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

RECOMMENDED FOR FULL-TEXT PUBLICATION

Pursuant to Sixth Circuit I.O.P. 32.1(b)

File Name: 13a0094p.06

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

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X

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UNITED STATES SECURITIES AND EXCHANGE

Plaintiff-Appellee, --

COMMISSION,

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No. 10-3546

,

>

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v.

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SIERRA BROKERAGE SERVICES, INC., c/o

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Jeffrey A. Richardson, President, et al.,

Defendants, -

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Defendant-Appellant. -

AARON TSAI,

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Appeal from the United States District Court

for the Southern District of Ohio at Columbus.

No. 2:03-cv-326—Algenon L. Marbley, District Judge.

Argued: October 11, 2012

Decided and Filed: April 4, 2013

Before: BATCHELDER, Chief Judge; GIBBONS, Circuit Judge; and

ROSENTHAL, District Judge.*

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COUNSEL

ARGUED: Ronald E. DePetris, Southampton, New York, for Appellant. Hope Hall

Augustini, SECURITIES AND EXCHANGE COMMISSION, Washington, D.C., for

Appellee. ON BRIEF: Ronald E. DePetris, DEPETRIS & BACHRACH, LLP, New

York, New York, Matthew T. Anderson, LUPER NEIDENTHAL & LOGAN,

Columbus, Ohio, for Appellant. Hope Hall Augustini, David Lisitza, SECURITIES

AND EXCHANGE COMMISSION, Washington, D.C., for Appellee.

*

Honorable Lee Rosenthal, United States District Judge for the Southern District of Texas, sitting

by designation.

1

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 2

_________________

OPINION

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ALICE M. BATCHELDER, Chief Judge. The Securities and Exchange

Commission filed this civil enforcement action against twelve Defendants, alleging that

they violated registration, disclosure, and anti-fraud provisions of federal securities law.

The SEC moved for summary judgment against the Defendants, and the Defendants

made a cross-motion for summary judgment. The district court granted the SEC’s

motion in part and denied it in part, granted permanent injunctions against the

Defendants, and denied the Defendants’ cross-motion. On appeal, Defendant-Appellant

Aaron Tsai challenges the grant of summary judgment and permanent injunction against

him. For the reasons that follow, we AFFIRM.

I.

The district court explained the “reverse merger” process that led to the SEC’s

claims against Tsai in this case:

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 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.

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 3

SEC v. Sierra Brokerage Servs., Inc., 608 F. Supp. 2d 923, 927 (S.D. Ohio 2009). A

reverse merger enables a private company to access public markets without undertaking

the expensive process of an initial public offering. See SEC v. Kern, 425 F.3d 143, 146

(2d Cir. 2005). This inexpensive way to “go public” creates a market for shell

companies.

Tsai is the only Defendant on appeal, though there are other Defendants who play

significant roles in this case. Tsai has formed over 100 shell companies. No neophyte

in the world of securities, Tsai has been a registered representative of multiple brokerage

firms and has passed five exams related to the securities industry. The SEC has sued

Tsai once before, though in that case Tsai consented to the final judgment without

admitting or denying the allegations him, and the judgment came several years after the

events leading to the instant suit. See SEC v. Surgilight, Inc., Lit. Rel. No. 19169, 85

SEC Docket 391, 2005 WL 770873 (Apr. 6, 2005).

Tsai incorporated MAS Acquisition XI Corporation (“MAS XI,” and “Bluepoint”

after the reverse merger occurred), the issuer of the stock in this case, in Indiana in 1996,

and he served as its CEO, president, and treasurer from the outset. Even though MAS

XI’s bylaws required three directors as of the date on which the bylaws took effect, Tsai

was MAS XI’s only director at that time. After its incorporation, MAS XI issued 8.5

million shares of common stock to Tsai, but he reported beneficial ownership of only

8.25 million shares to the SEC.

