Initiated By
FINRA
Allegations
Gordon was named a respondent in a FINRA complaint alleging that he, with his member firm and a firm principal, participated in a fraudulent scheme and defrauded investors by selling investments in saltwater disposal wells at excessive, undisclosed markups through a middleman "development" company they owned and controlled. The complaint alleges that the fraudulent markups totaled over $8 million. The complaint also alleges that as a manager of the fund, Gordon owed fiduciary duties to the fund. Gordon violated his fiduciary duties by causing the development company to usurp the fund's investment opportunities and resell those investments to the fund at excessive prices, and by failing to take steps to ensure fair pricing to the fund, Gordon used the development company to extract ill-gotten profits from retail investors who purchased interests in individual saltwater disposal wells outside the fund. The development company purchased these interests and resold them to retail investors, sometimes through the firm, at undisclosed, excessive markups. Investors were not informed, in the private placement memorandum or otherwise, that the fund would pay or had paid excessive markups for its purchases of interests in saltwater disposal wells from the development company. As a result, Gordon willfully violated Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5(a)-(c) thereunder, and FINRA Rules 2010 and 2020. The complaint further alleges that the development company was largely engaged in buying and reselling well interests, which were securities. Although this rendered it a dealer of securities, Gordon failed to register the development company with FINRA or the SEC. By virtue of his ownership and control of the development company, Gordon had the ability to cause the development company to register as a dealer but failed to do so. As a result, Gordon willfully violated Section 15(a) of the Securities Exchange Act of 1934 and FINRA Rule 2010. In addition, the complaint alleges that despite deriving a substantial portion of its revenue from private offerings by affiliates, Gordon's firm failed to adopt or implement reasonable procedures to address conflicts of interest in transactions involving affiliates. In overseeing all the firm's sales activities, including sales of fund interests and interests in individual saltwater disposal wells, Gordon labored under numerous and obvious conflicts of interest. Nonetheless, the firm failed to adopt or implement an alternate supervisory structure for offerings where Gordon was conflicted. Moreover, because Gordon and the firm were aware of the frauds being perpetrated in connection with sales of fund and well interests, and permitted registered representatives of the firm to sell the interests, Gordon and the firm failed to reasonably supervise the firm's sales activities. Gordon and the firm did not even acknowledge that individual well interests were securities and allowed them to be sold away from the firm for compensation without any supervision, other than requiring registered representatives to submit "outside business activity" disclosures. Gordon and the firm knowingly permitted, and expressly or tacitly approved, the firm's registered representatives to sell interests in direct working interests marketed as "real estate" to retail investors and to receive selling compensation for those transactions. In addition to allowing representatives to engage in private securities transactions in violation of the firm's written supervisory procedures, Gordon and the firm failed to record the sales on the firm's books and records, failed to supervise the sales as if the transactions were executed on behalf of the firm, and failed to otherwise reasonably supervise the transactions.
Resolution
Decision
Bar
Bar (Permanent)
Registration Capacities Affected
All capacities
Duration
Indefinite
Start Date
6/30/2020
Sanctions
Monetary Penalty other than Fines
Amount
$28,934.60
Sanctions
Restitution
Amount
$3,331,082.00
Amount
$4,682,201.00
Regulator Statement
Extended Hearing Panel decision rendered November 29, 2018. The sanctions are based on findings that Gordon willfully defrauded investors by charging unreasonable and undisclosed markups on sales of fractional interests in saltwater disposal wells in violation of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act), Exchange Act Rule 10b-5 thereunder and FINRA Rules 2020 and 2010. The findings stated that Gordon and the member firm's president formed a business relationship with a development company that constructed and operated disposal wells that return saltwater byproduct from nearby oil wells to rock formations below the ground. Gordon and the president, with two firm associates, formed a salt-water reclamation fund (the fund) to bring in investors and the capital needed to construct and operate the wells. Gordon, the president and the sales associates made all investment decisions for the fund, were the fund's Investment Committee and owners of the fund's managing member and the firm served as the managing broker dealer for the distribution of fund shares. Investors purchased units in the fund at a cost of approximately $12.4 million. The findings also stated Gordon breached fiduciary duties of loyalty and care to the fund by causing the development company to usurp opportunities to purchase lower priced well interests that should have been reserved for the fund, and by causing the fund to purchase those interests at marked up prices. The findings also included Gordon willfully defrauded retail customers by selling fractional well interests as securities through the development company while charging excessive markups, without disclosing the basis or extent of the price markups, and by selling well interests through a network of representatives while marketing the investments as real estate. The fund's original private placement memorandum did not disclose to investors that the development company would resell interests to the fund at substantially higher prices than it purchased them. FINRA found that Gordon, aware it qualified as a dealer of securities, caused the development company to act as an unregistered dealer in willful violation of Section 15(a) of the Exchange Act and FINRA Rule 2010. FINRA also found that Gordon failed to establish, maintain, and implement supervisory procedures adequate to address conflicts of interests. The same individuals who stood to profit from the disposal well sales were responsible for overseeing the transactions. Gordon was responsible for supervising sales of private placements by affiliates and was a member, along with the president, of the firm's Investment Committee, responsible for reviewing and accepting the firm's participation in private placements, direct participation programs and underwritings. Gordon failed to exercise the supervision expected of him in private securities transactions and to enforce the firm's prohibitions against selling away. Gordon permitted firm registered representatives to sell well interests marketed as real estate to retail investors, and to receive selling compensation for those transactions, without supervision. Foregoing any consideration of the reasonableness of the markups in the private securities transactions. On December 21, 2018, Gordon appealed the decision to the NAC. NAC decision rendered June 23, 2020 wherein the findings made are affirmed and the sanctions imposed are affirmed. The bar is in effect as of June 30, 2020. The decision became final July 27, 2020.
Broker Comment
THE PANEL'S DECISION IS CURRENTY ON APPEAL.
This is a case of first impression. FINRA has never before heard a case involving alleged markups in purchases and sales of saltwater disposal well interests ("SWDs"). SWDs are an unusual product which FINRA was unfamiliar with when its investigation began. The FINRA Panel issued a decision on November 29, 2018 which ignored important exculpatory evidence, including the fact that no investors lost money on the purchase of an SWD and the fact that the PPM for the Fund disclosed that the Development Company was formed, among other reasons, to facilitate IRC Section 1031 exchange transactions.
The PPM also contained numerous disclosures concerning actual and potential conflicts of interest between the Fund, the Development Company and principals of the Firm. The evidence at the hearing established that, contrary to FINRA's allegations, the Development Company's acquisition costs were not material to customers who invested in SWDs. After the Firm elicited testimony to this effect and other exculpatory testimony, FINRA voluntarily decided not to call additional customers as witnesses. Although the Panel found that the Firm, its President and its CEO had a good-faith belief that SWDs were not securities but instead were real property, they nonetheless ignored this finding and the ample exculpatory evidence presented at the hearing and ultimately reached erroneous conclusions. While the Panel ordered "restitution" based on the alleged markups, customers have the option to reject this restitution due to the fact that many SWD investors made their investment to capitalize on the tax-advantaged savings available under IRC Section 1031. The Firm, its President and its CEO maintain that the Panel's decision was based on erroneous factual and legal conclusions, including allowing FINRA to call incorrectly-identified witnesses at the hearing.
