The opinion of the court was delivered by: Cedarbaum, J.
Section 5 of the Securities Act of 1933 makes unlawful the public sale of unregistered securities. 15 U.S.C. § 77e. At one time, Rule 144(k) exempted securities from registration before public sale if the securities were issued privately, solely in exchange for restricted securities of the same company if the restricted securities were more than two years old. 17 C.F.R. § 230.144(k). The Securities and Exchange Commission ("SEC") now moves for summary judgment against Hisao Sal Miwa, the CEO of Greenstone Holdings, Inc. ("Greenstone"), and John Frohling, Greenstone's general counsel, for violating Section 5 by causing Greenstone to issue more than 300 million unregistered shares of stock. The SEC also moves for summary judgment on the securities fraud charges brought against both defendants. The SEC charges that, from 2006 through 2008, Frohling wrote several legal opinions that falsely stated that stock issued by Greenstone was exempt from registration under Rule 144(k), in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a). The SEC also charges Miwa with violating Sections 10(b) and 17(a) by issuing press releases that falsely described Greenstone's business as thriving.
In defense, Frohling argues that the SEC is unable to prove the intention to defraud required by Section 10(b). Miwa argues that he was not responsible for the press releases and that the press releases were not false. On October 20, 2011, I held oral argument on the SEC's motion. At oral argument, both Frohling and Miwa were given leave to submit admissible evidence in response to the SEC's Rule 56.1 statement. Frohling and Miwa have been unable to raise any genuine dispute of material fact with respect to the allegations of the complaint. For the reasons that follow, the motion of the SEC is granted.
I.Frohling's § 10(b) and § 17(a) Liability
Miwa incorporated Greenstone in Delaware in 2004. Greenstone developed several chemical products, including a chemical called GreenShield. Greenstone advertised GreenShield as an environmentally safe wood sealant for use primarily by construction and railroad companies. In December 2005, with Greenstone facing a severe liquidity crisis, Miwa arranged to convert Greenstone into a publicly traded company. Greenstone acquired the shares of a public shell company--Auto Centrix, Inc.--and changed the company's name to Greenstone. Miwa took over as CEO of the new Greenstone public corporation in January 2006.
Greenstone then hired Corporate Stock Transfer, Inc. ("CST") to serve as its stock transfer agent and issue stock certificates. From September 2006 through June 2008, until the SEC suspended the trading of Greenstone stock, Greenstone distributed millions of shares of unregistered stock to the public. In order to sell Greenstone shares to the public, Frohling took steps to create the false appearance that the Greenstone stock issuances complied with the limited registration exemption then provided by Rule 144(k) of the Securities Act. The SEC alleges that, as counsel for Greenstone, Frohling wrote or concurred in at least ten legal opinions that falsely stated facts which, if true, would have supported an exemption from registration under Rule 144(k) for the public sale of Greenstone stock.
Rule 144 has been amended,*fn1 but the Second Circuit has described its operation during the relevant time period as follows:
Rule 144 generally affects only "restricted securities," or those securities that have never been publicly sold. To comply with Rule 144, a person ordinarily must meet numerous requirements concerning public information, holding periods, number of shares, manner of sales, and notice to the Commission. However, under subsection (k) of the Rule, if a person is not now and has not been an affiliate of the issuer within the last three months, and at least two years have elapsed since the securities to be sold were last acquired from an issuer or affiliate of the issuer, then that person need not comply with the other Rule 144 requirements.
SEC v. Kern, 425 F.3d 143, 148 (2d Cir. 2005); see also 17 C.F.R. § 230.144(k). The two-year ownership requirement is satisfied if the securities were acquired for "consideration consisting solely of other securities of the same issuer surrendered for conversion." 17 C.F.R. § 230.144(d)(3)(ii). In that event, the securities would be deemed to have been acquired at the same time as the securities surrendered for conversion. Id.
As noted above, Rule 144(k) applied only to "restricted securities." 17 C.F.R. § 230.144(k). The term "restricted securities" was, in relevant part, defined as "securities acquired directly or indirectly from an issuer in a transaction or chain of transactions not involving any public offering." 17 C.F.R. § 230.144(a)(3)(i). To determine whether stock was acquired in the course of a "public offering," courts consider:
(1) the number of offerees; (2) the sophistication and experience of the offerees; (3) the nature and kind of information which has been provided; and (4) the size of the offering and the precautions taken to prevent the offerees from reselling their securities. Steed Finance LDC v. Nomura Sec. Int'l, Inc., No. 00 CIV. 8058(NRB), 2001 WL 1111508, at *5 (S.D.N.Y. Sept. 20, 2001).
