Securities & Exchange Commission v. CMKM Diamonds, Inc.

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

SECURITIES AND EXCHANGE Nos. 11-17021

COMMISSION, 11-17025

Plaintiff-Appellee,

D.C. No.

v. 2:08-cv-00437-

LRH-RJJ

CMKM DIAMONDS, INC.,

Defendant,

OPINION

and

1ST GLOBAL STOCK TRANSFER LLC;

HELEN BAGLEY; BRIAN DVORAK,

Defendants-Appellants.

Appeals from the United States District Court

for the District of Nevada

Larry R. Hicks, District Judge, Presiding

Argued and Submitted

April 15, 2013—San Francisco, California

Filed September 10, 2013

2 SEC V. CMKM DIAMONDS, INC.

Before: Susan P. Graber and Morgan Christen, Circuit

Judges, and John R. Tunheim,* District Judge.

Opinion by Judge Tunheim

SUMMARY**

Securities Law

The panel affirmed in part, and reversed in part, the

district court’s orders in a civil enforcement action brought by

the Securities and Exchange Commission against numerous

defendants allegedly involved in a scheme to sell unregistered

securities of CMKM Diamonds, Inc. in violation of Section 5

of the Securities Act of 1933.

The panel reversed the district court’s grant of summary

judgment against CMKM’s transfer agent, 1st Global Stock

Transfer, LLC and its owner Helen Bagley, because there was

a material issue of fact regarding whether Global and Bagley

were necessary participants and substantial factors in the

distribution of CMKM’s stock sufficient to impose liability

under Section 5 of the Securities Act of 1933. The panel

affirmed the magistrate judge’s denial of the motion of Brian

Dvorak, CMKM’s attorney at the time of scheme, to stay the

proceedings, and the district court’s disgorgement order

*

The Honorable John R. Tunheim, United States District Judge for the

District of Minnesota, sitting by designation.

**

This summary constitutes no part of the opinion of the court. It has

been prepared by court staff for the convenience of the reader.

SEC V. CMKM DIAMONDS, INC. 3

(ordering defendants to disgorge proceeds from the illegal

securities’ sales, plus prejudgment interest) as to Dvorak.

COUNSEL

Mark S. Dzarnoski (argued), Gordon & Silver Ltd., Las

Vegas, Nevada, for Defendants-Appellants 1st Global Stock

Transfer LLC and Helen Bagley.

John Wesley Hall, Jr. (argued), Law Offices of John Wesley

Hall, Jr., Little Rock, Arkansas, for Defendant-Appellant

Brian Dvorak.

Allan Armistead Capute (argued), Securities and Exchange

Commission, Washington, D.C., for Plaintiff-Appellee.

OPINION

TUNHEIM, District Judge:

These consolidated appeals arise out of a civil

enforcement action brought by the Securities and Exchange

Commission (“SEC”) against numerous defendants allegedly

involved in a scheme to sell unregistered securities of CMKM

Diamonds, Inc. (“CMKM”). The district court granted

summary judgment in favor of the SEC, ruling that 1st Global

Stock Transfer, LLC (“Global”), Helen Bagley, and Brian

Dvorak (collectively, “Defendants”) participated in an

unregistered distribution of securities in violation of Section

5 of the Securities Act of 1933 (“Securities Act”), 15 U.S.C.

§ 77e. The district court ordered Defendants to disgorge

4 SEC V. CMKM DIAMONDS, INC.

proceeds from the illegal sales, plus prejudgment interest.

Prior to the district court’s ruling on summary judgment,

Dvorak brought a motion to stay the civil proceedings until

the conclusion of his criminal proceedings involving the same

conduct, which a magistrate judge denied.

Global and Bagley appeal the district court’s entry of

summary judgment and the disgorgement order; Dvorak

appeals the magistrate judge’s order denying his motion to

stay and the district court’s disgorgement order. We conclude

that the district court erred in granting summary judgment

against Global and Bagley because a material issue of fact

remains regarding whether Global and Bagley were necessary

participants and substantial factors in the distribution of

CMKM’s stock sufficient to impose liability under Section 5.

We therefore reverse the judgment of the district court as to

Global and Bagley and remand for further proceedings. We

affirm the magistrate judge’s denial of Dvorak’s motion to

stay the proceedings and the district court’s disgorgement

order as to Dvorak.

I. BACKGROUND

A. The Scheme

CMKM is a publicly held Nevada corporation. During the

relevant time period, CMKM’s common stock was not

registered with the SEC under the Securities Act, 15 U.S.C.

§ 77a et seq. CMKM’s stock was registered, however, under

Section 12(g) of the Securities Exchange Act of 1934

(“Exchange Act”), 15 U.S.C. § 78l(g), and was traded on the

Pink Sheets, now known as OTC Pink, an electronic

quotation and trading marketplace for both registered and

unregistered securities.

