# United States Securities & Exchange Commission v. Sierra Brokerage Services Inc.

> District Court, S.D. Ohio · March 31, 2009 · 608 F. Supp. 2d 923

URL: https://www.frixlaw.com/law-library/cases/1465164

## Case

- **Full name:** UNITED STATES SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. SIERRA BROKERAGE SERVICES INC., Et Al., Defendants
- **Court:** District Court, S.D. Ohio
- **Decided:** March 31, 2009
- **Citations:** 608 F. Supp. 2d 923; 2009 U.S. Dist. LEXIS 27366
- **Precedential status:** Published
- **Opinion:** Opinion by Marbley
- **Judges:** Algenon L. Marbley
- **Cited by:** 20 later opinions in the Frix Law Library

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## Opinion text

OPINION & ORDER
ALGENON L. MARBLEY, District Judge.
I. INTRODUCTION
The Securities and Exchange Commission (“SEC”) filed this civil enforcement action against twelve defendants alleging that they violated registration, disclosure, and anti-fraud provisions of federal securities law in connection with the public sale of Bluepoint Linux Software Corporation’s (“Bluepoint”) shares. In Count I, the SEC claims that Defendants Aaron Tsai (“Tsai”), Michael Markow (“Markow”), Global Guarantee Corporation (“Global Guarantee”), Francois Goelo (“Goelo”), Yongzhi Yang (“Yang”), K & J Consulting Ltd. (“K & J Consulting”), Ke Lou (“Lou”), M & M Management Ltd. (“M & M”), Sierra Brokerage Services, Inc. (“Sierra”), and Jeffrey Richardson (“Richardson”) violated Sections 5(a) and 5(c) of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. §§ 77e(a) and 77e(c), by trading securities in interstate commerce without filing registration statements. Counts II, III, IV, and VI of the Complaint allege that Defendants Markow, Global Guarantee, Goelo, Yang, K & J Consulting, Lou, M & M, Sierra, Richard Geiger (“Geiger”), and Richardson engaged in a “pump and dump” scheme that manipulated the market price for Bluepoint shares on March 6, 2000, in violation of Sections 17(a)(1) and 17(a)(3) of the Securities Act, 15 U.S.C. §§ 77q(a)(l) and 77q(a)(3); Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), Rule 10b-5 thereunder, 17 C.F.R. § 240 .10b-5; and Section 15(c)(1) of the Exchange Act, 15 U.S.C. § 78o (c)(1). Counts VIII and IX allege that Defendants Tsai (acting individually), and Goelo (individually and as part of a group), Yang (individually and as part of a group), K & J Consulting, Markow, Global Guarantee, Lou, and M & M (acting collectively) failed to report their beneficial ownership of securities in violation of Section 13(d) of the Exchange Act, 15 U.S.C. §§ 78m(d)(l) and (2), Rules 13d-1(a) and 13d-2(a) thereunder, 17 C.F.R. §§ 240 .13d-l, 240.13d-2; and Section 16(a) of the Exchange Act, 15 U.S.C. § 78p(a) and Rule 16a-3 thereunder, 17 C.F.R. §§ 240 .16a-3.
Now before the Court is the SEC’s motion for summary judgment (doc. no. 124) against Defendants Tsai, Markow, Global Guarantee, Yang, K & J Consulting, Lou, M & M, Goelo, Sierra, and Richardson on the Section 5 registration claim (Count I) and on the Section 13(d) and 16(a) disclosure claims (Counts VIII and IX). Defendants Tsai, Markow, Global Guarantee, Goelo, Yang, K & J Consulting, Lou, M & M, and Geiger (collectively “Defendants”) have cross motioned for summary judgment on the registration and disclosure counts (Counts I, VIII, and IX) and also
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seek summary judgment on the market manipulation scheme counts (Counts II, III, IV, and VI). (Doc. no. 112). For the reasons explained below, the SEC’s motion is GRANTED in PART and DENIED in PART and the Defendants’ motion is DENIED.
II. BACKGROUND
A. Facts
This case centers on Defendant Tsai’s creation of MAS Acquisition XI Corporation (“MAS XI”), a “shell” company that ultimately merged with Bluepoint and sold shares to the public on the Over-the-Counter Bulletin Board in March of 2000. The SEC maintains that the Defendants’ conduct relating to that process repeatedly violated the federal securities laws.
“Shell companies,” like MAS XI, are also referred to as “blank check” companies. Shell companies or blank check companies are formed with the purpose of qualifying for public trading on the Over-the-Counter Bulletin Board and later being sold to a privately-held company. The private company is then merged into the shell. To accomplish the reverse merger, the public shell company exchanges its stock with the outstanding shares of the private company. The shareholders in control of the shell company transfer most of their shares to the owners of the private company.
The public shell company often changes its name to the name previously used by the private company and continues the business activity of the formerly private company except that the company is now an issuer of publicly traded securities.
See SEC v. M & A West, Inc.,
No. C01-3376, 2005 WL 1514101 , at *2 (N.D.Cal. June 20, 2005) (explaining reverse mergers). This process allows the private company to go public cheaply, i.e., without the expense of an initial public offering.
See SEC v. Kern,
425 F.3d 143 , 146 (2d Cir.2005). Shell companies have no assets or revenue; instead, they exist merely to serve as a vehicle for the businesses activities of the company which merges into them.
See Black’s Law Dictionary
149 (2d Pocket Ed. 2001).
1. Defendants
Tsai is a resident of Taiwan. Tsai controls MAS Capital Securities, Inc., a U.S. incorporated securities broker-dealer that is registered with the SEC. From 1996 to 2000, he formed 101 public shell corporations. The shell companies were created so that they could be merged with private companies that want to go public. One of those shell companies was MAS XI, which ultimately was merged with Bluepoint.
Tsai is experienced in the securities industry. Between 1998 and 2000, Tsai was a registered representative of five brokerage firms. He is also educated in the securities industry. Between 1998 and 1999, he took and passed several exams related to the securities industry including: (1) the Series 7 exam, a New York Stock Exchange exam for stock brokers which Tsai passed with high marks in 1998; (2) the Series 24 exam, which is a securities principal license exam for managers of brokerage firms; (3) the Series 28 exam; (4) the Series 55 exam for stock traders; and (5) the Series 63 exam, which covers state regulations regarding securities.
Tsai also has experience with securities violation litigation. On April 4, 2005, final judgment was entered against him by the District Court for the Middle District of Florida enjoining him from future violations of the registration provisions of the federal securities laws and ordering disgorgement and civil penalties.
SEC v. Surgilight Inc.,
SEC Litig. Release No. 19169, 2005 WL 770873 (Apr. 6, 2005) (M.D. Fla. Case No. 6:02-CV-413). Tsai consented to the final judgment without admitting or denying the allegations against him.
Id.
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a. Promoter Defendants
Defendants Yang, Markow, Goelo, Lou, K & J Consulting (Yang’s company), Global Guarantee (Markow’s company), and M & M (Lou’s company) are collectively referred to throughout this Opinion as the “Promoter Defendants.” Yang is a California resident. He currently works as a business consultant and owns his own building materials importer business. Yang holds a Ph.D. in mathematics and has a computer science background.
In 1999, Yang worked as a consultant for Shenzhen Sinx Software Technology Corporation, which was later renamed Bluepoint. In that role, Yang was responsible for finding an American public shell corporation into which Bluepoint could merge. He was ultimately involved in negotiating and consummating the reverse merger between Max XI and Bluepoint. Yang controls K & J Consulting, Ltd, a British Virgin Islands company, through which he held and traded Bluepoint stock in 2000.
Like Tsai, Yang is no stranger to securities litigation. On February 28, 2005 the District Court for the Central District of California entered a final judgment against Yang in
SEC v. Hartcourt Companies.
SEC Litig. Release No. 19133, 2005 WL 597024 (Mar. 15, 2005) (C.D. Cal. Case no. CV 03-3698). The Court enjoined him from future violations of the registration and anti-fraud provisions of federal securities law, ordered $186,619 in disgorgement, and imposed $20,000 in civil penalties.
Markow is a California resident. He is a financial consultant with substantial experience conducting reverse mergers. He formed and controls Global Guarantee, which consults with other companies regarding their business plans and financing. In 2000, Markow acquired and sold Blue Point stock through Global Guarantee. He facilitated the reverse merger between MAS XI and Bluepoint.
Markow is a repeated securities law violator. In 1994,1995, and 1999, the National Association of Securities Dealers (“NASD”) held Markow liable for monetary awards in arbitration proceedings based on his securities-related misconduct. (NASD Arbitration Awards; 12/3/2004 Markow Dep. 220-221, 223.) In 1998, California issued two “desist and refrain” orders against him for operating as a broker-dealer without a license and for selling securities that had not been qualified. (5/15/1998 Cal. Desist and Refrain Orders). In 2000, Alabama issued a “cease and desist” order against him for operating as an unregistered broker dealer. (3/3/2000 Ala. Cease and Desist Order.)
Goelo is a resident of the Cayman Islands. Goelo knew Yang through internet investor message boards. He also knew Markow from his reputation as a professional in facilitating reverse mergers. When he learned that Yang was interested in taking Bluepoint public and trading on the American market, Goelo introduced Yang to Markow. Goelo owns and controls Xplorer Ltd. and Unikay Ltd. through which he bought and sold Bluepoint stock in 2000.
Luo is a citizen of the People’s Republic of China but is a Georgia resident. He controls M & M, a Virgin Islands company through which he bought and sold Bluepoint stock in 2000.
b. Other Defendants
Richardson is the president, head trader and part-owner of Sierra a broker-dealer located in Columbus Ohio. Sierra served as a market-maker for Bluepoint when it began trading on the OTCBB. Geiger was a representative and trader at Sierra. He was ultimately fired. Sierra stopped operating in April 2003.
NASD has repeatedly fined Sierra, Richardson, and Geiger for improper practices in as follows:
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• July 2008: Richardson permanently barred by NASD from association with any member of NASD because of his sales of unregistered securities. (Certified NASD Letter of Acceptance, Waiver & Consent, No. CMS030156 (July 2003).)
• January 2003: Sierra fined $5,000 for buying and selling securities without maintaining its minimum net capital (Certified NASD Letter of Acceptance, Waiver & Consent, No. C8B030001 (Jan. 2003).)
• July 2002: Sierra fined $10,000 jointly and severally with Richardson because Richardson permitted Geiger and other Sierra employees to work as equity traders without being registered. (Certified NASD Letter of Acceptance, Waiver & Consent, No. C8B020014 (July 2002).) Geiger was also fined $10,000 for this incident and suspended from association with any NASD member for 20 days. (Certified Web CDR for Richard Geiger.)
• June 2000: Sierra $15,000 and Richardson $5,000 for faffing to accurately record the time and execution of securities sales in violation of NASD’s rules. (Certified NASD Letter of Acceptance, Waiver & Consent, No. C8A000036 (June 2000).)
• November 1998: Sierra fined $2,500 for failing to report transactions accurately and timely and for failing to develop or document training procedures. (Certified NASD Letter of Acceptance, Waiver & Consent, No. C8B980040 (Nov. 1998).)
• January 1997: While working at a different firm, i.e., not Sierra, Geiger was fined $10,000, suspended ten days, and barred from acting as a securities firm principal for one year because of his behavior at another trading firm. (Certified Web CDR for Richard Geiger.) Based on this censure, the state of Ohio refused to grant Geiger a securities sales license.
(Id.)
2. Formation of the Shell Company, MAS XI
On October 7, 1996, Tsai incorporated MAS XI in Indiana. MAS XI was a shell company with no business activity or operations of its own. It existed only to issue shares of stock and to be available for a reverse merger. MAS XI was authorized by its articles of incorporation to issue 80 million shares of common stock and 20 million shares of preferred stock. On the date of its incorporation, MAS XI issued 8.5 million shares of common stock to Tsai. He reported his beneficial ownership of 8.25 million shares with the SEC.
1
Tsai was the CEO, president, and treasurer of MAS XI from its inception.
As with his other shell corporations, Tsai formed MAS XI as a vehicle to accomplish a reverse merger in the future. To make MAS XI an attractive candidate for a reverse merger, Tsai wanted to register the company as a voluntary reporting company with the SEC and to clear its stock for trading on the Over-the-Counter Bulletin Board (“OTCBB”).
2
Consequently, in April of 1999, Tsai made MAS XI a voluntary reporting company with the SEC by filing a Form 10-SB. In the Form 10-SB and subsequent related SEC filings, Tsai reported his transfer of MAS XI shares to individual shareholders in 1997-1998.
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S. Initial Transfers to Five “Former Director" Shareholders
Tsai and MAS XI transferred shares to five individuals in 1997 and 1998. No registration statements were filed for these transfers. In his SEC filing, Tsai claimed that five people were former MAS XI directors. The five shareholders were: April C., David Carra (“Carra”), Charles Roberson (“Roberson”), Stephen Lee (“Lee”), and Rick Hemmer (“Hemmer”) (collectively “former directors”). April C. is a mentally disabled person who has lived in a group home since 1997. According to April C.’s case manager, April C. would not be able to understand what a corporate director is, what shares of stock are worth, or what legal documents, such as stock powers, mean. (11/9/2004 Hawkins Dep. 34-35.) Carra was a janitor in 1997 but is currently unemployed. Hemmer currently works in auto assembly and previously worked as a shoe salesman. Lee is currently a financial consultant and worked for an import/export company in 1997. (4/30/2004 Lee Dep. 10-12.) At least three of the five former directors were unaware of ever having been MAS XI directors. (4/29/2004 Hemmler Dep. 26, 37; 7/21/2004 Carra Dep. 12, 15; 4/30/2004 Lee Dep. 31.) Similarly, Roberson testified that while he remembers signing something with the word director on it, he did not think he would be required to perform any duties as a director.
