Securities and Exchange Commission v. SharpSecurities and Exchange Commission v. Sharp
Case Information
UNITED STATES DISTRICT COURT DISTRICT OF MASSACHUSETTS )
SECURITIES AND EXCHANGE COMMISSION,)
)
Plaintiff, )
) v. ) CIVIL ACTION ) NO. 21-11276-WGY FREDERICK L. SHARP, ZHIYING YVONNE )
GASARCH, COURTNEY KELLN, MIKE K. )
VELDHUIS, PAUL SEXTON, JACKSON T. )
FRIESEN, WILLIAM T. KAITZ, AVTAR S.)
DHILLON, and GRAHAM R. TAYLOR, )
)
Defendants. ) YOUNG, D.J. September 6, 2022
MEMORANDUM & ORDER
I. INTRODUCTION
In this case, the Securities and Exchange Commission (the “SEC”) brings an enforcement action against nine defendants for their alleged violation of several securities laws and regulations. Six of these nine defendants move to dismiss the case against them based on two main arguments: (1) the claims against them are untimely because the SEC (a) is applying the incorrect statute of limitations and (b) does not allege sufficient facts within the applicable time-period to impose liability; and (2) the SEC does not state facts with sufficient particularity plausibly to allege violations of the aforementioned statutes and regulations.
First, the SEC applies the correct statute of limitations to scienter-based disgorgement claims. The limitations period is governed by Section 6501 of the William M. Thornberry National Defense Authorization Act for Fiscal Year 2021 (“NDAA”), which applies retroactively to extend the statute of limitations to ten years for claims commenced after its passage. This conclusion is necessitated by the clear mandate provided by Congress in the text of the statute.
Furthermore, as to timely pleading on the face of the complaint, the defendants are incorrect on two bases: (1) the SEC alleges sufficient facts within both the ten- and five-year time periods -- the latter being still applicable to other types of claims relevant to this action; and (2) the five-year statute of limitations may not even apply to, or have start to run for, several of the defendants, as exceptions to the statute of limitations apply for those who have been absent from the United States.
Second, the SEC has alleged sufficient facts with particularity as to all defendants to buttress the violations claimed. This Court therefore DENIES all six of the defendants’ motions to dismiss in their entirety.
II. PROCEDURAL HISTORY
On August 5, 2021, the SEC brought this enforcement action for violation of securities and exchange laws against nine defendants: Frederick L. Sharp (“Sharp”), Zhiying Yvonne Gasarch (“Gasarch”), Courtney Kelln (“Kelln”), Mike K. Veldhuis (“Veldhuis”), Paul Sexton (“Sexton”), Jackson T. Friesen (“Friesen”), William T. Kaitz (“Kaitz”), Avtar S. Dhillon (“Dhillon”), and Graham R. Taylor (“Taylor”) (collectively, the “Defendants”). See Compl., ECF No. 1. On the same day the SEC filed an emergency ex parte motion for a temporary restraining order (“TRO”) freezing assets and requesting equitable relief against all the Defendants. See Pl.’s Emergency Ex Parte Mot. TRO, Order Freezing Assets, & Order Other Equitable Relief, ECF No. 3. Judge Gorton entered an order granting the TRO on August 6, 2021. See TRO Order, Order Freezing Assets, & Order Other Equitable Relief, ECF No. 7. Subsequently, a series of preliminary injunctive orders were sought and granted. [1] After these preliminary injunctions were issued, six of the defendants -- Friesen, Taylor, Sexton, Gasarch, Kelln, and Veldhuis -- moved to dismiss the case. See Def. Jackson T. Friesen’s Mot. Dismiss Compl., ECF No. 109; Def. Graham R. Taylor’s Mot. Dismiss Strike Pl.’s Compl., ECF No. 126; Def. Paul Sexton’s Mot. Dismiss Compl., ECF No. 132; Def. Yvonne Gasarch’s Mot. Dismiss Compl., ECF No. 143; Def. Courtney Kelln’s Mot. Dismiss SEC’s Compl., ECF No. 147; Def. Mike K. Veldhuis’s Mot. Dismiss Compl., ECF No. 151.
The Defendants have fully briefed these motions. See Mem. Supp. Def. Jackson T. Friesen’s Mot. Dismiss Compl. (“Friesen Mem.”), ECF No. 110; Mem. Supp. Def. Graham R. Taylor’s Mot. Dismiss Strike Pl.’s Compl. (“Taylor Mem.”), ECF No. 127; Def. Paul Sexton’s Mem. Supp. Mot. Dismiss Compl. (“Sexton Mem.”), ECF No. 133; Mem. Supp. Def. Yvonne Gasarch’s Mot. Dismiss Compl. (“Gasarch Mem.”), ECF No. 144; Mem. Law Supp. Def. Courtney Kelln’s Mot. Dismiss SEC’s Compl. (“Kelln Mem.”), ECF Freezing Assets, & Order Other Equitable Relief Def. Dhillon, ECF No. 48. Judge Sorokin also granted this preliminary injunction on August 30, 2021. See Dhillon Prelim. Inj. Order, ECF No. 54. Kaitz’s TRO was further extended two more times. See Second Extension TRO Kaitz, ECF No. 60; Third Extension TRO Kaitz, ECF No. 97. This Court also granted preliminary injunctions against Friesen, Gasarch, and Kaitz. See Order Entry Prelim. Inj. Friesen, ECF No. 91; Order Entry Prelim. Inj. Kaitz, ECF No. 100; Order Entry Prelim. Inj. Gasarch, ECF No. 101.
No. 148; Mem. Supp. Mot. Dismiss Mike K. Veldhuis (“Veldhuis Mem.”), ECF No. 152. The SEC opposed these motions. See Pl.’s Opp’n Friesen’s Mot. Dismiss Compl. (“SEC’s Opp’n Friesen”), ECF No. 124; Pl.’s Opp’n Sexton’s Mot. Dismiss Compl. (“SEC’s Opp’n Sexton”), ECF No. 157; Pl.’s Opp’n Def. Taylor’s Mot. Dismiss Compl. (“SEC’s Opp’n Taylor”), ECF No. 158; Pl.’s Opp’n Def. Gasarch’s Mot. Dismiss Compl. (“SEC’s Opp’n Gasarch”), ECF No. 162; Pl.’s Opp’n Def. Kelln’s Mot. Dismiss Compl. (“SEC’s Opp’n Kelln”), ECF No. 167; Pl.’s Opp’n Def. Veldhuis’s Mot. Dismiss Compl. (“SEC’s Opp’n Veldhuis”), ECF No. 171.
At the same time, the SEC moved for entry of default as to Frederick Sharp, see Pl.’s Mot. Entry Default Def. Frederick L. Sharp, ECF No. 116, which this Court granted, see Electronic Order Granting Mot. Entry Default Sharp, ECF No. 122. This Court later entered final judgment against Sharp. See Final J. Def. Frederick L. Sharp, ECF No. 211.
At a hearing held on January 20, 2022, this Court heard argument on the Defendants’ six motions to dismiss and tentatively denied all of them pending further review. [2] See Electronic Clerk’s Notes (“Clerk’s Notes”), ECF No. 189; see also Hearing Tr. 22:6-9, ECF No. 193. The Court also allowed the SEC to file a motion for leave to file an amended complaint as to Gasarch and Taylor. See Clerk’s Notes; Hearing Tr. 22:10- 13. The SEC so moved, submitting a proposed Amended Complaint containing more specific allegations as to Taylor and Gasarch. See Pl. Mot. Leave File Am. Compl., ECF No. 195; id. Ex. 1, Proposed Am. Compl. (“Am. Compl.”), ECF No. 195-1. Taylor and Gasarch both oppose the Amended Complaint on the ground that it is futile, as it would not redress the insufficiency of the Complaint’s factual allegations. See Def. Taylor’s Opp’n Pl.’s Mot Leave File Am. Compl. (“Taylor’s Opp’n Am. Compl.”) 4-11, ECF No. 199; Gasarch’s Opp’n SEC’s Mot. Leave Am. Compl. (“Gasarch’s Opp’n Am. Comp.”) 1-6, ECF No. 205. Taylor also suggests that these new allegations are “manufactured.” See Taylor’s Opp’n Am. Compl. 1.
This Court hereby GRANTS the SEC’s motion to amend the complaint. The issues of futility will be dealt with on the merits by determining whether the allegations raised in the Amended Complaint are sufficient to pass muster under Federal Rule of Civil Procedure 12(b)(6) (“Rule 12(b)(6)”). As to the allegation that these claims are manufactured, this is an issue of fact to be dealt with at the fact-finding stage. All of the motions to dismiss, see Def. Jackson T. Friesen’s Mot. Dismiss Compl.; Def. Graham R. Taylor’s Mot. Dismiss Strike Pl.’s Compl.; Def. Paul Sexton’s Mot. Dismiss Compl.; Def. Yvonne Gasarch’s Mot. Dismiss Compl.; Def. Courtney Kelln’s Mot.
Dismiss SEC’s Compl.; Def. Mike K. Veldhuis’s Mot. Dismiss Compl., filed as to the prior complaint, Compl., will be treated as applying to the Amended Complaint with equal force, as it is identical in nearly all material respects to the original complaint, with the exception of allegations against Taylor and Gasarch, see generally Am. Compl. As to any additional objections raised by Taylor and Gasarch in their oppositions to the SEC’s motion for leave to amend, these objections shall be construed as additional possible grounds for dismissal pursuant to Rule 12(b)(6).
III. FACTS ALLEGED
A. Background This SEC-enforcement action targets a specific type of securities violation pertaining to stock registration and sale requirements. See Am. Compl. ¶ 35. Securities must be registered pursuant to Section 5 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77e, unless (1) they fall under an applicable exemption or (2) the stock is sold in accordance with the conditions of SEC Rule 144, 17 C.F.R. § 240.144.
One registration exemption is that securities need not be registered if the individual selling the stocks is not an “issuer, underwriter, or dealer.” 15 U.S.C. § 77d(a)(1). Section 2(a) of the Securities Act defines an issuer as any “person who issues or proposes to issue a security” and an underwriter as “any person who has purchased from an issuer with a view to . . . the distribution of any security.” 15 U.S.C. § 77b(a)(4), (11). Rule 144 dictates that an individual is not an underwriter if he is not an affiliate of the issuer at the time of sale and has not been an affiliate for the last three months -– as long as one year has elapsed from when the securities were obtained from the issuer or an affiliate. See 17 C.F.R. § 230.144(b)(1)(i). An “affiliate” is “a person that directly, or indirectly . . . controls, or is controlled by, or is under common control with, such issuer.” Id. § 230.144(a)(1).
When referring to a “control group” this Court describes individuals who are affiliates or controlled by the issuer. This Court utilizes the term “restricted stock” as shorthand for stock that has been acquired from an issuer or affiliate, absent one of the above exemptions, or is held by an issuer or affiliate that has not been registered; this stock cannot be sold to the public without violating securities laws. When referring to “unrestricted stock” this Court describes stock that can be sold in the public market. “Unrestricted stock” can become restricted if it is purchased by an affiliate. This Court also refers to stock as “registered” or “unregistered” depending on whether a registration statement has been filed with respect to that stock’s sale transaction.
Another securities requirement, relevant to this suit, mandates that an individual must file a disclosure statement if she becomes the beneficial owner of more than five percent equity stock of a company. See 17 C.F.R. 240.13d-1(a).
B. The Scheme
This SEC-enforcement action centers around a “scheme[] to sell fraudulently hundreds of millions of dollars in stocks in the United States markets” over a period that spanned 2010 to 2019. Am. Compl. ¶¶ 1, 42. The scheme generated more than one billion dollars in gross proceeds. Id. ¶ 43. “In exchange for lucrative fees,” a sophisticated enterprise, the Sharp Group, provided a series of services to public company control persons -- shell companies to conceal stock ownership, nominal beneficial shareholders, offshore accounts, stock transfers, money transfers, encrypted accounting and communication systems, and fabricated documents -- in order to facilitate the dumping of penny stocks [3] to the detriment of unsuspecting investors, without full and fair disclosure. See id. ¶¶ 2, 4-6. This enforcement action targets both the sophisticated enterprise and the public company control persons who were complicit. See id. ¶¶ 2-3.