SEC V. CMKM DIAMONDS, INC. 5

Between January 2003 and March 2005, at least eleven

individuals and three entities allegedly participated in a

scheme to issue billions of shares of unrestricted CMKM

stock and then sell the stock to the public without filing a

registration statement. CMKM, holding itself out as a gold

and diamond mining company, increased its number of shares

to 800 billion. Urban Casavant and John Edwards,

respectively CMKM’s CEO and director of “post-merger

matters,” then began issuing and selling shares of unrestricted

stock. CMKM in fact had no legitimate operations. The

company issued false press releases, operated a promotional

racing team that traveled around the country, and provided

investors with fake maps and videos of mineral operations in

North and South America. The proceeds of the stock sales

were used primarily to finance the personal lifestyles of

Casavant and Edwards. As a result of the scheme,

approximately 40,000 investors lost at least $64.2 million.

In an attempt to appear to comply with securities

regulations, Edwards received false opinion letters supporting

the issuance of unrestricted CMKM stock from Defendant

Dvorak. Based upon these letters, CMKM’s transfer agent,

Defendant Global and its owner Bagley, issued unrestricted

shares of CMKM stock. Using these certificates, Edwards

sold 260 billion shares of stock through Daryl Anderson,

Kathleen Tomasso, and Anthony Tomasso. Anderson was

Edwards’ registered representative at NevWest Securities

Corporation (“NevWest”) and sold over 200 billion shares.

Edwards also issued 77.3 billion shares of stock to companies

owned by the Tomassos, which in turn sold the shares to the

public.

6 SEC V. CMKM DIAMONDS, INC.

B. Dvorak’s Role

Dvorak acted as CMKM’s attorney during the course of

the scheme. Casavant told Dvorak that numerous investors

had already paid for shares of stock in CMKM when the

company was in its initial stages, but stock certificates had

never been issued to those investors. Casavant also told

Dvorak that new certificates needed to be issued to certain

investors whose shares were the subject of an earlier 100-for-

one stock split. Casavant then began issuing those certificates.

After receiving the newly issued CMKM stock certificates,

Dvorak would write an opinion letter stating that the stocks

referred to in the certificates should be issued without a

restrictive legend.1

Dvorak’s opinion letters indicated that the stocks issued

by CMKM met the safe harbor of Rule 144(k), and therefore

were exempt from registration under the Securities Act. See

15 U.S.C. § 77d(a)(1); 17 C.F.R. § 230.144(k).2 Dvorak’s

1

A restrictive legend placed upon a security alerts buyers that the

security has not been registered under the Securities Act and may be

offered and sold only if the security is registered, or its sale qualifies for

an exemption from registration. See Use of Legends and Stop-Transfer

Instructions as Evidence of Nonpublic Offering, SEC Release No. 33-

5121, 1971 WL 120470 (Feb. 1, 1971). When the requirements of an

exemption from registration have been met, however, an issuer will often

seek to have the restrictive legend removed to avoid delays in the transfer

and to make the securities more saleable. See Robert A. Barron, Some

Comments on the Removal of Restrictive Legends and Stops from

Restricted Securities Prior to the Sale of Such Securities, 34 Sec. Reg. L.J.

308 (2006).

2

In relevant part, Rule 144(k) provided that the unregistered sale of

securities did not violate the Securities Act if the securities were held for

at least two years by a nonaffiliate of the issuer. See 17 C.F.R.

SEC V. CMKM DIAMONDS, INC. 7

letters concluded that the stocks satisfied the two-year

holding period of Rule 144(k) because, perhaps implausibly,

the investors had paid for the stock or performed services for

CMKM more than two years prior to issuance of the stock

certificates or because a 100-for-one stock split had occurred

more than two years earlier. Therefore Dvorak’s letters

concluded that the shares should be issued without a

restrictive legend.

During the course of the scheme, Dvorak drafted 450

opinion letters regarding at least 233.7 billion shares of stock,

issued to 258 individuals, that CMKM claimed could have

been issued more than two years earlier. Dvorak received

$318,843 from other participants in the scheme, including

approximately $350 per opinion letter.

C. Global and Bagley’s Role

Defendant Global is a Nevada corporation owned and

operated by Bagley. In October 2001, Global registered with

the SEC as a transfer agent3 pursuant to 15 U.S.C. § 78q-1(c)

and in 2002 began serving as CMKM’s transfer agent.

During the course of the scheme, CMKM approved several

increases in its number of authorized shares, until the number

§ 230.144(k) (2008). Rule 144(k) has since been replaced by Rule 144(b)

which changed the two-year holding period of Rule 144(k) to a one-year

holding period. See 17 C.F.R. § 230.144(b); SEC v. M&A W. Inc.

538 F.3d 1043, 1046 n.1 (9th Cir. 2008) (citing Revisions to Rules 144

and 155, Exchange Act Release No. 33-8869, 2007 WL 4270700 (Dec. 6,

2007)).

3

Issuers of securities use transfer agents to, among other things, monitor

the issuance of securities, register transfers of securities, and maintain the

issuer’s security holder records. See 15 U.S.C. § 78c(a)(25).

8 SEC V. CMKM DIAMONDS, INC.

of authorized shares approached 800 billion. Global and

Bagley were notified of these authorizations, and between

2002 and 2004 Global issued up to 622 billion shares of

unrestricted CMKM stock based on attorney opinion letters.

