Decisions
KENNETH WALTER HRAPPSTEAD, et. al. [Decision]
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BCSECCOM #:
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Document Type:
Decision
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Published Date:
1999-04-16
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Effective Date:
1999-04-07
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Details:
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COR#99/085
IN THE MATTER OF THE SECURITIES ACT
R.S.B.C. 1996, c. 418
AND
IN THE MATTER OF KENNETH WALTER HRAPPSTEAD
doing business asNORTH AMERICAN GROUP and
KENNETH WALTER HRAPPSTEAD
HEARING
| PANEL: | BRENT W. AITKEN | MEMBER |
 | ROY WARES | MEMBER |
| DIANE K. WOLCH | MEMBER |
DATE OF HEARING: JANUARY 26, 1999
DATE OF DECISION: APRIL 7, 1999
| APPEARING: | PATRICIA A. A. TAYLOR | FOR COMMISSION |
| | STAFF |
DECISION OF THE COMMISSION
1. INTRODUCTION
This is a hearing under section 161(1) of the Securities Act, R.S.B.C. 1996, c.418. A notice of hearing was issued on September 24, 1998. The respondent, Kenneth Walter Hrappstead, was given notice of these proceedings but did not appear. He did, however, submit an affidavit which was entered as an exhibit.
The staff of the Commission alleges that:
- (a) Hrappstead, doing business as North American Group, held information sessions with investors encouraging them to invest in “High Yield Investment Programs” which promised to pay up to 2,100% return with no risk;
(b) the Investment Programs constituted a “security” for which no prospectus was issued and no exemption was available, contrary to section 61 of the Act; and
(c) by soliciting investments in the Investment Programs, Hrappstead traded in securities and acted as an adviser without registration, contrary to section 34 of the Act.
Hrappstead lives in Victoria, a short distance from Vancouver, the location of these proceedings. The hearing was not long and his evidence could likely have been heard in one day. Nevertheless, he elected not to appear and instead submitted an affidavit.
Section 173(b) and (c) of the Act provides:
- 173. The person presiding at a hearing required or permitted under this Act or the regulations
. . .
(b) must receive all relevant evidence submitted by a person to whom notice has been given . . . , and
- (c) is not bound by the rules of evidence.
On the basis that the affidavit was relevant, we admitted it. The question is now the weight that it should be given.
The Commission, In the Matter of Eugenio Sirianni and Francesco Sirianni, [1991] 40 BCSC Weekly Summary 7, cited Clarke v. Superintendent of Brokers, Insurance and Real Estate (1985) 67 B.C.L.R. 294 in which Hutcheon J. reviewed section 17 of the Commercial Appeal Commission Act, under which that Commission could admit anything relevant, whether or not admissible in a court. At page 296, he stated:
- No doubt the intention behind the section is to remove from the hearing of the appeal the technicalities that are thought to surround the rules of evidence and in particular hearsay evidence. In place of technicalities, the commission is expected to receive what is tendered as evidence and to weigh the significance of that evidence.
Hrappstead’s affidavit evidence contradicted viva voce evidence produced at the hearing. The difficulty with Hrappstead’s affidavit evidence is that it afforded no opportunity for cross-examination and no opportunity for the panel to view the demeanour of the respondent. These factors are important in determining credibility and the weight to be attached to the evidence in light of the circumstances.
It is in the public interest that hearing panels have before them the best evidence available. This will normally mean that a respondent should appear and testify viva voce from memory as would a witness in a court proceeding. If unusual circumstances prevent this, evidence may be produced, but it must be carefully weighed by the panel.
In this case, however, we find that there are no unusual circumstances; Hrappstead simply chose not to attend. We are satisfied that he had notice of the hearing and there was no suggestion that anything prevented his attendance. Under these circumstances, we choose to give no weight to his affidavit.
3. BACKGROUND
Hrappstead resides in Victoria, B.C. North American Group (“NAG”) is neither incorporated in B.C. nor is it a reporting issuer under the Act. There was no evidence that it is an incorporated entity and it appears to be a trade name under which Hrappstead does business. Neither Hrappstead nor NAG is registered in any capacity under the Act.
The RCMP received information in April 1997 that Hrappstead, operating under the name North American Group, had held information sessions promoting “High Yield Investment Programs” (“Investment Programs”). An investigation was undertaken by Corporal George Pemberton. As part of this investigation, Constable Lai-Shan Ng, acting undercover as a potential investor, approached Hrappstead in May 1997. From May through July 1997 Ng had several conversations with Hrappstead, who provided her with information respecting the Investment Programs.
