Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—D. Colo.: SEC’s muddled presentation prevents court from considering summary judgment motion, (Dec 27, 2017)

By Harold Berman, J.D.

The SEC did not provide sufficient clarity in its summary judgment motion to enable careful consideration of its arguments, a federal district court in Colorado ruled. The court denied the SEC’s summary judgment motion against Taj Mahabub and the company he founded for securities violations, finding that the SEC did not clearly state the elements of its theories of liability and precisely how each of Mahabub’s alleged actions or omissions satisfied each element, such that the court could understand which actions violated which portions of the securities laws. The court denied the SEC’s motion without prejudice, allowing for it to submit a revised motion (SEC v. Mahabub, December 22, 2017, Martinez, W.).

Securities fraud allegations. The SEC alleged securities fraud against Taj "Jerry" Mahabub, and GenAudio, Inc., the company he founded. The SEC moved for summary judgment against Mahabub. In addition to opposing summary judgment, Mahabub moved to strike certain exhibits the SEC submitted in its reply brief.

Motion to strike. As a preliminary matter, the court denied Mahabub’s motion to strike. Mahabub objected to several of the SEC’s asserted facts in support of its summary judgment motion, on the basis that the evidence in support of the asserted facts was inadmissible. The court found that Mahabub failed to show that the SEC would be unable to present its evidence in an admissible form at trial.

Summary judgment motion. The court denied the SEC’s summary judgment motion, without prejudice. The court first criticized the SEC’s general approach in presenting its arguments for summary judgment, concluding that the SEC "essentially argues that a cloud of misrepresentations and omissions collectively satisfies a cloud of liability theories." The SEC needed to specifically state its theories of liability, and how the alleged actions and statements satisfied the elements of each theory, such that the court could understand precisely which actions allegedly violated which portions of the securities laws.

Despite the SEC’s lack of clarity, the court ventured what it believed the elements of liability to be in this case for violations of Exchange Act Section 10(b)/Rule 10b-5, and Securities Act Section 17(a).

Scienter and "in connection with". A finding of violations under both laws required, among other things, a finding that the action or omission be made "in connection with" the purchase or sale of securities, and in the case of Exchange Act Section 10(b)/Rule 10b-5, and one portion of Securities Act Section 17(a), a finding of scienter. The court expressed concerns about the scienter and "in connection with" requirements. It was unclear whether there was any authority establishing that scienter required specific intent to affect a decision regarding the purchase or sale of securities, or if scienter instead could be established by any knowing falsehood, even if the accused did not know about the transaction the falsehood might influence.

The scope of the phrase "in connection with" was similarly unclear. The court was concerned that if both elements were construed broadly to mean that fraudulent statements and transactions simply occurred in tandem, then this would allow for a violation in cases of mere coincidence. The court mandated that the SEC and Mahabub state their views in their revised summary judgment briefs as to whether the scienter and "in connection with" elements were satisfied merely when a defendant made a false statement while securities were for sale, or rather because securities were for sale.

Reliance, injury and causation. The court found that the SEC did not need to prove reliance, injury or causation, except for any claim it brought under Securities Act Section 17(a)(2), dismissing Mahabub’s assertion that the SEC could not obtain summary judgment because it failed to show a causal connection between the alleged deception and injury. The SEC was not required to show reliance or injury in enforcement actions, and so it was irrelevant whether there was a causal connection between the fraud and the injury.

The case is No. 1:15-cv-02118-WJM-MLC.

Attorneys: Leslie J. Hughes for the SEC. Andrew Bryan Holmes (Holmes Taylor & Jones LLP) for Taj Jerry Mahabub.

Companies: GenAudio, Inc.

LitigationEnforcement: Enforcement FraudManipulation ColoradoNews