TARGET OIL & GAS CORPORATION AND MICHAEL SMITH v. COMMONWEALTH OF KENTUCKY, DEPARTMENT OF FINANCIAL INSTITUTIONS, DIVISION OF SECURITIESAnnotate this Case
MAY 26, 2006; 10:00 A.M.
TO BE PUBLISHED
C ommonwealth O f K entucky
C ourt O f A ppeals
TARGET OIL & GAS CORPORATION
AND MICHAEL SMITH
APPEAL FROM FRANKLIN CIRCUIT COURT
HONORABLE ROGER CRITTENDEN, JUDGE
ACTION NO. 04-CI-00588
COMMONWEALTH OF KENTUCKY,
DEPARTMENT OF FINANCIAL INSTITUTIONS,
DIVISION OF SECURITIES
** ** ** ** **
KNOPF AND VANMETER JUDGES; BUCKINGHAM, SENIOR JUDGE.1
Target Oil and Gas Corporation and Target’s
president, Michael Smith, (Target) appeal from an order of the
Franklin Circuit Court, entered August 10, 2004, requiring
Target to comply with a subpoena duces tecum issued by the
Senior Judge David C. Buckingham sitting as Special Judge by assignment of
the Chief Justice pursuant to Section 110(5)(b) of the Kentucky Constitution
and KRS 21.580.
executive director of the Commonwealth’s Office of Financial
Target maintains that the subpoena exceeds the
director’s investigative authority and otherwise amounts to an
unconstitutional invasion of its internal affairs.
Target is a Kentucky corporation apparently
headquartered in Danville that engages in the notoriously risky
business of oil and gas exploration.
It finances its
operations, at least in part, by selling shares in its ventures
The Division of Securities within the Office of
Financial Institutions regulates the sale of securities in
Kentucky, and in late 2003 the Division began investigating
unspecified investor complaints against Target.
investigation led to the subpoena at issue in this case,
pursuant to which the Division seeks financial records, records
of Target’s drilling practices, and, in particular, “a list of
all investors [since the inception of the company in 1999] and
the amount of the interest that they each hold.”
In Commonwealth, ex rel. Hancock v. Pineur,2 our
Supreme Court adopted the three-part test for determining the
validity of an administrative subpoena duces tecum first
articulated by the United States Supreme Court in such cases as
533 S.W.2d 527 (Ky. 1976).
Oklahoma Press Publishing Company v. Walling3 and United States
v. Morton Salt Company.4
Quoting from Morton Salt our Supreme
Court noted the similarity between the early stages, at least,
of an administrative investigation and the investigation by a
grand jury and held that the administrative subpoena should be
enforced if the court is satisfied that “the inquiry is within
the authority of the agency, the demand is not too indefinite
and the information sought is reasonably relevant.”5
This standard appears to be satisfied in this case.
With respect to the director’s authority to make the inquiry,
KRS 292.320 makes it unlawful
for any person, in connection with the
offer, sale, or purchase of any security,
directly or indirectly:
(a) To employ any device, scheme, or
artifice to defraud;
(b) To make any untrue statement of a
material fact or to omit to state a material
fact necessary in order to make the
statements made, in the light of the
circumstances under which they are made, not
(c) To engage in any act, practice, or
course of business which operates or would
operate as a fraud or deceit upon any
327 U.S. 186, 66 S.Ct. 494, 90 L.Ed. 614 (1946).
338 U.S. 632, 70 S.Ct. 357, 94 L.Ed. 401 (1950).
Commonwealth v. Pineur, 533 S.W.2d at 529. Cf. United States v. R.
Enterprises, Inc., 498 U.S. 292, 301, 111 S.Ct. 722, 112 L.Ed.2d 795 (1991)
(discussing grand-jury subpoenas and holding that such a subpoena should be
presumed reasonable and thus enforceable unless the resistor shows that
“there is no reasonable possibility that the category of materials the
Government seeks will produce information relevant to the general subject of
the grand jury’s investigation.”).
