Securities & Exchange Commission v. Johnson ( 2006 )

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit
4-5-2006
SEC v. Johnson
Precedential or Non-Precedential: Non-Precedential
Docket No. 04-4114
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NOT PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 04-4114
__________
SECURITIES AND EXCHANGE COMMISSION
v.
ED JOHNSON,
Appellant
_____________________
On Appeal From the United States District Court
For the District of New Jersey
(D.C. Civil No. 02-cv-05490)
District Judge: Honorable Garrett E. Brown
________________________
Submitted Under Third Circuit LAR 34.1(a)
March 24, 2006
Before: ROTH, RENDELL and AMBRO, Circuit Judges.
(Filed: April 5, 2006)
_____________
OPINION OF THE COURT
_____________
PER CURIAM
Ed Johnson, proceeding pro se, appeals from an order entered by the United States
District Court for the District of New Jersey, granting permanent injunctions, ordering
disgorgement, and imposing civil monetary penalties, following a jury verdict in favor of
the Securities and Exchange Commission (“SEC”) in this civil law enforcement action.
For the reasons that follow, we will affirm.
I.
Because we write only for the parties, who are familiar with the facts, we will not
recite them except as necessary to the discussion. In November 2002, the SEC filed a
complaint alleging that Johnson committed securities fraud by causing his company,
MERL Holdings, Inc.com (“MERL”), to file with the SEC two registration statements
that contained numerous misrepresentations and omissions, by issuing false and
misleading press releases, and by trading on inside information. Following a two-week
trial, the jury returned a verdict in favor of the SEC, finding that Johnson violated Section
10(b) of the Securities Exchange Act1 and Rule 10b-5 promulgated thereunder,2 as well as
Section 17(a) of the Securities Act,3 and that he engaged in insider trading in violation of
the same provisions.
After hearing additional arguments, the District Court issued an order (1)
1
Section 10(b) of the Exchange Act prohibits “manipulative” or “deceptive”
conduct “in connection with the purchase or sale of any security.” 15 U.S.C. § 78j(b).
2
Rule10b-5 proscribes (1) the employment of any “device, scheme or artifice to
defraud;” (2) the making of “any untrue statement [or omission of] material fact;” and (3)
the engagement “in any act, practice, or course of business which operates . . . as a fraud
or deceit upon any person, in connection with the purchase or sale of any security.” 17
C.F.R. § 240.10b-5.
3
Section 17(a) makes it unlawful for any person in the offer or sale of any security
to (1) “employ any device, scheme, or artifice to defraud”; (2) “obtain money or property
by means of any untrue statement [or omission] of a material fact”; or (3) “engage in any
transaction, practice, or course of business which operates . . . as a fraud or deceit upon
the purchaser.” 15 U.S.C. § 77q(a).
2
permanently enjoining Johnson from committing future violations of the federal securities
law; (2) barring him from serving as an officer or director of a public company; (3)
barring him from participating in an offering of “penny stock”; (4) requiring him to
disgorge $42,262 in profits from his illegal insider trading, plus prejudgment interest; (5)
imposing a penalty of $42,262 for insider trading; and (6) imposing a civil penalty of
$120,000. Johnson timely appealed. We have jurisdiction pursuant to 28 U.S.C. §§ 1291and 1292(a)(1).
II.
Johnson argues that the evidence presented at trial was not sufficient to “support a
finding of a knowing or reckless violation.” We will not overturn a jury verdict “unless
the record is critically deficient of that quantum of evidence from which a jury could have
rationally reached its verdict.” Swineford v. Snyder County, 15 F.3d 1258, 1265 (3d Cir.
1994). “We have previously held that the scienter required for securities fraud includes
recklessness,” which is defined as “[h]ighly unreasonable (conduct), involving not merely
simple, or even inexcusable negligence, but an extreme departure from the standards of
ordinary care, . . . which presents a danger of misleading buyers or sellers that is either
known to the defendant or is so obvious that the actor must have been aware of it.”
S.E.C. v. Infinity Group Co., 212 F.3d 180, 192-93 (3d Cir. 2000) (citing Sundstrand
Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977)).
