Ninth Circuit Holds That Transfer Agents Are Not Necessarily Sellers for Purposes of Section 5 Liability

In SEC v. CMKM Diamonds, Inc. (, the Ninth Circuit considered a claim against a transfer agent and its principal for liability under Section 5 of the Securities Act.  Several individuals had schemed to sell unregistered securities in violation of the securities laws in a company traded on the pink sheets.  To facilitate that scheme, those individuals obtained opinion letters of counsel (who was indicted for his role in the scheme) that the sales were lawful under recognized exceptions to the registration requirements.  The transfer agent was tasked with transferring the securities subject to those sales.  Here, the transfer agent was concerned about the sales and consulted a second law firm who determined it was appropriate to rely on the opinions of the first firm.  In that basis, the transfer agent effected the transfer of the securities. The SEC brought claims against the transfer agent, asserting that the transfer agent was a "seller" within the meaning of Section 5.  Under Section 5, not only is the actual seller who passes title a "seller" but also participants in the transaction who are a "substantial factor" in the sale are deemed to be sellers.  The SEC moved for summary judgment contending that (1) the transfer agent was a seller because its act to transfer ownership of the securities was a substantial factor in effectuating the sale, and (2) Section 5 is a strict liability provision such that the transfer agent's state of mind, even if innocent, is irrelevant to the analysis.  The district court granted summary judgment.  The Ninth Circuit reversed, holding that whether the transfer agent was a "substantial factor" in the sale was a question of fact.  The Court rejected the transfer agent's argument that it should only be held liable if it acted unreasonably or with scienter.  But, the Court held that the substantial factor had to be carefully applied with respect to a transfer agent who potentially faces strict liability in connection with a transaction.

While the Court expressly rejected a state of mind requirement, the Court contrasted the transfer agent's seemingly appropriate conduct of reviewing an attorney opinion letter and seeking out a second for confirmation with more nefarious actions of other participants in previously decided cases.  The Court seemed to "back door" some state of mind consideration by reviewing not just whether the transfer agent was a participant in the transaction but rather whether the transfer agent participated in the wrongful actions.