UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF VIRGINIA
Plaintiff, Securities and Exchange Commission ("Commission" or "SEC"), for its Complaint alleges:
1. This "prime bank" offering case involves violations of the antifraud provisions of the federal securities laws by two insurance salesmen and a mortgage broker-Lytle Foglesong, T. Greg Cook, and James Malbaff, respectively-and by a partnership through which Cook and Malbaff conducted business-Malbaff & Cook.1 During 1997 and 1998, Foglesong, Malbaff and Cook fraudulently obtained over $1.1 million from more than thirty investors through their promotion of several individual so-called investment programs. During the course of their solicitations, Foglesong, Malbaff and Cook each made numerous material misrepresentations concerning, among other things, the views of the SEC, the Federal Reserve and other agencies regarding these investment programs, their own due diligence, the safety of the programs, and the use of investor funds. Thereafter, and continuing as late as June 1999, Foglesong, Malbaff and Cook, knowing that most of the investors' funds had been misappropriated after being transferred to the programs' remote operators, joined together in attempting to lull investors into inaction. For his part, Foglesong also skimmed outright at least $70,000 in investor funds, spending the money on personal items.
2. By engaging in this conduct the defendants violated the antifraud provisions of both the Securities Act of 1933 ("Securities Act") and the Securities Exchange Act of 1934 ("Exchange Act") as well as the broker-dealer registration provisions of the Exchange Act. Unless enjoined by this Court, the defendants will likely continue to engage in such violations. Accordingly, the SEC seeks injunctions against future violations, disgorgement and civil money penalties.
3. This Court has jurisdiction over this action pursuant to Sections 20 (d) (1) and 22 (a) of the Securities Act [15 U.S.C. §§ 77t (d) (1), 77v (a)] and Sections 21(d), 21(e) and 27 of the Exchange Act [15 U.S.C. §§ 78u (d), 78u (e) and 78aa] and 28 U.S.C. § 1331.
4. The defendants, directly or indirectly, made use of the mails, or the means or instrumentalities of interstate commerce, or the means or instruments of transportation or communication in interstate commerce in connection with the acts, practices, or courses of conduct alleged herein in the Western District of Virginia and elsewhere.
5. Lytle Earl Foglesong, age 51, is a resident of Winchester, Virginia. Foglesong is an independent insurance agent who holds a lapsed "Series 6" securities license-a license that is limited to the mutual fund and variable annuities arena. He obtained this license through his prior association with Massachusetts Mutual Life Insurance Company. During 1997, Foglesong began marketing so-called investment programs to investors, including his insurance clients
6. James Harold Malbaff, age 60, is a resident of Haymarket, Virginia. Malbaff is a mortgage broker and homebuilder who sold investments through the partnership of Malbaff & Cook.
7. Thomas Gregory ("T. Greg") Cook, age 43, is a resident of Haymarket, Virginia. Cook is an insurance salesman who holds a "Series 6" securities license through his association with Hartford Equity Sales Company. In 1997, he joined with Malbaff to promote investments.
8. Malbaff & Cook ("M&C") is a Virginia partnership founded in 1996, with its ownership divided equally between Malbaff and Cook. M&C was the vehicle that Cook and Malbaff used to promote the programs.
FRAUDULENT OFFERS AND SALES OF SECURITIES
THE R& D MARKETING PROGRAM
9. The first of the defendants to solicit investors for so-called investment programs was Foglesong, who in the spring of 1997, began promoting such a program. The program was operated by R&D Marketing of Logan, Utah.
10. Foglesong began promoting the program after signing an agreement with R&D Marketing in April 1997, pursuant to which Foglesong became an "associate" for purposes of promoting a high yield investment program. According to the agreement, the program was supposed to pay $1 million 45 days after the " commencement of the trading activity," based on a $300,000 investment. Both before he signed the R&D Marketing agreement and continuing thereafter, Foglesong presented the high yield investment program to investors in face-to-face meetings and in a series of telephone calls. By doing so, Foglesong solicited his own existing insurance clients, members of his own family, and others to invest in the R&D Marketing program.