KRS 292.460 authorizes the director to inquire concerning
potential violations of KRS 292.320.
That statute provides that
the director may, in his or her discretion,
(1) . . . make such public or private
investigations within or outside of this
state as he [or she] deems necessary to
determine whether any registration should be
granted, denied, or revoked, or whether any
person has violated or is about to violate
any provision of this chapter or any rule or
order under this chapter . . .
(2) For the purpose of any investigation or
proceeding under this chapter, the executive
director or any officer designated by him
[or her] may administer oaths and
affirmations, subpoena witnesses, compel
their attendance, take evidence, and require
production of any books, papers,
correspondence, memoranda, agreements, or
other documents or records which the
executive director deems relevant or
material to the inquiry.
An inquiry into potential securities fraud is thus
within the director’s authority as is a subpoena to further that
The subpoena in this case should be upheld, therefore,
provided that it is not too broad and that the material it seeks
is reasonably relevant.
Target does not challenge the
Director’s subpoena as too broad.
The director seeks only about
five years’ worth of financial and operations history.
demand does not seem unduly burdensome.
Those records are
clearly relevant, moreover, to an inquiry into whether Target’s
agents have misrepresented the company’s practices to investors.
Likewise, the investors themselves are relevant, for without
talking to them the investigators will not be able to evaluate
the alleged complaints or Target’s denials of wrongdoing.6
At first glance, therefore, the director’s subpoena
Target contends, however, that the subpoena is
not within the director’s authority for two reasons.
maintains that the director’s authority has been preempted by
the National Security Markets Improvement Act of 1996 (NSMIA).7
As Target correctly notes,
[t]he primary purpose of NSMIA was to
preempt state “Blue Sky” laws which required
issuers to register many securities with
state authorities prior to marketing in the
state. By 1996, Congress recognized the
redundancy and inefficiencies inherent in
such a system and passed NSMIA to preclude
states from requiring issuers to register or
qualify certain securities with state
authorities. . . . To accomplish this
objective, the NSMIA precludes states from
imposing disclosure requirements on
prospectuses, traditional offering documents
and sales literature relating to covered
The federal law includes a saving clause, however,
which permits the states to retain jurisdiction over fraudulent
Tom v. Schoolhouse Coins, Inc., 236 Cal.Rptr. 541 (Cal.App. 1987).
Pub. L. No. 104-290, 110 Stat. 3416 (1996), codified in part at 15 U.S.C. §
Zuri-Invest AG v. Natwest Finance Inc., 177 F. Supp. 2d 189, 192 (S.D.N.Y.
2001) (quoting from Lander v. Hartford Life & Annunity Ins. Co., 251 F.3d
101, 108 (2nd Cir. 2001); other citations and internal quotation marks
Consistent with this section, the securities
commission (or any agency or office
performing like functions) of any State
shall retain jurisdiction under the laws of
such State to investigate and bring
enforcement actions with respect to fraud or
deceit, or unlawful conduct by a broker or
dealer, in connection with securities or
As explained by the Conference Committee,
[t]his preservation of authority is intended
to permit state securities regulators to
continue to exercise their police power to
prevent fraud and broker-dealer sales
practice abuses, such as churning accounts
or misleading customers. It does not
preserve the authority of state securities
regulators to regulate the securities
registration and offering process through
commenting on and/or imposing requirements
on the contents of prospectuses or other
Thus, even if Target’s securities are covered by the NSMIA and
are therefore exempt from the Kentucky registration statutes,
the director is not precluded from investigating claims that
Target may have misled its customers.11
Target insists, however, that the director’s antifraud authority is limited to fraud practiced against Kentucky
It asserts that it does not solicit or sell to
Kentucky investors and thus that in this case even an anti-fraud
15 U.S.C. § 77r(c)(1).
Conference Report, H.R. Conf. Rep. 104-864, 104th Cong, 2d Sess., at 40
(1996), reprinted in 1996 U.S.C.C.A.N. 3920, 3921.