In brief, the scheme allegedly worked as follows. Sharp, Gasarch, and Kelln (the “Sharp Group”) helped facilitate illicit stock sales of large, unregistered blocks of restricted penny stocks by helping conceal their clients’ identities as control persons. See id. ¶¶ 5-6. Veldhuis, Sexton, and Friesen (the “Veldhuis Control Group”) were affiliates who collaborated with the Sharp Group to sell restricted unregistered stocks on the public market in collaboration with Dhillon, Taylor, and Kaitz. See id. ¶¶ 7-8.
For example, blocks of stock actually controlled by Sharp and other control groups were grouped into small blocks and “sold” to offshore dummy entities (all in actuality controlled by Sharp Group and other control groups) which would then sell the shares to the public. Id. ¶¶ 54-55. Engaging in this shell game allowed the stocks to go unregistered and prevented the need for disclosure by individuals who held more than five percent of the companies’ stock. See id. Sharp further utilized offshore trading platforms to obscure the identities of the true beneficial owners. Id. ¶ 56.
C. The Players
Sharp was the “mastermind” of this operation. Id. ¶ 44. Sharp cultivated relationships with clients -– individuals seeking to sell stock while skirting securities laws -- connected them with offshore trading platforms, created “front companies” to serve as nominee shareholders, and facilitated the surreptitious fraudulent sales of unregistered restricted stocks. See id. ¶¶ 44-47. Sharp also hired individuals to operate administrative services and created encrypted communication and accounting systems which he housed physically outside the United States, hoping they would be unreachable by SEC investigators. Id. ¶¶ 49-51.
Kelln , one of Sharp’s employees, helped obtain, allocate, and distribute shares to conceal their common control. Id. ¶¶ 52. Much of Kelln’s work was grouping stocks for transmission to transfer agents [4] such that the totals appeared under five percent to avoid disclosure and registration requirements. Id. ¶¶ 53-55.
Gasarch , another employee of Sharp’s, organized wire transfers of the proceeds from the illegal stock sales while concealing the beneficiaries, maintained records in the encrypted accounting system, and routinely created false invoices to support the payments. Id. ¶¶ 57-58.
“ Veldhuis, Sexton, and Friesen acted as a group for purposes of acquiring, holding, and ultimately disposing of [] shares . . . .” Id. ¶ 153. They teamed up with Sharp and his employees surreptitiously to sell the stock of several corporations sometimes in concert with Dhillon, Taylor, and Kaitz. See id. ¶¶ 7-8. In short, the Veldhuis Control Group was a Sharp Group client, which used its services to sell restricted stock to the public. See id. ¶ 50.
Dhillon assisted by chairing the board of four of the companies whose stocks were subject to these illegal sales; he utilized his insider corporate status to issue shares to his associates and direct their sale to the public, while leaving them unregistered, in violation of several federal securities laws. Id. ¶¶ 9-11. When questioned about his involvement in these sales by the SEC, Dhillon allegedly made false statements. Id. ¶ 16.
Taylor participated by “arrang[ing] to merge a public company with one of Dhillon’s private companies, ultimately resulting in the distribution and fraudulent sale of shares,” for which he received a portion of the proceeds. Id. ¶ 14. Additionally, Taylor “controlled nominee shareholders who held and traded stock surreptitiously in concert with Dhillon and the Veldhuis Control Group.” Id.
Kaitz participated by using a media company he owned and operated, Full Services Media LLC, to promote stock that the Veldhuis Control Group was looking to dump. Id. ¶ 12. In promoting sale of this stock, Kaitz concealed the Veldhuis Control Group’s control over the stock as well as their involvement in paying for the advertisements; when questioned by the SEC he denied his involvement. Id. ¶¶ 12-13.
Sharp, Gasarch, Kelln, Veldhuis, Sexton, Friesen, and Taylor all currently reside in Canada, whereas Kaitz and Dhillon reside in the United States -– Maryland and California, respectively. Id. ¶¶ 22-30.
D. Iterations of the Scheme
1. OncoSec In 2011 Dhillon became the chairman of OncoSec Medical Incorporated’s (“OncoSec”) board of directors and therefore an affiliate of the company. Id. ¶¶ 218-19.
Dhillon used an individual to conceal his control of the stock (“Person A”) and organized the sale of OncoSec stock through a front company -- illegally skirting registration restrictions. See id. ¶¶ 217-24. Person A misrepresented Dhillon’s connection to the shares held by the front company and sold shares on Dhillon’s behalf from 2013 to 2017 to the public. Id. ¶¶ 225-29. Between April and June 2014 Taylor also sold hundreds of thousands of OncoSec shares through a nominee entity he controlled without registering them and paid Dhillon the profits. Id. ¶¶ 235-36.
During the same period the Veldhuis Control Group was executing similar trades. In 2011, “the Veldhuis Control Group directed the transfer” of OncoSec shares “to seven Sharp Group- administered” nominee entities -- at the time the Veldhuis Control Group was an affiliate of OncoSec due to the proportion of shares it held. Id. ¶ 214. Between 2011 and 2012 the Veldhuis Control Group sold millions of dollars in restricted OncoSec shares on the United States markets, without ever registering the shares. See id. ¶¶ 215-16.
2. Stevia First/Vitality
In 2012 Dhillon became the Chairman of a Company called Stevia First Corp. (“Stevia First”), which was later renamed Vitality Biopharma, Inc. (“Vitality”) (collectively, “Stevia First/Vitality”). Id. ¶¶ 8, 70. Through a reverse merger, [5] Dhillon combined Stevia First/Vitality with a public shell company, became a director of the new company, purchased the former CEO’s shares, and engaged in a seven-for-one forward stock split which considerably increased the number of shares he held of the company; he later also became the chairman of the company’s board of directors. Id. ¶¶ 72-78. Dhillon, although an affiliate of Stevia First/Vitality due to his control position on the board, repeatedly failed to register the company’s stock before selling it, a violation of securities laws. See id. ¶¶ 79-80. Dhillon also failed to file Schedule 13D Disclosure statements -- required due to his greater than five percent share of stock in the company. Id. ¶ 81.
In 2012, Dhillon distributed his shares to the nominee entities controlled by the Sharp Group (including individually by Gasarch), the Veldhuis Control Group, and Taylor to obscure his interest in the shares and skirt the registration and disclosure requirements; these individuals worked in concert to sell the stocks on the public market. See id. ¶¶ 83-84, 110-15. This was all part of the plan to make these stocks appear unrestricted when they were, in reality, still restricted. See id. ¶ 84. At the same time, the Veldhuis Control Group promoted the sale of Stevia First/Vitality by issuing misleading materials about the stock. Id. ¶¶ 85-86. Kaitz was involved in this effort and received payments from the Veldhuis Control Group to publicize the stock. Id. ¶ 87. From March to May 2012 the Veldhuis Control Group with Kaitz’s assistance unloaded thousands of shares generating $24,000,000 in profits; meanwhile, Taylor and Dhillon “shared in these illicit proceeds” which were funneled by the Veldhuis Control Group through the Sharp Group. Id. ¶¶ 88-89.
Later in 2012 and in 2014 Stevia First/Vitality issued more shares to a Sharp-nominee shareholder. Id. ¶ 91. The Sharp Group had those stocks divided among two other nominee shareholders, who then sold those stocks to the public “for the benefit of Dhillon, the Veldhuis Control Group, and Taylor.” Id. ¶¶ 91-92. Throughout 2013 and 2014 Kelln facilitated the sale of these shares, helped make transfers, and provided false documentation to legitimize the sales. Id. ¶ 93. In 2014, the Veldhuis Control Group discussed via encrypted communications the distribution of these illegitimate funds with each other as well as with Gasarch and continued to sell Stevia First/Vitality Stock while utilizing the Sharp Group’s services. Id. ¶¶ 94- 106, 117-18. Beginning in 2014 and continuing into 2016, Taylor held additional shares via nominee shareholders, which would then be transmitted to Sharp Group nominee shareholders and eventually transfer agents for sale to the public –- a process facilitated by Kelln. See id. ¶¶ 119-25.
Between 2015 and 2016 the Veldhuis Control Group directed millions in unregistered sales of restricted Stevia First/Vitality stock in coordination with another stock promotional campaign run by Kaitz, which the Veldhuis Control Group funded. Id. ¶¶ 125-27, 132-34. The Veldhuis Control Group coordinated with Sharp, Gasarch, and Kelln, as shown by encrypted communications in 2015. See id. ¶¶ 130-31.
In 2016 “Stevia First changed its name to Vitality and executed a 1-for-10 reverse split of its common stock.” Id. ¶ 141. The Veldhuis Control Group sent several payments to Stevia First/Vitality and in exchange Dhillon issued millions of shares to nominee entities controlled by the Sharp Group. Id. ¶ 142. During this time the Veldhuis Control Group sold the Stevia First/Vitality stock to the public, even though it was restricted. Id. ¶ 144. Between 2016 and 2018 Kelln retained an attorney to create opinion letters that falsely reported these nominee entities were not affiliates of Stevia First/Vitality, thereby enabling these restricted sales. Id. ¶¶ 143-44. In 2017, Kelln also strategically transmitted sets of shares from nominal shareholders to transfer agents to ensure that the shareholders always appeared to be in possession of less than five percent of the company’s shares, effectively skirting the disclosure requirements. Id. ¶¶ 145-48. Around December 2016 the Veldhuis Control Group again funded a stock promotion touting Stevia First/Vitality’s stock and once again utilized Kaitz’s services. Id. ¶ 149.
Sexton, Veldhuis, Friesen, Taylor (who forwarded proceeds to Dhillon), and Kaitz each received the proceeds from these illicit sales. Id. ¶¶ 136, 151-52.
3. Arch
Dhillon, alongside the Veldhuis Control Group, and with the assistance of Taylor and Kaitz, replicated his efforts on Stevia First/Vitality with a company named Arch Therapeutics, Inc. (“Arch”) in 2013. Id. ¶¶ 8, 161. In 2013 Dhillon organized a reverse merger between one of his private companies and a public shell company, controlled by the Veldhuis Control Group, creating Arch. Id. ¶ 162. Dhillon became Arch’s chairman, and Arch began issuing shares and underwent a stock split. Id. ¶¶ 163-64. Prior to the merger, the Veldhuis Control Group with Kelln’s assistance directed the transfer of Arch shares to several Sharp-controlled nominee-entities for their benefit. Id. ¶¶ 164-69.
After the merger, “the Veldhuis Control Group engaged Kaitz to promote” the stock. Id. ¶ 171. Kaitz’s promotion included false statements that misrepresented who was paying for the promotion and that disguised the Veldhuis Control Group’s involvement in the stock sales –- these promotions were coordinated with the Sharp Group and Dhillon’s assistance. See id. ¶¶ 173-75, 179.
The Veldhuis Control Group sold millions of Arch shares to the public without registration although they were Arch affiliates –- either because of their majority shareholder status or because of their concerted actions with Dhillon, the company’s chairman. Id. ¶¶ 177-78. Dhillon and Taylor participated actively in these sales and received the proceeds. Id. ¶¶ 180-83. “The Veldhuis Control Group and Taylor continued to engage in fraudulent sales of Arch stock into 2017” in coordination with the Sharp Group and Dhillon. Id. ¶ 184, 188. The Veldhuis Control Group reaped the proceeds and issued payments to Dhillon and Taylor from 2012 to 2018. See id. ¶¶ 189-90. Dhillon also received direct proceeds of sales orchestrated by Taylor. See id. ¶ 193.
Furthermore, Dhillon schemed to sell Arch stock through another individual, Person A, who established a front company used to sell stock surreptitiously, while concealing from intermediaries and purchasers the provenance of these shares and the fact they were restricted due to Dhillon’s affiliate status. Id. ¶¶ 197-99, 202. Sale of stock through this front company occurred from April to July 2016. See id. ¶¶ 203-04.
4. Other Events
The Sharp Group provided services to disguise stock sales apart from those involving Stevia First/Vitality, Arch, and OncoSec. Id. ¶ 237. Specifically, the Sharp Group provided nominee-entities to disguise Veldhuis, Sexton, and Friesen’s control of other issuing companies from 2011 to 2018. See id. Kaitz was involved in promoting these companies while materially omitting or misrepresenting the reality of Veldhuis, Sexton, and Friesen’s control of these nominee-entities. See id. ¶¶ 238-39. Kelln helped deposit stock via brokerage firms in small blocks in order to skirt the five percent limit –- in particular the SEC cites instances of Kelln doing so in 2017. Id. ¶¶ 242-45. IV. PLEADING STANDARD
To withstand a motion to dismiss, a complaint must “state a
claim upon which relief can be granted . . . .” Fed. R. Civ. P.
