The Ninth Circuit recently reversed a ruling by the U.S. District Court of Nevada granting summary judgment in favor of the SEC in a case alleging violations of Section 5 of the Securities Act of 1933 in connection with the sale of unregistered securities. The SEC's complaint alleged that 1st Global Stock Transfer LLC ("Global"), a transfer agent, and Global's owner, Helen Bagley (collectively "Defendants"), assisted in the sale of unregistered securities for CMKM Diamonds, Inc. ("CMKM"), a purported diamond and gold mining company. The SEC's complaint further alleged that CMKM had no legitimate business operations but instead the Company concocted false press releases and distributed fake maps and videos of mineral operations to its investors. While CMKM was one of several defendants in the action, the SEC only moved for summary judgment against Global, Bagley, and CMKM's attorney. The District Court granted the SEC's motion for summary judgment against the three defendants, but only Global and Bagley appealed that ruling.
In perpetrating the scheme, CMKM's attorney was alleged to have provided hundreds of false opinion letters supporting the issuance of unregistered stock without restrictive legends to indicate that the stock was unregistered. Relying on these opinion letters, Global and Bagley issued additional CMKM stock without restrictive legends, believing that the issuance was legal. After a year and a half of this practice, Bagley became suspicious and asked a second law firm to confirm the opinion letters. The second law firm, however, relied on the first attorney's opinion letters and also issued an opinion letter stating that the issuance of additional CMKM stock was valid. Based on the additional opinion letter, Global and Bagley continued to issue CMKM shares without restrictive legends.
In granting the SEC's motion for summary judgment against Global and Bagley, the District Court concluded that they were "necessary participants" and "substantial factors" in the unregistered distribution of CMKM stock. The court reasoned that but for their removal of the restrictive legends on CMKM's stock certificates, the issuance of unregistered stock would not have occurred. The District Court rejected the argument that the SEC was required to show that Defendants knew, or had reason to know, that the distribution of stock was illegal, noting that Section 5 is a strict liability statute.
On September 10, 2013, the Ninth Circuit reversed the District Court's ruling, holding that participant liability for Section 5 requires more than a finding of "but for" causation when determining whether a defendant's role was both "necessary" and "substantial." The Ninth Circuit noted that Defendants' mere position as transfer agent was insufficient to show their "substantial participation" because the position alone did not explain the roles they actually played in the alleged scheme. Furthermore, the Ninth Circuit noted that Global and Bagley acted pursuant to opinion letters from two separate attorneys – pointing out the stark contrast to defendants in prior Ninth Circuit rulings that affirmed Section 5 liability. In the Ninth Circuit's earlier opinions, the court found "substantial participation" where the defendants were "integrally involved in the securities-distribution schemes, from devising the scheme to finding investors and buyers to structuring the sales." Finding no such evidence against Global or Bagley, the Ninth Circuit reversed and remanded.
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