State v. Justin, 779 N.Y.S.2d 717 (N.Y.Sup.Ct. 2003); Zuri-Invest AG v.
Natwest Finance Inc., supra.
inquiry is beyond the director’s authority.
the director is not obliged to accept Target’s denials at face
value; and even if Target’s assertion is true, as noted above
KRS 292.320 makes it unlawful for a Kentucky securities issuer
to practice fraud “upon any person,” not just upon Kentucky
We agree with the Court of Appeals of Arizona that
[a] state has an interest in seeing that its
territory is not used as a base of
operations to conduct illegal sales [of
securities] in other states. Thus, the host
state has an interest in protecting its
reputation as not being the center for
illegal or questionable securities
The director’s investigative authority is not undermined,
therefore, by Target’s assertion that it deals only with out-ofstate investors.
Target’s defensive arsenal is not yet exhausted.
the subpoena in this case does not exceed what is authorized by
statute, it does exceed, Target contends, what is authorized by
In particular, Target maintains that the
subpoena amounts to an unreasonable search in violation of the
Fourth Amendment to the United States Constitution and that it
amounts to an arbitrary governmental act in violation of Section
2 of the Constitution of Kentucky.
Target is correct to the
extent that administrative investigations implicate Fourth12
Arizona Corporation Commission v. Media Products, Inc., 763 P.2d 527, 533
(Ariz.App. 1988) (citation and internal quotation marks omitted).
Amendment and Due-Process protections, but its argument founders
on the fact that the three-part Morton Salt standard discussed
above has been held to satisfy the constitutional requirements.
In Morton Salt the United States Supreme Court expressly held
that an administrative subpoena satisfying the three-part test
shall not be deemed unreasonable for Fourth-Amendment purposes.13
And in Commonwealth v. Pineur,14 the Supreme Court of Kentucky
held that a judicial determination that the administrative
subpoena satisfied the Morton Salt reasonableness standard was
an adequate protection against unconstitutionally arbitrary
Finally, attempting to wrap itself in the mantle of
cases such as NAACP v. Alabama15 that hold that advocacy groups
have First-Amendment rights that may be infringed by
investigations into their membership,16 Target contends that its
First-Amendment rights are violated by that portion of the
director’s subpoena requiring it to provide a list of its
The short answer to this contention is that
“[p]roducing a customer list does not offend the First Amendment
because commercial transactions do not entail the same rights of
338 U.S. at 652-53.
357 U.S. 449, 78 S.Ct. 1163, 2 L.Ed.2d 1488 (1958).
See Roberts v. United States Jaycees, 468 U.S. 609, 104 S.Ct. 3244, 82
L.Ed.2d 462 (1984) (discussing First-Amendment associational rights).
association as political meetings.”17
activities are clearly and solely commercial, the director’s
demand for a list of Target’s investors does not offend the
In sum, because the director’s subpoena is within his
statutory authority to investigate potential acts of fraud and
misrepresentation in the marketing of securities and because it
does not invade any of Target’s constitutional rights, the trial
court correctly ordered that it be enforced.
affirm the August 10, 2004, order of the Franklin Circuit Court.
BRIEFS FOR APPELLANTS:
BRIEF FOR APPELLEE:
Jeffrey W. Jones
William E. Doyle
Office of General Counsel
Office of Financial
United States v. Bell, 414 F.3d 474, 485 (3rd Cir. 2005). See also IDK,
Inc. v. County of Clark, 836 F.2d 1185 (9th Cir. 1988); Tom v. Schoolhouse
Coins, Inc., 236 Cal.Rptr. 341 (Cal.App. 1987); In the Matter of a Witness
Before the Special October 1981 Grand Jury, 722 F.2d 349 (7th Cir. 1983).