IN THE UNITED STATES DISTRICT COURT
SECURITIES AND EXCHANGE COMMISSION,
JOHN J. LAWBAUGH,
CIVIL ACTION NO.DKC 03-cv-2768
Plaintiff Securities and Exchange Commission alleges for its Complaint the following:
1. This matter involves a series of fraudulent schemes by John J. Lawbaugh ("Lawbaugh"), the majority shareholder, Chairman of the Board, and Chief Executive Officer of two registered face-amount certificate companies, 1st Atlantic Guaranty Corporation ("1st Atlantic") and its subsidiary, SBM Certificate Company ("SBM"), whereby Lawbaugh made material misrepresentations and omissions in financial filings with the Commission by
overstating company assets and failing to disclose transfers, thereby hiding the fact that Lawbaugh had misappropriated approximately $2 million in corporate funds for his personal use.
2. In addition, Lawbaugh misappropriated approximately $1 million from at least three investors by falsely promising that he would invest their funds in 1st Atlantic's face-amount certificates. Lawbaugh never invested the money, and instead deposited the money into his personal accounts.
3. Lawbaugh has engaged, and unless restrained and enjoined by this Court, will continue to engage in acts, transactions, practices, and courses of business which violate Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S. C. § 77q(a); Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, thereunder; and Sections 17(e)(1), 34(a), 34(b), and 37 of the Investment Company Act of 1940 ("Investment Company Act"), 15 U.S.C. §§ 80a-17(e)(1), 80a-33(a), 80a-33(b), and 80a-36.
JURISDICTION AND VENUE
4. The Commission brings this action pursuant to the authority conferred upon it by Section 20(b) of the Securities Act, 15 U.S.C. § 77t(b); Sections 21(d) and (e) of the Securities Exchange Act, 15 U.S.C. §§ 78u(d) and (e); and Sections 42(d) and (e) of the Investment Company Act, 15 U.S.C. § 80a-41(d) and (e), to enjoin such acts, transactions, practices, and courses of business, to enforce compliance with the noted statutes, and for such other and further appropriate relief as this Court should deem appropriate; and pursuant to Section 36(a) of the Investment Company Act, 15 U.S.C. § 80a-35(a), to enjoin defendant Lawbaugh from acting as an officer, director, member of any advisory board, investment adviser, or depositor of any registered investment company, or as principal underwriter for any registered investmentcompany which is an open-end company, unit investment trust, or face-amount certificate company, either permanently or temporarily.
5. This Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act, 15 U.S.C. § 77v(a), Section 27 of the Securities Exchange Act, 15 U.S.C. § 78aa, and Section 44 of the Investment Company Act, 15 U.S.C. § 80a-43.
6. Certain of the acts, transactions, practices, and courses of business constituting the violations alleged herein occurred in this District of Maryland and elsewhere, and were effected, directly or indirectly, by making use of the means and instruments of transportation and communication in interstate commerce, or the means and instrumentalities of interstate commerce, or the mails, or the facilities of a national securities exchange.
7. Lawbaugh, age 38, resides in Maryland. He was the Chairman of the Board and Chief Executive Officer of 1st Atlantic and SBM until August 16, 2002, when the Boards of Directors of those entities removed him from those positions.
8. 1st Atlantic is a Maryland corporation, incorporated in 1997 by Lawbaugh. Its principal place of business is Bethesda, Maryland. It has been registered with the Commission as a face-amount certificate company pursuant to the Investment Company Act since December 1997.
9. A face-amount certificate company is a form of investment company that issues fixed-income debt securities. These companies agree to pay the principal amount of theinstruments (the "face amount") plus accrued interest on maturity. Their profitability depends
upon the difference between the return generated on their investments and the expenses incurred from selling and satisfying certificate obligations.
10. Under Sections 28(a) and 28(b) of the Investment Company Act, 15 U.S.C. § 80a-28, such companies must maintain reserves equal to certificate liabilities plus $250,000. Only "qualified assets," as defined in the Act, may be counted toward reserve requirements.
