In Securities Exchange Commission v. Benger, et al., No. 09 CV 676, 2010 WL 918065 (N.D. Ill. Mar. 10, 2010), the SEC brought an action against defendants for assorted violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, as well as equitable relief, in connection with an allegedly fraudulent securities offerings under Regulation S. The SEC’s complaint grouped defendants into two categories: (1) Distribution Agents who allegedly masterminded the fraud, and (2) Escrow Agents who allegedly assisted the Distribution Agents. This case involves a motion to dismiss by Philip T. Powers ("Powers"), one of the alleged Escrow Agents.
The SEC asserted that defendants collectively ran a “boiler room” scheme. The Distribution Agents allegedly entered into agreements with issuers selling shares purportedly exempt from registration under Regulation S. Under the agreements, 60% of the investors’s proceeds for sales of securities went to Distribution Agents as commission – characterized by the SEC as “penny stocks.”
According to the allegations, Distribution Agents employed what the SEC referred to as “boiler room agents” – sales agents located outside the US who use aggressive sales methods to persuade citizens to invest. These agents made cold calls to elderly British and European citizens, pressuring them to invest. The binding Share Purchase Agreements failed to disclose that the commission charged exceeded 60% of the total consideration paid by the investors. Instead, it falsely notified investors of a nominal fee of $50 or 1% of cost of shares.
Escrow Agents collected investors’s payments and then distributed the sales proceeds. Specifically, Powers was alleged to have acted as the Escrow Agent for many of the penny stock transactions in question. According to the SEC, Powers, as an agent for Handler, Thayer & Duggan, maintained control of the investors’ bank and brokerage accounts. Additionally, he purportedly received the foreign investors’ money and distributed the monies according to agreement. At no time during his participation in the scheme did he register with the SEC as a broker or a dealer.
Count IV of the SEC’s complaint accused Powers of aiding and abetting, alleging that he provided “substantial assistance with either knowledge of the material misrepresentation and omissions concerning commissions, or with a reckless disregard of the fraud.” To determine if the SEC sufficiently stated a claim for aiding and abetting a securities violation, the court looked to whether the SEC sufficiently alleged that Powers acted with the requisite scienter and substantially assisted the Distribution Agents.
First, the court held that the SEC sufficiently pled facts that Powers had knowledge of the Distribution Agents’ assumed fraud. The SEC asserted that Powers knew that the scheme distributed more than 60% of the investors’s funds to Distribution Agents as commission because he personally allocated the monies among the agents. He was also alleged to have dealt directly with the Share Purchase Agreements and knew of the misleading statement regarding the nominal fee charged to investors. The court also found that because of Powers’s own expertise in securities law, it could be inferred that he knew that a commission exceeding 60% was not normal practice. See Id. ("Furthermore, considering Powers' own expertise in compliance with securities laws, it may also be inferred that Powers himself would have known that charging commissions in excess of sixty percent in connection with the sales of securities was not customary."). Therefore, the court found that the Commission had alleged facts sufficient to show that Powers acted with the requisite scienter.
Second, the court found that the SEC alleged facts sufficient to establish that Powers substantially assisted the Distribution Agents in the fraud. To establish this element, the SEC had to show that “the aider and abettor proximately caused the harm to [the victim] on which the primary liability is predicated.” As the court concluded:
- Powers is alleged to have played an integral part in the completion of the sale to the investor by, inter alia, taking custody of and distributing the investors' funds according to the terms of the escrow agreements, which were corollaries to the distribution agreements; receiving and processing the signed SPAs [Share Purchase Agreements], which failed to disclose the exorbitant commissions; communicating the receipt of those SPAs to the issuers; and sending the investors their share certificates, which, as far as the investors' knew, meant that their total consideration have been transmitted to the issuer.
Count V of the SEC’s complaint alleged that Powers failed to register as a broker or dealer as required by Section 15(a)(1) of the Securities Exchange Act of 1934 (“the Act”). The court stated that whether Powers acted as a broker within the meaning of the Act depended on whether he was engaged in the business of “effecting transactions in securities for the account of others.” The court held that the SEC sufficiently alleged that Powers was “effecting transactions in securities for the account of others.” He received compensation based on the gross proceeds of the sale, collected investors’s funds, distributed the monies among agents, and received and processed documents relating to the securities sales. Accordingly, the court held that the SEC sufficiently stated a claim under Section 15(a) and therefore denied Powers’ motion to dismiss Count V of the SEC’s complaint. As a result, the court found the SEC’s motion to strike portions of Powers’s reply brief relating to Count V as moot.
The primary materials for this case may be found on the DU Corporate Governance website.