Securities & Exchange Commission v. CMKM Diamonds, Inc. , 729 F.3d 1248 ( 2013 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
SECURITIES AND EXCHANGE Nos. 11-17021
COMMISSION, 11-17025
Plaintiff-Appellee,
D.C. No.
v. 2:08-cv-00437-
LRH-RJJ
CMKM DIAMONDS, INC.,
Defendant,
OPINION
and
1ST GLOBAL STOCK TRANSFER LLC;
HELEN BAGLEY; BRIAN DVORAK,
Defendants-Appellants.
Appeals from the United States District Court
for the District of Nevada
Larry R. Hicks, District Judge, Presiding
Argued and Submitted
April 15, 2013—San Francisco, California
Filed September 10, 2013
2 SEC V. CMKM DIAMONDS, INC.
Before: Susan P. Graber and Morgan Christen, Circuit
Judges, and John R. Tunheim,* District Judge.
Opinion by Judge Tunheim
SUMMARY**
Securities Law
The panel affirmed in part, and reversed in part, the
district court’s orders in a civil enforcement action brought by
the Securities and Exchange Commission against numerous
defendants allegedly involved in a scheme to sell unregistered
securities of CMKM Diamonds, Inc. in violation of Section 5
of the Securities Act of 1933.
The panel reversed the district court’s grant of summary
judgment against CMKM’s transfer agent, 1st Global Stock
Transfer, LLC and its owner Helen Bagley, because there was
a material issue of fact regarding whether Global and Bagley
were necessary participants and substantial factors in the
distribution of CMKM’s stock sufficient to impose liability
under Section 5 of the Securities Act of 1933. The panel
affirmed the magistrate judge’s denial of the motion of Brian
Dvorak, CMKM’s attorney at the time of scheme, to stay the
proceedings, and the district court’s disgorgement order
*
The Honorable John R. Tunheim, United States District Judge for the
District of Minnesota, sitting by designation.
**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
SEC V. CMKM DIAMONDS, INC. 3
(ordering defendants to disgorge proceeds from the illegal
securities’ sales, plus prejudgment interest) as to Dvorak.
COUNSEL
Mark S. Dzarnoski (argued), Gordon & Silver Ltd., Las
Vegas, Nevada, for Defendants-Appellants 1st Global Stock
Transfer LLC and Helen Bagley.
John Wesley Hall, Jr. (argued), Law Offices of John Wesley
Hall, Jr., Little Rock, Arkansas, for Defendant-Appellant
Brian Dvorak.
Allan Armistead Capute (argued), Securities and Exchange
Commission, Washington, D.C., for Plaintiff-Appellee.
OPINION
TUNHEIM, District Judge:
These consolidated appeals arise out of a civil
enforcement action brought by the Securities and Exchange
Commission (“SEC”) against numerous defendants allegedly
involved in a scheme to sell unregistered securities of CMKM
Diamonds, Inc. (“CMKM”). The district court granted
summary judgment in favor of the SEC, ruling that 1st Global
Stock Transfer, LLC (“Global”), Helen Bagley, and Brian
Dvorak (collectively, “Defendants”) participated in an
unregistered distribution of securities in violation of Section
5 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C.
§ 77e. The district court ordered Defendants to disgorge
4 SEC V. CMKM DIAMONDS, INC.
proceeds from the illegal sales, plus prejudgment interest.
Prior to the district court’s ruling on summary judgment,
Dvorak brought a motion to stay the civil proceedings until
the conclusion of his criminal proceedings involving the same
conduct, which a magistrate judge denied.
Global and Bagley appeal the district court’s entry of
summary judgment and the disgorgement order; Dvorak
appeals the magistrate judge’s order denying his motion to
stay and the district court’s disgorgement order. We conclude
that the district court erred in granting summary judgment
against Global and Bagley because a material issue of fact
remains regarding whether Global and Bagley were necessary
participants and substantial factors in the distribution of
CMKM’s stock sufficient to impose liability under Section 5.
We therefore reverse the judgment of the district court as to
Global and Bagley and remand for further proceedings. We
affirm the magistrate judge’s denial of Dvorak’s motion to
stay the proceedings and the district court’s disgorgement
order as to Dvorak.
I. BACKGROUND
A. The Scheme
CMKM is a publicly held Nevada corporation. During the
relevant time period, CMKM’s common stock was not
registered with the SEC under the Securities Act, 15 U.S.C.
§ 77a et seq. CMKM’s stock was registered, however, under
Section 12(g) of the Securities Exchange Act of 1934
(“Exchange Act”), 15 U.S.C. § 78l(g), and was traded on the
Pink Sheets, now known as OTC Pink, an electronic
quotation and trading marketplace for both registered and
unregistered securities.
SEC V. CMKM DIAMONDS, INC. 5
Between January 2003 and March 2005, at least eleven
individuals and three entities allegedly participated in a
scheme to issue billions of shares of unrestricted CMKM
stock and then sell the stock to the public without filing a
registration statement. CMKM, holding itself out as a gold
and diamond mining company, increased its number of shares
to 800 billion. Urban Casavant and John Edwards,
respectively CMKM’s CEO and director of “post-merger
matters,” then began issuing and selling shares of unrestricted
stock. CMKM in fact had no legitimate operations. The
company issued false press releases, operated a promotional
racing team that traveled around the country, and provided
investors with fake maps and videos of mineral operations in
North and South America. The proceeds of the stock sales
were used primarily to finance the personal lifestyles of
Casavant and Edwards. As a result of the scheme,
approximately 40,000 investors lost at least $64.2 million.