11. Lawbaugh established 1st Atlantic in 1997, and owns all of its stock. As a result of the events that form the subject of this Complaint, Lawbaugh's stock is currently the subject of an Escrow Agreement with 1st Atlantic that prevents Lawbaugh from exercising his voting rights, establishes a framework for the sale of Lawbaugh's shares, and provides for the repayment of the misappropriated funds from the proceeds of any sale.
12. SBM Certificate Company ("SBM") was originally incorporated in Minnesota in June 1990 to assume the face-amount certificate business of SBM Company, which commenced operations in 1914. SBM has been registered with the Commission as a face-amount certificate company under Section 8(a) of the Investment Company Act since January 1991. It was reincorporated in Maryland in 2000, when it was acquired by State Bond & Mortgage Company, LLC ("State Bond") and its principal place of business is located in Bethesda, Maryland.
13. 1st Atlantic is the parent company of State Bond, which provides administrative services and personnel both to 1st Atlantic and to SBM. State Bond, in turn, owns 100 percent of SBM. 1st Atlantic has not issued any new face-amount certificates since December 1999.
14. At all times until August 16, 2002, 1st Atlantic and SBM acted by and through defendant Lawbaugh.
15. As Chairman of the Board and Chief Executive Officer of both SBM and 1st Atlantic, Lawbaugh owed a fiduciary duty to the certificate holders of both entities, and he had an affirmative obligation to act for the sole benefit of certificate holders.
16. Lawbaugh breached his fiduciary duty by misappropriating corporate funds and converting them to his personal use.
17. Beginning in 1997 and continuing to February 2003, Lawbaugh engaged in a series of intentional and deliberate fraudulent schemes to misappropriate corporate and investor money.
18. Beginning in 1998 and continuing until July 2002, Lawbaugh diverted approximately $2 million from 1st Atlantic and SBM through a series of fraudulent transactions involving the skimming of money through overpayment schemes as well as fraudulent payments to companies Lawbaugh secretly controlled for services that were never rendered.
19. Lawbaugh then made, and caused to be made, material misrepresentations and omissions in numerous financial forms for SBM and 1st Atlantic, which forms were filed with the Commision and distributed to investors. In these filings, SBM and 1st Atlantic overstated their respective assets and failed to disclose both the fact and the financial impact of Lawbaugh's misappropriations.
20. In addition, beginning in at least 1997 and continuing until February 2003, Lawbaugh engaged in a separate fraudulent scheme. Lawbaugh misappropriated approximately $1 million from at least three investors by promising to invest their funds in 1st Atlantic face-amount certificates, but instead depositing those funds directly into his personal bank accounts. Lawbaugh then lulled the investors by creating and disseminating fictitious account statements.
Lawbaugh's Misappropriation of 1st Atlantic and SBM Assets
21. One of the ways in which Lawbaugh diverted corporate funds to his own personal use was through an overpayment scheme, whereby Lawbaugh would falsify settlement sheets and other documents to inflate the price of the transaction, cause the corporations to pay amounts in excess of the actual price, and then divert the difference to secret bank accounts that Lawbaugh controlled.
22. Lawbaugh, who controlled 1st Atlantic and SBM, personally handled transactions involving the purchase and sale of portfolio assets, which typically involved real estate and investments secured by real estate. Although these were legitimate transactions conducted as part of the business of 1st Atlantic and SBM, Lawbaugh used these transactions as a means to divert corporate money to accounts he controlled.
23. Lawbaugh caused 1st Atlantic and SBM to overpay vendors involved in the transactions, and then directed the vendors to wire the overpayments to bank and brokerage accounts he controlled. These accounts included two bank accounts that Lawbaugh opened for his personal benefit in the name of 1st Atlantic, as well as Lawbaugh's own personal securities brokerage account, and other accounts held in the name of companies Lawbaugh controlled.
24. These bank and brokerage accounts were not authorized by or known to anyone else at 1st Atlantic or SBM.
25. By way of example, in September 2001, SBM agreed to purchase real estate tax lien certificates, encumbering properties in a development located in Prince George's County Maryland ("PG County"), for $702,029.
