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.

Ninth Circuit Clears Up Scienter Analysis

In In re VeriFone Holdings, Inc. Securities Litigation (, the Ninth Circuit weighed in on the proper analysis for determining whether a plaintiff in a securities action has properly pled scienter.  After the Private Securities Litigation Reform Act of 1995 (PSLRA), federal courts looked to the specific individual allegations in the complaint to determine whether the plaintiff had pled the requisite strong inference of scienter.  In Tellabs, the Supreme Court clarified the scienter analysis and required that the federal courts take a "holistic" approach -- that is, to determine whether the complaint and all of its allegations as whole create a strong inference of scienter.  Particularly after a subsequent Supreme Court decision in Matrixx Initiatives, at least some federal courts had begun taking the view that only the holistic approach was proper; in other words, courts should not look at the individual allegations one by one to determine whether any individually create a strong inference of scienter.  The Nonth Circuit in VeriFone set this debate to rest in the Ninth Circuit at least, holding that courts should undertake the individual review of allegations for scienter and then step back and look at the complaint as a whole to determine if the standards are met.  The Ninth Circuit referred to this as a two step approach. At first look, it seems that the Ninth Circuit approach is plaintiff friendly.  They have two opportunities to plead scienter:  either through individual allegations so powerful that they create a strong inference of scienter or based upon the allegations of the complaint taken as a whole.  Indeed, a holistic approach only might lead a court to reject even a powerful individual allegation because taken together with all of the rest of the facts before it, there are off-setting facts that suggest an innocent explanation.

But, as a practical matter, the Ninth Circuit approach may not be so plaintiff friendly after all.  The approach allows defendants to focus courts' attention on the individual allegations and pick each apart.  If a defendant can successfully do so, it seems unlikely in most instances that a court is going to find a strong inference of scienter from a bunch of individual allegations that, standing alone, don't amount to enough.  The exercise of going through the first step may advantage defendan