12(b)(6). The complaint must include sufficient factual
allegations that, accepted as true, “state a claim to relief
that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550
U.S. 544, 570 (2007). Courts “draw every reasonable inference”
in favor of the plaintiff, Berezin v. Regency Sav. Bank, 234
F.3d 68, 70 (1 st Cir. 2000), but they disregard statements that
“merely offer legal conclusions couched as fact or threadbare
recitals of the elements of a cause of action,” Ocasio-Hernández
v. Fortuño-Burset,
V. ANALYSIS
The Defendants seek to dismiss the SEC enforcement action against them on two key bases: (1) the SEC applies the wrong statute of limitations to certain claims, and thus the SEC does not plead timely facts on the face of the complaint; and (2) the SEC does not plead sufficient facts with particularity to establish violations. This Memorandum addresses each issue in turn and concludes that neither is meritorious. Therefore, this Court denies each defendant’s motion to dismiss.
A. Timeliness The Court addresses two key issues with regard to timeliness: (1) whether the SEC utilizes the proper statute of limitations for scienter-based disgorgement claims; and (2) whether the allegations in the SEC’s complaint are timely on their face as to each defendant for each violation.
This Court concludes, first, that the SEC applies the correct statute of limitations, as the NDAA applies retroactively to cases commenced after its passage, given the express mandate by Congress. Second, while some claims at issue are subject to a five-year statute of limitations, and others are subject to a ten-year statute of limitations, all are timely pled.
1. The Applicable Statute of Limitations for Scienter- Based Disgorgement Claims
Six of the Defendants [6] move to dismiss the SEC’s scienter- based securities claims for disgorgement on the basis that they are time-barred. See Friesen Mem. 7-10; Taylor Mem. 8-20; Sexton Mem. 7-18; Gasarch Mem. 5-8; Kelln Mem. 20 & n.7; Veldhuis Mem. 11. [7] The Defendants argue that in seeking disgorgement for securities violations that took place between five and ten years ago, the SEC is applying the NDAA retroactively. See Taylor Mem. 1-2. In essence, the Defendants assert that claims based on conduct that occurred between 2011 and January 1, 2016, are untimely because the NDAA’s new statute of limitations cannot apply retroactively to revive stale claims. See Friesen Mem. 7-10; Taylor Mem. 10-20; Sexton Mem. 7-18; Gasarch Mem. 7-8; Kelln Mem. 20 n.7; Veldhuis Mem. 11. The Defendants support this argument by comparing the NDAA’s language to that of the Public Company Accounting Reform and Investor Protection Act of 2002 (“Sarbanes-Oxley”), “which courts have consistently held is not sufficient to revive time- barred claims,” and by arguing that applying the NDAA retroactively in this way would violate the Ex Post Facto Clause because disgorgement is penal in nature. See Taylor Mem. 2. The SEC rebuts that Sarbanes-Oxley ought not bear on the Court’s analysis, as it is distinguishable from the NDAA; and that disgorgement is not akin to criminal punishment and thus that the Ex Post Facto Clause does not apply. See SEC’s Opp’n Taylor 9.
This Court holds that the NDAA’s ten-year statute of limitations on disgorgement for scienter-based claims applies retroactively to both cases pending on and cases commenced after its passage, because the statute contains an express retroactivity command from Congress. In arriving at this conclusion this Court: (a) provides a brief overview of the status of the law before and after the passage of the NDAA; (b) explains why an analysis of the NDAA’s language demands retroactive application; and (c) determines that retroactive application of the new statute of limitations is not violative of the Ex Post Facto Clause.
a. The Background of the NDAA
The Supreme Court has twice restricted the SEC’s
disgorgement power in recent years. The first time in Kokesh v.
SEC,
This state of affairs changed when Congress renewed the NDAA on January 1, 2021, over the President’s Veto. See All Information for H.R. 6395 – William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, Congress.gov, https://www.congress.gov/bill/116th-congress/house- bill/6395/all-info (last visited Aug. 11, 2021). The NDAA provides that:
The Commission may bring a claim for disgorgement under paragraph (7) . . . not later than 10 years after the latest date of the violation that gives rise to the action or proceeding in which the Commission seeks the claim if the violation involves conduct that violates –- (I) section 10(b);
(II) section 17(a)(1) of the Securities Act of 1933 (15 U.S.C. 77q(a)(1));
(III) section 206(1) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-6(1))
(IV) any other provision of the securities laws for which scienter must be established.
William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, Pub. L. No. 116-283, § 6501, 134 Stat. 3388, 4626 (2021) (codified in part at 15 U.S.C. § 78u(d)(8)(A)) (“NDAA § 6501”). Section 6501 of the NDAA (“Section 6501”) departed from the status quo by extending the Kokesh five-year statute of limitations to ten years. [8] This change left an unanswered question: can the SEC disgorge profits from individuals who committed conduct between five and ten years before the NDAA’s passage against whom actions are now being filed?
This appears to be an issue which the First Circuit has yet to consider. [9] Furthermore, the precise matter of concern in this case –- whether the NDAA applies retroactively to actions commenced after its passage –- is an issue of first impression for this Court. [10]
This action was commenced after the passage of the NDAA -– the SEC filed the Complaint on August 5, 2021, see Compl. 1 -- and seeks to reach conduct between five and ten years before the NDAA’s passage, see generally Am. Compl. Therefore, this Court must consider the NDAA’s retroactivity.
b. Retroactivity Analysis for the NDAA
The relevant provision of the NDAA details that the
amendments, including the Act’s alteration of the statute of
limitations, “apply with respect to any action or proceeding
that is
pending on, or commenced on or after
” January 1, 2021.
NDAA § 6501 (emphasis added); see also SEC v. Ahmed, No. 3:15-
675 (JBA),
[10]
Another session of this Court has, however, applied the
ten-year statute of limitations retroactively to a case
pending
at the NDAA’s passage. See SEC v. Navellier & Assocs., Inc.,
No. 17-CV-11633-DJC,
“Retroactive application of a new statute . . . occurs
whenever the statute is applied to causes of action already
accrued prior to its enactment date.” Lieberman v. Cambridge
Partners, L.L.C.,
“There is no doubt,” however, “that Congress has the raw
power to enact statutes that operate retroactively.” Lattab v.
Ashcroft,
272-273. First, this Court must assess whether Congress
“expressly prescribed the statute’s proper reach” or clearly
“command[ed]” retroactive application. Id. at 280. Second, if
the Court concludes Congress has not done so, it must consider
“whether the application [of the statute] in question would have
an impermissibly retroactive effect.” Lattab,
This requires scrutinizing the NDAA’s text, starting with
the word “pending” in the phrase “pending on, or commenced on or
after” and applying the normal rules of construction. See Lindh
v. Murphy,
2067, 2074 (2018) (quotations omitted and alterations in
original). A case is pending until the “last court in the
hierarchy [of Article III courts] [] rules on the” matter.
Plaut v. Spendthrift Farm, Inc.,
There appears no doubt then that the language “pending on,
or commenced on or after” suggests an express mandate of
retroactivity for
pending cases
. In fact, the parties both
imply as much. See Taylor Mem. 1, 12 n.6; SEC’s Opp’n Taylor
10. Furthermore, several courts in a variety of circuits agree
that the NDAA applies retroactively to pending claims. See SEC
v. Gallison, No. 15-cv-5456,
(2d Cir. 2021) (identifying the retroactivity of the NDAA’s ten-
year statute of limitations for disgorgement claims in the
context of a pending case); SEC v. Navellier & Assocs., No. 17-
cv-11633,
Where the parties diverge, and what they argue has yet to be determined by any court, is whether the language “pending on, or commenced on or after” creates the same explicit mandate of retroactivity for cases “commenced . . . after” the statute’s passage. This Court holds that it does.
First, “pending on, or commenced on or after” indicates an express mandate of retroactivity, given the explicit temporal scope suggested by the word “pending”; the words “commenced . . . after” cannot be divorced from the context of their placement adjacent to the word “pending”. See Yates v. United States, 574 U.S. 528, 543 (2015) (discussing the well-known statutory canon “of noscitur a sociis –- a word is known by the company it keeps”).
Second, the Supreme Court has identified nearly the precise
language used in the NDAA -- “pending on or commenced on or
after” the date of the statute’s enactment -- as explicitly
suggesting an express mandate of retroactivity from Congress.
See Landgraf,
Third, simple logic demands this reading. If this Court
read only “pending on” to apply retroactively, and not
“commenced on or after,” it would lead to an irrational outcome:
(1) a case filed before or on December 31, 2020 seeking
disgorgement for pre-January 1, 2016 conduct would receive the
extended statute of limitations and be timely, and (2) a case
filed January 2, 2021 seeking to reach the very same conduct
would be untimely. SEC-enforcement actions would be able to
reach more –- or less -– allegedly violative conduct, simply by
virtue of their filing date under the exact same statutory
scheme. Furthermore, reading the statute in this way would
reward the SEC for filing what the Defendants argue are stale
claims before the statute’s enactment and penalize it for doing
so once it arguably possessed such authority. The Supreme Court
has previously rejected such nonsensical readings of retroactive
mandates. See Int’l Union of Elec., Radio & Mach. Workers, Loc.
790 v. Robbins & Myers, Inc.,
Furthermore, in the context of similar statutory mandates,
courts have held that statutory retroactivity must be applied to
cases “commenced after” an Act’s passage in a way that is
congruous to how it is applied in pending cases. See, e.g.,
Heaven v. Gonzales,
Fourth, the legislative history of the NDAA supports this
conclusion. “Where the text of a statute is clear, as it is
here, we need not go on to consider the act’s legislative
history to divine Congress’s intent.” Telecommunications Regul.
Bd. of P.R. v. CTIA-Wireless Ass’n,
Therefore, the text, context, and legislative history of the NDAA all suggest an explicit mandate for retroactive application of the ten-year statute of limitations. https://www.banking.senate.gov/imo/media/doc/Clayton%20Testimony %2011-17-202.pdf.
[13] Before the NDAA’s passage Congressmen decried Kokesh as a “boon to white collar criminals” and described expanding the statute of limitations for disgorgement as a solution that “would ensure the SEC [had] the tools it [needed] to hold bad actors accountable.” 165 Cong. Rec. H8930 (daily ed. Nov. 18, 2019) (statement of Rep. Green). After its passage, some members of Congress touted Section 6501 as an effort to strengthen the SEC. See Press Release, House Committee on Financial Services, Waters Statement on Inclusion of Key Democratic Financial Services Bills in FY 2021 NDAA (Dec. 3, 2020),
https://financialservices.house.gov/news/documentsingle.aspx?Doc umentID=407049 (citing the NDAA as one of the “measures that will help law enforcement prevent these criminals from using shell companies to hide their activities and will close loopholes and increase penalties on those bad actors who are using our system for activities that threaten the U.S. and our allies”).
The Defendants raise two main counterarguments to the conclusion that Congress’ language indicates an express mandate of retroactivity; this Court finds both unpersuasive.
First, the Defendants argue that the language
“commenced on
or after”
has already been considered insufficient to allow
retroactive application in the context of Sarbanes-Oxley, Pub.
L. No. 107–204, § 804, 116 Stat. 745, 801 (codified in part at
28 U.S.C. § 1658(b)) (emphasis added). Taylor Mem. 12-13. The
Defendants are correct that several circuit and district courts
have held that the language “commenced on or after”
alone
is not
an “express retroactivity command.” Aetna Life Ins. Co. v.
