The opinion of the court was delivered by: Motley, District Judge.
In this securities fraud action brought under the Securities
Act of 1933 ("the Securities Act") and the Securities Exchange
Act of 1934 ("the Exchange Act"), the Securities and Exchange
Commission ("the Commission" or "the SEC") brings this motion
for summary judgment seeking (i) a finding that George J. Coates
("Coates") violated Section 10(b) of the Exchange Act,
15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 U.S.C. § 240.10b-5, and
(ii) an order requiring Coates to pay civil penalties under the
Securities Enforcement Remedies and Penny Stock Reform Act of
1990, 15 U.S.C. § 78u(d) ("the Remedies Act"). Coates claims
that no civil penalties should be assessed against him. For the
following reasons, this court GRANTS the Commission's motion in
part and denies it in part and DENIES Coates' motion.
On July 22, 1994, the Commission filed a complaint against
defendants, alleging, among other things, that they violated
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by
making false and misleading statements to investors in
connection with the sale of Coates International, Ltd. ("CIL")
securities. See Pl.'s R.
56.1 Stm't ¶ 1.*fn1 The Commission sought a permanent
injunction, disgorgement, and civil penalties against defendants
pursuant to the Remedies Act. See id. ¶ 3. On July 22, 1994,
the court, upon application made by the Commission on the same
date, granted the Commission interim relief, including an asset
freeze as to both Coates and CIL and the appointment of a
temporary receiver for CIL. See id. ¶¶ 3, 112. The temporary
receiver was directed to take possession of the assets of CIL,
to operate the business, and otherwise to maintain the status
quo. See July 10, 1996 Opinion and Order at 2-3. In violation
of this order, Coates' wife subsequently withdrew $25,000.00
from their joint bank account. See id. ¶ 113.
On February 21, 1995, the court entered two final consent
judgments as to Coates and CIL ("Coates Judgment" and "CIL
Judgment") that settled this matter, except for the issue of
civil penalties against Coates. See id. ¶¶ 5, 6. The consent
judgments permanently enjoined Coates and CIL from violating
Sections 5(a), 5(c) and 17(a) of the Securities Act, Section
10(b) of the Exchange Act and Rule 10b-5. See Pl.'s Mem. Supp.
Summ. J. at 5. The consent judgments also required Coates and
CIL to disgorge certain funds and other assets. See id. The
extent of the defendants' obligations to disgorge funds
depended, in part, on the results of a registered rescission
offer to certain purchasers of CIL stock. See id. The CIL
Judgment discharged the temporary receiver and, instead, named
him as Special Master of CIL, with specific responsibilities
including assisting in CIL's compliance with the consent
judgments. See July 10, 1996 Opinion and Order at 3.
The Coates Judgment froze all of Coates' assets other than
certain salary. See Pl.'s R. 56.1 Stmt. ¶ 114. The day after
issuing the Coates Judgment, Coates transferred his patents
relating to the Coates System to his son, Gregory Coates, in
exchange for one dollar, in violation of the asset freeze. See
id. ¶ 115. Paragraph XI of the Coates Judgment stated that the
court reserved judgment as to the issue of civil penalties
against Coates and set forth certain factors for the court to
consider in determining whether civil penalties are warranted.
See id. ¶ 6.
The consent judgments permanently enjoined Coates and CIL from
violating federal securities laws and called for the
disgorgement of certain funds and assets. See id. ¶ XX. The
CIL Judgment required that CIL make a registered offer
("rescission offer") to all persons who purchased CIL stock from
CIL or Coates from April 24, 1990 to February 21, 1995, the date
of the rescission offer. Coates and CIL were required to pay the
amounts due to the rescinding shareholders. See Pl's R. 56.1
Stm't ¶ 117. Prior to the distribution of funds to rescinding
shareholders, the Special Master was to propose, subject to
approval and order of the court, a plan of distribution. See
id. ¶ 118.
The CIL Judgment required that CIL file a registration
statement with respect to the rescission offer by July 21, 1995.
CIL's registration statement was twice amended, and on November
13, 1995, the Second Amended Registration Statement was declared
effective. See Pl.'s R. 56.1 Stmt. ¶¶ 9-10. Coates signed the
Second Amended Registration Statement on CIL's behalf in his
capacity as, among other things, president, principal executive
officer, and a director of CIL. See Pl.'s Mem. Supp. Summ. J.
The proceedings in this case were initially before Judge Wood
who oversaw the defendants' conduct after the entry of the
consent judgment as well as the funding of the rescission offer.
