SEC v. Big Apple: Court of Appeals Affirms; Rule 10b-5 and § 17(a)(2) Not Analogous

In SEC v. Big Apple Consulting USA, Inc., 783 F.3d 786, 2015 BL 100537 (11th Cir. 2015), the Court of Appeals for the Eleventh Circuit affirmed the district court’s ruling that Big Apple Consulting USA, Inc. (“Big Apple”), its wholly owned subsidiary MJMM Investments, LLC (“MJMM”), Marc Jablon, and Mark C. Kaley (collectively, “Defendants”) violated the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) in an action brought by the Securities and Exchange Commission (“SEC”).

According to the complaint, MJMM executed a consulting agreement with CyberKey Solutions, Inc. (“CyberKey”) on June 15, 2005. The parties agreed Big Apple and its subsidiaries would promote CyberKey’s business in exchange for shares of CyberKey stock. James Plant, CEO of CyberKey, informed Defendants of a fictitious contract with the Department of Homeland Security (“DHS”) worth $25 million. On December 8, 2005, Plant publicized the DHS contract in a press release. From 2005 to 2007, MJMM received 77 million shares of CyberKey stock in exchange for services rendered and an additional 648 million shares through the exercise of options. During this time, Big Apple’s call center aggressively promoted CyberKey to securities brokers and dealers.

The SEC alleged that Defendants “violated § 17(a) of the Securities Act and aided and abetted violations of § 10(b) of the Exchange Act and SEC Rule 10b-5, in violation of § 20(e) of the Exchange Act.” At the time of the action, Section 20(e) “authorized the SEC to bring an action against any person who ‘knowingly provides substantial assistance’ to a primary violator of the Exchange Act.”

At trial, the jury found Defendants violated § 17(a) and § 20(e) with “both actual knowledge and severe recklessness.” On appeal, Defendants claimed the trial court erred by submitting the § 17(a) claims to the jury and that the jury was given improper instructions.

Section 17(a)(2) of the Securities Act makes it “unlawful for any person…to obtain money or property by means of any untrue statement of a material fact.” Defendants argued the holding in Janus Capital Group, Inc. v. First Derivative Traders should apply to § 17(a)(2) claims since the language of Rule 10b-5 and § 17(a)(2) were analogous. Applying this logic, Defendants claimed CyberKey had ultimate authority over the content of CyberKey’s press release, and thus the Defendants were not liable because they did not “make” the material misrepresentation.

The court rejected this argument, finding the language in § 17(a)(2), which focused on obtaining property by means of an untrue statement, was broader than that of SEC’s Rule 10b-5(b), which focused on the action of making an untrue statement. Here, the court concluded the text of § 17(a)(2) suggested that “it is irrelevant for purposes of liability whether the seller uses his own false statement or one made by another individual.” For these reasons, the court affirmed the lower court’s decision and found Defendants liable under § 17(a)(2).

Defendants also argued the lower court erred in failing to apply the “actual knowledge” standard for violation of § 20(e) of the Exchange Act. The court affirmed the district court’s decision that a finding of “severe recklessness” was sufficient to prove violation of § 20(e) of the Exchange Act.

The SEC further alleged that “Big Apple, MJMM, and Marc Jablon violated § 5(a) and (c) of the Securities Act.” These defendants asserted the applicability of § 4(a)(1) of the Securities Act, which exempts “transactions by any person other than an issuer, underwriter, or dealer.” The court affirmed the lower court’s determination, on a motion for summary judgment, that the exemption was unavailable because these persons were underwriters.

Accordingly, the Court of Appeals affirmed the lower court’s decision on all grounds in favor of the SEC.

The primary materials for this case may be found on the DU Corporate Governance website.