787 F.3d 375
6th Cir.2015Background
- Zada solicited about $60 million from ~60 individuals by promising high-return investments in Saudi Arabian oil stored on tankers; he gave investors promissory notes as receipts.
- In truth Zada never bought oil; he used investor funds for personal expenses and to pay earlier investors (Ponzi-like behavior).
- SEC filed a civil enforcement action alleging unregistered securities and securities fraud; discovery included testimony/affidavits from investors (about 10 with direct statements) and Federov’s affidavit; Zada invoked the Fifth Amendment and submitted limited third-party affidavits.
- District court granted summary judgment for the SEC, ordering disgorgement (~$56.6M) plus an equal civil penalty, for a total near $120M.
- Zada appealed, arguing (1) the notes were not "securities" under the Securities Acts and (2) the civil penalty punished his invocation of the Fifth Amendment.
Issues
| Issue | Plaintiff's Argument (SEC) | Defendant's Argument (Zada) | Held |
|---|---|---|---|
| Whether the promissory notes are "securities" under the Securities Acts | Notes are presumptively securities; economic substance shows investors intended investments in oil markets | Notes were "loans" (family-resemblance to non-securities) and thus not securities | Notes are securities; Reves factors favor SEC |
| Whether Zada violated registration requirements (15 U.S.C. § 77e) | Unregistered securities were offered/sold | Transactions were non-securities loans, so §77e inapplicable | Violation affirmed; summary judgment proper |
| Whether Zada committed securities fraud (misrepresentations, scienter, connection to securities) | Zada materially misrepresented use of funds, acted with scienter, in connection with securities sales | Denies misrepresentations to every investor; labels transactions as loans | Fraud elements satisfied as to scheme; summary judgment for SEC affirmed |
| Appropriateness of disgorgement and civil penalty | Disgorgement should approximate ill-gotten gains (~$56.6M); penalty up to gross gain allowable given substantial losses/risks | Court impermissibly penalized Zada for invoking Fifth Amendment by noting "lack of acceptance of responsibility" | Disgorgement upheld; penalty (equal to disgorgement) upheld—court's comment about acceptance of responsibility harmless error |
Key Cases Cited
- Reves v. Ernst & Young, 494 U.S. 56 (establishes presumption that notes are securities and the four-factor "family resemblance" test)
- Bass v. Janney Montgomery Scott, Inc., 210 F.3d 577 (6th Cir. 2000) (applies Reves factors in this circuit)
- SEC v. George, 426 F.3d 786 (6th Cir. 2005) (securities-fraud summary-judgment standards; treating a scheme as a unitary fraud)
- SEC v. Wallenbrock, 313 F.3d 532 (9th Cir. 2002) (look to economic realities over labels)
- Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808 (2d Cir. 1994) (Reves factor guidance on buyer motivation and distribution)
- Monterosso v. SEC, 756 F.3d 1326 (11th Cir. 2014) (disgorgement and scope of ill-gotten gains precedent)
- Hoxie v. DEA, 419 F.3d 477 (6th Cir. 2005) (permitting adverse inference from invocation of Fifth Amendment in civil context)
- Martin Cnty. Coal Corp. v. Universal Underwriters Ins. Co., 727 F.3d 589 (6th Cir. 2013) (standard of review for summary judgment)
- United States v. Gurley, 384 F.3d 316 (6th Cir. 2004) (standard of review for penalty/disgorgement issues)