Post on 18-Jun-2020
COURT OF APPEALS, STATE OF COLORADO
2 East 14th
Avenue
Denver, CO 80203
District Court, City and County of Denver
Honorable Michael Martinez, Judge
Case No. 2009CV7181
FRED J. JOSEPH, Securities Commissioner for the State
of Colorado
Plaintiff-Appellant,
v.
HEI RESOURCES, INC. f/k/a HEARTLAND ENERGY,
INC., CHARLES REED CAGLE, BRANDON DAVIS,
HEARTLAND ENERGY DEVELOPMENT
CORPORATION, BEDROCK ENERGY
DEVELOPMENT, INC., JOHN SCHIFFNER, and JAMES
POLLAK,
Defendants-Appellees.
COURT USE ONLY
Case No. 2013 CA 2090
Attorneys for AARP Foundation Litigation:
JAY SUSHELSKY*
Bar Registration Number: 496378 (Washington DC)
MELVIN RADOWITZ*
601 E Street NW
Washington, DC 20049
Telephone: (202) 434-2151
E-Mail: jsushelsky@aarp.org
PAULA GREISEN*
Bar Registration Number: 19784
King & Greisen, LLP
1670 York Street
Denver, CO 80206
Telephone: (303) 298-9878
*Counsel of Record
BRIEF AMICUS CURIAE OF AARP IN SUPPORT OF
PLAINTIFF-APPELLANT
i
CERTIFICATE OF COMPLIANCE
I hereby certify that this brief complies with all requirements of C.A.R. 28
and C.A.R. 32, including all formatting requirements set forth in these rules. The
undersigned certified that:
This brief complies with C.A.R. 28(g). It contains 6,386 words.
This brief complies with C.A.R. 28(e). Citations to the record are to precise line
and page numbers (Trial Tr. page : line, date), not to an entire document.
/s/ Jay E. Sushelsky
Jay E. Sushelsky
ii
TABLE OF CONTENTS
CERTIFICATE OF COMPLIANCE ..................................................................... i
TABLE OF AUTHORITIES ................................................................................. v
I. STATEMENT OF AMICUS CURIAE ISSUE ........................................... 1
II. STATEMENT OF THE CASE ................................................................... 1
III. IDENTITY OF AMICUS CURIAE ............................................................ 1
IV. INTEREST OF AMICUS CURIAE ............................................................ 2
V. SUMMARY OF ARGUMENT ................................................................... 3
VI. ARGUMENT ............................................................................................... 4
1) OLDER INVESTORS, BECAUSE THEY ARE
PARTICULARLY VULNERABLE TO SCAMS, ARE IN
NEED OF ALL AVAILABLE PROTECTIONS ............................. 4
a) Under The Defined Contribution Retirement Regime,
Older Investors Bear Substantial Risks ................................. 5
b) Older Americans are Particularly Vulnerable to
Investment Fraud and Financial Exploitation ......................... 8
i) Older Investors Face Higher Risks of
Fraud Because They Are Attractive Targets ................ 9
ii) Older Investors Face Higher Rates of
Diminished Financial Decision-Making
Capacity ........................................................................ 9
iii
iii) Older Investors Face Higher Rates
of Cognitive Decline ...................................................11
iv) Older Adults Suffer from Higher Rates
of Isolation ..................................................................12
v) Older Adults Face High Rates of
Financial Abuse and Exploitation ..............................13
2) HEI USED HIGH PRESSURE SALES TECHNIQUES TO
HAWK INAPPROPRIATELY RISKY INVESTMENTS TO
OLDER PEOPLE WHO COULD NOT AFFORD TO LOSE
THEIR INVESTED FUNDS ..........................................................15
a) HEI Used Questionable Sales Techniques and
Concealed Risks to Press Vulnerable People into
Inappropriate Investments .....................................................15
i) HEI’s Boiler Room Salesmen Used Targeted,
Persistent Cold Calls to Wear Down
Potential Investors ......................................................17
ii) HEI Created a False Sense of Urgency to
Encourage Precipitous Investment
Decision-Making ........................................................19
iii) HEI Claimed to Drill Near Producing Wells and
Promoted Its Advanced Technology to Create an
Illusion of Guaranteed Returns ...................................20
iv) HEI Unrealistically Guaranteed Success to
Appeal to Vulnerable Investors ..................................22
v) HEI Materially Misrepresented the Risks
of Investment ..............................................................24
iv
b) HEI Sold Oil and Gas Interests that Violated Generally
Accepted Investment Principles ............................................26
VII. CONCLUSION ..........................................................................................31
CERTIFICATE OF SERVICE ..................................................................33
v
TABLE OF AUTHORITIES
Cases
LaRue v. DeWolff, Boberg & Assocs., 552 U.S. 248 (2008) ................................. 5
Statutes
Colorado Securities Act, Colo. Rev. Stat. § 11-51-101 (2013) ............................. 5
Colo. Rev. Stat. § 18-6.5-102 (2013) ...................................................................13
Record
Trial Tr., July 22, 2013 ............................................. 18, 22, 23, 24, 25, 26, 28, 29
Trial Tr., July 23, 2013 ....................................... 19, 20, 21, 23, 24, 25, 28, 30, 31
Trial Tr., July 24, 2013 ................................................................................. 20, 26
Trial Tr., July 25, 2013 ........................................................................... 19, 21, 25
Trial Tr., July 26, 2013 ................................................................................. 17, 18
Miscellaneous
Alzheimer’s Assn., 2013 Alzheimer’s Disease Facts and Figures (2013) ..........11
Zvi Bodie & Dwight B. Crane, Personal Investing: Advice, Theory,
and Evidence, 53 Fin. Analysts J. 13 (1997) ...................................... 26, 27
Cmty. Oriented Policing Servs., U.S. DOJ, Prob. Oriented Guides for Police
No. 20, Financial Crimes Against the Elderly (2003) ...............................12
Richard Fry et al., Pew Research Ctr., The Old Prosper Relative to the
Young: The Rising Age Gap in Economic Well-Being (2011) .................... 9
Richard L. Kaplan, Enron, Pension Policy, and Social Security
Privatization, 46 Ariz. L. Rev. 53 (2004) .................................................... 7
