STATE OF FLORIDA

DIVISION OF ADMINISTRATIVE HEARINGS

DEPARTMENT OF BANKING AND ) FINANCE, DIVISION OF SECURITIES ) AND INVESTOR PROTECTION, )

)

Petitioner, )

)

vs. ) Case No. 96-1862

)

ZUMA ENGINEERING CO., INC., )

a Florida Corporation, and )

MICHAEL J. GRUTTADAURIA, )

)

Respondents. )

)

RECOMMENDED ORDER

Pursuant to notice, the Division of Administrative Hearings, by its designated Administrative Law Judge, David M. Maloney, conducted a final administrative hearing in this case on September 9, and 10, 1997, in Tampa, Florida.

APPEARANCES

For Petitioner: Josephine A. Schultz

Chief Counsel

The Fletcher Building, Suite 526

101 East Gaines Street Tallahassee, Florida 32399-0350

For Respondents: Michael J. Gruttadauria, pro se

1908 Downing Place

Palm Harbor, Florida 34683 STATEMENT OF THE ISSUES

Whether Respondents, Zuma Engineering Company, Inc., ("Zuma") and Michael J. Gruttadauria, sold securities in Florida in violation of Sections 517.07 and 517.12, Florida Statutes?

Whether Respondents, in connection with the offer and sale to

Florida investors of Zuma promissory notes, (whether the notes constituted securities or not) violated the anti-fraud provisions of Section 517.301(1)(a), Florida Statutes? Whether Mr.

Gruttadauria, as President of Zuma, may be held responsible for Zuma's corporate acts even if Mr. Gruttadauria did not have direct knowledge of them?

PRELIMINARY STATEMENT

On April 17, 1996, the Division of Administrative Hearings received a letter from the Department of Banking and Finance.

The letter requested that a hearing officer (administrative law judge) be assigned to conduct proceedings in a matter captioned as:

Re: ZUMA ENGINEERING CO., INC., a Florida corporation, MICHAEL J. GRUTTADAURIA, JEFFREY GEORGE TURINO, ROBERT DARREN CARLSON, MICHAEL FAY MANN, CHARLES FRANCIS PERKS and MICHAEL

T. GARRETT.

Letter of Assistant General Counsel Ellen C. Marino, Department of Banking and Finance, dated April 16, 1996.

Attached to the letter were copies of a document entitled, "Administrative Complaint and Notice of Intention to Issue Cease and Desist Order and to Impose Administrative Penalties and Notice of Rights" (the "Administrative Complaint"). Also attached were copies of petitions for formal administrative proceedings filed by Michael J. Gruttadauria and Jeffery Turino in response to the administrative complaint.

The case was assigned to the undersigned and set for hearing September 10 through 13, 1996, in Tampa, Florida. Final hearing was continued pursuant to a Joint Motion for Continuance, re-set and continued again. It finally reached hearing one year later, on September 9 and 10, 1997. In the meantime, petitions for formal administrative proceedings were received by other parties named in the Administrative Complaint. By the time the case reached hearing, however, the cases of the Respondents other than Zuma and Mr. Gruttadauria had been resolved with the Department.

At hearing, the Department presented the testimony of five witnesses, John Michael Brown, area financial manager for the Department's Division of Financial Investigations; Mary M. Delano, a financial investigator in criminal enforcement in the Department's Central Florida Office; Carlyle H. Charles; Nancy Lechner; and Marilyn Blumber Cane, Professor of Law at Nova Southeastern University, expert in Securities Law. The Department also offered 18 exhibits, Petitioner's Exhibit Nos.

1 -18, each of which was admitted into evidence in its entirety with the exception of Petitioner's Exhibit No. 11, which was admitted as to pgs. 3 and 4, only.

Respondents recalled Mr. Brown and Ms. Delano as witnesses and Mr. Gruttadauria testified in behalf of Respondents.

Respondents offered two exhibits. Respondents' Exhibit No. 2 was admitted into evidence, but following an objection from the Department, Respondents' Exhibit No. 1 was ruled inadmissible.

The record was held open for the late filing of the Department's Certificate regarding the registration status of Jeffrey George Turino. The exhibit has been marked as Petitioner's Exhibit No. 19 and is admitted into evidence.