3
(8/28/2000 Roberson Dep. 39-40.) All of the shares held by the five former directors were “restricted,” meaning that they could not be traded publicly.
MAS XI issued shares to the five former directors on two occasions. First, on January 1, 1997, MAS XI issued 500 shares of common stock to five former directors. Second, on September 30, 1998, MAS XI issued an additional 750 shares to those same five people. Tsai reported to the SEC that MAS XI transferred those shares to the former directors as “compensation for their services” as directors. (6/22/1999 Form 10-SB/A 27.) At his deposition, however, Tsai admitted that three of the purported former directors — April C., Lee, and Hemmer — never performed any services for MAS XI. (10/19/2004 Tsai Dep. 92.) He also testified that he does not remember if the other two, Carra and Roberson, performed any services for MAS XI.
(Id.)
On January 1, 1997, Tsai gave 50, 000 shares of his shares to each of the five former directors (a total of 250,000 shares). The former director shareholders were not issued stock certificates at the time they became shareholders. Instead, the shares held by the former directors were recorded as book entries.
4
Stock certificates were only issued shortly before and in furtherance of MAS XI’s merger with Bluepoint in 2000.
The five former director shareholders did not attend shareholder meetings. Instead, Tsai held annual shareholder meetings by himself. Although MAS XI’s bylaws required that shareholders be sent notice of the time and place of shareholder meetings, Tsai does not remember ever doing so. The five former director shareholders did not vote on MAS XI directors. Instead, Tsai elected directors by himself during shareholder meetings at which he was the only attendee. Tsai does not remember sending out written consent to shareholders regarding actions taken with
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out holding an annual or special shareholder meeting as required by the bylaws. Similarly, Tsai was the only MAS XI director at the time the bylaws went into effect even though three directors were required.
4. Transfer to 28 Additional Shareholders
In July of 1999, Tsai hired Kensington Capital Corporation (“Kensington”) to help get MAS XI cleared for public trading on the OTCBB. As part of that process, MAS XI had to file a Form 211 with NASD. On July 26, 1999, NASD sent Kensington a letter stating that MAS XI’s Form 211 application was deficient because MAS XI’s tradable shares were concentrated in the hands of only five shareholders.
In response, Tsai arranged a transfer of shares from the five former director shareholders to 28 additional shareholders (“28 additional shareholders”). No registration statement was filed prior to this transfer. These transfers brought the number of MAS XI shareholders up to 33 — the five original shareholders plus the 28 additional shareholders (collectively “MAS XI Shareholders”). The additional shareholders were Tsai’s friends or people he met at bible study. Tsai arbitrarily decided how many shares to transfer away from the five former directors and how many shares each of the 28 additional shareholders would receive. Tsai did not tell the former director shareholders to whom their shares would be transferred. Nor did the 28 additional shareholders know where their shares came from. A number of the new shareholders erroneously thought that their shares came from Tsai.
Tsai admitted that he arranged the transfers “to further the purpose of the company ... because the purpose of the company is to become publically traded.” (10/19/2004 Tsai Dep. 110-11.) He also admitted that helping the company in this way benefitted him. Tsai accomplished the transfers by using blank stock powers which were signed by the former directors near the time they received their shares. The blank stock powers were essentially blank forms which did not include information such as the number of shares that could be transferred or the name of the company at the time the former director shareholders signed them.
Tsai claims that he discussed the transfer with the former director shareholders before transferring their shares to the 28 additional shareholders. Stephen Lee testified that he signed the stock power because Tsai “was a friend and it was something that he needed, so I signed. I didn’t even — at that time didn’t even know what stock power was.” (7/21/2004 Lee Dep. 30.) Similarly, Carra testified that at the time he signed the blank stock power, he thought he was being given a power, similarly to a power of attorney, over something. (7/21/2004 Carra Dep. 23.) Roberson also testified that he did not understand the stock power when he signed.
5
(8/28/2000 Roberson Dep. 55.) Once Tsai had obtained the signed blank stock powers, he was able to transfer shares out of the names of the former directors without additional documentation.
After the shares were distributed into the hands of the 33 MAS XI shareholders, Kensington submitted a new list of shareholders to NASD. On December 13, 1999, “acting in reliance upon the information contained in the [Form 211] filing,” NASD cleared MAS XI for public trading on the
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OTCBB. Tsai testified that after the Form 211 was completed, the shares held by the MAS XI shareholders became more liquid because they could be traded in a public marketplace, the OTCBB. Tsai admits that generally, liquid shares are more valuable than illiquid shares. To his knowledge, however, most of the MAS XI shareholders were unaware that the Form 211 process had been successfully completed.
5. MAS XI’s Merger with Bluepoint
In December of 1999, Bluepoint
6
was looking for a U.S. shell company with which to merge. Bluepoint was a computer software company that had developed a Chinese version of the Linux operating system.
7
Around that time, Bluepoint hired Yang as a consultant. He was tasked with finding an American shell company and facilitating a reverse merger.
Goelo knew Yang from an internet chat-room. Goelo introduced Yang to Markow who put Yang in contact with Tsai. Tsai and Bluepoint’s CEO negotiated a reverse merger between Bluepoint and MAS XI. On January 7, 2000, Tsai and Bluepoint’s CEO signed a Plan and Agreement of Reorganization, in which they formally agreed to conduct a reverse merger.
Yang, Markow, and Goelo remained involved and in contact during the merger process and in the lead up to public trading. Markow kept a to-do list and schedule of merger-related tasks that he forwarded to Yang and Goelo. He also ferried documents between Tsai and Bluepoint’s CEO. Markow contacted Richardson at Sierra and asked Sierra to become Bluepoint’s market maker. Goelo posted information about Bluepoint on online stock trading message boards. Yang translated Bluepoint’s business plan into English. Tsai reviewed the business plan while deciding whether to agree to the merger. Markow also reviewed Bluepoint’s business plan and discussed it with Goelo. The business plan described Bluepoint’s product, its officers, the risks to the company, and the prospects for financial growth.
One risk to Bluepoint’s future productivity mentioned in the business plan was that, based on the terms of a licensing agreement, Bluepoint was required to publish its source code. This meant that competitors could copy the source code and quickly develop similar products. Thus, Bluepoint’s technological advantage could be undermined relatively quickly. The business plan also discussed Bluepoint’s projected market share. Yang knew that Bluepoint’s total net sales as of the end of 1999 (the last quarter before public trading began) were only $23,027. Markow knew that revenues were “either nonexistent or more extremely minimal.” These business risks were never disclosed to the investing public.
6. February 2000 Sale of Shares to the Promoter Defendants
To prepare for the merger, Tsai returned roughly 8.2 million of the shares he held to MAS XI. Those shares were can-celled. The day that the merger was formally approved, MAS XI effected a fifteen-for-one stock split. As a result of the stock split the 250,000 shares held by the 33 MAS XI Shareholders were now 3.75 million shares.
The reverse merger was consummated on February 17, 2000. MAS XI changed its name to Bluepoint as part of the merg
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er process. Following the merger, Bluepoint had 20 million shares of common stock outstanding. Of those shares, 15.5 million were restricted shares which were transferred to the Chinese officers and directors of Bluepoint pursuant to the terms on the Plan and Agreement of Reorganization. Yang was given 500,000 of those restricted shares. Tsai also owned another 450,000 restricted shares. That left approximately 4.5 million “unrestricted” shares outstanding. 3.75 million of those shares were held by the 33 MAS XI shareholders.
8
According to Tsai, Markow informed Tsai that he had a group of investors that wanted to buy shares from the 33 MAS XI shareholders. (10/19/2004 Tsai Dep. 224.) Tsai arranged to transfer the 3.75 million shares by the MAS XI shareholders to Markow. On January 7, 2000, Goelo emailed Yang informing him that the purchase price for the shares was $250,000. Yang told Lou.
A few weeks later Goelo, Yang, and Lou wired Markow the $250,000 as follows: $91,250 from Goelo on January 20, 2000; and $79,365 each from Yang and Lou on February 7, 2000. Goelo, Yang, and Lou all testified that the money they sent to Markow was to pay for the purchase of their shares from MAS XI’s shareholders. Markow testified that they sent him the money to compensate him for his role in the reverse merger.
9
(3/1/2002 Markow Test. 68-69, 82, 83.) Markow has also testified, however, that he chose to take his remuneration for his role in the reverse merger in the form of a share of the outstanding 4.5 million shares. (12/3/2004 Markow Dep. 103.)
As soon as Markow received the money, he sent a $250,000 check to Tsai. Markow and Tsai claim that the money was a finder’s fee paid to Tsai for his role in the reverse merger.
10
After receiving the check, Tsai arranged the sale of shares in the name of the 33 MAS XI shareholders to the Promoter Defendants. First, Tsai issued stock certificates for the stocks issued to the 33 MAS XI shareholders. He then mailed the stock certificates and stock powers to Markow. Markow paid the 33 MAS XI shareholders $100 for their stocks. Each shareholder received the same flat fee payment regardless of whether they sold hundreds or thousands of shares. Consequently, the price paid per share varied from $.07 cents per share to $.67 per share. Several of the shareholders testified that they did not know that they had sold their shares or who
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Markow was. Markow admits that he never contacted the 33 MAS XI shareholders and did not negotiate with them to arrive at the $100 price. MAS XI did not issue a registration statement before the sale of the shares to the Promoter Defendants.
Shortly thereafter, Markow re-certified the 3.75 million shares in the names of the Promoter Defendants, companies they controlled, and their relatives and friends. On February 22, 2000, Markow directed MAS XI’s transfer agent to make the following distribution:
Yang 220,000 Shares
K
&
J Consulting (Yang Controlled) 450,000 shares
Yang’s family members 780,000 shares
Lou 220.000 shares
M & M (Lou Controlled) 410.000 shares
Lou’s family members 370.000 shares
Unikay Ltd. (Goelo controlled) 375.000 shares
Xplorer Inc. (Goelo controlled) 400.000 shares
Goelo’s Girlfriend 200.000 shares
Global Guarantee (Markow controlled) 325,000 shares
Yang controlled the 120,000 shares assigned to his mother and deposited them in his company’s brokerage account at Sierra. Lou controlled all of the shares assigned to his family members and deposited the 150,000 shares held by his child into his company’s account at Sierra. Goelo’s girlfriend assigned her shares to Goelo and he deposited them in his Sierra account. In total, the Promoter Defendants deposited 2.43 million of the 3.75 million shares into accounts at Sierra that they controlled.
7.
The Promoter Defendants’ Percentage Ownership in Bluepoint
After the merger, the Promoter Defendants and their family members collectively owned 18.75% of Bluepoint’s 20 million shares. The Promoter Defendants themselves held 14.5% (2.9 million shares) of Bluepoint’s total shares. Yang alone controlled 5.85% (1.17 million) of the total Bluepoint shares. Similarly, Goelo admits that he alone owned over 5% of the outstanding shares after he bought 40,000 additional shares on March 6, 2000.
The Promoter Defendants never reported their percentage ownership of Bluepoint shares to the SEC. Goelo mentioned his concerns regarding percentage of ownership in a January 5, 2000 email to Markow in which he proposed a new distribution of stock ownership and stated “[t]here is the issue of controlling more than 5% of the stock of the Company to be considered as well and I may have to split the holding amongst two Companies: Unikay Ltd and Xplorer Inc.” By March 6, 2000, the Promoter Defendants collectively deposited 2.43 million Bluepoint shares in Sierra brokerage accounts they controlled.
8. Public Trading of Bluepoint Shares
On March 6, 2000, Bluepoint began publicly trading on the OTCBB. In the lead up to public trading, Yang, Goelo, and Markow all worked on editing Bluepoint press releases. Markow fronted the money to pay for issuing the press releases.
Prior to public trading, no registration statements had been filed for any MAS XI/Bluepoint shares. Bluepoint’s Form 8-K and Schedule 14f-1 were publicly available before the first day of trading. Those forms generally described Bluepoint’s business operations and its access to the Chinese Linux market. Yang admits that investors did not have any access to financial information about Bluepoint or information about Bluepoint’s business risks.
Once public trading began the Promoter Defendants and Sierra sold Bluepoint shares. Shortly after trading began on March 6, 2000, Sierra bought 100,000 Bluepoint shares from K & J Consulting. Goelo purchased 40,000 of those shares from Sierra. Later that day, Sierra bought additional shares from Yang and Lou. Geiger transacted all of Sierra’s trades. Richardson approved Sierra’s purchases. He also purchased shares from Sierra and later
*935
resold those shares at a profit. Markow sold shares of Bluepoint on March 7, 2000 and August 10, 2000.
Between March 6, 2000 and April 27, 2001 the Promoter Defendants sold their shares in Bluepoint at a profit. Yang sold his shares for $1,195,278. Lou sold his shares for $1,161,869. Markow sold his shares for $1,233,640. Goelo sold his shares for $216,861.
