SEC v. Greenstone Holdings, Inc.: Court Employs Proximate Cause Analysis to Hold Indirect Participant Liable for the Sale of Unregistered Securities
In SEC v. Greenstone Holdings, Inc., No. 10 Civ. 1302 (MGC), 2013 BL 186597 (S.D.N.Y. July 10, 2013), the court granted summary judgment to the SEC on claims relating to the participation by former counsel to Greenstone Holdings, Inc. (“Greenstone”) Virginia K. Sourlis (“Sourlis”) in the issuance and sale of Greenstone securities in violation of Section 5 of the Securities Act of 1933 (“1933 Act”).
According to the allegations, Greenstone, to avoid a liquidity crisis, sought to convert into a public company by purchasing the shares of a public shell company. “From September 2006 through June 2008, Greenstone distributed millions of shares of unregistered stock to the public.”
According to the SEC, Sourlis, an attorney, issued a single letter to Greenstone finding that certain shares met the requirements of Rule 144. Specifically, in the letter dated January 11, 2006, Soulis addressed the issuance of shares in exchange for certain convertible promissory notes. The letter specified that the notes had been issued by Greenstone’s predecessor shell corporation to some of its non-affiliate vendors and later assigned to Greenstone investors. As the court described:
Sourlis stated that no consideration was received by the company or by the vendors (referred to by Sourlis as “Original Note Holders”) in connection with the assignment, and that no commissions were paid in connection with the assignment. Sourlis stated that she had been told by the vendors that the original convertible notes had been held for at least two years prior to the assignment and that none of the vendors were “affiliates” of the company under Rule 144.
Sourlis concluded that the shares could be issued without a legend.
The letter was delivered to Corporate Stock Transfer, Inc. (“CST”), the transfer agent for Greenstone. As a result, CST issued six million shares of Greenstone without restrictive legends.
The court, however, found that the letter contained incorrect information.
The convertible notes described by Sourlis did not even exist. Therefore, Sourlis's statement that she was informed by the vendors that they had held the notes for at least two years was necessarily false. Likewise, Sourlis's other statements—that the company had informed her that the notes were issued to various vendors; that the notes had been assigned to the four entities; and that no consideration was received by the company or vendors in the assignment for the notes—were also false.
Pursuant to Section 5 of the 1933 Act, shares cannot be sold unless registered with the SEC or offered pursuant to an applicable exemption. A Section 5 violation requires the SEC to show that (1) the defendant made direct or indirect offers to sell securities; (2) the offered securities were not effectively registered; and (3) interstate means were employed to facilitate the offers or sales of the securities in question. To establish involvement in the offering, a person not directly engaged in the transfer of the title of a security can be held liable if she has “engaged in steps necessary to the distribution of [unregistered] security issues.” The behavior must be more than di minimis to meet a “but for” standard with respect to the transaction.
At the time of the Greenstone sales at issue, Rule 144 provided for a limited exemption from registration “if the securities were issued privately, solely in exchange for restricted securities of the same company, [and] if the restricted securities were more than two years old.”
The court found sufficient involvement by Sourlis in the offering. “CST required a legal opinion letter providing the authority to issue the unregistered shares without a restrictive legend.” The shares “would not have issued the shares without Sourlis's letter.” Such evidence was “sufficient to hold an attorney liable under Section 5.” The alleged “lack of diligence on the transfer agent's part” was insufficient to “relieve Sourlis of liability.”
The primary materials for this case may be found on the DU Corporate Governance website.