United States Securities and Exchange Commission v. Brown

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
______________________________
UNITED STATES SECURITIES AND )
EXCHANGE COMMISSION, )
)
Plaintiff, )
)
v. ) Civil Action No. 09-1423 (GK)
)
ELAINE M. BROWN, et al., )
)
Defendants. )
______________________________)
MEMORANDUM OPINION
Plaintiff United States Securities and Exchange Commission
(“SEC”) brings this action against Defendants1 Elaine M. Brown and
Gary A. Prince alleging violations of the Securities Act of 1933
(“Securities Act”), 15 U.S.C. § 77a et seq, the Securities Exchange
Act of 1934 (“Exchange Act”), 15 U.S.C. § 78a et seq, and Rules
promulgated under the Exchange Act. This matter is before the Court
on Defendants’ Motions to Dismiss the Complaint pursuant to Fed. R.
Civ. P. 12(b)(6) and 9(b). [Dkt. Nos. 13, 14]. Upon consideration
of the Motions, Opposition, Replies, and the entire record herein,
and for the reasons stated below, Defendant Brown’s Motion to
Dismiss is granted in part, and denied in part, and Defendant
Prince’s Motion to Dismiss is denied.
1
The Complaint was originally brought against a third
Defendant, Steven R. Chamberlain. On February 18, 2010, after
receiving notice of Defendant Chamberlain’s death, the Court
granted the Consent Motion for Order Dismissing Defendant Steven R.
Chamberlain as a Party pursuant to Fed. R. Civ. P. 21.
I. Background2
Defendants Brown and Prince are former employees of Integral
Systems, Inc. (“Integral”), a publicly traded Maryland corporation
that manufactures ground-based controls for satellite systems.
Defendant Brown was the Chief Financial Officer and Principal
Accounting Officer of Integral from 1997 until May of 2007, and the
Vice President of Administration from 2007 until she resigned from
that position in July 2008. Defendant Prince was hired as
Integral’s Chief Executive Officer in 1982, but then resigned in
1995 shortly before pleading guilty in the Central District of
California to a conspiracy to commit securities fraud and to making
false statements in connection with his conduct as an officer of
another corporation. United States v. Prince, No. 95-cr-00771 (C.D.
Cal. Sept. 5, 1995).
In 1994, the United States District Court for the District of
Columbia enjoined Prince from violating the antifraud and lying-to-
auditors provisions of the Exchange Act based on the conduct
underlying his guilty plea in the Central District of California.
SEC v. Bolen, No. 93-cv-01331 (D.D.C. Aug. 18, 1994). In 1997, the
SEC issued an Order (“1997 Order”) permanently barring Prince from
2
For purposes of ruling on a motion to dismiss, the
factual allegations of the complaint must be presumed to be true
and liberally construed in favor of the plaintiff. Aktieselskabet
AF 21. November 2001 v. Fame Jeans Inc., 525 F.3d 8, 15 (D.C. Cir.
2008); Shear v. Nat’l Rifle Ass’n of Am., 606 F.2d 1251, 1253 (D.C.
Cir. 1979). Therefore, the facts set forth herein are taken from
the Complaint unless otherwise noted.
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appearing before the Commission as an accountant. In re Gary A.
Prince, Release No. 38,765, 64 S.E.C. Docket 2074, 1997 WL 343054
(June 24, 1997).
In 1998, Prince was re-hired by Integral. Until his
termination from Integral on March 30, 2007, Prince held various
titles, including Director of Mergers and Acquisitions, Director of
Strategic and Financial Planning, and Managing Director of
Operations. The SEC alleges that Prince had “substantial authority
and responsibilities” during this nine-year period that made him a
de facto officer of Integral in violation of its 1997 Order. The
“substantial authority and responsibilities” included Prince’s
authority to approve major contracts, attendance at Integral’s
Board of Director meetings, and evaluation of potential mergers.
Prince was also allegedly a member of a policy-making group of
senior executive officers, and he was compensated at levels equal
to Integral’s top-ranking officers. Compl. ¶¶ 21-29.
In the period between 1998 and August 2006, when Integral
Systems named Prince as an officer, Prince’s alleged status as a de
facto officer of the company was never disclosed in periodic
filings with the SEC or in proxy statements. The SEC claims this
was a material omission in violation of provisions of the
Securities Act, the Exchange Act, and related Rules. Specifically,
the SEC alleges that both Defendants (1) violated § 17(a) of the
Securities Act, (2) violated § 10(b) of the Exchange Act and Rule
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10b-5, (3) aided and abetted Integral Systems’s violations of
Exchange Act § 13(a) and Rules 12b-20 and 13a-1, (4) violated
Exchange Act Rule 13a-14, and (5) aided and abetted violations of
Exchange Act § 14(a) and Rule 14a-9 by Steven Chamberlain, Integral
Systems’s former Chief Executive Officer. Defendant Prince is also
charged with violations of Exchange Act § 16(a), Rule 16a-3, and
the 1997 Order.
On September 28, 2009, Defendants Brown and Prince filed
Motions to Dismiss [Dkt. Nos. 13 and 14], relying upon the statute
of limitations contained in 28 U.S.C. § 2462, Fed. R. Civ. P. 9(b),
and Fed. R. Civ. P. 12(b)(6). Defendant Brown also argues that the
entire Complaint is void because the term “officer” is
impermissibly vague.
II. Standard of Review
Under Rule 9(b), “the circumstances that the claimant must
plead with particularity include matters such as the time, place
and content of the false misrepresentations, the misrepresented
fact, and what the opponent retained or the claimant lost as a
consequence of the alleged fraud.” United States ex rel. Totten v.
Bombardier Corp., 286 F.3d 542, 551-52 (D.C. Cir. 2002)).
“Conclusory allegations that a defendant’s actions were fraudulent
and deceptive are not sufficient to satisfy 9(b).” Shekoyan v.
Sibley Int’l Corp., 217 F. Supp. 2d 59, 73 (D.D.C. 2002).
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The purpose of the heightened pleading standard in Rule 9(b)
is two-fold. First, it ensures that the defendant is put on notice
of the claims brought against him or her. Second, Rule 9(b)’s
particularity requirement “prevents attacks on [the defendant’s]
reputation where the claim for fraud is unsubstantiated, and
protects against a strike suit brought solely for its settlement
value.” In re U.S. Office Prod. Sec. Litig., 326 F. Supp. 2d 68, 73
(D.D.C. 2004). Rule 9(b) does not abrogate the “short and plain
statement of the claim” standard in Rule 8(a); instead, the two
rules function in harmony. In re U.S. Office Products Sec. Litig.,
326 F. Supp. 2d 68, 74 (D.D.C. 2004) (citing Kowal v. MCI Comms.
Corp., 16 F.3d 1271, 1278 (D.C. Cir. 1994)).
Under Rule 12(b)(6), a plaintiff need only plead “enough facts
to state a claim to relief that is plausible on its face” and to
“nudge[] [his or her] claims across the line from conceivable to
plausible.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007).
“[A] complaint [does not] suffice if it tenders naked assertions
devoid of further factual enhancement.” Ashcroft v. Iqbal, 129
S. Ct. 1937, 1949 (2009) (internal quotations omitted) (citing
Twombly, 550 U.S. at 557). Instead, the complaint must plead facts
that are more than “merely consistent with” a defendant’s
liability; “the pleaded factual content [must] allow[] the court to
draw the reasonable inference that the defendant is liable for the
misconduct alleged.” Id. at 1940.
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“[O]nce a claim has been stated adequately, it may be
supported by showing any set of facts consistent with the
allegations in the complaint.” Twombly, 550 U.S. at 563. Under the
standard set forth in Twombly, a “court deciding a motion to
dismiss must . . . assume all the allegations in the complaint are
true (even if doubtful in fact) . . . [and] must give the plaintiff
the benefit of all reasonable inferences derived from the facts
alleged.” Aktieselskabet AF 21. November 2001 v. Fame Jeans Inc.,
525 F.3d 8, 18 (D.C. Cir. 2008) (internal quotations marks and
citations omitted); see also Tooley v. Napolitano, 586 F.3d 1006,
1007 (D.C. Cir. 2009) (declining to reject or address the
government’s argument that Iqbal invalidated Aktieselskabet).