26. Lawbaugh caused SBM to wire $938,744 to the title company handling the purchase, which then wired $702,029, the actual purchase price, to PG County for payment of the tax lien certificates.
27. Lawbaugh then directed the title company to disburse $47,971 back to SBM and $188,744 to one of the bank accounts Lawbaugh had secretly opened in the name of 1st Atlantic.
28. To conceal his theft, Lawbaugh created a fictitious letter which purported to be from PG County. The letter, dated October 31, 2001, falsely stated that the tax lien certificates had a value of $901,115. Lawbaugh gave this letter to SBM's accounting department and independent auditors.
29. Another example of intentional overpayments orchestrated by Lawbaugh occurred in July 2002, when Lawbaugh caused SBM to wire $5.4 million to a third party escrow account for the purchase of a REMIC (Real Estate Mortgage Investment Conduit) certificate consisting of a pool of first mortgage loans, even though in reality the purchase price was only $4.5 million.
30. Lawbaugh then directed the escrow agent to wire the excess $900,000 to a bankaccount in the name of one of Lawbaugh's sham entities, CTS Liquidating Company.
31. To conceal his theft, Lawbaugh altered the version of the contract he gave to the accounting department to reflect a $5.4 million purchase price. The original agreement reflects the $4.5 million price. SBM's CFO discovered the fraud shortly after the transaction occurred and Lawbaugh returned the $900,000.
32. In addition to his overpayment scheme, Lawbaugh also misappropriated corporate funds for his personal use through a series of fraudulent transactions whereby he directed that payments be made to companies that he controlled for services that never were rendered.
33. Between 1998 and 2002, Lawbaugh misappropriated approximately $400,000 from 1st Atlantic and SBM in this manner, using bank accounts in the name of companies he controlled, including Commercial Finance Group, Inc. ("CFG"), IRE, Ltd, and CTS Liquidating Company. Lawbaugh falsely listed these entities on contract documents as having provided loan origination services, construction consulting, courier services, and/or loan discounts, when, in fact, no services had been rendered. Indeed, these companies had no employees, no boards of directors, no offices and no assets other than the bank accounts that received the diverted funds.
34. Lawbaugh did not disclose his interest in these companies to 1st Atlantic or SBM at any time while he was engaged in the fraudulent activities described herein.
35. One example where Lawbaugh used another company to misappropriate money from SBM occurred in February 2001, when SBM entered into a loan agreement, through a line of credit arrangement, with a real estate development company. Lawbaugh authorized SBM to fund $1,065,000 as a draw on the real estate company's line of credit. However, the real estatecompany actually borrowed only $831,000 and, in total, Lawbaugh diverted $195,279 of SBM funds to himself in this transaction.
36. Of the remaining $234,000 funded, $150,000 was returned to SBM, and Lawbaugh then directed the escrow agent to wire the balance, $84,000, to one of his personal bank accounts.
37. In addition, in connection with the loan on the credit line, Lawbaugh instructed the escrow agent to wire $111,279 of the $831,000 to CFG, one of his companies. Lawbaugh prepared a falsified HUD-1 Settlement Statement for this loan transaction. The statement showed that CFG received payments for loan origination fees, contract consulting, and courier charges, when, in fact, CFG did not provide any of these services.
Misrepresentations and Omissions in Public Filings
38. Lawbaugh also intentionally or recklessly made, and caused to be made, material misrepresentations and omissions about 1st Atlantic's and SBM's respective financial conditions in multiple Commission filings, which were disseminated to investors and potential investors.
39. SBM has registered its offerings of face-amount certificates, as required, pursuant to the provisions of the Securities Act and is required to make annual and periodic reports pursuant to Section 13(a) of the Securities Exchange Act. As of June 11, 2002, SBM had 1,840 certificate holders. As of March 24, 2003, SBM had required deposits (certificate liabilities plus a $250,000 base requirement) of $32.2 million and qualified assets of $32.6 million.
