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Securities and Exchange Commission v. Frohling

United States Court of Appeals, Second Circuit

December 6, 2016

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee,
v.
JOHN B. FROHLING, Defendant-Cross-Claimant-Cross-Defendant-Appellant, HISAO SAL MIWA, Defendant-Cross-Claimant-Cross-Defendant, VIRGINIA K. SOURLIS, Defendant-Cross-Claimant, DANIEL D. STARCZEWSKI, JOE V. OVERCASH, JR., FRANK J. MORELLI, III, THOMAS F. PIERSON, Defendants-Cross-Defendants, ACTIVE STEALTH, LLC, BAF CONSULTING, INC., BLUEWATER EXECUTIVE CAPITAL, LLC, EMERGING MARKETS CONSULTING, LLC, KCS REFERAL SERVICES, LLC, MBA INVESTORS, LTD., NEW AGE SPORTS, INC., POWER NETWORK, INC., PROJECT DEVELOPMENT, INC., SEVILLE CONSULTING, INC., STARR CONSULTING, INC., TUSCANY CONSULTING, INC., YT2K, INC., Relief-Defendants-Cross-Defendants, GREENSTONE HOLDINGS, INC., JAMES S. PAINTER, III, Defendants.

          Argued: October 19, 2016

         Appeal by defendant attorney from a November 25, 2015 final judgment of the United States District Court for the Southern District of New York, Miriam G. Cedarbaum, Judge, granting plaintiff Securities and Exchange Commission's motion for summary judgment in this enforcement action, holding defendant liable for securities laws violations (§§ 5 and 17(a) of the Securities Act of 1933, 15 U.S.C. §§ 77e, 77q(a); § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5) in connection with false opinion letters he wrote or approved to enable impermissible public offerings of unregistered shares of stock of defendant Greenstone Holdings, Inc.; ordering him to pay a total of $204, 161.86 as a civil penalty, disgorgement, and prejudgment interest; and permanently barring him from participating in certain stock offerings. Defendant contends principally that the district court erred in ruling that there was no genuine issue to be tried as to his knowledge of the falsity of the letters.

         Affirmed.[**]

          ALLAN A. CAPUTE, Special Counsel to the Solicitor, Washington, D.C. (Anne K. Small, General Counsel, Michael A. Conley, Deputy General Counsel, Jacob H. Stillman, Solicitor, Securities and Exchange Commission, Washington, D.C., on the brief), for Plaintiff-Appellee.

          JOHN B. FROHLING, pro se, Jersey City, New Jersey, Defendant-Cross-Claimant-Cross-Defendant-Appellant.

          Before: KEARSE, POOLER, and DRONEY, Circuit Judges.

          KEARSE, Circuit Judge

         In this appeal, which was reinstated following a remand for final resolution of pending claims, see SEC v. Frohling, 614 F.App'x 14 (2d Cir. 2015), defendant-cross-claimant-cross-defendant-appellant John B. Frohling pro se appeals from a November 25, 2015 Superseding Final Judgment of the United States District Court for the Southern District of New York, Miriam G. Cedarbaum, Judge, in this enforcement action brought by the Securities and Exchange Commission ("SEC") in connection with public offerings of unregistered shares of stock of defendant Greenstone Holdings, Inc. ("Greenstone"). The district court granted a motion by the SEC for summary judgment on issues of liability, holding Frohling--who as Greenstone's securities counsel in 2006-2008 wrote, approved, or concurred in 11 opinion letters relating to all of the relevant offerings--liable for violating § 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a); § 5 of the Securities Act, 15 U.S.C. § 77e; and § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. The Superseding Final Judgment orders Frohling to pay a total of $204, 161.86 as a civil penalty, disgorgement, and prejudgment interest, and permanently bars him from participating in so-called "penny stock" offerings, i.e., offerings of "any equity security that has a price of less than five dollars, except as provided in Rule 3a51-1 under the Exchange Act, " Superseding Final Judgment at 4.