III. Analysis
Defendants make several arguments in support of their Motions
to Dismiss. First, Defendant Brown seeks to narrow the scope of the
Complaint by arguing: (1)that the statute of limitations in 28
U.S.C. § 2462 bars all claims based on conduct occurring before
July 30, 2005; and (2) that Defendants had no obligation to
disclose Prince’s conviction after 2002, so all claims based on
their failure to do so from 2002-2006 should be dismissed. Second,
Brown argues that all claims should be dismissed because the term
“officer,” the definition/interpretation of which is central to the
SEC’s allegation that Prince acted as a de facto officer at
Integral, is void for vagueness. Third, Brown argues that Counts I
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and II fail to plead fraud with the particularity required by Rule
9(b).
Finally, Defendants Brown and Prince both argue that certain
counts in the Complaint fail to state a claim under Rule 12(b)(6).
Brown argues that Counts I, II, IV, and V fail as against her.
Prince challenges Counts I and II on the basis that the SEC has
failed to allege facts sufficient to hold him liable as a primary
actor under §§ 17(a) and 10(b) or to establish that he has a duty
to disclose information under these provisions.
A. Statute of Limitations
As neither the Exchange Act nor the Securities Act includes a
statute of limitations, Brown argues that the “catch-all” statute
of limitations in 28 U.S.C. § 2462 applies to bar all claims based
on conduct that occurred more than five years before the filing of
the Complaint. Def. Brown’s Mot. at 14. Section 2462 states that:
Except as otherwise provided by Act of
Congress, an action, suit, or proceeding for
the enforcement of any civil fine, penalty, or
forfeiture, pecuniary or otherwise, shall not
be entertained unless commenced within five
years from the date when the claim first
accrued if, within the same period, the
offender or the property is found within the
United States in order that proper service may
be made thereon.
28 U.S.C. § 2462. Specifically, Brown argues that § 2462 bars the
SEC from seeking equitable relief and civil penalties against her
on the basis of conduct that occurred before July 30, 2004, or more
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than five years before the SEC filed its Complaint on July 30, 2009
[Dkt. No. 1].
1. Equitable Relief
In response to Brown’s argument, the SEC contends that
equitable relief--which includes the injunctions and officer-and-
director bar sought against Defendant Brown--are “remedial” in
nature. Remedial relief does not constitute a “penalty” under §
2462, and so is not subject to its statute of limitations. See SEC
v. Tandem Mgmt., Inc., No. 95-cv-8411, 2001 WL 1488218, at *6
(S.D.N.Y. Nov. 21, 2001) (“Courts have found that SEC suits for
equitable and remedial relief, including requests for permanent
injunctions and disgorgement, are not governed by § 2462 because
they are not actions or proceedings for a “penalty” within the
meaning of the statute.”) (collecting cases).
Brown disagrees. Relying on Johnson v. SEC, 87 F.3d 484 (D.C.
Cir. 1996), she argues that the equitable relief sought in this
case is actually penal in nature. In Johnson, our Court of Appeals
held that a broker’s censure and six-month suspension following an
administrative SEC proceeding were punitive in nature, and thus
subject to § 2462’s statute of limitations. In reaching this
conclusion, the Court explained that “a ‘penalty,’ as the term is
used in § 2462, is a form of punishment imposed by the government
for unlawful or proscribed conduct, which goes beyond remedying the
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damage caused to the harmed parties by the defendant’s action.” Id.
at 488.
In addition, the Court of Appeals was careful to emphasize
that the administrative judge in the SEC proceeding had focused on
Johnson’s wrongful conduct under the Exchange Act, and not the
likelihood of future harm. Id. at 489-90. As the Court explained,
“[t]his sanction would less resemble punishment if the SEC had
focused on Johnson’s current competence or the degree of risk she
posed to the public.” Id. at 489; see also McCurdy v. SEC, 396 F.3d
1258, 1265 (D.C. Cir. 2005) (where SEC’s suspension of plaintiff
was not punishment because it was meant to protect public); Meadows
v. SEC, 119 F.3d 1219, 1228 n.20 (5th Cir. 1997) (distinguishing
Johnson, and concluding that the SEC’s temporary bar from
association following an administrative proceeding was not penal in
nature because the Administrative Law Judge made findings regarding
the risk of future harm).
This Court must therefore consider whether the equitable
relief sought against Brown would be justified, if granted, on the
basis of Defendant’s wrongful conduct--in which case it is penal in
nature--or on the risk of future harm. “To obtain equitable
remedies, the government must demonstrate a ‘reasonable likelihood
of further violation[s] in the future.’” United States v. Philip
Morris USA, Inc., 566 F.3d 1095, 1132, (D.C. Cir. 2009) (quoting
SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1168 (D.C. Cir. 1978));
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see also SEC v. First City Fin. Corp., Ltd., 890 F.2d 1215, 1228
(D.C. Cir. 1989) (applying Savoy Indus. test to SEC action); SEC v.
Bolla, 401 F. Supp. 2d 43, 73-74 (D.D.C. 2005) (same). The courts in
this Circuit therefore must consider “the likelihood that
misconduct will recur,” among other consistent factors, in order to
determine whether injunctive relief or an officer-and-director bar
is merited. SEC v. Johnson, 595 F. Supp. 2d 40, 45 (D.D.C. 2009). The
Second Circuit has similarly made clear that the likelihood of
Defendants’ future misconduct is an “essential” component in
imposing a lifetime bar. SEC v. Patel, 61 F.3d 137, 141, 142 (2d
Cir. 1995); accord SEC v. Levine, 517 F. Supp. 2d 121, 145 (D.D.C.
2007).
Thus, the equitable relief sought by the SEC should only be
granted under this Circuit’s law upon a showing of future risk of
harm. Given this requirement, Johnson’s reasoning--that the
sanctions were punitive in nature because they focused exclusively
on the individual’s past conduct--is inapplicable to this case.
Equitable relief which is granted upon a showing that it is
necessary to prevent future harm to the public is remedial, and not
punitive. Thus, the statute of limitations in § 2462 does not apply
to the equitable relief sought by the SEC. Defendant Brown’s Motion
to Dismiss the claims for injunctive relief and an officer-and-
director bar under § 2462 is therefore denied.
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2. Civil Penalties
The parties do not dispute that the SEC’s claim for civil
penalties, in contrast, is subject to the five-year statute of
limitations in § 2462. Defendants argue that § 2462 therefore
should apply to bar any such claims based on conduct occurring
before July 30, 2004. The SEC counters, however, that these claims
are saved because the statute of limitations in § 2462 is tolled by
the fraudulent concealment doctrine and the continuing violation
doctrine.
a. The Fraudulent Concealment Doctrine
It is well established that, like all federal statutes of
limitation, § 2462 is subject to equitable tolling. Holmberg v.
Armbrecht, 327 U.S. 392, 397, 66 S. Ct. 582, 585, 90 L. Ed. 743
(1946) (equitable tolling “is read into every federal statute of
limitation”); 3M Co. v. Browner, 17 F.3d 1453, 1461 n.15 (D.C. Cir.
1994) (suggesting that doctrine of fraudulent concealment would
apply to § 2462); Fed. Election Comm’n v. Williams, 104 F.3d 237,
240 (9th Cir. 1996) (applying doctrine of fraudulent concealment to
§ 2462); SEC v. Gabelli, No. 08-cv-3868, 2010 WL 1253603, at *6-7
(S.D.N.Y. March 17, 2010) (same).
“To toll the limitations period for fraudulent concealment,
the Commission must demonstrate: (1) that Defendants concealed the
existence of the cause of action; (2) that it did not discover the
alleged wrongdoing until some point within five years of commencing
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this action; and (3) that its continuing ignorance was not
attributable to lack of diligence on its part.” SEC v. Jones, 476
F. Supp. 2d 374, 382 (S.D.N.Y. 2007). Fed. R. Civ. P. 9(b) requires
that a plaintiff “plead with particularity the facts giving rise to
the fraudulent concealment claim and [] establish that [it] used
due diligence in trying to uncover the facts.” Larson v. Northrop
Corp., 21 F.3d 1164, 1173 (D.C. Cir. 1994) (internal quotation and
citation omitted).
The Complaint fails to allege any facts that would establish
that the SEC used due diligence in trying to uncover Defendants’
wrongdoing from 1998 to 2005. More problematically, the Complaint
fails to allege when the SEC discovered the claims; there are no
allegations that the SEC remained ignorant of Prince’s role at
Integral up until five years or less before filing its Complaint.