vi
Naomi Karp & Ryan Wilson, AARP Pub. Policy Inst.,
Protecting Older Investors: The Challenge of
Diminished Capacity (2011) ......................................................... 5, 8, 9, 11
Eun-Jin Kim & Loren Geistfeld, What Makes Older Adults Vulnerable
to Exploitation or Abuse?, 13 F. for Fam. & Consumer Issues (2008),
http://ncsu.edu/ffci/publications/2008/v13-n1-2008-spring/Kim-
Geistfeld.php ..............................................................................................12
Jeff Langenderfer & Terence A. Shimp, Consumer Vulnerabiltiy
to Scams, Swindles, and Fraud: A New Theory of
Visceral Influences on Persuasion,
18 Psychol. & Marketing 763 (2001) ........................................................17
Peter A. Lichtenberg et al., Is Psychological Vulnerability Related
to the Experience of Fraud in Older Adults?,
36 Clinical Gerontologist 132 (2013) ........................................................12
Annamaria Lusardi, Financial Literacy and Financial Decision-Making
in Older Adults, 36 Generations 25 (2012) ...............................................11
Kevin McCormally, Protect Yourself, Loved Ones from Financial
Abuse of the Elderly, Kiplinger, Nov. 2011 ................................................ 9
Oil & Gas Investment Fraud, N. Am. Sec. Adm’rs Ass’n,
http://www.nasaa.org/6782/oil-gas-investment-fraud/ ....................... 14, 21
Oil and Gas Scams: Common Red Flags and Steps You Can Take
to Protect Yourself, U.S. SEC, http://www.sec.gov/investor/
pubs/oilgasscams.htm ................................................................................16
Karla Pak & Doug Shadel, AARP Foundation National Fraud Victim
Study (2011) .................................................................................... 8, 10, 17
State of Colo. Elder Abuse Task Force, S.B. 12-078 Elder Abuse Task Force
Policy Decisions (2012) .............................................................................13
vii
U.S. DOL, Private Pension Plan Bulletin Historical Tables
and Graphs (2013) ....................................................................................... 6
U.S. GAO, Elder Justice: National Strategy Needed to Effectively
Combat Elder Financial Exploitation (2012)............................... 13, 14, 16
U.S. GAO, Income Security: The Effect of the 2007-2009
Recession on Older Adults (2011) ............................................................... 7
U.S. SEC, A Guide for Seniors: Protect Yourself Against Investment
Fraud (2013) ....................................................................................... 14, 16
U.S. SEC, Investor Alert: Private Oil and
Gas Offerings (2013) ........................................................ 15, 16, 21, 22, 27
U.S. Treasury Inspector Gen. for Tax Admin., Statistical Trends
in Retirement Plans (2010) .......................................................................... 7
Edward A. Zelinsky, The Defined Contribution Paradigm,
114 Yale L.J. 451 (2004) ............................................................................. 6
Jason Zweig, Finances and the Aging Brain, Wall St. J.,
Mar. 28, 2014, http://online.wsj.com/news/articles/
SB10001424052702304185104579435470263886360 ............................10
1
I. STATEMENT OF AMICUS CURIAE ISSUE
Whether a broad application of the Colorado securities laws is necessary to
protect vulnerable investors from investment fraud and financial exploitation?
II. STATEMENT OF THE CASE
For purposes of this amicus curiae brief, the relevant background facts and
procedural history are sufficiently set forth in the Petitioner-Appellant’s Brief.
III. IDENTITY OF AMICUS CURIAE
AARP is a nonpartisan, nonprofit organization with a membership that helps
people turn their goals and dreams into real possibilities, strengthens communities
and fights for the issues that matter most to families such as healthcare,
employment and income security, retirement planning, affordable utilities and
protection from financial abuse. AARP fosters the economic security of
individuals as they age by supporting laws and public policies designed to protect
older people from fraudulent business practices and preserve the legal means for
them to seek redress for exploitation. Among these activities, AARP advocates for
improved access to the civil justice system and supports the availability of the full
range of enforcement tools, including federal and state consumer protection
statutes and securities regulation provisions.
2
A significant percentage of the investing public in the United States markets
is comprised of members of the age 50 and older population. Older persons are
frequent targets of financial fraud, often because they have significant assets or are
looking for investment opportunities that will supplement Social Security and other
sources of retirement income. As a result, AARP prioritizes initiatives that combat
financial exploitation and fraud perpetrated against its constituency. AARP
regularly comments on legislative and regulatory proposals that address securities
and investment fraud, files amicus briefs in cases involving the securities laws and
consumer issues, and opposes legislative efforts to limit the remedies available to
defrauded investors.
IV. INTEREST OF AMICUS CURIAE
The resolution of this case will have a significant impact on the State of
Colorado’s power to maintain the integrity of the market place for investment
products within the state and to protect Colorado’s citizens from financial abuse
through the marketing of fraudulent investment products. This is of particular
concern at this time to AARP, given the entry of many first-time investors into the
market and the enhanced responsibility for retirement investing that employees
have assumed as a result of the shift in the retirement plan paradigm from defined
3
benefit pension plans (under which employers bear the risk of loss) to defined
contribution pension plans (under which plan participants bear the risk of loss). In
light of the significance of the issues presented by this case, AARP respectfully
submits this brief, as amicus curiae, to facilitate a full consideration by the Court of
these issues.
