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SEC v. PETROFUNDS

June 22, 1976

Securities And Exchange Commission, Plaintiff,
v.
Petrofunds, Inc., et al., Defendants


Weinfeld, District Judge.


The opinion of the court was delivered by: WEINFELD

WEINFELD, District Judge:

This motion for a preliminary injunction and the appointment of a temporary receiver is the opening sally in what is already a vigorously contested lawsuit. Plaintiff, the Securities and Exchange Commission ("Commission") has brought this action alleging fraud in connection with the sale of interests in oil and gas drilling programs to public investors. It moves for a preliminary injunction enjoining some but not all defendants *fn1" from continuing to commit acts allegedly in violation of the securities acts of 1933 and 1934, disposing of or exercising any control over the assets of the corporate defendants or the drilling programs, issuing any new securities, declaring any dividend or distributing any assets of the corporate defendants, and altering the structure of the corporate defendants or the drilling programs. In addition, the Commission requests the court to appoint a temporary receiver for Petrofunds, Inc. ("Petrofunds"), McRae Oil Corp. ("McRae Oil"), McRae Consolidated Oil and Gas, Inc. ("Consolidated"), Louisiana Gas Purchasing Corp. ("LGP"), Louisiana Gas Intrastate, Inc. of Shreveport ("LGI"), Sunny South Oil and Gas, Inc. ("SSOG") and the drilling programs, who would take custody of the books, records and assets of these entities, conserve and manage them, seek an accounting, and report to the court on "the true state of affairs of the Petrofunds oil and gas drilling programs."

 The alleged unlawful and fraudulent acts upon which the motion is founded are said to have been committed between 1968 and 1973. Within that period and thereafter Petrofunds raised approximately $80,000,000 through public sales of participating interests in oil and gas drilling programs. The sales followed the filing of Petrofunds' registration statements with the Commission and the issuance of prospectuses with respect to various drilling programs. The public investors under these programs acquired either a joint venture or limited partnership interest in the drilling programs to which they subscribed. Petrofunds arranged for the acquisition, testing, development and operation of oil and gas leaseholds; in effect it was the agent of the participants in the joint ventures and the general partner of the limited partnerships.

 The last effective date of a Petrofunds' registration statement for the public sale of interests in a gas or oil drilling operation was April 13, 1973, and the last sale of securities thereunder was made in November 1973. *fn2"

 The instant motion by the Commission is made more than two years after it commenced in March 1974 and thereafter continued an investigation into the affairs of Petrofunds. Since the onset of the investigation Petrofunds has not publicly offered any new drilling programs.

 Defendant James McRae is a principal of and the moving force behind Petrofunds. Kelly and Benson are two of its officers and directors. Other defendants include various corporations allegedly under the direct or indirect control of McRae, including some which allegedly were used to siphon off profits and interests of gas drilling operations which properly belonged to the public investors. Also named as a defendant on the motion is Osias Biller, a lawyer and accountant, who allegedly acted in concert with McRae and other individual defendants and received interests in drilling operations at the expense of the public investors.

 The charges of fraudulent conduct center in the main about three items: (1) the acquisition of drilling prospects through so-called "interpositioned companies" and the consequent skimming off of interests, profits and commissions; (2) the diversion of assets by the use of investors' money to promote the programs and for personal expenses such as apartments, vacations and clothing; and (3) a sale of natural gas production to the Louisiana Power & Light Company ("LPL") and the construction of a pipeline by it for the benefit of certain defendants. *fn3" As set forth below, in each instance the defendants have countered the Commission's charges and presented evidence raising sharp factual issues.

 A. The Acquisition of Prospects

 At the heart of the Commission's case is its charge that "the defendants controlled a vast amount of acreage and established a number of interpositioned shell companies into which this acreage, in the form of oil and gas prospects, was 'parked' for eventual sale to public drilling programs which Petrofunds promoted." Essentially the claim is that Petrofunds, instead of using the proceeds of its public sales of interests to acquire acreage or leaseholds to explore for gas and oil, used the interpositioned companies controlled by McRae and his associates for that purpose, and thereafter these companies entered into projects with Petrofunds. Allegedly the net effect was that the interpositioned companies skimmed off profits that properly belonged to Petrofunds to the extent that they marked up costs and received commissions and undivided interests without performing legitimate services.