Judge Wood entered multiple rulings some of which appear in the
following court orders: (1) Opinion and Order dated July 10,
1996, (2) Opinion and Order dated August 19, 1996, (3) Order
dated August 20, 1996, and (4) Order dated September 9, 1996.
See Pl.'s R. 56.1 Stmt. ¶ 12.
In the August 19, 1996 Order, the court rejected a request by
Coates that he not be ordered to relinquish tangible assets to
satisfy his obligation to fund payments to the rescinding
shareholders unless a sale of his intangible assets (i.e. his
CIL stock) failed to generate the required amount of cash, and
held as follows:
In light of the bad faith that Coates has
demonstrated throughout this litigation as set forth
in this order and in my previous orders in this
matter — see, e.g., [August 1994 Order] (describing
withdrawal of $25,000 from Coates' bank account by
Coates' wife after Coates had been informed of
temporary restraining order issued by this court
freezing his assets) — I order Coates to transfer
title to his automobiles and his Rental Property to
the Special Master on or before August 26, 1996.
See id. ¶ 120. In this order, the court also required Gregory
Coates to transfer the patents back to Coates on or before
August 26, 1996 and required Coates to transfer the patents to
the Special Master on August 27, 1996. See id. ¶ 121. In the
August 20, 1996 Order and the September 1996 Order, the court
extended the deadlines for performance of the transfers to
September 10, 1996. See id. ¶¶ 122, 123. The September 1996
Order also required Coates to transfer title to all of his
automobiles to the Special Master on or before September 10,
1996. See id. ¶ 123. The transfers of the patents and
automobiles did not take place on or before September 10, 1996.
See id. ¶ 124. Untimeliness aside, Coates complied with every
order of the court. See Def.'s R. 56.1 Stmt. ¶ 124B.
The rescission offer process concluded in July 1997. On July
15, 1997, Judge Wood entered an order detailing the conditions
under which the Special Master would be discharged. See July
15, 1997 Order. The July 15, 1997 Order also appointed the
Special Master to be Escrow Agent for the sole and limited
purpose of holding the escrow sum which consisted of the
interest payments still owed to two of the rescinding
shareholders. See id. On July 31, 1997, Judge Wood entered an
Order Vacating Restraints Against George J. Coates. In this
order, the restraints imposed in Paragraph VII of the Coates
Judgment were vacated; however, the terms of all prior orders
including the Coates Judgment were not altered. See July 31,
In an order dated August 8, 1997, Judge Wood denied
defendants' request that they should be relieved of their
obligation under the CIL Judgment and subsequent court orders to
pay interest to the Quintas Trust and Rainer Heubach, two of the
rescinding shareholders. See August 8, 1997 Order. The
interest is in an escrow account under the auspices of the
Escrow Agent, the former Special Master. See id. By order
dated August 15, 1997, Judge Wood denied a motion by defendants
to reconsider her August 8, 1997 order; however, she granted a
stay of the August 8, 1997 order to pay interest until a final
decision was issued on the summary judgment motion regarding
civil penalties. See August 15, 1997 Order.
This case was subsequently transferred from Judge Wood to
Judge Motley on October 30, 1998. The pending motions were
argued orally on November 19, 1998.
Coates founded CIL in October 1991. See Pl.'s R. 56.1 Stmt.
¶ 13. Coates is the inventor of the Coates System, a spherical
rotary valve system for use in piston driven internal combustion
engines. See id. ¶ 16. CIL's business is entirely dependent on
the activities of Coates, who at times has been CIL's president,
chairman, chief executive officer, and controlling stockholder.
See id. ¶ 15. From CIL's inception through November 1, 1995,
the Coates System has been the only actual or potential source
of operating revenue for CIL. See id. ¶ 19. During the period
subject to the rescission offer, Coates and CIL sold a total of
478,350 shares of CIL stock at prices of $5, $10, $20, and $30
per share for a total of $6,578,000 in gross proceeds. See id.
1. EPA Emissions Standards
All new motor vehicles or new motor vehicle engines for sale
in the United States intended for road use, including those with
engines equipped with the Coates System, are subject to
Environmental Protection Agency ("EPA") emissions standards and
are required to pass a series of tests known as the Federal
Testing Procedure or "FTP" tests. See id. ¶¶ 20, 22; see also
40 C.F.R. § 86.090-5. Included in the regulations governing the
emissions testing component of the FTP tests is a requirement
that emissions tests be conducted using a machine known as a
chassis dynamometer ("dynamometer"). See Pl.'s R. 56.1 Stmt. ¶
21; see also 40 C.F.R. § 86.135. Prior to July 1994, CIL never
received a Certificate of Conformity from the EPA stating that
engines modified with the Coates System were in compliance with
applicable federal emission standards. See Pl.'s R. 56.1 Stmt.
