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IN THE UNITED STATES DISTRICT COURT
COMPLAINT Plaintiff Securities and Exchange Commission alleges as follows: 1. This is a case of investment fraud committed by defendants Stand-By Systems, Inc. ("Stand-By") and Kenneth J. Palmer ("Palmer"), Stand-By's president. Throughout the 1990s, these defendants used fraud to sell the securities of defendant Stand-By to the public. As a result of their fraudulent scheme, the defendants raised approximately $1.6 million from 144 investors located throughout the country. 2. The defendants' scheme relied upon numerous deceptions, which were crafted to stimulate prospective investors to part with their money. Initially, defendants represented that Stand-By was in the process of developing personal oxygen dispensers and inhalation masks. Subsequently, they represented that development was complete and manufacturing had begun. In reality, little work was ever conducted to develop the oxygen system. In fact, a working prototype was never developed. As set forth below, the defendants also misrepresented the returns associated with the investment, and falsely claimed that investor funds would be used solely for operating expenses of Stand-By. In fact, Palmer diverted a large portion of investor funds for unauthorized personal and business expenditures. 3. By engaging in the conduct detailed in this Complaint, defendants Stand-By and Palmer, directly or indirectly, singly or in concert, have engaged in, and unless enjoined will again engage in, transactions, acts, practices and courses of business that constitute violations of Sections 17(a) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. §77q(a)] and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §78j(b)] and of Rule 10b-5 [17 C.F.R. §240.10b-5], promulgated thereunder. JURISDICTION AND VENUE 4. The investments offered and sold by the defendants are "securities" under Section 2(a) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. §77b] and Section 3(a)(10) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §78c]. 5. 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)], and Section 21(d) of the Exchange Act [15 U.S.C. §78u(d)], to permanently enjoin defendants Stand-By and Palmer from future violations of the federal securities laws. 6. This Court has jurisdiction over this action, and venue is proper, pursuant to Section 22(a) of the Securities Act [15 U.S.C. §77v(a)], and Section 27 of the Exchange Act [15 U.S.C. §78aa]. 7. Defendants, directly or indirectly, made use of the means or instruments of transportation and communication, and the means or instrumentalities of interstate commerce, or of the mails, in connection with the transactions, acts, practices and courses of business alleged herein. Certain transactions, acts, practices and courses of business alleged herein took place in the Northern District of Texas. DEFENDANTS 8. Stand-By Systems, was located in Dallas, Texas. The company was originally incorporated in Texas, in 1972 by defendant Palmer. It forfeited its corporate charter in 1975, but had it reinstated in 1992. Stand-By was purportedly in the business of manufacturing and selling personal oxygen dispensers and inhalation masks. It owned certain patents for personal oxygen dispensers and inhalation masks, and obtained Food and Drug Administration ("FDA") approval to market the products nationwide. 9. Kenneth J. Palmer, age 70 and a resident of Dallas, Texas, is the largest shareholder, CEO, president, and sole director of Stand-By and a related company, Stand-By Oxygen Systems, Inc. Except for certain limited information provided to the staff during its investigation, Palmer refused to testify based on his assertion of his Fifth Amendment privilege against self-incrimination. RELATED ENTITY 10. Stand-By Oxygen Systems, Inc. ("Stand-By Oxygen"), located in Dallas, Texas, is a Texas Corporation formed in February 1995, to purchase a factory in Texarkana, Texas, purportedly, to manufacture Stand-By's products. Stand-By Oxygen is owned and controlled by Palmer. STATEMENT OF FACTS The Business of Stand-By 11. Defendant Palmer formed Stand-By in 1972, to be the exclusive marketing agent for an oxygen dispenser and inhalation mask ("oxygen system") manufactured by another company. Its commercial potential was limited by the fact the FDA did not approve the product, and it therefore could not be marketed to consumers. However, the Federal Aviation Administration authorized the product to be used aboard aircraft. By mid-1974, the manufacturer sold the patent rights to a competitor and, as a result, Stand-By lost its business opportunity and was dissolved. 12. In 1992, Palmer re-activated Stand-By and soon thereafter obtained the oxygen system patents and approval from the FDA to market the system. In 1997, Palmer's related company, Stand-By Oxygen, purchased a manufacturing facility in Texarkana, Texas, purportedly to begin manufacturing the oxygen system. However, to date, the oxygen system has not been manufactured. The Offer and Sale of Stand-By Convertible Notes 13. From 1992, through approximately May 1999, Stand-By and Palmer raised at least $1.6 million from some 144 investors in at least 23 states, through the sale of notes that were convertible into Stand-By common stock. The majority of these funds, approximately $1 million, were raised from 1997 through early 1999. Palmer made most of the securities sales to business associates and church acquaintances. Many of these investors also referred others to Palmer. 14. According to the terms of the investment, investors could convert the notes they purchased to Stand-By common stock and obtain 10 shares for every dollar invested. As a further inducement to invest, the investment terms allowed note-holders to receive the return of their principal, with accrued interest, rather than shares of common stock, at any time following the "funding" of the company. However, the contract did not specify what constituted the "funding" of the company, nor did it indicate how much interest would be paid upon exercise of the purported repayment option. Defendants' Misrepresentations and Omissions