Proposed Recommended Orders were timely served by both parties. Petitioner's was received on October 7, 1997, and Respondents' was received on October 14, 1997.

FINDINGS OF FACT

The Parties The Department

1. Petitioner, the Department of Banking and Finance, Division of Securities and Investor Protection, is the state agency mandated by the Florida Securities and Investor Protection Act, Chapter 517, Florida Statutes, to "administer and provide for the enforcement of all the provisions of [Chapter 517]." Section 517.03, Florida Statutes.

   Zuma

   
   

2. Respondent Zuma Engineering Co., Inc., is a Florida corporation that has ceased operating and is no longer in business. Its last known address was 11700 Belcher Road South, Largo, Florida 34643.

3. In the early part of this decade, Zuma's business operation was to consist primarily of the recycling of scrap rubber tires through a manufacturing process that produced crumb rubber to be used in the construction of roads. Zuma had other

   revenue components planned as well: picking up tires from used tire dealers, shipping used tires to overseas dealers, collecting factory on-site dump fees for used tires, and pursuing the manufacture of rubber mulch to be used in playgrounds.

   Michael Gruttadauria

   
   

4. Mr. Gruttadauria is the President of Zuma.

   
   

   Mr. Gruttadauria has been the President of Zuma since its inception, that is, since the day Zuma was incorporated.

   
   

   Former Respondents

   
   

5. Jeffrey George Turino was Zuma's Chief Financial Officer. He had been a licensed securities dealer at some time prior to 1990 but his license lapsed. Mr. Gruttadauria relied on Mr. Turino for the raising of capital for Zuma through the sale of promissory notes.

6. The other former respondents were selling agents for Zuma. Several of them were insurance salesmen who benefited from pre-existing relationships with insurance business clients to sell them promissory notes as investments in Zuma.

7. For example, former Respondent Darren Carlson was Nancy Lechner's mother's insurance agent. Carlson sold Ms. Lechner's mother nursing home insurance. In the course of their business relationship, both Ms. Lechner and her mother learned that

   Mr. Carlson also sold annuities and offered other investments. Ms. Lechner, a nurse, and her mother, "were looking for . . .

   investments that paid a little more interest than what the banks would pay, and he mentioned Zuma to us." (Vol. 1, Tr. 118.)

   Mr. Carlson told Ms. Lechner it was "a recycling company. They had very unique equipment that made tires into mulch and rubber that went back into the roads, . . . I had heard of recycling on the TV and how fantastic it's doing. So we invested in it." (Vol. 1, Tr. 119).

8. Mr. Carlson did not give Ms. Lechner and her mother a business plan, an offering circular or a prospectus, but after hearing of their concerns over whether the investment was safe or not, "he told us that if anything were to happen to the company that there is always the equipment, which was worth a lot of money, that we would get our money back." (Vol. 1, Tr. 120.)

9. Ms. Lechner and her mother invested $47,000 in Zuma in 1995. In return, they received promissory notes. At the time of the investment, they did not understand that they had loaned the money to Zuma. They were not told that the equipment, which supposedly ensured the safety of the investment, was pledged, collateralized or leased. Had they known Zuma did not own the equipment, they would not have made the loan. Importantly, too, they were not told that there were approximately $2,000,000 in outstanding promissory notes at the time they invested.

   Mr. Carlson also failed to tell Ms. Lechner and her mother that Zuma had applied for but not yet received a state permit necessary to carry out its operation of producing crumb rubber.

   Had Ms. Lechner known about the lack of a permit, she would not have invested in Zuma.

10. After the investment was made, Ms. Lechner and her mother did not receive any interest payments as required by the notes. Nor have she or her mother ever received re-payment of any of the principal. Their $47,000 has been lost. The only contact initiated by the company after the investment was a newsletter claiming that 1995 had been an explosive year for Zuma with a major tire company considering investment in Zuma and entry into a joint venture research agreement with the University of South Florida's College of Chemistry.

    
    

    Bad Business From the Start

    
    

11. Zuma was undercapitalized from the beginning. Zuma did not have the millions of dollars necessary to conduct a successful crumb rubber factory. It did not own its equipment nor did it own the property on which the business was sited.