¶ 25. Before July 1994, the EPA never conducted any emissions
tests or other tests involving the Coates System or vehicles
associated with the Coates System, CIL, or Coates. See id. ¶
CIL disseminated two documents dated December 6, 1991 to CIL
stockholders and other potential investors regarding a private
offering of CIL's Series A Preferred Stock ("December 1991
Offering"). See id. ¶ 33. These documents were titled
"Confidential Private Offering Memorandum" and "Confidential
Information Memorandum." Coates testified at his deposition that
he personally provided Deloitte & Touche, the preparers of the
December 1991 memoranda, with the information contained therein.
See id. ¶ 35. The Confidential Information Memorandum stated
that the Coates System modified "engine, under an internally
supervised test, far surpassed the emission standards imposed by
the [EPA]." Id. ¶ 38. It further stated that the "Coates
engine emits significantly lower levels of pollutants than a
conventional engine" and listed comparisons between the federal
emissions standard and the Coates System in a chart entitled
Exhaust Federal Coates Improvement
Emissions Standard System
CO (%) 1.2 .2 84%
HC (ppm) 220 97 56%
Pl.'s Ex. 10, Confidential Info. Mem. at 13. However, the
testing that produced the figures listed above was not performed
at an independent motor vehicle emissions testing contract
laboratory recognized by the EPA. The tests were performed at a
CIL facility using a machine other than a dynamometer. See
Pl.'s R. 56.1 Stmt. ¶ 40. Additionally, neither memoranda
referenced above disclosed anything about the 1990-91 Compliance
test results, which stated that the emissions levels of a Coates
System engine were substantially higher than the maximum levels
permitted by the EPA. See id. ¶ 41.
In a letter to CIL stockholders and other potential purchasers
of CIL stock dated March 24, 1992, Coates wrote:
[O]ur first official independent emission test has
indicated the lowest emissions in the world. . . .
Further testing with the EPA is continuing and should
be completed within six weeks depending on the
Pl.'s Ex. 7, Larkin Decl. Ex. A, March 24, 1992 Letter. The
letter also contained a solicitation to purchase additional CIL
stock. See id.; see also Pl.'s R. 56.1 Stmt. ¶ 45.
Similarly, in a letter to CIL stockholders and other potential
purchasers of CIL stock dated March 26, 1992, Coates wrote:
The results of our first independent emissions test
have demonstrated that our design produces the lowest
level of pollutants in the world. In fact, we have
eliminated some of the most harmful emissions
completely. . . . With further EPA testing going as
scheduled, this phase of evaluation should be
finished within six weeks.
Pl.'s Ex. 8, Carter Decl. Ex. A, March 26, 1992 Letter. The
letter also contained a solicitation to purchase additional CIL
stock. See id.; see also Pl.'s R. 56.1 Stmt. ¶ 49.
The Coates System was evaluated by two third parties,
Harley-Davidson, Inc. ("Harley") and Chrysler. See Pl.'s R.
56.1 Stmt. ¶¶ 52, 68. Under a July 1991 prototype manufacturing
agreement between CIL and Harley, CIL tried to retrofit the
Harley motorcycle engine with the Coates System. Harley
conducted dynamometer tests of two prototype motorcycle engines
modified with Coates System technology.
On or about November 1991, Harley notified Coates of the test
results on the Harley modified engines. See id. ¶ 53. The test
results indicated that the prototype engines had experienced
mechanical durability problems. See id. ¶ 52; see also Pl.'s
Ex. 11, Tuttle Dec. Ex. B, Harley November 18, 1991 Letter to
Coates ("Harley Letter"). Specifically, the Harley tests
revealed several problems with the modified Harley engines,
including "valve train failure" of one engine and deep score
marks on the rear exhaust rotary valve and seal of the second
engine. See Pl.'s R. 56.1 Stmt. ¶ 54; see also Harley
Letter. The Harley engineers offered the following conclusions
as to the two prototype engines equipped with the Coates System
in their November 18, 1991 letter to Coates:
1. The reliability/durability of the current rotary
valve trains systems for both ...