In an attempt to appear to comply with securities
regulations, Edwards received false opinion letters supporting
the issuance of unrestricted CMKM stock from Defendant
Dvorak. Based upon these letters, CMKM’s transfer agent,
Defendant Global and its owner Bagley, issued unrestricted
shares of CMKM stock. Using these certificates, Edwards
sold 260 billion shares of stock through Daryl Anderson,
Kathleen Tomasso, and Anthony Tomasso. Anderson was
Edwards’ registered representative at NevWest Securities
Corporation (“NevWest”) and sold over 200 billion shares.
Edwards also issued 77.3 billion shares of stock to companies
owned by the Tomassos, which in turn sold the shares to the
public.
6 SEC V. CMKM DIAMONDS, INC.
B. Dvorak’s Role
Dvorak acted as CMKM’s attorney during the course of
the scheme. Casavant told Dvorak that numerous investors
had already paid for shares of stock in CMKM when the
company was in its initial stages, but stock certificates had
never been issued to those investors. Casavant also told
Dvorak that new certificates needed to be issued to certain
investors whose shares were the subject of an earlier 100-for-
one stock split. Casavant then began issuing those certificates.
After receiving the newly issued CMKM stock certificates,
Dvorak would write an opinion letter stating that the stocks
referred to in the certificates should be issued without a
restrictive legend.1
Dvorak’s opinion letters indicated that the stocks issued
by CMKM met the safe harbor of Rule 144(k), and therefore
were exempt from registration under the Securities Act. See
15 U.S.C. § 77d(a)(1); 17 C.F.R. § 230.144(k).2 Dvorak’s
1
A restrictive legend placed upon a security alerts buyers that the
security has not been registered under the Securities Act and may be
offered and sold only if the security is registered, or its sale qualifies for
an exemption from registration. See Use of Legends and Stop-Transfer
Instructions as Evidence of Nonpublic Offering, SEC Release No. 33-
5121, 1971 WL 120470 (Feb. 1, 1971). When the requirements of an
exemption from registration have been met, however, an issuer will often
seek to have the restrictive legend removed to avoid delays in the transfer
and to make the securities more saleable. See Robert A. Barron, Some
Comments on the Removal of Restrictive Legends and Stops from
Restricted Securities Prior to the Sale of Such Securities, 34 Sec. Reg. L.J.
308 (2006).
2
In relevant part, Rule 144(k) provided that the unregistered sale of
securities did not violate the Securities Act if the securities were held for
at least two years by a nonaffiliate of the issuer. See 17 C.F.R.
SEC V. CMKM DIAMONDS, INC. 7
letters concluded that the stocks satisfied the two-year
holding period of Rule 144(k) because, perhaps implausibly,
the investors had paid for the stock or performed services for
CMKM more than two years prior to issuance of the stock
certificates or because a 100-for-one stock split had occurred
more than two years earlier. Therefore Dvorak’s letters
concluded that the shares should be issued without a
restrictive legend.
During the course of the scheme, Dvorak drafted 450
opinion letters regarding at least 233.7 billion shares of stock,
issued to 258 individuals, that CMKM claimed could have
been issued more than two years earlier. Dvorak received
$318,843 from other participants in the scheme, including
approximately $350 per opinion letter.
C. Global and Bagley’s Role
Defendant Global is a Nevada corporation owned and
operated by Bagley. In October 2001, Global registered with
the SEC as a transfer agent3 pursuant to 15 U.S.C. § 78q-1(c)
and in 2002 began serving as CMKM’s transfer agent.
During the course of the scheme, CMKM approved several
increases in its number of authorized shares, until the number
§ 230.144(k) (2008). Rule 144(k) has since been replaced by Rule 144(b)
which changed the two-year holding period of Rule 144(k) to a one-year
holding period. See 17 C.F.R. § 230.144(b); SEC v. M&A W. Inc.
538 F.3d 1043, 1046 n.1 (9th Cir. 2008) (citing Revisions to Rules 144
and 155, Exchange Act Release No. 33-8869, 2007 WL 4270700 (Dec. 6,
2007)).
3
Issuers of securities use transfer agents to, among other things, monitor
the issuance of securities, register transfers of securities, and maintain the
issuer’s security holder records. See 15 U.S.C. § 78c(a)(25).
8 SEC V. CMKM DIAMONDS, INC.
of authorized shares approached 800 billion. Global and
Bagley were notified of these authorizations, and between
2002 and 2004 Global issued up to 622 billion shares of
unrestricted CMKM stock based on attorney opinion letters.
