Rule 144 Opinion Letters – Do They Protect Anyone?


The Ninth Circuit Court of Appeals has previously suggested that scienter is not required under Section 5.  SEC v. Phan, 500 F.3d 895, 905-06 (9th Cir. 2007).  Yesterday, the Court addressed the issue directly.  SEC v. CMKM Diamonds, Inc., Case Nos. 11-17021 & 11-17025 (Sept. 10, 2013). 

The case arose out of a scheme to distribute billions of shares of stock to thousands of investors without registration under the Securities Act.  The SEC sued, among others, the company’s transfer agent and owner and was successful in winning a summary judgment motion against them.  The defendants argued that the district court erred when it determined that Section 5 is a strict liability statute and failed to consider whether they knew, or should have known, that their conduct violated the Securities Act.  While the Ninth Circuit refused to incorporate scienter into the statute, it did reverse on the basis that a triable issue of fact existed as whether the defendants could be held liable.

District Court Judge John R. Tunheim (sitting by designation) found that to be liable under Section 5 a person must be “both a ‘necessary participant’ and ‘substantial factor’ in the sales transaction.” quoting Phan, 500 F.3d at 906 (quoting SEC v. Murphy, 626 F.2d 633, 648, 652 (9th Cir. 1980)).  After reviewing the facts, he concluded:

That Global [the transfer agent] and Bagley [the owner] issued large quantities of shares without a restrictive legend after receiving two attorney opinion letters is insufficient, in and of itself, to establish that Global and Bagley were substantial factors as a matter of law.  Based upon this evidence, a reasonable jury could conclude that Global and Bagley were not substantial participants in the CMKM scheme.

 What About Those Attorney Letters?

There weren’t two opinion letters. There were hundreds of attorney letters.  One lawyer, subsequently indicted, drafted 450 opinion letters regarding at least 233.7 billion shares of stock, issued to 258 individuals.  At some point, the transfer agent’s owner became uncomfortable with that lawyer’s letters and requested, and received, an opinion from a large law firm.  In a footnote Judge Tunheim wrote: “Because Section 5 is a strict liability statute, it appears that the district court erred in determining that good faith reliance on counsel could preclude liability under the statute.”

Remembering 9/11

Lisa Anne Frost was one of my wife’s students.  Twelve years ago, she was murdered by al Qaeda terrorists who hijacked United Airlines Flight 175 and flew it into the South Tower of the World Trade Center.  She was 22, she’ll never be 23.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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