JOSE F. SANCHEZ, Cal. Bar No. 161362
Attorney for Plaintiff
UNITED STATES DISTRICT COURT
SECURITIES AND EXCHANGE COMMISSION,
DONNE CORPORATION, SHERMAN S. SMITH, SHAWN SMITH, AND BRUCE ANDERSON,
Civil Action No. C 02-04238 SC
COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS
Plaintiff Securities and Exchange Commission ("Commission") alleges as follows:
1. From approximately January 1998 through January 2001, Defendants Donne Corporation ("Donne"), its founder and chairman Sherman S. Smith ("Smith"), its president and chief executive officer Bruce Anderson ("Anderson"), and its chief financial officer Shawn Smith (collectively, "defendants") raised approximately $4 million through the fraudulent unregistered offer and sale of Donne stock.
2. In soliciting prospective investors, defendants targeted religious individuals, guaranteeing some of them returns of 12 percent per year on their Donne investment. However, because Donne's business was never profitable or solvent, defendants used the proceeds from Donne's stock sales to new investors to pay these returns. Defendants also used Donne investor funds to pay returns on an unrelated investment that had been sold by Smith before 1998. None of this was ever disclosed to investors. In this way, defendants operated a Ponzi-like investment scheme.
3. Defendants also made the following misrepresentations and omissions of material fact when selling Donne stock:
4. The defendants, by engaging in the conduct described in this Complaint, have violated the securities registration provisions of Sections 5(a) and 5(c) of the Securities Act, 15 U.S.C. §§ 77e(a) & 77e(c), and the antifraud provisions of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), and Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. Smith further has violated the antifraud provisions of Sections 206(1) and (2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) & 80b-6(2). By this action, the Commission seeks, among other relief: (1) permanent injunctions against each defendant; (2) civil penalties against Smith, Anderson, and Shawn Smith; (3) disgorgement of all ill-gotten gains, plus prejudgment interest thereon, against Smith, Anderson and Shawn Smith; and (4) an officer and director bar against Smith.
5. This Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77v(a), Sections 21(d)(3)(A), 21(e) and 27 of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78u(d)(3)(A), 78u(e) & 78aa, and Section 214 of the Investment Advisers Act of 1940 ("Advisers Act"), 15 U.S.C. § 80b-14. Defendants have, directly or indirectly, made use of the means or instrumentalities of interstate commerce, of the mails, or of the facilities of a national securities exchange in connection with the transactions, acts, practices and courses of business alleged in this Complaint.
6. Venue is proper in this district pursuant to Section 22 of the Securities Act, 15 U.S.C. § 77v, Section 27 of the Exchange Act, 15 U.S.C. § 78aa, and Section 214 of the Advisers Act, 15 U.S.C. § 80b-14, because certain of the transactions, acts, practices and courses of conduct constituting violations of the laws alleged herein occurred within the Northern District of California and because certain of the defendants reside therein.
7. Assignment to the San Francisco Division or Oakland Division is appropriate pursuant to Civil Local Rules 3-2(c) and 3-2(d), because a substantial part of the events that gave rise to the claims alleged herein occurred in Napa County, California.
8. Donne was incorporated in California in 1998, and had offices in Napa, California and Brandon, Florida. Before 1998, Donne was a soleproprietorship owned by Smith. From approximately January 1998 through January 2001 ("the relevant time"), Donne provided consulting services to churches in the areas of finances, development and construction. Neither Donne nor its securities offerings have ever been registered with the Commission. Donne's corporate status was suspended by the California Secretary of State on or about May 15, 2002.
9. Smith, age 56, resides in Napa, California. Smith is Donne's founder and chairman. During the relevant time, Smith sold Donne's stock and controlled the funds raised from Donne investors. During the relevant time, he was registered with the State of California as an investment adviser. Smith is also a Baptist minister and has written various books and lectured throughout the country on such topics as church and personal finances.
10. Anderson, age 46, resides in Tampa, Florida. During the relevant time, Anderson was Donne's president and board member. Anderson was Donne's chief executive officer ("CEO") from October 1999 until May 2001, when he resigned from Donne. As president and CEO, Anderson oversaw Donne's business activities and supervised Donne's employees. Anderson also was a signatory on Donne's bank accounts.
11. Shawn Smith, age 31, resides in Napa, California. He is Smith's son. Since about October 1998, Shawn Smith has been Donne's chief financial officer ("CFO") and a board member. As CFO, he maintained Donne's bank accounts and business records as well as communicated with Donne's investors. Before working for Donne, Shawn Smith worked in various investment advisory and brokerage businesses.