For these reasons, the Court concludes that the SEC has failed to
adequately plead Defendants’ fraudulent concealment, and the five-
year statute of limitations in § 2462 is not tolled for the civil
penalties claims. See Gabelli, 2010 WL 1253603, at *7 (rejecting
fraudulent concealment doctrine when plaintiff SEC failed to allege
due diligence).
b. The Continuing Violation Doctrine
In the alternative, the SEC argues that the claims barred by
§ 2462 are part of a “continuing, integrated fraudulent scheme”
which ended within the limitations period. Pl.’s Opp’n at 25. In
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other words, the five-year statute of limitations did not begin to
accrue until the scheme ended with the disclosure of Prince’s role
at Integral on August 8, 2006. Id.
Our Court of Appeals has not considered whether the
“continuing violation doctrine,” which originated in the federal
employment discrimination context, applies to claims brought in the
securities fraud context. District courts in the Second and Third
Circuits have indicated great skepticism that it does. In re
Comverse Tech., Inc. Sec. Litig., 543 F. Supp. 2d 134, 155 (E.D.N.Y.
2008) (noting that “[t]he weight of authority in [the Second
Circuit] is skeptical of the application of the continuing
violations doctrine in securities fraud cases”); In re DVI, Inc.
Sec. Litigation, No. 03-cv-5336, 2005 WL 1307959, at *11 (E.D. Pa.
May 31, 2005) (declining to extend continuing violation doctrine to
case brought under securities laws) (unreported opinion); but see
SEC v. Kelly, 663 F. Supp. 2d 276, 287-88 (S.D.N.Y. 2009) (applying
continuing violation doctrine in case brought by SEC).
However, even if the doctrine does apply in the securities
fraud context, there are factual disputes which would determine its
application. For example, the parties disagree as to when the
alleged scheme to conceal Prince’s officer status began, when
Defendant Brown’s obligation to disclose his status arose, and if
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she had such an obligation.3 Discovery has not yet even been
concluded. The Court therefore defers consideration of this issue
until it has the benefit of a more fully developed factual record.
Cf. In re Comverse, 543 F. Supp. 2d at 155 (concluding “it would be
prudent to defer consideration of [the continuing violation
doctrine] issue until the factual record [] is more fully
developed”); SEC v. Schiffer, No. 97-cv-5853, 1998 WL 226101, at *3
(S.D.N.Y. May 5, 1998) (concluding that decision on continuing
violation doctrine issue was premature, given undetermined fact
issues). The Motion to Dismiss the SEC’s claims for civil penalties
based on conduct occurring before 2005 is therefore denied without
prejudice at this time.
B. Regulation S-K’s Look-Back Provision
Until December 23, 2009,4 Item 401(f) of Regulation S-K
required disclosure of injunctions and/or criminal proceedings or
convictions “that occurred during the past five years and that are
material to an evaluation of the ability of any director . . . or
executive officer.” 17 C.F.R. § 229.401(f) (2009). Defendant Brown
argues that any claims included in Counts I-V which allege her
failure to disclose Prince’s conviction and injunction after June
3
This of course would be a material fact in dispute for
the jury to resolve.
4
17 C.F.R. § 229.401(f) was amended on December 23, 2009
to require disclosure of injunctions and/or criminal proceedings or
convictions that occurred during the past ten, as opposed to five,
years. See 17 C.F.R. § 229.401(f) (2010).
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23, 2002--five years after the Commission permanently enjoined
Prince from appearing or practicing before it as an accountant--
must be dismissed because there was no duty to disclose under
Regulation S-K after that date.
The SEC responds that the five-year limitation in Regulation
S-K is irrelevant because the sole test for determining whether
information must be disclosed is whether it is material, i.e.
whether there is “a substantial likelihood that a reasonable
investor would consider it important.” Basic, Inc. v. Levinson, 485
U.S. 224, 231-232, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988). Under the
SEC’s view, if an officer’s legal history remains material to
investors after five years, it must be disclosed regardless of
Regulation S-K’s five-year limitation.
“[N]o authority suggests that Regulation S-K is preemptive of
the materiality requirement.” Degulis v. LXR Biotechnology, Inc.,
928 F. Supp. 1301, 1314 (S.D.N.Y. 1996). The SEC is therefore
correct that the fact that Regulation S-K does not require
disclosure of particular information does not answer whether the
information is material to investors under the securities laws. See
SEC v. Pace, 173 F. Supp. 2d 30, 32-33 (D.D.C. 2001) (illegal
transfer of $36,659.28 to defendant’s personal account “was
material-and had to be disclosed-even if Item 404 [of Regulation S-
K] did not require it”); In re WorldCom, Inc. Sec. Litig., 346
F. Supp. 2d 628, 689 (S.D.N.Y. 2004) (“[N]on-disclosure of an
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underwriter or issuer’s conflicts of interest can constitute
material omissions, even where no regulation expressly compels the
disclosure of such conflicts.”).
However, the SEC’s argument does not answer the issue raised
by Brown. Putting aside materiality, there is no general duty to
disclose all material information under the securities laws. Basic,
Inc. v. Levinson, 485 U.S. at 239 (“Silence, absent a duty to
disclose, is not misleading . . . .”); Chiarella v. United States,
445 U.S. 222, 235, 100 S. Ct. 1108, 1118, 63 L. Ed. 2d 348 (1980).
However, corporate officers such as Defendant Brown do have a
duty to disclose material information when required by a specific
rule or regulation or “when silence would make other statements
misleading or false.” In re XM Satellite Radio Holdings Sec.
Litig., 479 F. Supp. 2d 165, 178 (D.D.C. 2007) (citation and internal
quotations omitted). In the latter case, “[t]he touchstone of the
inquiry is . . . whether defendants’ representations or omissions,
considered together and in context, would affect the total mix of
information and thereby mislead a reasonable investor . . . .” Id.
(citation and internal quotations omitted).
Although Item 401 of Regulation S-K did not impose a duty on
Defendant Brown to disclose Prince’s legal background after June
23, 2002, it is certainly possible that the omission could have
affected the “total mix of information” in Integral’s filings,
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rendering them misleading and giving rise to a duty to disclose.5
In fact, the SEC’s Complaint alleges just this, and for purposes of
a Motion to Dismiss, these allegations must be deemed true. Compl.
¶¶ 40-57. Defendant Brown did not address this issue, but instead
assumed that Regulation S-K was the only potential source of a duty
to disclose Prince’s legal background. Consequently, the Motion to
Dismiss on the basis of Item 401 of Regulation S-K is denied.
C. Void for Vagueness
Defendant Brown next argues that the Complaint should be
dismissed in its entirety because the definition of “officer,”
which lies at the heart of the SEC’s allegations that Defendants
concealed Prince’s officer status, is an unconstitutionally vague
term. A rule is unconstitutionally vague when “men [sic] of common
intelligence must necessarily guess at its meaning.” Broadrick v.
Oklahoma, 413 U.S. 601, 607, 93 S. Ct. 2908, 2913, 37 L. Ed. 2d 830
(1973). If the rule is an economic regulation or if it includes a
scienter requirement, the Court’s review is less strict. Village of
5
For this reason, United States v. Yeaman, 987 F. Supp. 373
(E.D. Pa. 1993), relied upon by the Defendant, is distinguishable.
In Yeaman, the court concluded that the defendant had no duty to
disclose his legal background in filings with the SEC because Item
401 of Regulation S-K did not require it. Id. at 384-85. However,
the Court did not consider whether the omission rendered the
defendant’s filings misleading. In addition, because Yeaman
involved a criminal prosecution, the Court rested its conclusion in
part on the need for notice to the defendant of a duty to disclose
in order to satisfy due process.
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Hoffman Estates v. Flipside, Hoffman Estates, Inc., 455 U.S. 489,
498, 102 S. Ct. 1186, 1193, 71 L. Ed. 2d 362 (1982).
As the SEC points out, the terms “officer” and “executive
officer” are defined in Exchange Act Rules 3b-2 and 3b-7. “Officer”
means “a president, vice president, secretary, treasurer or
principal financial officer, comptroller, or principal accounting
officer, and any person routinely performing corresponding
functions with respect to any organization . . . .” 17 C.F.R. §
240.3b-2. “Executive Officer” means a registrant’s “president, any
vice president . . . in charge of a principal business unit,
division, or function (such as sales, administration, or finance),
and any other officer who performs a policy making function or any
other person who performs similar policy making functions for the
registrant.” 17 C.F.R. § 240.3b-7.
