481 F.3d 901 (6th Cir. 2007), 05-6317, Brown v. Earthboard Sports USA, Inc.

Docket Nº:05-6317.
Citation:481 F.3d 901
Party Name:Clinton D. BROWN, Plaintiff-Appellant, v. EARTHBOARD SPORTS USA, INC.; Hugh Jeffreys; Jeffrey A. Vaughn; Lincoln Financial Advisors Corporation, d/b/a Sagemark Consulting, Defendants-Appellees.
Case Date:March 16, 2007
Court:United States Courts of Appeals, Court of Appeals for the Sixth Circuit
 
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481 F.3d 901 (6th Cir. 2007)

Clinton D. BROWN, Plaintiff-Appellant,

v.

EARTHBOARD SPORTS USA, INC.; Hugh Jeffreys; Jeffrey A. Vaughn; Lincoln Financial Advisors Corporation, d/b/a Sagemark Consulting, Defendants-Appellees.

No. 05-6317.

United States Court of Appeals, Sixth Circuit

March 16, 2007

Argued: July 17, 2006.

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ARGUED:

Michael R. Schmidt, Cohen, Todd, Kite & Stanford, Cincinnati, Ohio, for Appellant.

Donald J. Mooney, Jr., Ulmer & Berne, Cincinnati, Ohio, Mark E. Elsener, Porter, Wright, Morris & Arthur, Cincinnati, Ohio, for Appellees.

ON BRIEF:

Michael R. Schmidt, Cohen, Todd, Kite & Stanford, Cincinnati, Ohio, for Appellant.

Donald J. Mooney, Jr., Pamela Kay Ginsburg, Ulmer & Berne, Cincinnati, Ohio, Mark E. Elsener, Porter,

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Wright, Morris & Arthur, Cincinnati, Ohio, for Appellees.

Before BOGGS, Chief Judge; COLE, Circuit Judge; and ROSEN, District Judge. [*]

BOGGS, C.J., in which COLE, J., joined. ROSEN, D.J. (pp. 922-24), delivered a separate opinion concurring in part and dissenting in part.

OPINION

BOGGS, Chief Judge.

Plaintiff-Appellant Clinton Brown, a wealthy businessman, made a risky investment in the securities of a small privately-held California company called Earthboard Sports USA ("Earthboard"). He was induced to embark on such a course of action by the "tip" he had received from Defendant-Appellee Jeffrey Vaughn, an acquaintance and financial advisor who considered Brown to be a prospective client, that a large public company was about to acquire Earthboard on extremely, even ridiculously, favorable terms. However, the promised acquisition turned out to be an entirely fictitious creation of Earthboard's president, one Hugh Jeffreys, a felon. When the truth was finally revealed, Brown and many others lost their investments. Brown then sued Earthboard, Jeffreys, Vaughn, and Vaughn's employer Lincoln Financial Advisors Corp. ("Lincoln") in federal court, claiming a variety of federal and state securities violations. The district court entered default judgment against Earthboard and Jeffreys.

Subsequently, the district court granted summary judgment in favor of Vaughn and Lincoln. Relevant to the appeal before us now, the district court held that (1) Brown's complaint that the parties had sold him unlawfully unregistered shares under Kentucky's Blue Sky law was preempted by the National Securities Markets Improvement Act of 1996, Pub.L. No. 104-290, 110 Stat. 3416 ("NSMIA"), because the securities had been sold "pursuant to" a valid federal registration exemption; and (2) Brown did not adduce sufficient evidence to create a genuine issue of material fact with respect to two vital elements of a securities fraud suit: scienter and loss causation. Brown filed a timely notice of appeal. For the reasons stated below, we reverse the district court with respect to the claims against Vaughn, but affirm summary judgment in favor of Lincoln.

I

As Brown appeals from summary judgment, we review the adduced evidence in the light most favorable to him. Earthboard is a privately-held Cosa Mesa, California corporation that designs and manufactures all-terrain "extreme" skateboards and related equipment. In 1999, it offered subscriptions in certain of its securities and filed for an exemption from federal registration requirements with the United States Securities and Exchange Commission ("SEC"). Specifically, the company filed for a federal registration exemption pursuant to Rule 506 of Regulation D, 17 C.F.R. § 230.506, a safe harbor provision authorized by Section 4(2) of the 1933 Securities Act, 15 U.S.C. § 77d(2), for limited private placements. Rule 506 permits a private issuer to sell unregistered securities to any "accredited investor" and up to thirty-five other unaccredited purchasers, so long as certain requirements are met.

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Such a filing is generally intended to exempt the sale from federal and state registration requirements pursuant to NSMIA. Earthboard did not file any amendments to its 1999 filing or file for a new exemption. Thus, the company continued to offer subscriptions in its securities until about 2003, all purportedly pursuant to its 1999 filing.