40. Lawbaugh made material misrepresentations and omissions in SBM's Forms10-K for the years ending December 31, 2000, and December 31, 2001 (both of which forms he signed), and in SBM's Forms 10-Q filed in 2000, 2001 and 2002.
41. SBM's 10-K overstated SBM's qualified assets by $1,396,907 for the year ending December 31, 2000, and overstated SBM's qualified assets by $292,236 for the year ending December 31, 2001.
42. Following the discovery of Lawbaugh's fraud, SBM filed a Post Effective Amendment on November 1, 2002 containing restated financial statements for the years ended December 31, 2000 and 2001.
43. In conjunction with SBM's restatements, SBM declared that, had it known about Lawbaugh's diversion of company cash before issuing its 2000 and 2001 financial statements, that information would have negatively affected those financial statements. Significantly, these inaccurate financial statements were included in SBM prospectuses and annual reports and they also formed the basis of the financial disclosures in the periodic reports filed for 2000 and 2001.
44. Thus, at the time SBM investors purchased face-amount certificates in 2000 and 2001, SBM's prospectuses and other periodic filings contained material misleading financial information that overstated the qualified investments held on deposit as well as the level of reserves.
45. Furthermore, the SBM restatements included approximately $2.2 million in assets Lawbaugh had transferred in 2000 and 2001 from 1st Atlantic to restore SBM's diminished reserves. Had Lawbaugh not transferred these assets, SBM's reserves would have fallen below the statutorily required minimum balance, which would have precluded SBM from continuing tooffer and sell face-amount certificates.
46. Although SBM disclosed the transfer of these assets in its periodic filings, the company never disclosed that such transfers were made necessary by Lawbaugh's improper depletion of SBM's assets, or that SBM was unable to independently generate enough capital through its business operations to assure that its statutorily required reserves remained adequately funded.
47. 1st Atlantic also filed registration statements, prospectuses, and periodic reports with the Commission in connection with its offerings of face-amount certificates. As of May 15, 2003, 1st Atlantic had 170 certificate holders to whom it owed approximately $4.0 million.
48. 1st Atlantic filed a prospectus in November 1998, and filed Forms 10-Q for the quarters ending March 31, 1999 and June 30, 1999. These prospectuses and annual and periodic reports contained information relating to the value of the registrants' qualified investments held on deposit, the amount of their certificate liability, and the sufficiency of the reserves required to be maintained by face-amount certificate companies under Section 28 of the Investment Company Act, 15 U.S.C. § 80a-28.
49. After the issuance of 1st Atlantic's prospectus in November 1998, two transactions occurred, in August and October 1999, by which Lawbaugh diverted $487,500 from 1st Atlantic through the overpayment scheme previously described. This caused 1st Atlantic's financial records to reflect inflated asset values.
50. Although when 1st Atlantic filed its prospectus in November 1998, these acts hadnot yet occurred, 1st Atlantic continued to use the 1998 prospectus in its marketing to potential investors until December 1999, by which time the prospectus materially misrepresented 1st Atlantic's financial condition.
51. In addition, SBM and 1st Atlantic both failed to disclose - in all of their periodic and annual filings with the Commission - Lawbaugh's self-dealing through related-party transactions. At no time during the fraud did 1st Atlantic or SBM disclose the fact that they had paid approximately $400,000 in fees to companies owned or controlled by Lawbaugh, including CFG, IRE, Ltd., and CTS Liquidating.
52. From 1998 until 2002, 1st Atlantic and SBM sold investors 169 and 1,840 face-amount certificates respectively.
Discovery of Lawbaugh's Fraud and Subsequent Events
53. In the spring of 2002, SBM's CFO discovered Lawbaugh's fraud. In October of 2002, SBM filed a Form 8-K to report that a special committee had conducted an internal investigation and concluded that Lawbaugh had diverted approximately $1,769,000 from SBM (of which $900,000 was later returned), and that as a result, SBM's financial statements required restatement.
54. Lawbaugh was removed from his positions as Chairman of the Board and Chief Executive officer of each registrant, effective August 16, 2002.