12. Since about 1995, Smith has raised money to fund various businesses. As part of his fundraising efforts, Smith solicits, and causes others to solicit, hisinvestment advisory clients as well as individuals he meets through his church activities across the country.
13. Beginning sometime in 1995 and continuing to 1997, Smith raised money to fund his own investment advisory business known as SSS&A Investment Advisers ("SSS&A"). Smith pitched SSS&A as an investment (the "SSS&A investment") and promised returns of 12 percent per year.
14. When Smith ran out of the money raised for SSS&A, in or around January 1998, defendants started raising funds for Donne, promising the same investment returns.
15. The offer and sale of Donne stock was never registered with the Commission, nor exempt from the securities registration provisions of the federal securities laws.
16. During the relevant time, defendants raised approximately $4 million from Donne stock sales. Defendants offered and sold Donne stock at $10 per share. Investors received stock certificates in exchange for their Donne investment.
17. In selling Donne stock, defendants targeted individuals whom Smith had met or who were referred to Smith as a result of his work as pastor and investment adviser. More than 50 individuals located throughout the United States purchased Donne stock. Most of the Donne investors are religious and actively involved in their respective churches.
18. Before purchasing Donne stock, most investors attended a presentation about Donne. In October 1999, Donne's board, which included Anderson and Shawn Smith, authorized Smith to hold presentations for prospective investors in California and Nevada. Smith held investor presentations in at least West Virginia, Maryland, and California. Shawn Smith was present during a presentation held in Napa, California on or about December 8, 1999 (the"December 1999 Napa Presentation").
19. Before investing in Donne, investors received similar information about Donne and the Donne investment. Investors were told, either orally and/or in writing, that, among other things: (a) Donne was a profitable business; (b) the Donne investment was safe; (c) Donne investor funds would be used for Donne's expenses; and (d) the value of Donne stock would triple in two to five years. Some investors were also told they would receive a guaranteed return on their Donne investment.
20. As an example, Smith told one investor, who was also his investment advisory client at the time, that he would invest the majority of her family's $1.7 million inheritance in Donne and that she would receive a guaranteed 12 percent per year return on her investment. Then, when this investor asked for an accounting of her investment and, later, a return of her original principal, both Smith and his son, Shawn Smith, repeatedly told her that the Donne investment was safe and profitable and that Donne would soon go public.
21. Some Donne investors received regular monthly dividend payments equal to 12 percent per year on their Donne investment. During the relevant time, the defendants paid approximately $121,847 in investor dividends. Because Donne was never profitable or solvent, however, the defendants used proceeds from Donne's stock sales to new investors to fund the payment of dividends to existing investors.
22. Defendants also used Donne investor money to fund the returns and/or the repayment of some SSS&A investments. At least $400,000 of Donne investor money was used for these undisclosed purposes.
23. Defendants each knew or were reckless in not knowing that they were using the proceeds from Donne's stock sales to pay Donne's dividends and SSS&A's obligations. This Ponzi-like investment scheme was never disclosed toDonne investors and was inconsistent with defendants' representations that proceeds from Donne's stock sales would be used solely to pay Donne's operational expenses.
24. The defendants prepared and distributed to prospective investors a number of documents that contained materially false and misleading statements and/or that omitted material facts concerning Donne's financial condition, projected earnings and investment returns, and use of investor funds. The defendants each knew or were reckless in not knowing that the following documents, among others, were false and misleading when provided to investors:
25. At the December 1999 Napa Presentation, Smith distributed a business plan that contained false and misleading information about Donne. Before this business plan was distributed to prospective investors, each of the defendants had reviewed a draft of the business plan and knew or were reckless in not knowing that the business plan contained false and misleading information and would be used to solicit investors.
26. Donne's business plan contained projections relating to Donne's business income, financial condition, and investment returns for a five-year period beginning in 2000. The business plan stated that, "[b]y March 31, 2000, Donne [would] have nearly $1,250,000 in operating capital with 1st quarter revenue of $347,000" and "will be in a stable financial position." The business plan also projected by year end 2000 gross income of $1,338,540, cash in the bank of $1,595,881, and a return on owner's equity of 19.36%. The business plan further projected that Donne would be worth $100 million after five years. These projections were based on information provided by Anderson.
27. The individual defendants each knew or were reckless in not knowing in or around October 1999 that these projections had no reasonable basis in fact. Smith, Anderson, and Shawn Smith were all present at an October 14, 1999 board meeting in Napa, California (the "October 1999 board meeting"), when the board discussed Donne's financial statements for the period January 1998 through September 1999. These financial statements showed that, as of October 1, 1999, Donne was operating at a substantial loss, had a significant negative net worth, and had no cash in the bank.
