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United States Securities and Exchange Commission v. Brown

September 27, 2010


The opinion of the court was delivered by: Gladys Kessler United States District Judge


Plaintiff United States Securities and Exchange Commission ("SEC") brings this action against Defendants*fn1 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.

I. Background*fn2

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 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 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).

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.

"[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 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 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 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)); 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.

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 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 ยง 2462 is not tolled for the civil ...

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