Opinion ID: 200195
Heading Depth: 2
Heading Rank: 1

Heading: Requirements and Evidence of Violations of the Anti-Fraud Provisions of the Securities Laws

Text: 26 Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), in relevant part, provides: 27 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 — 28 (1) to employ any device, scheme, or artifice to defraud, or 29 (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 light of the circumstances under which they were made, not misleading, or 30 (3) to engage in any transportation, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. 31 Id. Under section 17(a) of the Securities Act, [s]pecific reliance by the investor need not be shown. United States v. Ashdown, 509 F.2d 793, 799 (5th Cir.1975). Negligence is sufficient to establish liability under section 17(a)(2). Aaron, 446 U.S. at 695-697, 100 S.Ct. 1945. 32 Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), makes it unlawful for any person, directly or indirectly,... to use ... 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. Id. The SEC promulgated Rule 10b-5 under the Securities Exchange Act, 15 U.S.C. § 78j(b). Pursuant to this rule, it shall be unlawful for any person: 33 (a) To employ any device, scheme, or artifice to defraud, 34 (b) To make any untrue statement of a material fact o 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 35 (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, 36 in connection with the purchase or sale of any security. 37 17 C.F.R. 240.10b-5. A statement is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether or not to invest his money in a particular security. See Basic v. Levinson, 485 U.S. 224, 231-232, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). 38 Under section 10(b) and rule 10b-5, the defendants must act with scienter. Scienter is a mental state embracing intent to deceive, manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). The plaintiff must demonstrate that the defendants acted with a high degree of recklessness or consciously intended to defraud. Aldridge, 284 F.3d at 82. Recklessness is a highly unreasonable omission, involving not merely simple, or even inexcusable[] negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious the actor must have been aware of it. Greebel v. FTP Software, 194 F.3d 185, 198 (1st Cir.1999) (quoting Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir.1977)). 39 Fife and Khan assert that they did not act with the requisite degree of scienter. This argument fails. Fife and Khan made material representations, either recklessly or with scienter, with regard to the sale and offer of securities and made misleading and false statements to investors. 40 During the two and a half years that Fife controlled the Raymond James account, he made only two purchases in the Brite balance sheet enhancement program; both purchases were for treasury bills, one on margin and the other for cash. Fife lost approximately $1.7 million in one of these treasury bill purchases. Fife did not use investor funds to participate in third world projects, the underlying premise of the enhancement program. Further, during Fife's control of investor funds, $20.5 million of investor funds were dissipated. 41 Although Fife alleges that he never saw any investor contracts between Brite and its investors, his letter to Rheaume indicates that he was at least aware of some of the Agreement's terms by using some of the contract language in his letter such as private placement by invitation for qualified clients and without putting its funds at risk. At the time the letter was written, Fife had already transferred and invested Rheaume's money without prior authorization. He had not been successful in his balance sheet enhancement program in the previous six months, and a very great risk of loss accompanied participation in the balance sheet enhancement program. Thus, Fife's statements were material misrepresentations. 42 Since Fife and Khan were partners engaging in balance sheet enhancement programs, they knew of the risks involved in participating in these programs, failed to inform investors of these risks, and positively represented that there was no risk. If a project did not succeed, the investor would not receive back his investment or any return on his investment principal. Instead of advising clients of these risks, they promised high returns. Both Fife and Khan contacted Brite investors soliciting additional opportunities to invest funds without disclosing the high risks associated with the balance sheet enhancement program. These misrepresentations and omissions were material because a reasonable investor would want to know the risks involved in the balance sheet enhancement program. See Basic, 485 U.S. at 231, 108 S.Ct. 978. Moreover, Fife repeatedly made false representations to Brite investor, Rheaume, concerning the management of its investment funds. 43 The SEC made a sufficient showing that Fife and Khan made material misrepresentations in connection with the purchase or sale of securities in interstate commerce under the balance sheet enhancement program. In view of defendants' past conduct, the defendants' occupations, and their continued defense that their past conduct was blameless, we conclude that the SEC made an adequate showing that repetition of such conduct in the future is reasonably likely. Therefore, the district court's grant of a preliminary injunction as to Fife and Khan under the section 17(a) of the Securities Act and section 10(b) of the Securities Exchange Act was not an abuse of discretion. 44