V. SUMMARY OF ARGUMENT
First, older Americans are particularly susceptible to fraudulent investment
sales practices. The shift from the defined contribution to the defined benefit
system of retirement savings exacerbated the difficulties faced by workers in
ensuring adequate retirement savings. Older people may seek investment
opportunities to quickly grow their savings at precisely the time they become most
vulnerable to fraudulent investment sales techniques due to the onset of problems
that disproportionately plague older adults, such as reduced financial capacity and
risk perception, isolation, and financial exploitation. Financial fraud is particularly
devastating to this group because older people have little time to make up losses
through work or other investments. The securities laws must be broadly applied to
provide the older people of Colorado a remedy for investment fraud.
4
Second, HEI’s boiler room operation used high-pressure sales techniques to
take advantage of the vulnerabilities of potential investors. HEI materially
misrepresented the risks of oil and gas development to mislead potential investors.
Even though HEI knew these investments were inappropriate for many of its older
investors, who had low risk tolerance and could not afford to lose their
investments, HEI salesmen encouraged these investors to drain their retirement
savings to invest in HEI wells, even going so far as to help one investor mortgage
his farm to make payments. Many of these investors suffered devastating losses.
Colorado’s securities laws should be applied broadly to give these defrauded
investors a remedy, without which their losses will not be vindicated.
VI. ARGUMENT
1) OLDER INVESTORS, BECAUSE THEY ARE
PARTICULARLY VULNERABLE TO SCAMS,
ARE IN NEED OF ALL AVAILABLE PROTECTIONS.
Investors reach peak retirement savings at the age when they become most
vulnerable to investment fraud. The shift to the defined contribution system of
retirement savings has left older investors with smaller nest eggs, eager to find
investment opportunities to increase their savings and retirement income.
However, older investors are particularly vulnerable to fraud: AARP Public Policy
5
Institute estimates that 20% of Americans over the age of 65 have been victims of
fraud or financial exploitation. Naomi Karp & Ryan Wilson, AARP Pub. Policy
Inst., Protecting Older Investors: The Challenge of Diminished Capacity 13
(2011). Older investors are more likely to be swindled or exploited because
financial decision-making acuity declines with age, and because older adults face
higher rates of cognitive impairment, isolation, and elder abuse.
The statutory purposes of the Colorado Securities Act are to “protect
investors and maintain public confidence in securities markets” while avoiding
unnecessary burdens on market participants. Colo. Rev. Stat. § 11-51-101(2)
(2013). Moreover, as a remedial act the statute must be “broadly construed to
effectuate its purposes.” Id. § 11-51-101(3). A broad application of the Colorado
Securities Act here would fulfill the purposes of the law by protecting and
providing recourse to the investors, particularly the older investors who appear to
have been targeted by HEI.
a) Under The Defined Contribution Retirement Regime,
Older Investors Bear Substantial Risks.
In LaRue v. DeWolff, Boberg & Associates, the Supreme Court recognized
that “[d]efined contribution plans dominate the retirement plan scene today.” 552
U.S. 248, 255 (2008). While the traditional defined benefit plan was once “the
6
dominant paradigm for the provision of retirement income,” in the last thirty years
that paradigm has changed. Edward A. Zelinsky, The Defined Contribution
Paradigm, 114 Yale L.J. 451, 471 (2004). According to the most recent statistics
released by the U.S. Department of Labor, more than 88 million participants held
$3.8 trillion in assets in defined contribution plans at the end of 2011. U.S. DOL,
Private Pension Plan Bulletin Historical Tables and Graphs 5 (2013). The defined
contribution paradigm is entrenched in today’s retirement, tax and social policy,
and it has changed the way that American workers finance their retirement. See
Zelinsky, supra, at 457-58.
As a result of this shift, workers bear more risk. Under the defined benefit
paradigm, employees received a guaranteed pension benefit from the employer; if
the employee’s contributions were insufficient to fund that benefit, the employer
made up the difference. Today, by contrast, employees are responsible for
ensuring adequate retirement savings and they bear the risks of investment.
While these risks were challenging for employers to navigate, for employees
they are treacherous. Under the defined benefit model, institutional investors rely
on professional advisers, take advantage of economies of scale to minimize
transaction costs, and benefit from a long time horizon to maximize returns. Id. at
7
457-60. Individual investors, on the other hand, work on a shorter time horizon,
face higher transaction costs, and must learn how to invest. As a result,
individually managed retirement accounts underperform institutional accounts,
often by “significant margins.” Richard L. Kaplan, Enron, Pension Policy, and
Social Security Privatization, 46 Ariz. L. Rev. 53, 83 (2004).
Compounding these problems is the fact that most individuals do not save
enough. In 2007, before the recession, “one-half of the households with someone
aged 55 to 64 years had financial assets of $72,400 or less, not much more than the
median annual working income of $54,600.” U.S. Treasury Inspector Gen. for Tax
Admin., Statistical Trends in Retirement Plans 9-10 (2010). Additionally, the
value of defined contribution retirement plans decreased during the most recent
recession. The recession was particularly trying for older adults, who have higher
rates of unemployment than other groups but less time to make up the lost value of
their retirement plans. U.S. GAO, Income Security: The Effect of the 2007-2009
Recession on Older Adults 1 (2011).
The shift to defined contribution plans made employees responsible for their
own retirement savings plans, and then the recession decimated the value of these
savings. Retirees and employees nearing retirement age became desperate to
8
bolster their depleted retirement accounts. These individuals became particularly
susceptible to financial fraud and schemes designed to take advantage of this
vulnerability by holding out the prospect of financial gains out of proportion to
market realities.
b) Older Americans are Particularly Vulnerable to Investment
Fraud and Financial Exploitation.
While financial fraud is a problem for people of all ages, older investors are
more likely to be swindled. The mean age of an investment fraud victim is 69
years old. Karla Pak & Doug Shadel, AARP Foundation National Fraud Victim
Study 25 (2011). One 2010 study estimated that 20% of adults ages 65 and older
had “been taken advantage of financially in terms of an inappropriate investment,
unreasonably high fees for financial services, or outright fraud.” Karp & Wilson,
supra, at 13. However, rates of victimization are likely much higher; while
financial fraud is underreported in all demographic groups, older adults are
significantly less likely to report fraud than their younger counterparts. Pak &
Shadel, supra, at 5.
