United States Securities & Exchange Commission v. Kahlon
2017 U.S. App. LEXIS 20175
| 5th Cir. | 2017Background
- Yossef Kahlon, sole owner of TJ Management Group (TJM), purchased large blocks of unregistered “penny stock” shares (2008–2010) and resold them quickly for profit, netting over $7.7 million in gross revenue.
- TJM executed subscription agreements representing purchases were for "investment purposes" and received unrestricted stock certificates, but resales typically began within five days of purchase.
- The SEC sued in 2012 for violations of Section 5 of the Securities Act (failure to register offerings). The district court granted the SEC summary judgment on liability and later on remedies. Kahlon/TJM appealed.
- Defendants relied on the Rule 504(b)(1)(iii) (Seed Capital) exemption — claiming sales were covered by Texas state exemptions permitting sales to accredited or institutional purchasers — but produced no evidence transactions occurred exclusively under Texas law.
- The district court ordered a permanent injunction against Section 5 violations, disgorgement of gross trading revenue plus prejudgment interest, a first-tier civil penalty, and a lifetime bar on penny-stock trading. The Fifth Circuit affirmed liability and the remedies.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Kahlon/TJM violated Section 5 by selling unregistered securities | SEC: sales were unregistered interstate offers/sales — prima facie violation | Kahlon: sales qualified for Rule 504(b)(1)(iii) (state-exemption route), so no registration required | Affirmed — summary judgment for SEC; defendants failed to show transactions occurred exclusively under Texas law |
| Scope of Rule 504(b)(1)(iii) — does “exclusively according to state law exemptions” require compliance in every state where offers/sales occur? | SEC: ‘‘exclusively’’ requires compliance in each state where transactions occur; otherwise preemption and federalism problems | Kahlon: reading imposes extra requirements not in the rule; SEC guide postdates conduct | Held for SEC — regulation and federalism principles require state exemptions to apply where transactions occurred; defendants offered no proof of that |
| Appropriateness of a permanent bar on penny-stock trading | SEC: bar justified by repeated, high-volume violations and risk of recurrence | Kahlon: bar is overbroad for strict-liability, technical violations; no fraud or repeated misconduct after SEC inquiry | Affirmed — district court did not abuse discretion; bar tailored to misconduct and risk of repeat violations |
| Disgorgement measure — gross revenue vs. net profit | SEC: disgorgement should strip ill-gotten gains (gross revenue with interest) | Kahlon: disgorgement should be reduced by business expenses; gross revenues disproportionate per Blatt | Affirmed — court did not abuse discretion; prevailing authority allows disgorgement measured by gross revenue without offsets |
Key Cases Cited
- Am. Family Life Assurance Co. of Columbus v. Biles, 714 F.3d 887 (5th Cir. 2013) (summary-judgment standard and appellate affirmance on any district-court basis argued below)
- Distribuidora Mari Jose, S.A. de C.V. v. Transmaritime, Inc., 738 F.3d 703 (5th Cir. 2013) (viewing evidence in favor of nonmovant on summary judgment)
- SEC v. Blatt, 583 F.2d 1325 (5th Cir. 1978) (factors for injunctive relief and disgorgement principles)
- SEC v. AMX, Int’l, Inc., 7 F.3d 71 (5th Cir. 1993) (standard for disgorgement review)
- Wolf v. Frank, 477 F.2d 467 (5th Cir. 1973) (prejudgment interest review standard)
- R&W Tech. Servs. Ltd. v. CFTC, 205 F.3d 165 (5th Cir. 2000) (civil-penalty review standard)
- SEC v. Cont’l Tobacco Co., 463 F.2d 137 (5th Cir. 1972) (prima facie elements for Section 5 violation)
- Edgar v. MITE Corp., 457 U.S. 624 (1982) (states’ authority to regulate intrastate securities transactions; federalism limits on preemption)
- SEC v. Patel, 61 F.3d 137 (2d Cir. 1995) (factors on fitness for officer/director roles referenced in remedies analysis)