12. Zuma's business never turned a profit either. In fact, its revenue never came close to approaching what was necessary just to break even. From 1990 through 1993, it had significant losses. For these four years, tax returns show revenue of only

    $37,000. Total expenses for the four years amounted to $572,000. Of these expenses, commissions paid to agents who obtained capital by selling promissory notes executed by Zuma amounted to

    $248,000. During the same time period, Zuma paid out over

    
    

    $117,000 in interest. Zuma's financial picture was portrayed at hearing in bleak terms by Mary M. Delano, the Department's financial investigator who had reviewed Zuma's financial records:

    [T]he business was operating at a large loss and . . . the revenues were far below what was necessary to maintain the operations of the business.

    
    

    . . . with a commissions and interest expense of that significance . . . the borrowings of the company were significant and . . . the cost of those borrowed funds were significant, also.

    
    

    Vol. 1, Tr. 80.

    
    

13. Zuma's financial picture did not improve after 1994. But Zuma continued to obtain loans through promissory notes mainly from elderly people like Ms. Lechner's mother. Loans evidenced by promissory notes for the period of time from 1991 through 1995 totaled nearly three million dollars.

    Promissory Notes

    
    

14. Because it did not have adequate capitalization, Zuma, through its principals, employees, associates and agents offered to sell and did sell promissory notes to finance its operation. Most had a maturity date in excess of nine months. The face value of the notes ranged from $25,000 to $170,0000. They were sold to Florida investors.

15. Typical of these investors was Carlyle H. Charles' mother. She invested over $105,000 in Zuma for which she

    received a promissory note. The note was executed on June 5, 1997, the day after her 91st birthday.

16. The funds in the case of Mr. Charles' mother came from surrender of two annuities. Even with interest which should have been paid, Mr. Charles' mother would have lost over $6,000 the first year of the life of the loan because of surrender penalties imposed by the annuity companies. Had Mr. Charles' mother understood that she would have lost so much money the first year from surrender penalties, there is "no way" (Vol. 1, Tr. 103,) that she would have loaned or invested the money in Zuma. The surrender penalty was not explained to Mr. Charles' mother by the insurance agent who had established the annuities for her. Nor was it explained by Darren Carlson who actually sold the promissory note to Mr. Charles' mother. She did not realize, moreover, the nature of the investment in Zuma. After discussion with Carlson, she thought that she had either entered new annuities or had the old ones adjusted to improve her payments.

17. Mr. Charles' mother has never received any interest payments on the promissory note or repayment of any of the principal. Any possibility of re-payment has dimmed to the point of hopelessness now that Zuma is out of business.

18. All told, Zuma sold more than seventy notes to more than forty investors. Most of these were elderly people, retirees and widows, in their seventies and eighties, who did not understand the full import of the investments in Zuma. None of

    Zuma investors were provided with an offering circular, a prospectus or a financial statement about Zuma.

19. While these investors lost all of their investments, Mr. Carlson and Zuma's other selling agents were paid handsome commissions for the sale of Zuma promissory notes, usually between 10 percent and 15 percent of the face value of the notes.

    Registration with the Department

    
    

20. Zuma's promissory notes were not registered as securities with the Department pursuant to Chapter 517, Florida Statutes.

21. Neither Zuma nor Mr. Gruttadauria have ever been registered with the Department to sell securities.

    Mr. Gruttadauria's involvement

    
    

22. Mr. Gruttadauria relied on Mr. Jeffrey Turino, Zuma's Chief Financial Officer, with regard to the sale of the promissory notes. Prior to an investment being made, Mr. Gruttadauria never met or talked with an investor except for Jack Wheeler. In Mr. Wheeler's case, Mr. Gruttadauria met with Mr. Wheeler and Mr. Turino before the promissory note was executed and, at Mr. Wheeler's insistence, Mr. Gruttadauria signed the note both on behalf of Zuma and personally.

23. Mr. Gruttadauria also signed every promissory note on behalf of the corporation. Many of these notes were signed long after Zuma's financial condition had become desperate. During this time, Mr. Gruttadauria saw the selling agents as often as

    once or twice a week. He did not ask them who the investors were or what their interest in investing in Zuma might be.

    Mr. Gruttadauria wanted to know as little as possible about the people who were investing large sums of money in his failing business.

