Securities & Exchange Commission v. CMKM Diamonds, Inc.
729 F.3d 1248, 2013 WL 4793215, 2013 U.S. App. LEXIS 18780 (2013)
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Rule of Law:
Liability for participating in an unregistered securities distribution under Section 5 of the Securities Act requires a defendant to be both a "necessary participant" and a "substantial factor" in the transaction, which is a fact-specific inquiry into the defendant's actual role rather than their professional title. Section 5 is a strict liability statute, meaning the defendant's knowledge or intent (scienter) is not an element of the violation.
Facts:
- CMKM Diamonds, Inc. ('CMKM'), a public corporation whose stock was not registered with the SEC, orchestrated a scheme to issue and sell billions of shares of unrestricted stock to the public without filing a registration statement.
- CMKM's CEO Urban Casavant and director John Edwards promoted the company as a legitimate mining operation using false press releases and promotional materials.
- Brian Dvorak, acting as CMKM's counsel, drafted 450 opinion letters incorrectly stating that CMKM stock was exempt from registration requirements and could be issued without a restrictive legend.
- 1st Global Stock Transfer, LLC ('Global'), owned and operated by Helen Bagley, was retained by CMKM to serve as its transfer agent.
- Relying on Dvorak's legal opinion letters, Global and Bagley issued up to 622 billion shares of unrestricted CMKM stock.
- Bagley testified that although CMKM's activities "didn't make sense," she believed her role as a transfer agent was simply to process what appeared to be proper paperwork.
- In June 2004, Bagley became uncomfortable with Dvorak and requested a second opinion from another law firm, Edwards & Angell LLP ('Angell').
- Angell issued its own opinion letters, stating it relied on Dvorak's findings, which concluded the shares could be issued without restrictive legends. Global and Bagley continued to issue the shares.
Procedural Posture:
- The Securities and Exchange Commission ('SEC') filed a civil complaint against Global, Bagley, Dvorak, and others in the U.S. District Court for the District of Nevada.
- The SEC moved for summary judgment against Global, Bagley, and Dvorak.
- Dvorak, who also faced a related criminal indictment, filed a motion to stay the civil proceedings, which a magistrate judge denied.
- The district court granted summary judgment for the SEC, finding Global, Bagley, and Dvorak liable for violating Section 5 of the Securities Act.
- The district court entered a final judgment that included a disgorgement order against the defendants.
- Global and Bagley appealed the district court's grant of summary judgment and the disgorgement order to the U.S. Court of Appeals for the Ninth Circuit.
- Dvorak appealed the denial of his motion to stay and the district court's disgorgement order to the U.S. Court of Appeals for the Ninth Circuit.
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Issue:
Is a transfer agent who, in reliance on attorney opinion letters, removes restrictive legends and issues unregistered stock certificates a "necessary participant" and "substantial factor" in an illegal securities distribution as a matter of law, therefore making them liable under Section 5 of the Securities Act?
Opinions:
Majority - Tunheim, District Judge
No. A transfer agent's performance of its functions is not, as a matter of law, sufficient to establish liability under Section 5. To hold a non-seller liable under Section 5, the SEC must prove they were both a 'necessary participant' and a 'substantial factor' in the sales transaction. The court reaffirmed that Section 5 imposes strict liability and scienter is not an element. However, the 'substantial factor' test requires a case-by-case factual analysis of the defendant's actual role, not just their title. Here, Global and Bagley's actions of removing restrictive legends and issuing shares in reliance on two separate attorney opinion letters were ministerial. This conduct is distinct from prior cases where defendants were found liable as a matter of law because they devised the financing scheme, met with investors, or structured the transactions. Because a reasonable jury could conclude that Global and Bagley were not substantial participants in the scheme, summary judgment was inappropriate and the case must be remanded for a factual determination.
Analysis:
This decision clarifies the scope of participant liability under Section 5 of the Securities Act, particularly for ancillary service providers like transfer agents. The court's holding reinforces that a defendant's title is not dispositive; liability hinges on a factual inquiry into their actual level of involvement. By distinguishing ministerial acts from more integral participation, the ruling makes it more difficult for the SEC to obtain summary judgment against peripheral actors in a securities scheme. This precedent emphasizes that even under a strict liability statute, a defendant's role must be more than a 'but for' cause; it must be a substantial, contributing factor to the illegal distribution.
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