11. As a result of his efforts, by June 18, 1997, Foglesong had raised $300,000 for the program from six investors. In his solicitations, Foglesong told the investors that they could earn returns ranging from 25% to 50%, in periods ranging from 45 to 90 days, and that their monies would be used to purchase bank instruments. Foglesong also told the investors (1) that the World Bank was involved in the program; (2) that he had invested his own money in the program; (3) that he had met in person with the operators of the program in Chicago; (4) that the program was backed by the Federal Reserve; and (5) that both the IRS and the SEC knew and approved of the program. All of these statements were false and materially misleading at the time Foglesong made them, and Foglesong knew or was reckless in not knowing that the statements were materially false and misleading.
12. At the time the investors submitted their funds to Foglesong, he provided them with dated and signed receipts. These receipts reflected the basic purported terms of the investment. In jargon typical of prime bank fraud schemes, the receipts referred to the money invested as "good, clear, clean and unencumbered and of non-criminal origin," and claimed a very high return on investment. For example, on or about June 4, 1997, Foglesong dated, signed, addressed and mailed a receipt to an investor located in Charlottesville, Virginia that reads as follows:
This is to confirm that I have given a check in the amount of $50,000 (Fifty Thousand Dollars) to Lytle E. Foglesong to be placed into a "HIGH YIELD INVESTMENT PROGRAM", using assets that are good, clear, clean and unencumbered and of non-criminal origin.
I also understand that the maturity of the program will be approximately 90 days after issue and that the expected gain will be 50% (FIFTY PERCENT).
13. Five of the six investors tendered their funds to Foglesong by June 16, 1997; the sixth, who invested $60,000, submitted his funds two days later. However, Foglesong only forwarded the first $240,000 that he had collected to R&D Marketing and misappropriated the remaining $60,000 for personal use.
14. The $240,000 in investor funds that Foglesong transferred to R&D Marketing soon disappeared. After returns on the investment were to have been realized under the terms of the investment contract, Foglesong received correspondence from R&D Marketing in October 1997 informing him that the money had been stolen. Despite this knowledge , Foglesong lulled the investors he had solicited into inaction by giving them elaborate and convoluted explanations of non-existent problems associated with the mechanics of the "trading program." Specifically, throughout the fall of 1997 and into early 1998, Foglesong passed "Updates" along to the investors, which had been provided to him by R&D Marketing and which purported to explain the status of the investment. As Foglesong well knew, the "Updates" were false and materially misleading because, similar to other Foglesong communications with investors during this period, they failed to disclose that the money had already been lost. All the while, Foglesong continued to receive commission payments from R&D Marketing.
15. For over a year, Foglesong also misled (and lulled into inaction) the investor from whom he had stolen the $60,000 by pretending that the investor's money had been wired together with other funds to R&D Marketing. Ultimately, when confronted by this investor during a meeting in Edinburgh, Virginia in the fall of 1998, Foglesong finally admitted his theft. At that meeting, Foglesong also unsuccessfully attempted to have the investor sign a document to falsely characterize the $60,000 investment as a "personal loan."
16. Defendant Foglesong knew or was reckless in not knowing that his representations and omissions to investors concerning the investment in the R&D Marketing "high yield" program, as described in paragraphs 11-15 above, were materially false and misleading at the time he made them.
THE KERR PROGRAM
17. Three months after Foglesong joined the R&D Marketing program, Malbaff and Cook also entered the arena. In July 1997, they attended a meeting at the Los Angeles condominium of an investment program operator named William Kerr. Prior to the meeting, a Kerr promoter told Cook that Kerr was a man of great wealth who had access to an extraordinary investment opportunity. At the meeting-which Malbaff and Cook attended along with about a dozen other invitees-Kerr told those present (1) that he had control of a $200 million trust; (2) that he used the trust as leverage to purchase medium term bank notes ("MTNs"), and (3) that those MTNs yielded profits of more than 13,000% of the amount invested. Kerr further claimed, among other things, that his company, the China Investment Group, conducted the trading of the notes, and that the World Bank supported his trading program.