9
i) Older Investors Face Higher Risks of Fraud
Because They Are Attractive Targets.
There is no single explanation for the higher rates of fraud amongst older
adults. However, one likely driver has been dubbed the “Willie Sutton Effect:”
older people are more likely to be defrauded because “that’s where the money is.”
Kevin McCormally, Protect Yourself, Loved Ones from Financial Abuse of the
Elderly, Kiplinger, Nov. 2011, at 38. Despite low rates of retirement savings, older
households are still better off than their younger counterparts: in 2009, households
headed by people over the age of 65 had forty-seven times the net worth of
households headed by people ages 35 and below. Richard Fry et al., Pew Research
Ctr., The Old Prosper Relative to the Young: The Rising Age Gap in Economic
Well-Being 1 (2011).
ii) Older Investors Face Higher Rates of Diminished
Financial Decision-Making Capacity.
Rates of fraud against older adults may also be higher because of age-related
changes in financial decision-making capacity, which generally peaks around age
53, and then declines over time. Karp & Wilson, supra, at 11. An AARP
Foundation study found that, compared to the general population, adults over the
age of 50 are likely more vulnerable to fraud because they are more interested in
10
persuasion statements, more likely to expose themselves to sales situations such as
“free lunch” presentations, and less likely to take preventative measures, such as
checking references and signing up for the Do Not Call List. Pak & Shadel, supra,
at 38. A second study found that investors over the age of 65 made mistakes that
younger investors avoided, and showed “striking and costly inconsistencies” in
their financial behavior. Jason Zweig, Finances and the Aging Brain, Wall St. J.,
Mar. 28, 2014, http://online.wsj.com/news/articles/SB10001424052702304185
104579435470263886360.
These changes might be due to a process known as “socioemotional
selectivity,” which leads older people to pay more attention to others who make
them feel happy and comfortable, while neglecting “warning signs that might have
been obvious at a younger age.” Id. Socioemotional selectivity makes it more
difficult to avoid fraud or “distinguish safe investments from risky ones.” Id.
Compounding these problems is the fact that while financial decision-making
capacity may decline with age, confidence in financial decision-making does not;
if anything, confidence increases over time. This “mismatch between actual and
perceived knowledge may explain the prevalence of scams perpetrated against
11
elderly people.” Annamaria Lusardi, Financial Literacy and Financial Decision-
Making in Older Adults, 36 Generations 25, 27 (2012).
iii) Older Investors Face Higher Rates of Cognitive
Decline.
Older Americans are also particularly vulnerable to fraud because they
suffer from disproportionately high rates of cognitive decline. Over 13% of
Americans ages 71 and older have Alzheimer’s disease and other dementias.
Alzheimer’s Assn., 2013 Alzheimer’s Disease Facts and Figures 16 (2013). An
additional 22% of people ages 71 and older have mild cognitive impairment. Karp
& Wilson, supra, at 7.
Financial capacity is one of the “first abilities to decline as cognitive
impairment encroaches.” Karp & Wilson, supra, at 11. Financial capacity
deteriorates rapidly once cognitive impairment progresses to Alzheimer’s disease –
while nearly half of the subjects in a 2010 study were capable of understanding
investment options and returns after an initial Alzheimer’s diagnosis, just 26%
could do so one year later. Id. However, declines in financial capacity can be
detected in adults with mild cognitive impairment one year before they progress to
Alzheimer’s disease; without a diagnosis, individuals and their families likely do
not become aware of the issue immediately. Id.
12
iv) Older Adults Suffer from Higher Rates of Isolation.
Higher rates of isolation also contribute to the disproportionate rates of fraud
against older adults. Isolated adults are three times more likely to be victims of
fraud than other populations. Peter A. Lichtenberg et al., Is Psychological
Vulnerability Related to the Experience of Fraud in Older Adults?, 36 Clinical
Gerontologist 132, 141 (2013). Isolation increases adults’ reliance on service
providers and retailers as a source of social support, which “increases their risk of
being abused through deceptive market practices.” Eun-Jin Kim & Loren
Geistfeld, What Makes Older Adults Vulnerable to Exploitation or Abuse?, 13 F.
for Fam. & Consumer Issues 1 (2008), http://ncsu.edu/ffci/publications/2008/v13-
n1-2008-spring/Kim-Geistfeld.php. Older adults who are socially isolated are also
more vulnerable to financial fraud because they have fewer opportunities to seek
advice before a purchase due to their limited social networks, and “because the
sales pitch itself addresses an unmet need for social interaction, resulting in their
feeling obligated to be friendly or compliant in return.” Cmty. Oriented Policing
Servs., U.S. DOJ, Prob. Oriented Guides for Police No. 20, Financial Crimes
Against the Elderly 13 (2003).
13
v) Older Adults Face High Rates of Financial Abuse and
Exploitation.
Because older adults often control more assets than younger people, and
because of contributing factors such as isolation and cognitive decline, older
people may also lose assets through a form of elder abuse known as financial
exploitation. Financial exploitation is defined as the use of “deception,
harassment, intimidation, or undue influence to permanently or temporarily deprive
an at-risk elder of the use, benefit, or possession of his or her money, assets, or
property.” Colo. Rev. Stat. § 18-6.5-102 (2013). In Colorado, financial
exploitation is the fastest growing category of elder abuse and constituted 21% of
all reported elder abuse in 2012. State of Colo. Elder Abuse Task Force, S.B. 12-
078 Elder Abuse Task Force Policy Decisions 32 (2012).
Financial exploitation involves theft by friends and caretakers, as well as
exploitation perpetrated by financial services providers and strangers, such as the
sale of fraudulent investments or “financial products or services unsuitable for an
older adult’s circumstances.” U.S. GAO, Elder Justice: National Strategy Needed
to Effectively Combat Elder Financial Exploitation 5 (2012) [hereinafter Elder
Justice]. An investment is unsuitable for older adults if it will not provide its
intended benefit within the older adult’s lifetime. Investments that are highly risky
14
or speculative are also unsuitable for most older adults because they have low risk
tolerance: many will not live long enough to recover losses through work or other
investment performance, and most cannot afford the loss if a risk does not pay off.