To make MAS XI attractive for a reverse merger, Tsai pursued clearing the

company’s stock for trading on the Over-the-Counter Bulletin Board (“OTCBB”), a

public securities market that the National Association of Securities Dealers (“NASD”)

oversaw. To prepare MAS XI for clearance on the OTCBB, Tsai used thirty-three initial

shareholders of MAS XI (“thirty-three shareholders”). The thirty-three shareholders

consisted of two groups. Five individuals were in the first group. Tsai claimed they

were former directors of MAS XI, but admitted that three of them never actually

performed any services for MAS XI and that he could not remember whether the other

two had performed any services. In fact, the “former directors” never participated in a

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 4

board meeting of any kind. Notwithstanding the former directors’ lack of involvement,

Tsai had MAS XI issue a small number of shares to each of the former directors in 1997

and again in 1998 as “compensation for their services.” In 1997, Tsai also gave 50,000

shares of his own to each of the five former directors. This transfer accounts for the

250,000 shares as to which Tsai reported no beneficial ownership to the SEC.

The second group within the thirty-three shareholders (the twenty-eight

“additional shareholders”) entered the scene after Tsai’s initial and failed attempt to have

MAS XI cleared for public trading. The NASD had rejected Tsai’s initial “Form 211”

filing—a securities listing application form that needed the NASD’s approval before

MAS XI’s stock could be quoted on the OTCBB—because MAS XI’s shares were

concentrated in the hands of only five shareholders. Following the NASD’s rejection,

Tsai accordingly transferred shares from the five former directors to the twenty-eight

additional shareholders, who were his friends or acquaintances.

Tsai made these transfers using stock powers, which are powers of attorney over

securities, that the five former directors had signed in advance of any transfer and

perhaps as early as the time they became shareholders. In his preparations for reverse

mergers, Tsai had a practice of obtaining shareholders’ signatures on stock powers prior

to specific transfers of their stock. He did this to preempt delays that might occur if he

had to track those shareholders down and obtain their signatures months or years later.

In this case, Tsai recalled that after he obtained the former directors’ signatures he likely

went back and typed information onto the blank stock power forms. Tsai accordingly

transferred some of the former directors’ stock to the twenty-eight additional

shareholders; he admitted to deciding arbitrarily the amounts of stock each of the

additional shareholders received. It should be noted that Tsai obtained stock powers

from each of the twenty-eight additional shareholders as well. And, once Tsai held

signed stock powers, he did not need any other document to transfer the thirty-three

shareholders’ stock.

With the total number of shareholders at thirty-three, Tsai succeeded in his

second attempt to obtain clearance for public trading from the NASD. Tsai turned to the

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 5

next stage of his plans: the reverse merger. Another set of entities (the “promoter

Defendants”) played a significant role in the events surrounding the reverse merger and

leading to the suit against Tsai. They include Yongzhi Yang (a business consultant),

K&J Consulting (Yang’s company, which he used to trade unregistered shares of MAS

XI which, by that time, had become Bluepoint), Michael Markow (a financial consultant

with experience in reverse mergers), Global Guarantee (Markow’s company, which he

used to trade unregistered shares of Bluepoint), Francois Goelo (who introduced Yang

to Markow, and controlled two companies that he used to trade unregistered shares of

Bluepoint), Ke Luo (who helped pay Tsai for his efforts), and M&M (Luo’s company,

which he used to trade unregistered shares of Bluepoint).

In December of 1999, Yang was working as a consultant for a Chinese software

company (that later became Bluepoint) that was seeking a U.S. shell for a merger. Goelo

knew Yang and introduced Yang to Markow. Tsai recalled Markow’s contacting him

to discuss the possibility of a reverse merger with Bluepoint. The collective efforts of

Goelo, Yang, and Markow paid off on January 7, 2000, when Tsai and Bluepoint’s CEO

formally agreed to a reverse merger.

