In the U.S. District Court for the Eastern District of Michigan, a judge refused to throw out an SEC enforcement action against two men accused o f securities fraud. James Mulholland Jr. and Thomas Mulholland allegedly sold fake demand notes connected to a failing real estate venture. Contending lack of subject matter jurisdiction, and also that, per the law, the notes were not securities, the defendants had sought to have the Michigan securities case dismissed, the court, however, disagreed, pointing out that each note is presumed to be a security unless rebutted by fitting under or sufficiently resembling one of a number of note categories that the US Supreme Court has determined to not be a security.
The two men ran Mulholland Financial Services Inc., which they financed by putting out demand notes that they sold through “word-of-mouth referrals,” as well as to relatives, friends, and clients. When the financial firm started to collapse and it had to be dissolved, James and Thomas allegedly kept using the company to raise investor money, including $2 million in 2009, and selling demand notes to over six dozen investors while promising a 7% return. They also are accused of telling prospective investors that MFSI would make the profits that would lead to the returns, with principal and the interest made to be given within 30 days of any written demand request.
Many of these investors were reportedly retirees who were unseasoned investors. When the Mulhollands filed for bankruptcy protection, these investors lost everything they had placed in the notes.
The court said that it is obvious that the defendants’ main motivation for issuing the notes was to make money, they appeared to have a plan for how they were to distribute the notes, the 7% return that was promised constituted a “reasonable expectation” by the public, the notes were uninsured and uncollateralized, and no regulatory scheme was identified by the defendants that would apply if securities laws weren’t applicable. The court said that all these factors meet the criteria of the Reves test, from the US Supreme Court’s Reves v. Ernst & Young, therefore supporting that the demand notes are securities.
COURT CONCLUDES DEMAND NOTES WERE SECURITIES UNDER FEDERAL ACTS, Bloomberg Law, March 13, 2013
Reves v. Ernst & Young (PDF)
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