Enter. Mortg. Acceptance Co.,
Second, the Defendants claim that the SEC-enforcement
action at issue here is unique because it seeks to revive
moribund or stale claims. See, e.g., Taylor Mem. 1, 13. This
argument falls short. For one, it is unclear whether the NDAA
can in actuality be classified as reviving a lost right. Cases
that discuss the revival of stale claims distinguish between
statutes of limitations and statutes of repose, highlighting the
latter as “unequivocally creat[ing] a new cause of action.” See
Lieberman
262 (S.D.N.Y. 1966), the case in which the SEC first argued for
the “right to seek restitution of the ill-gotten profits of
securities law violators”). In fact, before the district courts
began issuing disgorgement as a remedy, the SEC had to resort to
other forms of recourse such as injunctive relief and voluntary
restitution. See id. at 642-43. Therefore, the NDAA’s
expansion of the statute of limitations for
disgorgement
addressed the limitations on a remedy -- not a right.
Furthermore, even if this case were construed as reviving a
stale claim via the NDAA, Congress has the power to revive stale
claims as long as it does so clearly. See Resol. Tr. Corp. v.
Seale,
a. Ex Post Facto Concerns
The Defendants also object to the applicability of the ten-
year statute of limitations by claiming that it violates the Ex
Post Facto Clause of the Constitution. See, e.g., Taylor Mem.
14-17.
[15]
The first step of the Ex Post Facto analysis is to
determine whether a statute is civil or criminal. Smith v. Doe,
Here, disgorgement is denominated as a civil remedy by the
Exchange Act. See 15 U.S.C. § 78u(d). The “ordinary meaning,”
Mohamad v. Palestinian Auth.,
has been regarded in our history and traditions as a punishment; imposes an affirmative disability or restraint; promotes the traditional aims of punishment; has a rational connection to a nonpunitive purpose; or is excessive with respect to this purpose.
Id. at 97. The Court “ordinarily defer[s] to the legislature’s
stated intent,” Hendricks,
First, disgorgement has not been historically regarded as
punishment. As discussed earlier, disgorgement that seeks to
remedy unjust enrichment is equitable in nature and equity
“historically excludes punitive sanctions.” Liu, 140 S. Ct. at
1940. The Supreme Court’s decision in Liu further anchored this
historical notion by cabining disgorgement to a wrongdoer’s net
profits and requiring that such awards be returned to the
victims. See id. Well before the cabining of SEC enforcement
power by Liu, however, courts “repeatedly stressed that []
disgorgement is an equitable, not a punitive, remedy” and
applied this concept in limiting the boundaries of the
disgorgement remedy. See Elaine Buckberg & Frederick C. Dunbar,
Disgorgement: Punitive Demands and Remedial Offers, 63 Bus. Law
347, 357 (2007-2008). In fact, several sister circuits agree
that disgorgement has not “historically been viewed as
punishment.” See SEC v. Palmisano,
Second, the law does not impose an affirmative disability
or restraint. The paradigmatic test for whether a statute
burdens defendants in this way is whether it “restrain[s] [the]
activities” in which defendant may engage. See Smith, 538 U.S.
at 100. There is no doubt that disgorgement simply imposes
duties of monetary repayment and, unlike bars, does not limit
what types of behaviors or work in which defendants may engage.
See Rizek v. SEC,
Third, disgorgement has a rational connection to a non-
punitive purpose. It seeks to make violations less profitable
by “depriving violators of the fruits of their illegal conduct.”
SEC v. Contorinis,
2004); SEC v. Gordon,
Disgorgement does not necessarily promote the aims of
traditional punishment –- such as “incapacitation [or]
retribution,” Doe v. Snyder,
Finally, for reasons similar to those outlined by this Court, two other district courts have ruled that retroactive application of the NDAA’s ten-year statute of limitations does not violate the Ex Post Facto Clause. See Gallison, 2022 U.S.
Dist. LEXIS 35810, at *16 (“Accordingly, the NDAA’s extension of the statute of limitations applicable to disgorgement does not violate the Ex Post Facto Clause.”); Kellen, 2021 U.S. Dist. LEXIS 204153, at *10 (concluding the same).
The Defendants have, therefore, in no way met their burden
of providing the “clearest proof” that disgorgement is “punitive
in either purpose or effect.” Ward,
Defendants’ primary counterargument is that, because Kokesh held
disgorgement to be a penalty within the meaning of 28 U.S.C. §
2462, it must be punitive in nature. See Taylor Mem. 15. This
is unpersuasive for at least two reasons: (1) Kokesh “is limited
to its interpretation of Section 2462 and does not inform
whether disgorgement is a criminal penalty for purposes of the
Ex Post Facto Clause,” Gallison,
2. Whether the Allegations Are Timely Pled Having now determined the appropriate statute of limitations for scienter-based disgorgement claims, this Court next moves to determining: (a) what is the relevant statute of limitations for each claim alleged by the SEC; and (b) whether each claim contains sufficient allegations within the applicable limitations period.
a. What Statute of Limitations Applies to Each Claim The SEC seeks injunctive relief, civil monetary penalties, disgorgement, and orders barring the defendants from engaging in future trades. See Am. Compl. ¶ 307(A)-(L).
First, this Court holds that Section 6501 applies retroactively to expand the statute of limitations to ten-years as to scienter-based claims for disgorgement , which include violations of:
(I) section 10(b);
(II) section 17(a)(1) of the Securities Act of 1933 (15 U.S.C. 77q(a)(1));
(III) section 206(1) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–6(1)); or
(IV) any other provision of the securities laws for which scienter must be established.
15 U.S.C. 78u(d)(8)(A)(ii). Non-scienter-based claims for disgorgement continue to require a five-year statute of limitations under the NDAA, see id. § 78u(d)(8)(A)(i), as they did under Kokesh, see 28 U.S.C. § 2462; Kokesh, 137 S. Ct. at 1639. [16]
Second, the statute of limitations for
civil penalties
has
always been set at five-years under 28 U.S.C. § 2462. See
Gabelli v. SEC,
LEXIS 35810, at *13 n.14 (noting the same).
Third, it was previously unclear what statute of
limitations applied to claims for
injunctive relief
, for both
scienter and non-scienter-based violations. Compare SEC v.
Graham,
The SEC filed the original Complaint on August 5, 2021.
See Compl. 1. The applicable limitations period thus runs from August 5, 2016 to August 5, 2021 for civil penalties and non- scienter-based disgorgement claims . The applicable limitations period for scienter-based disgorgement claims and injunctions spans from August 5, 2011 to August 5, 2021. No briefing or objections have been raised as to the bars; thus, this Court reserves any concomitant questions on those particular remedies for a later stage.
The SEC raises claims under Sections 17(a)(1) and (3), 5(a) & (c), 15(b) of the Securities Act and Sections 10(b), 13(d), and 20(e) of the Exchange Act. Am. Compl. 250-307. Claims brought pursuant to sections 10(b) of the Exchange Act and Rule 10b-5 thereunder, and 17(a)(1) of the Securities Act are explicitly defined as claims to which the ten-year statute of limitations applies for disgorgement under the NDAA, see NDAA § 6501, although the five-year statute of limitations continues to apply to civil penalties sought pursuant to these acts, see 28 U.S.C. § 2462.
The NDAA’s ten-year statute of limitations also applies to “any other provision of the securities laws for which scienter must be established.” NDAA § 6501. “Scienter is a mental state embracing intent to deceive, manipulate, or defraud. [The First Circuit] has held that a plaintiff can demonstrate scienter by showing that defendants either consciously intended to defraud, or that they acted with a high degree of recklessness.” Mississippi Pub. Emps.’ Ret. Sys. v. Bos. Sci. Corp., 523 F.3d 75, 85 (1st Cir. 2008) (citations and quotations omitted).
Sections 17(a)(3) and 5(a) & (c) of the Securities Act, and
Section 13(d) of the Exchange Act are not scienter-based because
neither their governing statutes nor the caselaw interpreting
them require scienter. See 15 U.S.C. § 77q(a)(3) (governing
Section 17(a)(3) of the Securities Act and not requiring
scienter); SEC v. Ficken,
The only remaining claims are those brought under Section
20(e) of the Exchange Act and 15(b) of the Securities Act.
These types of claims require knowing or reckless behavior. 15
U.S.C. § 78t(e) (governing Section 20(e) of the Exchange Act and
requiring knowledge or recklessness); 15 U.S.C. § 77o(b)
(governing Section 15(b) of the Securities Act and requiring
knowledge or recklessness). Claims that require knowledge or
recklessness constitute scienter-based claims, see Bos. Sci.
Corp.,
b. Sufficient Allegations Exist Under Either Statute of Limitations.
Several of the Defendants argue that at least some claims against them ought be dismissed because, even if the ten-year statute of limitations applies for scienter-based disgorgement claims, the SEC has not alleged sufficient facts in the complaint to establish that violations occurred within the five- year statute of limitations for purposes of the civil penalty- and non-scienter-based disgorgement claims. See Sexton Mem. 20; Taylor Mem. 6-10; Gasarch Mem. 5-6; Friesen Mem. 7; Kelln Mem. 20; Veldhuis Mem. 11 (incorporating arguments from other memoranda by reference).
The SEC rebuts that, where applicable, the five-year statute of limitations should be tolled for time spent outside the United States and that it has alleged sufficient facts within the five-year period sustain its claims. See SEC’s Opp’n Taylor 16-18; SEC’s Opp’n Sexton 1, 18-19; SEC’s Opp’n Gasarch 4-5, 9-10; SEC’s Opp’n Kelln 17-18; SEC’s Opp’n Veldhuis 15-16.
This Court concludes that the allegations are timely under both the ten-year and the five-year statute of limitations, for each respective type of claim, for the following reasons: (i) the SEC has timely pled facts on the face of the Amended Complaint for each Defendant; and (ii) the five-year statute of limitations for non-scienter-based disgorgement and civil penalties is not applicable for individuals who have not been present within the United States for the last five years -- therefore it is unclear whether the SEC even needed to plead facts within the five-year period for all Defendants.
i. Allegations are Timely on the Face of the Complaint.
Generally, seeking dismissal based on a statute of
limitations having run is an affirmative defense. See Fed. R.
Civ. P. 8(c); Martínez-Rivera v. Puerto Rico,
In securities cases, however, “[t]he [SEC] has the burden
of pleading and proving facts demonstrating the timeliness of
its action . . . .” SEC v. Tambone,
This general rule applies with particular force to § 2462, which prohibits the court from “entertain[ing]” actions that accrued more than five years earlier and seeking certain forms of relief. Allowing discovery to proceed with respect to claims that appear to be time-barred on the face of a plaintiff's complaint would constitute “entertain[ing]” those claims, which § 2462 clearly prohibits.
Cohen,
There appears to be little argument that the allegations are timely under the ten-year statute of limitations. See generally Taylor Mem.; SEC Opp’n Taylor. Therefore, this Court focuses its inquiry on whether there are sufficient allegations within the five-year statute of limitations for the SEC to raise civil penalties and disgorgement for non-scienter-based claims.
The SEC states several times in its complaint that all of the Defendants committed an assortment of violations from 2010 to 2019 -- which contains the relevant five-year time period starting in August 2016. See Am. Compl. ¶¶ 1, 5, 42-43, 68. Furthermore, the complaint contains specific allegations as to every defendant within the relevant time period. For example, at the end of 2016 Veldhuis , Sexton and Friesen conducted unregistered sales of millions of Stevia First/Vitality shares. Id. ¶¶ 125, 134. At the same time, the Veldhuis Control Group also surreptitiously funded a promotional campaign by Kaitz, which encouraged these stock sales by disseminating allegedly false information. Id. ¶ 125, 149. At various times in 2016 Veldhuis, Sexton, and Friesen sent numerous wire transfers to Stevia First/Vitality, which in exchange issued shares to Sharp- controlled nominee entities; this and other services provided by Sharp enabled the Veldhuis Control Group to sell restricted Stevia First/Vitality stock to the public, without registering it, even though the nominees were Stevia First/Vitality affiliates. Id. ¶¶ 142-43.
At least until December 2016 Taylor sold millions in Stevia First/Vitality stocks via Sharp-Group administered nominee entities. Id. ¶ 134. He also received funds, and redistributed part of them to Dhillon, during this period. Id. ¶ 152. Taylor engaged in fraudulent sales of another company, Arch’s, stock into 2017 directing sales through nominee entities to skirt registration requirements. Id. ¶ 184. He also signed and backdated fraudulent Option Agreements to justify his payments to Dhillon and provided these documents to Canadian regulators in 2021. Id. ¶ 191.