9. Additional Facts Relating to the Market Manipulation Claims
Only the Defendants have moved for summary judgment on the price manipulation claims (Counts II, III, IV, and VI). Therefore, the facts relating to this claim are viewed in the light most favorable to the SEC, the non-movant.
In the lead up to public trading of Bluepoint’s shares, Goelo engaged in an internet touting campaign. In December of 1999 and January of 2000, he posted numerous messages on “Silicon Investor,” an online investor message board. In his posts and emails Goelo extolled the virtues of Bluepoint stock, encouraged potential investor to “load up” when trading began, and suggested that they promote the stock to others. Goelo informed Yang and Markow that he was lining up support on the message boards. Yang instructed Goelo not to post information himself because they had “inside information.” After receiving that instruction, Goelo requested that two of his friends post positive information about Bluepoint online. They did so, posting dozens of positive posts on the Silicon Investor and “Raging Bull” sites during March of 2000, while trading was beginning. There is evidence suggesting that Markow and Goelo compensated one of those positive posters, defendant Armstrong, for his activities.
11
OTCBB trading of Bluepoint stock began on March 6, 2000. That morning the price of Bluepoint shares shot up from an initial price of $6.00 per share to a peak of $21.00 per share less than an hour later. Sierra was a market-maker
12
for Bluepoint. Geiger conducted Sierra’s market making activities on the first day of trading under Richardson’s supervision.
A review of the trading activity on March 6, 2000 shows that Sierra was heavily involved in trading Bluepoint. From the first Bluepoint trade at 9:42 a.m. until 10:59 a.m., Sierra held the “inside bid” (the highest bid quote) for 69% of the time, while the next most active market maker held the inside bid for only 20% of the time. Similarly, as Bluepoint’s price rose from $6.02 to $19.50, Sierra accounted for 80% of the trading activity. During that time, Sierra raised its bid seven times to become the inside bid.
The Promoter Defendants were also involved in trading on March 6, 2000. In fact, within the first eleven minutes of trading Defendants Yang, Goelo, Lou, and Sierra repeatedly traded with one another, twice in pre-arranged sales. Specifically, in the first trade of the day Yang sold Sierra 100,000 shares of Bluepoint for $6.00 per share. Immediately thereafter, Geiger sold 40,000 of those shares back to Goelo for $6.02 per share. Goelo bought the additional shares from Sierra even though he already owned 975,000 Bluepoint shares which he has acquired for $0.09 per share during the reverse merger.
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Furthermore, Yang, Goelo, and Geiger had prearranged those two sales as well as the price per share before the first day of trading.
A few minutes after the Yang-SierraGoelo sales, Sierra bought an additional 100,000 shares from Yang and Lou (50,000 shares each from K & J Consulting, Yang’s company, and M & M, Lou’s company). Sixteen minutes after the first trade, a customer named Kim Giffoni (“Giffoni”) purchased 5,000 shares from Sierra at $7.1875 per share. Giffoni testified that Markow suggested that he make the purchase and arranged the transaction, including the price at which Sierra would sell the shares, before the first day of trading. Markow also asked Giffoni not to sell his shares during the first day of trading and offered him a financial incentive to comply with his request.
At the time that the Promoter Defendants engaged in those transactions they controlled over 80% of the tradable Bluepoint shares (the “float”). They had also failed to register Bluepoint’s stock, which meant that very little public information was available about the company. For example, the investing public had not been informed of the business risks contained in Bluepoint’s business plan. Similarly, the Promoter Defendants had not disclosed their beneficial ownership of a substantial percentage of Bluepoint’s stock, so the investing public did not know who owned Bluepoint or that one of the main owners, Markow, was a repeated securities law violator.
Sierra’s trading of Bluepoint shares on the morning of March 6, 2000 was irregular in several ways. Sierra’s first purchase of a single block of 100,000 shares from Yang was reported to NASD as four purchases, giving the appearance of more market activity than had actually occurred. Sierra also took an unusual “long” position in Bluepoint shares at the beginning of its first day of trading, meaning that it built up a large inventory of Bluepoint shares. In the first eleven minutes of trading, Sierra bought 200,000 shares of Bluepoint, investing $700,000. Geiger and Richardson also agreed to buy the first 100,000 shares from Yang for $6.00 even though they had not performed any market analysis before agreeing to that price. Instead, Geiger merely accepted the price suggested by Yang.
Yang has testified that he, Markow, and Goelo were all concerned with maintaining the price of the Bluepoint shares. He admitted that it was important to everybody that the price be set and remain above four or five dollars a share (the threshold for penny stock status) because many investors will not buy and sell penny stocks. Finally, the evidence shows that Sierra increased its inside bid
13
while it was already long on Bluepoint and immediately after it had purchased 100,000 shares. According to Arthur J. Pacheco (“Pacheco”), the SEC’s expert witness, there is “no legitimate reason for a market maker to increase its own inside bid immediately after the purchase of 100,000 shares unless its purpose was to move the price of the stock up.” (Pacheco Dec. ¶ 7.)
B. Procedural History
On April 11, 2003 the SEC filed a complaint against Tsai, Markow, Yang, Goelo, Lou, Geiger, Richardson, Sierra, Global Guarantee, K
&
J Consulting, M & M, and Armstrong for violations of the federal securities law. On September 2, 2004, the SEC moved for a declaration that Tsai’s attorney-client privilege and confidentiality had been waived under the crime-fraud exception. The parties extensively briefed the motion (“crime-fraud briefing”) and on October 4, 2004, the Court heard oral ar
*937
guments on the motion. Magistrate Judge Abel granted the SEC’s motion in February of 2005.
On July 20, 2005 the SEC and the moving defendants filed their motions for summary judgment. The SEC seeks partial summary judgment on Counts I (registration claim), VIII and IX (disclosure of beneficial ownership claims) of the Complaint. It also asks the Court to:
(1) Permanently enjoin Tsai, Markow, Global Guarantee, Yang, K & J Consulting, Lou, M & M, Goelo and Richardson from violating Section 5 of the Securities Act;
(2) Permanently enjoin Tsai, Markow, Global Guarantee, Yang, K
&
J Consulting, Lou, M & M, and Goelo from violating Sections 13(d)(1) and 16(a) of the Exchange Act and Rules 13d-1(a) and 16a-3;
(3) Permanently enjoin Markow, Global Guarantee, Yang, K & J Consulting, Lou, M
&
M, and Goelo from violating Section 13(d)(2) of the Exchange Act and Rule 13d-2(a);
(4) Order Tsai, Markow, Global Guarantee, Yang, K & J Consulting, Lou, M
&
M, and Goelo, Sierra, and Richardson to disgorge all of the profits they received from their alleged securities violations as well as prejudgment interest.
The SEC seeks trial on all other claims.
The moving Defendants cross-motioned for summary judgment on Counts I, VIII, and IX. They also seek summary judgment on the price manipulation claims (Counts II, III, IV, and VI). Defendants Richardson and Sierra did not join the other defendants’ summary judgment motion and did not file their own. Moreover, although Defendant Richardson requested (doc. no. 140) and ultimately received (doc. no. 193) additional time to file an opposition to the SEC’s motion for summary judgment, he never did so. Defendant Sierra also failed to oppose the SEC’s motion for partial summary judgment.
During the pendency of the Parties’ motions for summary judgment several things occurred which are relevant to the resolution of the motions. First, final judgment was entered against defendant Jerome Armstrong on July 25, 2007. (Doc. no. 202). Armstrong consented to the entry of final judgment without admitting or denying the allegations of the complaint. Second, Defendant Global Guarantee failed to comply with the Court’s January 7, 2008 and March 17, 2008 Orders and the Court entered a default against it on February 27, 2009. Therefore, Global Guarantee’s liability is no longer in dispute. Third, on March 26, 2009, Defendant Richardson consented to the entry of final judgment against him without admitting or denying the allegations in the Complaint. The Consent was filed with the Court on March 30, 2009. (Doc. no. 216). In the Consent, Richardson agreed to the imposition of a permanent injunction against him. Consequently, Richardson’s liability will not be determined by the Court in its resolution of the parties’ motions for summary judgment. Finally, on March 31, 2009, the Court ordered an entry of default against Sierra pursuant to Federal Rule of Civil Procedure 55(a), with the amount of the default judgment to be determined by a future order. As a result, Sierra’s liability will not be discussed in or determined by this Order.
On May 25, 2007 the Court granted the SEC’s motion for leave to file supplemental legal authorities in support of its motion for summary judgment. On May 23, 2008 the SEC again moved for leave to file supplemental legal authority in support of its motion for summary judgment motion. (Doc. no. 208). That motion is GRANTED.
III. STANDARD OF REVIEW
Summary judgment is proper if “there is no genuine issue as to any material fact [and] the moving party is entitled to judg
*938
ment as a matter of law.” Fed.R.Civ.P. 56(c). But “summary judgment will not lie if the ... evidence is such that a reasonable jury could return a verdict for the non-moving party.”
Anderson v. Liberty Lobby, Inc.,
477 U.S. 242, 248 , 106 S.Ct. 2505 , 91 L.Ed.2d 202 (1986). In considering a motion for summary judgment, a court must construe the evidence in the light most favorable to the non-moving party.
Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,
475 U.S. 574, 587 , 106 S.Ct. 1348 , 89 L.Ed.2d 538 (1986). The movant therefore has the burden of establishing that there is no genuine issue of material fact.
Celotex Corp. v. Catrett,
477 U.S. 317, 322-23 , 106 S.Ct. 2548 , 91 L.Ed.2d 265 (1986);
Barnhart v. Pickrel, Schaeffer & Ebeling Co.,
12 F.3d 1382, 1388-89 (6th Cir.1993). The central inquiry is “whether the evidence presents a sufficient disagreement to require submission to a jury or whether it is so one-sided that one party must prevail as a matter of law.”
Anderson,
477 U.S. at 251-52 , 106 S.Ct. 2505 . When ruling on a motion for summary judgment, a district court is not required to sift through the entire record to drum up facts that might support the nonmoving party’s claim.
InterRoyal Corp. v. Sponseller,
889 F.2d 108, 111 (6th Cir.1989). Instead, a court may rely on the evidence called to its attention by the parties.
Id.
The standard of review for cross-motions of summary judgment does not differ from the standard applied when a motion is filed by only one party to the litigation.
Taft Broad. Co. v. U.S.,
929 F.2d 240, 248 (6th Cir.1991). Furthermore,
[t]he fact that both parties have moved for summary judgment does not mean that the court must grant judgment as a matter of law for one side or the other; summary judgment in favor of either party is not proper if disputes remain as to material facts. Rather, the court must evaluate each party’s motion on its own merits....
Id.
(citations omitted).
IV. LAW’& ANALYSIS
A. Section 5 Registration Provision Claims
The SEC and the Defendants have cross-motioned for summary judgment on the SEC’s registration violation claims. Under Sections 5(a) and 5(c) of the Securities Act, securities must be registered with the SEC before any person may sell or offer those securities. 15 U.S.C. § 77e(a) & (c).
14
The purpose of the registration requirement is to “provide adequate disclosure to members of the investing public.”
SEC v. Harwyn Indus. Corp.,
326 F.Supp. 943, 954 (S.D.N.Y.1971). To establish a prima facie violation of Section 5, the SEC must prove that: (1) no registration statement was in effect for the securities; (2) that the defendant di
*939
rectly or indirectly sold or offered to sell the securities; and (3) that means of interstate transportation or communication were used in connection with the offer or sale.
Eur. & Overseas Commodity Traders, S.A. v. Banque Paribas London,
147 F.3d 118 , 124 n. 4 (2d Cir.1998). Scienter is not an element of a Section 5 violation because Section 5 imposes strict liability on sellers of securities.
SEC v. Calvo,
378 F.3d 1211, 1215 (11th Cir.2004);
Swenson v. Engelstad,
626 F.2d 421, 424 (5th Cir.1980) (the Securities Act imposes strict liability on offerors and sellers of unregistered securities);
SEC v. Cavanagh,
1 F.Supp.2d 337, 361 (S.D.N.Y.1998) (hereinafter
Cavanagh
I) (to prove a violation of Section 5, a plaintiff need not establish scienter).
A defendant is liable as a seller under Section 5 if he was a “necessary participant” or “substantial factor” in the illicit sale.
15
See, e.g., SEC v. Calvo,
378 F.3d 1211, 1215 (11th Cir.2004);
SEC v. Holschuh,
694 F.2d 130, 139-40 (7th Cir.1982). Thus, even if a defendant did not directly sell securities to investors himself or pass title, he is liable for registration violations if he “has conceived of and planned the scheme by which the unregistered securities were offered or sold.”
SEC v. Friendly Power Co.,
49 F.Supp.2d 1363, 1371 (S.D.Fla.1999);
see also Pinter v. Dahl,
486 U.S. 622, 647 , 108 S.Ct. 2063 , 100 L.Ed.2d 658 (1988). If the plaintiff is able to make out a prima facie case, the defendant bears the burden of showing that the challenged securities transactions fall within one of the enumerated exemptions from registration.
SEC v. Ralston Purina Co.,
346 U.S. 119, 126 , 73 S.Ct. 981 , 97 L.Ed. 1494 (1953);
SEC v. Cavanagh,
155 F.3d 129 , 133 (2d Cir.1998) (hereinafter
Cavanagh
II).
