The Commission lost another case at trial earlier this month. The Court’s conclusions, as well as the Commission’s mixed results in recent court actions (here), raises disturbing questions about the effectiveness, methods and direction of the enforcement program.
This loss came following a bench trial in an action against Kenneth R. Kramer who is one of several defendants in the case. SEC v. Sky Way Global LLC, Case No. 8:09-cv-445 (M.D. Fla. Filed March 13, 2009). The underlying action centers on a pump-and-dump scheme. The SEC did not claim that Mr. Kramer was involved in the scheme which is at the center of the complaint. See also Lit. Rel. No. 20960 (March 18, 2009).
The SEC complaint: The complaint says little about Mr. Kramer until the end. The final three paragraphs of the 25 page document claim that Mr. Kramer was retained by defendant Baker to locate investors for Sky Way. Mr. Baker, the Commission alleged, located the public shell which used in a reverse merger to create Sky Way, the company whose shares were alleged to have been pumped and dumped.
According to the complaint Defendant Baker and Mr. Kramer had an agreement under which he would use six sales agents to find investors. In return Mr. Kramer would earn a 10% commission on any sales of Sky Way stock. Mr. Kramer prepared charts summarizing the sales activities which were given to Mr. Banker and others. Overall he was paid $915,000 composed of $200,000 in cash with the balance in Sky Way stock. The complaint claims Mr. Kramer violated Exchange Act Section 15(b). It requested the entry of a permanent injunction, disgorgement and prejudgment interest, a civil penalty and a penny stock bar.
The Court’s findings of fact: Following a bench trial the Court found that Mr. Kramer had known defendant Baker for about twenty years. Over time the two men had collaborated on various projects. In August 2003 Mr. Kramer executed a cooperation agreement with a company controlled by Mr. Kramer. Under that agreement they would cooperate in presenting each other with prospective merger and acquisition candidates, potential sources of investment and venture capital and other business opportunities. At the time Mr. Baker’s company had an agreement with Sky Way under which it would earn a 5% commission on money raised for the company, any merger and the total value of any contract brought to it. Mr. Baker was one of an array of independent contractors retained by the company to facilitate locating technology, merger candidates, venture capital and similar items.
At some point, the Court found, Mr. Kramer was introduced to Sky Way. He understood that the company would pay him for introducing investors to the company. Because Mr. Kramer thought the company was a good investment he purchased shares and recommended them to his friends. They also purchased shares. When Mr. Baker asked him for records of the purchases he prepared documents depicting the transactions.
Conclusions of law: Exchange Act Section 15(b), the Court noted, makes it unlawful for “any broker or dealer . . to make use of the mails or any other means . . . of interstate commerce . . .” to effect any transactions . . . to induce the purchase or sale of any security . . “ unless registered with the SEC. A broker is defined in the statute to be “any person engaged in the business of effecting transactions in securities for the accounts of others.”
The key concepts of “effecting transactions” and “engage[ing] in the business” are not defined. A six factor test is generally considered in analyzing the question. Those factors consider if the person: 1) works as an employee of the issuer; 2) receives a commission; 3) sells or earlier sold the securities of another issuer; 4) participates in negotiations between the issuer and investor; 5) provides either advice or a valuation as to the merits; and 6) actively rather than passively finds investors. None of these factors is dispositive. Indeed, recommending a particular investment or participating in negotiations “typically occurs in an array of different commercial activities and professional pursuits, including brokering” the Court found.
A series of cases have carved out a so-called “finder’s exception” to the registration requirement. Under the exception merely bringing parties together,r even if it involves the purchase and sale of a security, is not enough to require registration under Section 15(a). Rather, the Court noted the evidence must establish that the alleged broker participated at key points in the chain of distribution such as in the negotiations, analyzing he issuer’s financial needs, discussing the details of the transaction and recommending the investment. Even when the finder receives a commission based fee the Commission has concluded in a series of no-action letters that this is not enough standing alone the Court concluded.
In this case Mr. Kramer’s conduct “consisted of nothing more than bringing together the parties to a transaction. The Commission presented no evidence that Kramer either participated in the negotiations, discussed the detail of the transaction, analyzed the financial status of Skyway, or promoted an investment in Skyway to . . . “ investors according to the Court.
Mr. Kramer did receive compensation from defendant Baker based on the sales of stock. In urging that this demonstrates defendant Kramer acted as a broker, the SEC argued that the identity of the people involved the transactions, and Mr. Kramer’s relation to them, is not relevant. The Court found that Mr. Kramer’s activities in this case were limited to “(1) sharing his opinion that Skyway was a good company and a good investment and (2) directing attention to Skyway’s web site and press releases. Some of Kramer’s intimate friends and family (1) purchased Skyway shares and (2) talked to other people about Skyway.” The Commission failed to present any evidence to the contrary.
Finally, the Court rejected the SEC’s argument, based on the 2010 no-action letter Brumbert, Mackey & Weil, that transaction based compensation without more is sufficient. This no-action letter “cannot serve ex post facto as the basis for condemning conduct that occurred from 2003 to 2005. Furthermore, The Commission’s proposed single-factor ‘transaction-based compensation’ test for broker activity . . . is an inaccurate statement of the law both in 2003 and in 2011.” The Court found the defendant not liable.
That the SEC again lost in court raises questions. That the court found almost a total lack of evidence to support the minimal allegations of the complaint raises even more. Misstatements of basic points of securities law and an attempt to apply it in an unfair manner however suggests a “win at all costs” mentality which ill-befits the Commission’s enforcement program or its goals of bringing a new ethics to the market place.