Courts regularly rely on these definitions to determine
whether an individual acted as a de facto officer of a company.
See, e.g., C.R.A. Realty Corp. v. Crotty, 878 F.2d 562, 565 (2d.
Cir. 1989); SEC v. Solucorp, 274 F. Supp. 2d 379, 420 (S.D.N.Y.
2003). While an individual’s title is relevant to the question of
whether he or she was an officer, courts must look to the facts of
each situation and determine whether the defendant “exercise[d] the
executive responsibilities traditionally associated with corporate
officers.” United States v. Jensen, 537 F. Supp. 2d 1069, 1081 (N.D.
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Cal. 2008), vacated on other grounds, United States v. Reyes, 577
F.3d 1069 (9th Cir. 2009).
Given this case-by-case approach, it is not surprising that
the SEC, as Defendant Brown points out, has refused to clarify
whether certain corporate positions such as general counsel
categorically fall within the definition of “officer.” See Def.
Brown’s Mot. to Dismiss at 12. However, this refusal does not mean
that the term lacks any standard at all. Village of Hoffman
Estates, 455 U.S. at 495 n.7 (vagueness challenges not raising
First Amendment issues must prove that no standard of conduct is
specified at all). Given the expansive definitions set forth in
Rules 3b-2 and 3b-7, the Court is not persuaded that corporate
officers like Defendant Brown must guess at the meaning of the term
“officer.”
Moreover, with the exception of Count I, all of the claims in
the Complaint include a scienter requirement. Aaron v. SEC, 446
U.S. 680, 691, 100 S. Ct. 1945, 1953, 64 L. Ed. 2d 611 (1980)
(scienter required for § 10b and Rule 10b-5 claims); SEC v.
Treadway, 430 F. Supp. 2d 293, 323 (S.D.N.Y. 2006) (knowledge
required in aiding and abetting claims); 15 U.S.C. § 7241(a)(1),
(2), (3) (requiring certification from officers that, based on
their knowledge, no material omissions were made in annual
reports). Because the SEC must prove that Brown either knew or was
reckless with regard to Prince’s officer status, the danger of
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imposing liability in the absence of notice of what constitutes an
“officer” is minimal. Finally, the securities laws are economic in
nature, which means they are subject to a less strict vagueness
test because the “subject matter is [] more narrow, and because
businesses, which face economic demands to plan behavior carefully,
can be expected to consult relevant legislation in advance of
action.” Village of Hoffman Estates, 455 U.S. at 498. For these
reasons, Defendant Brown’s Motion to Dismiss the Complaint on the
ground that “officer” is void for vagueness is denied.
D. Failure to Plead Fraud with Particularity Under Rule 9(b)
Defendant Brown argues that the Complaint fails to satisfy
Rule 9(b)’s heightened pleading requirement because it: (1) does
not allege Prince’s role as an executive officer by demonstrating
that he performed a policy making function similar to those
performed by Integral’s president or vice president in charge of a
principal business unit, division, or function; (2) does not state
when Prince became an executive officer at Integral, beyond stating
that it was after 1998; and (3) does not specify which of Prince’s
alleged job responsibilities “caused him to cross the threshold
from non-officer to executive officer.” Def. Brown’s Mot. at 7-11.
As noted earlier, a complaint alleging fraud must “state the
time, place, and content of the false representations, the fact
misrepresented and what was retained or given up as a consequence
of the fraud[,] ... and identify individuals allegedly involved in
-20-
the fraud.” See U.S. ex rel. Williams v. Martin-Baker Aircraft Co.,
389 F.3d 1251, 1256 (D.C. Cir. 2004) (citing Kowal v. MCI Comms.
Corp., 16 F.3d 1271, 1278 (D.C. Cir. 1994)). Specifically,
[a] complaint alleging securities fraud
complies with Rule 9(b) if it sets forth (1)
precisely what statements were made in what
documents or oral representations or what
omissions were made and (2) the time and place
of each such statement and the person
responsible for making (or, in the case of
omissions, not making) same, and (3) the
content of such statements and the manner in
which they misled the plaintiff, and (4) what
the defendants obtained as a consequence of
the fraud.
Burman v. Phoenix Worldwide Industries, Inc., 384 F. Supp. 2d 316,
328 (D.D.C. 2005) (citation omitted).
The Complaint alleges that Defendant Brown concealed Prince’s
“role and involvement in the company” “[f]or over seven years, from
approximately December 1998 through August 2006.” Compl. ¶ 1. The
alleged false representations--the failure to disclose Prince’s
officer status--were made in “seven annual reports” from 1999
through mid-2006 filed with the SEC on Forms 10-K or 10-KSB and
“seven proxy statements” filed by Integral Systems from 2000
through mid-2006. Each of these filings, with the exception of the
1999 10-KSB, were allegedly reviewed and signed by Defendant Brown.
Id. ¶¶ 32-35; see also Howard v. Everex Sys., Inc., 228 F.3d 1057,
1061-62 (9th Cir. 2000) (allegation that corporate officer signed
periodic filing containing misstatements with scienter suffices to
plead liability as a primary violator of § 10(b)). Thus, the
-21-
Complaint sufficiently alleges what omissions were made and the
time, place, and persons responsible for the omissions.
Next, the Complaint adequately pleads the way in which the
alleged omissions misled the SEC, namely by concealing Prince’s
role as a de facto officer of the company from 1998 through 2006.
The SEC alleges that, after being re-hired in 1998, Prince “became
one of Chamberlain’s closest advisors, preparing recommendations
concerning annual salary increases and bonuses for all senior
managers,” as well as a member of a policy-setting group “of the
most senior executive officers at Integral Systems, known at
various times as the ‘Group of Six’ (‘G-6’) and ‘Group of Seven’
(or ‘G-7’).” Id. ¶ 23. He reported directly to the Chief Executive
Officer of Integral Systems, appeared at the Executive Vice
President level on internal organizational charts, and his office
was located in the same area as company officers holding official
titles. Id. ¶ 24.
In addition, the Complaint alleges that Prince was put in
charge of Integral System’s mergers and acquisitions program after
being rehired. That position involved operational decision-making
and a role as Director of Integral Systems’s acquisition vehicle,
ISI Merger Corporation, and a role as Chairman of the Board of
Newpoint Technologies, Inc., an Integral Systems subsidiary. The
Complaint further alleges that Prince regularly attended board of
director meetings from 2000 to 2006, and that he became head of the
-22-
Contracts Department in 2005. Id. ¶¶ 26-27. Finally, the Complaint
alleges that Prince’s compensation was equal to that of the top
officers holding official titles at Integral Systems from 1999
through 2005. Id. ¶ 28.
Given these allegations, the Court concludes that the
Complaint adequately pleads sufficient facts to put Defendants on
notice of the SEC’s claims. While Defendant Brown may question
whether the SEC will ultimately carry its burden to prove that
Prince acted as an officer of Integral Systems throughout the
period from 1998 until 2006, that will be for a jury to decide. “To
comply with the requirements of Rule 9(b), a plaintiff does not
need to recite the evidence or plead detailed evidentiary matters.”
McQueen v. Woodstream Corp., 248 F.R.D. 73, 78 (D.D.C. 2008)
(internal quotation and citation omitted). Defendant Brown’s Motion
to Dismiss Counts I and II under Rule 9(b) is therefore denied.
E. Failure to State a Claim for Relief Under Rule 12(b)(6)
Defendant Brown makes three arguments under Rule 12(b)(6).
First, she argues that Count I fails to state a claim for
violations of § 17(a) of the Securities Act, 15 U.S.C. § 77q(a),
because it fails to allege that an offer or sale of securities ever
occurred. Second, Brown argues that Count IV, which alleges
violations of Exchange Act Rule 13a-14, 17 C.F.R. § 240.13a-14,
fails to state a claim because the Rule does not set forth an
independent cause of action. Finally, Brown argues that Count V,
-23-
alleging violations of Exchange Act § 14(a) and Rule 14a-9, fails
to allege essential elements of these claims.