The SEC claims that Tsai, the Promoter Defendants, Sierra, and Richardson violated Section 5. The SEC claims that each of the following unregistered transfers violated Section 5: (1) Tsai’s transfer of shares to the five former directors in 1997; (2) the August 1999 transfer of shares to the 28 additional shareholders arranged by Tsai; (3) the sale of 3.75 million MAS XI shares to the Promoter Defendants arranged by Tsai and Markow; (4) the Promoter Defendants’ post-merger sale of shares on the OTCBB; (5) Sierra’s post-merger sales of shares on the OTCBB; and (6) Richardson’s post-merger sale of shares on the OTCBB. The SEC also argues that Markow, Yang, and Goelo violated Section 5(c), by offering to sell unregistered Bluepoint securities by editing and distributing press releases announcing the March 6, 2000 public trading of Bluepoint. They further argue that Goelo offered to sell by posting messages on internet message boards designed to stimulate investor interest.
The Parties do not dispute that no registration statements were filed or were in the process of being filed at the time of those stock transfers or press releases. The Defendants counter, however, that: (1) the SEC has not established a prima facie case regarding Tsai’s January 1997 and February 1999 “gift” transfers; (2)
*940
the 1997 and 1999 gift transfers and the February 2000 sales were exempt from registration under Rule 144(K); (3) sales of Bluepoint stock by the Promoter Defendants are exempt under Section 4(1); and (4) the SEC cannot rely on a non-fraud theory of liability because the registration violations alleged in the Complaint are based on fraud.
1. Section 5 Prima Facie Case
Turning to the SEC’s prima facie case, it is undisputed that none of the securities sold by the Defendants were registered. The Defendants only attack the SEC’s prima facie showing regarding Tsai’s 1997 transfer to the five former director shareholders and his 1999 transfer to the 28 additional shareholders. With regard to the sales prong, the Defendants argue that Tsai’s 1997 and 1999 transfers to the MAS XI shareholders were gifts, not sales. In support, they point out that Tsai received no compensation from the former directors or 28 additional shareholders, but gave the shares away for free. With regard to the interstate means/use of the mails prong they argue that the SEC has not proved this element for the 1997 transfer.
Every “disposition of a security or interest in a security, for value” constitutes a sale. 15 U.S.C. § 77b(a)(3). The value flowing from a transfer, however, need not come from the immediate recipient of the stock.
Harwyn,
326 F.Supp. at 954 (transfer in the form of a dividend was for value even though stockholders paid nothing for the shares). The analysis of whether value was received must consider the entire transaction.
In the Matter of Capital General Corp.,
Release Nos. 33-7008, 34-32669, 1993 WL 285801 , at *11 (July 23, 1993);
SEC v. Datronics Engineers, Inc.,
490 F.2d 250, 253 (4th Cir.1973).
Defendants are correct that a bona fide gift of a security would not constitute a sale.
See Shaw v. Dreyfus,
172 F.2d 140, 142 (2d Cir.1949) (transfers were not sales under Section 16(b) of the Exchange Act where the parties conceded they were bona fide gifts). But, where the “donor” of a security derives some real benefit from the purported “gift,” it will be treated as a sale. 2 Thomas Lee Hazen,
Law of Securities Regulation,
§ 5.1 (6th ed. 2009). Thus, where a “gift” disperses corporate ownership and thereby helps to create a public trading market it is treated as a sale.
16
Datronics,
490 F.2d at 253-54 ;
Capital General,
1993 WL 285801 , at *10 (Capital General’s distributions of securi
*941
ties in a shell company were a sale in violation of Section 5 because value accrued to the defendants “by virtue of the creation of a public market for the issuers securities, and the fact that, as a public company the issuer could be sold for greater consideration”). In other words, where a gift is “followed by widespread downstream sales of those securities, these would-be gifts may be characterized as a subterfuge to evade registration.” Id.;
accord Harwyn,
326 F.Supp. at 954 (payment of a stock dividend without registration violated section 5 because the purpose of the stock spin-off was to create a public market for the securities without registration); 24 William M. Prifti,
Securities: Public & Private Offerings,
§ 9.18 (2008) (if gifted securities “are intended for the creation of a public market, the gifting clearly constitutes a disposition for value and the sale of a security”).
In this case, Tsai admits that he created MAS XI, like his other 100 shell companies, for the express purpose of merging them with a private company. To do so, he needed to make MAS XI a public company. He also admits that he gifted shares to the former directors in 1997, “because we need [sic] shareholders so we can try to take the company public later on.” (3/25/2002 Tsai Test. 30.)
Similarly, the 1999 gifts to the additional 28 shareholders were arranged by Tsai to further his goal of taking MAS XI public. The gifts were spurred by his attempts to get MAS XI cleared for trading on the OTCBB by completing the required Form 211. The undisputed record evidence shows that Tsai arranged the August 1999 gifts in response to the July 26, 1999 letter he received from NASD, which explained that MAS XI’s Form 211 application was deficient because its shares were concentrated in the hands of only five shareholders. (10/19/2004 Tsai Dep. 105.)
To remedy this, Tsai admits that he arranged for the five former directors to transfer shares to the additional 28 shareholders. Those transfers were made without the five former shareholders knowledge of how many shares they would be “gifting” or to whom they were transferring their shares.
17
Likewise, the 28 addi
*942
tional shareholders did not know where the shares were coming from and assumed it was from Tsai. Moreover, Tsai admits that both the 1997 and 1999 transfers were designed to further the MAS XI’s purpose “because the purpose of the company is to become publically traded.”
(Id.
110-11.) He also admits that helping the company in this way benefitted him personally. Shortly after receiving notice of the additional shareholders, NASD cleared MAS XI for public trading on the OTCBB. Tsai retained an interest in MAS XI after the transfers. He also admits that he was ultimately paid a $250,000 fee for his role in the reverse merger with Bluepoint.
Under these circumstances, Tsai’s purported “gifts” were for value and constituted sales under Section 5.
Capital General ,
dealt with a nearly identical scenario. 1993 WL 285801 , at *5, 10-11. In that case, a defendant named Yeaman was sanctioned for,
inter alia,
Section 5 violations arising from his plan to create public companies without registration and to later transfer control of those companies to promoters or privately held companies for a fee.
Id.
at *5 .
Like Tsai, Yeaman and his company created 69 shell companies over the course of several years.
Id.
He distributed shares of those companies to hundreds of people as “gifts” without filing registration statements.
Id.
After the gifts, Yeaman, like Tsai, kept a controlling interest in the shell companies.
Id.
He then advertised that his company had publicly-held issuers available for mergers and successfully transferred control of 36 of the shells to issuers or private companies.
Id.
For his efforts, he received over $750,000 in fees.
Id.
After the transfers of control, Yeaman retained stock in the companies and helped them prepare NASD filings so that they could be publicly traded on the OTCBB.
Id.
The SEC held that the unregistered “gifts” of stock constituted sales and violated Section 5. The SEC explained that “... the fact that the recipients may not have provided direct monetary consideration for the shares does not mean that there was not a sale or offer for sale for the purposes of Section 5.”
Id.
at *10 . The SEC concluded that the shares were not distributed for a charitable purpose but so that Yeaman could sell control of the shell companies for significant value.
Id.
at *11 . The SEC reasoned that the distributions were for value because “after the stocks were gifted, [their value] increased due to the creation of a public trading market for the securities.”
Id.
That increased value would flow to Yeaman both because he retained a controlling interest in the shells after the transfer and because he was compensated when he ultimately found buyers for the shells.
Id.
Like the defendant in Capital General, Tsai transferred shares as gifts as part of a plan to take his shell company public and transfer control of the company for a greater value. Defendants themselves argue that the MAS XI shares had little to no value before the Bluepoint merger.
18
*943
The transfers were necessary to clear the company for public trading on NASD, which in turn made the company a more attractive candidate for a reverse merger. Thus, Tsai’s 1997 and 1999 “gift” transfers were for value because they helped to create a public market in the securities. Tsai benefited from this because it increased the value of the shares he held in MAS XI and because it allowed him to collect a $250,000 fee in connection with the merger. Consequently, the “gifts” were sales triggering the Section 5 registration requirement.
With respect only to the 1997 gift of shares to the five former directors, Defendants argue that the SEC has not shown that interstate means were used. The use of the mails or interstate means element of a Section 5 claim is “broadly construed to include tangential mailings or intrastate telephone calls.”
SEC v. Softpoint, Inc.,
958 F.Supp. 846, 861 (S.D.N.Y.1997). With relation to the 1997 sale, the SEC has provided evidence that one of the five former director shareholders, Stephen Lee, was living in New York at the time of the 1997 transfer and that he received his MAS XI stock certificates (including a certificate for the 1997 transfer) by mail while he was living in California. (4/30/2004 Lee Dep. 20-21, 25-26; 8/25/2000 Lee Test. 45-48). Upon receiving the stock certificates, Lee testified that he called Tsai to ask what they were. Lee also testified at his deposition, that while he was living in California he signed his blank stock power and mailed it to Tsai. (4/30/2004 Lee Dep. 29-31.) Although these mailings occurred after the 1997 transfer, they are sufficient to satisfy the interstate means/use of the mails requirement of Section 5.
United States v. Wolfson,
405 F.2d 779, 784 (2d Cir.1968) (interpreting Section 5 to prohibit use of the mails to ship securities certificates after sale, to remit the proceeds to the seller, to send stock offers, to send buyers’ confirmation slips and to cover even more tangential uses);
see also Aquionics Acceptance Corp. v. Kollar,
503 F.2d 1225, 1228-29 (6th Cir.1974) (use of the mails to transport a stock certificate months after a sale is sufficient to satisfy interstate requirement of Section 10b — 5);
Nicewarner v. Bleavins,
244 F.Supp. 261, 265 (D.Colo.1965) (one post-transfer Chicago to Denver telephone call regarding an error in the transfer and one post-transfer letter about the same problem were sufficient to establish use of interstate means or of the mails). Furthermore, the Court notes that it is undisputed that Tsai’s 1999 sale to the additional 28 shareholders and his 2000 sales of Bluepoint shares on the OTCBB involved interstate means. Thus, even if the 1997 sale did not involve interstate means, as the Court believes it did, the SEC has established a prima facie case of a Section 5 claim based on his other transfers.
As the SEC has established all the elements of its Section 5 prima facie case, the Defendants must prove that they qualify for an exemption from the registration requirement to avoid liability.
2. Applicability of Exemptions 4(1) and Rule 144(k)
Defendants argue that they are entitled to summary judgment because their unregistered sales of securities fit into exemptions 4(1) and Rule 144(k) to the registration requirement. The Securities Act contains several enumerated exceptions to the registration requirement. The Defendants bear the burden of establishing their transfers fall within one of the enumerated exemptions from registration.
Ralston
*944
Purina Co.,
346 U.S. at 126 , 73 S.Ct. 981 ;
Cavanagh II,
155 F.3d at 133. “Registration exemptions are construed strictly to promote full disclosure of information for the protection of the investing public.”
SEC v. Cavanagh,
445 F.3d 105 , 115 (2d Cir.2006) (hereinafter
Cavanagh IV).
Section 4(1) of the Securities Act exempts “transactions by any person other than an issuer, underwriter, or dealer” from Section 5’s registration requirement. 15 U.S.C. § 77d(1). To clarify the definition of the term “underwriter” the SEC drafted Rule 144. The Rule creates a “safe harbor” by limiting the definition of the term to exclude those who meet the requirements of the Rule.
SEC v. M & A West Inc.,
538 F.3d 1043, 1050 (9th Cir.2008). Rule 144(k) on which Defendants rely, creates a “safe harbor” for unregister sales of restricted securities if: (1) the seller has not been an affiliate of the issuer for the preceding three months, and (2) at least two years have elapsed since the securities were last acquired from an issuer or affiliate of the issuer.
19
17 C.F.R. § 230.144 (k). A defendant who does not satisfy the requirements of Rule 144 can still avoid liability if he does not meet the statutory definition of an underwriter.
SEC v. Kern,
425 F.3d 143 , 148 (2d Cir.2005). Conversely, a person who satisfies Rule 144 must still demonstrate that he is neither an issuer nor a dealer to qualify for the 4(1) exemption.
Id.
Defendants argue that the February 2000 sale of the MAS XI shareholders shares to the Promoter Defendants was exempt under Rule 144(k). They also claim that Tsai’s 1997 and 1999 sales and the Promoter Defendants’ sales of shares to the public are exempt from registration under Section 4(1) of the Securities act. The SEC contends that no exemptions apply to the sales and that it is entitled to summary judgment on the Section 5 violations.
a. Rule 144(k) Safe Harbor
The Rule 144(K) requires both (1) that a person wait 90 days after ceasing to be an affiliate before selling securities, and (2) that two years have elapsed between the time the securities were acquired from an affiliate or issuer and when they are resold. An affiliate is “a person that directly, or indirectly ... controls, or is controlled by,
or is under common control with [the] issuer.”
17 C.F.R. § 230.144 (a)(1) (emphasis added). Under that definition, shareholders who are controlled by the same person that controls the issuer are affiliates.
SEC v. Kern,
425 F.3d 143 , 149 (2d Cir.2005). In early February 2000, the Promoter Defendants bought their shares from the 33 MAS XI Shareholders and resold them less than a month later when public trading of Bluepoint shares began. The shareholders acquired their shares from Tsai in 1997 (for the five former director shareholders) and from the existing shareholders at Tsai’s direction in 1999 (for the additional 28 shareholders). The Defendants concede that Tsai was an affiliate of MAS XI, the issuer. Thus, the Defendants can only rely on Rule 144(k)’s safe harbor if the MAS XI Shareholders were not affiliates and held their shares for two years.
