UPDATE: SEC Settlement Gives Respondent 168 Years To Pay

From January 2007 to March 2012, Schalk violated Section 5(a) and 5(c) of the Securities Act in connection with unregistered offers and sales of at least $1,973,000 of the securities of Raintree Racing, LLC ("Raintree Racing"), and at least $362,000 of the securities of Raintree Thoroughbred Farm, Inc. ("Raintree Farm") to at least sixteen investors in at least six states. In connection with these sales, Schalk made material misrepresentations and failed to disclose material facts to investors concerning (i) the merits and risks associated with the investment, (ii) the speculative nature of the promised 20% return on investment, (iii) the safety of invested principal, and (iv) the financial condition of Raintree Racing. In addition, Schalk prepared Raintree Farm Private Placement Memoranda (PPMs), and prepared and enabled the distribution of account statements to investors that made material misrepresentations and omissions concerning the financial condition of Raintree Farm. Schalk also diverted at least $220,000 of Raintree Racing and Raintree Farm assets to his personal bank account. As a result of the conduct described above, investors lost $1,472,959.

Pursuant to this Order, Respondent agrees to disgorgement of $1,472,959, prejudgment interest of $280,271.55, and a third tier civil penalty of $1,600,000.00 based on the number of investors, and further agrees to additional proceedings to determine his ability to pay. In connection with such additional proceedings: (a) Respondent agrees that he will be precluded from arguing that he did not violate the federal securities laws described in this Order; (b) Respondent agrees that he may not challenge the validity of this Order, including amounts lost by investors and misappropriated by Respondent as stated in this Order; (c) solely for the purposes of such additional proceedings, the allegations of the Order shall be accepted as and deemed true by the hearing officer; and (d) the hearing officer may determine Respondent's ability to pay on the basis of affidavits, declarations, excerpts of sworn deposition or investigative testimony, and documentary evidence. Respondent reserves the right to contest his ability to pay the disgorgement, civil penalties, and prejudgment interest ordered.

IT IS ORDERED that Respondent's ability to pay the amounts set forth in Section V hereof shall be determined by an Administrative Law Judge to be designated by further order as provided by Rule 110 of the Commission's Rules of Practice, 17 C.F.R. § 201.110, and that the Administrative Law Judge may determine Respondent's ability to pay in additional proceedings on motion of the Commission on the basis of affidavits, declarations, excerpts of sworn deposition or investigative testimony, and documentary evidence.

Relying on the public interest factors enunciated in Steadman v. SEC, the Division argues that the sanctions ordered by the Commission "are entirely appropriate." Opp. at 4-6; see Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The Division also argues that Schalk has not convincingly shown his inability to pay disgorgement because he has not accounted for the money he diverted from the Raintree entities and continues to operate Raintree Farm. Opp. at 8. Finally, the Division argues that in light of Schalk's conduct and the public interest, he should be required to pay the penalties imposed. Id. at 9-10.

Schalk denied that he is still operating Raintree Farm, asserting that he does not know why its website is still active. Id. at 3. With regard to the $220,000 he diverted from the Raintree entities, Schalk states that he contributed $350,000 to one or perhaps both of the entities. Id. at 4. He asserts that his attorney told him that he "could recoup those monies." Id. According to Schalk, the $220,000 represents a portion of the funds he "recoup[ed]" with his counsel's blessing. Id. Schalk did not submit a declaration from his counsel in support of this assertion.

I disregard Schalk's assertion that the $220,000 he took from the Raintree entities represents a portion of the funds he "recoup[ed]" with his counsel's blessing. The OIP recites that he diverted these funds without authorization. OIP at 9. Schalk agreed not to contest the amount that he took and further agreed to accept the OIP's allegations as true. Id. at 13. Schalk has therefore failed to account for the $220,000 he took from the Raintree entities.

[REDACTION in the original] I do doubt, however, that he needs what most people would view as a luxury vehicle. This is especially so in light of the fact that he is liable for disgorgement of $1,472,959 and prejudgment interest of $280,271.55.