Tsai had MAS XI declare a 15-for-1 stock split. That stock split multiplied the

thirty-three shareholders’ stock to approximately 3.75 million shares. Markow, working

to facilitate the sale of the stock, told Tsai that he had arranged a group of investors

eager to buy from the thirty-three shareholders. Tsai accordingly created stock

certificates for the thirty-three shareholders’ stock. These certificates had never been

issued in the first place; instead, the thirty-three shareholders’ ownership had only been

recorded as book entries. Tsai mailed the certificates and stock powers to Markow, who

sent each of the thirty-three shareholders $100, for a total of $3,300, regardless of how

many shares each one held. Tsai testified that most of the thirty-three shareholders

probably had no knowledge of the reverse merger or of their shares’ having been cleared

for public trading before Tsai sent their certificates and stock powers to Markow.

Tsai received a check, written to his company MAS Capital, Inc., for $250,000

from Markow, who had received wire transfers—that together totaled approximately

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 6

$250,000—from Goelo, Yang, and Luo. Tsai received the $250,000 for transferring the

stock of the thirty-three shareholders, which Tsai acknowledged.

On February 22, 2000, Markow ordered that the thirty-three shareholders’ stock

be re-certified in the names of the promoter Defendants, companies they controlled, and

their relatives and friends. Less than one month later, on March 6, 2000, Bluepoint

shares began trading on the OTCBB. The promoter Defendants publicly sold their

unregistered shares in Bluepoint.

The SEC filed a civil enforcement action against the twelve Defendants,

including Tsai. In Count I, the SEC claimed that Tsai violated Sections 5(a) and 5(c) of

the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77e(a), (c), by trading

securities in interstate commerce without filing registration statements. In Counts VIII

and IX, the SEC alleged that Tsai failed to disclose his beneficial ownership of securities

in violation of Section 13(d) of the Securities Exchange Act of 1934 (“Exchange Act”),

15 U.S.C. § 78m(d)(1)-(2), and Rules 13d-1(a) and 13d-2(a) thereunder, 17 C.F.R.

§ 240.13d-1,-2, and that Tsai violated 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.

The SEC moved for summary judgment against Tsai on Counts I, VIII, and IX;

Tsai made a cross-motion for summary judgment. The district court granted the SEC’s

motion for summary judgment against Tsai on all three Counts, granted a disgorgement

order against Tsai for $250,000 plus $101,987 in prejudgment interest, and permanently

enjoined Tsai from violating the registration and disclosure provisions. The court denied

Tsai’s cross-motion for summary judgment.

On appeal, Tsai makes four arguments. First, he argues that the district court

erred by permitting the SEC to move for summary judgment on the basis of an alleged

“non-fraud-based” violation of Section 5’s registration requirements when, Tsai alleges,

the SEC’s complaint and interrogatory answers only indicate a “fraud-based” theory of

violation. Tsai argues that this shift prejudiced his defense. Second, Tsai argues that the

district court erred by holding that SEC Rule 144(k) did not apply to the sale of the

unregistered securities. Third, he argues that the district court erred by granting

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 7

summary judgment with respect to his reporting violations under the Exchange Act.

Finally, he argues that the district court erred in issuing the injunction. We consider and

reject each argument.

II.

This court reviews de novo an order granting summary judgment. Tysinger v.

Police Dep’t of City of Zanesville, 463 F.3d 569, 572 (6th Cir. 2006). A court must grant

“summary judgment if the movant shows that there is no genuine dispute as to any

material fact and the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P.

56(a). In making this determination, “the court must view the evidence in the light most

favorable to the non-moving party and draw all reasonable inferences in its favor.”

Tysinger, 463 F.3d at 572. The ultimate 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 v. Liberty Lobby, Inc., 477 U.S.

242, 251-52 (1986). But “the mere existence of some alleged factual dispute between

the parties will not defeat an otherwise properly supported motion for summary

judgment; the requirement is that there be no genuine issue of material fact.” Id. at 247-

48. “[T]he substantive law will identify which facts are material,” and “summary

judgment will not lie if the dispute about a material fact is ‘genuine,’ that is, if the

evidence is such that a reasonable jury could return a verdict for the nonmoving party.”