Kelln helped recruit attorneys for the Sharp Group in 2016 and 2018 to create fraudulent opinion letters to legitimize the unregistered sale of restricted Stevia First/Vitality stock. Id. ¶ 144. In 2017, Kelln directed the redistribution of funds among nominee entities to help clients skirt the five percent disclosure required of Section 13(d) of the Exchange Act. Id. ¶ 147.
Throughout 2016 and 2017, Gasarch created fictitious invoices, loan and subscription agreements, and other documents for Sharp Group nominee entities that were used to cover up the fraudulent payments to clients from the Sharp-Group. Id. ¶ 58. Specifically, the SEC cites four documents that Gasarch made and sent from August 2016 to October 2017. Id. Gasarch also communicated with transfer agents pretending to be the nominal owner of Sharp-Group administered entities in furtherance of the scheme and helped move clients’ shares to the transfer agents in 2016, 2017, and 2018. Id. ¶¶ 61-62. It ought be noted that Gasarch claims she gave birth in 2016 and took leave from the Sharp Group, see Gasarch Mem. 1 n.1; this court must, however, accept the SEC’s well pled allegations as true at the motion to dismiss stage.
Gasarch and Kelln received $1,000,000 each of funds from the Sharp Group’s conduct and some of these payments continued on from 2016 to 2019. Id. ¶ 68.
This is by no means an exhaustive list of the SEC’s post- 2016 allegations, yet these facts alone establish a sufficient basis for the timeliness of the SEC’s complaint -- even in the absence of application of tolling provisions. To the extent that there is doubt regarding whether these claims are sufficient to allege “violations” within the relevant time period, this memorandum later addresses the sufficiency of the allegations with respect to each claim. See infra Section V.B.2.
The Defendants argue that certain factual allegations are
insufficient to establish timeliness, because they are only
indicative of residual benefits from a much earlier violation;
for example, funds received in 2016 are simply benefits from
violations which occurred mainly in 2012. See, e.g., Sexton
Mem. 3. This is unpersuasive for two reasons: (1) first, as
discussed in more detail below, the SEC makes sufficient
allegations of
violations
not just receipt of funds within the
five-year statute of limitations for each Defendant, see infra
Section V.B.2; (2) second, to the extent the Defendants
challenge the accuracy of the SEC’s timeline, determination of
this issue would be premature. It is well-established in this
Circuit that “[w]here questions of fact are presented, statute
of limitations defenses are ordinarily submitted to the jury.”
Melendez-Arroyo v. Cutler-Hammer de P.R. Co.,
Supp. 3d 49, 56 (D. Mass. 2019) (Hillman, J.) (quotations omitted).
ii. The Five-Year Statute of Limitations Does Not Apply to Individuals Who Have Been Absent from the United States.
For several of the Defendants the five-year statute of limitations may not apply to civil penalties and may not have begun to run for non-scienter-based disgorgement claims. Both civil penalties and non-scienter-based claims for disgorgement continue to be subject to a five-year statute of limitations, notwithstanding Section 6501. See 28 U.S.C. § 2462 (imposing a five-year statute of limitations on civil penalties); 15 U.S.C. § 78u(d)(8)(A)(i) (imposing a five-year statute of limitations on non-scienter-based disgorgement claims). Each statute, however, includes modifications to the limitations provisions for time spent outside the United States.
Civil penalties are governed by 28 U.S.C. § 2462, which dictates that an action “shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.” 28 U.S.C. § 2462 (emphasis added). How this requirement ought be applied is matter of first impression within the Circuit.
The Southern District of New York, however, has read this
requirement to mean that if a Defendant has not been found in
the United States at any time during the limitations period, or
within five years of when the claim first accrued, then a claim
is actionable -- even if more than five years have elapsed since
the SEC’s claims first accrued. SEC v. Straub, 921 F. Supp. 2d
244, 259-61 (S.D.N.Y. 2013); see also SEC v. Wey, 246 F. Supp.
3d 894, 935 (S.D.N.Y. 2017) (“For the reasons cited in Judge
Sullivan’s opinions [Straub,
SEC v. Straub, No. 11 CIV. 9645 (RJS),
Non-scienter-based disgorgement
claims are governed by
Section 6501, which provides that, for purposes of calculating
the limitations period, “any time in which the person against
which the action or claim, as applicable, is brought is outside
of the United States shall not count towards the accrual of that
period.” See NDAA § 6501; 15 U.S.C. § 78u(d)(8)(C).
[17]
A date of
accrual is when a statute of limitations begins to run. See
Carreras-Rosa v. Alves-Cruz,
The Amended Complaint makes several allegations that are relevant to whether the five-year statute of limitations does not apply to (as to civil penalties), or has not yet begun to run for (as to non-scienter-based disgorgement), the Defendants: (1) the Complaint alleges that Taylor, Friesen, Veldhuis, Sexton, Kelln, and Gasarch all reside in Canada and spend most of their time there, Am. Compl. ¶¶ 23-29; (2) Sexton visited Dhillon in the United States once in 2014 and claims to have made several other trips to the United States since, id. ¶ 120; Sexton Mem. 6 n.5; (3) while the face of complaint makes no mention of Taylor or Gasarch’s presence in the United States, see SEC Opp’n Gasarch 5; see generally Am. Compl., Taylor claims he visited the United States on numerous occasions, Taylor’s Opp’n Am. Compl. 7, and Gasarch’s counsel represents that she “traveled to the United States for personal reasons during the limitations period,” see Gasarch’s Opp’n Am. Compl. 7 n.2; and (5) as to the remaining Defendants -– Friesen, Veldhuis, and Kelln –- neither the Defendants nor the SEC ever allege that Plaintiffs visited the United States between 2011 and 2019, see generally Am. Compl.; Kelln Mem. 17 (“There is no allegation that Kelln ever . . . traveled to the United States during the relevant time.”); SEC Opp’n Kelln 17 (noting Kelln’s concession); SEC’s Opp’n Veldhuis 16; Friesen Mem. 2 (noting the general absence of allegations against Friesen).
As already discussed, see supra Section V.A.2.b.i.,
although the SEC has an affirmative duty to make timely
pleadings on the face of the complaint, Tambone, 802 F. Supp. 2d
at 304, untimeliness is an affirmative defense, see Fed. R. Civ.
P. 8(c)(1); Martínez-Rivera,
Although Taylor and Gasarch claim they have visited the United States multiple times, both fail to provide any evidence to support their claims, see Taylor’s Opp’n Am. Compl. 7; Gasarch’s Opp’n Am. Compl. 7 n.2, and none of the remaining Defendants even argue they were present in the United States during the period. Therefore, Taylor, Gasarch, Kelln, Veldhuis, and Friesen have failed to meet their burden for levelling this affirmative defense at the motion to dismiss stage; this entails that the five-year statute of limitations may either not apply to, or not have start to run for, these Defendants.
Accordingly, dismissal on this basis would be premature.
B. Sufficiency of the Allegations on the Merits Almost all of the Defendants move to dismiss the SEC’s claims based on the factual sufficiency of the allegations. Friesen, Veldhuis, Gasarch, and Kelln challenge the SEC’s claims on the basis that they do not sufficiently plead the elements of the alleged violations. See Friesen Mem. 10-20; Veldhuis Mem. 8-10; Gasarch Mem. 9-15; Kelln Mem. 7-16. Sexton raises the Federal Rule of Civil Procedure 9(b) (“Rule 9(b)”) pleading standard in his motion to dismiss but does not brief the issue, and Taylor does not make claims steeped in factual sufficiency in his motion to dismiss or memorandum in support but does so in his opposition to the SEC’s motion for leave to amend the complaint. See Sexton Mot. Dismiss 1; Taylor Opp’n Am. Compl. 4-11; see generally Sexton Mem.; Taylor Mem.
This Court concludes that the SEC has sufficiently pled each claim against each Defendant in accordance with the requisite standards. In so ruling, the Court first, addresses the appropriate pleading standard under Rule 9(b); and second, considers each of the claims raised against the Defendants. In conducting the latter analysis this Court focuses on the five- year statute of limitations, as the sufficiency of the allegations within this time-period was most contested by the Defendants.
1. Standard to be Applied Pursuant to Federal Rule of Civil Procedure 9(b)
This Court applies the Rule 9(b) pleading standard for SEC
enforcement actions. See SEC v. Durgarian,
It is important to note that Congress has “impose[d] heightened pleading requirements” even more severe than those laid out in Rule 9(b) “in actions brought pursuant to § 10(b) and Rule 10b–5,” if the case is a private enforcement action . Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 81 (2006). In these cases, the pleaded facts must give rise to a “strong inference” of scienter -- meaning the plaintiff must plead with particularity the facts that give rise to that inference. Tellabs, Inc. v. Makor Issues & Rts., Ltd., 551 U.S.
308, 322-24 (2007); see also In re Boston Sci. Corp. Secs.
Litig.,
The First Circuit has
outright rejected
that the “strong
inference” requirement is applicable to SEC enforcement actions.
Papa,
2. Analysis for Each Claim
a. Claims Brought Under 10(b) of the Exchange Act and 17(a)(1) of the Securities Act Kelln, Veldhuis, Sexton, Friesen, and Taylor face counts brought under both sections 10(b) of the Exchange Act and 17(a)(1) of the Securities Act. See Am. Compl. ¶¶ 250-55.
Section 10(b) of the Exchange Act establishes that it is unlawful “[t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.” 15 U.S.C. § 78j(b). The SEC’s interpretive Rule 10b-5(a), issued under its rulemaking authority states “[i]t shall be unlawful for any person, directly or indirectly, . . . [t]o employ any device, scheme or artifice to defraud” and subsection (c) makes it unlawful “[t]o engage in any act, practice, course of business which operates or would operate as a fraud or deceit upon any person. 17 C.F.R. § 240.10b–5(a)-(c). Section 17(a)(1) of the Securities Act makes it “unlawful for any person 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 use of the mails, directly or indirectly” to “employ any device, scheme, or artifice to defraud.” 15 U.S.C. § 77q(a)(1).
“The elements of an action for securities fraud under
Section 10(b) of the Exchange Act (and Rule 10b–5 thereunder)
and Section 17(a)(1) of the Securities Act are substantially the
same under the Supreme Court’s precedents.” SEC v. Tambone, 417
F. Supp. 2d 127, 131 (D. Mass. 2006) (Gorton, J.); see also SEC
v. Patel, No. CIV. 07-CV-39-SM,
In order to commit a Section 10(b) violation a plaintiff
must have: “(1) made a material misrepresentation or a material
omission . . . or used a fraudulent device [scheme or artifice];
(2) with scienter; (3) in connection with the purchase or sale
of securities.” SEC v. Monarch Funding Corp.,
Stoneridge Inv. Partners, LLC v. Sci.-Atlanta, Inc., 552 U.S.
148, 158 (2008); In re DVI, Inc. Sec. Litig.,
[i]n order to state a claim that a defendant is a “primary violator”, the complaint must allege not only a fraudulent scheme but also facts to demonstrate that the defendant under consideration “substantially participated” in the alleged scheme . . . . In other words, the SEC must allege how each of the defendants’ actions had a principal purpose and effect upon creating a false appearance in fact in furtherance of the scheme to defraud.
Durgarian,
As to the second requirement of this test, “[s]cienter is a
mental state embracing intent to deceive, manipulate, or
defraud. This Circuit has held that a plaintiff can demonstrate
scienter by showing that defendants either consciously intended
to defraud, or that they acted with a high degree of
recklessness.” Bos. Sci. Corp.,
(1st Cir.1999)).
The third requirement simply demands that the “deceptive
devices and contrivances” be used in connection with “the
purchase of sale or securities”; this reaches sales regardless
“whether conducted in the organized markets or face to face.”
Superintendent of Ins. of State of N. Y. v. Bankers Life & Cas.
Co.,
The SEC successfully alleges facts for these remaining requirements as to all of the Defendants. What follows is an analysis of whether the SEC pleads the following from 2016 to 2021, for each Defendant: (1) involvement in a scheme to defraud and substantial participation via actions that were independently deceptive or fraudulent (alleged with particularity), and (2) the requisite scienter -- intentional or reckless (alleged generally).