Id. at 5.
Oil and gas exploration partnerships are suspect investments for older
people. See, e.g., U.S. SEC, A Guide for Seniors: Protect Yourself Against
Investment Fraud 6 (2013) [hereinafter Guide for Seniors]; Oil & Gas Investment
Fraud, N. Am. Sec. Adm’rs Ass’n, http://www.nasaa.org/6782/oil-gas-investment-
fraud/. These investments are highly speculative because the chances of
discovering oil and gas are uncertain and typically very low. Additionally, these
investments are illiquid because investors cannot withdraw invested funds, and
may be pressured to invest additional money at regular intervals in the course of
completing a single well. These investments are therefore inappropriate for many
older investors.
15
2) HEI USED HIGH PRESSURE SALES TECHNIQUES TO
HAWK INAPPROPRIATELY RISKY INVESTMENTS TO
OLDER PEOPLE WHO COULD NOT AFFORD TO LOSE
THEIR INVESTED FUNDS.
a) HEI Used Questionable Sales Techniques and Concealed
Risks to Press Vulnerable People into
Inappropriate Investments.
Fraudulent offerings in the oil and gas industry have spiked in recent years,
and the SEC has investigated an average of twenty potentially fraudulent schemes
every year since 2006. U.S. SEC, Investor Alert: Private Oil and Gas Offerings 1
(2013) [hereinafter Investor Alert]. Even legitimate drilling operations are risky
investments because they are highly speculative and illiquid. Id. at 2. In
fraudulent schemes, however, promoters might take investor funds without ever
drilling, or they may take a significant cut of investors’ money, whether or not the
well is productive, leaving promoters with little incentive to make the venture
profitable for everyone else. Id. at 4.
The Securities Exchange Commission and other investor protection groups
have promulgated “red flag warnings” to help investors identify potentially
fraudulent investment opportunities in the oil and gas industry and other domains.
These red flags include the use of boiler rooms and cold-calls featuring high
pressure sales tactics to recruit investors, sales pitches about wells that “can’t miss”
16
but without adequately described risks, creation of a false sense of urgency to
“hard-close” sales, pitches focused on the implementation of new technologies to
make old wells more productive or the opportunity to drill near another
“tremendous discovery,” and a reluctance to share third-party well reports and
other pertinent information. See, e.g., id. at 1-3; Oil and Gas Scams: Common Red
Flags and Steps You Can Take to Protect Yourself, U.S. SEC, http://www.sec.gov/
investor/pubs/oilgasscams.htm; Guide for Seniors, supra, at 5.
Investor protection groups warn consumers about these techniques precisely
because they are effective in snaring already-vulnerable people in scams and
investments inappropriate for their circumstances. See, e.g., Elder Justice, supra;
Guide for Seniors, supra. HEI took advantage of these techniques and investor
vulnerabilities. HEI salesman employed boiler room tactics designed to push
vulnerable people into investing in highly speculative oil and gas ventures without
providing adequate disclosures of the risks of investment, and without regard for
investors’ ability to withstand the risks involved. Furthermore, after an investor
was on the hook, HEI continued to use these same tactics to induce the investment
of additional funds, even after the promised returns never materialized.
17
i) HEI’s Boiler Room Salesmen Used Targeted,
Persistent Cold Calls to Wear Down Potential
Investors.
First, HEI’s sales efforts were targeted at vulnerable people. HEI made
persistent, repeated, and unsolicited calls to potential investors, who were found
almost exclusively through telemarketing “lead lists” purchased by the company.
Trial Tr. 11:24—12:14, July 26, 2013. These “lead lists” likely included
disproportionate numbers of older investors at heightened risk of succumbing to
boiler room tactics. In 1996 AARP determined that older people were less likely
to hang up on telemarketers or take other protective measures to insulate
themselves from fraudulent marketing attempts; moreover, telemarketers’ target
lists were “comprised disproportionately of people over age 50 (56%) in
comparison to this group’s much smaller (36%) representation of the total
population.” Jeff Langenderfer & Terence A. Shimp, Consumer Vulnerabiltiy to
Scams, Swindles, and Fraud: A New Theory of Visceral Influences on Persuasion,
18 Psychol. & Marketing 763, 777 (2001). The proportion of older adults on
telemarketing lists has certainly grown since the advent of the Do Not Call list, as
older adults are significantly less likely than younger people to add themselves to
the list. Pak & Shadel, supra, at 38.
18
Moreover, cold calls are particularly effective with isolated adults, who are
often deprived of social contact and therefore may value relationships with
salespeople to the extent that they ignore the warning signs that a salesperson is not
trustworthy, or forego a meaningful analysis of a salesperson’s arguments before
buying. Salesmen may intentionally try to develop relationships with isolated
adults to increase their susceptibility to inappropriate sales pitches and fraud. See
supra Part IV.1.b.iv.
HEI employed 30 or more salesmen who made up to 300 calls per day to
phone numbers found on purchased lead lists. Trial Tr. 13:15—15:12, July 26,
2013. HEI’s cold calls were persistent; salesmen seized onto people who answered
the phone and did not hang up, even if they initially claimed not to be interested in
HEI investments. For instance, Walter Hojsak was the target of such a campaign
of unsolicited calls from HEI before he became an investor. Mr. Hojsak first
learned of HEI after receiving “numerous calls” from Dale Phillips. Trial Tr.