Id. at 248. Finally, 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. United States, 929 F.2d 240, 248 (6th Cir. 1991).

A.

Before presenting his other challenges, Tsai argues that the SEC’s alleged

variance from a “fraud-based” claim in its complaint to a “non-fraud-based” claim in its

motion for summary judgment prejudiced his defense because he did not seek discovery

from the NASD that he otherwise would have sought to defend against such a theory.

Tsai asserts that the SEC belatedly shifted from characterizing the thirty-three

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 8

shareholders as nominees to characterizing them as real owners of MAS XI stock, and

that the district court wrongly permitted that shift.

Our reasoning in Colonial Refrigerated Transportation, Inc. v. Worsham, 705

F.2d 821 (6th Cir. 1983), provides a framework for addressing Tsai’s argument. In that

case, we explained federal pleading and when prejudicial variance should prevent

recovery:

The function of an affirmative federal pleading, under Fed. R. Civ. P.

8(a)(2), is to give the opposing party fair notice of the nature and basis

or grounds for a claim, and a general indication of the type of litigation

involved. The “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. . . . [T]he federal rules, and

the decisions construing them, evince a belief that when a party has a

valid claim, he should recover on it regardless of his counsel’s failure to

perceive the true basis of the claim at the pleading stage . . . provided that

such a shift in the thrust of the case does not work to the prejudice of the

opposing party.

Id. at 825 (citations and internal quotation marks omitted).

The SEC’s argument does not cause a “shift in the thrust of the case” that would

prejudice Tsai because the SEC’s initial complaint specifically identifies the legal and

factual bases for its claims. Count I of the SEC’s complaint explicitly alleges violations

of Sections 5(a) and 5(c) of the Securities Act. It then alleges that:

From February 2000 through at least July 2000, Defendant[] Tsai . . .

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.

By listing Sections 5(a) and (c), and by alleging facts that relate to Section 5’s elements,

the SEC alerted Tsai to the legal and factual bases for his liability. And, though the

SEC’s complaint labeled MAS XI’s shareholders as being nominees and not real owners,

it adequately identified the underlying factual issue: how to characterize Tsai’s

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 9

relationship to the thirty-three shareholders. Hence, the district court correctly permitted

the SEC to advance this non-fraud-based argument.

B.

The Securities Act and the required filing of registration statements under

Section 5 exist to protect investors by requiring they receive sufficient information to

make informed investment decisions. See SEC v. Ralston Purina Co., 346 U.S. 119, 124

(1953). Sections 5(a) and 5(c) of the Securities Act together require that securities be

registered before they can be sold or offered for sale. 15 U.S.C. § 77e(a), (c); see SEC

v. Holschuh, 694 F.2d 130, 137 (7th Cir. 1982). A party can violate the registration

requirements of Sections 5(a) and (c) of the Securities Act through even indirect

involvement in the public sale of unregistered securities. Some securities sales, though,

are exempt from registration requirements, 15 U.S.C. § 77d; SEC v. Cavanaugh, 155

F.3d 129, 133 (2d Cir. 1998), and Tsai claims the sales of securities in this case are

exempt and that the district court inappropriately made findings of fact in its analysis.

Section 4(1) of the Securities Act, 15 U.S.C. § 77d(a)(1), provides that

Section 5’s registration requirements shall not apply to “transactions by any person other

than an . . . underwriter.” The Securities Act defines an “underwriter” as

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 any such

undertaking, or participates or has a participation in the direct or indirect

underwriting of any such undertaking . . . .

15 U.S.C. § 77b(a)(11). Recognizing the extent of a “distribution” is key to accurately

identifying underwriters. “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 v. SEC, 363 F.3d 481, 487 (D.C. Cir. 2004)

(citation and internal quotation marks omitted).

