Sec. & Exch. Comm'n v. WeedSec. & Exch. Comm'n v. Weed
This case arises out of a government investigation of a pump-and-dump scheme ("the scheme") involving publicly-traded shares of CitySide Tickets, Inc. ("CitySide"). Plaintiff Securities and Exchange Commission ("the SEC" or "the Commission") contends that defendant Richard Weed ("Weed" or "defendant"), an attorney, together with two former stockbrokers, Coleman Flaherty ("Flaherty") and Thomas Brazil ("Brazil"), committed securities fraud in connection with the scheme.
Pending before the Court were (1) the SEC's motion for partial summary judgment on the SEC's first, second, fourth, fifth and sixth claims for relief (Docket No. 69) and (2) Weed's motion for partial summary judgment on the SEC's third claim for relief (Docket No. 73). By order of the Court (Docket No. 105) entered on May 10, 2018, the SECs motion was allowed and Weed's motion was denied, with the notation that an explanatory memorandum and order ("M & O") would follow. This is that M & O.
A. Factual Background
Brazil and Flaherty are former stockbrokers who ran several iterations of the pump-and-dump scheme with the assistance of Weed. Flaherty controlled a public shell company, UpTurn. In 2009, the owner of CitySide, a sporting event ticket broker, proposed that Flaherty make an investment in CitySide. Flaherty counter-proposed a reverse merger as a result of which CitySide would become a publicly-traded company after a merger with the public shell company, UpTurn.
Brazil and Flaherty participated in the reverse merger deal and Weed performed the legal work necessary to complete the merger. As a result of the merger, Flaherty and Brazil held debt in CitySide, in the form of promissory notes, which could be converted into shares of CitySide stock. To facilitate the reverse merger, Weed completed legal work, including 1) a name change application with the Financial Industry Regulatory Authority ("FINRA"), 2) the paperwork for the reverse stock split, 3) the issuing of a controlling share block to CitySide's owner and 4) the conversion of the promissory notes into shares that were freely tradable ("unrestricted") securities.
After the merger, Flaherty and Brazil arranged for stock promoters to issue favorable press releases about CitySide in order to inflate the value of CitySide stock. Weed accomplished the conversion of the promissory notes held by Brazil and Flaherty into share certificates that were deposited into brokerage firms for trading and which allowed Flaherty and Brazil to execute sales of the certificates after the value of the stock was inflated. In a conversation that was recorded, Weed told Flaherty (who was cooperating with federal law enforcement agents at the time) "the deals are all vapor, and they cannot sustain themselves for six weeks".
In order to facilitate the conversion of the notes into freely tradable shares, Weed wrote legal opinion letters to transfer agents of CitySide who were responsible for issuing new securities and recording changes in ownership of securities. In those letters, Weed opined that the transfer agent could lawfully allow the issuance of unrestricted shares of stock under
[n]one of the persons who have elected to convert [their] notes into common stock are affiliates of the [i]ssuer and none of these persons have been affiliates during the preceding three months.
The recipients of the shares were, in fact, Flaherty or nominees of Flaherty and Brazil, all affiliates of the issuing company. Flaherty sold approximately $1.3 million of CitySide stock after his notes were converted.
B. Procedural History
The SEC filed the civil complaint in this action on November 6, 2014 against Weed, Flaherty and Brazil alleging six violations of the securities laws. The following month, a grand jury returned an indictment charging Weed with criminal violations of Section 10(b), 15 U.S.C. §§ 78j(b) & 78ff, and Rule 10b-5,
On May 16, 2016, after ten days of trial, a jury convicted Weed on all nine counts of the indictment and he was subsequently sentenced to a term of 48 months imprisonment. That conviction was affirmed in October, 2017 by the First Circuit Court of Appeals ("the First Circuit") and Weed's
The SEC and Weed filed motions for partial summary judgment in March, 2018. Those motions are the subject of this memorandum.
II. Motions for Partial Summary Judgment
A. Legal Standard
The role of summary judgment is "to pierce the pleadings and to assess the proof in order to see whether there is a genuine need for trial." Mesnick v. Gen. Elec. Co.,
If the moving party has satisfied its burden, the burden shifts to the non-moving party to set forth specific facts showing that there is a genuine, triable issue. Celotex Corp. v. Catrett,
B. Application
1. SEC's Motion for Partial Summary Judgment
The SEC contends that Weed is collaterally estopped from disputing the facts that form the basis of his criminal conviction. The Commission asserts that the factual underpinnings of those convictions are sufficient to establish the necessary elements of violations of the securities laws alleged in this civil action.