18. Malbaff and Cook returned to Virginia and, without taking any steps to verify any of Kerr's representations, began recruiting investors for the Kerr program. It was through those recruitment efforts that Malbaff met Foglesong. Malbaff and Cook, assisted substantially by Foglesong, ultimately raised $325,000 in investor funds for the Kerr program. Foglesong's contribution to this sum totaled $160,000, which he had raised from five different investors.
19. In their solicitations, Malbaff, Cook and Foglesong each knowingly or recklessly made false and misleading statements and omissions to investors. Each of the three told investors, for example, that he had put his own money into the Kerr program when, in fact, none of them had. Each also gave investors a "personal guarantee" that was supposed to secure the investors' principal against loss when, in fact, none had the capacity to do so. Moreover, both Cook and Foglesong falsely (and groundlessly) asserted that the program had been "checked out" by the FBI. In addition, Cook falsely and recklessly claimed that investors would double their money in 45 days; while Malbaff likewise falsely and recklessly represented that the program involved the trading of MTNs. For his part, Foglesong falsely asserted that the World Bank and the Federal Reserve were participants in the program. In fact, the World Bank and the Federal Reserve have issued warnings about such programs and have expressly disclaimed any involvement with them.
20. The $325,000 that the defendants sent to the Kerr program all passed through Cook's account at Crestar Bank in Alexandria, Virginia. Foglesong delivered the funds he had raised in the form of a single $160,000 check, payable to Cook and containing the notation, "Inv. Program." Cook passed the total $325,000 to Kerr, in three separate checks: a $125,000 check dated July 16, 1997; a $190,000 check dated August 29, 1997; and a $10,000 check dated September 6, 1997. Each check was signed by Cook and contained a notation that it represents a payment for participation in an investment program related to the China Investment Group Ltd.
21. In return for the money, Kerr provided Malbaff and Cook with two "Participating Notes." One noted reflected a $125,000 investment and the other a $200,000 investment. Both notes stated a fixed interest amount of 10% and a default interest amount of 18%. Under the designation, "Additional Sums," both notes represented that Kerr and the China Investment Group would pay a portion of the gross profits earned from their "investment" activity in accordance with a "schedule of returns as described in Exhibit A." Although no "Exhibit A" was in fact attached to the $125,000 note, the "Exhibit A" attached to the $200,000 note reflected an "ROI" of 1,010% commencing in November 1997 and an "ROI" of 13,860% culminating in April 1999. Although "ROI" was not defined, Malbaff and Cook understood it to mean projected returns on the investment. Finally, each note stated that returns would begin to be paid "45 international banking days" from the date of the note, and that the note was secured by Kerr's personal guarantee.
22. Kerr failed to perform his obligations under the terms of the notes by the fall of 1997, and Malbaff and Cook sought explanations from Kerr regarding the status of his program. By February of 1998, Malbaff and Cook realized that Kerr would not perform and they sent a demand letter to him threatening a lawsuit against him. However, Malbaff and Cook never sued Kerr; instead, together with Foglesong, they made statements and undertook actions designed to lull their investors into inaction for at least a year after they knew that the Kerr program was defunct.
23. One example of these lulling tactics was the defendants' response to an investor's demand that his $100,000 investment be refunded in early 1998. Rather than honor the defendants' personal guarantee, all three defendants solicited new investors to raise the money needed to make the $100,000 refund payment. The defendants then assigned the new investors, who contributed funds ranging from $2,000 to $50,000, interests in the Kerr program, although the defendants knew that the program was not performing. The defendants advised the new investors that they were acquiring an interest formerly held by an investor who wanted out of the program, and failed to tell the new investors material facts concerning the safety of the investment, including the threatened lawsuit against Kerr.