During most of 2003 and the first half of 2004, Bagley

relied upon opinion letters written by Dvorak. Bagley

testified that, relying on Dvorak’s letters she understood that

the stock was to be issued without a restrictive legend

because payment for the stock had been made, or the stock

split had occurred, at least two years earlier. Bagley also

testified that she may have wondered whether all of the shares

claimed by CMKM should actually have been issued two

years earlier, that it seemed strange to her that CMKM had so

many shares, and that nothing CMKM did as a company

“made sense” to her. Bagley further testified that Global is

“only the transfer agency. That’s all we do. If we get proper

paperwork, we do what needs to be done.”

In June 2004, Bagley requested that Dvorak’s opinions be

confirmed by Edwards & Angell LLP (“Angell”), another law

firm representing CMKM, because she was not comfortable

with Dvorak’s letters.4 In their opinion letters, the Angell

attorneys stated that “we have relied upon opinions . . . of

Dvorak & Associates, Ltd. for each of the Shareholders to the

effect that the already-issued shares as to which the Shares

are being issued as dividends were issued more than two

years ago and that the issuance of the Shares as dividends has

4

In her deposition, Bagley did not testify to any particular events that

made her feel uncomfortable with Dvorak’s opinions, nor did she testify

that she had any reason to doubt the accuracy of Mr. Dvorak’s work.

Bagley did state with respect to Dvorak that she “did not like him” and

“didn’t like his attitude.”

SEC V. CMKM DIAMONDS, INC. 9

been duly authorized.” The Angell opinion letter also stated

that “[w]e have examined such certificates, certified copies of

organizational and governance documents, certificates of

good standing, certifications of factual matters, company

resolutions and other records, pertinent documents and

instruments, and have investigated such other matters of law

and fact, as we have deemed necessary for the purpose of

rendering the opinions set forth herein.” Finally, the Angell

opinion letter concluded that “the Shares may be issued to the

Shareholders . . . and that the certificates evidencing the

Shares need bear no restrictive legend.” An Angell attorney

testified that he felt it was reasonable to rely upon the

opinions expressed by Dvorak in writing Angell’s opinion

letters. The attorney testified that he believed Dvorak’s

opinion letters to be valid, and had no reason to believe the

issuance of shares in reliance on the Dvorak opinion letters

was wrongful.

D. Procedural History

On April 7, 2008, the SEC filed a complaint against

Dvorak, Global, Bagley, and eleven other defendants in the

United States District Court for the District of Nevada. The

complaint alleged violations of Section 5 of the Securities

Act, 15 U.S.C. § 77e(a), which creates liability for the

distribution of unregistered securities.

On March 25, 2009, an indictment was issued in the

United States District Court for the District of Nevada based

on the same set of facts that gave rise to the civil proceedings.

The indictment named Dvorak, as well as five other

defendants who are not parties to this appeal.

10 SEC V. CMKM DIAMONDS, INC.

On December 23, 2010, the SEC filed a motion for

summary judgment against Dvorak, Global, and Bagley.

Global and Bagley, but not Dvorak, opposed the SEC’s

motion. On July 25, 2011, the district court granted summary

judgment against all three Defendants, holding that there was

no genuine issue of material fact that each Defendant was

both a necessary participant and a substantial factor in the

unregistered distribution of CMKM stock, and was therefore

liable for violating Section 5 of the Securities Act. As to

Global and Bagley, the district court concluded that they had

played more than a de minimis role in the scheme, and that

but for their participation in removing the restrictive legends

on the CMKM stock certificates there would not have been a

sale of unregistered securities. The district court rejected

Global and Bagley’s contention that summary judgment was

inappropriate because a material issue of fact remained

regarding whether they knew or had reason to know that the

distribution of stock was illegal, concluding that Section 5 is

a strict liability statute.

The district court entered final judgment on August 1,

2011. The court permanently enjoined Defendants from

violating Section 5 and ordered disgorgement of profits

gained as a result of violations of the Securities Act plus

prejudgment interest. Specifically, the court ordered Dvorak

to disgorge $409,638.11 and Bagley and Global, jointly and

severally, to disgorge $448,047.87

On January 18, 2011, while the SEC’s motion for

summary judgment was pending, Dvorak filed a motion to

stay the civil proceedings until the criminal proceedings

concluded, arguing that a stay was necessary to protect his

Fifth Amendment rights. In the alternative, Dvorak requested

that the court grant him additional time to respond to the

SEC V. CMKM DIAMONDS, INC. 11

SEC’s motion for summary judgment. Specifically, Dvorak

referenced the SEC’s evidence related to the criminal

proceedings, stating that “[w]ith 200 boxes of discovery

waiting to be scanned and delivered to defense counsel in the

criminal case, there may be more Dvorak will be able to

present to defeat summary judgment.”

United States Magistrate Judge Robert J. Johnston denied

Dvorak’s motion for a stay on April 7, 2011, rejecting

Dvorak’s argument that a stay was required by the Fifth

Amendment. The magistrate judge also stated that Dvorak

had not sought any particular discovery and had not referred

in his moving papers to Federal Rule of Civil Procedure

56(d), suggesting that Dvorak’s ability to respond to the

SEC’s motion for summary judgment would not be altered if

the court did not stay the case.