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 10

The SEC adopted Rule 1441 to help determine whether someone is engaged in

a distribution and, hence, is an underwriter: individuals who satisfy Rule 144’s safe

harbor are not underwriters for purposes of Section 4(1). 17 C.F.R. § 230.144 (2012).

The exemption that Tsai claims applies to the promoter Defendants’ sale of unregistered

securities is found in 17 C.F.R. § 230.144(k) (2000). Rule 144(k) prevents Section 5’s

registration requirements from applying to

restricted securities sold for the account of a person who is not an

affiliate of the issuer at the time of the sale and has not been an affiliate

during the preceding three months, provided a period of at least two

years has elapsed since the later of the date the securities were acquired

from the issuer or from an affiliate of the issuer.

17 C.F.R. § 230.144(k) (2000) (emphasis added). For purposes of Rule 144(k), “[a]n

‘affiliate’ of an issuer is a person that directly, or indirectly through one or more

intermediaries, controls, or is controlled by, or is under common control with, such

issuer.” 17 C.F.R. § 230.144(a)(1) (2000).

Acknowledging that Rule 144 does not define “control,” the Second Circuit has

found that

Rule 405 of Regulation C establishes a definition of “affiliate” identical

to that of Rule 144 and defines “control” 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.”

Kern, 425 F.3d at 149 (quoting 17 C.F.R. § 230.405). In Kern, the Second Circuit

applied that definition of “control” and found that the defendants controlled the

shareholders and issuers, making the shareholders “affiliates” and ensuring that Rule

144(k)’s safe harbor did not apply. Id. at 149-50. Kern is instructive here.

1

The SEC revised Rule 144 in 2007 such that today’s Rule 144, 17 C.F.R. § 230.144 (2012), has

reserved subsection (k). See Revisions to Rules 144 and 145, 72 Fed. Reg. 71,546, 71,547 (Dec. 17, 2007)

(“Rule 144[k], as it existed before today’s amendments, permitted a non-affiliate to publicly resell

restricted securities without being subject to the above limitations if the securities had been held for two

years or more, provided that the security holder was not, and, for the three months prior to the sale, had

not been, an affiliate of the issuer.”); id. at 71,547 n.23. Unless we note otherwise, in this opinion we refer

to Rule 144 and 144(k) as they were in 2000.

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 11

In Kern, the SEC had sued the defendants for selling the unregistered securities

of companies that were created for reverse mergers. Id. at 145-47. The Second Circuit

affirmed the district court’s grant of partial summary judgment to the SEC, and held in

part that the sales did not qualify for the Rule 144(k) safe harbor. Id. at 145, 149-50.

The Second Circuit found that the defendants had controlled two of the shell companies

and their shareholders, which placed both the shell companies and shareholders under

the defendants’ common control, making the shareholders affiliates for purposes of Rule

144(k). Id. at 149-50.

The defendants had distributed the stock of the shell companies to friends and

family. Id. at 146. They then bought the shell companies’ shares back from the “friends

and family,” and the shares were eventually sold on the public market. Id. The Second

Circuit found that what demonstrated the defendants’ control over the shareholders was

the defendants’ ability “to garner overwhelming proportions of [the shell companies’]

stock at a fraction of the price at which it was sold.” Id. at 150. The court noted that it

did “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, but it is clearly

sufficient.” Id. at 150 n.3.

Our review of the circumstances of this case in light of Kern persuades us that

the district court judge here properly concluded there was no genuine dispute of material

fact over whether the thirty-three shareholders were MAS XI’s affiliates. Given that the

$250,000 Tsai received motivated his transfer of the thirty-three shareholders’

stock—whether it motivated him directly by functioning as a purchase price for the stock

or indirectly by functioning as compensation for his role in the reverse merger—that

$250,000 is significantly higher than the low price of $3,300 that the thirty-three

shareholders received when Tsai transferred their shares. That differential demonstrates

Tsai’s control.