B.Frohling's Legal Opinions
The following facts are undisputed:
1.Martin & Pritchett Opinions at the Time of the Merger
In order to carry out the merger between Greenstone and Auto Centrix, several of Frohling's and Miwa's co-defendants (who will be referred to for the purposes of this opinion as "the Morelli Group") purchased the Auto Centrix shell corporation. The Morelli Group paid Greenstone $355,000 in exchange for 12.3 million unregistered shares of Greenstone stock. The shares were to be slowly resold on the open market according to the terms of a "Leak-Out Agreement" between Greenstone and the Morelli Group. Roughly one-third of the shares, or the proceeds from their sale, were to be used to pay certain of Greenstone's expenses, such as broker and attorney fees and public and investor relations.
Miwa wrote a letter to Greenstone's transfer agent, CST, on August 29, 2006, authorizing CST to issue 12.3 million unregistered shares. In order for the shares to be sold to the public, Miwa promised "an approving legal opinion of our Securities Counsel, Frohling & Hudak LLC." On the same day, Frohling wrote a letter to CST "approving the two opinions of [the law firm] Martin & Pritchett," and directing CST to transfer the shares to a number of entities controlled by the Morelli Group. On August 31, 2006, Frohling wrote another letter to CST to clarify that "[t]he shares referred to in our [prior] opinion letter . . . may be issued without restriction and the Transfer Agent also will not be required to affix a legend*fn2 to the shares or to make any notation on the transfer records regarding the sale of any of these shares." Based upon the belief that (1) Greenstone intended to issue the stock solely in exchange for old Auto Centrix "convertible promissory notes," and (2) the issue did not involve a public offering, the Martin & Pritchett opinions concluded that the shares "will be exempt from the registration and prospectus delivery requirements of the [Securities] Act, pursuant to the exemption set forth in Rule 144(k)." CST issued the 12.3 million shares according to Frohling and Miwa's instructions.
The information relied upon by Martin & Pritchett, and adopted and approved by Frohling, was false. Greenstone received ample new consideration in exchange for issuing the shares. As noted above, the Morelli Group paid Greenstone $355,000 as consideration for the 12.3 million shares and agreed to use a portion of the shares to pay for Greenstone's various operating and marketing expenses. Second, the stock issued to the Morelli Group was explicitly subject to a "leak out" agreement that allowed the purchasers to sell the stock to the public gradually over the subsequent eighteen months. Further, the 12 million shares represented roughly 95% of Greenstone's tradable shares at the time. The sale therefore could not satisfy the requirement for Rule 144(k) exemption that it be non-public. The Martin & Pritchett opinions, approved by Frohling, claimed a registration exemption under Rule 144(k) that did not apply.
2.Sourlis Opinion of February 2007
On February 1, 2007, Miwa again authorized CST to issue unrestricted, unregistered stock to the Morelli Group. This time, he authorized the issuance of 11,056,498 shares. On the same day, Frohling submitted to CST legal opinions written by attorney and co-defendant Virginia Sourlis. Frohling added that he concurred in the Sourlis opinion and requested that CST issue 6,150,000 shares*fn3 of Greenstone stock to four entities owned by individuals in the Morelli Group.
Once again, the legal opinions submitted by Frohling improperly relied on the Rule 144(k) registration exemption. The Sourlis opinion stated that the exemption applied because the shares were to be issued in exchange for the surrender of $77,339.65 worth of convertible promissory notes that had been issued by Greenstone's predecessor corporation, Auto Centrix, "on or before January 10, 2004." These convertible notes were issued by Auto Centrix to "various vendors" and the notes were assigned to the entities owned by the Morelli Group on January 10, 2006. Sourlis reasoned that the shares could be issued without a restrictive legend because they were to be exchanged solely for outstanding two-year-old Greenstone securities surrendered for conversion. Thus, they need not be held by the Morelli Group entities for two years under the exemption in Rule 144(d)(3)(ii). CST relied on Sourlis's opinion letter and Frohling's concurrence and issued the requested shares without a restrictive legend.
In fact, no such convertible notes even existed. Sourlis submitted
along with her opinion a list of Auto Centrix's "aged payables"--debts
that the company owed to vendors such as American Express, Verizon,
and FedEx. According to Sourlis, "the Original Convertible Notes were
issued by the Company to various vendors" on the list as payment for
Auto Centrix's debts. This was false. Co-defendant Thomas Pierson
testified at his deposition that any statement that such notes were
issued is "erroneous." Moreover, declarations from seven of the
vendors listed by Sourlis, including American Express and
Verizon, state that they never received notes of any kind.*fn4
This evidence directly contradicts statements in the Sourlis
opinion that Sourlis received verification from the noteholders that,
for example, no additional consideration was received in exchange for
the notes. Given that the notes did not exist, the statement in the
Sourlis opinion that "the Original Convertible Notes were assigned and
endorsed" was false as well.*fn5 As
discussed above, Frohling adopted Sourlis's statement in full when directing CST to issue additional stock even though he knew the true facts. Frohling again adopted a legal opinion that claimed for Greenstone stock a ...