SECURITIES AND EXCHANGE COMMISSION v. JOSEPH R. EARLE, JR., BARRY D. REAGH, WILLIAM CLAYTON, FRANCIS T. DUDLEY, STEVEN E. BRYANT, UPPER STREET MARKETING, INC., and PROJECT GROWTH INTERNATIONAL, INC.
Case No.: 3:22-cv-01914-H-MDD
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA
April 11, 2023
[Doc. No. 22.]
On December 5, 2022, Plaintiff Securities and Exchange Commission (“Plaintiff“) filed an amended complaint (“FAC“) alleging Defendants Joseph R. Earle, Jr., Barry D. Reagh, William Clayton, Francis T. Dudley, Steven E. Bryant, Upper Street Marketing, Inc., and Project Growth International, Inc. had violated federal securities laws. (Doc. No. 3, FAC). On February 15, 2023, Defendant Francis T. Dudley filed the present motion to dismiss Plaintiff‘s complaint for failure to state a claim pursuant to
BACKGROUND
The following allegations are taken from Plaintiff‘s FAC. This action is brought against Defendants, collectively, for violations of Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 (the “Exchange Act“) and Rule 10b-5 promulgated thereunder as well as Sections 5(a), 5(c), 17(a), and 17(b) of the Securities Act of 1933 (the “Securities Act“). (FAC ¶¶ 125-151). This action is brought against Defendant Francis T. Dudley for violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, as well as Section 17(b) of the Securities Act. (FAC ¶¶ 125-128, 149-152).
In Spring 2018, Defendant Earle became the chief financial officer of Growing Springs, LLC, a company that sold liquid conversion technology to cannabis and hemp growers to help them achieve higher crop yields. (FAC ¶ 26.) In July 2018, Defendant Earle met with G.M., the then chief executive officer of Defendant Upper Street Marketing, Inc. (UPPR), to discuss merging their companies and raising capital to expand business. (FAC ¶¶ 27-28.) G.M. introduced Defendant Earle to Defendant Reagh, who alongside G.M., jointly controlled UPPR. (FAC ¶ 29.) In August 2018, Defendant Earle formed Growing Springs Holdings Corporation (“GSHC“), which acquired the assets of Growing Springs, LLC. (FAC ¶ 30.) In October 2018, Defendant Earle and G.M. entered into an agreement between GSHC and UPPR, under which GSHC would receive shares of UPPR. (FAC ¶ 31.) This agreement, alongside another agreement of common stock between Defendant Earle and Tenzi made Defendant Earle the majority shareholder of UPPR, and Defendant Earle took over as president and CEO of UPPR. (FAC ¶ 32.)
Around the same time that UPPR and GSHC entered into this agreement, Defendants Earle and Reagh agreed to use UPPR for a pump-and-dump scheme. (FAC ¶¶ 33-35.) As alleged, this scheme consisted of four parts. First, Defendant Reagh had D.R. and Defendant Clayton deposit UPPR shares into a brokerage account based on false and misleading DSR forms. (FAC ¶ 36.) These DSR forms hid the material fact that Defendant Reagh was the beneficial owner of the shares and that Defendant Reagh would be
The following allegations taken from the FAC deal specifically with Defendant Francis T. Dudley‘s involvement.
In January 2019, after UPPR became receiving funds from the private offering, Defendant Earle hired Defendant Dudley, the owner of Venado Media, LLC, to assist with the promotional campaign. (FAC ¶ 69.) Defendant Dudley was the managing member and control person of Venado Media. (FAC ¶ 124.) In February 2019, Defendant Dudley sent a budget proposal for the promotional campaign, which included three to four research reports, re-releasing UPPR‘s press releases, the use of investor channels, and the use of display banners on financial websites. (FAC ¶ 70.) Between January and June 2019, Defendant Dudley‘s company, Venado Media, distributed approximately five research reports through two of Venado Media‘s labels, TheOTCReporter.com and DiscoveryStocks.com. (FAC ¶ 82.) Defendant Dudley reviewed each research report. (FAC ¶ 84.) Plaintiff alleges that the research reports “falsely and misleadingly stated that the compensation for the research reports came from Venado Media, LLC” when in fact, UPPR, the company whose shares were promoted in the research reports, paid Venado Media to write the reports. (FAC ¶ 86.) The complaint also alleges that Defendant Dudley “knew, or was reckless and negligent for not knowing, that Reagh was the beneficial owner of UPPR stock at the time Reagh helped pay for the research reports” and that Defendant Dudley “knew, or was reckless and negligent for not knowing, that Reagh intended to sell . . . some of his UPPR shares to the public once Dudley disseminated the favorable research reports.” (FAC ¶¶ 87-88.) Defendant Dudley did not disclose this information. (FAC ¶ 88.)
