SEC v. Zada: Affirming District Court’s Decision Granting Summary Judgment
In SEC v. Zada, 787 F.3d 375 (6th Cir. 2015), the United States Court of Appeals for the Sixth Circuit affirmed the decision by the United States District Court for the Eastern District of Michigan granting summary judgment in favor of the Securities and Exchange Commission (“SEC”) against Joseph Zada (“Zada”) for violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.
According to the “undisputed evidence,” Zada represented himself as an “extremely wealthy man,” throwing lavish parties and “traveled with bodyguards.” Zada would meet with potential investors and inform them of his connections with Saudi Arabia, telling investors he could use the funds to make large purchases of oil that would be stored on offshore tankers and be sold when oil prices rose. Investors were given promissory notes. Zada ultimately raised almost $60 million from investors in Michigan and Florida.
As the court noted:
- Little of what Zada told the investors was true. Zada's connections with Saudi royalty existed only in his imagination. On one occasion Zada invited investors to a party, where he paid actors to pose as a Saudi prince and princess. And Zada never bought any oil; instead, he used the investors' money to pay his personal expenses, which were substantial. For example, Zada spent over $4 million of investors' money to pay his personal credit-card bills. When Zada paid investors anything, he used money raised from other victims.
The SEC filed a civil enforcement action in the United States District Court for the Eastern District of Michigan, alleging violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Specifically, the SEC alleged Zada violated the anti-fraud provisions of the Securities Acts and failed to register securities. Zada asserted his Fifth Amendment right prompting the SEC to move for summary judgment, which the district court granted.
On Appeal, Zada argued: the investments he sold were not securities; he did not lie to every investor as to show securities fraud; and that the civil penalty would improperly punish him for invoking his Fifth Amendment privilege.
The court first addressed whether the notes were securities. To rebut the presumption that particular notes are securities, the defendant must demonstrate the notes bear a familial resemblance to other instruments that are not securities. The court uses four Reves factors to determine familial resemblance: (1) the motivation prompting the transaction; (2) the plan of distribution; (3) the reasonable expectations of the investing public; and (4) whether a “risk reducing factor” makes application of the Securities Acts unnecessary.
The court’s analysis focused primarily on the first factor—whether the victims’ purpose was investment or commercial-consumer. The court determined the investors had investment purposes since they expected a return on their funds. Therefore, the first factor favored the SEC. The court also found Zada sold the notes to a wide range of unsophisticated people and for investment purposes, favoring the SEC on the second and third factors. There was also no evidence of a risk-reducing factor favoring the SEC on the last factor as well. The court therefore concluded Zada had failed to rebut the presumption the notes were securities.
Next, the court addressed the securities fraud claim. A securities fraud claim requires proof that a defendant knowingly or recklessly made material misrepresentations or omissions in connection with the offer, sale, or purchase of securities. The Commission, according to Zada, had failed to show that he had made misrepresentation to all of the investors. The court noted the SEC was only required to prove Zada made misrepresentations in furtherance of his plan and because the SEC established the elements as to every victim individually, it was not required to present testimony from every victim.
Finally, Zada’s asserted that the imposition of a penalty of $56 million in part for the “lack of acceptance of responsibility” essentially amounted to punishment for the invocation of his Fifth Amendment against self incrimination. The court noted that “the argument has some force.” As the court noted: “His decision not to testify, viewed realistically, reflects not a denial of responsibility, but a desire to preserve his options in a criminal case that had not yet even begun.” Nonetheless, given other factors and the record as a whole, the court found the reference “harmless.”
Accordingly, the court affirmed the district court decision granting the motion for summary judgment.
The primary materials for this post can be found on the DU Corporate Governance Website.