Global and Bagley appeal the district court’s grant of

summary judgment and disgorgement order. Dvorak appeals

the denial of his motion to stay the proceedings as well as the

district court’s disgorgement order.

II. DISCUSSION

A. Liability Under Section 5

Global and Bagley argue that the district court erred in

granting summary judgment because genuine issues of

material fact remain as to whether Global and Bagley’s

actions as a transfer agent satisfied the standard for liability

under Section 5 of the Securities Act.

We review the district court’s grant of summary judgment

de novo, SEC v. Platforms Wireless Int’l Corp., 617 F.3d

12 SEC V. CMKM DIAMONDS, INC.

1072, 1085 (9th Cir. 2010), and view the evidence in the light

most favorable to the nonmoving party to “determine whether

there are genuine issues of material fact and whether the

district court correctly applied the relevant substantive law,”

Oak Harbor Freight Lines, Inc. v. Sears Roebuck & Co.,

513 F.3d 949, 954 (9th Cir. 2008).

“Sections 5(a) and (c) of the Securities Act, 15 U.S.C.

§ 77e(a), (c), make it unlawful to offer or sell a security in

interstate commerce if a registration statement has not been

filed as to that security, unless the transaction qualifies for an

exemption from registration.” Platforms Wireless, 617 F.3d

at 1085. Section 5(a)(1) “broadly prohibits sales of securities

irrespective of the character of the person making them.”

SEC v. Chinese Consol. Benevolent Ass’n, 120 F.2d 738, 741

(2d Cir. 1941). To establish a prima facie case for violation

of Section 5, the SEC must show that (1) no registration

statement was in effect as to the securities; (2) the defendant

directly or indirectly sold or offered to sell securities; and (3)

the sale or offer was made through interstate commerce. See

SEC v. Phan, 500 F.3d 895, 902 (9th Cir. 2007); see also SEC

v. Calvo, 378 F.3d 1211, 1214 (11th Cir. 2004) (per curiam).

“Once the SEC introduces evidence that a defendant has

violated the registration provisions, the defendant then has the

burden of proof in showing entitlement to an exemption.”

SEC v. Murphy, 626 F.2d 633, 641 (9th Cir. 1980) (citing

SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953)).

Global and Bagley challenge only the first element of the

SEC’s prima facie case, arguing that they did not sell or offer

to sell securities within the meaning of Section 5.

Although Section 5 provides that it is unlawful for any

person to sell or offer to sell an unregistered security,

15 U.S.C. § 77e(a), (c), liability under Section 5 is not limited

SEC V. CMKM DIAMONDS, INC. 13

to the person or entity who ultimately passes title to the

security. See Murphy, 626 F.2d at 649. “Instead, courts have

established the concept of ‘participant’ liability to bring

within the confines of § 5 persons other than sellers who are

responsible for the distribution of unregistered securities.”

Id. With respect to Section 5, a defendant’s “role in the

transaction must be a significant one before liability will

attach.” Id. at 648. Defendants play a significant role when

they are “both a ‘necessary participant’ and ‘substantial

factor’ in the sales transaction.” Phan, 500 F.3d at 906

(quoting Murphy, 626 F.2d at 648, 652). We have previously

stressed that the substantial factor test requires more than a

finding of “but for” causation, explaining:

Prior to the issuance of a security, numerous

persons perform mechanical acts without

which there could be no sale. For example, a

printer may prepare key documents or a bank

may advance cash to a customer upon the

customer’s presentation of an instrument and

then pass the instrument to another person.

Both would satisfy a “but for” causation test,

but these acts nonetheless do not render the

defendants sellers. Before a person’s acts can

be considered the proximate cause of a sale,

his acts must also be a substantial factor in

bringing about the transaction.

Murphy, 626 F.2d at 650 (citations omitted); see also SEC v.

Seaboard Corp., 677 F.2d 1289, 1294 (9th Cir. 1982). “The

proximate cause analysis required by Murphy . . . usually

involves a question of fact for the jury.” Anderson v.

Aurotek, 774 F.2d 927, 930 (9th Cir. 1985) (per curiam),

14 SEC V. CMKM DIAMONDS, INC.

overruled in part on other grounds by Pinter v. Dahl,

486 U.S. 622 (1988).5

Global and Bagley first argue that the district court erred

when it determined that Section 5 is a strict liability statute

and failed to consider whether Global and Bagley knew or

should have known that their conduct violated the Securities

Act. Global and Bagley argue that, as transfer agents, they

occupy a unique role in a securities transaction in which they

perform largely ministerial tasks in reliance upon attorney

opinion letters. Therefore, Global and Bagley argue, they can

be liable under Section 5 only if they acted unreasonably in

issuing the CMKM shares without a restrictive legend.

We have previously suggested that scienter is not an

element of Section 5 liability. See Phan, 500 F.3d at 905–06.

This is in accord with the majority of circuit courts that have

5

In Pinter, the Supreme Court overruled the use of the “substantial

factor” test for purposes of imposing liability under Section 12 of the

Securities Act. 486 U.S. at 654. Section 12 provides that “[a]ny person

who—(1) offers or sells a security in violation of [Section 5] . . . shall be

liable . . . to the person purchasing such security from him.” 15 U.S.C.