DISCUSSION
I. Legal Standard
A. Rule 12(b)(6)
A pleading that states a claim for relief must contain “a short and plain statement of the claim showing that the pleader is entitled to relief.”
A motion to dismiss under
B. Rule 9(b)
A complaint stating claims under Section 10(b) and Rule 10b-5 must satisfy the heightened pleading requirements of
II. Analysis
A. Section 10(b) of the Exchange Act and Rule 10b-5(b)
The SEC promulgated Rule 10b-5 under Section 10(b) of the Exchange Act. Rule 10b-5(b) makes it unlawful for a person to “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.”
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Rule 10b-5(b) creates a cause of action for either a “material misrepresentation” or an “omission.” Id. “The misstatement or omission complained of must be misleading; in the case of an omission, silence, absent a duty to disclose, is not misleading under Rule 10b-5.” Young v. Dreisbach, 182 Fed. App‘x. 714, 718 (9th Cir. 2006) (internal quotations and citations omitted); see also S.E.C. v. Hui Feng, 935 F.3d 721, 734 (9th Cir. 2019) (“A fiduciary duty to disclose certain information renders an omission of that information misleading.“) To be misleading, a statement or omission “must affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists.” Brody v. Transitional Hosps. Corp., 280 F.3d 997, 1006 (9th Cir. 2002) (citing McCormick v. The Fund American Cos., 26 F.3d 869, 880 (9th Cir. 1994)).
Defendant contends that Plaintiff‘s complaint alleges that Defendant violated Rule 10b-5 by omitting certain information, and that Plaintiff was therefore required to allege that Defendant owed a duty to disclose the omitted information in order to state a cause of action. (Doc. No. 22 at 11-13.) In particular, Defendant argues that Plaintiff alleges that Defendant violated Rule 10b-5 because Defendant “omitted to disclose that UPPR and Reagh had paid Dudley and Venado for the research reports” and “that Reagh was the beneficial owner of UPPR stock.” (Doc. No. 22 at 12-13.) Defendant argues that Plaintiff fails to allege that Defendant “owed a duty to disclose the source of the compensation paid to him for the research reports.” (Doc. No. 22 at 11.) Plaintiff asserts that the complaint alleges not that Defendant made actionable omissions, but rather, that Defendant “made affirmative false and misleading statements.” (Doc. No. 43 at 9.)
Plaintiff alleges that the research reports “falsely and misleadingly stated that the compensation for the research reports came from ‘Venado Media, LLC.‘” (FAC ¶ 86.) Plaintiff alleges that “[t]he stock research reports that Dudley drafted, and caused others to draft, were false and misleading. They claimed that those reports had been paid for by Dudley‘s own media company when, in fact, the payment for these purportedly independent research reports about UPPR‘s stock had actually come from UPPR and
2. Whether The Complaint Sufficiently Pleads Materiality
Defendant next contends that Plaintiff has not sufficiently plead that the omitted information is material. (Doc. No. 22 at 13.) A complaint must allege both that the statement or omission is misleading and that it is material. See In re Alphabet, Inc. Securities Litigation, 1 F.4th 687, 700 (9th Cir. 2021). Section 10(b) and Rule 10b-5 only require disclosure “when necessary ‘to make . . . statements made, in light of the circumstances under which they were made, not misleading.‘” Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 44 (2011) (quoting
Defendant argues that “it is not the source of compensation that is material,” but rather “the fact that the words Mr. Dudley disseminated were ‘in reality . . . bought and paid for.‘” (Doc. No. 22 at 14) (citing U.S. v. Amick, 439 F.2d 351, 365 (7th Cir. 1971)). Plaintiff alleges that the information is material because a “reasonable investor would have considered it important in making an investment decision to know that UPPR, the company whose shares Venado Media promoted in the research reports, had paid Venado Media to write them.” (FAC ¶ 86.) Plaintiff‘s allegations are sufficient to state a claim under Section 10(b) and Rule 10b-5. Plaintiff has identified allegedly material misstatements. It is plausible that a reasonable investor would have considered the source of compensation to be material, especially where the company whose stock was promoted in the reports was the one paying for the research reports. The Court cannot determine at this time - as a matter of law - that the misrepresentations regarding the source of compensation did not make the statements misleading to a reasonable investor. Given the fact-intensive nature
3. Whether The Complaint Sufficiently Pleads That Defendant‘s Conduct Was in Connection with The Purchase or Sale of Securities
To state a claim under Section 10(b) and Rule 10b-5, the Plaintiff must allege that the material misrepresentation or omission was made “in connection with” the purchase or sale of securities. See Platforms Wireless Intern. Corp., 617 F.3d at 1092. “[T]he in connection with requirement is met if the fraud alleged somehow touches upon or has some nexus with any securities transaction.” S.E.C. v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) (internal quotation marks and citations omitted). “Where the fraud alleged involves public dissemination in a document such as a press release, annual report, investment prospectus or other such document on which an investor would presumably rely, the ‘in connection with’ requirement is generally met by proof of the means of dissemination and the materiality of the misrepresentation or omission.” Id.
