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No. 02-1196

In the Supreme Court of the United States

SECURITIES AND EXCHANGE COMMISSION, PETITIONER

v.

CHARLES E. EDWARDS

ON WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT

JOINT APPENDIX
(VOLUME I)

THEODORE B. OLSON*
Solicitor General
Department of Justice
Washington, D.C. 20530-0001
(202) 514-2217

*Counsel of Record
for Petitioner

MICHAEL K. WOLENSKY*
ETHAN H. COHEN
LAURA J. SAURIOL
KUTAK ROCK LLP
225 Peachtree Street, N.E.
Suite 2100
Atlanta, GA 30303-1731
(404) 222-4600

*Counsel of Record
for Respondents

PETITION FOR WRIT OF CERTIORARI FILED: Feb. 13, 2003
CERTIORARI GRANTED: Apr. 21, 2003

 

UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT

No. 01-10107-DD

SECURITIES AND EXCHANGE COMMISSION,
PLAINTIFF-APPELLEE

v.

ETS PAYPHONES, INC., DEFENDANT
CHARLES E. EDWARDS, DEFENDANT-APPELLANT

DOCKET ENTRIES
_________________________________________________

DATE DOCKET ENTRY
_________________________________________________

12/27/2000 Fee Paid by Appellant Charles E. Edwards

* * * * *

08/28/2001 Brief of Appellant Charles E. Edwards Filed

* * * * *

_________________________________________________
DATE DOCKET ENTRY
_________________________________________________

10/12/2001 Brief of Appellee Securities and Exchange Commission Filed

* * * * *

10/29/2001 Reply Brief Filed (Corrected Reply Brief Filed 11/05/01)

* * * * *

08/06/2002 Opinion Issued

08/06/2002 Judgment Entered

* * * * *

09/20/2002 Appellee Securities and Exchange Commission's Petition for Rehearing and Rehearing En Banc Filed

* * * * *

11/15/2002 Petition for Rehearing and Rehearing En Banc Denied

* * * * *

UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA

No. 00-CV-2532

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF

v.

ETS PAYPHONES, INC., DEFENDANT
AND CHARLES E. EDWARDS, DEFENDANT

DOCKET ENTRIES
_________________________________________________
DOCKET

DATE NUMBER DOCKET ENTRY
_________________________________________________

9/29/00 1 Complaint for injunctive and other relief

* * * * *

9/29/00 3 Emergency motion by plaintiff for asset freeze, preliminary injunction and other equitable relief with brief in support

_________________________________________________
DOCKET

DATE NUMBER DOCKET ENTRY
_________________________________________________

* * * * *

10/11/00 11 Opposition by defendant Charles E. Edwards to motion for asset freeze, preliminary injunction and other equitable relief

* * * * *

10/24/00 20 Answer by defendant Charles E. Edwards to complaint

* * * * *

11/20/00 30 Order by Judge Jack T. Camp granting motion for asset freeze, preliminary injunction and other equitable relief

11/20/00 31 Preliminary injunction order by Judge Jack T. Camp [Entry date 11/22/00]

* * * * *

_________________________________________________
DOCKET
DATE NUMBER DOCKET ENTRY
_________________________________________________

* * * * *

12/27/00 49 Notice of appeal by defendant

* * * * *

1/3/01 53 Amended notice of appeal by defendant

* * * * *

1/10/02 157 Consent to Final Judgment of Permanent Injunction as to defendant ETS Payphones, Inc.

* * * * *

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION

No. 1:00-CV-2532

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF

v.

ETS PAYPHONES, INC. AND CHARLES E. EDWARDS, DEFENDANTS

COMPLAINT FOR INJUNCTIVE AND OTHER RELIEF

It appears to Plaintiff, Securities and Exchange Commission ("Commission" or "SEC"), and it alleges that:

OVERVIEW OF DEFENDANTS' SCHEME

1. This matter involves a fraudulent and unregistered offering of securities by ETS Payphones, Inc. ("ETS") and its chief executive officer, Charles E. Edwards ("Edwards") in violation of the registration and antifraud provisions of the federal securities laws. The scheme is based upon purported investments in customer-owned coin-operated telephones, and has raised approximately $300 million from more than 10,000 investors. ETS offers and sells pay telephones with leaseback contracts. Investments are offered and sold in units involving a telephone, site lease, lease/back agreement and buy/back agreement. The investments constitute investment contracts and therefore are securities. The investment program has operated as a Ponzi scheme, i.e. a scheme whereby returns are paid to investors from monies contributed by later investors.

2. No registration statement has ever been filed in connection with the securities.

3. Selling materials issued to investors state that pay phones are a profitable business. Edwards has represented to investors that ETS is profitable. In fact, ETS is operating in the manner of a Ponzi scheme and is incurring significant net losses from payphone operations.

4. ETS is dependent on the sale of new payphone investments in order to meet its current financial obligations, such as investor lease payments and refunds.

5. An ETS disclosure document given to investors grants the investor the right to sell their payphone back to ETS for the original purchase price. However, ETS does not have the financial resources to purchase the phones if a significant number of investors request refunds.

6. Based on the foregoing, the Commission is seeking an order prohibiting the destruction of documents, preliminary and permanent injunctions, accountings, disgorgement together with prejudgment interest, and civil penalties against ETS and Edwards and an asset freeze as to Edwards, based on violations of Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933 ("Securities Act"), [15 U.S.C. 77e(a), 77e(c) and 77q(a)] and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. 78j(b)] and Rule 10b-5 [17 C.F.R. 240.10b-5] thereunder.

JURISDICTION AND VENUE

7. The Commission brings this action pursuant to Sections 20(b) and 20(d) of the Securities Act [15 U.S.C. 77t(b) and 77t(d)] and Sections 21(d) and 21(e) of the Exchange Act [15 U.S.C. 78u(d) and 78u(e)] to enjoin the defendants from engaging in transactions, acts, practices and courses of business alleged in this complaint, and transactions, acts, practices, and courses of business of similar purport and object, for disgorgement or illegally obtained funds and other equitable relief, and for civil money penalties.

8. The Court has jurisdiction of this action pursuant to Sections 20(b), 20(d) and 22(a) of the Securities Act [15 U.S.C. 77t(b), 77t(d) and 77v(a)] and Sections 21(d), 21(e) and Section 27 of the Exchange Act [15 U.S.C. 78u(d), 78u(e) and 78aa].

9. The defendants, directly and indirectly, made use of the mails, and the means and instrumentalities of transportation and communication in interstate commerce, in connection with the transactions, acts, practices and courses of business alleged in the complaint.

10. Certain of the transactions, acts, practices and course of business constituting violations of the Securities Act and the Exchange Act have occurred in the Northern District of Georgia, including the solicitation of investors who reside within the Northern District of Georgia. Furthermore, defendant ETS is situated in and defendant Edwards resides within the Northern District of Georgia.

11. The defendants, unless restrained and enjoined by this Court, will continue to engage in the transactions, acts, practices and courses of business and similar purport and object.

THE DEFENDANTS

12. ETS Payphones, Inc. is a Georgia corporation formed in October 1994. Edwards owns ninety-nine percent of the ETS shares outstanding. ETS claims that it currently owns or operates 47,000 private payphones in 32 states. ETS's offices are located in Lithia Springs, Georgia, an Atlanta suburb. ETS filed a voluntary petition under Chapter 11 of the bankruptcy code on or about September 11, 2000.

13. Charles E. Edwards, age 61 and a resident of Duluth, Georgia, is the founder and chairman of ETS. ETS sales documents state that Edwards has over thirty years of experience building successful sales organizations and that he has spent the last nine years in the telecommunications industry.

FACTS

A. The ETS Investment Program

14. Beginning in or about October 1994 until on or about September 11, 2000, ETS under the direction of Edwards, offered "pay telephone" investments to the general public. Investments were offered in units, which include a pay telephone, a site location, a lease/ back agreement, and a buy/back agreement.

15. Each unit was sold for $6,750. ETS received $5,250. The marketing company received the difference.

16. The investments have been sold through various means, including sales agreements with marketing companies. The marketing companies have made arrangements with licensed insurance agents to market and sell the ETS payphones.

17. The marketing companies or their agents have made the sale and ETS and its subsidiary PSA, Inc. has purportedly assigned a payphone to the investor.

18. There has been as much as a three-month lag between the time an investor purchased his payphone until the time he actually was assigned the payphone.

19. ETS manages the operations of the payphones, and currently has approximately 47,000 payphones under management.

20. ETS and the marketing companies have used the mails and other jurisdictional means to market the investments.

21. ETS operates a website which contains statements such as "there are millions to be made from owning pay phones" and describe payphone ownership as "virtually recession-proof" and offering a "steady, immediate cash flow."

22. Many of the investors are elderly. Substantially all have no experience managing payphones and are dependent upon the experience and resources of ETS to obtain the promised return.

23. ETS and the marketing companies have offered three basic programs for payphone purchasers. However, the program recommended by the selling agents and the program that substantially all investors have subscribed to is called the Payphone Equipment Lease Program ("lease program").

24. Under this agreement, the investor purchased a payphone and entered into an agreement to lease the payphone back to ETS for a period of sixty months (the investor becomes the lessor and ETS becomes the lessee of the payphone). ETS agreed to pay the investor a lease payment of $82 per month per unit over the sixty-month period. These lease payments represent a 15% annual return to the investor, and are to be paid regardless of the revenue obtained from the specific payphone owned by the investor.

25. At the end of the sixty-month period, the investor had the option of renewing the lease or selling the payphone back to ETS for a full refund of the investment amount.

26. ETS also offered a full refund within 180 days of the investor's request during the initial sixty-month period.

27. During the term of the lease, the investors can cancel their leases upon 90 days notice and take possession of their phones.

28. Investors under the lease program have no involvement in the operation of the pay telephone site.

29. ETS manages and maintains the payphones, including interior and exterior maintenance as well as coin retrieval. Title to the phone and all tax advantages purportedly remain with the investor.

30. Under the lease program, ETS has the right to move the phone from one location to another.

31. The second alternative program, which was purportedly available but hardly ever sold, was called the Internal Maintenance Program ("internal program"). Under the internal program, investors would be responsible for external maintenance, including general appearance of the telephone and of the site, as well as collection of the coins. Under this program, ETS would manage internal telephone monitoring and determine the service needs of the telephone. ETS would be responsible for sending service technicians to make necessary repairs, and for reporting repairs and non-coin revenues (such as from credit cards or telephone cards) to the owners on a monthly basis. ETS would perform these services for a fixed monthly fee. Under this alternative the return to the investor would, at least hypothetically, vary depending on the revenues received by the assigned telephone.

32. As a third option, ETS also purported to offer to sell telephone equipment with no associated agreements. However, this option, like the internal program, was hardly ever sold.