§ 77l(a). The Pinter court explained that “[t]he ‘purchase from’

requirement of § 12 focuses on the defendant’s relationship with the

plaintiff-purchaser. The substantial-factor test, on the other hand, focuses

on the defendant’s degree of involvement in the securities transaction and

its surrounding circumstances.” Pinter, 486 U.S. at 651.

Section 5 does not contain a similar “purchase from” requirement, and

therefore we have held that Pinter did not overrule use of the substantial

factor test for purposes of imposing Section 5 liability. See Phan,

500 F.3d at 906 n.13; see also Geiger v. SEC, 363 F.3d 481, 487–88 (D.C.

Cir. 2004). Cases that preceded Pinter and described or applied the

necessary participant and substantial factor test in the context of Section

12 continue to be relevant for purposes of defining the scope of that test

with respect to Section 5. See, e.g., Phan, 500 F.3d at 906.

SEC V. CMKM DIAMONDS, INC. 15

considered the question. See Calvo, 378 F.3d at 1215; SEC

v. Holschuh, 694 F.2d 130, 137 n.10 (7th Cir. 1982); Swenson

v. Engelstad, 626 F.2d 421, 424 (5th Cir. 1980). But see

Kane v. SEC, 842 F.2d 194, 199 (8th Cir. 1988) (holding that

Section 5 liability “extends to those persons who are uniquely

positioned to ask relevant questions, acquire material

information, or disclose their findings”). We conclude that a

transfer agent’s role in a securities distribution is not

inherently unique and therefore does not justify subjecting

transfer agents to a different standard for Section 5 liability

than any other participant in the distribution of unregistered

securities. Transfer agents are not, for example, the only

potential participants in a securities distribution that may rely

on the opinions of attorneys. Nor are transfer agents the only

participants in a securities distribution that may play a

ministerial or de minimis role. A transfer agent, like any

other participant in a securities scheme, does not play

precisely the same role in every transaction. Therefore, we

decline to create an exception to strict liability for transfer

agents, and we reaffirm that scienter is not an element of

Section 5 liability.6 As explained more fully below, the

6

Because Section 5 is a strict liability statute, it appears that the district

court erred in determining that good faith reliance on counsel could

preclude liability under the statute. The cases cited by the district court in

support of that proposition involved other provisions of the securities laws

that do require scienter before imposing liability. See SEC v. Goldfield

Deep Mines Co. of Nev., 758 F.2d 459, 467 (9th Cir. 1985) (examining a

good faith defense in the context of entry of a permanent injunction

because an injunction may be entered only upon a finding of scienter to

violate the securities laws); SEC v. Savoy Indus., Inc., 665 F.2d 1310,

1314 n.28 (D.C. Cir. 1981) (discussing a good faith reliance defense in the

context of liability under the anti-fraud provisions of the securities

regulations that require a finding of scienter). In contrast “neither a good

faith belief that the offers or sales in question were legal, nor reliance on

the advice of counsel, provides a complete defense to a charge of violating

16 SEC V. CMKM DIAMONDS, INC.

“necessary participant” and “substantial factor” test is better

suited to determine participant liability. The myriad

securities schemes and participant roles within those schemes

must be considered by courts rather than a scienter

requirement based upon the title of a participant.

In support of their position that transfer agents should

face liability under Section 5 only when they act

unreasonably, Global and Bagley rely primarily on Nevada

state law. Under the Exchange Act, states are authorized to

enact legislation governing transfer agents that is “not

inconsistent” with federal securities regulations. 15 U.S.C.

§ 78q-1(d)(4). Transfer agents have a duty to register a

transfer of stock under Nevada state law provided that the

transfer is, among other things, rightful.7 Global and Bagley

argue that a reasonable belief that a transfer would be

wrongful under federal securities law provides a transfer

agent with a defense to the state law duty to register a

transfer. Therefore, Global and Bagley argue that it is

inconsistent for federal law to impose strict liability upon a

transfer agent’s wrongful transfer stock when compliance

Section 5 of the Securities Act.” SEC v. Friendly Power Co., 49 F. Supp.

2d 1363, 1368 (S.D. Fla. 1999) (citing Holschuh, 694 F.2d at 137).

7

Courts have held that a request to remove a restrictive legend is

substantially equivalent to a request to register a transfer under the

Uniform Commercial Code. See, e.g., Am. Sec. Transfer, Inc. v. Pantheon

Indus., Inc., 871 F. Supp. 400, 404–05 (D. Colo. 1994); Bender v. Memory

Metals, Inc., 514 A.2d 1109, 1115 (Del. Ch. 1986). We assume, without

deciding, for purposes of Global and Bagley’s argument that the requests

in this case to remove the restrictive legends from CMKM shares would

be subject to Nevada law governing a transfer agent’s duty to register a

transfer.

SEC V. CMKM DIAMONDS, INC. 17

with the state law duty to register a transfer is subject to a

reasonableness inquiry.