As to
Kelln
first, the SEC alleges she was a member of the
Sharp Group. See Am. Compl. ¶ 5. Kelln allegedly “routinely
performed a variety of complex administrative tasks associated
with obtaining, allocating, and distributing blocks of shares
across multiple nominee shareholders in a manner designed to
conceal the Sharp Group’s clients’ common control of all the
stock so distributed.” Id. ¶ 52. These acts, if alleged with
particularity, would constitute “substantial participation” in a
scheme to defraud as they involve active efforts to create and
conceal entities such that SEC regulations can be skirted. See
SEC v. Frohling,
The next question is whether the SEC alleges these fraudulent acts with particularity during the relevant time period (August 2016-2021). The complaint alleges the following relevant facts: (1) on various dates in 2016 and 2018 Kelln retained an attorney to prepare false opinion letters, which attempted to hide that nominee entities were affiliates of one of the companies that was selling stocks, Am. Compl. ¶ 144; (2) in 2017 Kelln aided in the transfer of Stevia First/Vitality shares from a Sharp Group administered nominee entity to an offshore trading platform (Wintercap SA), id. ¶ 145; (3) in 2017, Kelln instructed Wintercap SA to assign all the sales of shares made to a specific account in order to reduce the number of shares one of Sharp’s nominee entities was shown as holding - - “[t]his ruse prevented Hilton Capital from showing share ownership in excess of 5%. Specifically, Kelln wrote: ‘allocate all VBIO [ticker symbol of Stevia First/Vitality] to the [Hilton Capital] account today. We need to make room for pending 750k. Again 5% rule is biting me in the ass,’” id. ¶ 147. These allegations are just a sample of the allegations that are sufficient to establish the particularity needed here.
Second, the question is whether the SEC alleges Kelln possessed the requisite scienter. The SEC alleges “Kelln knew or recklessly disregarded” that transferring funds from the nominee entities controlled by the Sharp Group to Wintercap SA would have brought the total shares held by the nominee entity to more than five percent in violation of SEC regulations. Id. ¶ 146. This was demonstrated via her communications with Sharp, indicating the difficulty of skirting this regulation. Id. ¶ 147. This is sufficient to establish the requisite scienter.
As to Veldhuis, Sexton, and Friesen , the members of the Veldhuis Control Group, allegedly illegally sold Stevia First/Vitality, Arch, OncoSec and other Company’s stock. See id. ¶¶ 7-8. These individuals “teamed up with the Sharp Group to run lucrative, fraudulent schemes to sell stock surreptitiously in the public markets.” Id. ¶ 7. This conduct spans beyond “substantial participation” by providing the necessary infrastructure for the entire scheme; without these individuals’ surreptitious sales the shell game would not have been possible. Therefore, if alleged with particularity, the claims against Veldhuis, Sexton, and Friesen are sufficient for Section 10(b) liability.
First, the SEC successfully alleges this participation with particularity. At various points in 2016 the Veldhuis Control Group sent wire payments to Stevia First/Vitality, amounting to $ 4.4 million in exchange for the issuance of millions of shares to nominee entities. Id. ¶ 142. From 2016 to 2018 the Veldhuis Control Group acted in concert with Dhillon to sell Stevia First/Vitality’s stock to the public even though it was unregistered and restricted. Id. ¶ 144. Still in 2017 Veldhuis provided trading instructions to Wintercap SA to sell Stevia First/Vitality shares to the public. Id. ¶ 147-48. In an effort to pump up the value of Stevia First/Vitality stock between October 2016 and March 2017 the Veldhuis Control Group retained Kaitz to run promotional campaigns; Veldhuis wired money from Sharp Group nominee shareholders to foot the bill. Id. ¶ 150. Again, although these allegations are only in reference to one part of the scheme, they sufficiently provide the when, where, and how needed for particularity.
Second, by alleging that Veldhuis, Sexton, and Friesen (1) acted in concert with Dhillon, while representing to the public they were not affiliates of Dhillon’s company Stevia First/Vitality, id. 144, and (2) hired Kaitz to promote the stock sales as legitimate, while selling from affiliates of Stevia First/Vitality, the SEC sufficiently alleges the scienter necessary for this type of violation, id. ¶ 150.
As to
Taylor
, the SEC first alleges “Taylor [] controlled
nominee shareholders who held and traded stock surreptitiously
in concert with Dhillon and the Veldhuis Control Group.” Id. ¶
14. This constitutes “substantial participation,” as
controlling a “dummy entity” and transferring funds to skirt SEC
regulations is precisely the type of participation that other
sessions of this Court have contemplated as being substantial.
See In re Lernout,
Furthermore, the SEC alleges Taylor’s participation with particularity. Taylor participated in the fraudulent sales of Stevia First/Vitality in December 2016 in conjunction with the stock promotion directed by the Veldhuis Control Group; in fact, he received a portion of the $1.7 million in profits obtained. Id. ¶ 137. In December 2016, Taylor used “the obfuscation provided by the Sharp Group” to orchestrate payments garnered from the fraudulent Stevia First/Vitality sales, for the benefit of his company. Id. ¶ 140. Taylor was also associated with nominee entities who received payments from the sale of Stevia First/Vitality shares well into 2018. Id. ¶ 190. From 2015 to June 2016 Taylor sold Arch shares via an intermediary (Blacklight SA) generating $775,000 in proceeds -– these profits were funneled through Taylor’s nominee entities in May through October 2016 for Taylor and Dhillon’s benefit. Id. ¶ 186. On several dates in 2016 (June 28, July 5, August 8, September 27, November 2016) Arch issued millions of shares to a nominee entity controlled by Taylor (Heng Hong) which then transferred the shares to a Sharp Group nominee –- these shares were then utilized by the Veldhuis Control Group, which sold to unsuspecting investors in the public market. Id. ¶¶ 187-88. Second, the SEC alleges that Taylor participated in the scheme with scienter. Taylor’s provision of Heng Hong to allow for the obfuscation of Dhillon and other’s control, alongside his use of fraudulent invoices to receive payments for sales made through nominee entities associated with Heng Hong is sufficient to establish knowing or reckless scienter. See id. ¶¶ 138, 189. Furthermore, the SEC alleges that once Taylor became aware of its investigation, he signed false documents to obfuscate his involvement and provide legitimate explanations for his payments to Dhillon; he provided these documents to Canadian regulators. Id. ¶ 191.
i. Counterarguments
Veldhuis and Friesen raise two main counterarguments to the sufficiency of the SEC’s allegations: (1) the SEC fails to allege sufficient deceptive acts, see Friesen Mem. 15; Veldhuis Mem. 9-10; and (2) allegations that “lump multiple defendants together” as the “Veldhuis Control Group” are not sufficient to establish violations, see Friesen Mem. 1, 18; Veldhuis Mem. 5 (decrying the improper “group[ing]” of defendants).
As to the first counterargument, manipulation of securities markets constitutes a section 10(b) and 17(a) violation and “fictitious transactions” that “do not result in any change in beneficial ownership” or that artificially alter stock price constitute market manipulation. SEC v. Masri, 523 F. Supp. 2d 361, 366 (S.D.N.Y. 2007). The Defendants’ intentional efforts to conceal their and others’ identities as affiliates of companies in order to sell more shares falls within this type of market manipulation.
As to the second, the Defendants correctly highlight that complaints may not “clump[] [defendants] together in vague allegations,” as such pleadings fail to meet Rule 9(b) particularity. Three Crown Ltd. P’ship v. Caxton Corp., 817 F. Supp. 1033, 1040 (S.D.N.Y. 1993) (concluding references to “some or all of the defendants” were insufficient). This is not, however, what the SEC has done here. The SEC initially listed the constituent members of the Veldhuis Control Group, Am. Compl. ¶ 7, it then went on to define each individual’s role in the scheme, id. (“Working together, Veldhuis, Sexton, and Friesen . . . were one group of control persons . . . that teamed up with the Sharp Group to run lucrative, fraudulent schemes to sell stock surreptitiously in the public markets.”), and finally it mentioned with particularity when the Group took part in the larger exchange of securities, see, e.g., id. ¶¶ 58, 237 (describing how in 2016 and 2017 “[t]he Veldhuis Control Group utilized the Sharp Group’s services to disguise their . . . ownership of a significant percentage of [certain] public companies’ shares,” in other words “disguise[d] their control,” while selling those shares in the public market without registration). These allegations suggest that each of the Defendants bought and sold shares illegally by hiding their identities as control persons of various companies. Their concerted efforts to do so is of key importance to the functioning of the larger scheme –- which relied on buying and selling large blocks of shares strategically.
Several courts have determined that using shorthand abbreviations for multiple defendants, as was done here, is acceptable, where the complaint explains the role of each member of a group or when it is referring to collective conduct. See Monterey Bay Military Hous., LLC v. AMBAC Assurance Corp., 531 F. Supp. 3d 673, 729 (S.D.N.Y. 2021) (outlining how reference to “Jefferies” to summarize multiple “Jefferies Entities” was acceptable under Rule 9(b) because the basis of each entity’s liability was “readily inferable” from other parts of the complaint); SEC v. Sugarman, No. 19cv5998, 2020 U.S. Dist. LEXIS 181034, at **14-15 (S.D.N.Y. Sep. 30, 2020) (concluding that the SEC’s references to “Sugarman and Galanis,” two defendants, in unison “throughout the Complaint” was acceptable in part because “many of these references . . . explain their collective scheme”). References to the Veldhuis Control Group properly describe “conduct in tandem,” by Veldhuis, Sexton, and Friesen; “[t]his Court can hardy fault the SEC for the fact that [the defendants] acted in concert.” Sugarman, 2020 U.S. Dist. LEXIS 181034, at *16.
Furthermore, the Defendants cite to SEC v. Durgarian, for
the notion that “the SEC cannot simply group defendants together
and make undifferentiated allegations against that group without
providing facts specific to each defendants’ alleged
wrongdoing.” Friesen Mem. 12 (citing Durgarian, 477 F. Supp.
2d at 355). In Durgarian another session of this Court held
that the SEC’s “general assertion[s] that the defendants
attended [a] meeting” were “too attenuated to link them to the
fraudulent scheme.”
b. Claims Brought Under Section 17(a)(3) of the Securities Act
Gasarch, Kelln, Veldhuis, Sexton, Friesen, and Taylor are accused of violating Section 17(a)(3) of the Securities Act. Am. Compl. ¶¶ 250-52 (count II), 286-88 (count X). Section 17(a)(3) of the Securities Act makes it unlawful in “the offer or sale of any securities . . . by the use of any means of communication in interstate commerce or by use of the mails directly or indirectly” to “engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.” 15 U.S.C. § 77q(a), (a)(3). “[N]egligence,” as opposed to proof of scienter, “is sufficient to establish liability under . . . § 17(a)(3).” Ficken, 546 F.3d at 47.
“A defendant may be liable under § 17(a)(3) if he undertook
a deceptive scheme or course of conduct that went beyond . . .
misrepresentations.” SEC v. Bio Def. Corp., Civ. No. 12-11669-
DPW,
For the same reasons described above the SEC has alleged sufficient facts to establish a Section 17(a)(3) violation by the following defendants, for several reasons: (1) Kelln managed nominee entities, transfers, and the production of false documentation to legitimize the scheme; (2) Veldhuis , Sexton , and Friesen artificed several fraudulent transfers of shares; and (3) Taylor managed nominee entities and transferred unregistered stock to trading platforms for illegal sale to the public. See supra Section V.B.2.a.
As to Gasarch , the SEC sufficiently alleges all of the requirements for a Section 17(a)(3) violation. First, the SEC alleges generally that Gasarch participated in the scheme -- substantial participation is not necessary. Gasarch was allegedly a key member of the Sharp group which facilitated illegal stock sales from 2010 to the present. Am. Compl. ¶ 5.
Gasarch routinely arranged to transfer stock sale proceeds to accounts as directed by the Sharp Group’s clients in a manner designed to conceal the fact that undisclosed control persons were, in fact, the actual beneficial owners of the stock being sold, and the ultimate recipients of the sales proceeds. When she sent these wires, Gasarch also recorded them in [the Sharp Group’s encrypted] accounting system. She thus observed and maintained the records showing how the Sharp Group’s clients were generating, receiving, and disbursing their revenue from securities trading.