During most of 2003 and the first half of 2004, Bagley
relied upon opinion letters written by Dvorak. Bagley
testified that, relying on Dvorak’s letters she understood that
the stock was to be issued without a restrictive legend
because payment for the stock had been made, or the stock
split had occurred, at least two years earlier. Bagley also
testified that she may have wondered whether all of the shares
claimed by CMKM should actually have been issued two
years earlier, that it seemed strange to her that CMKM had so
many shares, and that nothing CMKM did as a company
“made sense” to her. Bagley further testified that Global is
“only the transfer agency. That’s all we do. If we get proper
paperwork, we do what needs to be done.”
In June 2004, Bagley requested that Dvorak’s opinions be
confirmed by Edwards & Angell LLP (“Angell”), another law
firm representing CMKM, because she was not comfortable
with Dvorak’s letters.4 In their opinion letters, the Angell
attorneys stated that “we have relied upon opinions . . . of
Dvorak & Associates, Ltd. for each of the Shareholders to the
effect that the already-issued shares as to which the Shares
are being issued as dividends were issued more than two
years ago and that the issuance of the Shares as dividends has
4
In her deposition, Bagley did not testify to any particular events that
made her feel uncomfortable with Dvorak’s opinions, nor did she testify
that she had any reason to doubt the accuracy of Mr. Dvorak’s work.
Bagley did state with respect to Dvorak that she “did not like him” and
“didn’t like his attitude.”
SEC V. CMKM DIAMONDS, INC. 9
been duly authorized.” The Angell opinion letter also stated
that “[w]e have examined such certificates, certified copies of
organizational and governance documents, certificates of
good standing, certifications of factual matters, company
resolutions and other records, pertinent documents and
instruments, and have investigated such other matters of law
and fact, as we have deemed necessary for the purpose of
rendering the opinions set forth herein.” Finally, the Angell
opinion letter concluded that “the Shares may be issued to the
Shareholders . . . and that the certificates evidencing the
Shares need bear no restrictive legend.” An Angell attorney
testified that he felt it was reasonable to rely upon the
opinions expressed by Dvorak in writing Angell’s opinion
letters. The attorney testified that he believed Dvorak’s
opinion letters to be valid, and had no reason to believe the
issuance of shares in reliance on the Dvorak opinion letters
was wrongful.
D. Procedural History
On April 7, 2008, the SEC filed a complaint against
Dvorak, Global, Bagley, and eleven other defendants in the
United States District Court for the District of Nevada. The
complaint alleged violations of Section 5 of the Securities
Act, 15 U.S.C. § 77e(a), which creates liability for the
distribution of unregistered securities.
On March 25, 2009, an indictment was issued in the
United States District Court for the District of Nevada based
on the same set of facts that gave rise to the civil proceedings.
The indictment named Dvorak, as well as five other
defendants who are not parties to this appeal.
10 SEC V. CMKM DIAMONDS, INC.
On December 23, 2010, the SEC filed a motion for
summary judgment against Dvorak, Global, and Bagley.
Global and Bagley, but not Dvorak, opposed the SEC’s
motion. On July 25, 2011, the district court granted summary
judgment against all three Defendants, holding that there was
no genuine issue of material fact that each Defendant was
both a necessary participant and a substantial factor in the
unregistered distribution of CMKM stock, and was therefore
liable for violating Section 5 of the Securities Act. As to
Global and Bagley, the district court concluded that they had
played more than a de minimis role in the scheme, and that
but for their participation in removing the restrictive legends
on the CMKM stock certificates there would not have been a
sale of unregistered securities. The district court rejected
Global and Bagley’s contention that summary judgment was
inappropriate because a material issue of fact remained
regarding whether they knew or had reason to know that the
distribution of stock was illegal, concluding that Section 5 is
a strict liability statute.
The district court entered final judgment on August 1,
2011. The court permanently enjoined Defendants from
violating Section 5 and ordered disgorgement of profits
gained as a result of violations of the Securities Act plus
prejudgment interest. Specifically, the court ordered Dvorak
to disgorge $409,638.11 and Bagley and Global, jointly and
severally, to disgorge $448,047.87
On January 18, 2011, while the SEC’s motion for
summary judgment was pending, Dvorak filed a motion to
stay the civil proceedings until the criminal proceedings
concluded, arguing that a stay was necessary to protect his
Fifth Amendment rights. In the alternative, Dvorak requested
that the court grant him additional time to respond to the
SEC V. CMKM DIAMONDS, INC. 11
SEC’s motion for summary judgment. Specifically, Dvorak
referenced the SEC’s evidence related to the criminal
proceedings, stating that “[w]ith 200 boxes of discovery
waiting to be scanned and delivered to defense counsel in the
criminal case, there may be more Dvorak will be able to
present to defeat summary judgment.”
United States Magistrate Judge Robert J. Johnston denied
Dvorak’s motion for a stay on April 7, 2011, rejecting
Dvorak’s argument that a stay was required by the Fifth
Amendment. The magistrate judge also stated that Dvorak
had not sought any particular discovery and had not referred
in his moving papers to Federal Rule of Civil Procedure
56(d), suggesting that Dvorak’s ability to respond to the
SEC’s motion for summary judgment would not be altered if
the court did not stay the case.
Global and Bagley appeal the district court’s grant of
summary judgment and disgorgement order. Dvorak appeals
the denial of his motion to stay the proceedings as well as the
district court’s disgorgement order.
