In SEC v. Ferrone, No. 11 C 5223, 2015 BL 347120 (N.D. Ill. Oct. 21, 2015), the United States District Court for the Northern District of Illinois denied in part and granted in part the Security and Exchange Commission’s (“SEC”) request for: (1) unconditional officer-director bars against Douglas McClain Sr. and Douglas McClain Jr. (collectively, “Defendants”); (2) disgorgement, in the amount of $335,000, from McClain Jr.; (3) permanent injunctions against Defendants; and (4) a $130,000 civil penalty against McClain Sr.
According to the allegations, McClain Sr. learned that the FDA had blocked Argyll Biotechnologies, LLC (“Argyll”) from beginning SF-1019 clinical trials on human subjects. From April-October 2007, McClain Jr. began selling hundreds of thousands of his Argyll shares. McClain Sr. allegedly made misleading statements to investors regarding the FDA’s approval process.
The SEC filed a claim against the Defendants on August 1, 2011 for various violations of Section 17(a) of the Securities Act of 1933 (“1933 Act”) and Sections 10(b), 13(a), 14, and 16(a) of the Securities Exchange Act of 1934 (“Exchange Act”). The court granted the SEC’s motion for summary judgment on its securities fraud claims against the Defendants in October 2014.
The SEC sought relief from the Defendants, including (1) permanent injunctive relief against the Defendants under section 20(b) of the 1933 Act and Section 21(d) of the Exchange Act; (2) a permanent ban as an officer or director for the Defendants under antifraud provisions of Sections 20(b) and 21(d) of the 1933 Act and the Exchange Act; (3) disgorgement of the Defendants profits from fraudulent activities; and (4) a civil penalty against McClain Sr.
Section 20(d) of the Exchange Act allows a court to prohibit, conditionally or unconditionally, a person from acting as an officer-director of a public company. 15 USC 78u(d). To determine officer-director fitness, a court weighs: (1) the underlying violation’s egregiousness; (2) a defendant’s repeat offender status; and (3) a defendant’s degree of scienter, based on the totality of the circumstances surrounding the alleged violation. A plaintiff may seek permanent injunctive relief if a court determines there is reasonable likelihood a defendant will reoffend. Finally, a third-tier penalty may be imposed if a defendant used fraud, deceit, or manipulation, which created significant risk of, or resulted in, substantial loss to others.
First, the court held Defendants’ illegal conduct was “flagrant, recurrent, and committed with a high degree of scienter,” and determined the Defendants would likely reoffend. As a result, the court permanently enjoined Defendants under Section 20(b) of the 1933 Act and 21(d) the Exchange Act. In addition, the court declined to grant a bar prohibiting the Defendants from ever serving as an officer or director or a public company. Instead, the court barred Defendants from serving as directors-officers of any public biopharmaceutical company. Id.(“The officer-director bar imposed against the McClains should be tailored to the facts of this case. Therefore, I find that the McClains are permanently unfit to serve as an officer or director only of any public biopharmaceutical company.”) The court also ordered $429,839.99 in disgorgement for McClain Sr. but concluded the proposed amount against McClain Jr. unsupported by evidence after finding the method used to calculate disgorgement was inappropriate. Finally, the court found the SEC’s requested $130,000 civil penalty against McClain Sr. was appropriate and a necessary deterrent against future securities fraud.
As such, the court denied in part, and granted in part, SEC’s request for penalties against Defendants for violations of the 1933 Act and the Exchange Act.
The primary materials for this case may be found on the DU Corporate Governance website.