Byron Cook’s partners contradict his Ken Paxton story

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(Jay Janner/Austin American-Statesman via AP)

Two of Rep. Byron Cook’s business partners contradict a crucial part of the story Cook has been telling about Attorney General Ken Paxton and their investments together.

Attorney General Ken Paxton was indicted in July 2015 on two counts of “intentionally failing to disclose” a commission he was apparently paid for recruiting investors to a company called Servergy. Those indictments are predicated on a presumption that it was in fact illegal not to disclose a commission.

But it’s that exact presumption that last year doomed a federal lawsuit that the Securities and Exchange Commission brought against Paxton. Federal District Judge Amos L. Mazzant, III found nothing in the law obligating Paxton to make that disclosure.

If the state criminal case is going to have a different result, prosecutors will have to find a way to convince a jury that Paxton did have a special obligation to volunteer information. They will likely try to argue, as the SEC did, that Paxton had a fiduciary duty to a small group of investors.

The story of the investment group revolves around Cook and some investors he knew: his longtime associates Joel Hochberg and Bill Sandford, a newer one named Bob Griggs, and of late, Paxton.

Some version of the story has been around since the beginning of the case.

According to the latest version, the one told by the SEC as it was trying to salvage a lawsuit against Paxton, the one it put together in consultation with Cook and Hochberg, you could go ahead and put Investment Group in capital letters.

The Investment Group had formal policies, clear understandings, and deep mutual trust, supposedly. Somewhere in that web of obligation, one might figure, Paxton had gotten himself tangled up.

The story, however, is untrue.

In court records, Sandford and Griggs say they weren’t even members of an investment group.

In response to a subpoena seeking the records of the supposed investment group, Griggs’ attorney wrote that to the extent that Cook, Hochberg, Sandford, and Griggs “shared investment opportunities with each other, they did so on an ad hoc basis rather than pursuant to any formal arrangement.”

Sandford told investigators he’d been investing with Cook and Hochberg for 30 years. When he was subpoenaed, his attorney wrote that “Sandford is not aware of any investment group of which he was a part.”

In fact, Cook’s own attorney, Terry Jacobson, has written that “no formal group existed.”

“Instead, there was an ad hoc arrangement where, from time to time, good friends might invest in the same transaction — or were at least offered the opportunity to invest in the same transaction. The persons who invested differed from transaction to transaction, and the length of time they had invested all differed from person to person.”

Jacobson did not respond to a request for comment.

The question of how these five investors related to each other — whether they had any fiduciary duties or legal obligations — will be of key importance in the Paxton case.

It’s of such importance that Paxton allies have filed three separate lawsuits against a company called Unity Resources, in which Cook, Hochberg, Paxton, and Sandford all invested. Two of the lawsuits are by clients accusing Unity of ripping them off; the third is to collect a $1.7 million debt.

The plaintiffs accuse Cook of self-dealing, to the detriment of his partners and themselves, although it’s not yet clear if the litigation will reach that question.

As Texas securities law closely mirrors federal law, on purpose, the battlefield here is already known. The question is whether the outcome will be any different.

There are two main ways that the prosecutors can argue that Paxton had an obligation to disclose the commission.

One, they can argue that his failure to disclose made some other statement an illegal half-truth. The indictments take some language about omitting material facts from the provision in Texas securities law forbidding half-truths and misleading statements.

Two, the prosecutors can make some version of the fiduciary argument.

The SEC tried to argue that because he didn’t disclose his financial arrangement, “every statement Paxton made encouraging the Investment Group members to invest was a materially misleading half-truth,” as Mazzant summarized it in his ruling.

Telling half-truths to investors is illegal, but the only way a failure to disclose the compensation could be part of a half-truth, Mazzant ruled, is if Paxton had specifically told a half-truth about his compensation: “for example, if Paxton informed his Investment Group that he was only receiving cash for promoting Servergy when in reality he was receiving cash and stock.”

But non-disclosure doesn’t make it a half-truth to call Servergy an “interesting” opportunity or a “great company,” Mazzant ruled.

The SEC’s problem was that after their theory was rejected, they had zero evidence of any lies or misleading statements told by Paxton.

Barring some new evidence, the state prosecutors are likely to run into the same issue: they’ve got a fraud case without any deception by the accused.

This where the fiduciary issue becomes important.

After Mazzant dismissed the lawsuit a first time, he allowed the SEC to refile its case, which it did, featuring a number of brand-new claims by Cook about the nature of his business relationship with Paxton and three other investors.

The SEC hoped these claims about “express policies” about not profiting off one another would sway Mazzant.

But Mazzant found that since Paxton exercised no “control or dominance” over the other investors, he was not a fiduciary.

It’s not yet clear if the state court will apply the same standard.

According to the case law on fiduciaries cited in the Cook litigation, Texas courts “do not create (a fiduciary) relationship lightly.” A “special relationship of trust and confidence must exist prior to, and apart from, the agreement made the basis of the suit.” Also, one party should be “accustomed to being guided by the other party’s judgement and advice and there exists a long association in a business relationship as well as a personal friendship.”

According to statements by Sandford and Griggs to the Texas Rangers, Paxton had joined in on three of their deals prior to Servergy.

Jon Cassidy can be reached at [email protected].

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