TOM HIRSCH (aka TOMAS N. HIRSCH) and DIANE ROSE HIRSCH, husband and wife; BERTA FRIEDMAN WALDER (aka BUNNY WALDER), a married person; HOWARD EVAN WALDER, a married person; HARISH PANNALAL SHAH and MADHAVI H. SHAH, husband and wife, Plaintiffs/Appellants,
ARIZONA CORPORATION COMMISSION, Defendant/Appellee
Appeal from the Superior Court in Maricopa County. No. LC2013-000213-001. The Honorable Crane McClennen, Judge.
For Plaintiffs/Appellants: Michael J. LaVelle, Matthew K. LaVelle, LaVelle & LaVelle, PLC, Phoenix.
For Defendant/Appellee: Julie A. Coleman, Arizona Corporation Commission, Phoenix.
Judge Kenton D. Jones delivered the opinion of the Court, in which Presiding Judge Margaret H. Downie and Judge Jon W. Thompson joined.
[¶1] Appellants appeal from a judgment entered by the superior court affirming an order of the Arizona Corporation Commission (Commission) finding Appellants had committed numerous violations of the registration and anti-fraud provisions of the Arizona Securities Act (ASA), Arizona Revised Statutes (A.R.S.) sections 44-1801 to -2126, levying administrative penalties totaling $4.65 million and ordering nearly $190 million in restitution. For the following reasons, we hold the Commission was authorized by statute and administrative rule to impose the administrative penalties levied and determine the amount of restitution owed. We further hold the Commission acted within its discretion in ordering the restitution and penalties
against Appellants, and, therefore, affirm the superior court's order.
FACTS AND PROCEDURAL HISTORY
[¶2] On March 12, 2009, the Securities Division (Division) of the Commission initiated an administrative proceeding against Radical Bunny, L.L.C. (Radical Bunny) and Appellants. The Division alleged Radical Bunny and Appellants had violated the registration and anti-fraud provisions of the ASA, specifically A.R.S. § § 44-1841 (sale of unregistered securities), -1842 (sale of securities by unregistered dealers and salesmen), and -1991 (fraud in purchase or sale of securities). The Division further alleged Appellants were jointly and severally liable for the violations of Radical Bunny, as controlling persons, pursuant to A.R.S. § 44-1999(B). In April 2010, Radical Bunny signed a consent and decision order agreeing to pay restitution in the amount of $189,800,867 for the registration and anti-fraud violations described below. This appeal arises out of the Commission's enforcement action against Appellants, who were not part of the consent and decision order with Radical Bunny.
A. The Investment Scheme
[¶3] The Commission's enforcement action concerned two separate loan programs conducted from 1999 to 2008 by Radical Bunny and Mortgages, Ltd. (ML). Radical Bunny was a member-managed limited liability company formed in 1999 for the specific purpose of pooling funds to invest in ML. Appellant Hirsch has been a member-manager of Radical Bunny since its inception.
[¶4] ML operated as a private mortgage lender for residential and commercial real estate projects, typically providing what is commonly referred to as bridge financing. As part of these operations, ML originated, invested in, sold, and serviced short-term loans secured by the underlying real estate.
1. The ML Pass-Through Program
[¶5] The first loan program Radical Bunny invested in was the ML Pass-Through Program (P-T Program), which ML used to help fund loans to its borrowers. Under this program, investors such as Radical Bunny received a " pass-through" fractional loan and lien interest in ML's loans and the collateral used to secure a specific loan. The investor thereby acquired an interest in the promissory note evidencing ML's loan and was assigned a beneficial interest in the corresponding real estate collateral, with the assignment recorded with the appropriate county recorder.
[¶6] Radical Bunny raised the funds it invested in the P-T Program by selling membership interests in its own company. Appellants found investors for Radical Bunny through referrals and general word of mouth. Investors would purchase a membership interest in Radical Bunny, which would then invest the money in the P-T Program; all endorsements of the secured promissory notes and corresponding assignments of beneficial interests in the underlying real estate collateral were then issued and recorded in Radical Bunny's name.
[¶7] Radical Bunny issued a " Direction to Purchase" to each investor that authorized a managing member of Radical Bunny, as the investor's agent, to acquire an interest in a specific ML loan. The Direction to Purchase also stated essential information, such as the amount invested, the investor's pro rata share in the ML loan, the annual interest rate owed to the investor, and the maturity date of the ML loan. For its services in facilitating the transaction, Radical Bunny
collected a management fee ranging from 0.25 to 0.5 percent of the interest paid by ML to Radical Bunny investors. Radical Bunny never registered the sale of its membership interests with the Commission, and neither Radical Bunny nor Appellants were registered with the Commission as securities dealers or salespersons. Radical Bunny raised approximately $40 million from investors between 1999 and 2005.
[¶8] In mid-2005, Appellants Shah and Walders joined Radical Bunny as member-managers. Shortly thereafter, Radical Bunny curtailed its investment activity in the P-T Program to concentrate on a second loan program that became the major focus of the Commission's enforcement action: the RB-ML Loan Program.
2. The RB-ML Loan Program
[¶9] The RB-ML Loan Program operated differently than the P-T Program, as Radical Bunny transitioned from being a " pass-through" investor in loans originating from ML to making loans directly to ML, with ML using the proceeds to fund loans to its own borrowers. Radical Bunny raised funds for this program, which essentially operated as a line of credit to ML, by selling fractional interests in the RB-ML loans. Participants would advance funds to Radical Bunny, which would hold the funds until an ML loan became available; Radical Bunny would then advance the funds to ML, and ML would sign a promissory note evidencing the loan in Radical Bunny's favor. These loans were typically for a term of one year and carried an annual interest rate of thirteen percent. ML made monthly interest payments to Radical Bunny, which, in turn, made monthly interest payments to Radical Bunny participants. Participants received an eleven percent return on their investment, and Radical Bunny received the two percent spread as a management fee. When a particular loan matured or was repaid in full, participants were given the option to " rollover" the principal into a new RB-ML Loan or liquidate the principal amount.
[¶10] As with the P-T Program, Radical Bunny issued each participant a " Direction to Purchase" stating the amount invested by the participant, the investor's proportional share in a specific RB-ML loan, the annual interest rate due the participant, and the loan maturity date. Unlike the Direction to Purchase used in the P-T Program, however, this Direction to Purchase did not identify any specific collateral securing the RB-ML loan, but simply asserted, " Your investment is collateralized by the beneficial interest under various deeds of trusts held by [ML]."
[¶11] In late 2006, Appellants became aware the RB-ML Loan Program could be operating in violation of federal and state securities laws and sought legal advice concerning Radical Bunny's business structure and activities. In January 2007, Appellants met with attorneys Ronald Logan and Carl Ranno. After hearing a description of Radical Bunny's business activities, Logan advised Appellants they " could not do business in the future without violating some State or Federal regulatory scheme," and were in violation of federal and/or state law by operating Radical Bunny without a license. Again, during the existence of this program, Radical Bunny never registered its sale of the interest in the loans with the Commission, and neither Radical Bunny nor Appellants registered as securities dealers or salespersons.
[¶12] In February 2007, attorneys at Quarles & Brady (Q& B), advised Appellants for the second time that it was likely the RB-ML program violated state and federal securities laws. Q& B further advised Appellants the RB-ML loans might not be secured at all. Several months later, Q& B informed Appellants it believed they had in fact violated federal and state securities laws and the collateral documents securing Radical Bunny loans were indeed defective. Q& B advised Appellants to stop accepting participants in its programs until they complied with ...