15. Stand-By and Palmer initially attracted investors by representing that the company was in the process of developing personal oxygen dispensers and inhalation masks. Subsequently, they represented that development was complete and manufacturing had commenced. In fact, some investors were told that Stand-By was supplying its oxygen system to hospitals, schools, airlines, and individual consumers. However, contrary to these representations, little work was ever conducted to develop the oxygen system. In fact, a working prototype was never developed. 16. Similarly, the defendants routinely represented to investors that commencement of manufacturing was imminent without any reasonable basis for such a claim. In fact, the defendants knew that certain impediments prevented the commencement of manufacturing. These impediments, at various times, included: the lack of a final prototype; the failure to demonstrate the cost-effectiveness of in-house manufacture of the products; and a lack of funds. Although Palmer was aware of these impediments, he failed to disclose this material information to investors. Defendants' Misrepresentations Regarding Use of Investor Funds 17. The defendants falsely represented to investors that Stand-By would use investor funds for operating expenses and to develop and market the Stand-By's products. However, Palmer diverted a large portion of investment funds for unauthorized personal and business expenditures, including the automobiles, maintenance of his boat, settlement of a personal judgment against him, club memberships, and living expenses. Palmer also used investor funds to purchase a residence located near the factory owned by Stand-By Oxygen ("factory residence") and an airplane, purportedly for Stand-By business use. However, Palmer personally held title to the factory residence and, shortly after its purchase, obtained a loan on the residence and used a large portion of the loan proceeds for personal expenses. Moreover, Palmer later sold the airplane and placed the proceeds into his personal account. Palmer also spent investor funds for expenses related to the factory residence, such as expensive interior decorations and landscaping. Misrepresentations Regarding Returns on Investment 18. The defendants advised investors that they would receive a "substantial return" on their investment by either electing to convert their notes to common stock or taking a lump sum payment of principal and interest at any time following the "funding" of the company. The defendants did not have a reasonable basis to claim that the investment would generate substantial returns. In fact, investors, for the most part, did not receive anything of value as an investment return. Most, in fact, did not even receive a refund of their investment. FIRST CLAIM Violations of Section 17(a) of the Securities Act 19. Paragraphs 1 through 18 are hereby re-alleged and incorporated herein by reference. 20. Stand-By and Palmer, in connection with the offer and sale of securities, by use of the means and instruments of transportation and communication in interstate commerce and by use of the mails, directly and indirectly, have (a) employed devices, schemes or artifices to defraud; (b) obtained money or property by means of untrue statements of material fact or 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) engaged in transactions, practices or courses of business which operate or would operate as a fraud or deceit. 21. As part of and in furtherance of their scheme to defraud, Stand-By and Palmer, directly and indirectly, made numerous misrepresentations concerning the status of Stand-By's product development, use of investor funds, and the potential return associated with the investment, which contained untrue statements of material facts and which 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, including, but not limited to, those set forth above. 22. The defendants made these misrepresentations and omissions knowingly or with reckless disregard for the truth. 23. By reason of the foregoing, Stand-By and Palmer have violated and, unless enjoined, will continue to violate the provisions of Section 17(a) of the Securities Act [15 U.S.C. 77q(a)]. SECOND CLAIM Violations of Section 10(b) of the Exchange Act and Rule 10-5 Thereunder 24. Paragraphs 1 through 18 are hereby re-alleged and incorporated by reference herein. 25. Stand-By and Palmer, directly or indirectly, in connection with the purchase and sale of securities, by use of the means and instrumentalities of interstate commerce and by use of the mails have (a) employed devices, schemes and artifices to defraud; (b) made untrue statements of material facts and 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, practices and courses of business which operate as a fraud and deceit upon purchasers, prospective purchasers and other persons. 26. As part of and in furtherance of their scheme, Stand-By and Palmer, directly and indirectly, made numerous misrepresentations which contained untrue statements of material facts, and which 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, including, but not limited to, those set forth above. 27. Stand-By and Palmer made the above-referenced misrepresentations and omissions knowingly or with reckless disregard for the truth. 28. By reason of the foregoing, Stand-By and Palmer have violated and, unless enjoined, will continue to violate the provisions of 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]. PRAYER FOR RELIEF WHEREFORE, Plaintiff Securities and Exchange Commission respectfully requests that this Court: I. Enter an Order permanently enjoining defendants, their agents, servants, employees, attorneys and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 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 of Rule 10b-5 [17 C.F.R. §240.10b-5] thereunder; II. Enter an Order requiring defendants to disgorge an amount equal to the funds and benefits they obtained illegally as a result of the violations alleged herein, plus prejudgment interest on that amount; III. Enter an Order imposing a third-tier civil penalty against each defendant pursuant to Section 20(d) of the Securities Act [15 U.S.C. § 77t(d)], and Section 21(d) of the Exchange Act [15 U.S.C. § 78u(d)], for the violations alleged herein; IV. Enter an Order requiring the defendants to file with this Court and serve upon Plaintiff Commission, an accounting, under oath, of (1) all monies and other assets they received, directly or indirectly, from investors in the securities described in the Commission's Complaint; (2) all assets in which the Defendants have a beneficial interest, directly or indirectly, wherever they may be located and by whomever they are being held; and (3) all accounts with any financial institution or securities brokerage firm maintained in any of their names or for any of their benefit on or after March 31, 1997; V. Enter an Order for such further relief as this Court may deem just and proper. Dated this _____ day of March 2002 Respectfully Submitted, __________________________
Attorney for Plaintiff
Of Counsel: Spencer C. Barasch
See also: Litigation Release No. 18781 (July 12, 2004) http://www.sec.gov/litigation/complaints/complr17463.htm
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