Opinion ID: 3050320
Heading Depth: 3
Heading Rank: 1

Heading: The SEC Enforcement Action

Text: On August 27, 2001, the SEC commenced a civil enforcement action against Alpha Telcom for violations of the federal SEC v. ROSS 13911 securities laws. On the same day, the district court appointed a receiver (“Receiver”) to manage the corporation and preserve its assets for eventual distribution to the injured investors. The Receiver’s appointment was confirmed on September 6, 2001. In the underlying enforcement action, the district court held that the “investment opportunity” offered by Alpha Telcom was actually a security for purposes of the Securities Act of 19331 (“the Act”) and that Alpha Telcom had violated § 5 of the Act by failing to register the securities with the SEC prior to selling them in interstate commerce. SEC v. Alpha Telcom, Inc., 187 F. Supp. 2d 1250, 1258 (D. Or. 2002). The district court granted equitable relief against Rubera, the sole owner of Alpha Telcom, in the form of a permanent injunction against future violations of the securities laws and disgorgement in the amount of $3,750,707.66, representing “gross wages, shareholder compensation, shareholder loans, and other payments to Rubera and his family.” Id. at 1262-63. However, the court declined to impose civil penalties under § 20 of the Act, concluding that they were “not warranted” given that this offense was Rubera’s first violation and “his conduct did not amount to fraud, deceit, manipulation, or the like.” Id. at 1263. We affirmed the district court in all respects. See SEC v. Rubera, 350 F.3d 1084 (9th Cir. 2003). B. The Disgorgement Motion and Subsequent Proceedings On December 23, 2003, approximately two weeks after we decided Rubera, the Receiver filed a motion to disgorge $21 million in commissions on the sales of these unregistered 1 The district court applied the three-part test set forth in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In Howey, the Supreme Court held that for purposes of the Act, a security was defined as “(1) an investment of money; (2) in a common enterprise; (3) with the expectation of profits to be derived from the efforts of others.” Alpha Telcom, 187 F. Supp. 2d at 1258 (citing Howey, 328 U.S. at 298-99). 13912 SEC v. ROSS securities from Alpha Telcom’s sales agents.2 In its motion, which the SEC joined, the Receiver styled its requested relief as “[r]equiring all Agents to disgorge Commissions received for their unlawful sale of unregistered securities in violation of Sections 5(a) and 5(c) of the Securities Act of 1933 . . . .” Citing our decisions in SEC v. Wencke, 783 F.2d 829 (9th Cir. 1989), and SEC v. Hardy, 803 F.2d 1034 (9th Cir. 1986), the Receiver further requested the court to allow it to proceed “through summary proceedings,” an approach he argued was permissible “in equity receivership cases such as this.” The Receiver asserted that the district court had broad powers to order disgorgement of “ill-gotten gains” and that the commissions, which were paid “to compensate and reward the Agents for their illegal sale of unregistered securities to investors,” were “in fact the ill-gotten gains received from these investors . . . .” According to the Receiver, “the Agents provided no benefit to Alpha other than to facilitate the process of luring in additional new investors.” The Receiver asserted that it was beyond dispute that “the money used to pay the Commissions to the Agents were ill-gotten gains from the sales of unregistered securities to unsuspecting investors.” Because “the Commissions were paid to [the Agents] specifically for their role in these illegal sales of the unregistered securities,” the agents had “no legitimate claim to the Commissions.”3 2 The Receiver identified approximately 650 sales agents and commissions totaling approximately $39 million. Some number of these sales agents could not be located or had died, and the Receiver determined that it would be inefficient to pursue agents who had earned less than $25,000 in commissions. It appears that the total commissions earned by the remaining agents totaled approximately $21 million. 