects profits solely from the efforts of others, the courts have interpreted the word “solely” with some flexibility, so as to further the purpose of the securities laws and ensure that they are not easily ³²⁹ circumvented.

Long v. Shultz Cattle Co., 881 F.2d 129, 133 (5th Cir.1989); SEC v. Glenn W. Turner Enter., 474 F.2d 476, 482 (9th Cir.), cert. denied, 414 U.S. 821 , 94 S.Ct. 117 , 38 L.Ed.2d 53 (1973). These cases restate the inquiry in terms of whether the efforts made by those other than the investor are the undeniably significant managerial and entrepreneurial efforts. Teague, 35 F.3d at 986 n. 7 (citing Bailey v. J.W.K. Properties, Inc., 904 F.2d 918, 920 (4th Cir.1990)); SEC v. International Loan Network, Inc., 297 U.S.App. D.C. 22, 968 F.2d 1304, 1308 (1992); Bailey, 904 F.2d at 920-21 ; Long, 881 F.2d at 133 ; SEC v. Aqua-Sonic Prods. Corp., 687 F.2d 577 , 582 (2d.

Cir.), cert. denied sub nom. Hecht v. SEC, 459 U.S. 1086 , 103 S.Ct. 568 , 74 L.Ed.2d 931 (1982); Glenn W. Turner Enters., 474 F.2d at 482-83 . 6 Thus, minimal efforts by the investor will not preclude an interest from being classified as an investment contract. The cases take a fact-driven approach to determining whether managerial efforts by those other than