One might not expect that filing a registration statement on Form S-8 could result in a criminal conviction.  However, that is what happened to the CEO and CFO of a small public company.  They were both convicted of selling securities without registration under the Securities Act of 1933.

A company required to file reports with the Securities and Exchange Commission pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 and that meets certain other conditions may use Form S-8 to register the sale of securities under any employee benefit plan to its employees (or employees of its parent or subsidiaries).  The General Instructions to Form S-8 define “employee” as including consultants or advisors.  However, the instructions state that Form S-8 is available for issuance to consultants or advisors only if:

  1. They are natural persons;
  2. The provide bona fide services to the registrant; and
  3. The services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market for the registrant’s securities.

In this case, U.S. v. Bailey, 2012 U.S. App. LEXIS 18125 (9th Cir. Aug. 27, 2012), the U.S. Attorney charged the defendants with selling securities to raise capital and not for bona fide services.  As evidence, the prosecutor presented testimony from an FBI agent to that the lack of any written agreement or invoices for services suggested unlawful activity.  The prosecutor also introduced as evidence a prior SEC civil complaint charging the CEO, the company and others with using Form S-8 to sell shares other than for bona fide services.   According to the opinion, the CEO settled the SEC’s civil case without an admission of liability.  After a jury trial, both the CEO and the CFO were convicted.   

A three judge panel overturned the CEO’s conviction, finding that the District Court had erred in admitting the SEC’s civil complaint pursuant to Federal Rule of Evidence 404 which generally prohibits the admission of evidence of a person’s character or trait but does allow the admission of evidence of prior wrongs or acts to show proof of motive, opportunity, intent, preparation, plan, knowledge, identity or absence of mistake or accident.

This has been a very painful lesson for the CEO.  He was sentenced to 30 months imprisonment.  According to a story written by John Roemer in yesterday’s Los Angeles Daily Journal, the CEO was denied bail and has already served most of his sentence.  It is unclear what impact, if any, this opinion will have on the CFO who did not appeal.

Disastrous LLC Bill Set To Pass

In La Debacle – California’s Flawed Bid To Enact The NCCUSL’s LLC Act, I wrote about the impending disaster that is SB 323 (Vargas).  In a nutshell, the bill purports force the hundreds of thousands of limited liability companies formed under the Beverly Killea Act to be governed by a new limited liability company law.  Not only is this unconstitutional, it will impose significant costs on these companies.  The author amended the bill on August 23, but it remains fundamentally flawed.  I hope that you take a few moments to email or write the Governor and urge a veto.  You can use this link.