In his Motion to Dismiss, Defendant Prince argues that Counts
I and II should be dismissed because the SEC has failed to allege
sufficient facts to establish his primary liability.
1. Count I, Alleging Violations of Section 17(a)
Defendant Brown argues that Count I fails to state a claim for
violations of § 17(a) of the Securities Act, 15 U.S.C. § 77q(a),
because it fails to allege that an offer or sale of securities ever
occurred. Section 17(a) provides that:
It shall be unlawful for any person in the
offer or sale of any securities . . . by the
use of any means or instruments of
transportation or communication in interstate
commerce or by the use of the mails, directly
or indirectly
(1) to employ any device, scheme, or
artifice to defraud, or
(2) to obtain money or property by
means of any untrue statement of a
material fact or any omission to
state a material fact necessary in
order to make the statements made,
in the light of the circumstances
under which they were made, not
misleading, or
(3) to engage in any transaction,
practice, or course of business
which operates or would operate as a
fraud or deceit upon the purchaser.
15 U.S.C. § 77q(a) (emphasis added).
The Supreme Court has instructed that the “offer or sale”
requirement should be construed broadly so as to encompass fraud in
any part of the selling process. See United States v. Naftalin, 441
-24-
U.S. 768, 772-73, 99 S. Ct. 2077, 2081, 60 L. Ed. 2d 624 (1979). As a
result, “Section 17(a) has been broadly construed to encompass a
wide range of conduct.” SEC v. Softpoint, Inc., 958 F. Supp. 846,
861 (S.D.N.Y. 1997) (collecting cases). Such conduct typically
involves omissions and misstatements made in securities
registration statements. See, e.g., SEC v. Leffers, 289 Fed. Appx.
449, 451 (2d Cir. 2008). However, at least one district court has
ruled that misstatements made in periodic filings, such as those
underlying the SEC’s claims in this case, suffice to state a claim
under § 17(a) “where the company’s securities are sold and
purchased throughout the period at issue.” SEC v. Goldsworthy, No.
06-cv-10012, Slip Op. at 19 (D. Mass. June 11, 2008).6
The SEC has failed to cite, and this Court has failed to
identify, any precedent holding that a complaint may properly state
a claim under § 17(a) when it fails to allege that an offer or sale
6
The SEC relies on SEC v. Power, 525 F. Supp. 2d 415, 419-20
(S.D.N.Y. 2007), which states that “[a] public company and its
management may violate [§ 17(a)] by making a material misstatement
in, or omitting material information from, a periodic report,
registration statement, or other filing with the Commission.” This
statement simply does not address the precise issue here, which is
whether the mere filing of a required document with the SEC
suffices to state a claim under § 17(a) absent a showing that
securities were offered and sold in the same period. This omission
is understandable, given that the issue was not raised in that
case: the defendant in Power challenged the SEC’s § 17(a) claim on
the basis that the government had failed to allege scienter or his
personal involvement in the fraud, and not on the ground that no
offer or sale was alleged. Moreover, Power’s sole citation in
support of this statement is Softpoint, 958 F. Supp. at 823-24, but
Softpoint only discusses misstatements in registration statements,
not periodic filings.
-25-
of securities ever occurred. See Naftalin, 441 U.S. at 772-73
(determining first that an offer or sale had occurred before
considering whether defendant’s fraud was “in” the offer or sale).
The Complaint alleges only that Defendants made material omissions
in seven annual reports and seven proxy statements, and that
Integral Systems is a public company whose stock is traded on the
public markets. Compl. ¶ 17. In the absence of any allegation that
there was an offer or sale of Integral Systems’s securities in the
period between 1998 and 2006, during which the alleged fraud
occurred, Count I fails to state a claim under § 17(a). Defendant
Brown’s Motion to Dismiss Count I is therefore granted.
2. Count IV, Alleging Violations of Exchange Act Rule
13a-14, 17 C.F.R. § 240.13a-14
Defendant Brown next argues that Count IV, which alleges
violations of Exchange Act Rule 13a-14, 17 C.F.R. § 240.13a-14,
fails to state a claim for relief because Rule 13a-14 does not set
forth an independent cause of action. Brown relies first upon the
language of Rule 13a-14, which states that “[e]ach report . . .
filed on . . . Form 10-K . . . must include certifications in the
form specified in the applicable exhibit filing requirements of
such report . . . [and] [e]ach principal executive and principal
financial officer of the issuer . . . must sign a certification.”7
7
The certification must state that “[b]ased on [the
certifying individual’s] knowledge, the report does not contain any
untrue statement of a material fact or omit to state a material
(continued...)
-26-
This language, Brown argues, does not prohibit or otherwise
regulate individual conduct, and so it cannot be interpreted as
establishing a separate cause of action. However, the Rule requires
certain executives and officers to sign a certification, which
quite clearly imposes a requirement on those individuals.
Second, Brown relies on an unreported opinion, SEC v. Black,
No. 04-cv-7377, 2008 WL 4394891, at *16-17 (N.D. Ill. Sept. 24,
2008), which held that Rule 13a-14 does not establish a separate
cause of action in an SEC enforcement proceeding. No courts appear
to have followed Black’s logic or holding; indeed, SEC claims
brought under Rule 13a-14 are routinely permitted. See, e.g., SEC
v. Stanard, No. 06-cv-7736, 2009 WL 196023, at *28 (S.D.N.Y. Jan.
27, 2009) (unreported opinion); SEC v. Brady, No. 05-cv-1416, 2006
WL 1310320, at *5 (N.D. Tex. May 12, 2006) (unreported opinion);
SEC v. Sandifur, No. 05-cv-1631C, 2006 WL 538210, at *8 (W.D. Wash.
Mar. 2, 2006) (unreported opinion); but see SEC v. Retail Pro,
Inc., 673 F. Supp. 2d 1108, 1143 n.8 (S.D. Cal. 2009) (citing Black
as evidence of a “conflict among courts at to whether a violation
of the certification requirement of Rule 13a-14 supports a separate
cause of action,” which it declined to address).
7
(...continued)
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by the report.” 15 U.S.C. §
7241(a)(1), (2), (3).
-27-
In its discussion of Rule 13a-14, the Black court appears to
have viewed the issue of whether the SEC may bring a claim under
the Rule as analytically identical to the issue of whether a
private plaintiff has an independent cause of action. The only
caselaw relied on as authority for the court’s holding consisted of
two rulings that there was no right of action under Rule 13a-14 for
claims brought by private investors.8 See Black, 2008 WL 4394891,
at *16 (relying upon In re Intelligroup Sec. Litig., 468 F. Supp. 2d
670, 706-07 (D.N.J. 2006), and In re Silicon Storage Tech., Inc.,
Sec. Litig., No. C-05-0295, 2007 WL 760535 (N.D. Cal. Mar. 9, 2007)
(unreported opinion)). However, the securities laws raise
“distinct” statutory interpretation questions in private actions.
See, e.g., SEC v. Kelly, 545 F. Supp. 2d 808, 813 (N.D. Ill. 2008).
Black does not address whether § 21(d)(1) of the Exchange Act,
15 U.S.C. § 78u(d)(1), enables the SEC to bring a claim under Rule
13a-14. Section 21(d)(1) authorizes the Commission to bring an
action in a United States District Court “to enjoin” any “acts or
practices constituting a violation of any provision of this title
8
The Black court also relied on the SEC’s press release
accompanying the final rule, which stated that “[a]n officer
providing a false certification potentially could be subject to
Commission action for violating Section 13(a) or 15(d) of the
Exchange Act and to both Commission and private actions for
violating Section 10(b) of the Exchange Act and Exchange Act Rule
10b-5,” but not under Rule 13a-14 itself. See Black, 2008 WL
4394891, at *16; SEC Release No. 34-46427, 2002 WL 3170215, at *9
(Aug. 28, 2002). The Court is not persuaded that this one sentence
in a press release forecloses the possibility of an independent
cause of action under Rule 13a-14.
-28-
[or] the rules or regulations thereunder.” 15 U.S.C. § 78u(d)(1);
see also SEC v. Johnson, 595 F. Supp. 2d at 43 (discussing authority
to enjoin violations of securities laws under 15 U.S.C. §
78u(d)(1)). In light of this specific statutory authority, the
Court concludes that the SEC’s claim to enforce Rule 13a-14 states
a valid cause of action. Defendant Brown’s Motion to Dismiss Count
IV under Rule 12(b)(6) is therefore denied.
