HOUSTON (CN) – The SEC claims two brothers tried to get their Texas oil-production company listed on a major stock exchange with a sham sale of 575,000 shares to their nephew, and concealed the family tie from regulators.
The Securities and Exchange Commission sued Kent P. Watts, 69 and his brother Michael E. Watts, 71, in Houston federal court on Friday.
The brothers made tens of millions of dollars in the 2000s on sales of shares in their former company Hyperdynamics Corp. after uplisting the stock from the over-the-counter market to the New York Stock Exchange, according to the lawsuit.
Unlike companies on the NYSE and the Nasdaq, those selling over-the-counter stocks don’t have to file with the SEC. Over-the-counter stocks usually sell for small amounts of money, so they are called penny stocks.
The commission says in its lawsuit that, buoyed by their success uplisting Hyperdynamics, the Watts brothers tried to do the same thing with Hydrocarb Energy Corp., but Hydrocarb went bankrupt in April 2016, after their alleged scam to hide their controlling stakes in the company unraveled.
Hydrocarb is now a private company with offices in Houston and Namibia, according to its website.
The brothers hatched their plan to take over Hydrocarb in 2013, and put it on paper with a memorandum of understanding they signed in July of that year, according to the complaint.
“In 2013, Mike and his family controlled Hydrocarb. Mike owned more than 5% of Hydrocarb’s stock, which he held in his name and in the name of Geoserve Marketing, another company he owned,” the complaint states. “Three other companies—each one owned by one of Mike’s three children—collectively owned more than 40% of Hydrocarb’s stock. Mike controlled his children’s companies, however, including the Hydrocarb stock held in their names.”
Kent and his immediate family, meanwhile, owned more than 50 percent of HCN, a private Nevada corp. that acquired an oil-and-gas concession in Namibia in 2011, and Kent was that company’s CEO, the SEC claims. The Watts’ plan called for Hydrocarb to buy HCN.
“As specified in the MOU, Mike would own approximately 47% of Hydrocarb’s stock following the acquisition, while Kent and the minority HCN shareholders would own approximately 43%,” the lawsuit states.
To prop up and stabilize Hydrocarb’s share price for the Nasdaq, which requires a minimum $2 closing price for five consecutive business days before it approves a stock to be traded on its exchange, Mike sold or bought 509,780 Hydocarb shares in 2013 and lost more than $18,000 on the transactions, according to the SEC.
A hiccup in the planned merger of the brothers’ companies, which was finalized in December 2013, came in autumn of that year after Hydrocarb paid HCN 575,000 shares in September and another 1.8 million shares the following month, the SEC says.
“With the planned acquisition looming, Kent realized that any Hydrocarb stock held by HCN would become Hydrocarb treasury stock once Hydrocarb acquired HCN. He knew that, if this stock became treasury stock, it would be unavailable for Kent to sell once Hydrocarb achieved the contemplated exchange listing,” the complaint states.
To keep the stock available to sell, the SEC says, Kent tapped his nephew, co-defendant Kirby Caldwell, to be a “straw-man buyer” of the 575,000 Hydrocarb shares. Caldwell bought the shares with a $1 million interest-free promissory note, though his income was “grossly insufficient” to pay the loan, according to the lawsuit.
Kent waited more than a year after the deal to tell the SEC that Caldwell is his nephew and that he, not Caldwell, was repaying the loan, the agency claims.
“The note transaction was simply a device used to conceal Kent’s true ownership and control over the 575,000 shares. In reality, the 575,000 shares were restricted and, therefore, not ‘free trading,’” the complaint states.
The Wattses kept the other 1.8 million shares that Hydrocarb paid to HCN from becoming restricted treasury stock with a similar sham deal, according to the SEC. Kent sold the shares to SMDRE, a Texas company owned by his brother Mike, for a $1.8 million interest-free loan not backed by any collateral.
Throughout their efforts to get Hydrocarb on the Nasdaq, the brothers filed fraudulent documents with the SEC, misled Hydrocarb’s auditor and lied to the company’s transfer agent, the SEC claims. Transfer agents track the people and entities that own a company’s shares, according to the agency.
The SEC apparently caught wind of the alleged scam after a Hydrocarb director moved during a July 2014 board meeting to remove Kent as executive chairman of the board, amid concerns he shared with two other directors.
“These directors believed the Watts family’s majority ownership of Hydrocarb shares made outside investment more unlikely. And they had lost confidence in Kent’s leadership after he failed to uplist Hydrocarb’s stock to an exchange,” the lawsuit states.
Kent blocked a vote on the motion with a procedural move, the SEC says, and three of five board members resigned.
Hydrocarb then broke the rules by not telling the SEC the trio resigned because of their squabble with Kent, according to the lawsuit.
The SEC seeks civil penalties for alleged violations of the Exchange and Securities Acts and an injunction to bar Kent from leading any company required to file reports with the commission or register securities with it.
Courthouse News got a busy signal on multiple calls it made to Hydrocarb’s Houston office on Monday.