3 The Receiver also argued that the commissions represented fraudulent transfers because the agents provided no value in exchange for the monies received as commissions. Having accepted the Receiver’s unjust enrichment theory, the district court declined to address the fraudulent transfer theory, which it described as unpersuasive, given that the agents had actually provided value in exchange for those commissions. The Receiver does not pursue this theory on appeal. SEC v. ROSS 13913 Joining the Receiver’s motion, the SEC argued that “it is well-established that District Courts may order disgorgement by nonparties in Commission enforcement actions.” According to the SEC, Disgorgement was proper here because (1) the court had already held that the investments were unregistered securities and thus were sold in violation of § 5 of the Act, rendering any proceeds “ill-gotten gains”; (2) the Agents had “no legitimate claim to these funds, as there is no evidence that they provided services to [Alpha Telcom] in exchange for the commissions . . . .”; and (3) even if the Agents did “expend[ ] effort,” they have no legitimate claim “because they offered and sold the securities in violation of the federal securities laws.” In support of its motion, the Receiver submitted detailed information about the financial condition of the Receivership Entities and of commissions paid out to each of the sales agents. On either December 24 or 31, 2003,4 it sent a Notice of Hearing on the motion for disgorgement to “the interested parties in this action” by first-class mail. The notice stated that the hearing would be held in Portland, Oregon on February 18, 2004, and that any response to the motion had to be filed and served within eleven days of service of the notice. The district court entered an order permitting the agents to file responses to the motion by February 2, 2004. On February 2, several of the agents, including Bustos and 10 other Appellants, preserving their jurisdictional objections, moved to intervene as of right as defendants in the action 4 The Notice itself was dated December 24, but the Certificate of Service attached to the Notice is dated December 31. The Receiver appears to have mailed additional documents on December 30, 2003: The “Proof of Service” filed by the Receiver states that five documents were sent to the agents: a notice of the hearing on the Receiver’s motion for disgorgement, the motion itself, two supporting declarations, and a request for judicial notice. In any event, as the district court noted, the Receiver did not even deign to send the documents by certified mail and could not conclusively establish whether all the agents had actually received the documents. 13914 SEC v. ROSS under FED. R. CIV. P. 24(a)(2), noting that, because the Receiver was attempting to have the district court “summarily adjudicate the Intervenors’ personal liability,” the agents had “a direct financial interest in this case” that could be adequately represented only by each named agent; they also requested an extension of time to respond. The Receiver objected to the agents’ motion, arguing that there was “no legal basis” for their request to intervene in the underlying enforcement action. Moreover, because the agents had allegedly known of the Receiver’s intent to disgorge commissions for over 18 months,5 the Receiver argued that the motion was “nothing more than a delay tactic designed to hinder the Receiver’s efforts to recover the ill-gotten gains received by these Agents.” On February 11, the district court granted the motion to intervene, stating that no formal answer was required and that the intervenors could “assert any defenses by motion or in their memoranda opposing the Receiver’s motion . . . .” However, “[d]ue to the advanced stage of [the] case,” the district court conditioned intervention “on Intervenor’s agreement not to revisit issues already adjudicated.” These issues presumably included the district court’s prior findings that the investments sold by the agents were unregistered securities.6 Despite the district court’s statement that no answer was required, the now Intervenor-Defendants filed a brief answer on February 18, 2004 and asserted several defenses, including lack of personal jurisdiction, improper venue, “insufficient process,” statute of limitations, and laches.7 They concurrently 5 The Receiver asserted that it had sent demand letters to all of the agents requesting that they voluntarily disgorge their commissions in July and October 2002. 6 The court granted 26 additional individuals permission to intervene on March 11, 2004. The six remaining Appellants belonged to this group. 7 They also asserted four substantive defenses to the disgorgement that are not relevant to our disposition of this appeal. SEC v. ROSS 13915 filed Preliminary Objections to the Receiver’s disgorgement motion setting forth the legal bases for their defenses. In March, they filed a lengthy opposition to the disgorgement motion, reiterating the procedural defenses raised in their Preliminary Objections and further objecting to the district court’s use of summary proceedings; they also provided further arguments against the Receiver’s disgorgement request, including challenges to the method of calculation. C. The Disgorgement Order The district court granted the Receiver’s disgorgement motion on August 18, 2004, and resolved the major issues that Bustos raises on appeal as follows. See In re Alpha Telcom, 2004 WL 3142555 (D. Or. Aug. 18, 2004).