Weed responds that collateral estoppel is inapplicable here because he did not have a full and fair opportunity to defend himself in the criminal proceeding. He claims that the government failed to produce exculpatory evidence for his trial counsel, rendering his conviction constitutionally infirm. Further, Weed contends that the factual issues that formed the basis of the criminal conviction are not identical to the SEC's claims in this civil action. Finally, he suggests that, with respect the sixth claim, collateral estoppel cannot apply because the factual allegations supporting that claim were not essential to the judgment in the criminal case.
Collateral estoppel bars the re-litigation of any factual or legal issue that was actually decided in previous litigation on a different cause of action involving a party to the first case. Keystone Shipping Co. v. New England Power Co.,
(1) the issue sought to be precluded in the later action is the same as that involved in the earlier action; (2) the issue was actually litigated; (3) the issue was determined by a valid and bindingfinal judgment; and (4) the determination of the issue was essential to the judgment.
Ramallo Bros. Printing, Inc. v. El Dia, Inc.,
a. Full and fair litigation of criminal proceeding
As a preliminary matter, Weed's contention that he did not have a "full and fair" opportunity to litigate the issues in his criminal proceeding is unconvincing. He suggests that the government in the criminal proceeding failed to produce certain exculpatory evidence, rendering the trial unfair and he has filed post-trial motions advancing that argument in the criminal proceeding. He maintains that, at the very least, the Court should refrain from applying collateral estoppel until the judicial officer presiding over the criminal proceeding has adjudicated Weed's motion to compel production of the alleged exculpatory evidence.
Since the date of the filing of Weed's memoranda in opposition to the SEC's motion for partial summary judgment, the motion to compel in the criminal proceeding has been denied. United States v. Weed, 14-cr-10348-DPW, ECF No. 242 (April 9, 2018). Weed has subsequently filed a motion to vacate pursuant to
The pendency of a criminal appeal or a habeas petition seeking post-trial relief "generally does not deprive a judgment of its preclusive effect". United States v. Int'l Bhd. of Teamsters, Chauffeurs, Warehousemen and Helpers of Am.,
b. Identity of issues
With respect to the substance of the collateral estoppel argument Weed asserts, first, that the factual issues that formed the basis for his the criminal conviction are not identical to the issues underlying the SECs civil claims. He contends that the prosecution in the criminal proceeding and the SEC here seek to show that the legal opinion letters he wrote were false in materially different ways. Specifically, Weed suggests that the SEC bases its claims on the alleged legitimacy of the promissory notes whereas the prosecution in the criminal case did not challenge that legitimacy. Next, Weed claims that evidence of his intent introduced at the criminal trial relies on conduct that post-dates conduct pled in this civil complaint.
The complaint alleges violations of Section 10(b) of the Securities Exchange Act of 1934 ("the Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder,
To establish a violation of Section 10(b) and Rule 10b-5 of the Exchange Act, the plaintiff must establish (1) a material representation or omission or manipulative practice, such as a scheme to defraud, (2) in connection with the purchase or sale of a security, (3) with scienter, or a wrongful state of mind and (4) the use of interstate commerce. 15 U.S.C. § 78j(b) ;
Section 17(a) of the Securities Act prohibits fraud and material misrepresentations or omissions in the offer or sale of securities. 15 U.S.C. § 77q(a) ; see also Ficken,
District courts have applied collateral estoppel in the securities fraud context
because the elements necessary to establish civil liability under Section 17(a) and 10(b) are identical to those necessary to establish criminal liability under Section 10(b).
SEC v. Haligiannis,
Weed's role was essential here: he wrote opinion letters to the transfer agents invoking Rule 144 and representing that "[n]one of the persons who have elected to convert" the notes into stock "are affiliates of the [i]ssuer". But, as Weed now acknowledges, these statements were "wrong".