         On appeal, Frohling contends principally that he had no knowledge that the opinion letters he issued, approved, or concurred in were false, nor any knowledge of facts to alert him that the opinion letters were false, and that the district court erred in ruling that there was no genuine issue to be tried as to his knowledge. For the reasons that follow, we find no basis for reversal. We assume the parties' familiarity with the underlying facts and procedural history of the case.

         A. Liability

         Section 5 of the Securities Act makes it unlawful, directly or indirectly, to publicly offer or sell unregistered stock, see 15 U.S.C. § 77e, unless the offering is covered by an exemption. The stock certificate for unregistered shares not covered by an exemption--"restricted" stock--normally bears a legend stating that the shares have not been registered and cannot lawfully be sold until they are registered. The pertinent exemption in this case, as it existed at the relevant time, allowed stock to be issued without the restricted-stock legend if the recipients were persons unaffiliated with the stock's issuer at the time of the sale or during the preceding three months, and if at least two years had elapsed since the shares were owned by the issuer or a person affiliated with the issuer, see SEC Rule 144(k), 17 C.F.R. § 230.144(k) (2005) ("Rule 144(k) exemption"). The two-year requirement was satisfied if unaffiliated persons acquired the shares in exchange for "consideration consisting solely of other securities of the same issuer" that had been received at least two years earlier, as the shares were deemed to have been acquired from the issuer at the time the surrendered securities had been acquired. Id. § 230.144(d)(3)(ii) (2005) (emphasis added). "To state a cause of action under Section 5, one must show '(1) lack of a [required] registration statement as to the subject securities; (2) the offer or sale of the securities; and (3) the use of interstate transportation or communication and the mails in connection with the offer or sale.'" SEC v. Cavanagh, 445 F.3d 105, 111 n.13 (2d Cir. 2006) (quoting Europe & Overseas Commodity Traders, S.A. v. Banque Paribas London, 147 F.3d 118, 124 n.4 (2d Cir. 1998)). A person not directly engaged in transferring title of the security can be held liable under § 5 if he or she "engaged in steps necessary to the distribution of [unregistered] security issues." SEC v. Chinese Consolidated Benevolent Ass'n, 120 F.2d 738, 741 (2d Cir. 1941).

         Section 10(b) of the Exchange Act and Rule 10b-5, which prohibit fraud in the purchase or sale of a security, are violated if a person has "'(1) made a material misrepresentation or a material omission as to which he had a duty to speak, or used a fraudulent device; (2) with scienter; (3) in connection with the purchase or sale of securities.'" SEC v. Pentagon Capital Management PLC, 725 F.3d 279, 285 (2d Cir. 2013) (quoting SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999)), cert. denied, 134 S.Ct. 2896 (2014). A false statement was made with the requisite scienter if it was made with the "intent to deceive, manipulate, or defraud." SEC v. Obus, 693 F.3d 276, 286 (2d Cir. 2012) (internal quotation marks omitted). "[S]cienter may be established through a showing of reckless disregard for the truth, that is, conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care." Id. (internal quotation marks omitted).

         The elements of a claim under § 17(a) of the Securities Act, which prohibits fraud in the "offer or sale" of a security, 15 U.S.C. § 77q(a), are "[e]ssentially the same" as the elements of claims under § 10(b) and Rule 10b-5. SEC v. Monarch Funding Corp., 192 F.3d at 308.

         Summary judgment may be granted "if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(a). A genuine dispute exists when the evidence is such that, if the party against whom summary judgment is sought is given the benefit of all permissible inferences and all credibility assessments, a rational factfinder could resolve all material factual issues in favor of that party. See, e.g., Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). Summary judgment is appropriate when "there can be but one reasonable conclusion as to the verdict, " id. at 250, i.e., "it is quite clear what the truth is, " Poller v. Columbia Broadcasting System, Inc., 368 U.S. 464, 467 (1962) (internal quotation marks omitted), and no rational factfinder could find in favor of the nonmovant. We review the district court's grant of ...


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