Opinion
No. MISC 07-0025 FCD GGH.
May 4, 2007
ORDER
The court orders the result here in that although the district judge referred the matter to the undersigned, Local Rule 73-302(a) requires that magistrate judges use their order jurisdiction whenever the law would permit the exercise of such jurisdiction. The subpoena matter here is no different from any discovery matter for which it is indisputable that magistrate judges would have order jurisdiction, e.g. Fed.R.Civ.P. 45.
Presently before the court is movants' motion to quash SEC subpoena, filed April 4, 2007. Respondent filed an opposition to the motion to quash on April 13, 2007. This matter is before the undersigned pursuant to an April 20, 2007 referral order by the Honorable Frank C. Damrell.
BACKGROUND
Movants Donald Neuhaus, Linda Neuhaus and Kimberly Snowden seek to quash Securities and Exchange Commission ("SEC") subpoenas to produce documents, issued March 20 and 21, 2007 on Tri Counties Bank and Wells Fargo Bank, respectively. The SEC seeks all documents relating to accounts held by movants individually in regard to both subpoenas, and to movants "DBA American Financial Services" in regard to the Tri Counties Bank subpoena only. These subpoenas are based on an SEC Order of Investigation regarding a company owned by Mr. and Mrs. Neuhaus, American Financial Services, Inc. ("AFS"), which was later called Secure Investment Services, Inc. ("SIS"). Movants seek to quash the subpoenas, "except as to the individual account identified in the Tri-Counties subpoena." Mtn. Quash at 2. After an order requesting clarification, movants explain that they seek to quash all subpoenas to the extent they seek information from personal, as opposed to corporate, bank accounts. Therefore, they do not seek to quash bank account numbered 321002420, as it is the general business account of AFS.
Mrs. Snowden's husband is a principal in the firm representing movants in this case.
A letter dated March 30, 2007, from movants' counsel to the SEC states that AFS is not a dba but a corporation authorized to do business in California. This letter also states that there is no account in the name of "Donald F. Neuhaus/Linda A. Neuhaus/Kimberly Ann Snowden dba American Financial Services." (Norcross Decl., Ex. 2). The SEC's letter of April 2, 2007 disputes this claim. (Id., Ex. 3).
The SEC indicates that the Order of Investigation, which the court has permitted to be filed under seal, authorizes investigation of whether the registration and/or antifraud provisions of the securities laws have been violated by SIS, AFS and Cash for Life, Inc. ("CFL"), or "their officers directors, employees, partners, subsidiaries, and/or affiliates, and/or other persons or entities, directly or indirectly," between 2001 and the present, by virtue of having offered and sold unregistered securities through fractional interests in discounted life insurance policies, and whether any fraud has occurred in the sales of these products.
According to movants, CFL has not existed since a date prior to the time period for which records are sought.
The transactions under investigation involve the discounted sale of life insurance benefits potentially payable to elderly or infirm beneficiaries who have little time to live. Movants would allegedly then sell interests in the benefits soon to be paid to "investors." The SEC believes that these sales are securities which need to be registered.
Movants argue that the subpoenas should be quashed as to all three individuals. First, Mrs. Snowden claims that of the four accounts she maintains at Wells Fargo, two are joint accounts with her husband, an attorney, and her income is not deposited into either of these accounts but rather they contain her husband's separate earnings. As a non-party, his personal records should not be examined. As to the other two accounts, Mrs. Snowden states that she is controller of SIS and deposits her wages into these accounts. There is no allegation of improper payment of wages, and the two other employees of the corporation were not subpoenaed. Therefore, Snowden argues that these accounts are not relevant.
Movants state that financial records for Donald and Linda Neuhaus are held by Tri Counties Bank. Financial records for Kimberly (and husband Kelly) Snowden are held by Wells Fargo Bank.
Movant Linda Ncuhaus asserts that although she is a shareholder and nominal director on the corporate accounts, she does not sign anything on any of these accounts, has no active role in AFS or SIS and receives no income from them. Her only connection to the investigation is that she is married to Donald Neuhaus. She contends that the SEC has not established her receipt of funds, or that receipt was improper.