Weed,
One of the frauds alleged by the SEC in this civil action is the same as the fraud for which Weed was convicted in the criminal proceeding, making collateral estoppel applicable here. See e.g., SEC v. Desai,
The SEC alleges violations of Section 17(a) and 10(b) that are based, in part, on the same factual allegations litigated in the criminal proceeding. The existence of additional allegations that may also support a finding of fraud under the same provisions does not preclude the Court from applying collateral estoppel here. See Haligiannis,
Accordingly, Weed is collaterally estopped from re-litigating his liability under claims one, two, four, five and six. Because the Court has determined that collateral estoppel applies, it declines to address the SEC's alternative argument that the Commission is entitled to summary judgment even absent a finding of collateral estoppel.
c. Remedies
The SEC seeks the following remedies: (1) a permanent injunction enjoining Weed from further violations of Section 10(b) and Rule 10b-5 and Section 17(a), (2) civil penalties in an amount within the court's discretion, (3) a permanent penny stock bar and (4) a permanent officer and director bar. The SEC notes that, because there is an order of forfeiture in the criminal case against Weed requiring him to forfeit the $90,000 in legal fees that he received as a result of his illegal conduct, the SEC is not seeking disgorgement in this civil action.
Weed responds by suggesting that, even if the Court allows the SEC's motion for partial summary judgment, the Court should decline to impose civil monetary penalties or an order of debarment because those penalties are excessively harsh and do little to deter any future violation of the securities laws. Weed notes that he is already facing a term of incarceration and criminal fines and forfeiture of at least $190,000. He contends that his portion of the proceeds of the alleged scheme, roughly $90,000 in legal fees over four years, was relatively modest. He will likely be 60 years old upon his release from prison and thus any future service as an officer or director of a public company is unlikely.
i. Permanent injunction
Section 20(b) of the Securities Act and Section 21(d)(1) of the Exchange Act provide for the imposition of injunctive relief preventing future violations of the securities laws upon a showing that a defendant has violated the securities laws and that there is a reasonable likelihood of future violations. 15 U.S.C. § 77t(b) ; 15 U.S.C. § 78u(d)(1) ; SEC v. Sargent,
the nature of the violation, including its egregiousness and its isolated or repeated nature, as well as whether the defendants will, owing to their occupation, be in a position to violate again.
Sargent,
The Court finds that those factors weigh in favor of enjoining Weed from future violations of Section 10(b), Rule 10b-5 and Section 17(a). The violations here were repeated in nature. Weed assisted Flaherty and Brazil in running through four recurrences of the pump-and-dump scheme and was prepared to run it a fifth time. Weed,
The SEC contends that a Tier III civil penalty is appropriate here, notwithstanding the penalties and period of incarceration that will be imposed in the criminal proceeding. Weed responds that civil penalties are inappropriate because of the fines and forfeiture in the criminal proceeding and because of the modest amount of gains Weed received as a result of the scheme.
Section 20(d) of the Securities Act and Section 21(d) of the Exchange Act authorize the imposition of civil penalties. 15 U.S.C. § 77t(d) ; 15 U.S.C. § 77u(d). The imposition of civil penalties is intended to "penalize [the] defendant for ...illegal conduct" and deter future securities violations. Sargent,
In determining an appropriate fine, courts consider the egregiousness of the violation, the willingness to admit wrongdoing, the isolated or repeated nature of the violations, the degree of scienter involved, the defendant's willingness to cooperate with the authorities and the defendant's current financial situation. SEC v. Esposito,
The Court has considered the relevant factors in deciding whether to grant injunctive relief and finds that those factors weigh in favor of imposing Tier III civil penalties. The SEC suggests that the exact amount of the penalty is within the Court's discretion. Balancing the seriousness of Weed's conduct with recognition that the forfeiture and fines imposed in the criminal proceeding are significant, the Court will impose a civil penalty in the amount of $150,000, the amount prescribed by the relevant statutes and regulations for one violation of the securities laws.
iii. Permanent penny stock and officer/director bar
The SEC also asks this Court to impose a permanent penny stock bar pursuant to 15 U.S.C. § 78t(g) and 15 U.S.C. § 78u(d)(6) and an officer and director bar pursuant to 15 U.S.C. § 77t(e) and 15 U.S.C. § 78t(d)(2). Weed responds that the Court should decline to impose a debarment order or penny stock bar because he will likely be over 60 years old when his prison term ends and future service as an officer or director of a public company is highly unlikely.