33. The lease program units are securities. ETS has never filed a registration statement with the Commission in connection with the offer and sale of these securities. No exemption from registration is applicable.

34. At least some ETS sales package included a selling brochure and a "Basic Disclosure Document Presented by ETS Payphones, Inc." (the "disclosure document"), which was presented to investors and potential investors at Edwards's direction.

35. The selling brochure includes general information about the payphone industry and includes discussions about the "profitability" of payphones.

36. The disclosure document contains brief descriptions of the company, brief biographies of management, and descriptions of the payphone management options available to investors. It also includes copies of the "telephone equipment lease agreement" and "the option to sell agreement" to be signed by ETS and the investor.

37. ETS also has a website on the Internet which includes three brief sections describing the business of ETS, the payphone industry generally and the "profitable opportunities" of payphones.

38. The ETS selling brochure contains statements in bold print such as "watch the profits add up" and "why are pay phones so profitable." The selling brochure also contains a table entitled "Incremental Economics of a Medium-Volume Pay Phone" which shows a positive gross margin of $164 per month.

39. On July 1, 2000, Edwards sent a document to investors which represented, among other things, that ETS was profitable. Edwards also verbally represented to investors that ETS was profitable.

40. Unaudited financial statements of ETS as of December 31, 1998, March 31, 1999 and June 30, 2000 reveal that ETS has consistently been in a precarious financial situations and that payphone operations were not profitable. At all times during the course of the scheme, Edwards was aware of the true financial condition of ETS.

41. For example, ETS financial statements prepared in accordance with generally accepted accounting principles revealed that ETS had a stockholders' deficit of $24,493,531 at March 31, 1999 and that ETS had a net loss from operations of $32,033,347 for the fifteen-month period ending March 31, 1999.

42. ETS has continued to lose money on its telephone operations, and specifically lost more than $33 million from its telephone operations during the first six months of 2000.

43. In fact, ETS has consistently been dependent on the sale of new payphones in order to meet its lease and refund obligations.

44. The financial conditions of ETS and its dependency on new investors has not been disclosed to investors.

45. In its lease agreements, ETS contracted to "buy back" the investor's payphone at any time during the first sixty months of the lease term (the "put option").

46. Pursuant to the lease agreements, the investor must notify ETS of his intention to exercise the put option and is promised a full refund of the investment within 180 days of notification.

47. Additionally, an investor can either renew the lease or receive a full refund at the end of the five-year lease term. ETS is obligated to pay the refunds.

48. If a significant number of investors were to exercise their put options or request refunds at or near the same time period, Edwards knew that ETS did not have the cash to make such payments. Edwards knew that fact but it was not disclosed to investors.

49. During the course of the scheme, Edwards has taken at least a $14 million out of ETS through loans and fees paid to companies controlled by him.

CLAIMS FOR RELIEF

COUNT I

Violations of § 17(a) of the Securities Act
[15 U.S.C. § 77q(a)]

50. Paragraphs 1-49 are hereby realleged and are incorporated herein by reference.

51. From in or about October 1994 through at least September 10, 2000, defendants ETS and Edwards, in the offer and sale of securities, specifically the above-described securities, by use of the means and instruments of transportation and communication in interstate commerce or by use of the mails,

(a) directly and indirectly employed devices, schemes and artifices to defraud purchasers of such securities;

(b) directly and indirectly obtained money or property by means of untrue statements of a material fact or omissions to state a material fact necessary in order to make the statements made, not misleading; and

(c) engaged in transactions, practices and a course of business which would have operated as a fraud or deceit upon the purchasers of such securities, all as more particularly described in paragraphs 1-49 above.

52. Defendants ETS and Edwards knowingly, intentionally, and/or recklessly engaged in the aforementioned devices, schemes and artifices to defraud.

53. By reason of the foregoing, defendants ETS and Edwards have violated and, unless restrained and enjoined, will continue to violate § 17(a) of the Securities Act [15 U.S.C. § 77q(a)].

COUNT II

Violations of § 10(b) of the Exchange Act
[§ 15 U.S.C. 778j(b) and Rule 10b-5 Thereunder [17 C.F.R. § 240.10b-5]

54. Paragraphs 1-49 are hereby realleged and are incorporated herein by reference.

55. From in or about October 1994 through at least September 10, 2000, defendants ETS and Edwards, by their conduct as set forth above, singly and in concert, by the use of means and instrumentalities of interstate commerce and by the use of the mails, directly and indirectly:

(a) employed devices, schemes, and artifices to defraud;

(b) made untrue statements of material facts and omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and

(c) engaged in acts, practices and courses of business which operated as a fraud and deceit upon persons, all more particularly described in paragraphs 1-49 above.

56. Said defendants knowingly, intentionally and/or recklessly engaged in the above-described conduct.

57. The statements and representations alleged herein were known to defendants or recklessly disregarded by them to be materially false and misleading. In making the material misrepresentations of fact and material omissions described herein, defendants acted with scienter, that is, with an intent to deceive, manipulate or defraud with reckless disregard for the truth.

58. By reason of the foregoing, defendants ETS and Edwards have violated and, unless restrained and enjoined will continue to violate § 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 thereunder [17 C.F.R. § 240.10b-5].

COUNT III

Violations of § 5(a) and 5(c) of the Securities Act [15 U.S.C. § 77e(a) and 77e(c)]

59. Paragraphs 1-49 are hereby realleged and are incorporated herein by reference.

60. From in or about October 1994 through at least September 10, 2000, defendants ETS and Edwards, directly and indirectly, singly and in concert have, and unless enjoined will continue to:

(a) make use of the means or instruments of transportation or communications in interstate commerce or of the mails to sell the securities described herein, through the use or medium of any prospectus or otherwise;

(b) carry securities or cause such securities, as described herein, to be carried through the mails or in interstate commerce, by means or instruments of transportation, for the purpose of sale or delivery after sale; and

(c) make use of the means or instruments of transportation or communications in interstate commerce or of the mails to offer to sell through the use or medium of any prospectus or otherwise the securities described herein,

without a registration statement having been filed or being in effect with the Commission; including but not limited to, the activities described in paragraphs 1-49 above.

PRAYER FOR RELIEF

WHEREFORE, the Plaintiff Commission, respectfully prays that the Court:

I.

Make findings that each and every defendant committed violations alleged herein.

II.

§ 17(a) of the Securities Act

Issue preliminary and permanent injunctions restraining and enjoining defendants ETS and Edwards, as well as their agents, servants, employees, attorneys and all persons in active concert or participation with them, who receive actual notice of the order of injunction, by personal service or otherwise, and each of them in the offer or sale of any securities by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, from directly or indirectly:

(a) employing any device, scheme, or artifice to defraud;

(b) obtaining 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 the light of the circumstances under which they were made, not misleading; or

(c) engaging in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser of such securities.

III.

§ 10(b) of the Exchange Act and Rule 10b-5 Thereunder

Issue preliminary and permanent injunctions restraining and enjoining defendants ETS and Edwards as well as their agents, servants, employees, attorneys, and all persons in active concert or participation with them, who receive actual notice of the order of injunction, by personal service or otherwise, and each of them in connection with the purchase or sale of securities, by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, from directly or indirectly:

(a) employing any device, scheme or artifice to defraud;

(b) making any untrue statement of a material fact or omitting 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

(c) engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit on any person.

IV.

§ 5(a) and 5(c) of the Securities Act

Issue preliminary and permanent injunctions restraining and enjoining defendants ETS and Edwards, as well as their agents, servants, attorneys, and all persons in active concert or participation with them, who receive actual notice of the order of injunction, by personal service, facsimile or otherwise, and each of them, by use of the mails or any means or instrumentality of interstate commerce, from directly or indirectly:

(a) making use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell securities, in the form or common stock or any other security, through the use or medium of any prospectus or otherwise, unless and until a registration statement is in effect with the Commission as to such securities;

(b) carrying securities, or causing them to be carried through the mails or in interstate commerce, by any means or instruments of transportation, for the purpose of sale or delivery after sale, unless and until a registration statement is in effect with the Commission as to such securities;

(c) making use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy, through the use or medium of any prospectus or otherwise, any interest in securities, in the form of common stock or any other security;

unless a registration statement is in effect with the Commission as to such securities, or while a statement filed with the Commission as to such security is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8 of the Securities Act. [15 U.S.C. 77h];

in violation of section 5 of the Securities Act. [15 U.S.C. 77e].

V.

Order Prohibiting Destruction of Documents

Orders prohibiting defendants ETS and Edwards, their agents, servants, employees, and those persons in active concert or participation with them who receive actual notice of the orders by personal service, facsimile or otherwise, and each of them, from directly or indirectly, tampering with, mutilating, altering, erasing, concealing, removing, destroying or otherwise disposing of any and all books, records, documents, files, correspondence, computer tapes, computer disks, computer diskettes or any other data recordings or any type, however created, produced or stored, relating to, pertaining to or referring to the defendants, their officers, directors, employees and agents, or any financial transactions by either of the defendants or to which either of the defendants was a party.

VI.

Order Requiring Accounting, Freeze of Assets And Disgorgement Of Ill-Gotten Gains

Issue Orders requiring an accounting from the defendants of all funds received from the sale of securities described in this Complaint, an order freezing the assets of defendant Edwards and an order for defendants ETS (to be enforced in ETS's bankruptcy proceeding for so long as it is pending or to be enforced in this proceeding in the absence of a pending bankruptcy), and Edwards to disgorge all ill-gotten gains or unjust enrichment with prejudgment interest, to effect the remedial purposes of the federal securities laws.

VII.

Civil Money Penalties

Issue an Order setting the amount of civil penalties against defendants ETS (to be enforced in ETS's bankruptcy proceeding for so long as it is pending or to be enforced in this proceeding in the absence of a pending bankruptcy) and Edwards pursuant to § 20(d) of the Securities Act [15 U.S.C. § 77t(d)] and § 21(d)(3) of the Exchange Act.

VIII.

Other Relief

Issue findings of fact and conclusion of law in accordance with Rule 52 of the Federal Rules of Civil Procedure, along with such other and further relief as may be just, equitable and appropriate in connection with the enforcement of the federal securities laws and for the protection of investors. Further, the Securities and Exchange Commission respectfully prays that the Court retain jurisdiction over this action in order to implement and carry out the terms of all orders and decrees that are entered or to entertain any suitable application or motion by the Commission for additional relief within the jurisdiction of this Court.

Respectfully Submitted,

/s/ WILLIAM P. HICKS
WILLIAMS P. HICKS
District Trial Counsel
Georgia Bar No. 351649

/s/ EDWARD G. SULLIVAN
EDWARD G. SULLIVAN
Senior Trial Counsel
Georgia Bar No. 691140

COUNSEL FOR PLAINTIFF
Securities and Exchange Commission
3475 Lenox Road, N.E., Suite 1000
Atlanta, GA 30326
(404) 842-7612

 

IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION

No. 1:00-CV-2532

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF

v.