It may be that Schalk signed this lease before the Commission issued the OIP. But, as he has agreed, by the time he signed the lease, he had already fraudulently induced investors to invest over $2 million. Crediting the cost of a luxury vehicle against Schalk's obligations would effectively encourage people in Schalk's situation to spend extravagantly. I therefore disregard half the amount of Schalk's lease.

During a prehearing conference held in December 2015, I noted that the Commission normally considers a respondent's alleged inability to pay in the course of assessing whether the public interest supports imposing a monetary penalty. Tr. 42. Indeed, in this proceeding, the Commission conducted its public interest analysis before assessing disgorgement and civil penalties. OIP at 13 ("[T]he Commission deems it appropriate in the public interest to impose the [following] sanctions."). The Commission then "institute[d] [these] proceedings to determine Respondent's ability to pay." Id.

The Division nevertheless argues that, regardless of Schalk's purported inability to pay, I could, and should, still order him to pay the full amount of disgorgement and penalties assessed by the Commission. Opp. at 4-6. This is because the Respondent's inability to pay is only one factor in the public interest analysis, and the other factors outweigh any purported inability to pay. Id. at 4-6, 8. In other words, the Division contends that I am permitted to reweigh the public interest factors and conduct my own public interest analysis.5 Tr. 43-44.

I disagree with the Division's argument. The language of the OIP is clear. The Commission "deem[ed] it appropriate in the public interest to impose the sanctions agreed to in the [settlement] [o]ffer, and to institute proceedings to determine Respondent's ability to pay," and therefore directed me to "determine Respondent's ability to pay in additional proceedings." OIP at 13-14 (emphasis added). In other words, the Commission already found it was in the public interest to accept the agreed-upon sanctions and to take Schalk's ability to pay into account. Nowhere in the OIP did the Commission direct me to perform a public interest analysis or to reevaluate whether it was in the public interest to consider ability to pay. Instead, as is made clear in the OIP, the Commission has already assessed the public interest. Id. at 13. If the Commission wanted me to conduct a public interest analysis, it would have specified so, as it has done on many occasions.6 Accordingly, as directed by the Commission, my sole task is to determine whether Schalk has demonstrated an inability to pay the disgorgement and civil monetary penalties assessed.

ORDERED that Russell C. Schalk, Jr. be ordered to pay $20,000 per year towards his

liabilities for disgorgement of $1,472,959.00, a civil money penalty of $1,600,000.00, and prejudgment interest of $280,271.55.

As discussed above, we have carefully reviewed the sworn financial statements and other documentation that Schalk has submitted. Those sworn financial statements indicate that Schalk's liabilities exceed his assets by nearly $200,000. Although Schalk's liabilities may currently exceed his assets, we believe that his future income, including the likelihood of earning commissions in addition to his $65,000 annual salary, and adjustments to his spending habits would enable him to make the $20,000 payments on an annual basis. We have also held that "when conduct is 'sufficiently egregious,' the Commission may impose a sanction despite a demonstrated inability to pay."Based on our review, we agree with the initial decision that requiring Schalk to pay $20,000 per year towards the disgorgement, civil money penalty, and prejudgment interest amounts to which he consented in the Order is in the public interest.

Page 7 of the Opinion

In fairness, there isn't much to criticize about the ALJ's Initial Decision, which was a very sound and forceful document. Moreover, given what was before the SEC's Chair and Commissioners, they likely did right in ordering the $20,000 per year payment by Respondent Schalk.  It's just that we're all left to wonder if this is ultimately an effective regulatory scheme. Can we squeeze blood out of the rock that is Schalk? Maybe, maybe not but the SEC has spoken and Schalk is obligated to make no more than a $20,000 payment per year. Which leaves us with a $3.356 million regulatory bill that the Respondent will now have some 168 years to pay off. Imagine winning a $3.356 million lottery and getting paid $1 a year!

• OIP
• Ability to Pay
• Public Interest
• SEC
• Offer of Settlement
• Initial Decision
• ALJ
• Schalk
• Raintree
• BrokeAndBroker
• Bill Singer