Id. ¶ 57. The SEC also alleges with particularity Gasarch’s participation. For example, Gasarch created false invoices, loan subscription agreements, and other documents that could back the illegitimate payments that emerged from the scheme: she did so at least on (1) August 23, 2016, (2) May 16, 2017, and (3) October 11, 2017. Id. ¶ 58. Gasarch also sent several emails pretending to be an owner of Sharp Group-administered nominee entities to further the Sharp Group’s scheme and legitimize the fraudulent transactions. Id. ¶ 61. For example, she did so on July 7, 2017, and July 12, 2018. Id. Gasarch was also a go-between for the movement of shares from clients to Wintercap SA from June and September 2016. Id. ¶ 62.
Finally, the SEC alleges that “Gasarch understood that her job was to obfuscate the source and destination of distributions” and cites to specific conversations Gasarch had with Sharp that buttress this conclusion. Id. ¶¶ 59-60. Gasarch’s understanding is further supported by the fact that she also helped keep the Sharp Group’s clients’ identities secret by personally serving as a nominee shareholder. Id. ¶ 64. For example, Gasarch administered Peregrine Capital Corp. f/k/a Peaceful Lion Holdings, a nominee shareholder. Id. The SEC therefore alleges generally knowing, reckless, or negligent scienter by Gasarch, going above and beyond the requirements for Section 17(a)(3) violations, which only require negligence. Id. ¶ 61.
c. Claims Brought Under Sections 5(a) and (c) of the Securities Act
Kelln, Veldhuis, Sexton, and Friesen are all accused of
violating Section 5(a) and (c). Am. Compl. ¶¶ 256-58 (count
III). Sections 5(a) and (c) of the Securities Act makes it
unlawful to sell unregistered securities through, or utilize in
connection with such sale, interstate commerce or the mails.
See 15 U.S.C. § 77e(a), (c); see also SEC v. N. Am. Rsch. & Dev.
Corp.,
First, the SEC has sufficiently alleged that hundreds of securities that were sold as part of this scheme were not registered. See, e.g., Am. Compl. ¶¶ 125, 144 (describing how the Veldhuis Control Group sold restricted Stevia First/Vitality shares), 144-45 (describing Kelln’s involvement with these (c) It shall be unlawful for any person, directly or indirectly, to make 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 security, unless a registration statement has been filed as to such security, or while the registration statement 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 77h of this title.
15 U.S.C. § 77e (a),(c).
restricted shares) 245-47 (describing how Kelln coordinated the trading of “purportedly unrestricted” but unregistered share of Garmatex stocks in the excess of $7 million).
Second, Kelln as a member of the Sharp Group was in 2016 and 2017 helping administer the transfer of shares from nominee entities to Wintercap SA, which would then sell unregistered stocks to the public. Id. ¶¶ 145, 147. Furthermore, in 2016 and 2018 Kelln helped in the distribution of the unregistered shares by hiring attorneys to prepare opinion letters to falsely represent that nominee entities were not affiliates of Stevia First/Vitality. Id. ¶ 144.
The SEC also alleges with particularity the offer and sale of unregistered securities by Veldhuis, Sexton, and Friesen . The SEC’s allegations that these individuals engaged in the sale of Stevia First/Vitality’s unregistered stock in 2016 and 2018 alone is sufficient to sustain this claim. Id. ¶¶ 134, 144 (mentioning Veldhuis, Sexton and Friesen’s efforts to sell restricted shares), 111 (designating these stocks as unregistered). As just one example of the Sharp Group and Veldhuis Control Group’s participation in the sale of unregistered stock the SEC alleges that: “On various dates in 2016, the Veldhuis Control Group sent numerous wire payments to [Stevia First/]Vitality, or to third parties on behalf of [Stevia First/]Vitality, totaling approximately $4.4 million. In exchange, [Stevia First/]Vitality -- with Dhillon operating as the chairman of its board of directors -- issued millions of shares . . . to nominee entities that the Sharp Group once again provided for use by the Veldhuis Control Group.” Id. ¶ 142. Both these sets of allegations are more than enough to establish Kelln, Veldhuis, Sexton, and Friesen were ‘substantial factors’ in the sale of unregistered securities.
“Finally, the [Amended] Complaint adequately alleges that
these sales and offerings were made in connection with the use
of interstate transportation, communication, or the mails.”
Esposito,
c. Claims Brought Under Section 13(d) and Rule 13d-1 of the Exchange Act
Veldhuis, Sexton, and Friesen are accused of violating Section 13(d). Am. Compl. ¶¶ 259-63 (count IV). Section 13(d) and Rule 13d-1 [20] of the Exchange Act requires anyone who obtains beneficial ownership of more than five percent of any class of shares to file ownership reports with the SEC. 15 U.S.C. § 78m(d); 17 C.F.R. § 240.13d-1. It states in relevant part:
Any person who, after acquiring directly or indirectly the beneficial ownership of any equity . . . which would have been required to be so registered . . . . and is directly or indirectly the beneficial owner of more than 5 per centum of such class shall . . . file with the Commission, a statement . . . .
15 U.S.C. § 78m(d)(1). Furthermore, “[w]hen two or more persons act as a . . . group for purposes of acquiring, holding, or disposing of securities” they are a “person” under the Exchange Act. Id. § 78(d)(3).
The SEC alleges with particularity that the Sharp Group assisted the Veldhuis Control Group in skirting the “five percent” beneficial ownership rule. Am. Compl. ¶¶ 146-48. It states that at one-point Kelln even wrote in messages how [20] “Rule 13d-1 of the Securities and Exchange Commission provides that the disclosure required by Section 13(d)(1) be set forth in a Schedule 13D.” Gen. Aircraft Corp. v. Lampert, 556 F.2d 90, 92 n.1 (1st Cir. 1977); see also 17 C.F.R. §§ 240.13d- 1, 240.13d-101.
difficult the rule was to navigate around, while assisting the Veldhuis Control Group. Id. ¶ 147. The SEC also explicitly states the following: “Veldhuis, Sexton and Friesen failed to file any report on behalf of the group as required under Rule 13d-1(k)(2), even though they collectively acquired, held, and were responsible for directing the disposition of, far more than 5% of [Stevia First/]Vitality’s outstanding stock through nominee entities that were under their group’s control.” Id. ¶ 153.
Although Veldhuis and Friesen argue that the Veldhuis
control group is not sufficiently alleged as acting as a group
for purposes of Section 13(d) liability, see Friesen Mem. 20;
Veldhuis Mem. 10, “the existence of a section 13(d)(3) group may
be demonstrated circumstantially” and “any arrangements [to act
as a group] may be formal or informal.” SEC v. Savoy Indus.,
Inc.,
d. Section 20(e) of the Exchange Act and Section 15(b) of the Securities Act
Kelln and Gasarch are accused of violating Section 20(e) of the Exchange Act. Am. Compl. ¶¶ 282-85 (count IX), 300-03 (count XIV). Section 20(e) makes it unlawful to assist anyone in the violation of the Exchange Act:
any person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this chapter, or of any rule or regulation issued under this chapter, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided.
15 U.S.C. § 78t(e). To survive a motion to dismiss the SEC must
allege: “(1) the existence of a securities law violation by the
primary (as opposed to the aiding and abetting) party; (2)
‘knowledge’ of this violation on the part of the aider and
abettor; and (3) ‘substantial assistance’ by the aider and
abettor in the achievement of the primary violation.” SEC v.
Apuzzo,
Gasarch, Taylor, and Kelln are accused of violating Section 15(b) of the Securities Act. Am. Compl. ¶¶ 273-76 (count VII), 277-81 (count VIII), 292-95 (count XII). Section 15(b) makes it unlawful to assist another in the violation of Securities Act:
any person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this subchapter, or of any rule or regulation issued under this subchapter, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided.
15 U.S.C. § 77o(b). “Because the operative language in § 15(b)
is nearly identical to that in § 20(e), the standard for aiding
and abetting liability is the same under both statutes.” SEC v.
Lek Sec. Corp.,
For the same reasons that the SEC plausibly alleges violations of 17(a)(1) and 10(b)(5) for Kelln and Taylor and 17(a)(3) for Gasarch, see supra Sections V.B.2.a.-b., it also alleges substantial assistance. Gasarch, Taylor, and Kelln all assisted the Sharp Group and the Veldhuis Control Group in the unregistered sale of Stevia First/Vitality Stock from 2016 to 2018.
C. Other Arguments Raised by Defendants The Defendants raise several other arguments in support of their motions to dismiss. The Court addresses them briefly here.
1. The Appropriateness of Injunctions More than one defendant -- Sexton and Kelln –- challenge the injunctions sought on the basis that they do not serve to enjoin any existing conduct and would simply compel the Defendants to obey the law. See Sexton Mem. 19; Kelln Mem. 19. More specifically, Kelln posits that “there is nothing remaining to be enjoined” because she no longer “works for Mr. Sharp, services his clients, or works in the securities industry in any way.” Kelln Mem. 19 (quotations and citations omitted).
The SEC rebuts that “there is no requirement” that “conduct must be ongoing to warrant an injunction” and that the “likelihood of recurrence” and other factors weigh in favor of an injunction. See SEC Opp’n Kelln 15-17. Furthermore, it states that it plausibly alleges conduct to the present and that the proper time to evaluate injunctive relief is after the liability stage. Id.
“The Securities and Exchange Act permits the SEC to seek an
injunction in federal district court to prevent violations of
securities laws.” SEC v. Sargent,
2. The Appropriateness of Disgorgement Kelln also challenges disgorgement as a remedy by arguing she was not unjustly enriched by the scheme, because she only received compensation in the form of an annual salary -- which cannot be attributed to the scheme. Kelln Mem. 18-19.
The SEC rebuts that Kelln “was the beneficiary of more than 1 million in funds derived from the Sharp Group’s conduct,” that her argument disgorgement can be obtained only from those directly enriched by the scheme is incorrect, and that her “causal assertion[s]” are premature and ignore allegations in the complaint. SEC Opp’n Kelln 15 (quotations omitted).
“[C]ourts commonly order defendants to disgorge not only
the proceeds of a fraud but also salary and bonuses earned
during the period of a fraud and amounts equivalent to losses
avoided as a result of the securities violation.” SEC v.
Johnston,
Kelln’s arguments here are inapposite. As discussed earlier, see supra Section V.B.2.a., the SEC has sufficiently alleged Kelln’s contribution to the scheme and the amount of ill-gotten gains she received, see Am. Compl. ¶ 68 (alleging she received $1 million). Limitation of the disgorgement remedy at this stage would be premature.
3. Issues of Personal Jurisdiction Kelln and Gasarch, both citizens and residents of Canada, see Am. Compl. ¶¶ 23-24; Kelln Mem. 17, argue this Court lacks personal jurisdiction over them, Kelln Mem. 16-18 (moving to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(2)); Gasarch’s Opp’n Am. Compl. 6-9 (opposing SEC’s Amended Complaint on this ground). For her part, Gasarch did not raise her objection to personal jurisdiction in her first responsive pleading and has therefore waived the defense. [21] Kelln, on the other hand, who properly raised the defense, see Kelln Mem. 16- 18, asserts the SEC has failed to establish minimum contacts because Kelln communicated with and facilitated trades only between foreign entities and “is not alleged to have ever sold stock in the United States markets as part of the scheme or to have ever held bank accounts in the United States.” Kelln Mem. 17.
“It is the plaintiff’s burden to establish that personal
jurisdiction exists over the defendants in this forum.” LTX
Corp. v. Daewoo Corp.,
Furthermore, the Court acts not “as a factfinder; rather, it
accepts properly supported proffers of evidence by a plaintiff
as true and makes its ruling as a matter of law.” Id. (quoting
163 Pleasant St. Corp.,
For personal jurisdiction inquiries under federal question
cases, like the one at bar, the First Circuit has held that “the
constitutional limits of the [C]ourt’s personal jurisdiction are
fixed . . . not by the Fourteenth Amendment but by the Due
Process Clause of the Fifth Amendment,” United Elec., Radio &
Mach. Workers of Am. v. 163 Pleasant St. Corp.,
Second, “[a] district court may exercise authority over a
defendant by virtue of either general or specific jurisdiction.”
Massachusetts Sch. of Law at Andover, Inc. v. Am. Bar Ass’n, 142
F.3d 26, 34 (1st Cir.1998). Specific jurisdiction exists where
there is a “nexus” between the claims in question and
“defendant’s forum-based activities.” Id. The SEC here bases
its arguments on specific jurisdiction. See SEC Kelln Opp’n 19.