ETS PAYPHONES, INC. AND CHARLES E. EDWARDS, DEFENDANT

ANSWER AND DEFENSES OF DEFENDANT CHARLES E. EDWARDS

Defendant Charles E. Edwards ("Defendant") answers Plaintiff's Complaint for Injunctive and Other Relief ("Complaint") as follows:

FIRST DEFENSE

Plaintiff's Complaint fails to state a claim against Defendant upon which relief may be granted.

SECOND DEFENSE

Plaintiff's Complaint should be dismissed because this Court lacks jurisdiction over the subject matter of Plaintiff's Complaint.

THIRD DEFENSE

Plaintiff's Complaint fails to plead fraud with particularity as required by Rule 9(b) of the Federal Rules of Civil Procedure.

FOURTH DEFENSE

Defendant relied upon the advice of counsel that ETS was not engaged in the offer or sale of securities.

FIFTH DEFENSE

The relief sought in Plaintiff's Complaint is barred, at least in part, by the applicable statute of limitations and the doctrine of laches.

SIXTH DEFENSE

The equitable relief requested in Plaintiff's Complaint is barred by the doctrine of unclean hands.

SEVENTH DEFENSE

Plaintiff is barred from seeking the relief requested by the doctrine of estoppel.

EIGHTH DEFENSE

Defendant, at all times relevant to the allegations contained in the Complaint, acted in good faith and with the intent and desire to comply with the law.

NINTH DEFENSE

Defendant responds to each and every enumerated paragraph of the Complaint as follows:

1.

Defendant denies the allegations contained in paragraph 1 of Plaintiff's Complaint.

2.

Defendant denies that the payphone leases were "securities" as alleged in paragraph 2 of Plaintiff's Complaint, but admits that, because no securities were involved, no registration statement was filed.

3.

Defendant denies the allegations contained in paragraph 3 of Plaintiff's Complaint.

4.

Defendant denies the allegations contained in paragraph 4 of Plaintiff's Complaint.

5.

Defendant denies the allegations contained in paragraph 5 of Plaintiff's Complaint.

6.

Defendant denies the allegations contained in paragraph 6 of Plaintiff's Complaint.

7.

Defendant is without sufficient knowledge or information to form a belief as to the truth of the allegations contained in paragraph 7.

8.

Defendant denies the allegations contained in paragraph 8 of Plaintiff's Complaint.

9.

Defendant denies the allegations contained in paragraph 9 of Plaintiff's Complaint.

10.

Defendant denies the allegations contained in paragraph 10 of Plaintiff's Complaint.

11.

Defendant denies the allegations contained in paragraph 11 of Plaintiff's Complaint.

 

12.

Defendant admits the allegations contained in paragraph 12 of Plaintiff's Complaint.

13.

Defendant denies that he is 61 years old and denies that ETS has "sales documents" utilized for the sale of securities, and admits the remainder of the allegations contained in paragraph 13 of Plaintiff's Complaint.

14.

Defendant denies the allegations contained in paragraph 14 of Plaintiff's Complaint.

15.

Defendant denies the allegations contained in paragraph 15 of Plaintiff's Complaint.

16.

Defendant denies the allegations contained in paragraph 16 of Plaintiff's Complaint.

17.

Defendant denies the allegations contained in paragraph 17 of Plaintiff's Complaint.

18.

Defendant admits the allegations contained in paragraph 18 of Plaintiff's Complaint, except with respect to the use of the word "investor" which implies that a security was involved, which Defendant denies.

19.

Defendant admits the allegations contained in paragraph 19 of Plaintiff's Complaint.

20.

Defendant denies the allegations contained in paragraph 20 of Plaintiff's Complaint.

21.

Defendant denies the allegations contained in paragraph 21 of Plaintiff's Complaint.

22.

Defendant denies the allegations contained in paragraph 22 of Plaintiff's Complaint.

23.

Defendant is without knowledge or information sufficient to either admit or deny what any "marketing companies" or "selling agents" may have done, and admits the remaining allegations contained in paragraph 23 of Plaintiff's Complaint, except with respect to the use of the word "investor," which implies that a security was involved, which Defendant denies.

24.

Defendant denies the allegations contained in paragraph 24 of Plaintiff's Complaint, except Defendant admits that lease payments are to be paid regardless of the revenue obtained from any specific payphone.

25.

Defendant denies the allegations contained in paragraph 25 of Plaintiff's Complaint.

26.

Defendant denies the allegations contained in paragraph 26 of Plaintiff's Complaint.

 

27.

Defendant admits the allegations contained in paragraph 27 of Plaintiff's Complaint, except with respect to the use of the word "investor" which implies that a security was involved, which Defendant denies.

28.

Defendant admits the allegations contained in paragraph 28 of Plaintiff's Complaint, except with respect to the use of the word "investor" which implies that a security was involved, which Defendant denies.

29.

Defendant admits the allegations contained in the first sentence of paragraph 29 of Plaintiff's Complaint and denies the remaining allegations of that paragraph.

30.

Defendant admits the allegations contained in paragraph 30 of Plaintiff's Complaint.

31.

Defendant denies the allegations in the first, second, and sixth sentences of paragraph 31 of Plaintiff's Complaint and admits the allegations in the third, fourth, and fifth sentences of paragraph 31 of Plaintiff's Complaint.

32.

Defendant denies the allegations contained in paragraph 32 of Plaintiff's Complaint.

33.

Defendant denies the allegations contained in paragraph 33 of Plaintiff's Complaint.

 

34.

Defendant denies the allegations contained in paragraph 34 of Plaintiff's Complaint.

35.

Defendant denies the allegations contained in paragraph 35 of Plaintiff's Complaint.

36.

Defendant admits that the "Basic Disclosure Document Presented by ETS Payphones, Inc." contains the matters set forth in paragraph 36 of Plaintiff's Complaint and denies any remaining allegations.

37.

Defendant denies the allegations contained in paragraph 37 of Plaintiff's Complaint.

38.

Defendant is without sufficient knowledge or information to form a belief as to the truth of the allegations contained in paragraph 38.

39.

Defendant denies the allegations contained in paragraph 39 of Plaintiff's Complaint.

40.

Defendant denies the allegations contained in paragraph 40 of Plaintiff's Complaint.

41.

The document speaks for itself. Defendant otherwise denies the allegations contained in paragraph 41 of Plaintiff's Complaint.

 

42.

Defendant denies the allegations contained in paragraph 42 of Plaintiff's Complaint.

43.

Defendant denies the allegations contained in paragraph 43 of Plaintiff's Complaint.

44.

Defendant denies the allegations contained in paragraph 44 of Plaintiff's Complaint.

45.

Defendant denies the allegations contained in paragraph 45 of Plaintiff's Complaint.

46.

Defendant denies the allegations contained in paragraph 46 of Plaintiff's Complaint.

47.

Defendant denies the allegations contained in paragraph 47 of Plaintiff's Complaint.

48.

Defendant denies the allegations contained in paragraph 48 of Plaintiff's Complaint.

49.

Defendant denies the allegations contained in paragraph 49 of Plaintiff's Complaint.

 

COUNT I

50.

Defendant incorporates by reference his above responses to the allegations contained in paragraphs 1-49 of the Plaintiff's Complaint.

51.

Defendant denies the allegations contained in paragraph 51 of Plaintiff's Complaint.

52.

Defendant denies the allegations contained in paragraph 52 of Plaintiff's Complaint.

53.

Defendant denies the allegations contained in paragraph 53 of Plaintiff's Complaint.

COUNT II

54.

Defendant incorporates by reference his above responses to the allegations contained in paragraphs 1-49 of the Plaintiff's Complaint.

55.

Defendant denies the allegations contained in paragraph 55 of Plaintiff's Complaint.

56.

Defendant denies the allegations contained in paragraph 56 of Plaintiff's Complaint.

 

57.

Defendant denies the allegations contained in para-graph 57 of Plaintiff's Complaint.

58.

Defendant denies the allegations contained in paragraph 58 of Plaintiff's Complaint.

COUNT III

59.

Defendant incorporates by reference his above responses to the allegations contained in paragraphs 1-49 of the Plaintiff's Complaint.

60.

Defendant denies the allegations contained in paragraph 60 of Plaintiff's Complaint.

PRAYER FOR RELIEF

Defendant denies that Plaintiff is entitled to any of the relief sought in paragraphs numbered I, II, III, IV, V, VI, VII, or VIII.

DEMAND FOR JURY TRIAL

Defendant demands a trial by jury for all matters triable by jury.

 

WHEREFORE, Defendant Charles E. Edwards, having fully answered Plaintiff's Complaint, respectfully requests judgment be rendered in his favor as to all allegations of the Complaint and that he be awarded attorneys fees and other costs and expenses, as well as such other and further relief as this Court deems just and appropriate. Defendant reserves the right to assert additional defenses as discovery progresses in this action.

Respectfully submitted,

KUTAK ROCK LLP
By: /s/ MICHAEL K. WOLENSKY MICHAEL K. WOLENSKY
Georgia Bar No. 772355
Ethan H. Cohen
Georgia Bar No. 17345
Suite 2100
Peachtree Center South
Tower
225 Peachtree Street, N.E.
Atlanta, GA 30303-1731
(404) 222-4600 (Telephone)
(404) 222-2654 (Facsimile)
Attorneys for Defendant
Charles E. Edwards

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION

No. 1:00-CV-2532-JTC

SECURITIES AND EXCHANGE COMMISSION

v.

ETS PAYPHONES, INC.; CHARLES E. EDWARDS, DEFENDANT

TRANSCRIPT OF PRELIMINARY INJUNCTION PROCEEDINGS BEFORE THE HONORABLE
JACK T. CAMP UNITED STATES DISTRICT JUDGE

 

APPEARANCES:
FOR THE PLAINTIFF:
WILLIAM P. HICKS
EDWARD GARY SULLIVAN
SUSAN SHERRILL
ATTORNEYS AT LAW

FOR THE DEFENDANT EDWARDS:
MICHAEL K. WOLENSKY
ANGELA B. MIELE
ETHAN H. COHEN
ATTORNEYS AT LAW

FOR THE DEFENDANT ETS:
SCOTT SORRELS
SHARON NAGLE
ATTORNEYS AT LAW

* * * * *

[15]

OPENING STATEMENT
BY MR. WOLENSKY.

* * * * *

[17]

Now, there is no allegation here of misappropriation from this company. The SEC says companies controlled by Mr. Edwards got some loans from the debtors. Companies-

THE COURT: Interest free loans, I think was the allegation.

MR. WOLENSKY: I'm sorry?

