Big Apple Consulting, Mark Jablon and Mark Kaley Lose Appeal
On April 9, 2015, the U.S. Court of Appeals for the Eleventh Circuit upheld a lower court’s ruling in the U.S. Securities and Exchange Commission v. Big Apple Consulting USA Inc., MJMM Investments, LLC, Marc Jablon and Mark Kaley, case number 13-11976.
The appellate panel affirmed the district court’s ruling in its entirety.
In 2009, the SEC filed suit against Big Apple, MJMM, a Big Apple subsidiary, Marc Jablon, Mark Kaley, Keith Jablon, and Matthew Maguire, alleging fraud, registration violations, and, with respect to Big Apple and MJMM, acting as unregistered broker-dealers. The agency further charged Marc Jablon, Maguire, and Kaley, an attorney, with aiding and abetting the two entities’ violations.
In June 2005, Big Apple was hired by James Plant, CEO of a penny stock company called CyberKey Solutions (CKYS) to perform investor relations and business consulting services. CyberKey was a technology company that sold flash drives and other electronic devices. According to the allegations, thanks to Big Apple’s energetic promotional efforts, and to the efficiency of its boiler room staff, the company attracted quite a lot of attention, and many buyers for its stock, in the course of 2006. Plant’s claims for his products, conveyed by Big Apple, went from the improbable to the absurd when he claimed a $24.5 million purchase order awarded the company by the Department of Homeland Security (DHS). Plant was arrested by the FBI in early 2007, and a comprehensive superseding indictment was filed a few months later. Meanwhile, the SEC Division of Enforcement brought civil charges against him. He was convicted in 2009, and is currently serving 97 months in Federal prison.
When Plant’s criminal trial was over, the SEC moved against Big Apple and its executives. In 2013, a jury found Big Apple, Jablon and Kaley guilty of violating the anti-fraud rules of Section 17(a)(2) of the Securities Act, and of aiding and abetting under Section 20(e) of the Exchange Act. Big Apple Consulting and its co-defendants, with the exception of Matthew Maguire and Keith Jablon, then appealed to the Eleventh Circuit, claiming the Florida district court erred on six grounds.
One of SEC’s key charges was that Maguire, Kaley and the Jablons “knew, or were severely reckless in not knowing,” that the supposed DHS contract—which was the foundation of their sales pitch to prospective buyers of CKYS stock, and fodder for a number of over-the-top press releases—was a fabrication. The Big Apple people had seen the purported contract, but claimed later they hadn’t paid much attention to it. They were aware that in August 2006, the National Association of Securities Dealers (NASD; now known as the Financial Industry Regulatory Authority (FINRA), sent CyberKey inquiries about the DHS contract, and requested information about the company’s relationship with Big Apple. Jablon and Kaley advised Plant to have his securities attorney handle the matter, but evidently never asked about it again.
The lower court found the Big Apple defendants liable for violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”) and Section 20(e) of the Securities Exchange Act of 1934 (“Exchange Act”). The SEC had originally charged the defendants with violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5, both anti-fraud provisions. CyberKey and Plant had been successfully charged with violations of both Section 10(b) and Rule 10b-5.
In 2011, however, the Supreme Court decided Janus Capital Group, Inc. v. First Derivative Traders, and its decision defined what it means to be a “maker” of a false statement under these rules. The SEC amended its complaint to allege that the defendants had violated Section 20(e) of the Exchange Act by aiding and abetting Plant’s Section 10(b) violations.
In their appeal, the Big Apple defendants argued that Janus extends to claims brought under Section 17(a). Janus turned on whether a mutual fund investment adviser could be held liable under Rule 10b-5(b) for misleading statements contained in its clients’ prospectuses, which the adviser had helped prepare. The Court held that “[o]ne who prepares or publishes a statement on behalf of another is not its maker.” Clarifying further, it specified that “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” The Big Apple defendants asserted that they could not be liable under Section 17(a) because its provisions are essentially the same as those of Rule 10b-5.
The Eleventh Circuit disagreed, noting that the wording of Rule 10b-5(b)–“To make any untrue statement of a material fact…”–is different from the wording of Section 17(a)(2) in an important way. The latter does not use the word “make,” and specifies that it is “unlawful for any person in the offer or sale of any securities… to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact.” The appellate panel further concluded that “obtain[ing] money… by means of any untrue statement” covers a broader range of conduct than merely “making” an untrue statement. In addition, the jury in the district court case found the defendants violated all three subsections of 17(a), not just subsection (2). All the SEC needed to prevail in the action was to show that the defendants engaged in one of the types of conduct described in the subsections.
Obviously, all stock promoters and investor relations representatives use materials given to them by client companies when they issue press releases, send out email blasts, or publicize the companies in other ways. No doubt many investor relations providers in the industry hoped Big Apple would prevail in its Janus argument. Had that happened, promoters would very likely have felt to some extent protected from SEC actions resulting from their dissemination of false and misleading information, as long as that information was demonstrably provided by the client company.
The Big Apple defendants also objected that the lower court had erred in finding them liable for “aiding and abetting” Plant’s and CyberKey’s violations of Section 10(b) under Section 20(e) of the Exchange Act. The district court judge instructed the jurors in the case that they could find that the defendants had acted “knowingly” if they “knew or were severely reckless in not knowing” that the DHS contract was a fabrication.
As the appellate panel saw it, the question was whether the Exchange Act, at the time of the case, required proof of “actual knowledge” of fraud, or whether a showing of “severe recklessness” was enough. The defendants claimed “actual knowledge” was necessary; the panel points out that Section 20(e) does not contain that phrase. Section 20(e) was enacted by Congress in 1995 as an independent authority under which the SEC could pursue aiding and abetting claims. It originally provided that “any person that knowingly provides substantial assistance to another person in violation of a provision of this title, or of any rule or regulation issued under this title, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided.” The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amended that provision by adding “or recklessly” after “knowingly.” The Big Apple appellants held that the change made it clear that prior to Dodd-Frank, “actual knowledge” on the part of the defendant was required to prove an aiding and abetting charge.