55. In addition, 1st Atlantic and its affiliated entities entered into an agreement with Lawbaugh to escrow his 1st Atlantic shares until an independent buyer is found. Under the agreement, Lawbaugh relinquished the voting rights associated with his shares to the 1st AtlanticBoard of Directors and agreed to sell his shares, with the proceeds to be first paid to 1st Atlantic and SBM to satisfy their claims against Lawbaugh. The agreement also required Lawbaugh to resign, effective November 12, 2002, from the Boards of Directors of both SBM and 1st Atlantic.
Lawbaugh's Misappropriation of Investors' Funds
56. In addition to misappropriating funds from 1st Atlantic and SBM, Lawbaugh misappropriated approximately $1,000,000 from at least three investors by promising that he would use their funds to purchase face-amount certificates and then doing nothing of the kind. Lawbaugh never purchased the promised investments and, instead, diverted the investor funds for his own benefit.
57. Lawbaugh used funds he had misappropriated from 1st Atlantic and SBM to make purported monthly "interest" payments totaling $140,000 to some of these investors, while he told other investors that, instead of receiving interest payments, their interest payments were being reinvested or "rolled over."
58. Lawbaugh concealed this activity from 1st Atlantic and SBM, and directed his personal assistant to draft correspondence, update purported client accounts, and prepare fictitious client statements. These fictitious statements, which appeared on 1st Atlantic's letterhead, listed the investment amount, supposed rate, and term, and contained false account summaries detailing the purported investment balance, and supposed interest paid and accrued.
59. Lawbaugh discouraged at least one investor from redeeming her "certificates" by falsely claiming that early redemption would subject her to steep early withdrawal penalties.
CLAIMS FOR RELIEF
Violations of Section 17(a) of the Securities Act,
Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder
60. The Commission realleges and incorporates by this reference each and every allegation in Paragraphs 1 through 59, above, as if the same were fully set forth herein.
61. From 1997 through February 2003, defendant Lawbaugh, in connection with the offer, purchase or sale or securities, directly or indirectly, by use of the means or instruments of transportation or communication in interstate commerce, or the means or instrumentalities of interstate commerce, or the mails, or the facilities of a national securities exchange:
(a) employed devices, schemes or artifices to defraud;
(b) obtained money or property by means of, or made, untrue statements of material fact, or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and
(c) engaged in acts, transactions, practices, or courses of business which operated as a fraud or deceit upon offerees, purchasers and prospective purchasers of securities.
62. By reason of the foregoing, defendant Lawbaugh violated Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b); and Rule 10b-5, 17 C.F.R. § 240.10b-5 thereunder.
Violation of Section 37 of the Investment Company Act
63. The Commission realleges and incorporates by this reference each and every allegation in Paragraphs 1 through 62, above, as if the same were fully set forth herein.
64. From 1997 through at least July 2002, defendant Lawbaugh stole, unlawfully abstracted, unlawfully and willfully converted to his own use or to the use of another, or embezzled moneys, funds, securities, credits, property, or assets of two registered investment companies, 1st Atlantic and SBM.
65. By reason of the foregoing, defendant Lawbaugh violated Section 37 of the Investment Company Act, 15 U.S.C. § 80a-36.
Violation of Section 17(e)(1) of the Investment Company Act
66. The Commission realleges and incorporates by this reference each and every allegation in Paragraphs 1 through 65, above, as if the same were fully set forth herein.
67. Lawbaugh, as CEO of both 1st and Atlantic and SBM, was an affiliated person of those two registered investment companies, within the meaning of that term as set forth at Section 2(a)(3) of the Investment Company Act. 15 U.S.C. § 80a-2(a)(3). Further, CFG, IRE, Ltd, and CTS Liquidating Company, each were controlled by Lawbaugh and, therefore, also were affiliated persons, as defined in Section 2(a)(3).
68. From 1997 through August 16, 2002, defendant Lawbaugh, while acting as an agent for 1st Atlantic or SBM and not acting as an underwriter or broker for either entity, received compensation for the purchase or sale of property to or for 1st Atlantic or SBM.