28. None of this financial information, however, was ever disclosed to prospective investors. Indeed, at some point during or after the October 1999 board meeting, Smith and Anderson each directed that Donne's financial statements for January 1998 through September 1999 be deleted from Donne's business plan. These instructions were followed. The Donne business plan that investors received did not contain these financial statements or any information regarding Donne's true financial condition. Nor did defendants ever provide accurate financial information to any Donne investors.
29. Donne's business plan also misrepresented that money raised from the private placement of Donne's stock would be used for Donne's future operational expenses. The defendants, however, failed to disclose that they planned to use investor funds to cover the company's operational shortfall as of October 1999, including the payment of dividends owed to some Donne investors, as well as to pay the expenses and other obligations of SSS&A.
30. Sometime during the first quarter of 2000, defendants mailed Donne's Winter 2000 newsletter to investors. Anderson and Shawn Smith wrote articles for this newsletter. Smith and others used this newsletter to sell Donne stock.
31. Shawn Smith told investors in his signed column that "Donne, contrary to many internet stocks, is currently solvent and does not need to go public to make money." He also reassured investors by telling them that the "goal remains ten times initial value in five years" and "[w]e are already on our way."
32. These statements were made without any reasonable basis in fact. Donne's financial condition had not improved by late 1999 or early 2000. To the contrary, as defendants well knew, Donne still was not profitable or solvent and was having cash flow problems.
33. In July 2000, Smith held a Donne investor meeting in Hagerstown, Maryland. Some prospective investors also were present. Anderson made a computer presentation and distributed an outline with information about Donne's current and future contracts and potential earnings. The outline specifically stated "financial goal 2000 obtained." In addition, Anderson told investors during his presentation that Donne was ahead of its projections and that Donne's stock would increase in value by the end of the year.
34. None of these statements had a reasonable basis in fact. By any measure, as of July 2000, Donne had not met any of its business plan projections. Indeed, throughout 2000, defendants knew or were reckless in not knowing that Donne was still operating at a substantial loss and having cash flow problems.
35. Shawn Smith prepared and sent Donne investors account statements, which showed an investor's original investment amount as well as any dividends paid or accumulated on the Donne stock. As Donne was never profitable or solvent, the representations that Donne was paying dividends were false and misleading. At most, any payment or accumulation of dividends actually represented a return of investors' original principal, not a return on investment. Because these material facts were never disclosed to investors, Donne's account statements gave the false and misleading impression that the Donne investment was secure and profitable.
36. In addition, in September 2000, Shawn Smith, with Smith's and Anderson's knowledge and approval, prepared and sent an account statement toinvestors which reported, among other things, that Donne's board of directors had made a decision to "revalue" Donne's stock from $10 to $30 per share by the end of 2000, based on Donne's "recent and projected advancements in the field" and that Donne was "not only on target, but . . . ahead of it."
37. These statements in the September 2000 account statement were false and misleading. Throughout 2000, Donne was still operating at a substantial loss and having significant cash flow problems.
38. The defendants each knew or were reckless in not knowing that the September 2000 account statement was false and misleading. The defendants were each present during a company meeting in Donne's Florida office in August 2000, when the "revaluation" of Donne's stock was discussed. The conclusion at the end of this meeting was that Donne's stock could not be "revalued" because Donne was still not profitable. Defendants also knew or were reckless in not knowing in September 2000 that Donne had lost two contracts that were expected to generate most of the projected profit for 2000.
39. Contrary to defendants' representations to investors, and in addition to funds used for SSS&A, defendants misused another $1.4 million of Donne investor proceeds to pay for other undisclosed expenses and obligations that had no relation to Donne's business. The majority of this $1.4 million was received and/or misappropriated by Smith, who used Donne investor funds to, among other things, build his home in Kentucky, purchase various cars for himself and others, finance a movie called "The Harvesters," and repay personal business debts.
40. By October 1999, the defendants each knew or were reckless in not knowing that Donne investor funds were being misused and/or misappropriated to pay for expenses and obligations unrelated to Donne's business. Throughout the relevant time, defendants commingled Donne investor funds with Smith's personal funds and failed to keep track of how Smith used Donne investor funds. Inaddition, at the time the Donne business plan was being finalized in or around October 1999, Smith told Anderson and Shawn Smith that he had used Donne investor funds to make "The Harvesters" movie, which was not related to or ever used in Donne's business. Further, throughout the relevant time, Shawn Smith, with Smith's approval, knowingly used funds in Donne's bank account to pay Smith's and SSS&A's expenses, debts and other obligations. None of this was ever disclosed to any Donne investors and was contrary to the defendants' express representations that Donne investor funds would be used solely to fund Donne's operational expenses.