The Promoter Defendants argue that the MAS XI shareholders were not affiliates because they did not have the power to cause MAS XI to prepare and file a registration statement. The SEC counters that Tsai exerted sufficient control over the MAS XI shareholders to render them affiliates. In
SEC v. Kern,
the Second Circuit analyzed whether shareholders were affiliates in a business transaction
*945
similar to the case
sub judice.
425 F.3d at 149.
Three of the
Kern
defendants were in the business of creating shell companies.
Id.
at 146. Those defendants purchased or incorporated three shell companies, which were the subject of the suit.
Id.
They distributed stock in each company as gifts to their friends and family. The shareholders were not involved in any of the shell companies’ decision-making, even though several of the share holders supposedly served as corporate officers.
Id.
Instead, the defendants controlled the shell companies and made business decisions.
After the shares were gifted, the defendants submitted Form 211 filings to get the shell companies registered on the OTCBB.
SEC v. Lybrand,
200 F.Supp.2d 384, 387 (S.D.N.Y.2002),
aff'd sub nom. SEC v. Kern,
425 F.3d 143 , 149 (2d Cir.2005). They then sought buyers for the corporations.
Id.
After finding a buyer, “defendants would gather the corporation’s shares from their friends and associates, who in most cases had held the shares for more than two years, and transfer ownership of the company in exchange for an agreed purchase price.”
Id.
The defendants bought the shares from the shareholders in cash at undocumented prices set by the defendants.
Kern,
425 F.3d at 146. The reacquired shares were later sold in what amounted to a reverse merger effected through public sales of the shell companies’ securities to another defendant and his clients.
Id.
The defendants argued that their unregistered sales were exempt under Rule 144(k).
Id.
at 148. The Court held that the defendants could not rely on Rule 144(k) because the friend and family shareholders were affiliates under the Rule.
Id.
at 150. The Court explained that the shareholders were affiliates because they were “under common control with” the shell company issuers, i.e., the defendants controlled both the shell companies and the shareholders.
Id.
at 149. The Court reasoned that the defendants controlled the issuer shell companies because they orchestrated the merger, had the power to distribute stock, served as corporate officers, and ignored corporate formalities.
Id.
They also controlled the shareholders because they were able to gather more than 90% of the shell companies’ stock from the shareholders at a fraction of the price at which it was sold to the other defendant in the merger proceeding.
Id.
at 150.
Similarly, in this case, the Court finds that the Promoter Defendants do not satisfy the requirements of Rule 144(k) because the MAS XI Shareholders from whom they bought their shares were affiliates of MAS XI. The Court has little difficulty finding that Tsai controlled MAS XI. Tsai admits that he was an affiliate of the issuer, MAS XI. He also admits that he “owned more than 95% of the shares of MAS XI and was the president and director who conducted the affairs of [MAS XI].” (Defs.’ Reply, 25.) Like the defendants in
Kern,
Tsai orchestrated the negotiations between MAS XI and Bluepoint that lead to the merger, he had and exercised the power to distribute stock, he served as a corporate officer, and he ignored corporate formalities, including repeatedly violating corporate bylaws.
20
*946
The Court also finds that Tsai controlled the MAS XI shareholders. Rule 144 does not define the term control, but the parties do not dispute that the Court may look to Rule 405 for an appropriate definition. “Control” is broadly defined in Rule 405 as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” 17 C.F.R. § 230.405 . The undisputed record evidence shows Tsai’s influence over the MAS XI shareholders amply satisfies that standard. Like the
Kern
shareholders, the MAS XI shareholders, including the five “former directors,” had no role in corporate decision-making. Tsai admits that the “shareholders” did not attend shareholder meetings or participate in electing corporate officers. The record shows that the shareholders were largely unaware of the nature and extent of their ownership; their director roles, if any with the company; to whom and how many of their shares were transferred; that their shares were cleared for public trading; and the occurrence of the reverse merger.
Tsai exercised his control over the shareholders repeatedly. In 1999, he orchestrated the transfer of the majority of the shares held by the five former director shareholders to an additional 28 shareholders without any compensation to the existing shareholders or their knowledge of the transfer. Tsai admitted that he determined how many of the five former director’s shares he would transfer on an arbitrary basis. In 2000, he arranged the transfer of all of the 33 MAS XI shareholders’ shares to the Promoter Defendants for a flat fee of $100 regardless of how many shares they sold. The Defendants argue that the fact that the MAS XI shareholders were paid for their shares supports their argument that Rule 144(k) applies. The
Kern
shareholders, however, were also compensated for their stock.
Id.
at 146.
Tsai controlled the disposition of the shareholders’ shares via blank stock powers which had been signed by the shareholders years before. The Defendants claim that the fact that the shareholders signed the blank stock powers authorized Tsai to transfer their shares in connection with a reverse merger and defeats the SEC’s control argument. When asked at their depositions, however, shareholders testified that they did not understand what the stock powers were when they signed them and that the stock powers were completely blank (including lacking a company name) when they were signed. Moreover, the fact that the shareholders may have agreed, however unwittingly, to have their shares controlled by Tsai does not alter the fact that he exerted control over their shares. Finally, as in
Kern,
there is proof that Tsai controlled the MAS XI Shareholders because he was able to arrange the transfer of all of their shares to the Promoter Defendants at a fraction of the price at which they were sold on the OTCBB and to the Promoter Defendants.
21
*947
This Court concludes that Tsai controlled MAS XI and the MAS XI Shareholders. Consequently, the MAS XI Shareholders were “under common control with” the issuer and were affiliates, so Rule 144(k) does not apply. The Defendants advance several arguments to avoid this conclusion, none of them compelling.
First, Defendants attempt to distinguish the facts in
Kern.
Tsai points out that the Kern defendants had reacquired the shareholders shares before they sold them to the merging company while the MAS XI shareholders’ shares were sold directly to the Promoter Defendants. They claim the
Kern
Court’s finding that the shareholders were controlled turns on the fact that the shares were reacquired by the defendants before resale. The Court cannot agree.
The
Kern
Court specifically cautioned “We do not intimate that such overwhelming proof of control exercised here is necessary to satisfy the broad definition of ‘control’ for the purposes of Rule 144.”
Id.
at 150 n. 3. The fact that the
Kern
defendants reacquired the stock from the shareholders merely provided evidence that they controlled the stock, i.e., that they had the “power to direct or cause the direction of the management and policies” if the shareholders. 17 C.F.R. § 230.405 . In this case, Tsai’s ability to arrange the transfer of the shares directly to the Promoter Defendants serves the same function. The minor factual distinction between the cases is of little import. The record shows that Tsai arranged the MAS XI shareholders sales of shares, including dictating the prices and amounts of transfers, without the shareholders’ knowledge. Those facts are sufficient to demonstrate that Tsai had the power to direct the management of the MAS XI shareholders’ shares.
Next, Tsai notes that he maintained ownership of 95% of MAS XI’s shares while the
Kern
defendants were minority shareholders who, nevertheless, controlled the shell company. While this might make the extent of Tsai’s control over MAS XI understandable, it does not negate all of the evidence that he controlled the MAS XI shareholders disposition of shares and did not treat them like actual shareholders. Finally, he mentions that the merger in
Kern
was effected by the buyer purchasing shares on the OTCBB via matched orders rather than a reverse merger effected by direct sale of shares to the new investors. Again, this minor distinction is irrelevant to the control question because the
Kern
Court found control based on the actions of the defendants
prior
to the public sale of shares. In short, the Defendants have failed to distinguish
Kern
in any meaningful way.
22
Second, the Defendants argue that the MAS XI shareholders cannot be deemed “affiliates” because they did not have the power to cause MAS XI to prepare and file a registration statement. Courts have considered whether a person has the power to cause the issuer to prepare and file a registration statement when evaluating whether that person is an affiliate.
See SEC v. Great Lakes Equities Co.,
No. 89-CV-70601, 1990 WL 260587 ,
*948
at *5 (W.D.Mich. Sept. 4, 1990) (defendant was not issuer because he lacked the power to cause the company to file a registration statement). Defendants, however, overlook the fact that a person can be considered an affiliate for several different reasons: (a) because they controlled the issuer; (b) because they were controlled by the issuer; or (c) because they were controlled by the same person who controlled the issuer. 17 C.F.R. § 230.144 (a)(1).
While the ability to force the issuer to prepare a registration statement may be highly relevant to deciding whether a person is an affiliate because they controlled the issuer, it is less directly predictive when deciding if a person is an affiliate in the other two instances. 7A J. William Hicks,
Exempted Transactions Under the Securities Act of 1933,
§ 10.41.5 (2d ed. 2004) (describing the power to force the preparation of a registration statement as a factor relevant to determining who controls the issuer). A person who is an affiliate because the issuer controlled them or because the person who controlled the issuer also controlled them lacks, by definition, the power to force the issuer to file a registration statement.
Instead, he is considered an affiliate because the person who can force the filing of a registration statement can also force him to sell his shares.
Id.
at § 9.70 (“A person under common control with an issuer has a disability that is shared by a person controlled by an issuer, i.e., he cannot effect a secondary distribution without the prior consent of the control person. Since a control person also controls an issuer, it is not unfair to insist that the person under common control file a registration statement before publicly reselling securities of an issuer”). Where, as here, shareholders are allegedly affiliates because they were controlled by the person who controlled the issuer, the Court agrees with the
Kern
Court that the relevant inquiry is whether the control person exerted “control” over the shareholders as that term is defined by Rule 405.
23
The sources relied on by the Defendants do not dictate otherwise.
Third, Defendants assert, without explaining how, that the Ninth Circuit’s ruling in
Pennaluna & Company, Inc. v. SEC,
410 F.2d 861 (9th Cir.1969), is instructive on the control issue.
24
The Court has analyzed
Pennaluna,
which addresses the question of whether shares acquired from an escrow account controlled by the control person of an issuer were sold on behalf of the control person, and finds it unenlightening to the questions presented in this case.
The Court has found that the MAS XI shareholders from whom the Promoter Defendants purchased their shares were affiliates. The MAS XI shareholders also acquired their shares from an affiliate, Tsai. The Promoter Defendants began selling the shares they acquired from the affiliate-shareholders within one month after purchase. Therefore, the Rule 144(k) safe
*949
harbor is unavailable to the Promoter Defendants because they cannot show that that two years have elapsed from when the securities were acquired from an affiliate and when they were resold. 17 C.F.R. § 230.144 (k). Furthermore, the Court need not address the parties’ arguments regarding the proper calculation of the two year holding period because Rule 144(k) cannot apply no matter how long the affiliate-shareholders held the shares.
b. Section 4(1) Exemption
Defendants claim that the 1997 and 1999 sales to the MAS XI Shareholders and the Promoter Defendants’ sales of Bluepoint shares onto the public market are exempt from registration under Section 4(1) of the Securities Act. The SEC contends that each of these transactions involved an issuer or underwriter and that all of these sales were part of an integrated scheme to distribute shares to the public. They claim that as a result, Defendants cannot rely on Section 4(1).
Section 4(1) of the Securities Act was created “to cover everyday trading between members of the investing public.”
SEC v. N. Am. Research
&
Dev. Corp.,
424 F.2d 63 , 72 (2d Cir.1970). To this end, it exempts “transactions by any person other than an issuer, underwriter, or dealer” from Section 5’s registration requirement. 15 U.S.C. § 77d(1). The exemption applies to transactions, not individuals.
Holschuh,
694 F.2d at 137 . Thus, even if a particular defendant was not an issuer, underwriter or dealer, he is not protected by exemption 4(1) if he participated in a sale or offer of sale by somebody who was an issuer, underwriter or dealer.
Id.
at 138 .
An “underwriter” is “any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in the direct or indirect underwriting of any such undertaking.” 15 U.S.C. § 77b(11). Within that definition, the term “issuer” means not only the company that issued the stocks but also “any person directly or indirectly controlling or controlled by the issuer or any person under direct or indirect common control with the issuer.”
Id.
A distribution is essentially synonymous with a “public offering.”
Ackerberg v. Johnson,
892 F.2d 1328, 1336-37 (8th Cir.1989). The 4(1) exemption is designed to exempt trading in already issued securities and not distributions by issuers or acts by others who engage in steps necessary to such distributions.
Holschuh,
694 F.2d at 137-138 ;
Ackerberg,
892 F.2d at 1335 .
Turning first to the 1997 and 1999 sales to the MAS XI shareholders, the Court finds that these transactions do not qualify for the 4(1) exemption because they involved issuers and underwriters. Tsai concedes that he was the controlling person of MAS XI at the time of those transfers he has also admitted that he arranged the 1997 and 1999
25
sales to ensure that that MAS XI could become publicly traded. “A control person such as an officer, director, or controlling shareholder, is an affiliate of an issuer and is treated as an issuer when there is a distri
*950
bution of securities.”
Cavanagh IV,
445 F.3d at 111 n. 12. Consequently, an affiliate cannot rely on the Section 4(1) exemption.
Id.
at 111.