119:7-8, July 22, 2013. He testified that there “must have been a half dozen calls
of not interested” before the HEI salesman eventually wore him down. Id. at
119:19-20. “[A]s the calls persisted, he got further and further into the topic.” Id.
at 119:24-25. The HEI salesman developed a relationship with Mr. Hojsak
19
through these frequent calls. Eventually Mr. Hojsak invested in multiple HEI
wells. David Topp, a retired farmer, was the target of a similar campaign by HEI
– “you get a call and you can’t get rid of them,” he said of the HEI salesman. Trial
Tr. 84:6, July 23, 2013. Mr. Topp also eventually invested.
ii) HEI Created a False Sense of Urgency to Encourage
Precipitous Investment Decision-Making.
HEI used high pressure sales techniques on these persistent calls to
encourage investment, including the creation of a false sense of urgency to
pressure potential investors to act. Defrauded investors are statistically less likely
to take protective measures to prevent fraud, such as calling references and
performing independent research to determine the merits of an investment. See
supra Part IV.1.b.ii. High-pressure sales tactics that create a false sense of urgency
increase vulnerable investors’ tendency to rely exclusively on the salesperson’s
assertions. Id.
For instance, Thomas Carpenter invested in the first well within five days of
the first cold call from HED. The salesman “pushed – he continually pushed that I
should get this done. And he said, you’ve got to get this done or you’re going to
miss the opportunity.” Trial Tr. 17:20-25, July 25, 2013. Mr. Zipperlen also
experienced time pressure to invest – in fact, HEI salesmen called while he was in
20
the hospital recovering from spinal fusion surgery, and after discovering that he
was in a hospital and not at home, they persisted in making repeated calls to
encourage him to invest before he missed his special opportunity. Trial Tr.
161:2—162:25, July 23, 2013. HEI investors did in fact rely on HEI’s promises
and did not consult with a geologist or expert in oil and gas exploration to
determine whether HEI’s claims were backed up by the well reports or any other
data. See, e.g., id. at 123:16-22; Trial Tr. 75:17-24, July 24, 2013.
iii) HEI Claimed to Drill Near Producing Wells and
Promoted Its Advanced Technology to Create an
Illusion of Guaranteed Returns.
HEI sales staff used two additional red-flag sales techniques to promote its
investments: they touted HEI’s use of advanced technologies to increase the
production of wells or increase the chances of drilling a successful well, and they
discussed the fact that proposed drill sites were proximate to producing wells or
proven fields to give investors false confidence that HEI wells would succeed. For
instance, HEI touted its 3D seismic technology to Mr. Zipperlen and Mr. Topp – it
was “a can’t-miss thing.” Trial Tr. 151:22-23, July 23, 2013. Thomas Carpenter
testified that he was first approached with an “extraordinary investment”
opportunity in a “proven field;” although the “top portion . . . had been pretty well
21
depleted . . . there was a lot of potential in the deep area . . . [and] recent
technology allowed them to go down to that deep area.” Trial Tr. 9:7-19, July 25,
2013. Likewise, Sherman Minckler invested because he was told the field where
the well was located was “a known, proven area,” so the “risks were minimal.”
Trial Tr. 121:23—123:9-10, July 23, 2013.
However, HEI’s rhetoric was misleading. The risks associated with oil and
gas development are never “minimal” – they are substantial – even when the well
is drilled with 3D seismic technology and near producing wells. The SEC
identifies claims that modern technology can increase production or the chances of
success as red flags of potential fraud because they lend an air of truth to
potentially bogus claims for investors who read the news and are aware of rapid
advances in technology, but who lack the necessary background to understand
them. See Investor Alert, supra; Oil & Gas Investment Fraud, supra. Similarly,
claims that wells are likely to succeed because of their proximity to “proven
reserves” or known producing wells are misleading. The use of the term
“reserves” makes an investment sound like a “sure thing,” but in reality the
chances of success of a well vary significantly based on the well’s position in a
field, the depth of drilling, and many other factors. See Investor Alert, supra.
22
The fact that a proposed well is located next to a producing well does not
guarantee success. By repeating these claims, however, HEI led investors to
believe that its wells presented little risk. Mr. Hojsak described the way he was led
to invest more with HEI after hearing repeatedly about other successes in the area
and HEI’s technology: “after numerous phone calls and then conversations . . . I
was led to believe that it was a secure investment . . . at some point, I started
having confidence in what was being presented to me, and particularly the
reference to the seismic data and the way that it was interpreted and the high level
of assurance, and then stipulating that other wells are doing very well in the area.”
Trial Tr. 137:5-13, July 22, 2013.
iv) HEI Unrealistically Guaranteed Success to Appeal
to Vulnerable Investors.
The SEC has noted that “one common thread among all fraudulent schemes,
including those related to oil and gas, are claims that they are about to strike it
rich.” Investor Alert, supra, at 3. Potential HEI investors were promised
guaranteed returns but were not given adequate disclosures of the potential risks of
the drilling enterprises. Over time, it becomes more difficult for some older adults
to distinguish safe investments from risky ones, see supra Part IV.1.b.iv, so high-
pressure sales techniques that wildly overstate the chances of success and potential
23
payoffs become more believable. For older investors with insufficient savings,
desperate to bolster their retirement accounts after losses in the market, promises of
high returns and low risks are particularly appealing.
For instance, Evelyn Ensminger was a 75-year-old retired teacher who “had
a big loss in the market” during the economic downturn and “was looking for
something that might bring back some of the funds.” Trial Tr. 34:24—35:1, July
22, 2013. She invested because she believed the HEI salesman who promised her
“extensive” returns on her investment, with figures “in millions.” Id. at 32:9-10.
Not only was the investment guaranteed to pay out, but the salesman promised an
income stream: she was told that some of the wells may produce for a long time,
and “some of them may go 25 years.” Id. at 32:11-12. Ms. Ensminger never
received the promised return on her investment.