3. Count V, Alleging Violations of Exchange Act §
14(a) and Rule 14a-9
Defendant Brown next contends that Count V, which alleges that
she aided and abetted violations of Exchange Act § 14(a) and Rule
14a-9, should be dismissed under Rule 12(b)(6) for failure to
allege necessary elements of the claims. Section 14(a) makes it
unlawful “for any person . . . in contravention of such rules and
regulations as the Commission may prescribe as necessary or
appropriate in the public interest or for the protection of
investors, to solicit or to permit the use of his name to solicit
any proxy . . . .” 15 U.S.C. § 78n(a). Rule 14a-9 states that “no
solicitation subject to this regulation shall be made by means of
any proxy statement . . . containing any statement which, at the
time and in the light of the circumstances under which it is made,
is false or misleading with respect to any material fact, or which
omits to state any material fact necessary in order to make the
statements therein not false or misleading.” 17 C.F.R. § 240.14a-9.
Count V alleges that Brown and Prince aided and abetted violations
-29-
of § 14(a) and Rule 14a-9 when they prepared, reviewed, and
approved materials in seven proxy statements filed by Integral
Systems between March 2000 and March 2006 which failed to disclose
Prince as an executive officer.
First, Brown argues that the SEC has failed to allege (1) an
essential link between the purpose of the proxy statements and the
alleged omission and (2) that the omission was material.9 Second,
Brown argues that the SEC has failed to allege which material
information concerning Prince was omitted from the proxy
statements, as well as which materials Brown prepared, reviewed,
and approved. Def. Brown’s Mot. to Dismiss at 31-32; Compl. ¶ 35.
It is well settled that a private plaintiff bringing a claim
under § 14(a) or Rule 14a-9 must allege that “(1) a proxy statement
contained a material misrepresentation or omission which (2) caused
the plaintiff injury and (3) that the proxy solicitation . . . was
an essential link in the accomplishment of the transaction.”10
9
Brown relies on the arguments advanced in Defendant
Chamberlain’s Motion to Dismiss. As noted earlier, Defendant
Chamberlain was dismissed as a party in this case on February 18,
2010. Although Chamberlain’s Motion to Dismiss was denied as moot
by minute order dated August 11, 2010, the Court will consider the
arguments concerning Count V in deciding Brown’s Motion to Dismiss.
See Def. Chamberlain’s Mot. to Dismiss at 13-20 [Dkt. No. 11].
10
No court appears to have addressed the specific issue of
whether the SEC, as opposed to a private plaintiff, must prove
injury when bringing a § 14(a) claim. The SEC argues that it is not
required to do so because its enforcement actions are meant to
protect the public interest in enforcing the securities laws, and
so a showing of reliance or injury to private individuals is
(continued...)
-30-
Bender v. Jordan, 439 F. Supp. 2d 139, 163 (D.D.C. 2006). Brown
argues that the facts pled do not allege an “essential link”
between the alleged misrepresentation or omission and “the subject
of the proxy solicitation.” Def. Chamberlain’s Reply at 8; see also
Def. Chamberlain’s Mot. to Dismiss at 14-15 (“There must be a clear
connection, that is - an ‘essential link’ between the alleged fraud
in the proxy statement and the corporate transaction authorized by
the proxy solicitation.”); Def. Brown’s Mot. to Dismiss at 32
(describing argument as concerning “the lack of an essential link
between the purpose of a proxy and the alleged omission”).
As the Supreme Court has explained, “[s]o long as the
misstatement or omission was material, the causal relation between
violation and injury is sufficiently established . . . if ‘the
10
(...continued)
“legally irrelevant.” Berko v. SEC, 316 F.2d 137, 143 (2d Cir.
1963) (finding reliance and injury to private shareholders “legally
irrelevant” to Commission’s Section 10(b) claim); see also United
States v. Haddy, 143 F.3d 542 (3d Cir. 1998) (concluding that
securities laws did not require proof of reliance in § 10b action
brought by government); SEC v. Lucent Techs., Inc., 610 F. Supp. 2d
349, 349 (D.N.J. 2009) (“Unlike a private litigant, the SEC need
not prove either reliance or damages” in a § 10b and Rule 10b-5
action).
In response, Defendant Brown relies on two cases in which
courts applied the test for private actions brought under § 14(a)
and Rule 14a-9 to actions brought by the Commission. Def.
Chamberlain’s Reply at 9 (citing SEC v. Mercury Interactive LLC,
No. C 07-2822, 2009 WL 2984769 (N.D. Cal. Sept. 15, 2009), and
Black, 2008 WL 4394891, at *13). However, both Mercury and Black
assumed without question that the elements for proxy violations
applied in private actions would apply equally in actions brought
by the SEC. As discussed, the question whether the SEC must prove
injury in a § 14(a) action is not actually raised by Brown, and so
it is not considered.
-31-
proxy solicitation itself . . . was an essential link in the
accomplishment of the transaction.’” TSC Industries, Inc. v.
Northway, Inc., 426 U.S. 438, 444, 96 S. Ct. 2126, 2130, 48 L. Ed. 2d
757 (1976) (quoting Mills v. Electric Auto-Lite Co., 396 U.S. 375,
385, 90 S. Ct. 616, 622, 24 L. Ed. 2d 593 (1970)). Thus, in a private
action, the essential link element requires a causal connection
between the proxy solicitation and the transaction that resulted in
injury to the plaintiff. However, Defendant Brown does not argue
that the Complaint fails to allege this causal connection. Instead,
Brown incorrectly characterizes the connection between the alleged
fraud and the subject of the proxy solicitation, which is the focus
of her argument, as a required showing under the essential link
element. In reality, the connection between the alleged omission
and the subject or purpose of the proxy solicitation is essentially
a question of materiality.
Brown’s first argument is therefore reduced to the single
question of whether the SEC has pled sufficient facts that the
omission was material to the transactions which were the subject of
the proxy solicitations. Under § 14(a), “[a]n omitted fact is
material if there is a substantial likelihood that a reasonable
shareholder would consider it important in deciding how to vote” on
the proxy solicitation. Id. at 449. Under Rule 12(b)(6), a
complaint may not be dismissed on the ground that the alleged
omission is not material “unless [it is] so obviously unimportant
-32-
to a reasonable investor that reasonable minds could not differ on
the question of [its] importance.” Ganino v. Citizens Utility Co.,
228 F.3d 154, 162 (2d Cir. 2000) (citation omitted).
The Complaint alleges that “[f]rom 2000 through mid-2006,
Integral Systems filed seven proxy statements to give notice of
Integral Systems’s annual meetings and to solicit for the election
of directors.” Compl. ¶ 35. Certainly, reasonable minds could
differ as to whether Prince’s officer status and legal background
is “obviously unimportant” to shareholders who must decide whether
or not to vote for Chamberlain or other directors involved in the
decision to re-hire him.11 Ganino, 228 F.3d at 162. The Court is
therefore satisfied that Count V alleges a material omission under
§ 14(a) and Rule 14a-9.
Next, Brown argues that the SEC fails to allege specific facts
in Count V regarding her role in aiding and abetting the alleged
violations of § 14(a) and Rule 14a-9. The Complaint states that
11
Brown relies on In re Browning-Ferris Industries
Shareholder Derivative Litigation, 830 F. Supp. 361, 370 (S.D. Tex.
1993), which held that the prior criminal investigation of a
corporate officer was not material to a proxy soliciting an
election for the board of directors because there was no indictment
or criminal conviction. In this case, Prince was convicted in a
criminal proceeding. Brown’s reliance on a separate portion of the
opinion holding that pending civil lawsuits against directors
facing re-election were not material because the lawsuits were not
brought against those specific directors is distinguishable from
the facts of this case. Moreover, the Browning-Ferris court also
ruled that plaintiffs failed to allege any relationship between the
pending civil lawsuits and the directors elected to the board
during the relevant period of time. Id. at 367.
-33-
“Defendant[] Brown [] prepared, reviewed, and approved materials in
the proxy statements, including the incorporated periodic reports,
knowing that they did not identify Prince or disclose any of the
required information concerning him,” thereby providing
“substantial assistance to . . . Integral Systems’s and
Chamberlain’s violations of Section 14 and Exchange Act Rule 14a-
9.” Compl. ¶ 57. Brown’s argument is that this allegation (1) fails
to specify which information concerning Prince was required; (2)
fails to specify which materials were prepared, reviewed, and
approved by Brown; and (3) erroneously states that the periodic
reports were incorporated into the proxy statements, when in fact
they were merely included with them.