The district court concluded that it “necessarily ha[d] jurisdiction over matters pertaining to [the] Receivership, and the assets thereof.” Moreover, the agents had entered into agreements with Alpha Telcom, headquartered in Oregon, and those agreements specified that Oregon law would govern any disputes. Finally, the court noted that the securities laws permitted nationwide service of process, and the agents’ contacts with the United States alone were sufficient to support the exercise of personal jurisdiction over them (citing, inter alia, 15 U.S.C. § 77v(a)). The court also concluded that venue was proper because the agents were scattered across the country, and it was more efficient to try the case in one location. 2. Summary procedures and lack of service of process The district court rejected the agents’ argument that they had not been properly served, holding that formal service was required only to institute an action. Because the Receiver’s disgorgement motion was not an independent action but simply “part of the Receivership proceeding” that sought to “re13916 SEC v. ROSS cover funds the agents received from Alpha Telcom that they allegedly have no legitimate claim to possess,” the agents were “nominal defendants” who were entitled only to receive notice of the motion and a reasonable opportunity to be heard. The district court noted that the “more serious flaw” was the fact that the Receiver could not prove that any particular agent actually received notice of the motion because it had failed to send the notice by certified mail. This flaw, however, was remedied by the fact that the Receiver sent multiple mailings to the listed agents, that the court had required the Receiver to send “a follow-up mailing to the agents,” the “rebuttable presumption that mail, properly addressed, has been delivered,” and the fact that the agents appeared to be in regular contact with each other. Moreover, the court found, the “vast majority” of the agents appeared to have received actual notice of the motion, and presumably any agent who had not received actual notice could collaterally attack the disgorgement order if he or she could prove lack of actual notice. 3. Unjust enrichment The Receiver’s theory of unjust enrichment depended on whether the agents had a “legitimate claim” to the commissions they received. The district court noted that the Receiver had not formally alleged any wrongdoing on the part of the agents and chided the Receiver for filling its papers with accusations of wrongdoing that were not “germane to the legal theories he advances.” The court declined to hold that the commissions were analogous to disbursements in the typical gratuitous donee case, where a third party receives value for no consideration from a wrongdoer, and expressly rejected three theories put forth by the Receiver as to why the agents had no legitimate claim to the commissions: (1) that Alpha Telcom received no value for the agents’ services because the company lost money on each sale, (2) that agents were willing participants in a Ponzi scheme, and (3) that the agents’ services helped to perpetrate a fraud. Rather, the district court SEC v. ROSS 13917 found the agents had no legitimate claim on the commissions because “[t]he services provided by the agents were, in hindsight, illegal.” They had sold unregistered securities, which is a strict liability offense. Because they “were paid for furnishing illegal services[, t]he law [would not] permit them to benefit from the sale of unregistered securities.”8 4. Computation of disgorgement amount Having decided that the agents would be liable for the funds, the district court detailed how it would handle claims by remaining agents who contested the amounts claimed by the Receiver and sought setoffs for expenses and taxes paid on the commissions. The court found that many of the agents had likely claimed personal expenses as business expenses on their tax returns, and therefore, citing its discretionary powers, established “a uniform setoff for expenses: 10 percent of the first $50,000 in commissions received by an agent, and 5 percent of all commissions over that amount.” The court determined that it was not practicable—and was far too expensive —to require the Receiver to evaluate each agent’s claimed expenses and rejected objections, noting that “this is equity, not rocket science.” Finally, the district court refused to grant a setoff for income taxes paid on the commissions, noting that this was “a matter between the agents and the IRS (or state officials). The court will not interfere.” D. Appellants’ Response and Appeal The district court gave the agents 20 days to file an objection to the amount of disgorgement and then addressed each agent’s individual objections in a detailed order dated February 1, 2005. The court subsequently entered a Judgment of Disgorgement on March 31, 2005, and issued a “Notice to Agents” on March 31, 2005, advising them of the proper 8 The district court assumed for the purposes of the motion that the agents had acted in good faith. 13918 SEC v. ROSS method for filing an appeal and waiving the normal fee for filing a notice of appeal. The Appellants timely appealed. On appeal, Bustos reiterates most of the objections made to the district court, and these center on two sets of issues. The first of these involves due process violations arising from the district court’s lack of personal jurisdiction, the Receiver’s failure to properly serve him with a summons and complaint, and the use of summary proceedings to adjudicate the disgorgement motion. The second involves various contentions that the district court abused its discretion in granting the motion for disgorgement and calculating the amount to be disgorged. Because we hold that Bustos’s due process rights were violated by the proceedings below, we address only the first set of issues in this appeal. We begin with a brief review of the principles of personal jurisdiction and the relationship between jurisdiction and service of process.