 To support its charges, the Commission has introduced evidence showing Matlock Oil Co., Fannin Oil Co., E-K Oil Co., Sunny South Oil and Gas, Inc., and others -- all alleged to be interpositioned companies controlled by McRae -- purchased various prospects from third parties and later resold the prospects to Petrofunds at a higher price or after subtracting commissions or undivided interests. The Commission has also tendered affidavits and testimony of witnesses who appeared before it during its private investigation. These, the Commission contends, show that McRae directed the formation and operation of the interpositioned entities and instructed leasehold owners to bring the deals to those entities and not to Petrofunds in the first instance.

 Apart from pointing to deficiencies in the quality of the Commission's proof, *fn4" McRae has submitted an affidavit specifically denying any participation in the formation or control of the alleged interpositioned companies, which are only several of more than fifty companies from which Petrofunds acquired interests in leasehold properties. Moreover, other affidavits in the record, as well as testimony taken before the SEC, support his claim that companies such as Matlock Oil, E-K Oil and SSOG were independently operated and formed for legitimate business reasons having nothing to do with McRae. There are also specific denials that these companies acquired prospects at McRae's direction.

 The disputed fact issues that pervade this recital also extend to other aspects of the alleged improper use of interpositioned companies. Thus, without dealing with each allegation in detail, the Commission's charges concerning the consolidation of the various interpositioned entities to form SSOG, and alleged overpayments to SSOG in the guise of compensation for SSOG's acceptance of turnkey drilling obligations *fn5" are countered by McRae's and Dorroh's sworn statements that McRae did not control SSOG and that Petrofunds' dealings with SSOG were fair and favorable to the programs. Indeed, it is their submission that the turnkey agreements protected Petrofunds' investors against unlimited and skyrocketing drilling costs. In 1972, they assert, SSOG refused to turnkey any wells for Petrofunds because of large losses on earlier contracts. The defendants contend that it was the risk of this loss assumed by SSOG that justified the compensation paid to it as the turnkey operator.

 The Commission's charge that McRae used the interpositioned companies to launder moneys siphoned off from public investors is resisted not only by McRae's denial of control over the companies but by his claim that payments to him from defendant Roberts, an attorney, were loans "made in purely conventional fashion, without use or means of any other company or individual." The Commission's exhibits, tendered without adequate explanation or supporting testimony, do not at this juncture compel an opposite conclusion.

 Finally, on this aspect of the case, there are irreconcilable conflicts concerning defendant Biller's role in the acquisition of prospects by the drilling funds. The Commission charges that Biller, an attorney and a CPA, acted as a selling agent for the Petrofunds programs and placed many of his clients in them. For this he allegedly received certain "carried interests" in prospects acquired by the interpositioned companies. In addition, the Commission contends that over one million dollars paid to Biller by Petrofunds and carried on its books for professional services rendered by him were unreasonably large, and that the excess over the fair and reasonable compensation for his services in fact represents commissions for his efforts in selling Petrofunds securities to his clients and others. Biller categorically denies the assorted charges levelled against him. He has presented over four million dollars in cancelled checks (which were made available to the Commission during the course of its investigation) which he states represent his purchases of various interests in Petrofunds projects, and negates the Commission's charge that he acquired such interests as compensation for promotional or related activities. Further, he avers that he purchased his interests not from Petrofunds but from the previous owners of the prospects, who offered opportunities to him for their own best interests and to gain additional funds. He contends that he was "carried" only to the extent of being relieved of his pro rata share of the costs of drilling the first well on a prospect to its casing point (the point at which it was determined whether or not to complete the well), and that thereafter he bore the full cost of completing the first well and of drilling subsequent wells. This arrangement, he claims, was favorable to the previous owners because it provided them with the funds ...


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