The existence of state law shielding a transfer agent from

liability for failing to remove a restrictive legend based upon

a reasonable belief that such a removal would be wrongful

does not conflict with our holding that Section 5 is a strict

liability statute. Liability under state and federal law is

mutually exclusive in this context. If a transfer agent is found

liable under Section 5 of the Securities Act for issuing shares

without a restrictive legend, it is impossible for the transfer

agent to be found liable under state law for refusing to issue

that same share. And a transfer agent will not face federal

liability for not removing a restrictive legend, but may face

state liability if it did not have a reasonable basis for its

refusal. Although the knowledge requirement for violations

of state and federal law differs, that difference does not

persuade us to incorporate an element of scienter into

Section 5.

Because Section 5 imposes strict liability for violations of

its registration requirement, we recognize that it is

particularly important that the necessary participant and

substantial factor test be carefully applied to each case so as

not to subject defendants with a de minimis or insubstantial

role in a securities scheme to strict liability. With that in

mind, we turn now to application of the necessary participant

and substantial factor test to the facts of this case.

The district court found that Global and Bagley were

necessary participants because, “but for their participation in

removing the restrictive legends, there would not have been

a sale of unregistered securities because the CMKM stock

would still have the restrictive legend on each certificate.”

18 SEC V. CMKM DIAMONDS, INC.

The court went on to conclude that Global and Bagley were

substantial factors in the scheme as a matter of law because

they “issued billions of shares of CMKM stock without the

restrictive legend and then transferred those unrestricted

certificates to defendant NevWest for the purpose of sale to

the general public.” Global and Bagley argue that, even if

Section 5 does not require scienter, their conduct as CMKM’s

transfer agent was insufficient to establish that they were a

substantial factor in the scheme to distribute CMKM stock.

The SEC argues, however, that Global and Bagley by virtue

of their status as CMKM’s transfer agent are necessarily

liable under Section 5 because a transfer agent’s role is

“central to the distribution” of securities.

We reject the SEC’s contention that Global and Bagley

are necessarily liable under Section 5 by virtue of their

position as CMKM’s transfer agent. A participant’s title,

standing alone, cannot determine liability under Section 5,

because the mere fact that a defendant is labeled as an issuer,

a broker, a transfer agent, a CEO, a purchaser, or an attorney,

does not adequately explain what role the defendant actually

played in the scheme at issue. Instead, whether a defendant

is a substantial factor in the distribution of unregistered

securities is a question of fact requiring a case-by-case

analysis of the nature of the securities scheme and the

defendant’s participation in it. See Anderson, 774 F.2d at

930. This does not mean that summary judgment will never

be appropriate, however. For example, in Murphy we

affirmed the district court’s grant of summary judgment in the

SEC’s favor regarding defendant’s Section 5 liability because

Murphy participated heavily in the

offerings. . . . He devised the corporate

financing scheme for [the issuer] . . . . He

SEC V. CMKM DIAMONDS, INC. 19

prepared and reviewed offering memoranda;

he met personally with broker-dealers,

investors and their representatives; and he

spoke at broker-dealer sales seminars. There

can be no gainsaying the importance of these

acts: Murphy’s extensive role in facilitating

the transactions clearly was a substantial

factor in the sales of unregistered securities.

Murphy, 626 F.2d at 638, 652. Similarly, in Phan we

affirmed summary judgment holding the defendant liable

under Section 5 where the defendant chose the date to call in

the investor’s $1.25 million obligation to the issuer, directed

the investor to sell the shares in order to repay her obligation,

provided the investor with a buyer, directed the issuer’s

lawyer to draft a contract for the stock sale, and instructed the

investor where to send the proceeds. 500 F.3d at 906.

Because of those facts we concluded that Phan “was both a

‘necessary participant’ and a ‘substantial factor in’ Wu’s

resale.” Id.; see also Calvo, 378 F.3d at 1215 (“[T]he

undisputed material facts amply support the district court’s

determination that, as a matter of law, Calvo illegally sold

unregistered securities” where “Calvo negotiated and signed

the contract with [the issuer] SOE pursuant to which [the

brokerage] received the unregistered shares as compensation;

he extended that contract on behalf of [the brokerage]; he

signed the documents that opened the . . . brokerage account

into which all of the unregistered SOE shares were deposited;

he signed stock transfer authorization and stock powers for

sales or transfers of stock out of [the] brokerage account; and

he received proceeds–albeit through [the brokerage]–from the

sale of SOE shares. Clearly, Calvo was a necessary

participant and a substantial factor in the illegal sale of

unregistered SOE stock.”).

20 SEC V. CMKM DIAMONDS, INC.

Here, the undisputed facts do not establish that Global and

Bagley were substantial participants in the CMKM

distribution as a matter of law. Global and Bagley read

opinion letters from Dvorak, instructing them to remove the

restrictive legends from CMKM stock, and then issued large

quantities of those shares without the restrictive legend.