Another fact shows Tsai’s control over the thirty-three shareholders. Unlike the

defendants in Kern, who had to purchase stock from shareholders before they could

profit from it, all Tsai had to do was employ the stock powers that the thirty-three

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 12

shareholders had signed in advance of the reverse merger. Even if Tsai, as he claims,

acted within the bounds of what the stock powers and thirty-three shareholders

authorized him to do, that authorization does not negate his control. The district court

correctly noted that “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.” Sierra, 608 F. Supp. 2d at 946. Tsai does not dispute that he

controlled the issuer, MAS XI, during the relevant time. And the promoter Defendants

both acquired and sold the affiliates’ stock in 2000, well before Rule 144(k)’s required

two-year holding period had elapsed. See 17 C.F.R. § 230.144(k) (2000).

We hold that there is no genuine dispute with respect to the facts undergirding

the conclusion that Tsai controlled the shareholders. His control over them and MAS

XI renders the Rule 144(k) safe harbor unavailable, makes the promoter Defendants

underwriters, and ultimately means the registration requirements of Section 5 applied to

these transactions.

C.

Along with registration requirements for the sales of securities, the SEC imposes

disclosure requirements. Tsai’s appeal implicates two provisions of the Exchange Act,

and both require owners of securities to report their ownership of stock when their

holdings exceed certain thresholds. Promulgated pursuant to the Exchange Act, Rule

13d-1(a) requires that any

person who, after acquiring directly or indirectly the beneficial

ownership of any equity security of a class which is specified in

paragraph (i) of this section, is directly or indirectly the beneficial owner

of more than five percent of the class shall, within 10 days after the

acquisition, file with the Commission, a statement containing the

information required by Schedule 13D (§ 240.13d-101).

17 C.F.R. § 240.13d-1(a). In defining “beneficial owner,” Rule 13d-3(a) provides that a

beneficial owner of a security includes any person who, directly or

indirectly, through any contract, arrangement, understanding,

relationship, or otherwise has or shares: (1) Voting power which

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 13

includes the power to vote, or to direct the voting of, such security;

and/or, (2) Investment power which includes the power to dispose, or to

direct the disposition of, such security.

17 C.F.R. § 240.13d-3(a).

The analysis necessary to determine whether Tsai was a beneficial owner with

“investment power” over the thirty-three shareholders’ stock resembles the analysis that

showed his control over those shareholders. Tsai did not report ownership of the

250,000 shares that the thirty-three shareholders held. Tsai explains that this omission

was because he did not own the thirty-three shareholders’ stock. But the Rule’s

definition of “beneficial owner” does not turn on the formal legality of a beneficial

owner’s relationship to shareholders; what is relevant is his power to dispose of or direct

the disposition of their stocks. Even assuming, as Tsai claims, that he fully explained

to shareholders that the stock powers would only be used in the context of a reverse

merger, that explanation did not negate his actual investment power. At the end of the

day, Tsai held stock powers that the thirty-three shareholders signed in advance; he

could and did use their shares as he saw fit. Accordingly, Tsai should have disclosed his

beneficial ownership of the shares.

SEC Rule 16a-3, 17 C.F.R. § 240.16a-3, also promulgated pursuant to the

Exchange Act, has a “beneficial ownership” reporting requirement similar to that of Rule

13d-1. Determining who is a “beneficial owner” under this Rule means identifying

any person who, directly or indirectly, through any contract,

arrangement, understanding, relationship or otherwise, has or shares a

direct or indirect pecuniary interest in the equity securities, subject to the

following: (i) The term pecuniary interest in any class of equity

securities shall mean 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) (emphasis added).