At trial, the SEC presented evidence that Johnson caused MERL to file with the
SEC registration statements that consolidated MERL’s assets and revenues with those of
3
a company, Essex Industries, Inc. (“Essex”), over which it exercised no control.4 An
expert called by the SEC testified that it was not appropriate under Generally Accepted
Accounting Principles for the Essex assets and revenues to be consolidated with those
contained in MERL’s financial statements. The evidence also established that Johnson
knew that the registration statements overstated the value of assets that MERL had
acquired from Hanold Schoolwear, Inc. and Hanold Bookstores, Inc. (“the Hanold
entities”).5 The SEC also introduced evidence indicating that Johnson had misrepresented
his personal background on the registration statements by failing to disclose a prior
criminal conviction. Furthermore, the SEC presented evidence that, between June 1998
and November 1999, Johnson caused MERL to issue several press releases containing
false and misleading information, and that Johnson sold his stock in MERL during the
4
Johnson testified that MERL acquired Essex in May 1996 from an individual
named Charles Weeden. Weeden later filed a state court lawsuit seeking rescission of the
sale and, in December 1996, the state court enjoined Johnson from “taking any action to
interfere with the day to day operations of Essex.” In May 1998, Johnson and Weeden
entered into a security agreement pursuant to which Johnson and MERL would have no
control over Essex. Johnson knew, however, that Essex’s operating results were
consolidated in MERL’s financial statements from 1997 and 1998. Those financial
statements were included in the registration statements filed with the SEC in January and
May 2000.
5
According to Johnson’s testimony, MERL acquired certain assets from the
Hanold entities in December 1998 in exchange for stock in MERL. Shortly after the
acquisition, however, Johnson realized that the assets were worth significantly less than
the value represented by the sellers. Consequently, MERL filed a claim in arbitration,
alleging that it had been the victim of fraud and misrepresentation. Nevertheless, the
valuation of the assets provided on the registration statement was based on the face value
of the stock MERL had given the sellers in exchange for the assets, rather than on the
actual value of the assets.
4
same period.
Johnson alleges that he relied on MERL’s accountants and auditors in filing the
registration statements. Good faith reliance on the advice of an accountant or another
professional has been recognized as a viable defense to scienter in securities fraud cases.
See SEC v. Goldfield Deep Mines Co. of Nev., 758 F.2d 459, 467 (9th Cir. 1985). That
defense is available, however, only when all pertinent facts are disclosed to the
professional. See Markowski v. S.E.C.,34 F.3d 99, 104-05 (2d Cir. 1994). Notably,
Johnson did not tell the auditors about a state court injunction and security agreement that
effectively prevented MERL from exercising control over Essex. In addition, Johnson
supplied to the auditors various baseless assumptions about a customer list acquired from
the Hanold entities, which resulted in their giving the list an inflated value. Under these
circumstances, we conclude that there was ample evidence upon which the jury could
have found Johnson reckless.6
III.
Johnson also argues that the District Court improperly instructed the jury
concerning the scienter required for securities fraud. Where, as here, a party fails to
6
We also note that there is no merit to Johnson’s unsupported contentions that the
SEC should have permitted him to revise the registration statements before filing its
complaint, that MERL’s withdrawal of the registration statements absolves him of
liability, that his failure to disclose his criminal conviction was a mere technical violation,
and that “there was no evidence to connect the past [stock] trades with the alleged errors
in the Company filings.”
5
object to a jury instruction, we may review for “plain error in the instructions affecting
substantial rights.” Fed. R. Civ. P. 51(d)(2); Bostic v. Smyrna School Dist., 418 F.3d
355, 359 (3d Cir. 2005). Johnson objects to what he characterizes as the District Court’s
statement “that the [SEC] could prove recklessness by inference, under the right
circumstances.” He contends that the evidence “did not present a picture of a man in
disregard of any duties or obligations.” As discussed above, however, the evidence at
trial was sufficient to demonstrate that Johnson’s conduct was highly unreasonable. In
addition, contrary to Johnson’s suggestion, it was permissible for the District Court to
instruct the jury that it could determine Johnson’s state of mind based on circumstantial
evidence. See Herman & MacLean v. Huddleston, 459 U.S. 375, 390 n.30 (1983) (noting
that circumstantial evidence can constitute proof of scienter in fraud cases). Johnson also
alleges that the instruction “seems to excuse the jury from any further deliberation if they
simply believe, as a subjective belief, that Johnson was reckless.” The instruction made
clear, however, that the jury’s finding must be based upon evidence. Indeed, the District
Court stated that the “burden is on the SEC to prove fraudulent intent and consequent lack
of good faith by a preponderance of the evidence.” Accordingly, the District Court did
not plainly err in instructing the jury.
