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Securities and Exchange Commission v. American Growth Funding II, LLC

United States District Court, S.D. New York

March 1, 2018

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
AMERICAN GROWTH FUNDING II, LLC, PORTFOLIO ADVISORS ALLIANCE, INC., RALPH C. JOHNSON, HOWARD J. ALLEN III, and KERRI L. WASSERMAN, Defendants.

          OPINION & ORDER

          KIMBA M. WOOD, UNITED STATES DISTRICT JUDGE

         In this action, the Securities and Exchange Commission ("SEC") asserts claims under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, and Sections 17(a)(1), (2), and (3) of the Securities Act of 1933 (the "Securities Act") against Defendants Ralph C. Johnson, American Growth Funding II, LLC ("AGF II"), Howard J. Allen III, Kerri L. Wasserman, and Portfolio Advisors Alliance, Inc. The SEC alleges that Defendants violated these securities laws by making materially false statements to investors and potential investors. Defendants deny these allegations. Defendants AGF II and Johnson (the "AGF Defendants") have now moved to exclude the Expert Report of Harris L. Devor, CPA (the "Devor Report").

         For the reasons stated below, the AGF Defendants' Motion is DENIED because (1) the opinions contained in paragraphs 13 to 32 of the Devor Report are admissible under Rule 402 because they are relevant to proving the materiality of Defendants' misrepresentations, (2) the opinions contained in paragraphs 33 to 57 of the Devor Report are admissible under Rule 402 because they are relevant (i) to proving that Defendants acted with scienter and (ii) to rebutting the AGF Defendants' defense of good faith, [1] and (3) the opinions contained in the Devor Report are admissible under Rule 403, because "unfair surprise" is not a proper ground for excluding the opinions contained in the that report and because those opinions are unlikely to confuse the issues or mislead the finder of fact.

         I. BACKGROUND

         A. The SEC's Allegations

         The SEC alleges that, in 2008, Defendant Johnson began operating a company called American Growth Funding LLC ("AGF"). (Compl., ¶ 20.) To raise money for AGF, Johnson used a number of investment vehicles, including Defendant AGF II. (Id.) Defendants sold "units" in AGF II to investors, promising a 1% return each month in exchange for investor funds. (Id., ¶ 21.) After receiving these investor funds, AGF II loaned these funds to AGF, which, in turn, loaned them to various third-party businesses. (Id., ¶ 23.)

         According to the SEC, Defendants made multiple material misrepresentations in connection with raising money for AGF II. (Compl., ¶¶ 1-7.) As relevant here, the SEC alleges that Defendants distributed Private Placement Memoranda ("PPMs") in 2011 and 2012 stating that, "[a]s has been policy in the past, [AGF IPs] annual financial statements will continue to be audited." (Compl., ¶¶ 24, 28.) In fact, however, AGF IPs 2011 and 2012 financial statements were not audited until 2014, at which time they were audited by non-party Seymour Weinberg. (Devor Report, ECF No. 85-1, ¶ 32.)

         B. The Devor Report

         On February 3, 2017, the SEC served Defendants with an expert report prepared by a certified public accountant, Harris L. Devor (the "Devor Report"). (ECF No. 84, at 3.) In essence, the Devor Report consists of two parts. First, Mr. Devor describes the characteristics of an external audit and explains why external audits, including those of AGF IPs financials, matter to investors. (ECF No. 85-1, ¶¶ 13-32.) Second, Mr. Devor describes AGF IPs financials, explains that certain types of analyses were needed to properly audit those financials, and explains why Mr. Weinberg's 2014 audits did not properly analyze those financials. (Id., ¶¶ 33-57.) In particular, Mr. Devor asserts that, because AGF IPs investments consisted almost completely of a loan receivable from AGF, and because that receivable was of questionable value, any legitimate audit of AGF IPs financial statements needed to analyze the underlying financials of AGF. (Id.) Mr. Weinberg's audits of AGF IPs financials did not do so. (Id.) Thus, Mr. Devor concludes that Mr. Weinberg essentially "failed to perform an audit at all." (A*, ¶¶ 41-49, 57.)

         C. Relevant Procedural History

         The SEC commenced this action on February 3, 2016. (Compl., ECF No. 1.) Defendants filed their respective Answers on April 22, 2016. (ECF Nos. 30, 32.) On or about February 3, 2017, the SEC served the Devor Report. (See ECF No. 84, at 3.) On March 9, 2017, Defendants Johnson and AGF II moved to exclude the Devor Report. (ECF No. 83.) On June 9, 2017, after discovery had closed, the SEC moved for summary judgment.[2] (ECF No. 119.)

         II. DISCUSSION

         The AGF Defendants have moved to exclude the Devor Report on the grounds that the opinions contained therein are irrelevant under Rule 402 and are unfairly surprising and misleading under Rule 403. (Defs.' Mem., ECF No. 84, at 4-11.)

         A. ...


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