THE COURT: I believe interest free loans was the allegation.

MR. WOLENSKY: Interest free loans. Mr. Edwards owns all of these companies 100 percent, although there is a dispute about somebody owning a portion of ETS. And that matter is in litigation. But he is the 100 percent shareholder, virtually 100 percent shareholder of all of these companies. And these interest free loans, for the most part, you will hear testimony about that, went to one entity called Twin Leaf, which is a management and holding company, and it has certain subsidiaries that provides support services to the ETS companies. And you will hear how those loans were used. But there is certainly no allegation of misappropriation. Everything is on the books and records of the company. There is no allegation of a secret taking of funds. There is no allegation of looting. There is no allegation of extravagant lifestyles. Everything Mr. Edwards owns is either real estate or in his businesses. He doesn't even have a brokerage account.

* * * * *

[29]

DAVID CRUMPTON

PLAINTIFF'S WITNESS

SWORN

DIRECT EXAMINATION

BY MR. HICKS:

* * * * *

[31]

Q. Judge, I tender Mr. Crumpton as an expert on the financial viability of companies, the general and financial statements of ETS.

* * * * *

[36]

MR. WOLENSKY: Your honor, I would submit, in light of the defendant's lack of training in the area, the lack of authoritative support for the opinions, and the lack of peer review, that expert testimony under the kwomo tire test is not available for this witness, and we would urge the court not to consider him an expert and not accept his testimony.

THE COURT: Mr. Hicks?

MR. HICKS: Judge, I would point out he has had 30 years of doing nothing but this essentially, and I think that makes him, with all his training, makes him more than a sufficient expert to evaluate a set of financial statements.

THE COURT: I am going to overrule your objection, Mr. Wolensky. I think the witness is well-qualified to review the finances and financial statements of the company, and offer his opinion as to whether they are viable in the sense that he defines viability, and has done that over the years. All right.

* * * * *

[39]

Q. What were the totals related to the payphone operations for 1999 and for six months of 2000?

A. For this 18-month period combined, the company had operating revenues from calling operations of about $76 million. The telephone calling operations expenses for this same period was approximately $74 million, which is about 96 percent of revenue.

The company had lease payments to investors during this 18-month period of $52 million, which is about 68 percent of revenue, and had G & A expenses, general and administrative expenses, of about $25 million over this 18-month period which is about 33 percent of revenue. The total cost and expenses that I just listed amount to about $151 million, or 197 percent of the telephone calling operations revenue, thus their losses from these operations is in the range of $74- to $75 million for a negative operating loss of 97 percent of revenue.

Q. If you just isolate, for example, the first six months of the year 2000, what was the loss over that period?

A. The loss over that period was $33 million on revenue of $29 million.

Q. Now, the company also had, did it not, revenue from sales of payphones?

A. It did.

Q. And was what that revenue?

A. For the 18-month period, the company had revenue from payphone sales of approximately $177 million, the cost which I could identify as being cost and expenses associated with the payphone sales, including refunds of leases, was approximately $88 million. So the profits from the payphone sales would equate to $88- to $89 million, or about a 50 percent gross margin, if you want to think of it that way.

Q. Now, to be clear, we are not talking about GAAP or NonGAAP here; correct? We are talking about cash?

A. That is essentially correct. This is not-these are based on the internally prepared financial statements which report payphone sales revenue at the time, essentially, at the time of the transaction itself. The only noncash piece of this that I am aware of would be some relatively minor amounts of depreciation and amortization. And relatively minor, we are talking about perhaps $1- or $2 million.

Q. Now, do you have an opinion with reasonable certainly as to whether the payphone operations, without the input of additional revenues from new sales of payphones, are or have been viable at any time?

A. Certainly for this 18-month period, the payphone operations is a losing-money proposition. The revenues itself as compared to just the cost of the operations and the cost of the lease payments, ignoring G & A completely, is a substantial loss. Perhaps over the 18 months looks like perhaps $50 million loss on $76 million of revenue.

Q. Do you have an opinion with reasonable certainty as to whether ETS was dependent on sales of payphones to new investors to stay afloat?

A. Yes, they were dependent on such sales. In reviewing the company's financial statements, they really had no other significant source of cash coming in the door to stay in business.

Q. Now, is ETS insolvent?

A. Yes, it is.

Q. Can you explain why?

A. This might be an appropriate point to digress and talk about GAAP and NonGAAP. The company's internal financial statements record the sales of the payphones, and the cost and expenses of the payphone sales basically at the time of sale; therefore, they had over this 18-month period about $88 million of profits from payphone sales. Under Generally Accepted Accounting Principals, that accounting treatment is inappropriate and misleading.

Under Generally Accepted Accounting Principals the accountant's, financial accountants's standards board concluded many years ago that these are not sales transactions at all in the economic substance, even though the legal form of it is a sale and lease back. The accounting profession concluded that in fact these are really loans from the investors to the company.

* * * * *

[44]

Q. Did the financial statements indicate any funds transferred to affiliates of the company?

A. They did.

Q. Can you tell us what they reflect?

A. The balance sheet as of June 30th showed accounts receivable due from affiliates of $11.6 million, and investments in subsidiaries of $6.1 million of 6.2 for a total of $17.8 million invested in or advanced to related parties or affiliates at that date.

Q. Is that item identified on any of the financial statements in the notes?

A. The footnotes to one of the financial statements, I believe it was the March 31, 1999 financial statements, indicated that these affiliates were companies controlled by the primary shareholder of ETS, that the loans are noninterest bearing, they are due on demand, and that the affiliates themselves did not have the cash to repay the borrowings.

Q. In addition to those, did the financial statements reflect the payment of fees to affiliates?

A. The footnotes to these March 1999 financial statements indicated that there was a fee paid to one of these affiliates starting January 1, 1999 of $250 for each payphone unit sale. Previous to January 1 of 1999 that figure was $150. The amount paid to affiliates as disclosed in these financial statements for the 15-month period ended March 31, 1999 was $3.1 million. I could not separately identify these fees to affiliates in the subsequent financial statements.

MR. HICKS: I have nothing further from this witness.

THE COURT: Mr. Wolensky?

CROSS-EXAMINATION

BY MR. WOLENSKY:

Q. Mr. Crumpton, you said that the amounts of these loans and fees, those are shown in the financial statements; correct?

A. The loans and to affiliates and to investments in subsidiaries are shown on the face of the balance sheet. The fees are disclosed in the footnotes to the March 31, 1999 financial statements.

Q. And those are financial statements that you got from the SEC; Right?

A. That is correct.

Q. Do you know where the SEC got them?

A. I don't. They were compiled, however, by independent accountants, the Leventhal and Horath firm.

Q. Did you ask-well, you said you didn't ask the company for any information, so you didn't try to find out the detail about this before you testified, did you?

A. I used the documents that were available to me. I did not contact the company and have had no contact with the company.

Q. Now, you testified a few minutes ago that there is some $177 million of recently acquired, in the last 18 months of so, of payphones that were acquired that are under lease that the company has agreed to repurchase on-that's the 180-day notice; is that correct?

A. That is correct. $177 million represents the total of the payphone sales revenue for the 18-month period ended June 30, 2000.

Q. So as an accountant you say, well, they sold $177 million, and they have-or that they've got-so they have an obligation of $177 million because they may have to buy them all back? I mean, that's how you account for that?

A. That is how the accounting profession treats those kinds of transactions.

Q. Do you know what the historical liquidations-you understand that over the years they have been about 1 percent; is that correct?

A. I don't know the historical percentage.

Q. Did you ask the SEC what it was?

A. No, and it is not really relevant from the standpoint of the treatment in the financial statements as current liabilities.

Q. Is it relevant for how the company looks at its business and how much money it is going to have to have to pay liquidations to look at what the historical record has been and how many it may have to liquidate in any given year? If you were running a business, you would want to know that, wouldn't you?

A. Yes. As long as there were sufficient resources to continue in business. If there are not sufficient resources to continue in business, then the historical percentage buy-back of the payphone units would not necessarily hold up.

Q. Well, let's talk about that a minute. Now, at one point you said, in response to Mr. Hick's question, that this company was dependent on payphone sales to new investors to stay afloat.

A. Correct.

Q. Well, you understand this company doesn't sell- ETS doesn't sell payphones to investors. You understand that, don't you?

A. I understand that they sell through distributors who resell to the investors.

Q. Don't you understand that the subsidiary PSA sells phones to distributors, and I think you gave the number of about $5300; right?

A. That is the number that was disclosed in the rescission offer to the Pennsylvania residents.

Q. Do you have any reason to doubt the accuracy of that number:

A. No.

Q. And then the distributors sells that phone or sells the phone, you said it is something like $7,000 to an individual; correct?

A. Yes. And those numbers, as I understand it, have changed over the course of the company's history. The $7,000, however, it was the number disclosed in the November of 1999 rescission offer, and would presumably be pretty current.

Q. And it's gone from $5,000 to $6,000, to $7,000. Is that what you understand?

A. Along those lines.

Q. So the sales that are made by PSA are made to distributors; correct?

A. I am not familiar with the PSA relationship. I do know that the sales are made through the distributors who resell to the investors, as I understand it.

Q. You understand that ETS doesn't sell payphones, don't you?

A. I understand that ETS is recording payphone sales revenue.

Q. ETS and subsidiaries; correct?

A. That is probably correct.

Q. Is there any reason why this company that you know of is required to maintain its internal financial statements using GAAP accounting convention?

A. Internally the company has flexibility to report as it sees fit.

Q. Is this company a public company, as far as you know?

A. Not as far as I know?

Q. It doesn't file reports with the SEC, does it?

A. Not that I am aware of.

Q. And the statements you have seen, the financial statements given you by the SEC, did the SEC advise you those were internal financial statements?

A. Yes.

Q. So if the company chooses to look at its business on a realistic basis, basically a cash basis, as Mr. Hicks called it, money in/money out, and obligations that are set up, that's up to the company to do that to guide its future business; correct?

A. The company can use the cash method if it's so chooses without violating any accounting principles insofar as disclosures, public disclosures.

* * * * *

[52]

Q. You do understand that the distributors in this are not affiliated with ETS in any way?

A. That is my understanding.

Q. Do you also understand once a payphone is purchased the payphone purchaser has the opportunity to select any management company they choose, or to manage it themselves?

A. Yes. I understand that to be an option, however, the company's disclosure in the Pennsylvania rescission indicated that most did not elect those options.

Q. Well, most, from the ones involved here, but there are many other payphones owners that have locations other than those dealing with ETS; correct?

A. Of these people? Of ETS customers? Or just generally.

Q. No. In general. It is a very large business; correct?

A. Yes. There are-right. Yeah. There are many other payphone operators.

* * * * *

[53]

Q. Do you understand that ETS has contracts with numerous well-known convenience stores, gas stations, and companies like that to place payphones at their locations?