Other investors were attracted to HEI with similar guarantees of success, and
the risks of these investments were minimized, if they were disclosed at all. David
Topp, a retired farmer who invested with HEI because he needed income during
his retirement years, said that HEI salesman were “always sure they[ would] hit
gas.” Trial Tr. 92:17-18, July 23, 2013. Mr. Topp invested in the Aviator project
after Reed Cagle told him he “knew there was gas there, so there was no risk to
24
us.” Id. at 94:19-20. Likewise, Mr. Hojsak testified that at one point the salesman
“guaranteed [the well was] going to produce oil;” otherwise he was guaranteed
success with a “95, 98 percent certainty. All the conversations that I had with them
would have quoted numbers in that range.” Trial Tr. 137:23—138:1, July 22,
2013. However, these highly touted prospects never materialized.
v) HEI Materially Misrepresented the Risks of
Investment.
Not only did HEI misstate the possibility of success in its wells, but it
actively concealed the risks that the investments would fail. For instance, the risks
of investment were concealed from Evelyn Ensminger, who did not receive the
Confidential Information Memorandum containing disclosures about the well until
after she had already invested, and she had “no opportunity to ask questions” about
the disclosure forms. Trial Tr. 36:9-10, July 22, 2013.
Moreover, the “conversion tables” produced by HEI to inform investors of
potential risks and payouts for each well “implied the chance of failure.” Trial Tr.
211:11-12, July 23, 2013. However, the conversion tables omitted the percentage
chance of failure routinely calculated by geologists before drilling a well
considering factors such as the probability of encountering source rock, trap, or a
reservoir. Id. at 211:9-14. The percentage chance of failure is highly variable by
25
well, and was not disclosed to HEI investors. Id. at 211:9—212:3. These investors
therefore lacked the information necessary, and relied on by experts in the field, to
assess the risks posed by each well because HEI did not provide it. Not only did
HEI claim its wells were guaranteed to succeed, but it withheld information that
would prove otherwise.
This pattern of concealment and deception continued throughout the lifetime
of HEI investors’ relationships with the company. For instance, Lois Fretter
testified that Reed Cagle would start conference calls by announcing “You made a
home run,” which to her was “proof that we had a successful well . . . [when it] had
nothing to do with success in the well.” Trial Tr. 89:6-10, July 22, 2013. Ms.
Fretter and Mr. Carpenter were both routinely excluded from investor conference
calls. “I was not included, even included, in one meeting, and I received
notification of the meeting three hours after the meeting was concluded.” Trial Tr.
25:2-5, July 25, 2013.
Multiple HEI investors requested information that would help them
understand and manage their investments, but HEI denied these requests. For
instance, Michael Cox sought the contact information of other investors and an
accounting of investment funds, but HEI did not produce these documents. Trial
26
Tr. 217:9-15—218:9-23, July 24, 2013. Likewise, Walter Hojsak requested an
accounting of funds spent and contact information for other investors after
becoming frustrated with the HEI operation. Although HEI claimed to operate
these oil and gas investments as partnerships in which each investor-partner had a
right to manage and make decisions for the group, Mr. Hojsak had to ask three
times before HEI finally agreed to divulge the other investors’ names, and his
request for an accounting was completely ignored. Trial Tr. 131:16-18, July 22,
2013. Mr. Hojsak also requested the 3D seismic data that would have helped him
make an informed decision about fracking a well – HEI refused to share it, and
“said it was proprietary information, that HEI did not want to release the data
because of concern with competitors.” Id. at 123:15-17.
b) HEI Sold Oil and Gas Interests that Violated Generally Accepted
Investment Principles.
HEI used these high pressure sales techniques to encourage investors to
make inappropriate investments in light of their circumstances and financial goals
and in violation of all generally accepted principles of personal investment. For
instance, financial experts agree that individuals should diversity their portfolios by
investing in different classes of assets, different assets within each class, and a mix
of safer and riskier investments in order to minimize risk. See Zvi Bodie &
27
Dwight B. Crane, Personal Investing: Advice, Theory, and Evidence, 53 Fin.
Analysts J. 13, 14 (1997). Second, investors should decrease the proportion of
high-risk investments in their portfolios as they age and approach retirement. Id.
Finally, when investing in high-risk enterprises, investors should not invest more
than they can afford to lose.
This is particularly true of private offerings, including oil and gas
enterprises. As the SEC notes, “Private securities offerings are generally limited
by law to certain institutional and high net worth investors. This limitation exists
because of the greater risks involved in private offerings as compared to, for
example, investing in publicly traded stock.” Investor Alert, supra, at 2.
Therefore, even legitimate oil and gas investments are often inappropriate for
people who simply cannot afford to lose the money. The labeling of HEI’s
investment units as partnerships does nothing to minimize the risks that accompany
investing with HEI; nor does it distinguish the units from fraudulent securities
offerings.
First, the portfolios of many HEI investors were not adequately diversified
by class and risk. HEI salesmen knew these wells were overly risky investments
for many HEI investors but encouraged investment in HEI wells nevertheless.
28
Many HEI investors carried too much risk as a result, and suffered the
consequences. For instance, Mr. Hojsak depleted his retirement savings by taking
funds from his IRA to invest with HEI. Mr. Hojsak testified that “on a couple of
occasions, [the salesman] specifically told me that I should use my IRA accounts,
that the return would be much better than anything that I could get if I left them
where they were.” Trial Tr. 130:17-20, July 22, 2013. Similarly, Kenneth
Pompliano depleted his 401(k) to invest in HEI wells. He believed HEI “looked
like a guaranteed return” so he also took out a second mortgage on his home in
order to finance additional investments. Trial Tr. 159:19, July 24, 2013. Today his
retirement savings account is depleted and his house is “way under water” as a
result of his investment with HEI. Id. at 160:6-7.