- Pemberton and Ng testified at the hearing. What follows is a summary of their testimony.
Hrappstead confirmed to Ng that he introduced people to Investment Programs and that he identified and recommended good investments. When Hrappstead met with Ng, he said he had two Investment Programs available. The first required an investment of U.S.$300,000 and would yield U.S.$1 million in four months. The second required U.S.$125,000 and would yield U.S.$600,000 in one month. When Ng advised that she had only about $20,000 to invest, Hrappstead suggested she invest in the Investment Programs by joining a “joint venture”; he said some investors had invested as little as $100 through this mechanism.
Hrappstead mentioned the risk of loss inherent in investing in equities and stressed the importance of investing so that the investor’s principal is secure. He pointed out that this was a key feature of his Investment Programs.
Ng requested written materials on the Investment Programs, which Hrappstead provided. The materials included a letter from Hrappstead in which he claimed to have Investment Programs available yielding “any where [sic] from say 4% per month up to 100% per month and higher depending on if the client re-enters the program again.” Investments were available from as low as $2,500 to $100 million. The materials also contained summaries on NAG letterhead of various Investment Programs. The following is an excerpt from one of these:
- March 28, 1997
RE: HIGH YIELD INVESTMENT PROGRAMS
The following information is being submitted in response to your request and is for information purposes only. It is not to be construed as a solicitation of investment funds or the sale of securities for investment, nor is this a complete report. This information has not been prepared by, nor does it represent the public policy of any Bank or Financial Institution and is only available to sophisticated, high income clients and institutional investors. Please be advised that the subject programs are subject to change or cancellation without prior notice. Under no circumstances, should the provision of this information be considered a solicitation. This information must be regarded in all circumstances as being available only to the original reprint. Presentation of this information is not intended to be, nor should it be, an offer to sell securities or a security offering. This is neither a solicitation, nor an offer from the program described herein.
INVESTMENT TYPE: LEVERAGED INVESTMENT / TRADE PROGRAM
MINIMUM INVESTMENT UNIT: THREE HUNDRED THOUSAND USD
INVESTMENT PROCEDURES:
The North American Group, herein called NAG has an agreement with a reliable Program Administrator to secure US $10MM from one of the 25 top European Banks. Further, in order to obtain bank commitment, the Program Administrator need provide only a COPY of a Bank cashiers cheque showing evidence that each $300,000.00USD unit is available for each $10MM USD unit entered into subject program. Furthermore, each $300,000.00USD investment unit will only be released upon proof of Bank commitment of the US $10MM.
In consideration for the investment, the Program Administrator will provide a return of 100% for each $300,000.00USD unit per month [emphasis added] for 10 months to the provider or [sic] a total of US $3MM for each such unit; and that such returns are protected by the Program Administrator to the extent that distribution of the returns are strictly for the parties of that provider and the Program Administrator shall issue a corporate cheque, post dated thirty-five (35) days, to guarantee the initial investment amount in full. The first disbursement of such returns to the Investor will occur within 11 banking days from the commencement date of the trading discounted at 90% of face value, for the total investment amount; and that the balance of such profits, which mature on a monthly basis, will then be distributed to the Investor on a quarterly basis, not discounted, thereafter for the remaining portion of the 10 month term.
On July 14, 1997 Ng told Hrappstead that she wished to invest $2,000. Hrappstead told her to leave her money in her own account for the time being as he did not have an Investment Program available at that time.
The next day, Corporal Pemberton and another officer called on Hrappstead at home and advised him that he was under investigation. Hrappstead was cordial and cooperative and eager to explain his Investment Programs. He readily admitted holding investor information sessions and showed the officers the information materials that he provided to investors.
After some discussion, Pemberton advised Hrappstead that in his opinion Hrappstead was in breach of the Act and that he could not continue to provide investment advice or distribute securities without the consent of the Commission. Hrappstead agreed to refrain from doing so and Pemberton testified that he believed that, as of the date of the hearing, Hrappstead had kept that promise.
Hrappstead told Pemberton that he had not placed any investor funds because he had not yet found a satisfactory Investment Program. There was no evidence to suggest that any investors actually invested any money in any of Hrappstead’s Investment Programs, and Commission staff does not believe that any money was raised from investors.
The materials supplied by Hrappstead to Ng, in addition to the summary reproduced above, included various contracts and other documents, including a “report” stated to have been “prepared for Robert Z. Knopp by Arthur Espy” and entitled “Historical Background of Trading Programs”. This document purports to describe the nature of the Investment Programs.
