Opinion
Civil No: 03cv1958-BTM (JFS).
September 20, 2005
OPINION AND ORDER
The matters before the Court are: 1) whether disgorgement should be ordered against Defendant May, and if so, the amount of such disgorgement; 2) whether a civil penalty should be ordered against Defendant May, and if so, the amount of such penalty; 3) whether an officer and director bar should be ordered against Defendant May; and 4) whether a penny stock bar should be ordered against Defendant May.
I. Background
On October 2, 2003, Plaintiff Securities and Exchange Commission ("SEC") filed a complaint against Defendants Richard May and B. Roland Frasier alleging fraud, in violation of Section 10(b) of the Securities Exchange Act of 1934 [ 15 U.S.C. § 78j(b)] and Rule 10b-5 promulgated thereunder [ 17 C.F.R. § 240.10b-5], and the sale of unregistered stock, in violation of Section 5 of the Securities Act [ 15 U.S.C. § 77e]. Plaintiff SEC alleged in the complaint that, between October 1999 and November 2000, Defendants Frasier and May, along with Max Gnehm (now deceased), orchestrated a fraudulent trading scheme involving the unregistered stock of Zandria Corp. ("Zandria"), an internet company previously located in San Diego, California. Defendant May played an important role in locating a shell public company and affecting a reverse merger, which resulted in the creation of Zandria. Defendant May received 1.375 million shares of Zandria stock for his efforts. Sales agents controlled by Defendants "cold called" potential investors and urged them to buy Zandria stock. At the same time, Defendant May sold most of his Zandria stock to those investors. Defendants then split the proceeds from these alleged fraudulent sales of stock. Plaintiff alleged in the complaint that Defendant May received a net amount of approximately $405,000 as a result of the Zandria stock trading scheme.
On October 2, 2003, Plaintiff filed in the record the signed Consent of Defendant Frasier to the Entry of Final Judgment. On October 21, 2003, a Final Judgment as to Defendant Frasier was signed and filed by the District Judge in this case. On August 19, 2005, Plaintiff filed a Consent to Order of Permanent Injunction signed by Defendant May. Defendant May agreed that, upon Plaintiff's motion, the Court would determine the remaining issues after a hearing.
The Consent to Order of Permanent Injunction by Defendant May provided in part:
2. Without admitting or denying the allegations of the Complaint (except as to personal and subject matter jurisdiction, which Defendant admits), Defendant hereby consents to the entry of the Order of Permanent Injunction in the form attached hereto and incorporation by reference herein, which, among other things: (a) permanently restrains and enjoins Defendant from violations of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") [ 15 U.S.C. § 78j(b)] and Rule 10b-5 promulgated thereunder [ 17 C.F.R. § 240.10b-5]; and Section 5 of the Securities Act [ 15 U.S.C. § 77e]; and (b) orders a hearing to determine what remedies, if any, are appropriate against Defendant.
3. Defendant agrees that upon the Commission's motion filed concurrently, the Court shall determine the following issues after a hearing: (a) whether it is appropriate to order disgorgement of ill-gotten gains and/or a civil penalty pursuant to Section 20(d) of the Securities Act [ 15 U.S.C. § 77t(d)] and Section 21(d)(3) of the Exchange Act [ 15 U.S.C. § 78u(d)(3)] and, if so, the amount(s) of disgorgement and/or civil penalty; (b) whether it is appropriate to order an officer and director bar pursuant to Section 20(e) of the Securities Act [ 15 U.S.C. § 77t(e)] and Section 21(d)(2) of the Exchange Act [ 15 U.S.C. § 78u(d)(2)]; and (c) whether it is appropriate to order a penny stock bar pursuant to Section 20(g) of the Securities Act [ 15 U.S.C. § 77t(g)] and Section 21(d)(6) of the Exchange Act [ 15 U.S.C. § 78u(d)(6). . . . Defendant further agrees to the following parameters for the hearing: (a) Defendant will be precluded from arguing that he did not violate the federal securities laws as alleged in the Complaint, but Defendant may present mitigating evidence relevant to the issues of whether disgorgement, a civil penalty, an officer and director bar, and a penny stock bar shall be ordered against Defendant, and the amount(s) of such disgorgement and/or civil penalty; (b) Defendant may not challenge the validity of this Consent or the Order of Permanent Injunction; (c) solely for the purposes of the hearing, the Stipulation of Facts and Admissible Evidence (attached as Exhibit A) shall be deemed true and accepted by the Court, and Defendant shall not contest the factual stipulations therein; (d) the Court may determine the issues raised at the hearing on the basis of the stipulations, affidavits, declarations, excerpts of sworn deposition or investigative testimony, and documentary and testimonial evidence, without regard to the standards for summary judgment contained in Rule 56(c) of the Federal Rules of Civil Procedure. Defendant consents to conducting the hearing before a U.S. Magistrate Judge pursuant to a consent and waiver filed concurrently.