II. DISCUSSION
A. Liability Under Section 5
Global and Bagley argue that the district court erred in
granting summary judgment because genuine issues of
material fact remain as to whether Global and Bagley’s
actions as a transfer agent satisfied the standard for liability
under Section 5 of the Securities Act.
We review the district court’s grant of summary judgment
de novo, SEC v. Platforms Wireless Int’l Corp., 617 F.3d
12 SEC V. CMKM DIAMONDS, INC.
1072, 1085 (9th Cir. 2010), and view the evidence in the light
most favorable to the nonmoving party to “determine whether
there are genuine issues of material fact and whether the
district court correctly applied the relevant substantive law,”
Oak Harbor Freight Lines, Inc. v. Sears Roebuck & Co.,
513 F.3d 949, 954 (9th Cir. 2008).
“Sections 5(a) and (c) of the Securities Act, 15 U.S.C.
§ 77e(a), (c), make it unlawful to offer or sell a security in
interstate commerce if a registration statement has not been
filed as to that security, unless the transaction qualifies for an
exemption from registration.” Platforms Wireless, 617 F.3d
at 1085. Section 5(a)(1) “broadly prohibits sales of securities
irrespective of the character of the person making them.”
SEC v. Chinese Consol. Benevolent Ass’n, 120 F.2d 738, 741
(2d Cir. 1941). To establish a prima facie case for violation
of Section 5, the SEC must show that (1) no registration
statement was in effect as to the securities; (2) the defendant
directly or indirectly sold or offered to sell securities; and (3)
the sale or offer was made through interstate commerce. See
SEC v. Phan, 500 F.3d 895, 902 (9th Cir. 2007); see also SEC
v. Calvo, 378 F.3d 1211, 1214 (11th Cir. 2004) (per curiam).
“Once the SEC introduces evidence that a defendant has
violated the registration provisions, the defendant then has the
burden of proof in showing entitlement to an exemption.”
SEC v. Murphy, 626 F.2d 633, 641 (9th Cir. 1980) (citing
SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953)).
Global and Bagley challenge only the first element of the
SEC’s prima facie case, arguing that they did not sell or offer
to sell securities within the meaning of Section 5.
Although Section 5 provides that it is unlawful for any
person to sell or offer to sell an unregistered security,
15 U.S.C. § 77e(a), (c), liability under Section 5 is not limited
SEC V. CMKM DIAMONDS, INC. 13
to the person or entity who ultimately passes title to the
security. See Murphy, 626 F.2d at 649. “Instead, courts have
established the concept of ‘participant’ liability to bring
within the confines of § 5 persons other than sellers who are
responsible for the distribution of unregistered securities.”
Id. With respect to Section 5, a defendant’s “role in the
transaction must be a significant one before liability will
attach.” Id. at 648. Defendants play a significant role when
they are “both a ‘necessary participant’ and ‘substantial
factor’ in the sales transaction.” Phan, 500 F.3d at 906(quoting Murphy, 626 F.2d at 648, 652). We have previously
stressed that the substantial factor test requires more than a
finding of “but for” causation, explaining:
Prior to the issuance of a security, numerous
persons perform mechanical acts without
which there could be no sale. For example, a
printer may prepare key documents or a bank
may advance cash to a customer upon the
customer’s presentation of an instrument and
then pass the instrument to another person.
Both would satisfy a “but for” causation test,
but these acts nonetheless do not render the
defendants sellers. Before a person’s acts can
be considered the proximate cause of a sale,
his acts must also be a substantial factor in
bringing about the transaction.
Murphy, 626 F.2d at 650 (citations omitted); see also SEC v.
Seaboard Corp., 677 F.2d 1289, 1294 (9th Cir. 1982). “The
proximate cause analysis required by Murphy . . . usually
involves a question of fact for the jury.” Anderson v.
Aurotek, 774 F.2d 927, 930 (9th Cir. 1985) (per curiam),
14 SEC V. CMKM DIAMONDS, INC.
overruled in part on other grounds by Pinter v. Dahl,
486 U.S. 622 (1988).5
Global and Bagley first argue that the district court erred
when it determined that Section 5 is a strict liability statute
and failed to consider whether Global and Bagley knew or
should have known that their conduct violated the Securities
Act. Global and Bagley argue that, as transfer agents, they
occupy a unique role in a securities transaction in which they
perform largely ministerial tasks in reliance upon attorney
opinion letters. Therefore, Global and Bagley argue, they can
be liable under Section 5 only if they acted unreasonably in
issuing the CMKM shares without a restrictive legend.
We have previously suggested that scienter is not an
element of Section 5 liability. See Phan, 500 F.3d at 905–06.
This is in accord with the majority of circuit courts that have
5
In Pinter, the Supreme Court overruled the use of the “substantial
factor” test for purposes of imposing liability under Section 12 of the
Securities Act. 486 U.S. at 654. Section 12 provides that “[a]ny person
who—(1) offers or sells a security in violation of [Section 5] . . . shall be
liable . . . to the person purchasing such security from him.” 15 U.S.C.