The Eleventh Circuit disagreed again with Big Apple. The jury in the case was instructed that if the defendants “knew or were severely reckless in not knowing” that Plant and CKYS had violated the cited anti-fraud provisions of the Exchange Act, they were liable. The panel concluded that the district court did not err in finding severe recklessness sufficient to constitute acting “knowingly.”
The district court judge included a “deliberate ignorance” instruction to the jury. At trial, the defendants objected that it was a criminal jury instruction that had no place in a civil case. In its rulings on two earlier cases, the Eleventh Circuit had defined “deliberate ignorance” as “the equivalent of knowledge,” and had explained that “To act ‘knowingly,’ therefore, is not necessarily to act only with positive knowledge, but also to act with an awareness of the high probability of the existence of the fact in question.” Both of the precedential cases were criminal, but the Big Apple appellate panel pointed out that since the burden of proof in criminal actions is higher, the standard should apply in civil cases as well. They backed their argument by noting that in 2011 the Supreme Court recognized that a deliberate ignorance instruction is appropriate in civil actions.
The defendants also suggested that the facts of the case weren’t clear enough to support a deliberate ignorance instruction. The panel’s view, for which it offered supporting evidence, was that “the defendants acted with deliberate ignorance of what would otherwise be obvious fraud and/or that they acted with severe recklessness to assist in fraud that was so obvious that they must have been aware of it.” The panel concluded that the district court had not erred in its deliberate ignorance instruction.
They also rejected the defendants’ claim that the district court had erred in granting partial summary judgment to the SEC. As to this claim, only Big Apple, MJMM and Marc Jablon were found liable. They’d been charged with acting as underwriters and unregistered broker-dealers in connection with the distribution of CyberKey stock. The defendants sustained that they were afforded protection by Section 4(1) of the Securities Act, which exempts “transactions by any person other than an issuer, underwriter, or dealer.”
The defendants obviously were not issuers; CyberKey was. But as the Eleventh Circuit notes, an underwriter is “any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security…” The district court found that the Big Apple defendants were underwriters “because they obtained CyberKey stock with a view to distribution.” Big Apple, MJMM, and their executives were paid for their services in unregistered CyberKey stock, and they sold large amounts of that stock into the market.
The concept addressed by the panel is in some ways paradoxical. People buy, or otherwise acquire, stock with the intention of realizing a profit, which means that ultimately they will sell that stock. In subscription agreements for private placements of unregistered stock, buyers attest that their purchase is for the purpose of “investment,” rather than for the purpose of resale. Citing precedent, the Eleventh Circuit noted that courts have generally agreed that if the investor holds his stock for two years or more, he cannot be considered to have purchased it with a “view to distribute.”
The Big Apple defendants argued that they held their CKYS stock “for months, if not half a year, maybe even longer,” implying they sold only when Rule 144 allowed them to do so. To the contrary, the SEC showed that, among other things, “by the end of the year , MJMM had sold more than 75% of the 200 million CyberKey shares it had acquired after June 30, 2006, and it sold the remaining shares by January 23, 2007.” That would not have satisfied the requirements of Rule 144, much less the two year hold found by several courts to be necessary for the stock sales not to be considered a distribution.
Testimony offered at trial showed Big Apple depended on stock sales to meet operating expenses, and that the stocks to be sold were chosen on the basis of their current price, liquidity, and, at times, purchase price. The appellate panel argued that since at least 95 percent of Big Apple’s clients, including CyberKey, paid in stock, “it is difficult to fathom how Big Apple could operate by receiving stock not with a ‘view toward’ distribution in order to maintain its own operating costs.” The Eleventh Circuit rejected the defendants’ contention that they were protected by Rule 144’s safe harbor provision because it failed to address the question of whether the stock was acquired “with a view to distribute.” In any case, as the SEC’s evidence showed, the defendants did not qualify for the Rule 144 exemption.
In addition, the panel sustained the lower court’s finding that the defendants could be considered dealers as well as underwriters. The panel held that to be a dealer, a person must be “in the business of” buying and selling securities. Big Apple’s business model was predicated on the purchase and sale of securities; in order to profit, it acquired stock from clients and sold it. The panel concluded that the defendants therefore failed to meet the Section 4(1) exemption from registration requirements.
Finally, the panel found no error in the lower court’s exclusion of some expert testimony, and of certain evidence, some of it in the form of YouTube videos that purportedly showed what a convincing con artist Plant was, nor did it support Kaley’s separate contention that he had been found liable on insufficient evidence.
The Eleventh Circuit’s ruling is important for the SEC and for stock promoters and investor relations firms. In recent years, the agency has stepped up enforcement actions against penny touts, and the Department of Justice has lent a hand with some critical criminal prosecutions. The appellate panel’s thoughtful analysis and conclusions reached in the Big Apple case makes clear that promoters cannot, among other things, hope to escape liability for clients’ blatant fraud by claiming they were unaware of it.
Securities Attorney, Carl Francis Schoeppl represented Big Apple and Marc Jablon in the appeal of the SEC action. In addition to representing Big Apple in their failed appeal, Schoeppl represented Big Apple in the loss of the underlying SEC action.
For further information, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real South, Suite 202 North, Boca Raton, FL, (561) 416-8956, or by email at [email protected]tieslawyer101.com. This information is our opinion and is provided to clients and friends of Hamilton & Associates Law Group, P.A. and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Going Public Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855