The so-called report is lengthy but does little to illuminate the reader as to the precise nature of the Investment Programs. It begins with a description of banking instruments used to finance the international shipment of goods and then goes on to describe a supposed evolution of a secondary market in those instruments that in turn has supposedly led to the types of trading programs in which the Investment Programs now participate. However, descriptions of how the transactions are conducted, how the various participants are remunerated, and how the investor’s return is generated are vague or non-existent. The materials justify this lack of clarity on the basis that trading in these programs is an insiders game and shrouded in secrecy. The following are excerpts from the “report”:
- In short this is very much an insider’s game, thoroughly known and understood by a privileged few. It is safe to say that 99.9% of the investing public in the U.S. or Canada has never heard of Trading Programs, and if one walks into any U.S. or Canadian Bank or brokerage firm to make inquiries, everyone there will tell you that such things don’t exist . . . that Letters of Credit are used only for trade transactions, and on and on.
- . . . the trading of these instruments is another of the many ways that banks make money. Therefore, it is something they would rather not share with outsiders. It would be difficult indeed to interest most investors in a CD yielding 4% today, if they knew that there was other paper available from the same bank yielding up to five times that rate. That is why bankers won’t talk about this business, and why the transactions they are engaged in are hidden in their financial reports, through an overseas subsidiary, or done in a parent holding company name. . . . There is another reason why so few experienced people talk about these transactions: virtually every contract involving the use of these high yield instruments contain very explicit Non-Circumvention and Non-Disclosure clauses forbidding the contracting parties from discussing any part of the transaction . . . . This is a highly private business, not advertised anywhere, not covered in the press, and not open to anyone but the best connected, wealthy entities that can come forward with substantial cash funds. From original issue or the instruments, all the way up to the “retail” level, the business is private.
- As is readily evident from the foregoing, one or [sic] the principal keys to the profitability or [sic] any transaction utilizing these instruments is having the . . . contacts . . . . As anyone may imagine, these contacts are most jealously guarded.
- So the real secret of successful investment, then, lies not in knowing just the how, why, and where of these transactions, but most importantly, in knowing the bankers, lawyers and other professionals who can weave these opportunities and the necessary resources into safe, clean, responsible investment programs with limited downside risk.
The “report” goes on to describe the importance of the investor’s meeting with the program manager to assess the quality of his experience, expertise and contacts. No guidance is offered the reader as to how to assess these qualities.
The materials also describe the process by which the investment is made. The process varies depending on the Investment Program being described, but in every case the investor’s cash is released into the Investment Program on the strength of a promise, in one form or another, of the delivery of the contracted return. For many of the Investment Programs, the investor participates as a joint venturer with other investors and with one or more of the intermediaries. At no point in the process is a meeting between the investor and the program manager contemplated: all contact is delegated to various intermediaries.
Included among the various forms of agreement is a “Limited Authorization to Contract and Represent” that grants Hrappstead “full authority to exclusively represent” the investor in the Investment Program, and a “Sample of Pay Order” in which a program administrator agrees:
- . . . to unconditionally pay one-half or 50 per cent (%) of the gross revenue resulting from the placement by us or our associates in the High
Yield Investment Program of united states [sic] dollars in the amount of 100 thousand dollars or such lesser or larger amount to Kenneth Walter., [sic] Hrappstead, representative of the North American Group . . .
4. ANALYSIS
Whether the Investment Programs are Securities
Commission staff argues that Hrappstead, through NAG, has traded and advised with respect to securities without being registered, contrary to section 34 of the Act. Because a breach of section 61 is also alleged, Commission staff is apparently also implying that the trades constituted a “distribution” within the meaning of the Act, although this was not specifically set forth in the Notice of Hearing. The allegations with respect to section 61 were not pursued by Commission staff at the hearing.
Neither section 34 or 61 applies unless the investments at issue are “securities” as defined in the Act.
A “security”, as defined in section 1(1) of the Act, includes, in paragraph (l) of that section, “an investment contract”. In SEC v. W.J. Howey Co. 328 U.S. 293 (1946), the U. S. Supreme Court enunciated the following test to determine whether a transaction is an investment contract:
- “Does the scheme involve ‘[1] an investment of money [2] in a common enterprise, [3] with profits to come solely from the efforts of others?’”
