The case against Attorney General Ken Paxton took a major hit Friday when the former chief executive officer of a server manufacturer was found not to be liable for six of the seven claims made against him by the Securities and Exchange Commission.
A federal jury found Bill Mapp, the former CEO of Servergy, liable for a single claim of negligence in representations he made about the company, but not liable for more serious claims that he had knowingly defrauded investors.
U.S. District Judge Amos L. Mazzant, III, will decide on the financial penalty that verdict carries within the next month or two.
Mazzant is the same judge who dismissed the SEC’s lawsuit against Paxton earlier this year.
The SEC originally named Mapp and Paxton co-defendants in the lawsuit.
Paxton still faces a three-count criminal trial in a Harris County district court next spring, but this verdict could inform that case directly, either through testimony from Mapp, or other company officers, if the judge allows it, or from news accounts that jurors might read.
Aside from the considerations that go into evaluating an accusation of fraud, much depends on how the jury perceives the company. Was Servergy just a startup that failed to launch after misjudging the demand for its product? Or was it something more nefarious?
To answer the first question with confidence, one would need to be able to discuss a myriad of runtime architectures, and whether 32-bit servers have a future in any of them, particularly for simple jobs such as data storage.
To answer the second question, one would need to be certain they do not, a conclusion that might be hard to reach when 32-bit applications are still commonplace in 2017.
In 2011, when Paxton invited potential investors to hear Mapp give his pitch, they were standard.
From the timeline established by the SEC, Mapp’s more questionable conduct came later, in 2012 and 2013, at times that the company was barely making payroll.
Paxton’s name did not come up during the eight-day trial, according to David Klaudt, who was one of Mapp’s attorneys.
Since the charges don’t include “specific instances of conduct that they’re alleging was misleading, we’re left to guess a little bit,” Klaudt said. “It probably pertains to conduct related to the private placement memorandum put out through Williams Financial Group for the fundraising round in February to September 2013.”
The SEC accused Mapp of misrepresenting his pre-order figures in order to lure investors and provided some evidence to back up the claims.
At the start of that 2013 round of fundraising, which brought in some $20 million of the $26 million the company raised, Servergy did, in fact, have a nonbinding preorder of 1,000 units from another company.
But that was the only big fish the company had on the line, and when Servergy lost that order after a few months, Mapp didn’t inform potential investors or have the investment solicitation materials updated, according to the SEC.
Two years earlier, which is the period that will be under consideration at Paxton’s trial, nobody was juicing the sales figures. Indeed, after two and a half years of litigation, the special prosecutors still haven’t produced any evidence that Paxton lied to or misled anyone, which is a required element in a fraud case.
In the SEC’s lawsuit against Paxton, the agency was unable to produce any evidence that Paxton had duped anyone. The closest it came was in arguing that when Paxton told potential investors that Servergy was a “great company,” he was telling a half-truth.
The SEC lawsuit provides a window into the eventual prosecution of Paxton, as the state and federal cases both rely on the same two witnesses: Paxton’s political enemy, state Rep. Byron Cook, and Cook’s friend Joel Hochberg.
The SEC has laid out two arguments that could be used against Paxton: that Servergy’s CTS-1000 servers were obsolete, and that Paxton should have disclosed to investors the fact that he was later given free stock in the company, possibly as compensation for recruiting them.
The first one matters if you want to argue that Servergy was shady, and selling bunkum. The problem is that the case for the obsolescence of Servergy’s product depends on a mass of technical detail, and is complicated by the fact that even the SEC had to admit that the company “is now generating revenue using the CTS-1000 to sell secure, cloud-based data storage services.”
So there’s a market for the server. It’s just not the market the company said it was aiming for in its promotional materials at the time.
The SEC claimed that a chart in the promotional materials comparing the CTS-1000 with rival products was misleading because it didn’t include an entry for the bus width (32-bit versus 64-bit) of the respective products.
That leaves the argument Paxton should have disclosed to investors that he would be getting stock in the company (if there was, in fact, such an agreement between Mapp and Paxton). The weakness in this argument is that there is no such specific requirement to disclose sales commissions in state or federal law, even as it applies to registered securities brokers.
That means the prosecution will have to argue that some general rule should be applied for the first time in this specific way.
The SEC argued that the law required such disclosure. They used a 1938 case out of New York to find an arguable parallel.
“The bottom line is when you’re selling a stock, you’ve got to disclose you’re making a commission,” SEC attorney Matt Gulde argued in court last year.
Mazzant shot that down, telling him, “You’re basically asking me to create a new general rule” requiring such disclosure.
He declined to do so, instead tossing the case.
Jon Cassidy can be reached at [email protected].