Tsai cannot rely on the exemption for those transactions because he can be viewed alternately as an issuer (due to his controlling status) or as an underwriter (because he purchased from the issuer with a view to distribution). Indeed, the Court finds that no reasonable person could conceive of the “gift” sales to the unwitting MAS XI shareholders as anything other than necessary preliminary links in the daisy-chain of Tsai’s overall plan to seek a profit from his shell company by securing public trading status and arranging a reverse merger which would inevitably lead to a public distribution. This conclusion is supported by the evidence in the case, which shows both that Tsai received $250,000 in fees in connection with the reverse merger and that Tsai retained over 450,000 shares of Bluepoint after the merger giving him the opportunity to profit directly by sales to the public.
The Defendants’ objection to this conclusion relies on their insistence that each sale of securities preceding and following the reverse merger must be viewed and analyzed in isolation. Thus, because Tsai’s sales of securities to the MAS XI shareholders in 1997 and 1999 were not themselves sales to the public, the Defendants argue that those transactions satisfy the Section 4(1) exemption. The Court disagrees. It is apparent from his testimony that Tsai arranged those transfers with a view to subsequent public distribution.
Furthermore, the term “distribution” refers to “the entire process in a public offering through which a block of securities is dispersed and ultimately comes to rest in the hand of the investing public.”
Geiger,
363 F.3d at 487. In this case, the various transfers are properly viewed as a single transaction designed to culminate in public trading.
See Cavanagh IV,
445 F.3d at 114-116 (various stages of a reverse merger viewed as a single transaction);
Kern,
425 F.3d at 152-153 (same);
M & A West, Inc.,
538 F.3d at 1052-53 (same). The fact that each individual transfer may not have involved a sale to the public does not render the transactions immune from registration where the participants clearly (and in Tsai’s case expressly) intended the transactions to result in public trading.
26
See Cavanagh I,
1 F.Supp.2d at 363 (explaining that the “integration doctrine” “is intended to prevent an issuer from avoiding registration by structuring a transaction in two or more apparently exempt offerings ... when they actually should be considered a single nonexempt transaction” (internal quotation marks omitted)).
This holding furthers the purpose of the registration requirement which is “to protect investors by promoting full disclosure
*951
of information thought necessary to informed investment decisions.”
Ralston Purina Co.,
346 U.S. at 124 , 73 S.Ct. 981 . Like the reverse merger described in
M & A West,
“the express purpose” of the MAS XI/Bluepoint reverse merger “was to transform a private corporation into a corporation selling stock shares to the public, without making the extensive public disclosures required in an initial offering.”
M & A West, Inc.,
538 F.3d at 1053 . In this case, the investing public had very little information about Bluepoint. By failing to register their transfers, the Defendants avoided revealing to the public important financial information about the company including that Bluepoint had only earned about $23,000 in revenue the previous quarter and that the Linux operating system it sold could not be fully protected by intellectual property laws. These undisclosed business risks were information to which the general trading public on the OTCBB lacked access.
See Ralston Purina,
346 U.S. at 124-25 , 73 S.Ct. 981 (purpose of the registration requirement is to protect investors by ensuring “full disclosure of information thought necessary to [make] informed investment decisions”). Where, as here, each transfer was taken in furtherance of a later public distribution, the Court will not exalt form over substance by myopically viewing each transfer as an isolated occurrence.
See id.
(“The Supreme Court has long instructed that securities law places emphasis on economic reality and disregards
form for
substance.”)
The Defendants also claim that the Promoter Defendants’ sales of Bluepoint shares onto the public market in March and April of 2000 are exempt from registration under Section 4(1) because the Promoter Defendants were not underwriters, issuers, or dealers. They are wrong. The Promoter Defendants cannot invoke the exemption because they were underwriters with respect to those sales, i.e., they purchased from an issuer with a view to distribution. The Promoter Defendants purchased their Bluepoint shares from the MAS XI shareholders. The MAS XI shareholders were “issuers” under the Securities Act because they were “under common control with the issuer,” MAS XI.
27
15 U.S.C. § 77b(11). They do not deny that they acquired their shares with the intent to distribute, nor would such an argument be credible as the record shows they sold their shares on the OTCBB approximately one month after purchase during the first day of Bluepoint trading on the OTCBB.
28
Alternatively, the Promot
*952
er Defendants were underwriters because they served as the final link in the chain through which unregistered Bluepoint shares were sold to the public. 17 C.F.R. § 230.144 (“Individual investors who are not professionals in the securities business may also be ‘underwriters’ ... if they act as links in a chain of transactions through which securities move from an issuer to the public.”)
The Promoter Defendants argue that even if they purchased from an affiliate (which they did) they were not engaged in a “distribution” because they sold their shares for them own benefit and not on behalf of Bluepoint. The case law, including the cases cited by the Defendants, does not support this interpretative gloss on the definition of the term “distribution.” Courts generally equate the term “distribution” with the phrase “public offering.” Hicks,
supra,
§ 9:18. A defendant may be deemed an underwriter if he either: (1) purchased from an issuer “with a view to” offering the securities in a distribution; or (2) sold the securities “for an issuer in connection with” a distribution.
See Ackerberg,
892 F.2d at 1336 . The Defendants ignore the first prong of the definition in their argument. A person is equally an underwriter if he engages in the distribution to line his own pockets. In short, the underwriter’s intent in engaging in the distribution is irrelevant to the determination of his status.
Lybrand,
200 F.Supp.2d at 393 (a person does not qualify for the 4(1) exemption if he directly or indirectly participated in a distribution, regardless of his intent).
29
3. The SEC’s “Nor^Fraud” Theory of Liability
As a final matter, the Defendants claim that the SEC cannot assert Section 5 liability “based on a non-fraud violation of Section 5” because the complaint and answers to interrogatories are based on allegations of a fraudulent scheme. According to them:
[t]he core of the Section 5 violation as alleged by the SEC is fraud (Tsai’s “ownership and control” of shares held by “sham” or “nominee” shareholders, and Tsai’s sale of these “nominee” shares to the Promoter Defendants for $250,000). There are no allegations whatsoever in the Complaint addressing the circumstance of 33 real shareholders (shareholders who owned the shares for their own benefit and received the proceeds of the sales of their stock in February 2000) and asserting that Tsai had sufficient “control” over their shares to defeat the exemption from registration for sales of their stock.
*953
(Defs.’ S.J. Mem. 24.) Consequently, they claim that the Complaint did not give them fair notice of the SEC’s charge against them. They also claim that they would have sought additional discovery had they known the SEC would pursue a non-fraud theory.
The Defendants’ argument is not well taken. First, the Court is unaware of any legal distinction between a “fraud violation of Section 5” and a “non-fraud violation of Section 5.” Section 5 registration violations are strict liability claims. The Defendants concede that scienter is not an element of a Section 5 claim and that the SEC can assert a claim based on non-fraudulent conduct, fraudulent conduct, or both. Therefore, the SEC is not required to prove fraud to establish liability on its registration claim.
See SEC v. Arvida Corp.,
169 F.Supp. 211, 215 (S.D.N.Y.1958) (defendants violated section 5 even though they acted in good faith).
Second, the Complaint gave the Defendants adequate notice of the claims against them. According to the Sixth Circuit, the function of a federal pleading under Fed. R.CivJP. 8(a)(2):
is to give the opposing party fair notice of the nature and basis or the grounds for a claim and a general indication of the type of litigation involved ... [t]he theory of the pleadings’ doctrine, under which a plaintiff must succeed on those theories that are pleaded or not at all, has been effectively abolished under the federal rules.
Colonial Refrigerated Transportation, Inc. v. Worsham,
705 F.2d 821, 825 (6th Cir.1983) (quoting
Oglala Sioux Tribe of Indians v. Andrus,
603 F.2d 707, 714 (8th Cir.1979)). The SEC’s complaint has more than adequately served this function.
Count 1 of the Complaint sets out the essential elements of Section 5 claim, i.e., each Defendants’ use of the mails or interstate commerce to sell or offer to sell unregistered securities:
From February 2000 through at least July 2000, Defendants Tsai, Markow, Global Guarantee, Goelo, Yang, K
&
J, Lou, M & M, Sierra, and Richardson, and each of them, directly or indirectly,
made use of
the means or instruments of transportation or communication in
interstate commerce or of the mails to offer and sell securities
through the use or medium of a prospectus or otherwise
when no registration statement has been filed
or was in effect as to such securities and when no exemption from registration was available.
(Complaint ¶ 78 (emphasis added).) The Complaint also references the same stock transfers that form the basis of the SEC Section 5 claim on summary judgment:
Tsai orchestrated a complex scheme to create the appearance that he had distributed MAS shares to dozens of shareholders who were in fact nominees. Tsai then sold this nominee stock to the Promoter Defendants. Yang and Lou resold 220,000 shares to Sierra, which immediately resold shares. Thereafter, all the promoters continued to sell shares they had acquired from Tsai, and Richardson sold the Bluepoint shares he obtained from Sierra. Overall, Tsai, the promoters, Sierra, and Richardson tunneled Blue Point Stock into the public trading market without a registration statement in effect.
(Id.
¶ 79.)
Furthermore, the background section of the Complaint provides specific facts about each transfer including: that the transfers to the former director shareholder occurred in January 1997 and September 1998; that the “former directors” did not perform any services as directors and did not know they were directors; that Tsai controlled the former directors’ shares via
*954
blank stock powers; that Tsai arranged the transfer to the 28 additional shareholders in August 1999; that Tsai and Markow arranged the transfer of shares from the MAS XI shareholders to Yang, Goelo, Markow, Lou and their companies on February 17, 2000; and the dates and amounts of the Defendants sales of Bluepoint shares on the OTCBB.
(Id.
¶¶ 33-37, 47, 53.)
In fact, the Court detects very little difference between the allegations in the Complaint and the SEC’s theory on summary judgment. The main difference appears to be that the Complaint alleges that the $250,000 that Markow paid to Tsai in February of 2000 was a direct payment for the 3.75 million MAS XI shareholders’ shares, while on summary judgment that payment is construed as a finder’s fee paid to Tsai for his role in the merger. The record is clear that this change was spurred by the fact that Markow changed his testimony regarding that payment shortly before the close of discovery.
Although he had repeatedly testified previously that his $250,000 payment to Tsai represented cash to buy shares in MAS XI, (3/1/2002 Markow Test., 69-70, 84, 100), Markow produced an affidavit in support of the Defendants’ crime-fraud briefing claiming, for the first time, that the $250,000 was actually a finder’s fee. (11/12/2004 Markow Aff. ¶2.) Regardless of the reason, the change in evidence did not radically alter the nature of the SEC’s registration violation claim against the Defendants. At best, the change slightly weakened the strength of the SEC’s evidence that Tsai retained control over the MAS XI shareholders and that his transfers to those shareholders were for value. This slight difference did not prevent the Defendants from having sufficient notice of the claims against them.
The Court also notes that the Defendants were given additional notice of the basis of the SEC’s Section 5 claims, and even much of the case law it relies in support of that claim during the extensive crime-fraud briefing.
(See
doc. no. 76.) That briefing occurred shortly before the close of discovery. Nevertheless, the Defendants did not seek additional discovery or ask for additional time for discovery despite the considerable insight into the SEC’s theory-of-the-case provided by the briefing. The Defendants argue that the crime-fraud briefing did not give them fair notice because it also relied on the fraud theory asserted in the Complaint. Having reviewed the briefing, it is apparent that the SEC addressed Markow’s change in testimony and argued that Tsai violated Section 5 even if the $250,000 was actually a finder’s fee. (Doc. no. 76, at 19 (arguing that “even setting aside the evidence that Tsai was always the beneficial owner of supposedly gifted shares, his “gifting” benefited him and his company, and thus constituted a sale requiring registration.”)) Thus, the crime-fraud briefing previewed before the close of discovery the exact arguments the SEC asserts on summary judgment.
Finally, the Defendants assert that they were prejudiced by the SEC’s “belated assertions of a non-fraud violation” because if they had known, they would have sought additional discovery from NASD regarding whether it believed Tsai’s “gifts” of MAS XI’s shares qualified for an exemption to the registration requirement. Specifically, Defendants claim that they would have sought discovery regarding: (1) a November 1999 letter in which NASD requested guidance from the SEC regarding whether certain factual scenarios involving shell companies constituted violations of Section 5; (2) NASD’s view of the common industry practice in such situations; and (3) whether NASD normally cleared companies for trading in such situations. The Defendants, however, actually
*955
sought much of this discovery including, deposing David McClarin, a NASD employee who was involved in clearing MAS XI shares for trading and acquiring expert testimony regarding industry custom in reverse mergers. Furthermore, the Complaint targets the same stock transfers that form the basis of the SEC’s motion for summary judgment and the Defendants admit that they never registered MAS XI or Bluepoint stock before any of those transfers. Therefore, the Court is unconvinced that the Complaint did not alert the Defendants that the applicability of the exemptions to the registration requirements would be an important area of discovery.
In sum, the SEC has made out a prima facie case that Defendants violated Section 5(a) of the Securities Act through their unregistered sales of Bluepoint securities and, in addition, that Markow, Yang and Goelo violated Section 5(c) by offering to sell unregistered securities. The Defendants have not demonstrated that any exemptions applied to their transactions. Therefore, the SEC is entitled to summary judgment on this issue.
B. Section 13(d) & Section 16(a) Disclosure Provision Claims
The parties have also cross-motioned for summary judgment on the SEC’s disclosure provision claims, Counts VIII and IX of the Complaint. Those Counts allege that Tsai (individually) violated both sections 13(d) and 16(a), that Yang and Goelo (individually) violated section 13(d); and that the Promoter Defendants (as a group) violated sections 13(d) and 16(a). The disclosure provisions found in sections 13(d) and 16(a) of the Exchange Act require persons who acquire beneficial ownership of, respectively, 5% or more than 10% of a corporation’s stock to disclose their ownership to the SEC.
