Securities Regulation Daily Wrap Up, LITIGATION—Cal. App.: Court reverses judgment in California fraud case for sole purpose of resentencing; denies conviction challenge, (Oct 18, 2022)

By Suzanne Cosgrove

The promissory notes that at the heart of the fraud case were unique but the court said they qualified as investment contracts under the Howey test and the California Corporations Code.

The California Court of Appeals rejected California entrepreneur Gary Jay Harmon’s challenge to two counts of his conviction for securities fraud but agreed he is entitled to resentencing under the recent Senate Bill No. 567, which went into effect on January 1, 2022, and offers resentencing relief (People v. Gary Jay Harmon, October 12, 2022).

Harmon was originally charged with a total of seven counts of felony grand theft and felony securities fraud from several individuals and a California film company in a case that involved a handful of California influencers who were mostly unaware their names were used in Harmon’s sales pitches. The trial court initially sentenced Harmon to 12 years and four months in prison.

Harmon contended his convictions for two counts of securities fraud should be reversed because the promissory notes he used to induce two of the individuals he was accused of defrauding, Mary McGreevy and Jesse Castillo, to send him money were not securities. The court disagreed, concluding that there was sufficient evidence to support the finding that both promissory notes were securities.

Meeting the Howey test. Citing the several cases but focusing on the Howey test, which focuses on whether a vehicle is an “investment contract,” the court noted its three criteria: (1) A person entrusts money or other capital to another; (2) the person who entrusts the money or capital to another does so with the expectation of receiving financial benefit from a common enterprise; and (3) the failure or success of the common enterprise is dependent on the managerial efforts of persons other than the one who entrusted the money or capital.

All three of these Howey tests were met in this case, the court found. McCreevy and Castillo “invested their money in a common enterprise because they tied their fortunes to the success or failure of Harmon’s business ventures.”

“While there is some evidence of negotiation, particularly by Jesse Castillo, in this case, the record reflects that the negotiations were limited in scope and did not extend to the adequacy of the collateral underpinning the transaction,” the court found.

The promissory notes, while unconventional, did not reflect the exchange of consideration present in another case cited, Marine Bank (Black and Marine Bank v. Weaver (1982) 455 U.S. 551), the court said. “Rather, Harmon dangled a too-good-to-be-true investment scheme to two members of the public who happened across his path, and they took the offer on Harmon’s material terms.”

Complicated dealings. In 2010, Harmon formed a nonprofit called the Sobrato Arts Foundation for Education (SAFE), but the group had no connection to the influential Sobrato philanthropic organization based in Mountain View, California. Harmon also formed the for-profit entities ISE Entertainment (ISE) and Luck Films, LLC, and recruited Kerry Wallum, to work for him to help pursue business opportunities. Harmon falsely claimed that Steve Wozniak, the co-founder of Apple Computer, was going “to put up $20,000,000,” which Wallum understood would fund his salary, housing and the business opportunities he and Harmon planned to pursue.

According to court documents, Wozniak later testified that he did not recognize Harmon’s name and denied having a plan or the ability to invest $20 million in ISE. Kenneth Hardesty, a friend of Wozniak’s who helps him review business proposals, said he met with Harmon in an effort to help Harmon form a business plan but said he was unable to make sense of Harmon’s plan. [CSR1] He denied discussing Harmon’s business plan with Wozniak. The purported ISE deal never materialized.

In 2012, at Steve Wozniak’s birthday party, Mary McGreevy met Harmon through Wallum, her friend. Harmon told McGreevy that he ran SAFE, a non-profit. Wallum, in turn, asked McGreevy for “a short-term bridge loan” to ISE to allow it to move forward with a series of initiatives.

McGreevy executed a promissory note that, as she understood it, would secure her a profit on a $140,000 loan, but she secured a return of only $20,000 of her stake.

Harmon also received money from Jesse and Roni Jo Castillo, who owned and operated a small winery that he visited in 2012. Harmon described his work at SAFE and suggested he host SAFE events at the winery. Harmon also let the Castillo’s daughter play a guitar he claimed another of his ventures, Boulder Creek Guitar Company, had built for Willie Nelson. Harmon told the Castillos that Nelson was going to invest in Boulder Creek Guitars and endorse and promote the guitars. Over time, the Castillos viewed Harmon as a connected individual who could open doors for their children to pursue music careers.

Jesse Castillo loaned him $125,000 with a promissory note that included various terms, including annual interest of 10 percent, but he was not repaid.

This is Case No. H047526 (Santa Clara County Super. Ct. No. F1662391).

Attorneys: John H. Deist, Office of the Attorney General, for The People. Jeffrey S. Kross (Jeffrey S. Kross, Attorney at Law) for Gary Jay Harmon.

LitigationEnforcement: Enforcement FraudManipulation InvestorEducation SecuritiesOfferings CaliforniaNews