This test was considered by the Supreme Court of Canada in Pacific Coast Coin Exchange v. Ontario Securities Commission [1978] 2 S.C.R. 112. In that case, the court said:
- The word ‘solely’ in that test has been criticized and toned down by many jurisdictions in the United States. It is sufficient to refer to SEC v. Koscot Interplanetary, Inc. [497 F. 2d 473 (1974)], and to SEC v. Glen W. Turner Enterprises, Inc. [474 F. 2d 476 (1973)] As mentioned in the Turner case, to give a strict interpretation to the word “solely” (at p. 482) “would not serve the purpose of the legislation. Rather we adopt a more realistic test, whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise”. In the same case of Turner, the expression “common enterprise” has been defined to mean (p. 482) “one in which the fortunes of the investor are interwoven with and dependent upon the efforts and success of those seeking the investment or of third parties”. These refinements of the test, I accept.
- . . . the “commonality” necessary for an investment contract is that between the investor and the promoter. There is no need for the enterprise to be common to the investors between themselves.
In this case, it is clear that the first two elements of the Howey test are present. The Investment Programs contemplate an investment of money in a common enterprise.
As for the third element of the test, the profit also is to come from the efforts of others. It is made clear from the materials that Hrappstead provided to investors that the key to the entire program is the expertise of the inside facilitators and those who know how to contact them. It is apparent that without the efforts of these people the promised return could not materialize.
We therefore find that the Investment Programs are investment contracts within the meaning of paragraph (l) of the definition of “security” in the Act.
It was alleged in the Notice of Hearing that the Investment Programs do not exist. Commission staff did not pursue this allegation at the hearing.
Trading securities contrary to section 34 of the Act
- Section 34 of the Act provides that:
- 34. (1) A person must not
(a) trade in a security or an exchange contract unless the person is registered in accordance with the regulations as
- (i) a dealer, or
(ii) a salesperson, partner, director or officer of registered dealer,
- The definition of “trade” in section 1 (1) of the Act reads:
- 1. (1) In this Act:
. . .
“trade” includes
(a) a disposition of a security for valuable consideration whether the terms of payment be on margin, installment or otherwise, but does not include a purchase of a security or a transfer, pledge, mortgage or other encumbrance of a security for the purpose of giving collateral for a debt,
. . . and,
(f) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the activities specified in paragraphs (a) to (e);
Hrappstead is not registered under the Act, so if Hrappstead’s activities in connection with the Investment Programs constitute trading then, in the absence of an exemption, he is in breach of section 34.
There is no evidence that any sales of Investment Programs took place. Therefore, if Hrappstead was trading, it was under paragraph (f) of the definition. Reviewing the activities of Hrappstead in connection with the Investment Programs, the following all appear to be activities that would fall within the meaning of paragraph (f):
- - the preparation and dissemination of materials describing the Investment Programs;
- - the preparation of forms of agreements for signature by investors;
- conducting information sessions with groups of investors; and
- meeting with individual investors.
We therefore have no difficulty finding that Hrappstead’s activities in connection with the Investment Programs constituted “trades” within the meaning of paragraph (f) of the definition of “trade” in section 1(1) of the Act.
To determine whether these trades are in breach of section 34, we must further determine whether any exemptions apply. When the trade at issue is not a physical trade, but an “act in furtherance”, obviously section 34 would not require registration if the trade being facilitated would not itself require registration if consummated. We therefore look to what exemptions might have been applicable to any physical trades had they taken place as a result of Hrappstead’s activities.
We find that it does not appear that any of the exemptions to section 34 would apply. The materials refer to very large minimum investment amounts, refer in numerous places to “private placements” and state that the Investment Programs are limited to “sophisticated, high income clients and institutional investors”. However, it is clear from the evidence that Hrappstead was equally prepared to facilitate participation in the Investment Programs by unsophisticated individuals of limited means. Ng was advised that some investors had invested as little as $100 through joint venture participation, and her intention to invest $2,000 was not rebuffed for being too small.
In addition, none of the documentary materials that purported to describe all of the agreements and declarations required to be signed by investors included forms that would be required to be filed under the Rules, such as Form 20A.
We therefore find that Hrappstead traded in the Investment Programs without registration, contrary to section 34 of the Act.
The activities of Hrappstead were not merely technical breaches of the Act. But for the fact that his activities were brought to a halt apparently before any investors invested in the Investment Programs, the consequences of his actions could have been very serious.
Advising contrary to section 34 of the Act
- “Adviser” is defined in the Act as follows:
- 1. (1) In this Act:
“adviser” means a person engaging in, or holding himself, herself or itself out as engaging in, the business of advising another with respect to investment in or the purchase or sale of securities or exchange contracts
- Section 34 of the Act provides that:
34. (1) A person must not
. . .