Given the breadth of the definition of “pecuniary interest,” it is futile for Tsai to

contend that he did not have an opportunity to share indirectly in a profit derived from

a transaction in the thirty-three shareholders’ securities. Tsai asserts that he could not

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 14

have had a pecuniary interest at the time the thirty-three shareholders received the stock

because that interest would have been too speculative. But, in fact, Tsai’s opportunity

for profit through the ultimate sale of the stock after a reverse merger existed at the time

the thirty-three shareholders acquired the stock and signed the stock powers. Indeed, the

stock of MAS XI—a shell corporation—had little or no value but for the possibility of

a reverse merger.

And even if the $250,000 Tsai received is characterized as a fee for Tsai’s

services in the reverse merger rather than as a direct payment for the thirty-three

shareholders’ stock, that sum is still evidence that Tsai capitalized indirectly on an

opportunity to share in profit derived from a transaction involving the thirty-three

shareholders’ stock. Tsai’s argument that the shareholders received economic benefit

ignores that the definition of “pecuniary interest” includes the opportunity to share in

any profit derived from that transaction. The $3,300 the shareholders received from

Markow for their shares does not, therefore, negate Tsai’s ability to profit and,

accordingly, his obligation to report his ownership.

D.

The district court permanently enjoined Tsai from violating registration

requirements of the Securities Act and reporting requirements of the Exchange Act.2

Tsai’s arguments on appeal do not address the injunction as it applies to the Exchange

Act and, hence, he has waived any challenge to that aspect of the injunction. United

States v. Sandridge, 385 F.3d 1032, 1035-36 (6th Cir. 2004).

This Court reviews for abuse of discretion the district court’s granting an

injunction. SEC v. Youmans, 729 F.2d 413, 415 (6th Cir. 1984). The district court here

2

As we note below, this is not Tsai’s first injunction, see SEC v. Surgilight, Inc., Lit. Rel. No.

19169, 85 SEC Docket 391, 2005 WL 770873 (Apr. 6, 2005), although that 2005 injunction differs

significantly from the one now under our consideration. The 2005 injunction arose in an entirely separate

case and was issued in another jurisdiction. Id. It was issued with Tsai’s consent and without his

“admitting or denying the [SEC’s] allegations.” Id. And the 2005 injunction was narrower than the

injunction here, which prohibits Tsai from violating disclosure requirements under “Sections 13(d)(1) and

16(a) of the Exchange Act [15 U.S.C. §§ 78m(d)(1) and 78p(a)] and Rules 13d-1 and 16a-3 thereunder [17

C.F.R. §§ 240.13d-1(a) and 240.16a-3]” in addition to prohibiting his violation of registration

requirements. Sierra, 608 F. Supp. 2d at 974 (alterations in original).

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 15

abused its discretion if it “relie[d] on erroneous findings of fact, applie[d] the wrong

legal standard, misapplie[d] the correct legal standard when reaching a conclusion, or

ma[de] a clear error of judgment.” Pipefitters Local 636 Ins. Fund v. BCBS of Mich.,

654 F.3d 618, 629 (6th Cir. 2011) (citation and internal quotation marks omitted).

A permanent injunction is appropriate where the SEC has shown “a reasonable

and substantial likelihood that [Tsai], if not enjoined, would violate the securities laws

in the future.” Youmans, 729 F.2d at 415. The Sixth Circuit has identified seven factors

that are relevant to determining whether there is a reasonable and substantial likelihood

of future violations:

(1) the egregiousness of the violations; (2) the isolated or repeated nature

of the violations; (3) the degree of scienter involved; (4) the sincerity of

the defendant’s assurances, if any, against future violations; (5) the

defendant’s recognition of the wrongful nature of his conduct; (6) the

likelihood that the defendant’s occupation will present opportunities (or

lack thereof) for future violations; and (7) the defendant’s age and health.

SEC v. Quinlan, 373 F. App’x 581, 585-86 (6th Cir. 2010) (quoting Youmans, 729 F.2d

at 415) (internal quotation marks omitted). No single factor is determinative. Youmans,

729 F.2d at 415.

We first note that the district court rightly applied the test of “whether the SEC

had shown a reasonable and substantial likelihood” that Tsai would violate securities

laws in the future. Id. The district court did mislabel the test when it said that the SEC

needed to show only a “‘reasonable likelihood’” of future violations. Sierra, 608 F.