(Doc. No. 32, Consent to Order of Permanent Injunction by Defendant Richard May, at 1-3.)
On August 30, 2005, the case as to Defendant May was referred to the undersigned Magistrate Judge for all further proceedings and the entry of judgment.
The parties executed the necessary consent pursuant to 28 U.S.C. § 636(c).
II. Discussion
On September 2, 2005, this Court conducted a bench trial on the following issues: 1) whether disgorgement should be ordered against Defendant May, and if so, the amount of such disgorgement; 2) whether a civil penalty should be ordered against Defendant May, and if so, the amount of such penalty; 3) whether an officer and director bar should be ordered against Defendant May; and 4) whether a penny stock bar should be ordered against Defendant May.Plaintiff SEC called two witnesses at the hearing: 1) SEC Staff Attorney Kerry Matticks; and 2) Defendant Richard May. In addition to the Stipulation of Facts and Admissible Evidence, Plaintiff presented evidence that Defendant netted $472,402.61 from the sale of Zandria stock, and Defendant did not dispute that figure. Plaintiff also questioned Defendant about his background. Defendant testified that he held a B.A. in finance, had been a broker and trader for many years, was aware of securities compliance issues, and had studied ethics as part of his training. Defendant also testified that he is currently working as a researcher and music teacher and makes about $1,300 a month, with $800 going towards his rent. Defendant offered his own testimony as his case in chief.
Although Plaintiff SEC's complaint alleges net receipt of approximately $405,000, the evidence received at the trial confirmed a net amount of $472,402.61.
Plaintiff argued that Defendant was not unsophisticated about securities law and that he did operate with the level of scienter required under Section 10(b). Defendant argued that four attorneys were involved in the transaction, and he believed they were good, competent attorneys who knew what they were doing. He believed the success of the Zandria stock was due to the dot-com boom, rather than market manipulation, and he relied on others, including attorney Frasier, regarding the registration of the stock. Defendant also argued against a permanent officer and director bar and penny stock bar, claiming that a permanent bar would be too harsh.
Based upon the evidence presented and the testimony and arguments at the hearing, the Court finds that it is relatively uncontroverted that Defendant has violated Section 5 of the Securities Act for the sale of unregistered securities. In addition, the weight of the record supports a finding of a Section 10(b) and Rule 10b-5 violation. Defendant was trading into a thin market and had regular contact with a person who was close to the marketplace. Nonetheless, Defendant's degree of scienter was low, because of his reliance, albeit misplaced, on the fact that an attorney, Roland Frasier, had set up the transaction and had given him assurances that it was legal. Furthermore, the evidence is that Zandria was an actual company involved in website development. However, there is no evidence that Defendant May ever made reasonable inquiry into the bona fides of these transactions, nor did he do any due diligence regarding the management, products or business plan of Zandria. In addition, during the period of selling, Defendant paid over $400,000 to Gnehm, who was responsible for marketing the securities.
Plaintiff SEC seeks relief against Defendant in the form of disgorgement of ill-gained profits with prejudgment interest, third tier penalties, a permanent director and officer bar, and a permanent penny stock bar.