(c) act as an adviser unless the person is registered in accordance with the regulations as
- (i) an adviser, or
(ii) an advising employee, partner, director or officer of a registered adviser and is acting on behalf of that adviser.
Section 8(c) of the Securities Rules provides that
- 8. A person registered as an adviser must be classified in one or more of the following categories:
. . .
(c) securities adviser: a person that engages or holds itself out as engaging in the business of advising others through direct advice or through publications about investing in, or buying or selling, specific securities, exchange contracts or both, not purporting to tailor that advice or publication to the needs of specific clients.
The first issue is to determine whether Hrappstead was “engaging in, or holding himself out as engaging in, the business of advising another with respect to investment in or the purchase or sale of securities”. The meaning of “advising” in this context was considered by this Commission In the Matter of Robert Anthony Donas [1995] 14 BC Weekly Summary 39. In that case, the Commission said the following, beginning at page 44:
- The concise Oxford Dictionary of Current English (1990 ed.) defines “advice” as “words given or offered as an opinion or recommendation about future action or behaviour”
It is because the very nature of advising involves the offering of an opinion or recommendation to others that the Act requires advisers to be registered and to meet certain conditions as to their education and experience. This requirement is intended to protect the public . . .
As indicated by the definition of “advice”, the nature of the information given or offered by a person is the key factor in determining whether that person is advising with respect to investment in or the purchase or sale of securities. A person who does nothing more than provide factual information about an issuer and its business activities is not advising in securities. A person who recommends an investment in an issuer or the purchase or sale of an issuer’s securities, is advising in securities. If a person advising in securities is distributing or offering the advice in a manner that reflects a business purpose, the person is required to be registered under the Act.
As for Hrappstead’s business purpose in providing this advice, one need look no further than what he stood to receive if the Investment Programs were successful: a commission equal to one half of the astronomical returns that he stated the Investment Programs would generate.
- We therefore find that Hrappstead acted as an adviser without registration, contrary to section 34 of the Act.
5. DECISION
We find that Hrappstead traded in securities without registration and acted as an adviser without registration, contrary to section 34 of the Act.
- In considering what orders would be in the public interest, we considered the following factors:
- (a) but for the timely intervention of the authorities, considerable harm could have been done by Hrappstead to investors in British Columbia,
(b) Hrappstead ceased his activities when asked by the RCMP and apparently has not resumed them,
(c) no investors appear to have invested in the Investment Programs, and
(d) Hrappstead has cooperated fully with the staff’s investigation.
We have taken into account the fact that no actual harm was done to investors, as well as Hrappstead’s cooperation with the investigation, although the mitigating effect of the latter is rather tempered by his apparent insistence that he has done nothing wrong. Nevertheless, we cannot overlook the potential for harm that was inherent in Hrappstead’s activities. It is also important that Hrappstead understand that his activities are unacceptable in the context of securities regulation in British Columbia.
- We therefore order in the public interest that:
- (a) under section 161(1)(c) of the Act, the exemptions contained in sections 44 to 47, 74, 98 and 99 of the Act do not apply to Hrappstead, and any issuer of which Hrappstead is at the date of this decision the sole shareholder, for a period of two years from the date of this decision;
- (b) under section 161(1)(d) of the Act, Hrappstead will resign from any position that he holds as a director or officer of any issuer, and is prohibited from becoming or acting as a director or officer of any issuer until
- (i) he has successfully completed a course of study satisfactory to the Executive Director concerning the duties and responsibilities of directors and officers, and
- (ii) a period of two years has elapsed from the date of this decision,
- except that Hrappstead may continue to act as a director and officer of those issuers which at the date of this decision he uses to operate his business as a contractor, general contractor and construction manager, provided that all of the shares of those issuers are owned by Hrappstead, his spouse or children, both legally and beneficially, and that none of those issuers is used to trade in securities of any issuer or as an investment vehicle for other persons;
- (c) under section 161(1)(d) of the Act, Hrappstead is prohibited from engaging in investor relations activities until
- (i) he has successfully completed a course of study satisfactory to the Executive Director, and
- (ii) a period of two years has elapsed from the date of this decision; and
- (d) under section 162 of the Act, Hrappstead pay an administrative penalty of $1,500.
- In light of Hrappstead’s cooperation with the investigation, we make no order as to costs.
DATED April 7, 1999.
FOR THE COMMISSION
| Brent W. Aitken | Roy Wares |
| Member | Member |
| Diane K. Wolch Member |