24. Each defendant engaged in other conduct designed either to lull victims, frustrate the ongoing investigation of their activities, or both. For example, Malbaff appeared at the home of an investor/witness on the eve of her appearance before the SEC in June 1999. Among other things, Malbaff told the witness that she did not have to appear as scheduled. He attempted to convince her that the Kerr program was still viable and there was reason to believe that her money could be recovered. Further, Malbaff told this investor she could obtain a full refund at any time she wished. Approximately one week before Malbaff talked to this witness, Foglesong told her that he, Malbaff and Cook were re-financing their houses to pay the investors.
25. Cook told another investor on a number of occasions that Cook would get the investor's money back from Kerr. Cook also attempted to influence the SEC testimony of that same individual in October 1999 by suggesting that he falsely claim that the money invested in the Kerr program was a personal loan to Cook rather than an investment in a program.
26. Defendants Foglesong, Malbaff, and Cook all knew or were reckless in not knowing that their representations and omissions to investors concerning the investment in the Kerr "high yield program," as described in paragraphs 19 and 22-25 above, were materially false and misleading at the time they made them.
27. After taking part in the Kerr program, Malbaff and Cook, again assisted by Foglesong, promoted a series of other programs between the Fall of 1997 and the Spring of 1998. All failed to perform. These programs were purportedly operated by (1) Integrated Assets Management, Inc.; (2) Trans-Oceanic Investments Ltd; and (3) the British Trade and Commerce Bank, all located in foreign jurisdictions. Malbaff and Cook forwarded investor funds ranging from $250,000 to $500,000 to these programs, only to withdraw from the programs after the promised profits did not materialize.
28. The investor funds that Malbaff and Cook committed to these failed programs included $92,000 raised from investors by Foglesong, which was the amount remaining after Foglesong had skimmed $10,000 for personal use.
29. In each of the programs referenced above in paragraph 27, Malbaff and Cook were able to retrieve the principal amounts they had committed to these programs, less nominal "administrative" fees. But Malbaff and Cook simply reinvested the recovered investor funds in the next program, in most cases without telling investors of the failure of the prior program.
THE CFC FINANCE PROGRAM
30. In June 1998, despite the ultimate failure of the Kerr program and all three aborted programs described above, Malbaff and Cook again reinvested the recovered funds in yet another program operated by a man named Trevor Prider. Malbaff & Cook committed a total $500,000 of investor funds to the Prider program, including the $92,000 raised by Foglesong for other programs, as referenced above. As described below, most of this $500,000 was ultimately lost.
31. Prider was an Australian citizen who, like Kerr, resided in California. He was the principal of an entity called CFC Finance Ltd. ("CFC"), a corporation registered in Antigua with an office in Santa Monica, California. Malbaff learned of Prider through a Kerr promoter. Without conducting any independent investigation, and undaunted by the previous investment failures, Cook traveled to California to meet Prider at his office on May 28, 1998.
32. During that meeting Prider made the following representations, among others, to Cook: (1) CFC was a "Qualified Institutional Buyer"; (2) CFC had a special license issued by the NASD and approved by the SEC to trade medium term bank notes; (3) based on Malbaff and Cook's $500,000 investment, Prider could obtain a $10 million "Statement of Account" that could be used to trade medium term notes. Prider further represented that the CFC program could return as much as 300% per week on Malbaff and Cook's investment. Without conducting a reasonable independent investigation, Malbaff and Cook wired a total of $500,000 in investor's funds to an account controlled by a Prider intermediary for placement into the CFC program. Defendants made this investment despite their inability to verify any of Prider's claims regarding his authority under the NASD and the SEC, and in the face of negative information contained in a letter received from the NASD regarding one of the other entities that was purportedly involved in the Prider investment scheme. Malbaff and Cook never obtained any financial reports regarding Northridge, Prider or CFC, nor did they seek or obtain an explanation from Prider or anyone else of the matters disclosed in the NASD letter.