A. At site locations?

Q. Yes.

A. Yes, I assume that they did.

Q. Do you know they have thousands of sites out there where they have payphones and they have a large operation of people going out and collecting money and servicing phones; you understand that, correct?

A. Yes. That makes sense.

* * * * *

[57]

CHARLES EDWARDS

PLAINTIFF'S WITNESS

SWORN

DIRECT EXAMINATION

BY MR. HICKS:

A. Charles Eller Edwards.

[58]

Q. Good afternoon, Mr. Edwards. Mr. Edwards, you are, for all intents and purposes the owner of ETS; are you not?

A. Yes, sir.

Q. All right. And you are currently the chairman of the board of ETS?

A. Yes.

Q. And previously you were the CEO of ETS; correct?

A. Correct.

Q. Over what period were you the CEO?

A. Up until approximately four months ago.

Q. From when?

A. From the date we started, which was 1994.

Q. All right. There is also a company called PSA; Correct?

A. Correct.

Q. Is that a wholly-owned subsidiary of ETS?

A. Yes.

Q. What that also under your control?

A. Yes.

Q. Was PSA the entity that technically sold the telephone?

A. They wholesale the phones to the distributors. Yes, sir.

Q. Now, in your capacity as CEO, were you familiar with the sales literature that ETS used?

A. ETS only used sales literature when it went out to obtain locations to put phones. We never sold any pay phones nor did we put out any sales literature to sell payphones.

[59]

Q. Let me show you a document, a copy of which is Exhibit 17. Have you ever seen this document?

A. Yes, sir, I designed it. This was given to people like Diamond Shamrock, or The Circle K, or The Mom and Pop on the corner when we were trying to establish the right to put a phone at their location.

Q. Were you aware that the distributors were using this, a document very similar to this to sell the phones?

A. They were using a similar document that they designed. Yes. But if they were not using that document, not to my knowledge.

Q. You saw their documents also, though, didn't you, sir?

A. Yes, sir.

Q. Were you aware of the financial condition of ETS throughout your tenure as CEO?

A. Yes, sir.

Q. Were you aware, for example, of the amount of revenues coming in from payphone operations versus sales of payphones?

A. Did you hear Mr. Crumpton discuss various financial statements this morning?

Q. Yes, sir.

A. And isn't it a fact that those financial statements were provided to the SEC by ETS?

Q. Yes, sir.

A. Were you also aware that you that ETS was dependent on new investors to sustain its operation?

[60]

A. Yes, sir. As we were set up at that point, yes, sir.

Q. Were you aware that ETS did not have the resources to make good on the puts, if a substantial number of investors chose to make a put, sell the phone back?

A. No, sir, because we had payphones backing up the lease, we had the ability to take those phones to the marketplace and sell them, so we did have the ability to raise funds to, other than the sales, to liquidate the phones.

* * * * *

[62]

Q. Are you the owner of Twinleaf?

A. Yes.

Q. Are you the sole shareholder?

A. Yes.

Q. What does that company do?

A. The company is a management company, that when we saw the revenue dropping two or three years ago in the payphone industry, we chose to diversify to be able to support ETS with products and services that would generate additional revenue as we saw coming down from our payphones. It is a full aixe carrier, legend communications, which is certified to do long distance in 49 states which carries all of the long distance on our ETS phones, and all of our corporate offices. It has a company called TPL which manufactures prepaid calling cards which we sent to each of our payphone owners, a 20-minute prepaid calling card with out check every time, plus they are [63] sold to convenience stores that we have phones in. We have Twin Lead Media, which is-we have a patented-

THE COURT: Excuse me, Mr. Edwards. Tell me again what the name of the company is.

THE WITNESS: Twinleaf, Inc.

THE COURT: Twinleaf:

THE WITNESS: Yes, sir. One word.

THE COURT: Thanks. Excuse me for interrupting you. Go ahead.

THE WITNESS: We have Twinleaf Media, which is a patented kiosk for backlit illumination of advertising on our payphones, which we have contracted with a number of our major chains to put in, mainly in our convenience stores. We have a company called Axis, which is a patented 3-D advertising. We are doing all of the BP and Amoco fountain centers 5,000 stores now, plus we do advertising on the side of the payphones of 3-D imaging. We have-we did have liberty motor sports, which has since been sold that advertised ETS on the NASCAR track. I am trying to remember if I got everything.

Q. Twinleaf is not owned by ETS, is it?

A. No, sir. It was set up-it was designed to support ETS. It was set up mainly for taxes. We have been in discussion with legal and accounting over the last six months prior to this ever happening to consolidate them all in one company, but to go forward with it, because they were designed for ETS's-

[64]

Q. Has Twinleaf borrowed money in ETS?

A. Yes, sir.

Q. What is the current outstanding balance?

A. Approximately $8.1 million.

Q. Are those interest-free loans?

A. Yes, sir.

Q. Are they demand loans, in essence?

A. Correct.

Q. Have any other entities owned by you, separate from the ones in bankruptcy, borrowed money from ETS?

A. The different companies within Twinleaf - not from ETS, no, sir.

Q. Or from PSA?

A. No, sir.

Q. Have they borrowed it from any subsidiary of ETS?

A. Legends may have. I don't know that for a fact, but Legends may have borrowed from PSA or ETS. I don't know for sure, but that would be the only one that I could consider would have.

Q. Did Twinleaf also receive fees from ETS?

A. Yes, sir.

Q. And how much-what is the total of that amount, as close as you can come?

A. We received $250 per phone, my staff. We were not on ETS or nor PSA's payroll. All of my staff, including legal, was all on Twinleaf's payroll; 90 percent of our time was spent managing and [65] working with ETS and PSA and the other companies.

Q. All right, sir, my question was, what was the total amount of fees that Twinleaf received from ETS?

A. I truly don't know, sir. I heard the gentleman say $3 million up here for the last 18 months. I would say that is fairly close.

Q. That was as of March of 1999. Would there be another million or two on top of that since that time?

A. I-we got paid up until we quit selling, and our income stopped when we voluntarily to quit selling, yes, sir.

Q. Did ETS also make investments in Twinleaf or any of those entities?

A. No, ETS made its investments in ETS vending, which is a company that puts out ATM's, and air, and air and vac machines in the convenience stores where we have payphones, and it also invested in POA, which is our limited partnership that owns the phones we have in Mexico.

Q. You mentioned Twinleaf Media. Is that the company that sells advertising kiosks?

A. No, it doesn't sell advertising kiosks. The kiosks are on ETS payphones or other payphones, and it sells the advertising that goes in these kiosks.

* * * * *

[66]

Q. What are Twinleaf's current assets?

A. Well, it wholly owns Legends-are you talking about actual or value?

Q. Value.

A. I would say approximately $13 to $15 million at actual costs.

Q. Now, how much of it that liquid, in cash and securities?

A. Very little of it would be liquid.

Q. So what is the bulk of it made up of?

A. Of actual businesses, operating businesses.

Q. Do any of your entities or yourself own an airplane?

A. No, sir. We leased a plane last year as a third party, three people leased a plane for approximately six months.

Q. What type of plane was that?

A. A Citation II.

Q. Is that a prop plane or a jet?

A. A jet plane.

[67]

Q. Who was it in particular that leased that plane?

A. Actually it was leased by Air Holdings, which is another wholly-owned subsidiary of Twinleaf, and with two other partners, Bullet Bob Turley, the Yankee ex-pitcher, was a partner and Chip McPhearson of Nations Development was the other third party that leased the plane.

Q. And you had a NASCAR racing team also?

A. Yes, sir.

Q. I would like to go into your current assets for a minute. How many houses do you own?

A. Four.

Q. Where are those houses?

A. Actually I own three, I'm sorry. We have one in Kingsport, that is my wife and I do; we have one on Sea Island; and one on St. Simons.

Q. Does your wife own any other houses besides those?

A. Yes. She owns a home in Duluth.

THE COURT: A home where?

THE WITNESS: In Duluth.

BY MR. HICKS:

Q. When were those homes purchased?

A. 1998. And-I think all three of them was purchased in 1998.

Q. About how much-what is the value of each of the houses?

A. The house on Sea Island, which is up for sale, which was an [68] investment, is for sale for $4.2 million. The house on St. Simons, which is also for sale, is 2.95.

Q. Million?

A. 2.95 million. And the one in Kingsport is $185,000.

Q. How about your wife's house? When was that purchased?

A. In 1996 or 1997.

Q. What is the value of that?

A. $6- or $700,000. I think it was bought for $610,000.

Q. All right. Do you have any cash or securities, liquid assets?

A. No. I have probably, cashwise, $2- or $3,000. I have my 401k, a SEP IRA 401, is basically all the cash I have.

Q. How much cash do you have in those accounts?

A. Approximately $21- or $22,000 in the 401; I have $23,000 in the SEP IRA-no, I'm sorry, it's got approximately $29,000. And I also do have approximately $27- or $28,000 cash value life insurance policy also.

Q. How much money did you personally take out of Twinleaf?

A. Last year?

Q. No. Over the course of the ETS operation.

A. The majority of my income came out of Twinleaf this year. Last year I took approximately $1.3 million out of Twinleaf, and this year I would have taken, for ten months-nine months. I'm at $360,000 a year, and I've got nine months of that pay.

Q. How about in 1998?

[69]

A. In 1998 it would be a combination of ETS and Twinleaf. It was approximately $900,000.

Q. You've attached to your affidavit a number of legal opinions.

A. Yes, sir.

Q. How many other law firms did you consult with on the subject of whether it is a security, other than what you've included here?

A. When I first started I worked with a gentleman by the name of Glenville Haldi. Then I worked with Shelley Freeman were the two initial ones I worked with. And then when-I am trying to think-Tom Sherman. I don't know which law firm he is with right now. But I had an opinion from Tom Sherman, then had an opinion from Powell Goldstein also.

Q. You have an opinion from Powell Goldstein or a draft?

A. A draft of an opinion. I'm sorry.

Q. Now, is it your testimony, based on your-based on your affidavit, that at some point some representative of the SEC told you that what you were doing didn't involve the securities laws?

A. No, sir. I did meet with a gentleman with the SEC that made a couple of recommendations to us that we did in fact do, and he said if we did those we would never hear from a regulatory agent, which of course is not true, and that was to give our lessors more control over their asset, and to either diversify [70] myself from the marketing or the leasing, because at that time I controlled both.

Q. Was that your conversation with Mr. Grant?

A. Mr. Larry Grant, yes, sir.

Q. When did this take place?

A. 1995.

Q. How big was your company at that time?

A. I would say we had 2 or 300 payphones at that time.

Q. I take it there was no discussion about Ponzi schemes or anything like that, was there?

A. No, sir.

* * * * *

Q. All right. Would it be true, I guess consistent with your prior testimony, that a 99 percent of the people who rent phones from PSA went into the lease back arrangement.