Global and Bagley then requested a second opinion letter

from Angell. After reading the Angell opinion letters, Global

and Bagley continued to issue large quantities of shares

without the restrictive legend.8 This conduct is in stark

contrast to the actions taken by the defendants in Murphy,

Phan, and Calvo. The defendants in those cases were

integrally involved in the securities-distribution schemes,

from devising the scheme to finding investors and buyers to

structuring the sales. That Global and Bagley issued large

quantities of shares without a restrictive legend after

receiving two attorney opinion letters is insufficient, in and of

itself, to establish that Global and Bagley were substantial

factors as a matter of law. Based upon this evidence, a

reasonable jury could conclude that Global and Bagley were

not substantial participants in the CMKM scheme. See

Geiger v. SEC, 363 F.3d 481, 487 (D.C. Cir. 2004) (“[N]ot

8

The district court reasoned that Global and Bagley “transferred those

unrestricted certificates to defendant NevWest for the purpose of sale to

the general public” in concluding that Global and Bagley were substantial

factors in the scheme. But this fact was not undisputed in the record. The

record indicates only that “Edwards hand delivered several recently issued

stock certificates in CMKM stock to NevWest,” and that “Edwards was

delivering to NevWest newly issued stock certificates in CMKM stock.”

The SEC does not identify any portion of the record indicating that Global

and Bagley transferred shares to NevWest. Therefore, the district court

erred in relying on the fact that Global and Bagley transferred stocks to

NevWest to support its conclusion that they were substantial factors in the

CMKM distribution.

SEC V. CMKM DIAMONDS, INC. 21

everyone in the chain of intermediaries between a seller of

securities and the ultimate buyer is sufficiently involved in

the process to make him responsible for an unlawful

distribution.” (internal quotation marks omitted)). This case

does not present evidence of significant and continuing

involvement in the development and execution of a scheme

to distribute securities in violation of the Securities Act like

that which has supported the entry of summary judgment in

other cases on the question of whether defendants were a

substantial factor in a securities distribution. Therefore, we

reverse the district court’s grant of summary judgment as to

Global and Bagley and remand for proceedings consistent

with this opinion.9

B. Motion to Stay

Dvorak appeals from the magistrate judge’s denial of his

motion to stay. Dvorak challenges both the magistrate

judge’s authority to decide the motion, as well as the

substantive reasons for the denial.

1. Authority of the Magistrate Judge

“[A] district judge may designate a magistrate judge to

hear any nondispositive pretrial matter pending before the

court.” Estate of Connors ex rel. Meredith v. O’Connor,

6 F.3d 656, 658 (9th Cir. 1993); see also 28 U.S.C.

§ 636(b)(1)(A). Under 28 U.S.C. § 636(b)(1)(B), a district

judge may also authorize a magistrate judge to “conduct

hearings, including evidentiary hearings, and to submit to a

9

Because we remand on the issue of Global and Bagley’s liability, we

do not reach their arguments about the reasonableness of the district

court’s disgorgement order against them.

22 SEC V. CMKM DIAMONDS, INC.

judge of the court proposed findings of fact and

recommendations for the disposition” of motions that the

magistrate judge lacks the authority to decide under

§ 636(b)(1)(a). As we have noted:

The primary difference between

subsections (1)(A) and (1)(B) is that the

former allows the magistrate judge to

“determine” the matter (subject to the review

of the district court for clear or legal error)

while the latter allows the magistrate only to

submit “proposed findings and

recommendations” for the district court’s de

novo review.

Reynaga v. Cammisa, 971 F.2d 414, 416 (9th Cir. 1992)

(quoting 28 U.S.C. § 636(b)(1)).

We have previously held that where the denial of a

motion to stay is effectively a denial of the ultimate relief

sought, such a motion is considered dispositive, and a

magistrate judge lacks the authority to “determine” the

matter. Id. at 416–17. We have not, however, squarely

addressed the question of whether a motion to stay a civil

proceeding, where the effect is not the denial of relief, is a

nondispositive motion that may be determined by a

magistrate judge under § 636(b)(1)(A). The First Circuit has

held that a motion to stay litigation that “is not dispositive of

either the case or any claim or defense within it” may

properly be determined by a magistrate judge. PowerShare,

Inc. v. Syntel, Inc., 597 F.3d 10, 13–14 (1st Cir. 2010). Here,

Dvorak simply speculated that he might have stronger

evidence to support his position in the civil proceedings if he

was able to go through the criminal proceedings first. The

SEC V. CMKM DIAMONDS, INC. 23

magistrate judge’s denial of Dvorak’s motion to stay the civil

proceedings did not dispose of any claims or defenses and did

not effectively deny him any ultimate relief sought.

Therefore Dvorak’s motion to stay was nondispositive, and

we conclude that the magistrate judge had authority to

determine Dvorak’s motion to stay under § 636(b)(1)(A).

2. Denial of Motion to Stay

In addition to challenging the magistrate judge’s authority

to rule on his motion, Dvorak raises numerous challenges to

the substance of the magistrate judge’s denial of his motion

to stay the proceedings. However, Dvorak did not object to

the magistrate judge’s order in the district court, and he

therefore has forfeited his right to appellate review of the

order. See Simpson v. Lear Astronics Corp., 77 F.3d 1170,

1174 (9th Cir. 1996) (“[A] party who fails to file timely

objections to a magistrate judge’s nondispositive order with

the district judge to whom the case is assigned forfeits its

right to appellate review of that order.”); see also Glenbrook

Homeowners Ass’n v. Tahoe Reg’l Planning Agency,

425 F.3d 611, 619–20 (9th Cir. 2005).

C. Disgorgement

On appeal, Dvorak argues that the district court erred in

ordering him to disgorge $409,638.11 because material issues

of fact remain as to the appropriateness of that amount.10

Specifically, Dvorak argues that bank records and exhibits

that he produced at his deposition contain evidence indicating

10

Dvorak disputes only the district court’s disgorgement order and does

not argue that the district court erred in entering summary judgment as to

his liability under Section 5.