Movant Donald Neuhaus concedes that he is a principal shareholder and officer of AFS and SIS. Nevertheless, he argues that he receives no salary, commissions, bonuses or other compensation, only loans secured by promissory notes, and therefore the SEC can not demonstrate improper payments to him. Second, he contends that the SEC can not establish that loans to him constitute "improper use" of investor funds. The corporate records contain this information, not his personal banking records, and therefore the subpoenas as to him are not relevant.
On April 20, 2007, this court issued an order permitting a determination on the motion by April 27, 2007, despite the statutory requirement that such decisions be made within seven calendar days of the filing of a response to the motion to quash, as this matter did not come to the court's attention until April 20, 2007. See 12 U.S.C. § 3410. On April 26, 2007, after reviewing the pleadings, the court ordered clarification of specific issues, and made the determination that a final order was not required to be issued until May 4, 2007. After receiving supplemental briefing, the court now issues the following order.
DISCUSSION
I. Procedural Requirements Under 12 U.S.C. § 3410
Movants have cited no law in support of their position, other than the Right to Financial Privacy Act of 1978 ("RFPA"), generally. After issuing its order of April 20, 2007, this court performed further review of the statutory requirements underlying the RFPA.
If a "customer" of a "financial institution" is subpoenaed by a "government authority," the government's sole right to obtain financial records of the customer is governed by the RFPA, 12 U.S.C. § 3402. In the event that a government authority subpoenas financial records under RFPA, and a dispute arises over whether the records are properly subject to subpoena, RFPA further provides:
If the court finds that the customer has complied with subsection (a) of this section, it shall order the Government authority to file a sworn response. . . .12 U.S.C. § 3410(b).
Pursuant to the quoted section of the RFPA, the court first is required to determine whether the motion to quash complies with § 3410(a) before the government's response, if any, is filed, and before the seven day period commences to run. Nothing in § 3410(b) permits the government to accelerate the court's required finding pursuant to § 3410(a) by its unilateral, unordered filing of an opposition. Because the court has not yet made the § 3410(a) determination, the opposition in response filed on April 13, 2007, is premature. After reviewing the motion to quash, the court now finds, for purposes of § 3410(a), that Donald Ncuhaus, Linda Neuhaus, and Kimberly Snowden, as individuals, are customers of a financial institution as defined in 12 U.S.C. § 3401(5).
II. Right to Financial Privacy Act
The RFPA permits customers to contest government access to certain records held by banks and other financial institutions.See Securities Exch. Comm'n v. Jerry T. O'Brien, Inc., 467 U.S. 735 (1984). RFPA is the exclusive means by which "government authority" can acquire financial records of a non-party "customer" (individual) via a judicial subpoena from a "financial institution." 12 U.S.C. §§ 3402, 3407, 3413(e) (ordinary discovery rules apply to parties in an action). Conversely, if applicable, the objection-to-production provisions of RFRA are the exclusive means by which a "customer" can challenge the government's subpoena of financial records. 12 U.S.C. § 3410(e).
The RFPA requires the government authority to notify the bank customer a subpoena is being served on a financial institution and the nature of the law enforcement inquiry to which the subpoena relates. 12 U.S.C. § 3407(2). Within ten days of service or fourteen days of mailing the subpoena, the customer may file a motion to quash in the district court which issued the subpoena. 12 U.S.C. § 3410(a). The RFPA provides "three grounds on which the district court may quash a subpoena: (1) the agency's inquiry is not a legitimate law enforcement inquiry or (2) the records requested are not relevant to the agency's inquiry or (3) the agency has not substantially complied with the RFPA." Sandsend Financial Consultants, Ltd. v Federal Home Loan Bank Board, 878 F.2d 875, 882 (5th Cir. 1989).
It is not disputed that the SEC's inquiry is a legitimate law enforcement inquiry or that the agency has substantially complied with the RFPA. What movants dispute is the relevance of the information sought through investigation to the legitimate purposes of the inquiry as outlined in the order directing private investigation. However, the SEC's burden is not a heavy one. The SEC need only show that it is engaged in a "legitimate" law enforcement activity and it has a "reasonable belief" that the sought records are relevant to that legitimate investigation. 12 U.S.C. § 3410(c).