A. No, sir. But if you restated that a bit, it might be true.

[71]

Q. How would you restate it?

A. Ninety-nine percent of the phones that were sold by the distributors chose to lease phones with ETS.

Q. And just to be clear, when you talk about the distributors, you are talking about these insurance agents and people that sold the things on your behalf?

A. They were independent marketing people that sold a multitude of different products.

* * * * *

CROSS-EXAMINATION

BY MR. WOLENSKY:

Q. Mr. Edwards, I would like to address a couple of items that were raised initially here by Mr. Hicks. Now, is your wife an independent business person?

A. Yes.

Q. She had a business of her own, and had her own income?

A. Absolutely.

Q. And she bought this property with her own money?

A. Yes.

* * * * *

[74]

Q. Mr. Edwards, in connection with the business of ETS, how many employees have you got?

A. Approximately 450.

Q. And how many locations does the company have offices to service telephones?

A. We have 33 offices in the United States, one in Puerto Rico, one in the Virgin Islands, one in St. Thomas, and four in Mexico. And we have approximately 100 employees in Mexico in addition to that, too.

* * * * *

[77]

Q. Can you explain to the judge, please, the types of services, management services, that Twinleaf provides to ETS and PSA?

A. On the legal side, our inhouse counsel worked for Twinleaf so it could advise all the companies. Then, myself, I was the, up until four months ago, I was the CEO and I helped run the day-to-day operations of ETS. I am the CEO and president of PSA.

We-my assistant handled all the cash in from the marketing groups when they purchased equipment, and then she made sure it went to the proper departments, and then she verified with accounting every two weeks when we did lease [78] checks that the proper checks were sent out, and it was tallied. A check and balance system, is what I am trying to say. And it was just overall management. Ninety percent of all my time was spent with ETS and PSA, and ten percent with the other companies that we had.

Q. And this management fee was the management fee that covered all of the services provided over the several years that a telephone might be under lease; is that correct?

A. Correct.

Q. So if the management fee was $250 for a phone, and that phone-

THE COURT: Was that the management fee?

MR. WOLENSKY: That is the current one, your Honor. It was $125.

BY MR. WOLENSKY:

Q. And when was that raised to 250, Mr. Edwards?

A. The first of this year.

Q. The 1st of 2000?

A. Yes.

Q. So currently that $250, if that phone were to stay under lease for five years, all of the management services provided by Twinleaf over that five-year period would be covered in that $250, or about $50 a year; correct?

A. Correct.

Q. Was that the normal expected time of a lease, five years?

[79]

A. No. And I am giving you a personal opinion working based on working with the lessors. We felt the term of our lease would run closer to ten years because I've gotten numerous calls where they wanted to extend their lease prior to even getting to near five years, because we always paid and paid on time.

Q. May I have just one moment, Your Honor?

(PAUSE).

MR. WOLENSKY: That is all I have of Mr. Edwards for now, Your Honor.

* * * * *

[81]

LARRY GRANT

PLAINTIFF'S WITNESS

SWORN

DIRECT EXAMINATION

BY MR.HICKS:

A. Joseph L. Grant.

Q. Good afternoon, Mr. Grant. You were formerly an attorney with the SEC?

A. I was.

Q. And when did you leave?

A. Three years ago, in 1997, August.

Q. And now at some point approximately five years or so ago did you have a meeting or meetings with Mr. Charles Edwards related [82] to a payphone business?

A. I did.

Q. Did you at any time advise him that what he was telling did not involve the sales of security?

A. I certainly did not. As a matter of fact, I indicated that it was my opinion that they were offering an investment contract when he first came in.

Q. Did you offer him any opinion that if he did this or he did that that he would not have any trouble from regulators or that it would be a security?

A. No, I did not.

MR. HICKS: Just a minute, Your Honor.

(PAUSE).

BY MR. HICKS:

Q. Did you have any indication at the time-first of all, did you get any financial information about the company at the time?

A. Did I get any financial?

Q. Yes.

A. I'm not sure. They did provide material. They were cooperative when he came in. I think he came in the first time by himself, and then at a couple of subsequent meetings he was represented by an attorney.

Q. All right. Did-was there any indication at that time that the company was or was going to operate as a Ponzi scheme?

[83]

A. No. Not to my recollection. As a Ponzi scheme? Not to my recollection.

Q. And in fact, how big was the company in terms of the amount of payphones that was represented to you at the time?

A. It was very nominal at that particular time. If I recall, I don't think they had more than 30 investors. If I recall, they were-they had some, to the best of my recollection, they were registered with-either with some state authority, I believe, and had some materials that they were providing to their proposed investors.

Q. Did they indicate to you that they were going to stop selling the investment?

A. They came in subsequently and the attorney said that Mr. Edwards was going to engage solely in the sale of the telephones, and not be involved in the other activities which, in my view, made it an investment contract, which was that they were finding the locations, they were putting the phones in, and servicing the telephones for the investors, so that the investor was merely passive, he simple provided the money for the telephone, although they said that the investor could decide where he wanted to put the telephone himself and arrange for all of his own activities.

Q. So they represented to you they were not going to do all of those collateral activities?

A. That is correct.

[84]

MR. HICKS: No Further Questions.

CROSS-EXAMINATION

BY MR WOLENSKY:

Q. Mr. Grant, when you handled this inquiry was there a file opened on it?

A. An informal, probably MUI, as we called it, Matter Under Inquiry.

Q. Were materials gathered from the company and other places?

A. To the best of my recollection, they provided some materials, I think a list of people that they had obtained monies from for telephones. And as I said, I recall, for some reason, some materials that they had put together, kind of like an offering of materials.

Q. And when you left the SEC you left that file?

A. Yes.

Q. As far as you know, the-

A. I didn't take any files with me.

Q. As far as you know, the SEC still has that file?

A. As far as I know.

Q. Now, the discussion that you had, you understood that there was going to be a split so that the company would not be both engaged in sales and in management of phones. Was that you understanding?

A. That is what the attorney represented.

Q. And in your view would that have eliminated the problem of [85] this being, as you said before, possibly an investment contract?

A. Not necessarily. No.

Q. Did you-

A. I told them that the mere fact that I wasn't recommending any action at that particular time did not mean that they were in compliance with the securities laws, and emphasized, as I normally did in preliminary inquiries, that even if they didn't have to comply with the registration provisions, that there was no exemption from the anti-fraud provisions of the federal securities laws.

* * * * *

[86]

Q. Did the SEC take any action against Mr. Edwards at that time?

A. Not to my knowledge.

* * * * *

 

[89]

JAMES D. BLYTH

DEFENDANT'S WITNESS

SWORN

DIRECT EXAMINATION

* * * * *

[92]

THE COURT: And why in the years of 1993 and 1994 and 1995 was there an apparent expansion of companies in the payphone business?

THE WITNESS: Primarily I believe, Your Honor, due to the 1996 Telecommunications Act. And as part of that act the FCC and their regulations promulgated compensation for dial-around calls, which are 800 calls originated from public payphones. And in the original order the FCC intended for the long distance carriers to pay $45.85 per payphone per month as a surrogate rate while all of the details were being worked out for the per-call compensation. And I think that's the primary reason that there was a proliferation of public payphones during that period of time.

THE COURT: Okay. Who owned the public payphones [93] prior to that time?

THE WITNESS: In 1984, as part of the divestiture, prior to that time, prior to 1984, all of the public payphones were owned by the regional Bell operating companies. As a result of Judge Green's decision, breaking up the Bell operating companies, it allowed for competition.

Between 1985 and 1987 the-we call the Cocot industry, or private independent payphone operations, started up in this country, and there have been a number of companies that have spawned out of that over that period of time. And the overall picture, there is about two-and-a-half million public payphones prior to divestiture, and now there is about 600,000 that are independently owned, and the rest are owned by the regional Bell operating companies.

* * * * *

 

[PLAINTIFF'S EXHIBIT 1]

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION

No. ______

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF

v.

ETS PAYPHONES, INC., DEFENDANT

DECLARATION OF DAVID H. CRUMPTON

I, David H. Crumpton, declare pursuant to the provisions of 18 U.S.C. 1746:

1. I am a Certified Public Accountant who maintains a current license in the State of Georgia. I am a member of the American Institute of Certified Public Accountants and the Georgia Society of CPAs; however, I am not currently engaged in the practice of public accounting.

2. I am a Principal and the Chief Financial Officer of Newleaf Corporation. In that capacity, I have extensive engagement experience as forensic accountant, receiver, bankruptcy examiner, financial advisor to bankruptcy trustees, and other financial consulting services to financially distressed and/or bankrupt business enterprises.

3. My office address is 2810 Spring Road, Suite 106, Atlanta, Georgia 30339. My telephone number is 770-433-9400.

4. I have been asked by the staff of the Securities and Exchange Commission to assist it in providing review and analysis of various financial statements and other documentation provided by ETS Payphones, Inc. ("ETS").

5. I have first hand knowledge of the contents of this declaration.

6. In connection with my duties in conjunction with this matter, I reviewed and analyzed the following unaudited financial statements (the "Financial Statements") of ETS:

a) Unaudited financial statement (labeled drafts) for the year ended December 31, 1998 compiled by independent accountants;

b) Unaudited financial statements for the fifteen month period ended March 31, 1999 compiled by independent accountants;

c) Internally prepared, unaudited financial statements for the year ended December 31, 1999; and

d) Internally prepared, unaudited financial statements for the six months ended June 30, 2000.

7. I have not independently verified the accuracy or validity of the numbers and other information included in the Financial Statements.

8. ETS is engaged in the sale of payphone units ("PPUs"), and ETS leases the PPUs back from the purchasers/lessors (the "Lessors") over five (5) year lease terms. The leases require ETS to pay lease payments to the Lessors on a monthly basis. The lease agreements provide that the Lessor has a "put" option to require ETS to repurchase the PPU at any time during the term of the PPU lease upon 180 days notice for the Lessor's original purchase price.

9. The ETS Financial Statements (except those financial statements for the fifteen month period ended March 31, 1999) show the funds received from the PPU sales to Lessors as income in the accounting period in which the related PPUs are placed in service. This method of accounting does not conform with generally accepted accounting principles which require that the sale and leaseback of the PPUs be treated as capital leases in the Financial Statements. Under the capital lease method of accounting, lease obligations are shown in financial statements as financing arrangements whereby the PPU assets and a corresponding capital lease obligation liability are recorded on the balance sheet in the amount of the discounted present value of the lease payments based on the annual interest factor inherent in the lease. Further, this method of accounting does not permit the cash receipts from the PPU sale transactions to be treated as revenue or as income. (The financial statements for the fifteen month period ended March 31, 1999, purport to conform with generally accepted accounting principles and follow the capital lease method of accounting.)

