Securities & Exchange Commission v. CMKM Diamonds, Inc.
2013 U.S. App. LEXIS 18780
| 9th Cir. | 2013Background
- CMKM, an essentially non-operational public company, issued billions of unrestricted shares and sold them to the public without a registration statement, causing investor losses.
- Dvorak, CMKM’s attorney, drafted ~450 opinion letters claiming shares met Rule 144(k) holding-period safe harbor; he was paid roughly $318,843.
- Global (transfer agent) and its owner Bagley removed restrictive legends and issued up to 622 billion CMKM shares based on those opinion letters; they later sought confirmation from Angell, another law firm.
- The SEC sued Dvorak, Global, Bagley and others under Section 5 of the Securities Act for distributing unregistered securities; a related criminal indictment named Dvorak.
- The district court granted summary judgment against Dvorak, Global, and Bagley, enjoined Section 5 violations, and ordered disgorgement ($409,638.11 for Dvorak; $448,047.87 jointly for Global/Bagley).
- On appeal, the Ninth Circuit reversed as to Global and Bagley (material fact issue whether they were necessary participants and substantial factors) but affirmed denial of Dvorak’s stay motion and affirmed Dvorak’s disgorgement order.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Global/Bagley were liable as participants under Sec. 5 for distributing unregistered securities | SEC: issuing/unrestricting certificates enabled public sales; transfer agent role made them necessary participants and substantial factors | Global/Bagley: transfer-agent acts were ministerial and based on attorney opinions; no substantial, culpable role so summary judgment improper | Reversed as to Global/Bagley — disputed fact exists whether they were necessary participants and substantial factors; remanded. |
| Whether scienter is required for Sec. 5 liability (and whether transfer agents get a different standard) | SEC: Sec. 5 is strict liability; no scienter element; participant test controls | Global/Bagley: transfer agents should be judged by reasonableness/good-faith reliance on counsel (state-law duties) | Held: Sec. 5 is strict liability; scienter not required; no special transfer-agent exception; but participant (necessary/substantial) test must be carefully applied. |
| Whether the magistrate judge properly denied Dvorak’s motion to stay the civil case pending criminal proceedings | SEC: civil case may proceed; stay not required | Dvorak: Fifth Amendment risk and need for criminal discovery justify stay | Affirmed: magistrate had authority to decide nondispositive stay motion; Dvorak forfeited objections by not raising them below; denial upheld. |
| Whether the disgorgement amount against Dvorak was improper | Dvorak: bank records and deposition exhibits would show disgorgement figure was not a reasonable approximation | SEC: disgorgement amount is a reasonable approximation; burden shifts to defendant to show unreasonableness | Affirmed: Dvorak failed to present those materials below and thus forfeited; district court’s disgorgement figure affirmed. |
Key Cases Cited
- SEC v. Platforms Wireless Int’l Corp., 617 F.3d 1072 (9th Cir.) (discusses Section 5, disgorgement burden and standards)
- SEC v. Phan, 500 F.3d 895 (9th Cir.) (participant liability: necessary participant and substantial-factor tests)
- SEC v. Murphy, 626 F.2d 633 (9th Cir.) (defining substantial-factor test and examples of significant participant conduct)
- Pinter v. Dahl, 486 U.S. 622 (U.S.) (distinguishing Section 12 purchase-from requirement; limits on substantial-factor test for Section 12)
- SEC v. Calvo, 378 F.3d 1211 (11th Cir.) (affirming Section 5 liability where defendant’s active role made them a substantial factor)