24. Nonetheless, Mr Gruttadauria recognized his responsibility for the financial affairs of Zuma in October of 1995 when he sent out the newsletter received by Ms. Lechner. In the closing paragraphs of a 5-page letter trumpeting Zuma's environmental achievements and advances in the areas of the market place, personnel, finance, and research the following appears:

    The reason this newsletter is so long, is that Michael G., [Mr. Gruttadauria], thought others had been sent out since last October, and it turns out I was misinformed on this and other matters, by an employee no longer with the firm. [T]he bottom line is that I have the ultimate responsibility of everything that has or has not now returned to a "hands on" mode in regard to the financial aspects of Zuma.

    * * *

    
    

    My attitude is that without you, Michael G., and Zuma would not only be where they are "today", but would never be able to get where we going "tomorrow". You have every right to receive accurate, truthful answers to any and all of your questions regarding Zuma.

    
    

    Thank you for "Today" and thank you again for "Tomorrow".

    
    

    Zuma Engineering Co., Inc. Michael J. Gruttadauria President/Founder

    Petitioner's Exhibit No. 18, (emphasis added)

    
    

25. To this day, with minor exceptions, all the promissory notes signed by Mr. Gruttadauria are in default.

    CONCLUSIONS OF LAW

    
    

26. The Division of Administrative Hearings has jurisdiction over the parties and the subject matter of this proceeding. Section 120.57(1), Florida Statutes.

27. The Department bears the burden of proving the allegations in its Administrative Complaint by clear and convincing evidence because it intends to impose penal sanctions on Respondents Zuma and Gruttadauria. Department of Banking and Finance v. Osborne Stern & Co., 670 So. 2d 932 (Fla. 1996).

    Promissory Notes in this Case Are Securities

    
    

28. The term "security" is defined by the Act as, "[a] note." Section 517.021(17)(a), Florida Statutes. According to the Department's expert, there is a presumption that any corporate note having a maturity in excess of nine months is a security. The presumption is rebuttable but Respondents have not attempted to rebut it. (Although Mr. Gruttadauria claimed not to know that the promissory notes were securities at the time of their sale, he accepts their status as securities after hearing the testimony of the Department's expert. See page 10 of Respondent's Proposed Recommended Order.) The promissory notes sold by Zuma and its selling agents in this case are securities.

    Sale of Unregistered Securities

    
    

29. Section 517.07 provides,

    
    

    "No securities except of a class exempt under any of the provisions of s. 517.051 or unless sold in any transaction exempt under any of the provisions of s. 517.061 shall be sold or offered for sale within this state unless such securities have been registered . . . and unless prior to each sale the purchaser is furnished with a prospectus . . .

    The promissory notes were sold by Zuma and its selling agents. The securities were not registered. The notes were not exempt from registration under Section 517.051 nor were they sold in any exempt transaction. Zuma is in violation of Section 517.07, Florida Statutes, by failing to register the promissory notes in this case as securities and by failing to furnish the purchasers of the notes with a prospectus.

    Sale by Unregistered Dealer or Issuer

    
    

30. Section 517.12(1), Florida Statutes, provides, in pertinent part,

    No dealer, associated person, or issuer of securities shall sell of offer for sale any securities in or from offices in this state

    . . . unless the person has been registered with the department. . .

    
    

    Zuma was not registered with the department. Not only was Zuma the issuer of the securities, it was also a "dealer" as dealer is defined in Section 517.021(6)(a)2., Florida Statutes:

    Any issuer who through persons directly compensated or controlled by the issuer engages, either for all or part of his time, directly or indirectly, in the business of

    offering or selling securities which are issued or are proposed to be issued by the issuer.

    
    

    Zuma is in violation of Section 517.12, Florida Statutes. As both a dealer in securities and an issuer of securities, it sold securities through its selling agents when it was not registered as a dealer or issuer with the Department.

    Fraud

    
    

31. Section 517.301, Florida Statutes, provides:

    
    

    1. It is unlawful and a violation of the provisions of this chapter for a person:

       
       

       1. In connection with the rendering of any investment advice or in connection with the offer, sale, or purchase of any investment or security,. . . directly or indirectly:

          
          

          1. To employ any device, scheme, or artifice to defraud;

             
             

          2. To obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or

             
             

          3. To engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon a person.

          
          

          Zuma has violated the provisions of Section 517.301, Florida Statutes. It obtained money in connection with the offer and sale of investments and securities by means of untrue statements of material facts and by omission to state material facts necessary to keep its other statements from being misleading.