10. ETS operates and services the operations of PPUs, retains for its own account all of the telephone calls operating revenues, and pays from its own account all of the PPU maintenance and operating expenses.

11. The total operating revenues of ETS from sources other than initial PPU sale transactions (i.e., primarily its telephone calling operations) amounted to ($ in thousands):

Calendar 6 M/E
1999 6/30/2000

Operating Revenues $ 47,381 $ 29,255

12. The total operating costs and expenses of ETS (including general and administrative expenses, but excluding route purchases, equipment purchases, lease refunds, and other costs of initial PPU sale transactions) amounted to ($ in thousands):

Calendar 6 M/E
1999 6/30/2000

Telephone calling
operations expenses $44,538 $29,166
Lease payments 29,517 22,903

General and
administrative
expenses 14,715 10,449

Total operating
costs and
expenses $ 88,770 $ 62,518

13. The Financial Statements indicate that ETS has derived the following amounts of profit from the payphone sales transactions with the Lessors of the PPUs ($ in thousands):

Calendar 6 M/E
1999 6/30/2000
Payphone sales $ 125,634 $ 51,979
Costs of payphone
sales, including
lease refunds __80,590 __8,170
Profits from
payphone sales $ 45,044 $ 43,809

14. ETS's Financial Statements do not reflect any significant sources of cash to ETS other than from the operating revenues set forth in item 11 hereof, which are substantially exceeded by the operating expenses set forth in item 12 hereof, and from the payphone sales transactions with the Lessors of the PPUs set forth in item 13 hereof.

15. The ETS balance sheet reflects accounts receivable from affiliates of $11,629,000 and investments in subsidiaries of $6,192,000 as of June 30, 2000, for a total of $17,821,000 invested in or advanced to related parties or affiliates. These amounts include net increases in such investments and advances of $10,993,000 in calendar year 1999 and $2,391,000 in the six months ended June 30, 2000. The notes to the financial statements for the fifteen month period ended March 31, 1999, state that the accounts receivable due from affiliates consist of loans made to companies controlled by the primary shareholder of ETS, that the loans are non-interest bearing, and that the borrowing entities did not have cash on hand, at that time, to repay the loans.

16. Based on the foregoing financial information, the financial activities of ETS related to the sale and leaseback of PPUs, the operations of the PPUs and investments in, and advances to, affiliates may be summarized as follows ($ in thousands):

Calendar 6 M/E
1999____ 6/30/2000

Summary of Uses of
Cash

Operating Revenues $ 47,381 $ 29,255

Telephone calling
operations expenses 44,538 29,166

Lease payments 29,517 22,903
General and
administrative expenses 14,715 10,449

Total operating costs
and expenses 88,770 62,518

Net losses from
operations 41,389 33,263

Investments in and
advances to affiliates,
net 10,993 2,391

Total operating
losses and payments
to affiliates $ 52,382 $ 35,654

Financing of Operating Losses and Payments to Affiliates-

Payphone sales $125,634 $ 51,979
Costs of payphone sales,
including lease refunds 80,590 8,170

Profit from payphone
sales $ 45,044 $ 43,809

17. The ETS Financial Statements reflect total net income from all activities of $2,490,000 in calendar year 1999 and $10,402,000 for the six months ended June 30, 2000. If the Financial Statements had treated the PPU sale and leaseback transactions as capital leases as required by generally accepted accounting principles, the profits from the payphone sales transaction would not be recognized as income. If the PPU profits from payphone sales of $45,044,000 for calendar year 1999 and $43,809,000 for the six months ended June 30, 2000, were subtracted from the reported net income, then ETS would have reported net losses of $42,554,000 and $33,407,000 in the respective periods. (The statement of operations for the fifteen month period ended March 31, 1999, which purports to follow generally accepted accounting principles, reflects a net loss of $26,770,000.)

18. The balance sheet of ETS as of June 30, 2000, reflects positive stockholders' equity (i.e., total assets in excess of total liabilities) of $12,591,000. If this balance sheet had treated the PPU sale and leaseback transactions as capital leases as required by generally accepted accounting principles, the PPU repurchase obligation under the leases would be recorded as a liability. Since ETS is obligated to repurchase the PPUs from the Lessors for an amount equal to the original sales price, the amount of this liability would substantially equate to PPU sales revenues derived from the PPU leases currently in effect. Further, the capital lease accounting treatment requires that the costs directly associated with the PPU sales revenue (equipment and route purchases, sales commissions, etc.) be recorded on the balance sheet at the lower of depreciated cost or net realizable value. Based solely on the PPU sales activity of ETS for calendar year 1999 and the six months ended June 30, 2000, (i.e., totally ignoring lease obligation liabilities and costs arising from PPU sales for periods prior to January 1, 1999), the adjustments to treat such PPU sale and leaseback transactions as capital leases would result in a decrease in stockholders' equity by a minimum amount of $88,853,000, which amount represents the total reported profits from PPU sales transactions during such period. If this $88,853,000 adjustment to reduce stockholders' equity were subtracted from the reported stockholders' equity of $12,591,000 at June 30, 2000, then ETS would have reported a deficiency in stockholders' equity (i.e., total liabilities in excess of total assets) of $76,262,000 at that date. (The balance sheet as of March 31, 1999, which purports to follow generally accepted accounting principles, reflects a deficiency in stockholders' equity of $24,493,000.)

19. The balance sheet of ETS as of June 30, 2000, reflects a deficiency in working capital of $6,378,000 representing the excess of current liabilities of $37,503,000 over current assets of $31,125,000. The PPU lease agreements require ETS to repurchase the PPUs from the Lessors upon 180 days notice, and as previously stated herein, the capital lease obligation liability is not reflected on the ETS balance sheet. The PPU repurchase obligations, based solely on the total PPU sales activity for calendar year 1999 and the six months ended June 30, 2000, (i.e., totally ignoring lease obligation liabilities arising from PPU sales for periods prior to January 1, 1999), represent a liability of $177,613,000 for the total sales during this period. Since the Lessors have the right to exercise their PPU repurchase rights upon 180 days notice to ETS, the full amount of this capital lease obligation liability could be reflected on the balance sheet as a current obligation. If this $177,613,000 current liability were added to the reported working capital deficiency of $6,378,000 at June 30, 2000, then ETS would have reported a working capital deficiency of $183,991,000 at that date. (The balance sheet as of March 31, 1999, which purports to follow generally accepted accounting principles, reflects a total capital lease obligation liability of $164,383,000.)

20. Based on the foregoing observations and the application of generally accepted accounting principles to the Financial Statements, the following conclusions may be reached:

a. ETS is insolvent at June 30, 2000.

b. In the event that any significant number of Lessors should exercise their put options to require ETS to repurchase their PPUs, ETS would be unable to meet its current obligations, as indicated by the deficiency in working capital at June 30, 2000.

c. ETS's operations of the pay telephone business have not been profitable. Over the eighteen months ended June 30, 2000 and the fifteen months ended March 31, 1999, ETS's operating expenses have substantially exceeded ETS's operating revenues.

d. Inasmuch as ETS's operations of the pay telephone business have not been profitable, coupled with the fact that ETS's only other significant source of cash has been derived from payphone sales transactions with Lessors of the PPUs, the payphone sales transactions have been the source of cash to finance (i) ETS's operating losses from telephone operations, (ii) the monthly rental payments made to the Lessors of the PPUs, and (iii) the payments which ETS has made to its affiliates.

I declare under penalty of perjury that the foregoing is true and correct.

Executed this 20th day of September, 2000.

/s/ DAVID H. CRUMPTON
DAVID H. CRUMPTON

[PLAINTIFF'S EXHIBIT 6]

DECLARATION OF A.S. GIBBS

I, A.S. Gibbs, declare under penalty of perjury that:

1. I have personal knowledge of all facts stated herein.

2. I am currently 86 years old. I am also retired.

3. I became aware of ETS Payphones, Inc. ("ETS") approximately three or four years ago through Mr. Phil Hayhill, a financial adviser with Eco-Cash Management.

4. I initially purchased a total of 25 payphones from ETS. My total investment in those payphones was $175,000.

5. I purchased an additional six payphones from ETS around two months ago. My total investment in those payphones was $42,000.

6. According to information received from ETS, my payphones are located in Texas and Florida. However, I have never actually seen my payphones. None of my payphones are located near my residence in Stuart, Florida.

7. I invested my money in ETS because it appeared to be a good investment opportunity and offered a good rate of return. I did not enter this investment with the idea of actually operating any payphones myself.

8. I leased all my payphones back to ETS. I receive monthly lease payments from ETS of approximately $80 per payphone.

9. I signed an agreement with ETS in which ETS promises to buy back my payphones within 180 days at my request.

10. I have always received my monthly lease payments from ETS. I have not yet exercised any buyback agreements.

11. I do not manage any of my payphones nor do I intend to ever manage any of my payphones. In fact, I do not possess the expertise to manage payphones. All of my payphones are managed by ETS.

12. Neither ETS or any of its representatives have ever informed me, either before or after making my investment, that the receipt of my monthly lease payments is dependent on the sale of payphones to new ETS investors.

13. Neither ETS or any of its representatives have ever informed me, either before or after making my investment, that ETS payphone operations are not profitable.

14. Neither ETS or any of its representatives have ever informed me, either before or after making my investment, that if a significant number of investors decided to exercise their options to sell their payphones back to ETS, that ETS does not have the available financial resources to satisfy its obligations.

Pursuant to 28 U.S.C. 1746, I declare under penalty of perjury that the foregoing is true and correct.

Executed this 9 day of September 2000.

/s/ A.S. GIBBS
A.S. GIBBS

 

[PLAINTIFF'S EXHIBIT 7]

UNITED STATES SECURITIES AND
EXCHANGE COMMISSION

File No. A-02501

IN THE MATTER OF ETS PAYPHONES, INC.

INVESTIGATIVE INTERVIEW

TRANSCRIPT

APPEARANCES:

On behalf of the Securities and Exchange Commission
BARRY R. LAKAS, Staff Accountant
Securities and Exchange Commission
Suite 1000, 3475 Lenox Road
Atlanta Georgia 30326
(404) 842-7600

On behalf of the Witness
HUBERT FOUASSE, PRO SE

[3]

* * * * *

HERBERT FOUASSE

being first duly sworn, was examined and testified as follows:

EXAMINATION

BY MR. LAKAS:

* * * * *

[7]

Q. Okay. Your educational background, and briefly that would be just the year you graduated high school, any college degrees.

A. High school '68, bachelor of arts '71, bachelor of education '77, D.C. in 1981, in chiropractic orthopedics in '87.

Q. What colleges did you attend?

A. My bachelors degrees were from the University of Manitoba; Life College was the chiropractic degree; and the chiropractic orthopedics was done through Los Angeles Chiropractic College; and a lot more postgraduate work that I really don't want to go through.