Liability for aiding and abetting a violation of the
securities laws requires proof of “(1) a securities violation by a
primary wrongdoer; (2) knowledge of the violation by the aider and
abettor; and (3) substantial assistance by the aider and abettor in
the primary violation.” Treadway, 430 F. Supp. 2d at 323; see also
SEC v. DiBella, 587 F.3d 553, 565 (2d. Cir. 2009). Even assuming
that the periodic reports were not incorporated into the proxy
statements, the allegations in Count V specify that certain
information regarding Prince, including his identity, were material
and therefore were required to be disclosed in the proxy
statements, and that Defendant Brown prepared, reviewed, and
approved materials for use in the proxy statements with the
-34-
knowledge that this required information was omitted. This suffices
to state a claim for aiding and abetting violations of § 14(a) and
Rule 14a-9. Defendant Brown’s Motion to Dismiss Count V is
therefore denied.
4. Failure to State a Claim for Primary Liability
Finally, Defendant Prince moves to dismiss Counts I and II
against him on the basis that the SEC has failed to allege his
primary liability for violations of the securities laws. Because
Count I, alleging violations of § 17(a), is dismissed in its
entirety for failure to allege that an offer or sale of Integral
Systems’s securities ever occurred, the Court will only consider
Defendant Prince’s arguments as they relate to Count II, alleging
violations of § 10(b) and Rule 10b-5.
Section 10(b) “prohibits only the making of a material
misstatement (or omission) or the commission of a manipulative
act”; it does not provide a cause of action against those who only
aid and abet such acts.12 Central Bank of Denver, N.A. v. First
Interstate Bank of Denver, N.A., 511 U.S. 164, 177, 114 S. Ct. 1439,
12
The SEC could have brought an action against Prince as a
secondary actor for aiding and abetting violations of § 10b and
Rule 10b-5 under 15 U.S.C. § 78t(e). See Stoneridge Inv. Partners,
LLC v. Scientific-Atlanta, 552 U.S. 148, 166, 128 S. Ct. 761, 773-
74, 169 L. Ed. 2d 627 (2008) (discussing SEC’s power to enforce
securities laws against secondary actors). However, it failed to do
so; Count II only alleges primary violations of § 10b and Rule 10b-
5. Compl. ¶¶ 43-45.
-35-
1448, 128 L. Ed. 2d 119 (1994). Primary liability under § 10(b) may
be found for any person who:
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce or of the mails, or of any facility
of any national securities exchange ... use[s]
or employ[s], in connection with the purchase
or sale of any security ... any manipulative
or deceptive device or contrivance in
contravention of such rules and regulations as
the Commission may prescribe as necessary or
appropriate in the public interest or for the
protection of investors.
15 U.S.C. § 78j. On the basis of this statute, the SEC promulgated
Rule 10b-5, which makes it unlawful for:
any person, directly or indirectly, . . . (a)
[t]o employ any device, scheme, or artifice to
defraud, (b) [t]o make any untrue statement of
a material fact or to omit to state a material
fact necessary in order to make the statements
made, in the light of the circumstances under
which they were made, not misleading, or (c)
[t]o engage in any act, practice, or course of
business which operates or would operate 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.
First, Prince argues that any claim under Rule 10b-5(b) must
fail because the Complaint fails to allege that he “made” any
material misstatement or omission or, alternatively, that he had a
duty to disclose or clarify any alleged material omission made by
Integral Systems. Second, Prince argues that the Complaint fails to
state a claim for “scheme liability” under Rule 10b-5(a) and (c)
-36-
because there are no allegations that Prince committed any
manipulative or deceptive acts.
a. Rule 10b-5(b)
The Complaint alleges that Prince was responsible for drafting
and preparing the Management Discussion and Analysis section of
Integral Systems’s periodic reports filed with the SEC, addressing
the company’s financial results for that period. Compl. ¶ 39.
Prince is also alleged to have created and prepared internal
quarterly financial results and forecasts which were incorporated
into the periodic reports. Id. Finally, Prince allegedly reviewed,
commented on, and approved Integral Systems’s draft annual reports
and proxy statements. Id. ¶ 35. Prince argues that these
allegations fail to state a claim for primary liability under Rule
10b-5(b) because they do not show (1) that he made any material
misstatement or omission or (2) that he had a duty to disclose or
clarify any material omission by Integral.
Three tests for primary liability have emerged in different
circuits. The “bright-line approach” is the most demanding of the
three approaches. See SEC v. May, 648 F. Supp. 2d 70, 77 (D.D.C.
2009) (discussing approaches to primary liability under securities
laws). Under the bright-line approach, a defendant in a private
action may be held primarily liable under § 10b and Rule 10b-5 only
if he or she actually makes a false or misleading statement and the
statement is attributed to the defendant at the time of its
-37-
dissemination. Id. The least demanding approach is called the
“substantial participation” approach, which requires a showing that
a defendant substantially participated or was intricately involved
in making a material misstatement or omission. See Howard v. Everex
Sys., Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000). The middle
approach--called the “creation” test--requires a secondary actor to
have “created” the misrepresentation or omission. SEC v. Wolfson,
539 F.3d 1249, 1259 n.16 (10th Cir. 2008). This Circuit has not yet
adopted one of the three approaches to primary liability for the
securities laws.
Prince urges this Court to adopt the “bright-line” approach to
determining primary liability, which, as noted, is the strictest of
the three approaches. See Wright v. Ernst & Young, LLP, 152 F.3d
169, 175 (2d Cir. 1998). Prince argues that, under the “bright-
line” approach, the SEC must plead that Prince made a statement or
omission, and that the statement or omission was attributed to him
at the time of its dissemination to the public.
Attribution is required under the “bright-line” approach in
private actions because a private plaintiff, unlike the SEC, must
prove that he or she relied on the defendant’s statements in order
to state a claim. See id. at 175; May, 648 F. Supp. 2d at 77. The
Second Circuit, which introduced the attribution requirement, has
not directly addressed whether it should apply in actions brought
by the SEC. However, other Circuits have rejected the attribution
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requirement in SEC actions as irrelevant because reliance need not
be proven. See, e.g., SEC v. Tambone, 597 F.3d 436, 447 n.9 (1st
Cir. 2010); Wolfson, 539 F.3d at 1260.
In addition, as the SEC points out, even the Second Circuit
has not consistently required in suits by a private plaintiff that
misstatements be attributed to the defendant for primary liability
to attach. See, e.g., In re Scholastic Corp. Sec. Litig., 252 F.3d
63, 75-76 (2d Cir. 2001) (finding primary liability for corporate
insider who was “involved in drafting, producing, reviewing and/or
disseminating of the false and misleading statements,” even though
statements not specifically attributed to him).
However, district courts in the Second Circuit have directly
addressed the issue, and have rejected the attribution requirement
in actions brought by the SEC. In one such case, the court
explained that “in an SEC enforcement action, there appears to be
no reason to impose a requirement that a misstatement have been
publicly attributed to a defendant for liability to attach, at
least so long as the SEC is able to show that the defendant was
sufficiently responsible for the statement--in effect, caused the
statement to be made--and knew or had reason to know that the
statement would be disseminated to investors.” SEC v. KPMG, LLP,
412 F. Supp. 2d 349, 375 (S.D.N.Y. 2006); see also SEC v. Richitelli,
No. 3:09-cv-361, 2010 WL 2802911, at *5 (D. Conn. July 12, 2010);
SEC v. Collins & Aikman Corp., 524 F. Supp. 2d 477, 490 (S.D.N.Y.
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2007); SEC v. Forman, No. 07-cv-11151, 2008 WL 2704554, at *2 n.3
(D. Mass. July 7, 2008) (unreported opinion); SEC v. Hopper, No.
Civ.A. H-04--1054, 2006 WL 778640, at *9 (S.D. Tex. March 24, 2006)
(unreported opinion).