24 SEC V. CMKM DIAMONDS, INC.

that $409,638.11 is not a reasonable approximation of the

amount by which Dvorak was unjustly enriched.

“The district court has broad equity powers to order the

disgorgement of ‘ill-gotten gains’ obtained through the

violation of the securities laws.” SEC v. First Pac. Bancorp,

142 F.3d 1186, 1191 (9th Cir. 1998) (citing SEC v. Clark,

915 F.2d 439, 453 (9th Cir. 1990)). “The district court also

has broad discretion in calculating the amount to be

disgorged.” SEC v. JT Wallenbrock & Assocs., 440 F.3d

1109, 1113 (9th Cir. 2006). In calculating disgorgement, a

district court need only make a “reasonable approximation of

profits causally connected to the violation” and is “not

required to trace every dollar of the offering proceeds

fraudulently retained by” the defendants. First Pac. Bancorp,

142 F.3d at 1192 n.6. (internal quotation marks omitted).

“The SEC bears the ultimate burden of persuasion that its

disgorgement figure reasonably approximates the amount of

unjust enrichment.” Platforms Wireless, 617 F.3d at 1096

(internal quotation marks omitted). If the SEC establishes

that the amount of disgorgement requested is a reasonable

approximation of defendants’ actual profits from the scheme,

“the burden shifts to the defendants to demonstrate that the

disgorgement figure was not a reasonable approximation.”

Id. (internal quotation marks omitted). Defendants bear the

burden of showing unreasonableness because they “are more

likely than the SEC to have access to evidence establishing

what they paid for the securities, if anything, to whom the

proceeds from the sales were distributed, and for what

purposes the proceeds were used.” Id.

Dvorak admits that the bank records and exhibits he now

references were not part of the record before the district court,

SEC V. CMKM DIAMONDS, INC. 25

because he failed to produce them or otherwise respond to the

SEC’s motion for summary judgment and request for a

disgorgement order. Therefore, Dvorak has forfeited his right

to appellate review of the district court’s disgorgement order.

See Peterson v. Highland Music, Inc., 140 F.3d 1313, 1321

(9th Cir. 1998) (“We apply a general rule against entertaining

arguments on appeal that were not presented or developed

before the district court.” (internal quotation marks omitted)).

Dvorak argues on appeal, however, that arguments in his

motion to stay constituted a response to the SEC’s request for

disgorgement. Specifically, Dvorak argues that his

deposition and exhibits thereto “controverted” the

reasonableness of the SEC’s request for disgorgement.

Because he could not afford a copy of his deposition

transcript, Dvorak argues that the district court should have

ordered the SEC to produce the entirety of Dvorak’s

deposition.

First, the district court did not err in failing to consider

Dvorak’s references to the disgorgement order made in

connection with his motion to stay, because district courts are

not required to review all papers filed in a case in order to

determine if a party has raised arguments in other filings that

could be construed as responsive to a pending motion. See

Simpson, 77 F.3d at 1175–76 (ruling that a complaint about

the amount of a sanctions order that was raised in a filing

other than the motion for review of the sanctions order “did

not put the district judge on notice that [the plaintiff] sought

to contest the amount of sanctions.”

Second, even if Dvorak is correct that his comments about

discovery in his motion to stay constituted a response to the

SEC’s request for disgorgement, these arguments are

insufficient to show that the district court abused its

26 SEC V. CMKM DIAMONDS, INC.

discretion in ordering Dvorak to disgorge $409,638.11. In his

briefing in support of the motion to stay litigation, Dvorak

stated that portions of his deposition and exhibits thereto

“clearly controverted” the amount of the SEC’s disgorgement

request. He requested that the SEC “fulfill its duty of candor

to the court and file the entire deposition and all its exhibits

as an exhibit to its Motion for Summary Judgment.” But

Dvorak did not indicate how the facts contained in his bank

account records and deposition transcript would demonstrate

the unreasonableness of the SEC’s disgorgement request.

Nor did Dvorak provide any explanation for why he was

unable to produce his own bank account records and exhibits

he produced at his deposition to oppose the SEC’s request for

disgorgement. Therefore, Dvorak failed to meet his burden

of showing that the disgorgement figure was not a reasonable

approximation of his illegal profits. See Platforms Wireless,

617 F.3d at 1096. Accordingly, we affirm the district court’s

disgorgement order as to Dvorak.

CONCLUSION

A material issue of fact remains regarding whether Global

and Bagley were necessary participants and substantial

factors in the distribution of CMKM securities sufficient to

impose liability under Section 5 of the Securities Act.

Therefore, we reverse the grant of summary judgment as to

Global and Bagley, and remand for further proceedings. We

affirm the magistrate judge’s denial of Dvorak’s motion to

stay and the district court’s disgorgement order as to Dvorak.

AFFIRMED in part, REVERSED in part and

REMANDED. The parties shall bear their own costs on

appeal.