* * * * *

[12]

A. Okay. Let's go to the substance of the questions here.

You are in investor in ETS Payphones, Inc.; is that correct?

A. Yes.

Q. When did you invest?

A. The first investment was March of '97.

Q. And how much did you invest?

A. That initial investment?

Q. Yes.

A. $5,000.

Q. So you bought one pay phone?

A. That's right.

Q. And who sold you this investment?

A. B.E.E. Communications.

Q. How did you hear about this investment?

A. A friend of mine.

Q. Did he put you in contact with anyone? In other words, did this friend buy this investment from a certain individual or entity?

A. He bought it from B.E.E. Communications.

Q. Okay. So you directly contacted B.E.E. [13] Communications?

A. I believe I did, yeah.

Q. Who did you contact there?

A. The name that comes to mind, because I think she was I think running B.E.E. Communications at the time, is Beverly Slater.

Q. So you contacted Beverly Slater directly?

A. Uh-huh.

Q. So you did not buy your investment through a life insurance agency?

A. No.

Q. You didn't buy it through a life insurance agent?

A. No.

Q. What was represented to you about this investment? Who made the representation?

A. Beverly Slater at B.E.E. Communications, and- Do you want me to go through the content of what was said?

Q. Yeah, whatever she told you. Did you already know a lot about the investment when you contacted Beverly Slater?

A. I knew what my friend had told me about it, what he knew about it, and that the investment was $5,000, and that you would be an owner of a phone, a location, and actually a physical phone, and that there would be a lease involved with ETS to perform management of these particular phone, management as far as running the day-to-day operation [14] of the phone, and that there would be a lease document, and that I would be paid I believe on the initial phone was $75 a month.

Q. So you went into this with the idea of this just being an investment; is that correct?

A. Uh-huh, yes.

Q. You did not go into this with the idea of actually buying a pay phone and running it yourself?

A. No. That option was offered, but I was not interested in that.

Q. Did she offer that option to you?

A. Yes.

Q. And that option would be that you could manage the pay phone yourself?

A. Right.

Q. Did she in any way encourage you to take the management option?

A. No. They left everything up to myself to decide.

Q. But you yourself knew nothing about operating a pay phone?

A. No.

Q. Did they offer any type of rate of return? By they I mean Beverly Slater and B.E.E. Communications.

A. Well, $75 a month on a $5,000 investment initially over a period of five years turns out to be I think 18 [15] percent.

Q. Did B.E.E. or Ms. Slater tell you that you could get your money back at any time on your investment?

A. Yes, uh-huh.

Q. That would be the full $5,000?

A. Yes.

Q. Could you go into that a little if you don't mind, just basically what she told you about that.

A. Yeah. The phone could be liquidated at any time. I believe as the contract states if I notify them that I want to liquidate the phone they would have 180 days to return the initial investment of $5,000.

Q. So basically you have to give them 180 days?

A. Right.

Q. Now, when she mentioned ETS Payphones would manage the pay phone, did she mention any other companies that might manage the pay phone?

A. Not that I recall.

Q. Did she tell you anything about ETS Payphones itself?

A. She told me about the principle involved, I guess.

Q. What did she say about ETS Payphones?

A. That they were a growing company, and that they had ambitions to be probably the biggest phone operators in the States.

[16]

Q. Did she give you any type of documents before you bought?

A. Yes.

Q. I'm not going to enter this as an exhibit yet. Does this look familiar?

A. Yes.

MR. LAKAS: Let's enter this as an exhibit.

[Exhibit Number 17 was marked for identification.]

Q. I'm handing the witness Exhibit Number 17 which is a B.E.E. Communications brochure, it includes a pamphlet entitled Opportunity Doesn't Always Knock, Sometimes it Rings, with a B.E.E. Communications logo on the bottom of the pamphlet. I'll let you look at that for a minute.

A. Okay.

Q. Have you ever seen that document before?

A. Yes.

Q. Is that what Beverly Slater handed you before the investment?

A. Yes.

Q. And did you read this document beforehand?

A. Yes.

Q. So when did you actually decide to make the investment? Right after you looked at this?

A. Yeah, that, and discussing this particular [17] investment with my friend.

Q. Did this brochure influence your investment decision in any way?

A. Well, it reiterated the options that are in there about which methods, levels of investment could be made, or I guess involvement.

Q. How about the fact that smart phones are profitable; did that influence your investment decision in any way?

A. Sure.

Q. Did you happen to read this box in the middle of the brochure about the economics of the medium-volume pay phone? Do you remember seeing that?

A. Yes.

Q. Did that influence your decision in any way?

A. Yeah, I suppose.

Q. Well, if you don't remember-

A. Yeah, as far as I can recall.

Q. So when you-this was March of 1997, when you decided to make the pay phone investment who did you write your check to?

A. B.E.E. Communications.

Q. And who did you give it to? Who did you give the check to?

A. B.E.E. Communications.

[18]

Q. But I mean who did you personally hand it to? Did you mail it to them?

A. I think I mailed it to B.E.E. Communications.

Q. And how was ETS Payphones going to come into the picture, then?

A. Well, as far as I know they're a management company of pay phones, so I was sent a copy of a sample lease, and proceeded from there.

Q. Did your friend tell you about ETS Payphones, or was it Beverly Slater?

A. It was my friend originally.

Q. On the last page of the brochure or the pamphlet included in Exhibit 17 there's a reference to ETS Payphones, Inc., but you already knew about ETS Payphones beforehand?

A. Yes.

Q. Before you made your B.E.E. investment.

A. Uh-huh.

Q. So ETS Payphones just was recommended by your friend and Beverly Slater?

A. Right.

Q. It was just understood you would be working with ETS Payphones on this?

A. Yes.

Q. Did you look at any other management companies?

A. No.

[19]

Q. Okay. So you made your $5,000 investment with B.E.E. Communications in March of '97. I assume you made the check out to B.E.E. Communications?

A. I believe so, yeah.

Q. And how long did it take you to hear from ETS Payphones? I assume they had to send you a form.

A. Yes, they sent a lease packet with-I think it was the sample lease packet, and that was probably within two or three weeks.

Q. So you filled out the lease packet, is that where ETS then leases the phone back from you, the investor? Is that how it's supposed to work?

A. Yeah.

Q. Did you ever talk to anyone from ETS?

A. Not initially after that first investment. It was a while before I did. I visited their-

Q. Oh, you did visit?

A. -within the year if I recall.

Q. Because you invested in March of 1997, when did you receive your first investment return check?

A. About sixty days later.

Q. And you had already filled out the ETS paperwork about the leasing program?

A. Uh-huh.

Q. When you filled out the leasing package for ETS [20] Payphones, do you have a copy of that lease package? I would just like to know what they gave you at the time.

A. I think this is it here. Yeah. Did you get a copy of that?

Q. Okay. Actually let's go through this bill of sale I guess you entered into with B.E.E.

[Exhibit Number 18 was marked for identification.]

Q. I have in front of me Exhibit Number 18, the title of the first page is Pay Phone Package COCOT Bill of Sale, it's a bill of sale executed the 1st of March 1997 between B.E.E. Communications and Hubert Fouasse. It's signed by B.E.E. Communications, Beverly Slater as the manager.

So this is what you originally signed with B.E.E. Communications for selling you the pay phone?

A. Right.

Q. Flipping over three pages, you signed a telephone equipment lease agreement. It says you're the lessor, and ETS Payphones, Inc. is the lessee, so the equipment lease agreement was basically done at the same time as when you purchased the pay phone; is that correct?

A. According to the dates there, yes.

Q. So do you know if this came later? Or was this just all done at the same time? This indicates it was done at the same time.

[21]

A. This document here?

Q. Yeah.

A. It came later.

Q. It did come later?

A. Uh-huh.

Q. And the option to sell agreement which is in the back of this document. That's also dated the 1st of March, 1997.

A. Uh-huh.

Q. What is this agreement saying?

A. Between myself and ETS Payphones.

Q. This is the document that says you have the right to sell the pay phone back to ETS Payphones?

A. According to the document it would appear to be, yeah.

Q. Yeah, it talks about the 180 days.

Well, in substance, though, maybe these documents came later, but according to ETS Payphones they considered that you entered into this agreement on the 1st of March 1997; is that correct?

A. Yeah.

* * * * *

[22]

Q. You said you made another investment in B.E.E. Communications; is that correct?

[23]

A. Yes.

Q. And what was the date of that investment?

A. November of '99.

Q. And how much money did you invest the second time?

A. $7,000.

* * * * *

 

[24]

Q. The lease date, okay. So you actually invested $7,000 on September 10th, 1999?

A Right.

Q. And the lease agreement started on November 2nd, 1999?

A. Right.

Q. Do you know where your pay phones are located?

A. This particular one here?

Q. Both of them.

A. Yes. It's in the documents.

Q. Have you ever-Well, just to the best of your recollection.

A. I have never visited my pay phones, though.

Q. But you have received all your monthly lease payments?

A. Yes.

Q. And you did request a refund on-Or you did elect the option to sell your pay phones; is that correct?

A. Yes, some of it.

[25]

A. Some of it?

Q. Yeah.

A. You still own one?

Q. I still own the first one here.

A. Oh, you still own the first one?

Q. Uh-huh.

A. So you did receive your $7,000 back?

Q. On one of the phones, yes.

A. And when did you request your refund?

Q. When did I request it?

A. Yes.

Q. I believe February of this year.

* * * * *

[34]

Q. Are you yourself an agent for B.E.E. Communications?

A. Yes.

Q. And have you sold pay phones?

A. Yes.

Q. And how many have you sold?

A. About fifteen or so.

Q. But even as an agent for B.E.E. did you have any meetings with ETS?

[35]

A. No.

Q. Who trains you to be an agent?

A. B.E.E. Communications.

* * * * *

[37]

Q. Did anyone ever tell you or inform you that your pay phone location could increase in value?

A. I don't recall anybody ever making that statement, but it sounds to me like it could, you know, and there was an increase in price of the phones over the period of time that I initially invested and today.

Q. So that's just speculation on your part, though?

A. Just speculation.

Q. You have never seen any proof of a pay phone location going up in value?

The way I understand it there may be a pay phone sitting in a 7-11 store somewhere, and a company like ETS might have the rights for that location, and your claim is that that location could actually go up in value even though they sold it to you for seven thousand, but the claim is that that site might be worth 10,000 now.

A. Uh-huh.

Q. You haven't seen any proof of that?

A. No, I haven't. I have not seen any documentation on that. If I recall, my friend may have mentioned that that's a possibility, and that sounded like a possibility to me, too.

* * * * *