2006 Decisions

Opinions of the United

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Precedential or Non-Precedential: Non-Precedential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NOT PRECEDENTIAL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. 
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

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)
3

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. §§ 1291

and 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
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

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
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

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

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
7

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

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

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
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.