Specifically, Section 13(d)(1) and Rule 13d-l(a) require a stock purchaser acquiring beneficial ownership of 5% or more of a company’s securities to disclose his ownership to the SEC by filing a Schedule 13D within ten days of the acquisition. 15 U.S.C. § 78m(d)(l)(D); 17 C.F.R. § 240 .13d-1(a).
30
Information disclosed in the Schedule 13D must be accurate.
See GAF Corp. v. Milstein,
453 F.2d 709, 720 (2d Cir.1971). Section 13(d) disclosures must also be updated. Section 13(d)(2) and Rule 13d-2(a) require that the Schedule 13D, be amended promptly whenever there is a “material change”
31
in ownership. 15 U.S.C. § 78m(d)(2); 17 C.F.R. § 240 .13d-2(a). Similarly, Section 16(a) and Rule 16a-3 require people who have beneficial ownership of more than 10% of a company to report their ownership with the SEC in a Form 3. 15 U.S.C. § 78p(a); 17 C.F.R. § 240 .16a-3. Any subsequent changes in beneficial ownership must also be reported in a Form 4. 15 U.S.C. § 78p(a); 17 C.F.R. § 240 .16a-3.
A “beneficial owner” is defined by Rule 13d-3 as “any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (1) [v]oting power which includes the power to vote, or to direct the voting of, such security; and/or (2) [i]n-vestment power which includes the power to dispose, or to direct the disposition of,
*956
such security.” 17 C.F.R. § 240 .13d-3. A person does not have to hold legal title to the stock or be the person in whose name the stock is issued to be a beneficial owner.
Rosenberg v. XM Ventures,
274 F.3d 137, 143-44 (3d Cir.2001). Instead, “the inquiry focuses on any relationship that, as a factual matter, confers on a person a significant ability to affect how voting power or investment power will be exercised.”
SEC v. Drexel Burnham Lambert Inc.,
837 F.Supp. 587, 607 (S.D.N.Y.1993) (internal quotation marks omitted).
Two definitions of “beneficial owner” are used for Section 16 purposes.
Feder v. Frost,
220 F.3d 29, 33 (2d Cir.2000). First, to determine if a person is subject to Section 16 based on his “beneficial ownership” of over 10%, the definition of beneficial owner from Section 13(d) applies. 17 C.F.R. § 240 .16a-1(a)(1). Once 10% owner status is determined, the second definition is used to determine which shares must be reported under 16(a) as effecting a change in ownership.
Feder,
220 F.3d at 33 . Under the second definition, a person is a beneficial owner of shares if he “directly or indirectly ... has or shares a direct or indirect pecuniary interest in the equity securities.” 17 C.F.R. § 240 .16a-1(a)(2). The term “pecuniary interest” is defined broadly as “the opportunity, directly or indirectly, to profit or share in any profit derived from a transaction in the subject securities.” 17 C.F.R. § 240 .16a — 1(a)(2)(i).
1. Individual Liability for Tsai, Yang, & Goelo
It is clear from the record that Tsai disclosed his ownership of 8.25 million MAS XI shares by filing a Schedule 13D and a Form 3 with the SEC in April 1999. According to the SEC, however, Tsai violated Section 13(d)(1), Rule 13d-l(a), 16(a) and Rule 16a-3 by filing inaccurate forms that failed to include his beneficial ownership of the 250,000 shares he transferred to the five former directors and by failing to update his 16(a) disclosure by filing a Form 4 to reflect the sale of the 250,000 shares to the Promoter Defendants.
Tsai counters that because the MAS XI shareholders received the full $100 paid for the sales of their stock in February 2000, he did not have a pecuniary interest in the stock as required to trigger the Section 16(a) reporting requirement. The definition of “pecuniary interest,” however, includes the profits
indirectly
derived from a transaction in the 250,000 shares. In connection with the February 2000 sale of those shares from the MAS XI Shareholders to the Promoter Defendants, Tsai received $250,000. Whether the payment was a “finder’s fee” as Tsai and Markow’s (later) testimony claims, or a direct payment for the shares as Goelo, Yang, Lou, and. Markow’s (original) testimony claims, the Court is satisfied that the fact that Tsai ultimately realized a $250,000 profit in connection with a disposition of the 250,000 shares warrants the conclusion that he had a pecuniary interest in those shares. Therefore, Tsai was a beneficial owner and was required to report those shares under Section 16(a).
Tsai also maintains that his investment power over the 250,000 shares was too limited to make him a beneficial owner under Section 13(d). He claims that he only had the authority to sell the MAS XI shareholders shares in connection with a reverse merger and lacked voting power with respect to the shares. Nevertheless, he concedes that he had the power to dispose of the MAS XI shareholders’ shares via the blank stock powers. He in fact exercised this power twice:, first when he transferred most of the shares held by the five former director shareholders to the 28 additional shareholders in 1999; and then again in 2000 when he sold the MAS XI shareholders’ shares to the Pro
*957
moter Defendants. This means that Tsai had investment power over the 250,000 shares and, thus, beneficial ownership. Tsai has not alerted the Court to any authority suggesting that the limitation on his investment power (that it must be used in connection with a reverse merger) takes it outside of the Section 13(d) definition of beneficial ownership. Moreover, that reading does not square with the express language of Rule 13(d) — 3 which states that a beneficial owner may
share
investment power. 17 C.F.R. § 240 .13d-3.
Tsai protests that requiring disclosure of the additional 250,000 shares would not further the purposes of Section 13(d)’s reporting requirement because, the market was already aware that he owned more than 95% of MAS XI through his incomplete disclosure.
Morales v. Quintel Entm't, Inc.,
249 F.3d 115, 122-123 (2d Cir.2001) (describing that Section 13(d)’s purpose was to “alert the marketplace to every large, rapid aggregation or accumulation of securities, regardless of technique employed, which might represent a potential shift in corporate control” (internal quotation marks omitted)). Tsai’s duties under the securities law, however, was to accurately report his beneficial ownership once it was over 5% and update material changes to those reports.
GAF Corp.,
453 F.2d at 720 (all information disclosed in a Schedule 13D must be accurate). It was not for him to selectively report his ownership based on his independent assessment of whether or not the market was sufficiently informed. Moreover, the market was unaware that Tsai had control and beneficial ownership of the 250,000 shares. Those shares became 3.75 million shares following the forward stock split and represented the bulk of the (purportedly) freely tradable shares. Tsai violated the disclosure requirements of Section 16(a) and 13(d) by failing to include those shares in his disclosure.
32
Similarly, Yang and Goelo both individually violated section 13(d) by failing to disclose their beneficial ownership of over 5% of Bluepoint’s stock following the reverse merger. The Defendants appear to concede this issue as they fail in their briefs to make any response to the evidence and arguments presented by the SEC on this issue. It is undisputed that Yang and Goelo each acquired over 5% of the outstanding Bluepoint shares following the reverse merger. It is also undisputed that Yang and Goelo never disclosed their ownership to the SEC.
Specifically, by February 22, 2000, Yang had beneficial ownership of 1.17 million of Bluepoint’s 20 million outstanding shares — over 5%. Yang acquired 500,000 shares from Tsai on February 17, 2000, apparently as compensation for his role as a consultant during the merger negotiations. As a result of Markow’s February 22, 2000 letter directing the distribution of the 3.75 million MAS XI shareholders’ shares between the Promoter Defendants, Yang acquired an additional 670,000 shares. Of those shares, 450,000 were issued in the name of Yang’s company, K
&
J Consulting and deposited into the company’s account at Sierra, which Yang controlled. Another 220,000 of those share were issued in Yang’s name and deposited
*958
into K & J Consulting’s E*Trade account, which Yang controlled.
By March 6, 2000, Goelo had beneficial ownership of 1,015,000 shares of Bluepoint, again over 5% of the total outstanding shares. Specifically, during Markow’s distribution of the 3.75 million MAS XI shareholders’ shares, Unikay Ltd. and Xplorer, Ltd., two companies controlled by Goelo, acquired a total of 775,000 shares. Goelo’s girlfriend, Ana Belloso Canto, also received 200,000 shares. Those shares were deposited in Goelo’s account at Sierra on March 6, 2000. Finally, Goelo acquired 40,000 additional shares in the first public sale of Bluepoint stock on March 6, 2000.
Consequently, Yang and Goelo are liable for Section 13(d) violations based on their failure to disclose their individual ownership of over 5% of Bluepoint’s shares. Moreover, as discussed below, they are also liable for their group acquisition of those shares.
2. Group Liability for the Promoter Defendants
Even if a person beneficially owns less than 5% of a class of securities, he is required to disclose his ownership if he is part of a group which collectively owns 5% or more.
See, e.g., Wellman v. Dickinson,
682 F.2d 355, 362 (2d Cir.1982). Under both Section 13(d) and Section 16(a) a group is defined as two or more persons who act as a “group for the purpose of acquiring, holding, or disposing of securities.” 15 U.S.C. § 78m(d)(3); 17 C.F.R. § 240 .16a-1(a)(1). The key question in group cases is whether the purported group members agreed to act together for the purpose of acquiring, holding, voting or disposing of the stock.
Morales,
249 F.3d at 123-24 . The agreement need not be formal or written; evidence of “coordinated action” may be sufficient to indicate the existence of a group.
Id.
at 127 ;
Well-man,
682 F.2d at 363 . Furthermore, the agreement does not have to be an agreement to seek corporate control of to influence corporate affairs.
Morales,
249 F.3d at 124 . “The plain language of § 13(d)(3) demands only an agreement ‘for the purpose of acquiring, holding, or disposing of securities.’ ”
Id.
(quoting Section 13(d)(3))
The SEC contends that the Promoter Defendants, Markow, Goelo, Yang, Lou, and the companies they controlled, acted as a group for the purpose of acquiring the 3.75 million Bluepoint shares from the 33 MAS XI shareholders following the reverse merger. It is undisputed that the Promoter Defendants collectively had beneficial ownership of significantly over 10% of Bluepoint’s shares when they acquired 3.75 million shares from the MAS XI shareholders in February 2000.
33
Their liability for Section 16(a) purposes turns on whether they acted as a group for the purposes of acquiring those shares, however, as none of the Promoter Defendants individually held more than 10% of Bluepoint’s shares. Similarly, for Section 13(d) liability purposes, Markow and Lou’s liability depends on whether they acquired their shares as a group with the other Promoter Defendants because neither of them individually owned 5% of Bluepoint.
Upon a review of the record in this case, the Court concludes that the Promoter Defendants acted as a group for the purposes of acquiring their Bluepoint shares in February 2000. Tsai agreed to arrange to sell the 3.75 million shares held in the names of the 33 MAS XI shareholders to Markow. Markow worked with Tsai to arrange the transfer from those shares to himself and the other Promoter Defendants. The Promoter Defendants communicated with each other about acquiring the shares, and divvying the shares up
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between them. In early January, Goelo emailed Markow about how to assign shares in the float. (1/9/2000 Email from Goelo to Markow). Goelo also emailed Markow proposing a different distribution of shares between his companies. (1/5/2000 Email from Goelo to Markow). In the letter, Goelo states, “[h]ere is the new break down I agreed to in order to make the deal possible and keep Yongzhi’s [Yang’s] partner happy ... There is the issue of controlling more than 5% of the stock of the Company to be considered as well and I may have to split the holdings amongst two Companies: Unikay Ltd and Xplorer Inc.”
(Id.)
On January 7, 2000, Goelo email Yang to tell him that the shares would cost $250,000 in total and how the purchase price should be divided between Goelo, Yang, and Lou. (1/7/2000 Email from Goelo to Yang). Yang then notified Lou. Yang, Goelo, and Lou pooled their money to purchase the shares. The three men each wired their respective portion of the purchase price to Markow. Markow forwarded the money he received to Tsai on February 8, 2000. Tsai then forwarded the stock certificate for the shares and the stock powers to Markow. On February 14, 2000, Markow sent a $100.00 check to pay each of the 33 MAS XI shareholders for their shares. Finally, on February 22, 2000, Markow sent a letter to MAS XI’s transfer agent instructing him to re-certify the shares in the names of the Promoter Defendants and companies (or people) they controlled.
The record shows that the Promoter Defendants worked together to acquire and apportion between themselves the 3.75 million shares.
34
Given the course of events, the Court finds that the Promoter Defendants informally agreed to act as a group for the purpose of acquiring their shares. Thus, they are a “group” for Section 13(d) and 16(a) purposes and their holdings are considered collectively. As the Promoter Defendants collectively had beneficial ownership of more than 10% of Bluepoint’s shares they violated Sections 13(d) and 16(a) by failing to disclose their ownership.
Defendants argue that the Court cannot find that the Promoter Defendants acted as a group because there is no evidence that they acted as a group towards any common objective after acquiring the shares — either for the purpose of controlling corporate management or acquiring additional shares. Merely acting collectively to acquire shares, they claim, is not enough. In support of this argument, they
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ask the Court to delve into the legislative history of Section 13(d)(3). The Court declines to do so.
The applicable statutory definition of a group includes those who act as a “group for the purpose of
acquiring,
holding, or disposing of securities.” 15 U.S.C. § 78m(d)(3) (emphasis added). Under the plain language of the statute joint action for the purpose of acquiring shares is sufficient.