Defendant argues that Defendant‘s alleged omission could not be conduct taken “in connection with” the sale of a security “because the information had no bearing on the value of UPPR stock.” (Doc. No. 22 at 16.) Further, Defendant contends that the omission of information “was not reasonably calculated to influence the average investor.” (Doc. No. 22 at 16.) Defendant‘s arguments are unpersuasive. Defendant cites Rana Research, to support his arguments, but Rana Research does not stand for the proposition that information must have a bearing on the value of stock in order for it to be considered conduct taken in connection with the sale of a security. See 8 F.3d at 1362. In fact, in Rana Research, Inc., the Ninth Circuit notes that “in connection with” should be interpreted “as broad[ly] and flexibl[y] as is necessary to accomplish the statute‘s purpose of protecting investors.” Rana Research, Inc., 8 F.3d at 1362.
Plaintiff alleges that Defendant distributed approximately five research reports “on or about January 16, January 22, March 11, and June 3, 2019” that “discussed UPPR‘s
4. Whether The Complaint Sufficiently Pleads Scienter
“To establish a violation of Section 10(b) and Rule 10b-5, the SEC is required to show that there has been a misstatement or omission of material fact, made with scienter.” Gebhart v. SEC, 595 F.3d 1034, 1040 (9th Cir. 2010) (internal quotation marks and citations omitted). Plaintiff may establish scienter by showing that Defendant either knew the statement was false or that Defendant was reckless as to the truth or falsity of the statement. Id. “Recklessness satisfies the scienter requirement only ‘to the extent that it reflects some degree of intentional or conscious misconduct.‘” SEC v. Rubera, 350 F.3d 1084, 1094-95 (9th Cir. 2003) (quoting In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 977 (9th Cir. 1999)). Where the SEC is the plaintiff, “the allegations must only pass muster under
Defendant contends Plaintiff has failed to supply any facts indicating how Defendant would have held the requisite knowledge or scienter when omitting the information from research reports. (Doc. No. 35 at 17.) Defendant cites to S.E.C. v. Dougherty, for the proposition that the complaint “must contain allegations of specific contemporaneous statements or conditions that demonstrate the intentional or the deliberately reckless false or misleading nature of the statements when made.” No. 19-cv-769-JLS-KSC, 2020 WL 13539068, at *8 (S.D. Cal. Feb. 27, 2020) (quoting Ronconi v. Larkin, 253 F.3d 423, 432 (9th Cir. 1990)). As Ronconi v. Larkin makes clear, this is the pleading requirement for a private securities plaintiff under the PSLRA. 253 F.3d at 432. As discussed above, the pleading requirement for scienter for the SEC differs from that for private plaintiffs under the PSLRA. Thus, Defendant‘s reliance on this standard in the present matter is incorrect and the Court will analyze Plaintiff‘s allegations based on the requirements of Rule 9(b).
Plaintiff‘s complaint contains numerous statements outlining Defendant‘s role in making, or approving, the allegedly false and misleading statements. For example, Plaintiff alleges that Defendant drafted, and caused others to draft, stock research reports “claim[ing] that those reports had been paid for by Dudley‘s own media company when, in fact, the payment for these purportedly independent research reports about UPPR‘s stock had actually come from UPPR and Reagh.” (FAC ¶ 9.) Plaintiff alleges that “Dudley reviewed each of the research reports” and that “Dudley knew, or was reckless and negligent for not knowing, that Reagh was the beneficial owner of UPPR stock at the time Reagh helped pay for the research reports.” (FAC ¶¶ 84, 87.) Plaintiff further alleges that Dudley “knew, or was reckless and negligent for not knowing, that Reagh intended to sell,
B. Scheme Liability under Rules 10b-5(a) and (c)
Defendant also moves to dismiss the complaint on the ground that it fails to adequately plead scheme liability under Rule 10b-5(a) and 10b-5(c). (Doc. No. 22 at 19-22.) Section 10(b) of the Exchange Act and Rules 10b-5(a) and (c) make it unlawful, in connection with the purchase or sale of a security, “to employ any device, scheme, or artifice to defraud” or “to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit.”