§ 77l(a). The Pinter court explained that “[t]he ‘purchase from’
requirement of § 12 focuses on the defendant’s relationship with the
plaintiff-purchaser. The substantial-factor test, on the other hand, focuses
on the defendant’s degree of involvement in the securities transaction and
its surrounding circumstances.” Pinter, 486 U.S. at 651.
Section 5 does not contain a similar “purchase from” requirement, and
therefore we have held that Pinter did not overrule use of the substantial
factor test for purposes of imposing Section 5 liability. See Phan,
500 F.3d at 906 n.13; see also Geiger v. SEC, 363 F.3d 481, 487–88 (D.C.
Cir. 2004). Cases that preceded Pinter and described or applied the
necessary participant and substantial factor test in the context of Section
12 continue to be relevant for purposes of defining the scope of that test
with respect to Section 5. See, e.g., Phan, 500 F.3d at 906.
SEC V. CMKM DIAMONDS, INC. 15
considered the question. See Calvo, 378 F.3d at 1215; SEC
v. Holschuh, 694 F.2d 130, 137 n.10 (7th Cir. 1982); Swenson
v. Engelstad, 626 F.2d 421, 424 (5th Cir. 1980). But see
Kane v. SEC, 842 F.2d 194, 199 (8th Cir. 1988) (holding that
Section 5 liability “extends to those persons who are uniquely
positioned to ask relevant questions, acquire material
information, or disclose their findings”). We conclude that a
transfer agent’s role in a securities distribution is not
inherently unique and therefore does not justify subjecting
transfer agents to a different standard for Section 5 liability
than any other participant in the distribution of unregistered
securities. Transfer agents are not, for example, the only
potential participants in a securities distribution that may rely
on the opinions of attorneys. Nor are transfer agents the only
participants in a securities distribution that may play a
ministerial or de minimis role. A transfer agent, like any
other participant in a securities scheme, does not play
precisely the same role in every transaction. Therefore, we
decline to create an exception to strict liability for transfer
agents, and we reaffirm that scienter is not an element of
Section 5 liability.6 As explained more fully below, the
6
Because Section 5 is a strict liability statute, it appears that the district
court erred in determining that good faith reliance on counsel could
preclude liability under the statute. The cases cited by the district court in
support of that proposition involved other provisions of the securities laws
that do require scienter before imposing liability. See SEC v. Goldfield
Deep Mines Co. of Nev., 758 F.2d 459, 467 (9th Cir. 1985) (examining a
good faith defense in the context of entry of a permanent injunction
because an injunction may be entered only upon a finding of scienter to
violate the securities laws); SEC v. Savoy Indus., Inc., 665 F.2d 1310,
1314 n.28 (D.C. Cir. 1981) (discussing a good faith reliance defense in the
context of liability under the anti-fraud provisions of the securities
regulations that require a finding of scienter). In contrast “neither a good
faith belief that the offers or sales in question were legal, nor reliance on
the advice of counsel, provides a complete defense to a charge of violating
16 SEC V. CMKM DIAMONDS, INC.
“necessary participant” and “substantial factor” test is better
suited to determine participant liability. The myriad
securities schemes and participant roles within those schemes
must be considered by courts rather than a scienter
requirement based upon the title of a participant.
In support of their position that transfer agents should
face liability under Section 5 only when they act
unreasonably, Global and Bagley rely primarily on Nevada
state law. Under the Exchange Act, states are authorized to
enact legislation governing transfer agents that is “not
inconsistent” with federal securities regulations. 15 U.S.C.
§ 78q-1(d)(4). Transfer agents have a duty to register a
transfer of stock under Nevada state law provided that the
transfer is, among other things, rightful.7 Global and Bagley
argue that a reasonable belief that a transfer would be
wrongful under federal securities law provides a transfer
agent with a defense to the state law duty to register a
transfer. Therefore, Global and Bagley argue that it is
inconsistent for federal law to impose strict liability upon a
transfer agent’s wrongful transfer stock when compliance
Section 5 of the Securities Act.” SEC v. Friendly Power Co., 49 F. Supp.
2d 1363, 1368 (S.D. Fla. 1999) (citing Holschuh, 694 F.2d at 137).
7
Courts have held that a request to remove a restrictive legend is
substantially equivalent to a request to register a transfer under the
Uniform Commercial Code. See, e.g., Am. Sec. Transfer, Inc. v. Pantheon
Indus., Inc., 871 F. Supp. 400, 404–05 (D. Colo. 1994); Bender v. Memory
Metals, Inc., 514 A.2d 1109, 1115 (Del. Ch. 1986). We assume, without
deciding, for purposes of Global and Bagley’s argument that the requests
in this case to remove the restrictive legends from CMKM shares would
be subject to Nevada law governing a transfer agent’s duty to register a
transfer.
SEC V. CMKM DIAMONDS, INC. 17
with the state law duty to register a transfer is subject to a
reasonableness inquiry.
