The opinion of the court was delivered by: Spatt, District J.
The Securities and Exchange Commission ("SEC") commenced this action against China Energy Savings Technology, Inc. ("China Energy"), New Solomon Consultants, Chiu Wing Chiu, Lai Fun Sim a/k/a Stella Sim, Sun Li, and Jun Tang Zhao (collectively, the "Defendants") alleging violations of: (1) Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 of the regulations, 17 C.F.R. § 240.10b-5; and (2) Sections 5(a) and 5(c) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§ 77e(a), (c) arising out of an alleged "pump and dump" scheme related to the sale of China Energy stock. The phrase "pump and dump" refers to a scheme by which someone causes the price of a stock to be artificially inflated, and then sells the stock when it is highly valued. The purchasers who bought the stock at a high price are typically left with worthless or much lower-valued securities when the price of the stock returns to its actual value.
Defendants China Energy, New Solomon, Chiu, Sim, Li, and J. Zhao have defaulted in this action and judgment was entered against them on the basis of that default, with all of the well-pleaded allegations in the Plaintiff's complaint deemed true. The scheme was fully described in a Report and Recommendation issued by United States Magistrate Judge A. Kathleen Tomlinson on March 13, 2008 following an inquest on damages. Judge Tomlinson explained that:
China Energy was formed in August 2004 when a Nevada shell corporation, Rim Holdings, Inc., owned by defendants Chiu and Sim, was renamed "China Energy." China Energy's business was developing, marketing, distributing and manufacturing energy saving products for use in commercial and industrial settings.
Defendant New Solomon is a British Virgin Island corporation with its principal place of business in Hong Kong. Defendant Chiu Wing Chiu, a resident of Hong Kong or the People's Republic of China, was the sole officer and director of New Solomon. Defendant Chiu exercised control over New Solomon and China Energy. Defendant Lai Fun Sim a/k/a Stella Sim, is a resident of Hong Kong. Defendant Sim was corporate secretary and a director of China Energy, and the sole officer and director of Eurofaith Holdings, Inc. ("Eurofaith"), a holding company controlled and directed by Defendant Chiu.
Defendant Sun Li is a resident of Hong Kong or the People's Republic of China. Sun Li was the Chief Executive Officer of China Energy and had a controlling interest in New Solomon. Defendant Jung Tang Zhao is a resident of Hong Kong and the president of Relief Defendant Precise Power. Defendant J. Zhao is also alleged to be an employee of China Energy.
Between June 2004 and July 2005, Chiu and Sim orchestrated China Energy's acquisition of Starway Management Limited ("Starway"). Starway's sole asset was a Chinese company that manufactures and markets energy related products. China Energy purchased this asset worth an estimated $20 million in exchange for 22 million shares of China Energy (then valued at $250 million). According to the SEC, these shares were transferred to entities controlled by Chiu. As a result, Chiu gained control of 65% of China Energy's outstanding common stock.
The SEC alleges that Defendants artificially increased the price of China Energy stock through a series of sham transactions. China Energy's stock price rose from $12 to $28 as a result of these activities. Between November 24 and December 9, 2004, Defendants' trading represented an average of 56% of the buy-side volume. During the first ten days of the pump, Defendants' buying activity represented 70% of the volume, and on three days during the period, Defendants accounted for 90% of the buy-side volume. At a time when the price of China Energy stock had risen as a result of Defendants' alleged manipulation, they sold millions of shares of the stock at an artificially inflated price.
The sale of this stock was effectuated in part through the use of brokerage accounts at Capital Growth Financial LLC ("Capital Growth"). The Capital Growth accounts are held in the names of the Relief Defendants, Goalwise and Du Li Qiang, and are alleged to have been used for no other purpose than to facilitate the sale of China Energy stock. The SEC identifies the accounts of Goalwise and Du Li Qiang as accounts under the control of the Defendants and seeks disgorgement of the proceeds of sales effectuated through those accounts as well as the accounts held in the names of the Relief Defendants.
Report and Recommendation, March 13, 2008 [DE 91] at 2--4.
In its complaint, the SEC also named Amicorp Development Limited, Essence City Limited, Precise Power Holdings Limited, Yan Hong Zhao, Ai Qun Zhong, and Tung Tsang (collectively, the "Relief Defendants") as Relief Defendants, alleging that proceeds of the scheme were held in the names of the Relief Defendants. On December 4, 2006, a temporary restraining order ("TRO") was entered freezing the assets of the Defendants and the Relief Defendants. On January 10, 2007, the Court extended the TRO as to all Relief Defendants, limiting the asset freeze to the disposition, transfer, or dissipation of any proceeds from the sale of China Energy stock.