For the reasons that follow, this court finds the SEC has met its burden to demonstrate reason to believe the sought records are relevant to any legitimate inquiry before the court pursuant to the Order of Investigation.
"The ultimate burden of showing that the records sought are relevant to a legitimate law enforcement inquiry is on the government." Collins v. Commodity Futures Trading Comm., 737 F. Supp. 1467, 1480 (N.D.Ill. 1990).
An agency `can investigate merely on the suspicion that the law is being violated, or even just because it wants assurance that it is not.' Morton Salt, 338 U.S. at 642, 70 S.Ct. at 363, 94 L.Ed. at 410. So long as the material requested `touches a matter under investigation,' an administrative subpoena will survive a challenge that the material is not relevant. Elrod, 674 F.2d at 613 (quoting Motorola v. McLain, 484 F.2d 1339, 1345 (7th Cir. 1973), cert. denied, 416 U.S. 936, 94 S.Ct. 1935, 40 L.Ed.2d 287 (1974)).Sandsend, 878 F.2d at 882.
The SEC alleges that the subpoenaed documents are relevant because it has evidence of apparent illicit conduct in connection with AFS, SIS and CFL's viatical or life insurance investment sales program, and movants are closely linked to those companies. For example, the SEC alleges that Mr. Neuhaus is president and possibly alter ego of two of the entities which sold unregistered securities under investigation. The SEC has attached a copy of a desist and refrain order issued by the State of California regarding sales of unregistered securities without disclosing material information (such as the fact that the securities are unregistered and that he has been ordered to cease and desist), as well as investor alert issued by the California Department of Corporations, in which Donald Neuhaus is named as a seller of fractional life benefit interests without a California broker-dealer license and without disclosing material information. (Exs. to Opp'n.) The SEC also points to Mr. Neuhaus' concession that he used his own funds to buy bonds from IFS, indicating that he is using his own bank accounts to operate these viatical or life insurance sales programs, which in turn indicates the possibility of self-dealing. Both Mrs. Neuhaus and Mrs. Snowden are listed as officers and/or directors of these entities. (Exs. to Opp'n.) The SEC's reply, filed May 1, 2007, includes an exhibit reflecting a withdrawal by Mrs. Snowden in the amount of $425,000 on April 21, 2006, from a Wells Fargo account held by SIS. (Ex. A to Reply). The verification of SEC attorney Lloyd Farnham, attests to the facts set forth in the SEC's opposition, and its reply. (Ex. C to Opp'n; Ex.B to Reply.)
The SEC also seeks the bank records in order to determine if investor funds were deposited into these accounts and to trace where these funds have been redirected. The investigation of these bank records may reveal whether there are other individuals or entities involved in wrongdoing. The SEC also asserts that inquiry into the entities' bank accounts or corporate ledgers would not necessarily tell the full story. The SEC will not assume that such records are complete; there may have been indirect transfers through intermediaries to the recipients which would not be reflected in the corporate records. Although Mrs. Neuhaus and Mrs. Snowden represent that they received no funds from AFS, SIS or CFL, the SEC insists that it is not required to accept such assertions but may perform inquiry to corroborate these statements. According to the SEC, even if Mrs. Neuhaus is not involved in any way, if her husband engaged in any securities laws violations, she could be unjustly enriched as a result of any community property interest.
Even if it is shown that funds were redirected to an innocent party, the SEC states that ill gotten gains may be retrieved, even from an innocent party, citing SEC v. Colello, 139 F.3d 674, 676 (9th Cir. 1998).
The SEC is correct. It is entirely reasonable to believe that tainted monies accruing from the sale of "securities" may well have found their way into otherwise innocent accounts. This conclusion is all the more reasonable given the legal connection of all movants to the targeted companies and their personal relationship to each other. Movants confuse the burden of proving wrongdoing and the individuals' connection to that wrongdoing with the burden of showing only a reasonable belief that looking into bank accounts may be relevant to an investigation.
Accordingly, the SEC has met its burden to demonstrate that the sought records pertain to its investigation of allegedly illegal conduct of entities or persons related to SIS, AFS, or CFL.
CONCLUSION
IT IS HEREBY ORDERED that movants' motion to quash, filed April 7, 2007, is denied.