The existence of state law shielding a transfer agent from
liability for failing to remove a restrictive legend based upon
a reasonable belief that such a removal would be wrongful
does not conflict with our holding that Section 5 is a strict
liability statute. Liability under state and federal law is
mutually exclusive in this context. If a transfer agent is found
liable under Section 5 of the Securities Act for issuing shares
without a restrictive legend, it is impossible for the transfer
agent to be found liable under state law for refusing to issue
that same share. And a transfer agent will not face federal
liability for not removing a restrictive legend, but may face
state liability if it did not have a reasonable basis for its
refusal. Although the knowledge requirement for violations
of state and federal law differs, that difference does not
persuade us to incorporate an element of scienter into
Section 5.
Because Section 5 imposes strict liability for violations of
its registration requirement, we recognize that it is
particularly important that the necessary participant and
substantial factor test be carefully applied to each case so as
not to subject defendants with a de minimis or insubstantial
role in a securities scheme to strict liability. With that in
mind, we turn now to application of the necessary participant
and substantial factor test to the facts of this case.
The district court found that Global and Bagley were
necessary participants because, “but for their participation in
removing the restrictive legends, there would not have been
a sale of unregistered securities because the CMKM stock
would still have the restrictive legend on each certificate.”
18 SEC V. CMKM DIAMONDS, INC.
The court went on to conclude that Global and Bagley were
substantial factors in the scheme as a matter of law because
they “issued billions of shares of CMKM stock without the
restrictive legend and then transferred those unrestricted
certificates to defendant NevWest for the purpose of sale to
the general public.” Global and Bagley argue that, even if
Section 5 does not require scienter, their conduct as CMKM’s
transfer agent was insufficient to establish that they were a
substantial factor in the scheme to distribute CMKM stock.
The SEC argues, however, that Global and Bagley by virtue
of their status as CMKM’s transfer agent are necessarily
liable under Section 5 because a transfer agent’s role is
“central to the distribution” of securities.
We reject the SEC’s contention that Global and Bagley
are necessarily liable under Section 5 by virtue of their
position as CMKM’s transfer agent. A participant’s title,
standing alone, cannot determine liability under Section 5,
because the mere fact that a defendant is labeled as an issuer,
a broker, a transfer agent, a CEO, a purchaser, or an attorney,
does not adequately explain what role the defendant actually
played in the scheme at issue. Instead, whether a defendant
is a substantial factor in the distribution of unregistered
securities is a question of fact requiring a case-by-case
analysis of the nature of the securities scheme and the
defendant’s participation in it. See Anderson, 774 F.2d at
930. This does not mean that summary judgment will never
be appropriate, however. For example, in Murphy we
affirmed the district court’s grant of summary judgment in the
SEC’s favor regarding defendant’s Section 5 liability because
Murphy participated heavily in the
offerings. . . . He devised the corporate
financing scheme for [the issuer] . . . . He
SEC V. CMKM DIAMONDS, INC. 19
prepared and reviewed offering memoranda;
he met personally with broker-dealers,
investors and their representatives; and he
spoke at broker-dealer sales seminars. There
can be no gainsaying the importance of these
acts: Murphy’s extensive role in facilitating
the transactions clearly was a substantial
factor in the sales of unregistered securities.
Murphy, 626 F.2d at 638, 652. Similarly, in Phan we
affirmed summary judgment holding the defendant liable
under Section 5 where the defendant chose the date to call in
the investor’s $1.25 million obligation to the issuer, directed
the investor to sell the shares in order to repay her obligation,
provided the investor with a buyer, directed the issuer’s
lawyer to draft a contract for the stock sale, and instructed the
investor where to send the proceeds. 500 F.3d at 906.
Because of those facts we concluded that Phan “was both a
‘necessary participant’ and a ‘substantial factor in’ Wu’s
resale.” Id.; see also Calvo, 378 F.3d at 1215 (“[T]he
undisputed material facts amply support the district court’s
determination that, as a matter of law, Calvo illegally sold
unregistered securities” where “Calvo negotiated and signed
the contract with [the issuer] SOE pursuant to which [the
brokerage] received the unregistered shares as compensation;
he extended that contract on behalf of [the brokerage]; he
signed the documents that opened the . . . brokerage account
into which all of the unregistered SOE shares were deposited;
he signed stock transfer authorization and stock powers for
sales or transfers of stock out of [the] brokerage account; and
he received proceeds–albeit through [the brokerage]–from the
sale of SOE shares. Clearly, Calvo was a necessary
participant and a substantial factor in the illegal sale of
unregistered SOE stock.”).
20 SEC V. CMKM DIAMONDS, INC.
Here, the undisputed facts do not establish that Global and
Bagley were substantial participants in the CMKM
distribution as a matter of law. Global and Bagley read
opinion letters from Dvorak, instructing them to remove the
restrictive legends from CMKM stock, and then issued large
quantities of those shares without the restrictive legend.