41. Paragraphs 1 through 40 are realleged and incorporated herein by reference.
42. The defendants, and each of them, by engaging in the conduct described above, directly or indirectly, made use of means or instruments of transportation or communication in interstate commerce or of the mails, to offer to sell or to sell securities, or to carry or cause such securities to be carried through the mails or in interstate commerce for the purpose of sale or for delivery after sale.
43. No registration statement has been filed with the Commission or has been in effect with respect to the offer and sale of any Donne securities.
44. No exemption from the securities registration requirements apply to the offer and sale of any Donne securities.
45. By reason of the foregoing, each of the defendants violated, and unless restrained and enjoined, will continue to violate, Sections 5(a) and 5(c) of the Securities Act.
46. Paragraphs 1 through 40 are realleged and incorporated herein by reference.
47. The defendants, and each of them, by engaging in the conduct described above, directly or indirectly, in the offer or sale of securities, by the use of means or instruments of transportation or communication in interstate commerce or by use of the mails:
(a) with scienter, employed devices, schemes or artifices to defraud;
(b) obtained money or property by means of untrue statements of material fact or by omitting to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
(c) engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon the purchasers of such securities.
48. By reason of the foregoing, each of the defendants violated, and unless restrained and enjoined will continue to violate, Section 17(a) of the Securities Act.
49. Paragraphs 1 through 40 are realleged and incorporated herein by reference.
50. The defendants, and each of them, with scienter, by engaging in the conduct described above, directly or indirectly, in connection with the purchase or sale of securities, by the use of means or instrumentalities of interstate commerce, or of the mails:
(a) employed devices, schemes or artifices to defraud;
(b) made untrue statements of material fact or omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or
(c) engaged in acts, practices or courses of business which operated or would operate as a fraud or deceit upon other persons.
51. By reason of the foregoing, each of the defendants violated, and unless restrained and enjoined will continue to violate, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
52. Paragraphs 1 through 40 are realleged and incorporated herein by reference.
53. Smith owed a fiduciary duty to those Donne investors who were also his investment advisory clients.
54. Smith, by engaging in the conduct described above, directly or indirectly, by use of the mails, or means or instrumentality of interstate commerce:
(a) with scienter, employed devices, schemes or artifices to defraud his clients or prospective clients; or
(b) engaged in transactions, practices, or courses of business which operated or would operate as a fraud or deceit upon clients or prospective clients.
55. By reason of the foregoing, Defendant Smith violated and, unless restrained and enjoined, will continue to violate, Sections 206(1) and 206(2) of the Advisers Act.
WHEREFORE, the Commission respectfully requests that the Court:
Issue findings of fact and conclusions of law that Donne, Smith, Anderson, and Shawn Smith committed the violations alleged and charged herein;
Issue, in a form consistent with Fed. R. Civ. P. 65, an order permanently enjoining Donne, Smith, Anderson, and Shawn Smith, and their officers, agents,servants, employees and attorneys, and those persons in active concert or participation with any of them, who receive actual notice of the order by personal service or otherwise, and each of them, from violating, directly or indirectly, Sections 5(a), 5(c) and 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder;
Issue, in a form consistent with Fed. R. Civ. P. 65, an order permanently enjoining Smith, and his officers, agents, servants, employees and attorneys, and those persons in active concert or participation with him, who receive actual notice of the order by personal service or otherwise, and each of them, from violating, directly or indirectly, Sections 206(1) and 206(2) of the Advisers Act;
Order Smith, Anderson, and Shawn Smith to pay civil penalties under the Securities Enforcement Remedies and Penny Stock Reform Act of 1990;
Order Smith, Anderson and Shawn Smith to disgorge all ill-gotten gains derived directly or indirectly from the illegal conduct, together with prejudgment interest thereon;
Issue an order prohibiting Smith from serving as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act or that is required to file reports pursuant to Section 15(d) of the Exchange Act.
Retain jurisdiction of this action in accordance with the principles of equity and the Federal Rules of Civil Procedure in order to implement and carry out the terms of all orders and decrees that may be entered, or to entertain any suitable application or motion for additional relief within the jurisdiction of this Court; and
Grant such other and further relief as this Court may determine to be just and necessary.
DATED: September 5, 2002
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