The SEC then moved for a preliminary injunction enjoining the Relief Defendants from transferring or disposing of any proceeds of China Energy stock currently in their possession pending resolution of this action. Oral argument on the motion was heard on January 5, 2007. The Relief Defendants denied that the proceeds of the China Energy stock sale in the Capital Growth accounts in their names are proceeds of the defendants' fraud. The Relief Defendants argued that they have a legitimate claim to the funds that remain in the Capital Growth Accounts because they received the underlying shares of stock on a bona fide basis as consideration for the sale of their shares of stock in Starway. However, the SEC produced evidence that it contended conclusively established that the funds in the Capital Growth Accounts are directly traceable to the defendants' alleged fraud.
On March 19, 2007 the Court issued a Memorandum and Decision finding that a factual dispute existed as to whether the Relief Defendants had a legitimate claim to the funds remaining in the Capital Growth Accounts. Specifically, the only factual support for the Relief Defendants' position was found in the individual declarations of, Jun Tang Zhao, Ai Qun Zhong, Tsang Tung, and Yan Hong Zhao executed in December 2006. Although these declarations were in English, none of these individuals speak or write English and the accuracy of their translation was not clear. As a result, the SEC moved to strike these declarations and the Court agreed. However, rather than issuing a preliminary injunction at that time, the Court allowed the Relief Defendants time to submit additional evidence regarding the accuracy of the translated declarations.
On May 2, 2007, the Relief Defendants submitted newly signed Chinese translations of the English declarations and a "Second Joint Declaration." As a result, the Court referred the matter to United States Magistrate Judge A. Kathleen Tomlinson for the purpose of resolving all questions of fact and law regarding the Plaintiff's motion for a preliminary injunction and to issue a Report and Recommendation to that effect. Judge Tomlinson conducted an evidentiary hearing in the matter on August 9, 2007.
On March 31, 2008, the Court adopted Judge Tomlinson's Report and Recommendation in full and ordered the assets of the Relief Defendants frozen to the extent that they were proceeds from the sales of China Energy stock, to remain in effect pending final resolution of this action. In her Report and Recommendation, Judge Tomlinson explained that the SEC alleged that the Relief Defendants were mere nominees of defendants Chiu and Sim.
Judge Tomlinson noted that the corporate Relief Defendants, Amicorp, Essence City, and Precise Power are British Virgin Island companies located in Hong Kong. Amicorp, founded in September 2005, opened a brokerage account at Capital Growth in January 2006. The account documents state that Relief Defendant Zhong is designated as the sole officer and the mailing address is the same address as New Solomon and China Energy. Relief Defendant Essence City opened an account at Capital Growth in September 2005, designating Relief Defendant Tung as the sole officer and director and its mailing address was a residential address used by Defendant Chiu. Finally, in December of 2005, Precise Power opened a Capital Growth account, designating Defendant J. Zhao as the sole officer and also using a residential address used by Defendant Chiu.
In addition to other evidence submitted to establish the relationship between Chiu and the Relief Defendants, the SEC obtained the sworn statement of Steven Cao, the Capital Growth account representative for the Essence City, Precise Power, Y. Zhao, Amicorp, and New Solomon accounts. Cao stated that he was often unable to contact the Relief Defendants directly, but could contact them through Chiu only.
Judge Tomlinson also reviewed the declarations submitted by the individual Relief Defendants in opposition to the asset freeze. In the first set of declarations submitted by J. Zhao, Tung Tsang, Zhong, and Y. Zhao in December of 2006, these individuals stated that they were shareholders of Shenzhen Dicken Industrial Development Limited ("Shenzhen Dicken"), a company based in the People's Republic of China that manufactured and marketed energy related products and was subsequently merged into China Energy. According to the First Declarations, the principals of Shenzhen Dicken formed a holding company known as Starway Management Limited ("Starway"). The shares of Shenzhen Dicken held by Y. Zhao, Tung Tsang, Zhong, and J. Zhao were transferred to Starway and in June of 2004, and these individuals later received shares of China Energy in exchange for their interest in Starway. Further, the first set of declarations stated that these individuals had no "relationship of any kind with Chiu." The "Second Joint Declaration" of J. Zhao, Y. Zhao, Zhong, Tsang Tung purported to clarify the first set of declarations and stated that what they "meant to convey was the lack of a relationship with Mr. Chiu on ...