In determining whether to permanently enjoin a defendant from servicing as an officer or director of a public company, courts consider (1) the egregiousness of the underlying securities law violation, (2) whether defendant was a repeat offender, (3) defendants' role in the fraud (4) defendant's degree of scienter, (5) defendant's economic stake in the fraud and (6) the likelihood that misconduct will recur. SEC v. Patel,
The Court has discussed at length many of the applicable factors in relation to the permanent injunction on future violations of securities laws and the imposition of civil penalties. To reiterate, Weed's conduct here was pervasive. See, e.g.,
2. Weeds Motion for Partial Summary Judgment
Weed moves for partial summary judgment on claim three, which alleges violations of Section 5(a) and 5(c) of the Securities Act, 15 U.S.C. §§ 77e(a) and 77e(c). He contends that the securities that were issued were exempt from registration under Section 3(a)(9) of the Securities Act because Section 3(a)(9) permanently exempts an entire class of securities and is therefore not a transactional exemption.
The Court notes, first, that Weed's interpretation of Section 3(a)(9) was considered and rejected in the District Court's disposition of his motion for acquittal and motion for a new trial in the criminal proceeding. In considering those post-trial motions at the sentencing hearing, Judge Woodlock noted that "3(a)(9) for 80 years has been viewed as transactional" and reiterated
that 3(a)(9) does not provide an exemption for the distributions of the securities that were received here, and it is a recent contrivance to say otherwise, nowhere supported by any materials or glosses and certainly not supported by a careful analysis of the historic development of Section 3(a)(9) and the Securities Act of '33 and the Securities and Exchange Act of '34.
United States v. Weed, 14-cr-10348-DPW, ECF No. 196 (Sept. 21, 2016). While a decision of another United States District Judge is not binding in this case, Camreta v. Greene,
Weed's proffered interpretation of Section 3(a)(9) is, however, contrary to the reading that the SEC has consistently employed for more than eighty years.
Weed,
Weed's interpretation of Section 3(a)(9) is unconvincing. Section 5 of the Securities Act makes it unlawful for anyone seeking to sell a security to do so without registering that security unless certain exemptions apply. 15 U.S.C. § 77e. At issue here is the Section 3(a)(9) exemption of
any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.
15 U.C.C. § 77c(a)(9).
In its third claim, the SEC alleges that Weed, along with Flaherty and Brazil, violated Section 5 by selling or offering to sell CitySide securities that were not registered with the SEC. Weed contends that those securities were exempt from the registration requirement because Section 3(a)(9) should be read to apply to a class of securities rather than to a transaction involving a single security. He suggests that, because the initial conversion of debt into common stock was exempted, that exemption is perpetuated as to any future transactions involving that security. Pursuing that interpretation to its logical conclusion, whenever a promissory note is exchanged for a share of stock, the resulting share would forever be exempt from the registration
Weed attempts to import the title and preamble of the statute, referencing exemptions to "classes of securities", to alter the plain meaning of Section (3)(a)(9). He suggests that, because the exemptions apply to classes of securities, once a security is exempt, it retains its exempt status in a subsequent transaction. The plain text of Section 3(a)(9), however, exempts "any security exchanged by the issuer with its existing securities holders" rather than any security that has ever been or once was exchanged by the issuer. See Summit Inv. & Dev. Corp. v. Leroux,
Although the plain language of the statute is clear, Weed's interpretation of Section 3(a)(9) is also suspect upon examination of the purposes of the exemptions. Weed's reading of the exemption would undermine the statutory registration scheme. To avoid the registration requirements under Section 5, a company would simply need to arrange for the exchange of a security for another kind of security, rendering the registration scheme a nullity. See King v. Burwell, --- U.S. ----,
Weed makes much of the fact that the Section 3(a)(9) exemption was transferred from Section 4, which explicitly refers to "transactions" rather than "classes of securities", to Section 3 in 1934. Compare Section 4(3),
ORDER
For the foregoing reasons, the SEC's motion for partial summary judgment (Docket No. 69) is ALLOWED and Weed's motion for partial summary judgment (Docket No. 73) is DENIED.
So ordered.