BNS Wins Summary Judgment Against the SEC

On July 20, 2015, the Central District entered summary judgment on all claims asserted by the United States Securities & Exchange Commission against our client. The SEC contended that our client -- himself a victim of a Ponzi scheme -- was responsible for repaying over $1 million in withdraws and interstate that the Ponzi schemer had persuaded another victim to withdraw so the Ponzi schemer could repay our client ( and cover up the scheme for a longer time). The SEC claimed that the money from the trust was a windfall or a gift from the trust. BNS showed that the Ponzi schemer had acquired the money and that our client was merely receiving the return from his investment.

Offers through social media or company websites under Rule 147.

On October 2, the SEC issued interpretations regarding the application of Rule 147 (17 CFR 230.147), the safe harbor provision under Section 3(a)(11) of the Exchange Act.  Generally known as the “intrastate offering exemption,” issuers can claim this federal registration exemption for offers and sales to residents of the same state the company resides in – in effect providing for easier investment in local companies by local citizens.  Although the exemption is relatively simple, Rule 147 provides more objective standards for companies to rely on when claiming the exemption. Earlier in April, the SEC reported that use of a third-party internet portal to promote offerings to local residents would not be incompatible with Rule 147.  To comply, the portal would need adequate measures to ensure only resident citizens would be targeted.  In the context state crowdfunding requirements, this would include disclaimers and restrictive legends to explain that the offer is only made to residents, as well as limiting information on available investments only to persons who confirm they are residents of the state.

In the recent interpretation, the SEC addressed whether a company could comply with Rule 147 when making offers or sales through social media or company websites.  The SEC reported that the use of a company’s personal website or social media would likely involve offers to those outside of the relevant state, but acknowledged the possibility of using technology to limit offer communications only to persons residing within the state.  The technology would limit communications to IP addresses that originate only from the resident state.  The SEC reiterated that disclaimers and restrictive legends should also be used.

The interpretations can be found here.

Deference Required in Evaluating Proposed Consent Decrees

In the long-awaited decision of S.E.C. v. Citigroup Global Markets, Inc. (2014 U.S. App. LEXIS 10516), the Second Circuit reversed the district court’s refusal to give deference to the S.E.C. and approve a consent decree proposed by the parties. In 2011, the S.E.C. filed a complaint against Citigroup alleging violations of §§17(a)(2) and (3) of the Securities Act, which was followed shortly after by a proposed consent decree. The decree included an injunction against future violations of 17(a)(2) and (3), profit disgorgement, prejudgment interest, and a civil penalty; the decree did not require Citigroup to admit guilt or liability. The district court declined to approve the decree, holding that it was “neither fair, nor reasonable, nor adequate, nor in the public interest.” The court then set a date for trial that both parties immediately appealed.

After finding jurisdiction under 28 U.S.C. §1292(a)(1) the Second Circuit reversed and remanded. The court clarified the standard for review as, “whether the proposed consent decree is fair and reasonable, [and that] the public interest would not be disserved.” By requiring that the consent decree be adequate, the district court applied the wrong standard. The Second Circuit listed the factors for evaluating the fairness and reasonableness of a consent decree and stressed that the inquiry should focus on correct procedures while giving deference to the decision by the S.E.C. Citing Chevron, the court reiterated that "determining whether the proposed decree best serves the public interest…rests squarely with the S.E.C., and...merits significant deference." In finding the public interest disserved, the district court abused its discretion.

Ninth Circuit Establishes the Need for Brokers Invoking the "Brokers' Exemption to Registration Requirement Must Conduct Inquiry

In World Trade Financial Corp. v. SEC ( the Ninth Circuit upheld the SEC's position that a broker-dealer seeking to sell unregistered securities under the "brokers' exemption" must conduct a reasonable inquiry.  In the WTFC case, the shares at issue contained no restricted legend.  The broker-dealer made no inquiry beyond checking for a restricted legend, despite what the SEC and the Ninth Circuit considered "red flags":  the corporation had just gone through a reverse merger, had little operating history, and was thinly traded on the "pink sheets."  As it turned out, the selling shareholders had obtained an incorrect legal opinion that the shares were not restricted. The Ninth Circuit had never before addressed whether brokers had an obligation under the circumstances to conduct an inquiry.  The Ninth Circuit joined the DC Circuit holding that a reasonable inquiry was required and that the broker-dealer here had egregiously failed to meet that standard by in effect making no inquiry at all.

SEC Trial Losses

This past two weeks saw the SEC lose two enforcement actions at trial.  In Kansas, a jury found against the SEC in a case against an executive of a high tech company accused of trying to hide a $1.2M payment to the company's then CEO.  In California, a federal judge ruled against the SEC in a case against executives of Basin Water who were accused of artificially boosting the company's financial performance.  Undeterred, the SEC continues to take the position that in at least some instances it will require admissions of guilt and therefore will push more cases to trial.  These latest cases show that the SEC can be defeated at trial.