Brown ran his own marketing firm from 1988 until 1999. In 1998, Brown's accountant, Gene Schindler, introduced him to Vaughn, a financial advisor and registered representative employed by Lincoln. Vaughn solicited 401(k) business from Brown's marketing firm, "ask[ing] to be one of [Brown's] investment advisors." Vaughn viewed Brown as a prospective client, and knew that Brown would received a large sum of money if he sold his firm. When Brown finally sold his company in 1999, Vaughn "wanted to know what [Brown's] plans were for the earn-out money." Thereafter, Vaughn contacted Brown periodically. During that time, it seems that Brown and Vaughn met on social occasions, playing golf occasionally, taking a golf vacation together at Brown's Arizona home, and enjoying Brown's time-share jet. They were both fans of Indiana University's basketball team, and they attended an Indiana/Kentucky game together. Brown dined at Vaughn's home at least once, Vaughn attended a Christmas party at Brown's home, and they attended a few charity-benefit dinners together.

Apparently, in August 2001, Vaughn first heard about Earthboard from his builder, who told him that the company was raising capital for expansion and put him in contact with the company's president, Jeffreys. Vaughn spoke with Jeffreys by telephone in August 2001, and again in late September 2001. They apparently did not meet each other in person until March 2002. According to Brown, Jeffreys told Vaughn on the telephone that Earthboard was involved in acquisition negotiations with VANS, a publicly-traded footwear company, and that, according to the terms of the deal, one share of Earthboard's securities would be exchanged for one share of VANS when the transaction finally closed. At that time, VANS shares were trading at about $12, but Jeffreys offered his company's shares to Vaughn for just $1 apiece. Thus, Vaughn stood to realize a 1100% capital gain when and if the promised transaction was closed. It was almost too good to be true.

Armed with what he probably took to be illicit or illegal "insider information," Vaughn allegedly decided to reap the rewards. Of course, the essential value of such an illicit "tip" lies in its concealment from the public eye, so it was probably impossible for Vaughn or anyone else to conduct any proper investigation of the transaction. But Vaughn allegedly did not allow his fundamental ignorance about Jeffreys, a felon previously convicted of fraud, or about the supposed Earthboard-VANS transaction, to govern his decisions. Of course, there was apparently not an ounce of truth to Jeffreys's "tips." 1

According to the evidence adduced by Brown, Vaughn started by investing his own money in this scheme, and he ultimately purchased about $228,000 worth of Earthboard shares. He signed a subscription agreement on September 25, 2001, and purchased 100,000 shares for $1 per share. The company seems to have accidentally

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sent him an extra 100,000 shares around that time, though it rescinded those surplus shares some time later. After introducing investors such as Brown to the "opportunity," he purchased another 99,000 shares on his own account for $99,000 on March 3, 2002, and the company gave him an additional 7,000 shares for free at that time "in lieu of [paying] me a commission," presumably to thank him for advising investors like Brown about the opportunity. He purchased another 29,000 shares on his own account in December 2002 for $1 per share.

After deciding to invest for himself, Vaughn began to solicit friends and acquaintances to participate in this "opportunity." Taking the evidence in the light most favorable to Brown, Vaughn contacted Brown in late November or early December 2001 to tell him that he "wanted the opportunity to prove to ... [Brown] how valuable he could be as a financial advisor and that he had an investment opportunity." Vaughn "wanted to meet [Brown] to discuss it." Due to "a sense of urgency in the phone call," Brown agreed to meet Vaughn for lunch about two days later. At that meeting, Vaughn "shared with ... [Brown] the details of this privately held enterprise called Earthboard, [and] its imminent sale to a publicly traded firm called VANS." To bolster the story's veracity, Vaughn allegedly lied to Brown by claiming that Earthboard's president, Jeffreys, was "a personal friend or acquaintance of his, that they had done business before in some way, shape or form and that [Jeffreys] owed him a favor." Vaughn then explained that subscriptions in Earthboard stock were available to a limited group of investors at $6 per share, and that the purported one-for-one stock swap upon the transaction's closing offered Brown the prospect of doubling his investment overnight. But Vaughn warned that time was pressing, for the VANS transaction was "imminent and ... [Brown] needed to move quickly if [he] wanted to be a part of it."

Brown said he was interested, and Vaughn replied "I need to get you a subscription agreement." Vaughn made arrangements to have a subscription agreement sent to Brown by fax. Earthboard sent the subscription agreement to Brown on December 5, 2001. Brown consulted his financial advisors, two of whom specifically questioned how Vaughn could have access to such inside information about an unannounced transaction involving a public company, but Brown would not be deterred. Relying entirely on Vaughn's "tip," Brown saw this as an opportunity to invest in VANS, a...

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