Supp. 2d at 971 (quoting Holschuh, 694 F.2d at 144). But that error is harmless because

the district court still rigorously applied the seven factors from Youmans as the

“reasonable and substantial likelihood” test requires. See Youmans, 729 F.2d at 415.

As part of its analysis of the Youmans factors, the district court found as

persuasive and discussed Tsai’s failure to provide sincere assurances that he will not

offend in the future, his failure to recognize the wrongful nature of his conduct, his line

of employment, and his failure to argue that his age and health preclude future violations.

Tsai, however, focuses his attack against the injunction on the district court’s scienter

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 16

finding.3 The inquiry under the scienter factor involves a continuum, and entails asking

about the degree to which scienter exists. Youmans, 729 F.2d at 415; Quinlan, 373 F.

App’x at 585. The district court found that the attendant circumstances suggest that Tsai

acted recklessly in committing his violations. Those attendant circumstances include his

experience in the industry and his substantial education concerning the very regulations

he violated. They also include Tsai’s alleged lie, made in his NASD Form 211 filing,

about transferring shares to five former director shareholders as “compensation for

services” when those directors never, in fact, provided such services and apparently

served only as honorary directors.

Tsai does not challenge the court’s scienter finding to the extent it rests on his

industry experience and education, but argues that the district court made an

inappropriate finding of fact by concluding that he lied in his Form 211 application. Tsai

claims that the five former directors served as honorary directors and were properly

listed on Form 211. Tsai’s argument that the district court made an inappropriate finding

of fact here could have merit—it is possible Tsai’s characterization of the directors, even

if incomplete, was not a lie. But Tsai’s failure to challenge the court’s findings with

respect to his industry experience and education means the court did not abuse its

discretion in finding he had at least some degree of scienter.

More importantly, even if Tsai’s challenges to the district court’s scienter finding

were entirely well-grounded and Tsai lacked any degree of scienter, he would not be able

to show the district court abused its discretion in granting an injunction. The absence

of scienter alone does not determine whether an injunction is appropriate. See Youmans,

729 F.2d at 415 (noting that “courts have taken care to stress that no one factor is

3

Tsai also challenges the district court’s focus under the second factor—“the isolated or repeated

nature of the violations”—on Tsai’s involvement in another case in which a shell company was used to

facilitate a reverse merger. See Surgilight, 85 SEC Docket 391. That case left Tsai enjoined from

violating the registration requirements of Sections 5(a) and 5(c) of the Securities Act. Id. Tsai is correct

that the 2005 injunction was issued after, and so did not apply to, Tsai’s actions that led to the current

litigation. But the existence of any injunction at all is part of Tsai’s history and, under the second factor,

is evidence that he is a repeat violator and at least suggests the possibility of his violating securities laws

in the future. Hence, the 2005 injunction tends to support the district court’s decision to issue an

injunction, a decision also in accord with the Seventh Circuit’s pronouncement that “Tsai and his

corporations take the law . . . entirely too lightly.” MAS Capital, Inc. v. Biodelivery Sciences Int’l, Inc.,

524 F.3d 831, 833-34 (7th Cir. 2008).

No. 10-3546 SEC v. Sierra Brokerage, et al. Page 17

determinative”). Indeed, had the district court refused to grant the injunction based

solely on a finding that Tsai did not have scienter, it would have abused its discretion by

making that single factor determinative. Id. at 416 (holding that the “district court

abused its discretion by focusing exclusively on the change of occupation factor”).

In light of all the Youmans factors, the district court did not abuse its discretion

by enjoining Tsai from violating registration and disclosure requirements.

III.

For the foregoing reasons, we AFFIRM the district court’s granting summary

judgment and a permanent injunction against Tsai.