Defendant contends that Plaintiff‘s “scheme liability claim fails for many of the same reasons as the Rule 10b-5(b) claim discussed above.” (Doc. No. 22 at 19.) Namely, Defendant contends that Plaintiff‘s scheme liability claim fails because Plaintiff has not adequately plead scienter, because the alleged omissions were not in connection with the purchase or sale of a security, and because Defendant owed no duty to disclose the information. (Doc. No. 22 at 20-21.) As discussed above, the complaint adequately alleges that Defendant made material misrepresentations regarding the source of compensation for the research reports and that these misrepresentations were made in connection with the purchase or sale of a security. Further, the complaint adequately pleads scienter. For the same reasons that the complaint adequately alleges a Rule 10b-5(b) violation, the complaint adequately alleges scheme liability under Rules 10b-5(a) and (c).
C. Section 17(b) of the Securities Act
Finally, Defendant argues that Plaintiff has failed to state a claim under Section 17(b) of the Securities Act. (Doc. No. 22 at 22-24.) Section 17(b) of the Securities Act makes it unlawful to:
Publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.
Defendant cites to SEC v. Recycle Tech, Inc., to support his argument that “Section 17(b) does not require affirmative disclosure of the source of the consideration received.” No. 12-cv-21656, 2013 WL 12063952, at *8 (S.D. Fla. Sept. 26, 2013)). Defendant asserts that he complied with Section 17(b) by “disclosing that he was a promoter and how much he was paid for his promotions” because these disclosures advised readers that Defendant‘s opinions were “bought and paid for.” (Doc. No. 22 at 23) (citing Amick, 439 F.2d at 365)).
Recycle Tech is an out-of-district case decided in the Southern District of Florida and is not binding on this Court. In Recycle Tech, the court acknowledged that “[t]he specific issue here - i.e., whether misidentifying the source of the consideration received violates Section 17(b)‘s requirement of ‘fully disclosing the receipt . . . of such consideration and the amount thereof’ - appears to be one of first impression.” 2013 WL 12063952, at *8. The court concluded that the “plain language” of the statute “does not require affirmative disclosure of the source of the consideration received.” Id. (citing U.S. v. Wenger, 427 F.3d 840, 849-50 (10th Cir. 2005)). This conclusion has not been adopted by the Ninth Circuit and this Court disagrees.
Section 17(b) specifies a small group of people - an issuer, underwriter, or dealer - from whom the receipt of consideration must be disclosed. Where consideration is received or to be received from an issuer, underwriter, or dealer, Section 17(b) mandates the full disclosure “of such consideration and the amount thereof.” (emphasis added). This plain reading of the statute is bolstered by the Congressional intent of Section 17(b). “Section 17(b) ‘is particularly designed to meet the evils of the ‘tipster sheet’ as well as articles in newspaper or periodicals that purport to give an unbiased opinion but which opinions in reality are bought and paid for.‘” U.S. v. Amick, 439 F.2d 351, 365 (7th Cir. 1971) (quoting Committee on Interstate and Foreign Commerce. H.R. Rep. No. 85, 73d Cong., 1st Sess. (1933)). Congress intended this disclosure requirement to counter articles and periodicals that misleadingly purport to give an unbiased opinion. The fact that consideration is received from an issuer, underwriter, or dealer - someone with “a financial interest in fraudulently presenting promotional literature as objective reporting” - goes to the heart of bias. See S.E.C. v. Wall Street Pub. Institute, Inc., 851 F.2d 365, 369 (D.C. Cir. 1988).
The plain language of the statute requires that the source of consideration is disclosed when it is received from an issuer, underwriter, or dealer. Plaintiff alleges that “UPPR, the company whose shares Venado Media promoted in the research reports, had paid Venado Media to write [the reports.]” (FAC ¶ 86.) Plaintiff further alleges that despite the fact that UPPR paid Venado Media to author the reports, the research reports merely stated that compensation for the reports came from Venado Media. (FAC ¶ 86.) In doing so, the research reports misrepresented the source of consideration. (FAC ¶ 86.) Because this misrepresentation runs afoul of the plain language requirements of Section 17(b), the Court concludes that Plaintiff has sufficiently plead a violation of Section 17(b).
CONCLUSION
For the reasons above, the Court denies Defendant‘s motion to dismiss Plaintiff‘s FAC. Defendant must file an answer to the FAC within thirty (30) days of the date of this Order.
IT IS SO ORDERED.
DATED: April 10, 2023
MARILYN L. HUFF, District Judge
UNITED STATES DISTRICT COURT