69. By reason of the foregoing, defendant Lawbaugh violated Section 17(e)(1) of the Investment Company Act, 15 U.S.C. § 80a-17(e)(1).
Violations of Sections 34(a) and 34(b) of the Investment Company Act
70. The Commission realleges and incorporates by this reference each and every allegation in Paragraphs 1 through 69, above, as if the same were fully set forth herein.
71. During the period from 1998 to July 2002, as set forth above, Lawbaugh willfully destroyed, mutilated, or altered accounts, books or other documents the preservation of which has been required pursuant to Section 31(a) of the Investment Company Act, 15 U.S.C. § 80a-33(a).
72. During the period from 1999 through July 2002, as set forth above, Lawbaugh caused 1st Atlantic and SBM to make untrue statements of material fact, or omit material information necessary to make other statements made not misleading, in prospectuses, periodic reports or other documents filed or transmitted pursuant to the Investment Company Act or the keeping of which is required by that Act.
73. By reason of the foregoing, defendant Lawbaugh violated Sections 34(a) and 34(b) of the Investment Company Act, 15 U.S.C. §§ 80a-33(a) and (b).
WHEREFORE, the Commission respectfully requests that this Court:
Issue an injunction permanently restraining and enjoining Lawbaugh, his agents, officers, servants, employees, and those in active concert or participation with him, directly or indirectly, singly or in concert, from violations of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a); Section 10(b) of the Exchange Act of 1934, 15 U.S.C. § 78j(b); and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b5; and Sections 17(e)(1), 34(a), 34(b), and 37 of the Investment Company Act of 1940, 15 U.S.C. §§ 80a-17(e)(1), 80a-33(a), 80a-33(b) and 80a-37.
Issue an injunction permanently restraining and enjoining Lawbaugh from acting as an officer, director, member of any advisory board, investment adviser, or depositor, or as principal underwriter of an open-end company, unit investment trust or face-amount certificate company, pursuant to Section 36(a) of the Investment Company Act, 15 U.S.C. § 80a-35(a), as a result of the violations set forth herein.
Issue an Order barring Lawbaugh from serving as an officer or director of an issuer that
has a class of securities registered pursuant to Section 12(b), 12(g) or 15(d) of the Exchange Act, pursuant to Section 21(d)(2) of the Exchange Act, 15 U.S.C. § 78(u)(d)(2), as a result of hisviolations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder.
Order defendant Lawbaugh to disgorge any and all unjust enrichment derived from the activities set forth in this Complaint, together with prejudgment interest, in accordance with a plan of disgorgement acceptable to the Court and to the Commission.
Order defendant Lawbaugh to pay civil penalties pursuant to Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d); Section 21(d)(3) of the Securities Exchange Act, 15 U.S.C. § 78u(d)(3); and Section 42(e) of the Investment Company Act, 15 U.S.C. § 80a-41(e), in an amount to be determined by the Court.
Order penalties against defendant Lawbaugh pursuant to Section 49 of the Investment Company Act, 15 U.S.C. § 80a-49, based upon Lawbaugh's violation of Section 37, 15 U.S.C. § 80a-36.
Grant such other and further relief as this Court may deem just and appropriate.
/ s /
Merri Jo Gillette, PA Bar No. 37037
David S. Horowitz, PA Bar No. 19781
Christina Rainville, PA Bar No. 54571
Amy J. Greer, PA Bar No. 55950
Attorneys for Plaintiff:
SECURITIES AND EXCHANGE COMMISSION
Mellon Independence Center
701 Market Street, Suite 2000
Philadelphia, PA 19106
Telephone: (215) 597-3100
Facsimile No.: (215) 597-2740
Thomas M. DiBiagio
United States Attorney
/ s /
Thomas F. Corcoran
Assistant United States Attorney
Federal Bar No. 24894
6625 United States Courthouse
101 West Lombard Street
Baltimore, MD 21201-2692
Dated: September ____, 2003
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