IV.
We next consider Johnson’s argument that the District Court erred by allowing the
SEC to examine him concerning his prior criminal conviction. Because the District
6
Court’s evidentiary ruling was made pre-trial at an in limine hearing, the District Court’s
decision is reviewed for abuse of discretion. See Walden v. Georgia-Pacific Corp., 126
F.3d 506, 517 (1997). In 1990, Johnson, who was then chief executive officer of a
savings and loan, was convicted of misapplication of funds. However, a registration
statement filed by MERL with the SEC indicated that MERL had no record of officers or
directors who had been involved in legal proceedings material to an evaluation of their
ability or integrity. The District Court ruled that the fact of Johnson’s conviction was
relevant to the SEC’s claim that the registration statement contained a misrepresentation.
This was not an abuse of discretion. In addition, Johnson’s counsel elicited testimony
from Johnson concerning the allegedly extenuating circumstances of the conviction, and
in so doing “opened the door” for the SEC to more extensively question Johnson about
the offense. Cf. United States v. Irizarry, 241 F.3d 273, 307 (3d Cir. 2003) (“‘When a
defendant offers an innocent explanation [for his criminal conduct] he “opens the door” to
questioning into the truth of his testimony....’” (alteration in original) (quoting United
States v. Payton, 159 F.3d 49, 58 (2d Cir. 1998))). Finally, there is no indication that the
District Court barred Johnson from presenting additional evidence concerning his
conviction, as he suggests.
V.
Johnson also challenges the assessment of penalties, which we review for abuse of
discretion. See S.E.C. v. Sargent, 329 F.3d 34, 38 (1st Cir. 2003). According to Johnson,
7
the penalties “far outweighed any harm from [his] conduct.” The District Court,
however, considered the relevant factors and properly concluded that they justified
imposition of the various penalties. For instance, although the SEC sought civil monetary
penalties totaling $600,000, the District Court imposed a fine of only $120,000 because
“the actual loss was minimal.” See generally 15 U.S.C. §§ 77t(d)(2)(C),
78u(d)(3)(B)(iii).7 Moreover, even though the District Court was authorized by statute to
impose a penalty of up to “three times the profit gained or loss avoided as a result of” the
insider trading, see id. § 78u-1(a)(2), it “required Johnson to pay the insider trading
penalty of one times his illegal profits” in light of the “small amount” of those profits. In
enjoining Johnson from committing future securities violations, the District Court found
that his conduct was egregious and persistent, that he remained in a position where future
violations of federal securities law would be possible, and that he maintained at trial that
he was blameless. The District Court’s decision to permanently bar Johnson from serving
as an officer or director of a public company was based on the additional facts that he had
previously committed breaches of fiduciary duty (as evidenced by his 1990 conviction for
misapplication of funds), that he committed the fraud while he was Chief Executive
Officer and Chairman of the Board at MERL, that the jury found that he acted knowingly
or recklessly, that he gained over $40,000 from his insider trading of MERL stock, and
that he is likely to perpetrate fraud again. The District Court also permanently prohibited
7
Because Johnson’s violations occurred before February 2, 2001, the applicable
inflation-adjusted penalty should be $110,000. See 17 C.F.R. § 201.1001 & tbl. I.
8
Johnson from offering “penny stock” to protect the investing public from future fraud,
and ordered Johnson to disgorge a sum equal to the amount of his profit from insider
trading. Under these circumstances, we are satisfied that the District Court acted within
its discretion.
Accordingly, we will affirm the order of the District Court, except as modified by
footnote 7.