33. Consistent with all the other programs entered into by Malbaff and Cook on behalf of investors, the Prider/CFC program failed to perform as represented and Malbaff and Cook again sought recovery of the invested funds. However, they recovered only $116,000 of the $500,000 from Prider. Malbaff and Cook returned some of the recovered money to investors while falsely representing the payments to be a return on the principal amount invested. In March of 2000, Malbaff and Cook filed a civil action in the Superior Court of Orange County California against CFC, Prider and others seeking the balance of the funds and damages.
34. Defendants Foglesong, Malbaff, and Cook knew or were reckless in not knowing that their representations and omissions to investors concerning the investment in the CFC program, as described in paragraphs 30-33 above, were materially false and/or misleading.
FIRST CLAIM FOR RELIEF
Violations of Section 10(b) of the Exchange Act and Rule 10b-5
35. Paragraphs 1 through 34 are hereby realleged and incorporated herein by reference.
36. In knowingly or recklessly misrepresenting the nature of the programs to investors, Defendants directly and indirectly, by the use of the means and instrumentalities of interstate commerce, or of the mails, in connection with the purchase and sale of securities:
a. have employed devices, schemes, or artifices to defraud;
b. have made untrue statements of material fact, or have omitted, are omitting and are about to omit 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. have engaged in transactions, acts, practices and courses of business which operated as a fraud upon purchasers of securities.
37. By reason of the foregoing, Defendants have violated 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]
SECOND CLAIM FOR RELIEF
Violations of Section 17(a) of the Securities Act
38. Paragraphs 1 through 34 are hereby realleged and incorporated herein by reference.
39. In knowingly or recklessly misrepresenting the nature of the programs to investors, Defendants directly or indirectly, in the offer or sale of securities, by the use of the means or instruments of transportation or communication in interstate commerce or by the use of the mails:
a. have employed devices, schemes or artifices to defraud;
b. have obtained money or property by means of untrue statements of material fact and omissions 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. have engaged in transactions, acts, practices and courses of business which operated or would operate as a fraud upon purchasers of securities.
40. By reason of the forgoing, Defendants have violated and are violating Section 17(a) of the Securities Act [15 U.S.C. § 77q (a)]
THIRD CLAIM FOR RELIEF
Violations of Section 15(a) of the Exchange Act
41. By engaging in the business of effecting transactions in securities for the account of others, the defendants each have acted as a broker or dealer, and each have made use of the mails or other means or instruments of interstate commerce to effect transactions in, or to induce or attempt to induce the purchase or sale of any security (other than exempted security or commercial paper, bankers' acceptance, or commercial bills) without being registered in accordance with Section 15(b) of the Exchange Act [15 U.S.C. § 78o(b)].
42. By reason of the forgoing, the defendants, and each of them, have violated Section 15(a) of the Exchange Act [15 U.S.C. § 78o(a)].
PRAYER FOR RELIEF
WHEREFORE, the Commission respectfully requests that this Court:
Grant as to defendants, and each of them, a Permanent Injunction, restraining and enjoining them, and each of them, and their officers, agents, servants, employees, attorneys and those persons in active concert or participation with them who receive actual notice by personal service or otherwise, from violating Sections 10(b) and 15(a) of the Exchange Act [15 U.S.C. §§ 78j(b), 78o(a) and Rule 10b-5 thereunder [17 C.F.R. § 240.10b-5]; and Section 17(a) of the Securities Act [15 U.S.C. § 77q(a)].
Grant orders directing defendants, and each of them, and their officers, agents, servants, employees, and attorneys, to disgorge all illegal gains, together with prejudgment interest.
Issue orders directing the defendants, and each of them to pay civil money penalties, pursuant to Section 20(d) of the Securities Act [15 U.S.C. § 77t (d)] and Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u (d)(3)].
Grant such other relief as this Court may deem just and proper.