A. Disgorgement
The district court has broad equity powers to order the disgorgement of ill-gotten gains obtained through the violation of the securities laws. S.E.C. v. First Pacific Bancorp, 142 F.3d 1186, 1191 (9th Cir. 1998), cert. denied, 119 S. Ct. 902 (1999). Disgorgement is designed to deprive a wrongdoer of unjust enrichment and to deter others from violating securities laws by making violations unprofitable. Id. Disgorgement plays a central role in the enforcement of the securities laws. S.E.C. v. Rind, 991 F.2d 1468, 1491 (9th Cir. 1993). By deterring violations of the securities laws, disgorgement actions further the Commission's public policy mission of protecting investors and safeguarding the integrity of the markets. Id. The Court finds that Plaintiff is entitled to judgment against Defendant May for disgorgement in the amount of $472,402.61, being the net proceeds Defendant received from his sale of Zandria Corp. stock.
B. Prejudgment Interest
Whether prejudgment interest will be awarded "is a question of fairness, lying within the [trial] court's sound discretion, to be answered by balancing the equities." Knapp v. Ernst Whitney, 90 F.3d 1431, 1441 (9th Cir. 1996) (quoting Wessel v. Buhler, 437 F.2d 279, 284 (9th Cir. 1971)). Based upon the facts presented and in balancing the equities in this case, the Court finds that an award of prejudgment interest is not proper. Defendant's degree of knowing complicity in a fraudulent scheme was minor. Plaintiff's request for prejudgment interest is denied.
C. Civil Penalty
Section 20(d)(1) of the Securities Act authorizes a district court to impose, upon a proper showing, a civil penalty to be paid by the person found to have violated the Securities Act. 15 U.S.C. § 77t(d)(1). As the stated above, Plaintiff SEC has made a showing that Defendant May violated the Securities Act and is subject to civil penalties. Section 20(d)(1) of the Securities Act provides for three different tiers of civil penalties which are to be determine by the court in light of the facts and circumstances. 15 U.S.C. § 77t(d)(2)(A).
The first tier provides for a penalty not to exceed the greater of $5,000 or the gross amount of pecuniary gain to defendant as a result of the violation. Id. The second tier applies if the violation involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement and allows for a penalty not to exceed $50,000 or the gross amount of pecuniary gain to the defendant as a result of the violation. Id. at § 77t(d)(2)(B). The third tier applies if the violation involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement, and the violation directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons and allows for a penalty for each violation not to exceed $110,000.Id. at § 77t(d)(2)(C); 17 C.F.R. § 201.1002 Table II.
The Court finds that Defendant's level of personal culpability and degree of scienter were low, and the Court is mindful of the fact that from all the evidence, Defendant is impecunious. Therefore, based upon the facts and circumstances of this case, the Court finds that a second or third tier penalty is inappropriate. Instead, Defendant shall pay a first tier civil penalty, in the amount of $5,000.
D. Officer and Director Bar
For fraud violations, a court may bar a person from acting as an officer or director of a public company permanently or for a specific period of time. 15 U.S.C. §§ 77t(e), 78u(d)(2). Courts have broad discretion in deciding whether to impose an officer and director bar. First Pacific Bancorp, 142 F.3d at 1193. The Court finds that a permanent bar is inappropriate. Defendant shall be barred from acting as an officer or director of a public company for a period of 12 months.
D. Penny Stock Bar
A court may bar a person from participating in an offering of penny stock permanently or for a specific period of time if the person participated in a penny stock offering at the time of the alleged misconduct. 15 U.S.C. §§ 77t(g), 78u(d)(6). The Court finds that a permanent bar is inappropriate. Defendant shall be barred from participating in an offering of penny stock for a period of 18 months.
III. Conclusion
Defendant May shall pay $472,402.61 in disgorgement, without prejudgment interest, and $5,000 in civil penalties. Defendant is also barred from acting as an officer or director of a public company for 12 months and offering of penny stock for 18 months.IT IS SO ORDERED.