Financial experts also generally agree that the fraction of high-risk
investments in an investor’s portfolio should decline with age; older people have a
shorter investment horizon, cannot afford to ride out major losses, and therefore
should reduce investment risk when retirement approaches. However, HEI
regularly sold its risky oil and gas investments to older investors and intentionally
targeted this older population, despite the fact that these investments were
inappropriate in light of their financial situations. HEI investors believed their
29
salesmen’s assurances that HEI wells were a “sure thing,” and ignored these well-
established investment principles to their detriment. For instance, Ms. Ensminger
was a 75-year-old retired teacher who bought into HEI because she “had a big loss
in the market” during the economic downturn and “was looking for something that
might bring back some of the funds.” Trial Tr. 34:23—35:1, July 22, 2013.
Likewise her sister, Ms. Fretter, was 76 years old when she invested in HEI; she
was also a retired teacher who “never reached 30,000 a year” while she was
working. Id. at 81:18-19. Neither of these women should have invested in HEI
because they could not afford to take on the risks involved in oil and gas
development in light of their age and financial circumstances. The HEI salesman
who targeted these women encouraged them to invest nevertheless. Both women
did invest thousands in HEI and never recovered their losses.
Finally, experts agree that investors should not invest more than they can
afford to lose when investing in high-risk enterprises. However, many HEI
investors invested more than they could afford to lose; in fact, HEI knew that these
oil and gas investments were not suitable for elderly investors, but the company’s
high-pressure sales team sold them interests in HEI wells notwithstanding.
Although HEI asked investors to sign forms indicating that they owned at least $1
30
million in assets and could afford to take on a risky investment, they did not screen
out investors who did not meet these criteria. In fact, Mr. Zipperlen told the
salesman who convinced him to invest in HEI that he had only $880,000 in assets,
less than the $1 million he claimed to own when he submitted his first payment to
the company. Nevertheless, the salesman told him to sign the statement that he
owned $1 million in assets. Trial Tr. 160:5-6, July 23, 2013.
Mr. Pompliano, who took out a second mortgage on his home to finance his
contributions to HEI, was not the only investor who went into debt in order to
finance his oil and gas investment. An HEI salesman actually helped Mr. Topp, a
retired farmer who invested in HEI because he needed an income stream to sustain
himself in retirement, mortgage his farm in order to invest in HEI. Id. at 85:19—
86:3.
As a result of HEI’s callous and deceptive practices, some investors suffered
such serious losses that they were forced to leave retirement. Mr. Zipperlen, a
former railroad employee who stopped working after sustaining serious injuries
and developing a disability, invested in HEI “because not having health insurance
after leaving the employ of the railroad and needing an income, that sounded like a
good opportunity. It sounded pretty positive.” Id. at 154:3-6. Mr. Zipperlen
31
invested thousands with HEI, and lost it all. He was forced to return to work,
despite a serious back condition, in order to make ends meet. Id. at 151:7-10. Mr.
Topp, the retired farmer who mortgaged his farm with the help of HEI, could not
afford his investment, either. He never recovered his money and was forced to
leave retirement and resume farming as a result of the failed investment in HEI.
See id. at 81:19-25. In fact, at this point Mr. Topp believes he owes money to HEI.
Id. at 93:14-15.
VII. CONCLUSION
HEI cold-called unknown investors on marketing lists, who had not added
themselves to the Do Not Call list; tenaciously developed telephone relationships
with people who did not hang up immediately; used inflated claims of investment
prospects and successes to encourage investment, while actively concealing risks
of oil and gas drilling; and was aware of investors’ inability to withstand the risks
of oil and gas investment but still helped them to contract debt in order to make
additional HEI investments that never paid off. HEI’s sales practices not only
targeted vulnerable older investors; they were designed to take advantages of their
vulnerabilities.
32
Colorado’s securities laws should be interpreted broadly, consistent with the
purpose of the laws, to protect vulnerable investors and to provide them with legal
recourse. It is respectfully submitted that the trial court’s judgment should be
reversed.
/s/Jay E. Sushelsky
Jay E. Sushelsky
Attorneys for AARP Foundation Litigation:
Jay E. Sushelsky*
Bar Registration Number: 496378 (Washington DC)
Melvin Radowitz*
601 E Street NW
Washington, DC 20049
Telephone: (202) 434-2151
E-Mail: jsushelsky@aarp.org
Paula Greisen*
Bar Registration Number: 19784
King & Greisen, LLP
1670 York Street
Denver, CO 80206
Telephone: (303) 298-9878
*Counsel of Record
33
CERTIFICATE OF SERVICE
This is to certify that I have served the Brief Amicus Curiae of AARP in
Support of Plaintiff-Appellant upon parties herein by e-filing pursuant to C.R.C.P.
121 this 15th
day of April 2014.
Counsel for Fred J. Joseph,
Securities Commissioner for the State
of Colorado:
John W. Suthers, Attorney General
Russell B. Klein, 31965*
Alexander C. Reinhardt, 34970*
Sueanna P. Johnson, 34840*
Charles J. Kooyman, 43595*
1300 Broadway, 8th Floor
Denver, CO 80203
Klein Tel: (720) 508-6413
Reinhardt Tel: (720) 508-6401
Johnson Tel: (720) 508-6155
Kooyman Tel: (720) 508-6440
russell.klein@state.co.us
alex.reinhardt@state.co.us
sueanna.johnson@state.co.us
charles.kooyman@state.co.us
*Counsel of Record
Counsel for HEI Resources, Inc. and
Charles Reed Cagle:
Donnie W. Wisenbaker, No. 45619
HEI Resources, Inc.
523 S. Cascade Ave., Unit D
Colorado Springs, CO 80903
Telephone: (719) 355-2911
Facsimile: (719) 355-3788
E-Mail: donnie@heipartners.com
Otto K. Hilbert, II, No. 18363
Robinson Waters & O’Dorisio, P.C.
1099 18th Street, Suite 2600
Denver, CO 80202
Telephone: (303) 297-2600
Facsimile: (303) 297-2750
E-Mail: ohilbert@rwolaw.com
/s/ Jay E. Sushelsky
Jay E. Sushelsky