Thus, the majority of courts which have directly addressed the
issue have concluded that attribution is not required under the
“bright-line” approach in actions brought by the SEC.13 Even
assuming the application of the strictest approach is proper, the
SEC, as plaintiff, need only show that Prince was sufficiently
responsible for the statement and knew or had reason to know the
statement would be disseminated to investors. KPMG, LLP, 412
F. Supp. 2d at 375.
As discussed above, the Complaint alleges that Prince was
responsible for drafting and preparing portions of Integral
Systems’s periodic reports dealing with the company’s financial
results and forecasts, and that he also reviewed, commented on, and
approved the company’s draft annual reports and proxy statements.
Compl. ¶¶ 35, 39. Prince correctly argues that the allegations that
13
The only exception cited by Prince is Lucent
Technologies, 610 F. Supp. 2d 342. However, the court in Lucent
Technologies was tasked with determining whether it should depart
from the law of the case by rejecting the attribution requirement,
which it had previously applied in the case at bar. The court
ultimately refused to impose primary liability for violations of
the securities laws on the basis that the defendants did not draft
or sign the filings, and so could not be said to have “made” the
misstatements allegedly contained within them. Lucent Techs., 610
F. Supp. 2d at 355-58.
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he prepared or drafted Integral Systems’s internal financial
results and forecasts fail to state a claim for primary liability,
even if those forecasts were later incorporated into the company’s
periodic filings, because the SEC does not allege that there were
any misstatements concerning the company’s finances. Prince’s Mot.
to Dismiss at 11.
However, the Complaint also alleges that Prince generally
reviewed, commented on, and approved Integral Systems’s periodic
filings and proxy statements but failed to correct the omission of
his status as an officer of the company and of his holdings and
transactions in the company’s securities. This allegation, if
proven, would establish that Prince was sufficiently responsible
for the omission14 under the “bright-line” approach. Because the
allegations state a claim under the “bright-line” approach, which
requires a showing that the defendant actually made a statement or
14
In SEC v. Berry, 580 F. Supp. 2d 911, 922 (N.D. Cal. 2008),
the district court found similar conclusory pleadings that the
defendant corporate officer “reviewed,” “discussed,” and
“finalized” various filings insufficient to plead primary liability
for the defendant’s role in the misstatement made in the filings.
In this case, however, the SEC alleges that Prince “approved”
Integral Systems’s periodic filings despite the omissions contained
therein, in addition to merely reviewing and commenting on them.
This additional allegation indicates more substantial
responsibility for preparing the filings. See id. (recognizing that
substantial involvement in preparing a fraudulent statement
supports a claim for securities fraud); cf. Howard v. Everex
Systems, Inc., 228 F.3d 1057, 1061 (9th Cir. 2000) (fact that
defendant signed document containing fraudulent statement is
sufficient to conclude that defendant “made” misstatement, even if
he was not involved in drafting the document).
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omission, they also state a claim under the less strict
“substantial participation” or “creation” approaches. Prince’s
Motion to Dismiss therefore fails under all three approaches.
Consequently, the Court need not decide which standard applies in
this Circuit.
Prince argues that Count II still fails to state a claim,
however, because the SEC has failed to allege that he had a duty to
disclose the omitted information. As discussed, the facts alleged
in the Complaint establish that Prince “made” a statement under
Rule 10b-5 when he reviewed, commented on, and approved Integral
Systems’s periodic filings. Under Rule 10b-5, an individual who
“makes” a statement has a duty to correct “any omission to state a
material fact necessary in order to make the statements made, in
the light of the circumstances under which they were made, not
misleading.” 17 C.F.R. § 240.10b-5. Thus, Prince had a duty to
correct the omissions in the periodic reports and proxy statements
which he was substantially involved in preparing. See also SEC v.
Druffner, 353 F. Supp. 2d 141, 148 (D.Mass. 2005) (“[T]he securities
laws give rise to a duty to disclose any information necessary to
make an individual’s voluntary statements not misleading.”).15
15
Prince relies on SEC v. Tambone, 417 F. Supp. 2d 127, 135
(D.Mass. 2006), a case decided under the “bright-line” approach for
primary liability, as authority for the principle that an
individual only owes a duty to correct an omission if the statement
containing the omission is attributed to the individual. However,
the court in Tambone concluded that the defendants had no duty to
(continued...)
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In summary, the Complaint alleges sufficient facts to
establish that Prince made a statement and, therefore, that he had
a duty to correct any misleading omissions in that statement.
Prince’s Motion to Dismiss the SEC’s Rule 10b-5(b) claim is
therefore denied.
b. Rule 10b-5(a) and (c)
In addition to the Rule 10b-5(b) claim for Prince’s alleged
omissions, the SEC argues that Prince is liable under Rule 10b-5(a)
and (c) for, respectively, employing a “device, scheme or artifice
to defraud,” and engaging in an “act, practice, or course of
business which operates or would operate as a fraud or deceit upon
any person.” 17 C.F.R. § 240.10b-5. Prince argues that the SEC has
failed to state a claim for such “scheme liability” under Rule 10b-
5(a) and (c) because (1) it has not alleged that he engaged in a
manipulative device or contrivance; and (2) the scheme allegations
merely reiterate the omissions underlying the Rule 10b-5(b) claim.
Prince’s Mot. to Dismiss at 14-15.
It is certainly true, as Prince argues, that Section 10(b)
“prohibits only the making of a material misstatement (or omission)
or the commission of a manipulative act.” Central Bank, 511 U.S. at
177. However, an individual’s participation in a scheme to defraud
15
(...continued)
correct the omission because the statement--prospectuses which were
prepared by a separate entity--had not been made by them, and not
because the statement was made by them but not publicly attributed
to them.
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may result in primary liability even in the absence of a
misstatement or manipulative act if the individual “engaged in
conduct that had the principal purpose and effect of creating a
false appearance of fact in furtherance of the scheme.” Simpson v.
AOL Time Warner Inc., 452 F.3d 1040, 1048 (9th Cir. 2006), vacated
on other grounds, Avis Budget Group, Inc. v. Cal. State Teachers’
Ret. Sys., 552 U.S. 1162, 128 S. Ct. 1119, 169 L. Ed. 2d 945 (2008).
However, to establish primary liability under Rule 10b-5(a) or
(c), the alleged conduct must be more than a reiteration of the
misrepresentations underlying the Rule 10b-5(b) misstatement
claims. Lucent Techs., 610 F. Supp. 2d at 361. Primary liability may
arise out of the same set of facts under all three subsections
“where the plaintiffs allege both that the defendants made
misrepresentations in violations of Rule 10b-5(b), as well as that
the defendants undertook a deceptive scheme or course of conduct
that went beyond the misrepresentations.” In re Alstom SA, 406
F. Supp. 2d 433, 475 (S.D.N.Y. 2005).
The Complaint’s sole allegation that Prince engaged in
deceptive conduct, apart from his alleged involvement in the filing
of fraudulent and misleading annual reports and proxy statements,
is that he violated § 16(a) of the Exchange Act, 15 U.S.C. §
78p(a), by failing to file the statements required under that
section. Section 16(a) requires anyone “who is a director or an
officer of the issuer of [any equity] security” to file a statement
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concerning any holdings and transactions of the issuer’s
securities. 15 U.S.C. § 78p(a).
As Prince points out, in order to prove this claim, the SEC
must first establish that he was, in fact, an officer of Integral
Systems. Assuming as we must in a Motion to Dismiss that the SEC
does establish that Prince did act as an officer of Integral
Systems with scienter, a reasonable fact finder could conclude that
his failure to file the reports required under § 16(a) was done
with the purpose and effect of concealing his officer status from
the public. See In re Alstom SA, 406 F. Supp. 2d at 474
(“[S]ubsections (a) and (c) of Rule 10b-5 encompass a wide range of
activities and are not limited to the prohibition of market
manipulation.”). The SEC’s allegations therefore state a claim
under Rule 10b-5(a) and (c) for scheme liability, and Prince’s
Motion to Dismiss is denied.
CONCLUSION
For the reasons set forth above, Defendant Brown’s Motion to
Dismiss Count I is granted, and the remainder of her Motion to
Dismiss is denied in all other respects. Brown’s Motion to Dismiss
under the statute of limitations in 28 U.S.C. § 2462 is denied
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without prejudice. Defendant Prince’s Motion to Dismiss is
denied in its entirety. An Order will accompany this Memorandum
Opinion.
/s/
September 27, 2010 Gladys Kessler
United States District Judge
Copies to: attorneys on record via ECF
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