          The transactions involving the sales of the promissory notes

          introduced into evidence in this proceeding and the practices of Zuma and its course of business demonstrated in this case constituted fraud and operated as deceits on the purchasers of the promissory notes.

          Mr. Gruttadauria's Responsibility

          
          

32. Although Mr. Gruttadauria did not participate directly in the sale of the promissory notes, with the exception of the case of Mr. Wheeler, Mr. Gruttadauria was the president of Zuma from its inception. He was responsible to see that its securities were registered and that Zuma, as a dealer or issuer of securities, was registered. He was also responsible for ensuring that purchasers of the securities were provided with a prospectus by Zuma or its selling agents.

33. Mr. Gruttadauria may not have known the investors or the methods of sale by Zuma's selling agents. But he signed every promissory note personally. He was in frequent contact with the selling agents. He knew that Zuma was in desperate financial condition and he had to have known or should have known that no reasonable person, whether elderly and frail or not, would have invested a large sum of money in Zuma if made aware of Zuma's financial difficulty.

34. As stated in Whigham v. Muehl, 500 So. 2d 1374 at 1378 (Fla. 1st DCA 1987), "just as partners are charged with knowledge of a liability for the conduct of a co-partner acting within the

    scope of the partnership, corporate officers and directors are charged with knowledge of corporate conduct and affairs."

    Mr. Gruttadauria is responsible for Zuma's violations of the provisions of Chapter 517, Florida Statutes.

    
    

    Penalty

    
    

35. In addition to cease and desist orders authorized by Section 517.221, Florida Statutes, the Department may also impose an administrative fine against any person found to have violated any provision of this chapter in an amount not to exceed $5,000 for each violation.

36. Zuma and Mr. Gruttadauria are responsible for failing to have Zuma registered as a dealer or issuer of securities. With regard to each promissory note introduced into evidence in this proceeding, moreover, they are responsible for two

violations of the provisions of Chapter 517: failure to register the note and fraud.

RECOMMENDATION

Based on the foregoing findings of fact and conclusions of law, it is RECOMMENDED:

That the Department of Banking and Finance enter a final order ordering Zuma Engineering Co., Inc., and Michael J. Gruttadauria to cease and desist from all present and future violations of Chapter 517, Florida Statutes, and fining them the maximum amount allowable by law: $5,000 for each violation of

the provisions of Chapter 517, Florida Statutes, found above; that is, $5,000 for failure to register Zuma as a dealer in securities and $10,000 times the number of promissory notes introduced into evidence in this proceeding ($5,000 for failure to register each and every note as a security with the department plus $5,000 for the fraud connected with each and every note.)

DONE AND ORDERED this 5th day of November, 1997, in Tallahassee, Leon County, Florida.

DAVID M. MALONEY

Administrative Law Judge

Division of Administrative Hearings The DeSoto Building

1230 Apalachee Parkway

Tallahassee, Florida 32399-3060

(904) 488-9675 SUNCOM 278-9675

Fax Filing (904) 921-6847

Filed with the Clerk of the Division of Administrative Hearings this 5th day of November, 1997.

COPIES FURNISHED:

Josephine A. Schultz, Esquire

Division of Securities and Investor Protection Department of Banking and Finance

526 Fletcher Building

101 East Gaines Street Tallahassee, Florida 32399-0350

Michael J. Gruttadauria 1908 Downing Place

Palm Harbor, Florida 34683

Harry Hooper, General Counsel Department of Banking and Finance Room 1302, The Capitol 01

Tallahassee, Florida 32399-0350

Honorable Robert F. Milligan Comptroller

Department of Banking and Finance The Capitol, Plaza Level Tallahassee, Florida 32399-0350

NOTICE OF RIGHT TO SUBMIT EXCEPTIONS

All parties have the right to submit written exceptions within 15 days from the date of this Recommended Order. Any exceptions to this Recommended Order must be filed with the agency that will issue the Final Order in this case.

Docket for Case No: 96-001862

Orders for Case No: 96-001862