Daniel v. Cantrell,
375 F.3d 377, 383 (6th Cir.2004) (“Where the plain language of a statute is clear, however, we do not consult the legislative history.”) The law does not require “that the narrow object of acquiring, holding, voting, or disposing of securities must itself serve a broader purpose of seeking corporate control or otherwise exerting influence over corporate affairs.”
Morales,
249 F.3d at 125 .
The Defendants’ reliance on the Seventh Circuit’s opinion in
Bath Industries, Inc. v. Blot,
427 F.2d 97 (7th Cir.1970), is similarly misguided.
Bath Industries
dealt with the question of whether existing shareholders — who did not jointly acquire their stock but who collectively owned over 10% of the company — were required to disclose their ownership under Section 13(d) “within 10 days of the time they agreed to act in concert towards any goal, whether or not any defendant purchased additional ... stock in furtherance of that goal.” 108-109. Essentially the
Bath
Court wrestled with the question of whether existing shareholders were prohibited from contemplating cooperative action because their joint holdings were more than 10%.
See id.
at 110 . The Court held that the statute does not prohibit existing shareholders from asserting “their determination to take over control of management, absent an intention to acquire additional shares for the furtherance of such a purpose.”
Id.
Consequently,
Bath
is not on point on the issue in this case, i.e., whether acting jointly to acquire over 10% of a company triggers disclosure requirements. In fact,
Bath
provides support for the proposition that an agreement to acquire the requisite percentage of shares as a group is statutorily sufficient. According to the
Bath
Court, “once the group agrees to act in concert to acquire shares, its members must comply with the Act’s disclosure requirements.”
Id.
at 110 .
C. Market Manipulation Claims
The SEC alleges that Defendants, Geiger, Markow, Global Guarantee, Goelo, Yang, K & J Consulting, Lou, M & M, Sierra, and Richardson (collectively “Manipulation Defendants”) engaged in a “pump-and-dump” scheme which artificially inflated the market price of Bluepoint shares in violation of the anti-fraud provisions of the securities laws, Counts II, III, IV, and VI.
35
According to the SEC, the Manipulation Defendants orchestrated a pump-and-dump scheme to secretly control Bluepoint’s tradable shares while inflating the demand for those shares by engaging in manipulative trading activity designed to give the appearance of demand for Bluepoint shares and generate trading momentum. The SEC further asserts that the Manipulation Defendants engaging in an internet touting campaign designed to drum up demand for the stock. The SEC claims that the Manipulation Defendants engaged in trading activity that was designed to artificially inflate Bluepoint’s price including: repeatedly trading shares
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between themselves; Sierra’s posting of bids and asks; and Sierra’s inaccurate reporting of transactions. Geiger and the Promoter Defendants have moved for summary judgment on the market manipulation counts. The SEC opposes and seeks trial on those counts.
Market manipulation generally refers to trading practices that are intended to mislead investors by artificially affecting market activity.
Santa Fe Indus., Inc. v. Green,
430 U.S. 462, 476 , 97 S.Ct. 1292 , 51 L.Ed.2d 480 (1977);
SEC v. Masri,
523 F.Supp.2d 361, 367 (S.D.N.Y.2007). Manipulation of securities prices violates Section 10(b) and Rule 10b-5 and Section 17(a).
SEC v. Resch-Cassin & Co.,
362 F.Supp. 964, 975 (S.D.N.Y.1973). Section 10(b) of the Exchange Act makes it illegal for any person to “use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance.” 15 U.S.C. § 78j(b). Section 10(b)’s prohibition is not limited to specific types of manipulation but, as Rule 10b-5 states, makes it unlawful “to engage in any practice, or course of business which operates or would operate as a fraud or deceit on any person.”
Resch-Cassin,
362 F.Supp. at 975 (S.D.N.Y.1973) (describing Section 10(b) and Rule 10b-5 as outlawing every device “ ‘used to persuade the public that activity in a security is the reflection of a genuine demand instead of a mirage’ ”) (quoting 3 Loss,
Securities Regulation,
1549-55 (2d ed. 1961)). In the context of a price manipulation case, the defendant’s failure to disclose that market prices are being manipulated constitutes a material omission of fact in the offer of securities.
Pagel, Inc. v. SEC,
803 F.2d 942, 946 (8th Cir.1986)
Section 9(a)(2) prohibits securities transactions that “creat[e] actual or apparent active trading in such security” but only applies to stocks listed on the exchanges. Sections 17(a) and 10(b), however, prohibit the same conduct as Section 9(a)(2) with respect to OTCBB stocks,' like Bluepoint.
Resch-Cassin,
362 F.Supp. at 975 ;
SEC v. Kimmes,
799 F.Supp. 852, 859 (N.D.Ill.1992) (Sections 17(a) and 10(b) prohibit deceptive conduct that stimulates demand for over-the-counter securities). Similarly, Section 15(c)(1) of the Exchange Act prohibits brokers and dealers from using “any manipulative, deceptive, or other fraudulent device or contrivance” in connection with securities transactions. 15 U.S.C. § 78o(c)(l). “The elements of a cause of action under 15c(l) are the same as for section 17(a)(1), section 10(b), and Rule 10b-5 except that Rule 15cl-2 requires that a statement or omission be made only with knowledge or reasonable grounds to believe that it is untrue and misleading.”
Great Lakes Equities Co.,
1990 WL 260587 , at *5.
The SEC must establish scienter to prove violations of Sections 15(c)(1), 17(a)(1), 10(b), and Rule 10b-5.
Aaron v. SEC,
446 U.S. 680, 691, 697 , 100 S.Ct. 1945 , 64 L.Ed.2d 611 (1980) (Section 10(b), Rule 10b-5, and Section 17(a)(1));
see Darvin v. Bache Halsey Stuart Shields, Inc.,
479 F.Supp. 460, 464 (S.D.N.Y.1979) (15(c)(1)). Scienter is “a mental state embracing intent to deceive, manipulate or defraud.”
Ernst & Ernst v. Hochfelder,
425 U.S. 185 , 193 n. 12, 96 S.Ct. 1375 , 47 L.Ed.2d 668 (1976). Recklessness is sufficient to establish scienter for all three provisions.
SEC v. George,
426 F.3d 786 , 792-93 (6th Cir.2005) (applying recklessness as scienter for Section 17(a)(1), 10(b), and 15(c)(1) violations);
Mansbach v. Prescott, Ball & Turben,
598 F.2d 1017, 1024 (6th Cir.1979) (Recklessness establishes scienter for Section 10(b) and Rule 10b-5 violations). Recklessness is “highly unreasonable conduct which is an extreme departure from the standards of ordinary care.”
Mansbach,
598 F.2d at 1025 . Scienter is not an element of claims under
*962
Section 17(a)(2) and 17(a)(3).
Aaron,
446 U.S. at 697 , 100 S.Ct. 1945 .
A defendant does not have to buy and sell securities himself for primary liability to be imposed on a market manipulation claim.
See SEC v. Sayegh,
906 F.Supp. 939, 946-47 (S.D.N.Y.1995) (primary liability imposed for Section 9(a)(2) violation in part because he directed others to raise their bids). “Primary liability can be imposed ‘not only on persons who made fraudulent misrepresentations but also on those who had knowledge of the fraud and assisted in its perpetration.’ ”
SEC v. First Jersey Sec., Inc.,
101 F.3d 1450, 1471 (2d Cir.1996) (quoting
Azrielli v. Cohen Law Offices,
21 F.3d 512, 517 (2d Cir.1994)). A defendant can also be secondarily liable for aiding and abetting the securities law violation of a primary violator if he had a “general awareness that his role was part of an overall activity that is improper” and he “knowingly and substantially” assisted the violation.
SEC v. Washington County Util. Dist.,
676 F.2d 218, 224 (6th Cir.1982). In this case, Markow is charged with both primary violations and, in the alternative, with aiding and abetting the alleged violations of the other Manipulation Defendants.
36
Manipulation in the securities market context refers to “intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.”
Ernst & Ernst v. Hochfelder,
425 U.S. 185, 199 , 96 S.Ct. 1375 , 47 L.Ed.2d 668 (1976). Courts have identified four factors indicating market manipulation: (1) control of the float, i.e., the number of shares available for trading; (2) dominance and control of the market for the security; (3) price leadership; and (4) collapse of the market after the manipulator’s activities cease.
SEC v. Martino,
255 F.Supp.2d 268, 287 (S.D.N.Y.2003); Res
ch-Cassin,
362 F.Supp. 964, 976 (S.D.N.Y.1973). Determining whether manipulation occurs requires the fact-finder to make “inferences drawn from a mass of factual detail” because “[f]indings must be gleaned from patterns of behavior, from apparent irregularities, and from trading data.”
In Re Pagel, Inc.,
Exchange Act Release No. 22,280, 1985 WL 548387 , at *3 (Aug. 1, 1985),
aff'd sub nom., Pagel, Inc. v. SEC,
803 F.2d 942 (8th Cir.1986). Proof of manipulation exists if “the manipulator caused either actual or apparent activity or caused a rise in the market price.”
SEC v. Martino,
255 F.Supp.2d 268, 286 (S.D.N.Y.2003) (quoting
Resch-Cassin,
362 F.Supp. at 976 ).
Much of the evidence regarding the SEC’s market manipulation claims focuses on the Manipulation Defendants’ trading activities on March 6, 2000. While the evidence establishing the trading transactions on that day is basically undisputed, the parties are deeply divided about the inferences to be drawn from that evidence. Essentially, the evaluation of Bluepoint’s trading activity constitutes a battle of the experts between Pacheco, the SEC’s expert who concludes that the defendants’ trading activity shows significant irregularities that suggest manipulation and the Manipulation Defendants’ expert
37
who claims that the trading activity does not suggest manipulation. Viewing the evi
*963
dence in the light most favorable to the non-movant, the Court concludes that summary judgment is inappropriate on the SEC’s market manipulation claims.
The SEC has provided ample evidence from which a reasonable jury could conclude that the Manipulation Defendants controlled the float. The record shows that following the reverse merger, Bluepoint had 20 million shares of common stock outstanding; 15.5 million of which were restricted shares held by Bluepoint’s Chinese officers and directors. This means that 4.5 million unrestricted, tradable shares were left in the float.
38
As early as January 9, 2000, the Promoter Defendants were discussing how to assign the shares in the float between themselves. The Promoter Defendants acquired 3.75 million of those shares in February of 2000 — approximately 83% of the float. Most of those shares were deposited in the Promoter Defendants’ accounts at Sierra. Goelo also repeatedly posted messages on the Silicon Investor message board in December of 1999 through January of 2000 in which he told potential investors that Bluepoint’s float was “TIGHTLY controlled” and that “We’ll sell only to smooth out the spikes.”
The SEC has also presented evidence that the Manipulation Defendants attempted to control the supply of Bluepoint’s shares by preventing mass sell-offs by the Promoter Defendants who controlled the float. Yang testified that he opened his brokerage account at Sierra on Markow’s instruction. Yang explained that Markow wanted a majority of the shares held by the Promoter Defendants deposited at Sierra because he did not want anybody to dump their shares. Also in this vein, Markow arranged to sell 5,000 shares to an investor named Kim Giffoni for around $7.00 per share a couple of weeks before trading began.
39
(Giffoni Dep. 105-06.) Markow also instructed Giffoni not to sell his shares on the first day of trading “for various reasons, including putting pressure on the stock.”
(Id.
152-53.) This agreement was reflected in Sierra’s files, which contained an agreement between Markow and Giffoni which stated that Giffoni would receive 10,000 shares in each of Markow’s next four reverse mergers if he did not sell more than 500 Bluepoint shares per day. Richardson testified that he was aware of the agreement.
Furthermore, a reasonable jury could also conclude that Goelo’s touting of Bluepoint’s stock on internet message boards was part of a larger scheme to excite demand for stock controlled by the Manipulation Defendants. Robert Zumbrunnen, the administrator of the message board on which Goelo posted, testified that postings on the site can affect the price of a stock, particularly where individuals post multiple messages claiming inside information or claiming that the stock was going to skyrocket. (12/6/2004 Zumbrunnen Dep. 27-28.) In various message board posts, Goelo did just that.
Goelo’s December 1999 posts, which were sent to several potential investors, boasted that “[t]his company we’re reverse merging [Bluepoint] will be the first publicly traded Pure Linux Business in China” and that “[i]t will begin trading at around $4.00 the first day ... and we’ll let all our friends know in advance so they can load up ... [e]xpect the stock to be trading at $50.00 within a few months.” On January 26, 2000, Goelo sent messages to at least four potential investors telling them “I am
*964
involved in a reverse merger of the top Chinese Linux Company” he went on to state “I’ll give forward notice to some friends to pick up shares before the press release unleashes the frenzy ... You and friends might be interested to support the stock on the new thread, as I am probably too closely involved in the deal to post myself.”
Goelo informed Yang and Markow about his touting, emailing them that “[t]he support on the message Boards is lined up and I’ll have the [Bluepoint] threads opening for business on [the message boards] around 9:30 on Friday.” Yang testified that he told Goelo not to participate in the posting on the message boards because they had “inside information” and were “insiders.” Goelo then asked several people to post information about Bluepoint online and provided them with information about the company. Defendant Armstrong did so, pos

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/1465164. Public record. Not legal advice.