Global and Bagley then requested a second opinion letter
from Angell. After reading the Angell opinion letters, Global
and Bagley continued to issue large quantities of shares
without the restrictive legend.8 This conduct is in stark
contrast to the actions taken by the defendants in Murphy,
Phan, and Calvo. The defendants in those cases were
integrally involved in the securities-distribution schemes,
from devising the scheme to finding investors and buyers to
structuring the sales. That Global and Bagley issued large
quantities of shares without a restrictive legend after
receiving two attorney opinion letters is insufficient, in and of
itself, to establish that Global and Bagley were substantial
factors as a matter of law. Based upon this evidence, a
reasonable jury could conclude that Global and Bagley were
not substantial participants in the CMKM scheme. See
Geiger v. SEC, 363 F.3d 481, 487 (D.C. Cir. 2004) (“[N]ot
8
The district court reasoned that Global and Bagley “transferred those
unrestricted certificates to defendant NevWest for the purpose of sale to
the general public” in concluding that Global and Bagley were substantial
factors in the scheme. But this fact was not undisputed in the record. The
record indicates only that “Edwards hand delivered several recently issued
stock certificates in CMKM stock to NevWest,” and that “Edwards was
delivering to NevWest newly issued stock certificates in CMKM stock.”
The SEC does not identify any portion of the record indicating that Global
and Bagley transferred shares to NevWest. Therefore, the district court
erred in relying on the fact that Global and Bagley transferred stocks to
NevWest to support its conclusion that they were substantial factors in the
CMKM distribution.
SEC V. CMKM DIAMONDS, INC. 21
everyone in the chain of intermediaries between a seller of
securities and the ultimate buyer is sufficiently involved in
the process to make him responsible for an unlawful
distribution.” (internal quotation marks omitted)). This case
does not present evidence of significant and continuing
involvement in the development and execution of a scheme
to distribute securities in violation of the Securities Act like
that which has supported the entry of summary judgment in
other cases on the question of whether defendants were a
substantial factor in a securities distribution. Therefore, we
reverse the district court’s grant of summary judgment as to
Global and Bagley and remand for proceedings consistent
with this opinion.9
B. Motion to Stay
Dvorak appeals from the magistrate judge’s denial of his
motion to stay. Dvorak challenges both the magistrate
judge’s authority to decide the motion, as well as the
substantive reasons for the denial.
1. Authority of the Magistrate Judge
“[A] district judge may designate a magistrate judge to
hear any nondispositive pretrial matter pending before the
court.” Estate of Connors ex rel. Meredith v. O’Connor,
6 F.3d 656, 658 (9th Cir. 1993); see also 28 U.S.C.
§ 636(b)(1)(A). Under 28 U.S.C. § 636(b)(1)(B), a district
judge may also authorize a magistrate judge to “conduct
hearings, including evidentiary hearings, and to submit to a
9
Because we remand on the issue of Global and Bagley’s liability, we
do not reach their arguments about the reasonableness of the district
court’s disgorgement order against them.
22 SEC V. CMKM DIAMONDS, INC.
judge of the court proposed findings of fact and
recommendations for the disposition” of motions that the
magistrate judge lacks the authority to decide under
§ 636(b)(1)(a). As we have noted:
The primary difference between
subsections (1)(A) and (1)(B) is that the
former allows the magistrate judge to
“determine” the matter (subject to the review
of the district court for clear or legal error)
while the latter allows the magistrate only to
submit “proposed findings and
recommendations” for the district court’s de
novo review.
Reynaga v. Cammisa, 971 F.2d 414, 416 (9th Cir. 1992)
(quoting 28 U.S.C. § 636(b)(1)).
We have previously held that where the denial of a
motion to stay is effectively a denial of the ultimate relief
sought, such a motion is considered dispositive, and a
magistrate judge lacks the authority to “determine” the
matter. Id. at 416–17. We have not, however, squarely
addressed the question of whether a motion to stay a civil
proceeding, where the effect is not the denial of relief, is a
nondispositive motion that may be determined by a
magistrate judge under § 636(b)(1)(A). The First Circuit has
held that a motion to stay litigation that “is not dispositive of
either the case or any claim or defense within it” may
properly be determined by a magistrate judge. PowerShare,
Inc. v. Syntel, Inc., 597 F.3d 10, 13–14 (1st Cir. 2010). Here,
Dvorak simply speculated that he might have stronger
evidence to support his position in the civil proceedings if he
was able to go through the criminal proceedings first. The
SEC V. CMKM DIAMONDS, INC. 23
magistrate judge’s denial of Dvorak’s motion to stay the civil
proceedings did not dispose of any claims or defenses and did
not effectively deny him any ultimate relief sought.
Therefore Dvorak’s motion to stay was nondispositive, and
we conclude that the magistrate judge had authority to
determine Dvorak’s motion to stay under § 636(b)(1)(A).
2. Denial of Motion to Stay
In addition to challenging the magistrate judge’s authority
to rule on his motion, Dvorak raises numerous challenges to
the substance of the magistrate judge’s denial of his motion
to stay the proceedings. However, Dvorak did not object to
the magistrate judge’s order in the district court, and he
therefore has forfeited his right to appellate review of the
order. See Simpson v. Lear Astronics Corp., 77 F.3d 1170,
1174 (9th Cir. 1996) (“[A] party who fails to file timely
objections to a magistrate judge’s nondispositive order with
the district judge to whom the case is assigned forfeits its
right to appellate review of that order.”); see also Glenbrook
Homeowners Ass’n v. Tahoe Reg’l Planning Agency,
425 F.3d 611, 619–20 (9th Cir. 2005).
C. Disgorgement
On appeal, Dvorak argues that the district court erred in
ordering him to disgorge $409,638.11 because material issues
of fact remain as to the appropriateness of that amount.10
Specifically, Dvorak argues that bank records and exhibits
that he produced at his deposition contain evidence indicating
10
Dvorak disputes only the district court’s disgorgement order and does
not argue that the district court erred in entering summary judgment as to
his liability under Section 5.
