Ninth Circuit Clarifies Summary Judgment Burden for SEC Penalties

On June 13, 2023, in SEC v. Husain,[1] the U.S. Court of Appeals for the Ninth Circuit clarified the high burden that the SEC must carry before a court may grant the Commission a civil monetary penalty at the summary judgment stage. Specifically, the Husain court reversed the grant of summary judgment on a penalty of $1,757,000 where a defendant’s sworn declaration created a genuine issue of material fact as to both the amount of his “gross pecuniary gain” and the factors the district court was required to consider in determining whether a penalty was appropriate, such as the defendant’s degree of scienter and contrition. The Ninth Circuit chose not to decide if or when a district court can rely on the total gain to all participants in a fraudulent scheme as a measure of an individual participant’s gross pecuniary gain when assessing such penalties.

Key Takeaways

In at least the Ninth Circuit:

• Defendants may defeat an SEC motion for summary judgment seeking a specific penalty by demonstrating the existence of a genuine issue of material fact as to the factors used to assess such a penalty, including by introducing such contested facts through a defendant’s own declaration; and
• To obtain a specific penalty at the summary judgment stage, the SEC will need to demonstrate control or constructive receipt of ill-gotten gains, particularly where a scheme or fraud involves multiple participants or when funds flow through multiple legal entities. Where the SEC relies on “gross pecuniary gain” to set the amount of a penalty, the SEC must demonstrate actual gain to the defendant it seeks to penalize.

Background

According to the SEC, Imran Husain and his attorney worked together to create shell companies where Husain served as an undisclosed control person, then conducted initial public offerings for the stock in these companies, which later were sold through reverse mergers. Throughout the scheme, the shell companies—at Husain’s direction—filed over 35 materially false and misleading reports with the SEC. 

Husain did not directly receive the proceeds of the shell companies; instead, the funds flowed to an escrow account, and after legal fees were paid from the account, funds were wired to bank accounts held by nominee-representatives appointed by Husain or to offshore accounts of two entities owned or controlled by Husain. In May 2016, the SEC charged Husain with multiple violations of the Securities Act of 1933 (“Securities Act”) and Securities Exchange Act of 1934 (“Exchange Act”), including conducting unregistered offerings; fraud in the offer or sale of the shell companies; a scheme to defraud in the offer or sale of the shell companies; aiding and abetting registration violations; and control person violations.

The Court’s Decision

In a 2-1 decision, Judge Kathryn H. Vratil (D. Kansas, sitting by designation), joined by Judge Sandra S. Ikuta, reversed the district court’s grant of summary judgment on a civil penalty of $1,757,000, which represented the total proceeds from the sale of the shell companies within the state of limitations, minus $30,000 another defendant was required to pay as disgorgement.

Husain’s sworn declaration stated that, from the total sales proceeds of the five shell companies, $287,500 was paid for legal fees and other expenses before he ever controlled the funds. The court found that this created a genuine issue of material fact whether that portion of the alleged “gross pecuniary gain”[2] should be attributed to Husain. While the district court had pointed to Husain’s concession of the total sales amount in finding that the pecuniary gain amount was undisputed, the Ninth Circuit held that the SEC failed to meet its burden because it could not establish that Husain “controlled or constructively received the proceeds” from the sales of the shell companies.[3]

Next, the panel rejected the district court’s application of two of the Murphy factors, which are used to weigh a civil penalty for violations of the Securities Act and Exchange Act “in light of the facts and circumstances.”[4] The Court of Appeals held that Husain’s declaration raised genuine issues of material fact regarding scienter and contrition. Because Husain admitted that he had deceived the SEC and had admitted wrongdoing, his refusal to take responsibility was not an undisputed fact appropriate for summary judgment. Similarly, the court rejected the district court’s conclusion that Husain had acted with a “high degree” of scienter, citing his sworn declaration that he had only intended to deceive the SEC—not investors—and that he relied upon the advice of his counsel in preparing his false and misleading disclosures.

Judge Wardlaw’s Dissent

Judge Kim McLane Wardlaw disagreed with the majority’s interpretation of “gross pecuniary gain,” reasoning that both Husain and his attorney, as participants in the scheme, “gained from each dollar of the sale of the shell companies, even if they ultimately disseminated those funds elsewhere.”[5] She also cautioned that the majority’s holding “could effectively preclude any court from awarding relief or maximum civil penalties without an evidentiary hearing, even for confessed violations of the securities laws.”[6] Examining the majority’s case law, she distinguished the facts at issue: here, Husain’s credibility was not at issue because he confessed to his actions and knowing state of mind, and it was appropriate for the district court to weigh the Murphy factors and assess the penalty.

Conclusion

In the wake of recent Supreme Court cases limiting both where the SEC can bring its cases and what relief they can pursue, Husain continues the trend of courts scrutinizing SEC claims and authority in the same way other litigants’ proof is tested. Husain serves as a reminder that even defendants found to have violated the securities laws may effectively contest the relief the SEC seeks.

[1] SEC v. Husain, No. 21-55859 (9th Cir. June 13, 2023).

[2] 15 U.S.C. §§ 77t(d)(2)(B), 78u(d)(3)(B)(ii).

[3] Husain at *15.

[4] SEC v. Murphy, 626 F.3d 633, 655 (9th Cir. 1980); 15 U.S.C. §§ 77t(d)(2)(A), 78u(d)(3)(B)(i).

[5] Husain at *34 (Wardlaw, J., dissenting).

[6] Id. at *47 (Wardlaw, J., dissenting).