In a rare development, a Denver federal judge rejected claims by the Securities and Exchange Commission ("SEC") that a Denver oil and gas exploration company was a $49 million Ponzi scheme. The SEC charged St Anselm Exploration Co. ("St. Anselm") and three of its officers in March 2011, alleging that the company operated in 'Ponzi-like fashion' in that it could only satisfy its debt burden by raising new funds from investors. After a two-week trial in July 2012, United States District Judge Robert Blackburn issued an order concluding that "The evidence fails to establish that SAE had any of the true hallmarks of a Ponzi scheme," and ordering the SEC to cover St. Anselm's costs.
St. Anselm is a Denver company that was founded twenty years ago by Michael A. Zakroff ("Zakroff"). Zakroff, along with Mark Palmer, Anna Wells, and Steven S. Etkind, were officers or employees of St. Anselm, which seeks to identify and acquire oil, gas, and geothermal prospects with the goal of enhancing their value and subsequently re-selling the interests in the future. This process often spanned several years, and to fund business operations in the interim, St. Anselm relied on raising funds by issuing short-term promissory notes to investors. According to the SEC, while St. Anselm's business historically focused on oil and gas interests prior to 2007, it began exploring the development of geothermal wells beginning in 2007. However, because of this expansion into geothermal power, the SEC alleged that St. Anselm was unable to meet its debt service obligations through existing revenues, and thus depended on raising funds from new investors. As depicted in two charts in the SEC's complaint, this suggested that St. Anselm depended on the inflow of new investor funds to pay principal and interest to existing investors - the hallmark of a Ponzi scheme:
As the chart shows, while the principal balance of outstanding notes ballooned from $30 million in 2007 to over $60 million in 2010, St. Anselm realized only approximately $24 million in revenues during the same time period, and filled the shortfall with over $40 million in proceeds from the sale of new promissory notes. According to the SEC, even the tens of millions raised in the sale of promissory notes was not enough for St. Anselm, which was forced to delay a July 2010 interest payment to investors due to insufficient funds on hand. According to the SEC, the defendants were keenly aware that their financial survival depended on their ability to raise new investor funds.
However, while these characteristics certainly fit the bill for the typical Ponzi scheme which the SEC has been successful at uncovering in recent years, Judge Blackburn took a very different view of the proffered evidence. Indeed, in his order, Judge Blackburn noted that St. Anselm's typical business cycle often spanned several years, and faulted the SEC for only considering the 2007-2010 time period and not accounting for the potential value of non-liquid assets According to Judge Blackburn, when considering the time period from 2006 - 2010, St. Anselm took in more than $61 million in revenue from sources other than promissory notes, which was enough to satisfy the $57 million in required debt payments during that period. Indeed, the nature of St. Anselm's business meant that while it would regularly achieve multi-million dollar profits on the sale of their investments, these sales did not occur on a routine pace due to the time period required to enhance the value of the interest.
Of particular note to Judge Blackburn, there was no evidence that any investor lost any of their invested principal, and nearly 99% of investors agreed to a debt restructuring effected by St. Anselm in June 2010. Additionally, St. Anselm continues to operate as a going concern, with ample cash to make payments on the restructured notes despite not raising new investor funds. Nor was there any evidence that the defendants were "living a high-budget, jet-setting lifestyle at the expense of unsuspecting investors." Based on these facts, Judge Blackburn concluded that the totality of evidence did not support a finding that:
Any defendant acted with an intent to deceive, manipulate, or defraud in their communications with investors about the state of the company, or that their conduct constituted an extreme departure from the standards of ordinary care, one which they either knew presented a danger of misleading note holders or that was so obvious that defendants must have been aware of it.
Shedding some insight into his reasoning, Judge Blackburn reasoned that the company may have simply gotten too optimistic about its business prospects - rather than operated a Ponzi scheme - and stated that
What this court perceives from the evidence presented in this case is not fraud, whether intentional or reckless, or even negligence, but a company that got too far out over its skis."
The case is the first in recent memory not only in which the SEC has taken an accused Ponzi schemer to trial, but also in which the SEC has been unsuccessful. Indeed, it may simply be explained as a company at the wrong place at the wrong time - in the era of Post-Madoff enforcement, the SEC has not hesitated to bring enforcement actions where it feels that investor funds are in danger. In this instance, while some circumstances of St. Anselm's business model may have fit the model for the typical Ponzi scheme, the similarities turned out to be part of a legitimate business, rather than a closely-guarded fraud. An SEC spokesman indicated that the agency was reviewing the decision.
A copy of the SEC complaint is here.
A copy of the Order is here.