24 SEC V. CMKM DIAMONDS, INC.
that $409,638.11 is not a reasonable approximation of the
amount by which Dvorak was unjustly enriched.
“The district court has broad equity powers to order the
disgorgement of ‘ill-gotten gains’ obtained through the
violation of the securities laws.” SEC v. First Pac. Bancorp,
142 F.3d 1186, 1191 (9th Cir. 1998) (citing SEC v. Clark,
915 F.2d 439, 453 (9th Cir. 1990)). “The district court also
has broad discretion in calculating the amount to be
disgorged.” SEC v. JT Wallenbrock & Assocs., 440 F.3d
1109, 1113 (9th Cir. 2006). In calculating disgorgement, a
district court need only make a “reasonable approximation of
profits causally connected to the violation” and is “not
required to trace every dollar of the offering proceeds
fraudulently retained by” the defendants. First Pac. Bancorp,
142 F.3d at 1192 n.6. (internal quotation marks omitted).
“The SEC bears the ultimate burden of persuasion that its
disgorgement figure reasonably approximates the amount of
unjust enrichment.” Platforms Wireless, 617 F.3d at 1096
(internal quotation marks omitted). If the SEC establishes
that the amount of disgorgement requested is a reasonable
approximation of defendants’ actual profits from the scheme,
“the burden shifts to the defendants to demonstrate that the
disgorgement figure was not a reasonable approximation.”
Id. (internal quotation marks omitted). Defendants bear the
burden of showing unreasonableness because they “are more
likely than the SEC to have access to evidence establishing
what they paid for the securities, if anything, to whom the
proceeds from the sales were distributed, and for what
purposes the proceeds were used.” Id.
Dvorak admits that the bank records and exhibits he now
references were not part of the record before the district court,
SEC V. CMKM DIAMONDS, INC. 25
because he failed to produce them or otherwise respond to the
SEC’s motion for summary judgment and request for a
disgorgement order. Therefore, Dvorak has forfeited his right
to appellate review of the district court’s disgorgement order.
See Peterson v. Highland Music, Inc., 140 F.3d 1313, 1321
(9th Cir. 1998) (“We apply a general rule against entertaining
arguments on appeal that were not presented or developed
before the district court.” (internal quotation marks omitted)).
Dvorak argues on appeal, however, that arguments in his
motion to stay constituted a response to the SEC’s request for
disgorgement. Specifically, Dvorak argues that his
deposition and exhibits thereto “controverted” the
reasonableness of the SEC’s request for disgorgement.
Because he could not afford a copy of his deposition
transcript, Dvorak argues that the district court should have
ordered the SEC to produce the entirety of Dvorak’s
deposition.
First, the district court did not err in failing to consider
Dvorak’s references to the disgorgement order made in
connection with his motion to stay, because district courts are
not required to review all papers filed in a case in order to
determine if a party has raised arguments in other filings that
could be construed as responsive to a pending motion. See
Simpson, 77 F.3d at 1175–76 (ruling that a complaint about
the amount of a sanctions order that was raised in a filing
other than the motion for review of the sanctions order “did
not put the district judge on notice that [the plaintiff] sought
to contest the amount of sanctions.”
Second, even if Dvorak is correct that his comments about
discovery in his motion to stay constituted a response to the
SEC’s request for disgorgement, these arguments are
insufficient to show that the district court abused its
26 SEC V. CMKM DIAMONDS, INC.
discretion in ordering Dvorak to disgorge $409,638.11. In his
briefing in support of the motion to stay litigation, Dvorak
stated that portions of his deposition and exhibits thereto
“clearly controverted” the amount of the SEC’s disgorgement
request. He requested that the SEC “fulfill its duty of candor
to the court and file the entire deposition and all its exhibits
as an exhibit to its Motion for Summary Judgment.” But
Dvorak did not indicate how the facts contained in his bank
account records and deposition transcript would demonstrate
the unreasonableness of the SEC’s disgorgement request.
Nor did Dvorak provide any explanation for why he was
unable to produce his own bank account records and exhibits
he produced at his deposition to oppose the SEC’s request for
disgorgement. Therefore, Dvorak failed to meet his burden
of showing that the disgorgement figure was not a reasonable
approximation of his illegal profits. See Platforms Wireless,
617 F.3d at 1096. Accordingly, we affirm the district court’s
disgorgement order as to Dvorak.
CONCLUSION
A material issue of fact remains regarding whether Global
and Bagley were necessary participants and substantial
factors in the distribution of CMKM securities sufficient to
impose liability under Section 5 of the Securities Act.
Therefore, we reverse the grant of summary judgment as to
Global and Bagley, and remand for further proceedings. We
affirm the magistrate judge’s denial of Dvorak’s motion to
stay and the district court’s disgorgement order as to Dvorak.
AFFIRMED in part, REVERSED in part and
REMANDED. The parties shall bear their own costs on
appeal.