Specific jurisdiction requires “minimum contacts” with the
forum, “such that the maintenance of the suit does not offend
traditional notions of fair play and substantial justice.”
Int’l Shoe Co. v. Washington,
First, an inquiring court must ask whether the claim that undergirds the litigation directly relates to or arises out of the defendant's contacts with the forum. Second, the court must ask whether those contacts constitute purposeful availment of the benefits and protections afforded by the forum’s laws. Third, if the proponent’s case clears the first two hurdles, the court then must analyze the overall reasonableness of an exercise of jurisdiction in light of a variety of pertinent factors that touch upon the fundamental fairness of an exercise of jurisdiction.
Phillips Exeter Acad. v. Howard Phillips Fund,
a. Relatedness
“The evidence produced to support specific jurisdiction
must show that the cause of action either arises directly out
of, or is related to, the defendant's forum-based contacts.”
Harlow v. Children’s Hosp.,
Another session of this Court held that false
representations to investors in the United States via email or
in person were sufficient to establish such a nexus and that
even representations made by a defendant’s agents to United
States individuals were sufficient to establish the Court’s
jurisdiction. SEC v. Elliott, Civil No. 20-10860-LTS, 2020 WL
7185854, at *4 (D. Mass. Dec. 7, 2020) (Sorokin, J.). Other
cases involving securities violations found specific
jurisdiction even with only a few contacts. See, e.g., SEC v.
Gilbert,
In general, alleging “conduct that was designed to violate
United States securities regulations and was thus necessarily
directed toward the United States” allows the SEC to meet its
burden for a prima facie case of jurisdiction. Straub, 921 F.
Supp. 2d at 255-56 (holding trading on the NYSE along with
fraudulent SEC registration statements constituted sufficient
minimum contacts). For example, in In re Parmalat Securities
Litigation, the Southern District of New York held that
allegations that “Parmalat securities traded actively in the
United States, that Parmalat made note offerings here, and that
company documents including Statutory Board reports were posted
on company web sites in English” were sufficient to satisfy
minimum contacts.
Kelln and Gasarch’s actions were specifically directed at skirting SEC regulations in order to deceive American investors trading in United States markets. For example, Kelln “routinely split Sharp Group clients’ shareholdings into blocks of stock, each comprising less than five percent of each public company’s outstanding shares to be held in the names of various nominee entities,” Am. Compl. ¶¶ 53-55, in order to skirt Schedule 13D and Section 5 filing requirements and deceive United States markets by concealing the true control over these stocks, id. ¶¶ 31-33 (describing how the companies involved in these schemes are traded on OTC Markets). Gasarch arranged for the transfer of stock sale proceeds from illegal sales, faked invoices and emails to help conceal the true identities of the owners of stock that would eventually be sold on United States markets, and managed nominee entities to facilitate these stock sales. Id. ¶¶ 57-58, 61-62. These intentional schemes to skirt United States laws and regulations in order to sell stocks on United States markets are sufficient alone to establish minimum contacts. The SEC, however, provides more specific allegations of contacts with the United States for each Defendant.
For Kelln , the SEC provides evidence that Kelln routinely contacted United States-based transfer agents regarding the stock that Sharp Group clients sold in violation of SEC regulations and contacted a United-States based attorney several times between 2016 and 2018. Decl. Trevor T. Donelan ¶¶ 9-10, ECF No. 168; see also Am. Compl. ¶¶ 53, 93, 143-44. As to Gasarch , the SEC alleged that she owned a United States-based corporate entity through which she received the profits from fraudulent trades. Am. Compl. ¶ 68.
b. Purposeful Availment “The purposeful availment prong examines whether the defendant’s contacts with the forum ‘represent a purposeful availment of the privilege of conducting activities in the forum . . . .’” New Life Brokerage Servs., Inc. v. Cal-Surance
Assocs., Inc.,
(quoting Swiss Am. Bank,
Where defendants are aware that their misrepresentations or
deceptions would be “relied upon by American investors” there is
“no clearer example of purposeful availment.” See CINAR, 186 F.
Supp. 2d at 306; see also Straub,
c. Reasonableness
In assessing reasonableness, the Court looks to: “five
gestalt factors: (1) the defendant’s burden in appearing in the
court; (2) the forum state’s interest in hearing the suit; (3)
the plaintiff’s convenience and interest in effective relief;
(4) the judicial system’s interest in obtaining the most
effective resolution of the controversy; and (5) the common
interests of all interested states in promoting substantive
social policies.” Hasbro, Inc. v. Clue Computing, Inc., 994 F.
Supp. 34, 45 (D. Mass. 1997) (Woodlock, J.) (citing Burger King
Corp. v. Rudzewicz,
VI. CONCLUSION
Therefore, this Court DENIES all six of the Defendants’ motions to dismiss in their entirety.
SO ORDERED.
/s/ William G. Young WILLIAM G. YOUNG JUDGE of the UNITED STATES [22]
Notes
[1] On August 13, 2021, the SEC filed a motion for a preliminary injunction against four of the Defendants: Sharp, Veldhuis, Sexton, and Taylor. See Pl.’s Mot. Prelim. Inj., Asset Freeze, & Order Other Equitable Relief, ECF No. 24; Pl.’s Status Report Prelim. Inj. Hearing 6, ECF No. 29; Revised Proposed Prelim. Inj. Order 1, ECF No. 36. Judge Gorton entered an order allowing the motion for a preliminary injunction. See Sharp, Veldhuis, Sexton, & Taylor Prelim. Inj. Order, ECF No. 39. Judge Gorton also allowed motions for extension of the TRO as to Kaitz, Gasarch, Kelln, Dhillon, and Friesen. See Extension TRO Kaitz, ECF No. 30; Extension TRO Gasarch, Kelln, & Dhillon, ECF No. 40; Extension TRO Friesen, ECF No. 42. Subsequently, Judge Sorokin allowed another motion to extend the TRO as to Friesen. See Second Extension TRO Friesen, ECF No. 45. The SEC moved for a preliminary injunction against Dhillon on August 28, 2021. See Joint Mot. Entry Prelim. Inj., Order
[3]
[2] This Court has federal question subject matter jurisdiction pursuant to section 22(a) of the Securities Act, 15 U.S.C. § 77v(a), and sections 21(d), 21(e) and 27 of the Exchange Act, 15 U.S.C. §§ 78u(d), 78u(e), 78aa.
[5]
[3] “[P]enny stocks” refers to stocks traded at less than $5 per share. See Am. Compl. ¶ 40.
[9]
[4] “[T]ransfer agents” are individuals or businesses that facilitate the transfer of securities –- and who keep track of whether a stock is restricted or unrestricted. See Am. Compl. ¶ 39.
[11]
[5] A “reverse merger” is shorthand for a public shell company acquiring a private company -- generally awarding the private company’s shareholders shares in the process –- in order to make the private company public (the merger often comes with a name change aligning with the private company). Am. Compl. ¶ 72.
[14]
[6] Dhillon entered into a tolling agreement with the SEC that “tolled the running of any limitations period or any other time- related defenses available to [him] for a period of approximately seven months and three days.” Am. Compl. ¶ 249.
[21]
[7] Taylor and Sexton brief this issue at the greatest length and level of specificity. See Taylor Mem. 1-20; Sexton Mem. 7- 18. To the extent the other defendants challenge the timeliness of the SEC’s action, their arguments are similar to or duplicative of Taylor’s, see Friesen Mem. 7-10; Gasarch Mem. 5-8 ; Kelln Mem. 20 & n.7; Veldhuis Mem. 11; thus, Taylor’s brief, arguably the most complete of the motions on this issue, will be used as a reference point throughout this Memorandum.
[22]
[8] Observers have raised several other questions regarding Section 6501. For example, another portion of Section 6501 states: “In any action or proceeding brought by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may order, disgorgement.” NDAA § 6501. This has created confusion as to whether the SEC can now seek disgorgement for any unjust enrichment, or whether it is still cabined by the wrongdoer’s profits. It has also opened questions as to whether the SEC must return funds to the defendant’s victims or whether it can place those disgorged funds into the Treasury. See, e.g., Ike Adams, Chris Mills, & David Petron, SEC Disgorgement Authority May Be Limited Even After Recent Amendments to the Exchange Act, ABA: Business Law Today (Jan. 27, 2021), https://www.americanbar.org/groups/business_law/publications/blt /2021/02/sec-disgorgement-authority/.
[25]
[9] The SEC has previously attempted to litigate the NDAA’s
retroactive applicability to a case pending on appeal in the
First Circuit. See Brief of the SEC, Appellee at 23, SEC v.
Morrone,
[26]
[11] Some observers have argued that Congress was motivated directly by Kokesh. See Adams, Mills, & Petron, supra note 8.
[12] The Director of the SEC’s Division of Enforcement complained of the challenges in the agency’s enforcement efforts in a post-Kokesh world. See Stephanie Avakian, Remarks at the Institute for Law and Economics, University of Pennsylvania Carey Law School Virtual Program, SEC (Sept. 17, 2020), https://www.sec.gov/news/speech/avakian-protecting- everyday-investors-091720. Furthermore, a former SEC Chairman has several times pleaded with Congress to establish lengthier limitations periods for SEC disgorgements. See Letter from SEC Chairman Jay Clayton, Nov. 17, 2019, reprinted in 165 Cong. Rec. H8931-32 (daily ed. Nov. 18, 2019), https://www.congress.gov/116/crec/2019/11/18/CREC-2019-11-18- pt1-PgH8929.pdf; Testimony on “Oversight of the Securities and Exchange Commission: Hearing Before the S. Comm. on Banking, Housing, & Urban Affs., 116th Cong. 24 (Nov. 17, 2020) (statement of Jay Clayton, Chairman, SEC),
[35]
[14] The Defendants also raise the argument that the NDAA’s
attempted revival of stale claims “[u]ndercuts the [v]ery
[p]urpose of [s]tatutes of [l]imitations. Taylor Mem. 17. This
argument fails for similar reasons as their other objections.
Given Congress’ clear power retroactively to alter statutes of
limitations, see Seale,
[40]
[15] While the Defendants do not raise this objection, a
common objection to applying statutes retroactively is that they
may cause a due process violation. The retroactive application
of a statute that restores a lost remedy via expanding the
statute of limitations does not violate due process. See Chase
Securities Corp. v. Donaldson,
[41]
[16] Although it does not make a practical difference, the NDAA also applies retroactively to govern the statute of limitations of non-scienter-based disgorgement claims, see NDAA § 6501, for the same reasons described above, see supra Section V.A.1.
[48]
[17] The five-year statute of limitations for non-scienter- based disgorgement claims remained constant, at five years, pre- and post-adoption the NDAA, although it was previously governed by 28 U.S.C. § 2462 and later became governed by 15 U.S.C. § 78u(d)(8)(C). See supra Section V.A.2.a. Because the statutes of limitations for disgorgement claims (and the manner in which they are to be calculated) are governed by Section 6501 and it applies retroactively, see supra Section V.A., it controls the standard for time spent outside the United States.
[61]
[69]
[18] Private plaintiffs can only bring suit under Rule 10b-5
against primary violators, whereas the SEC has the right to
bring aiding and abetting claims pursuant to Section 20(e) of
the Exchange Act. See Tambone,
[70]
[79]
[19] Specifically, the text of Sections 5(a) & (c) provides: (a) Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly -- (1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any propsectus or otherwise; or (2) to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale. * * *
[84]
[21] Gasarch raised this objection for the first time in a
footnote in her reply to the SEC’s opposition to her motion to
dismiss and discusses it at greatest length in her opposition to
the SEC’s amended complaint. See generally Gasarch’s Mot.
Dismiss Compl.; Gasarch Mem.; see also Reply Supp. Gasarch’s
Mot. Dismiss Compl. 8 n.4, ECF No. 184; Gasarch’s Opp’n Am.
Compl. 6-9. Rule 12, which governs the personal jurisdiction
defense, is subject to strict waiver, see Pilgrim Badge & Label
Corp. v. Barrios,
[95]
[22] This is how my predecessor, Peleg Sprague (D. Mass. 1841- 1865), would sign official documents. Now that I’m a Senior District Judge I adopt this format in honor of all the judicial colleagues, state and federal, with whom I have had the privilege to serve over the past 44 years.
[104]