S.E.C. v. Phan

• Decision Date: 29 August 2007
• Docket Number: No. 05-55269.,05-55269.
• Citation: 500 F.3d 895
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Alan V. PHAN, Defendant-Appellant, and The Hartcourt Companies Inc.; Yongzhi Yang, Defendants.
• Court: U.S. Court of Appeals — Ninth Circuit

500 F.3d 895

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Alan V. PHAN, Defendant-Appellant, and The Hartcourt Companies Inc.; Yongzhi Yang, Defendants.

No. 05-55269.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted February 14, 2007.

Filed August 29, 2007.

John A. Furutani and Mark C. Peters, Furutani & Peters, LLP, Pasadena, CA, for the defendant-appellant.

Jeffrey T. Tao, Senior Counsel, Securities and Exchange Commission, Washington, D.C., for the plaintiff-appellee.

Appeal from the United States District Court for the Central District of California; Lourdes G. Baird, District Judge, Presiding. D.C. No. CV-03-03698-LGB.

Before: HARRY PREGERSON, W. FLETCHER, and MARSHA S. BERZON, Circuit Judges.

BERZON, Circuit Judge:

The SEC alleged that Alan Phan used stock registered only for employee compensation purposes to raise capital from the public for the cash-strapped publicly traded company he led in 1999, thereby violating federal securities law. The district court granted summary judgment in favor of the SEC, holding that Phan both engaged in an unregistered securities sale and committed securities fraud. In this appeal, Phan contends that the admissible evidence, viewed in the light most favorable to him, supports his position rather than the SEC's.

We affirm the district court's summary judgment rulings concerning the registration issue. Whether or not the stock was initially issued to compensate bona fide consulting services, Phan was involved in its subsequent resale to raise capital for the company and thereby violated the registration provision of federal securities law. We agree with Phan, however, that the summary judgment record does not demonstrate that he made misstatements material as a matter of law. We therefore reverse the grant of summary judgment in favor of the SEC with respect to the antifraud claims and vacate much of the relief the district court awarded against Phan.

I.

During the relevant time period, Phan was chairman, CEO, and president of the Hartcourt Companies Inc. ("Hartcourt"), a publicly traded business development and investment holding company based in Long Beach, California. Believing, as did many others during the heady dot-com bubble of the late 1990s, that fortunes could be made by investing in the technology sector, Hartcourt decided to enter the Chinese technology market. To this end, Hartcourt entered into a pair of investment agreements with companies based in China and Hong Kong that obligated Hartcourt to pay those companies several million dollars in cash during the later half of 1999. As was true of many other companies venturing into the technology sector in the late 1990s, Hartcourt's ambition outstripped its financial resources, and the company found itself in the fall of 1999 having difficulty making the promised payments to its investment partners.

To help it find business opportunities in China, Hartcourt sought the assistance of Yongzhi Yang, a math professor in Alabama who worked part-time as a consultant to American companies seeking to invest in Chinese technology firms. According to Yang, he and his wife, Yan Wu, ran the consulting business as a joint enterprise; Yang preferred to use only Wu's name on public documents to hide from his university the fact that he moonlighted.

Hartcourt entered into a written Fee and Option Agreement (the "Fee Agreement") with Wu on August 23, 1999. The Fee Agreement specified that Wu "will use [her] best efforts to search for, identify and make known to [Hartcourt], Internet-related businesses and Assets ("Opportunities") which qualify as potential acquisitions by [Hartcourt]." The Fee Agreement explained that Wu's "talents and services are of a special, unique, unusual and extraordinary character and are of particular and peculiar benefit and importance to [Hartcourt]."

The Fee Agreement stated that Hartcourt would provide Wu with an option to purchase one million Hartcourt shares at a price of $1.25 per share, approximately Hartcourt's then-current share price. The Fee Agreement represented that this payment was "to satisfy [Wu's] time and expense incurred, up to and including the first acquisition by [Hartcourt] of an Opportunity introduced or arranged by [Wu]," and that Wu "has not been engaged to perform, nor will [she] agree to perform any services in connection with capital raising transactions."¹ The Fee Agreement specified that Wu would serve as a consultant through December 30, 1999, but that either party could terminate her service on thirty-days notice. The Fee Agreement contained no provision requiring Wu to forfeit the option if the Fee Agreement was terminated early, although it did state that Hartcourt "shall only be liable for payment of fees earned by [Wu] as a result of work prior to the effective date of the termination."

Under the terms of a separate Option Agreement (the "Option Agreement"), also signed on August 23, 1999, Hartcourt granted Wu an option to purchase one million shares to fulfill the promise made in the Fee Agreement. Wu had until December 1, 2001 to exercise the option and was required to pay the $1.25 per share at the time of exercise to receive the stock (the "prepayment" requirement). In other words, Wu immediately became the owner of the options, but would not receive the one million shares of Hartcourt until she paid $1.25 million.

Both agreements were filed with the SEC on September 7, 1999, as attachments to a Form S-8, which registered the issuance of those one million shares.² This form and its attachments were publicly available upon filing. The Securities Act of 1933 ("the 1933 Act"), 15 U.S.C. §§ 77a-77aa, requires publicly traded companies to register all new issuances of stock. A Form S-8 provides a streamlined method of registering stock issued to compensate employees and consultants, as opposed to the more detailed and prolonged process required to register shares used to raise capital. Registration of Securities on Form S-8, 64 Fed.Reg. 11,103, 11,103 (Mar. 8, 1999) ("S-8 Release") (codified at 17 C.F.R. § 239.16(b)). By signing the S-8 registration, Hartcourt explicitly agreed to amend the form "during any period in which offers or sales are being made" to "reflect . . . any facts or events arising after the effective date of the registration statement . . . which, individually or in the aggregate, represents a fundamental change in the information set forth in the registration statement" and to "include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement." 17 C.F.R. § 229.512(a)(1).

Right after it filed the S-8 form, Hartcourt issued one million shares of common stock to Wu. Contrary to the Option Agreement, however, Wu (and Yang) paid nothing to Hartcourt at that time. In a declaration submitted in the district court Yang explained that he pressed for the elimination of the prepayment requirement because "I wanted some guarantee that my wife and I would receive our option shares, since we did not have the money to pay the option price, and it made no sense for us to bring companies to Hartcourt if there was no guarantee that we would receive the shares."

Phan stated in his declaration that to satisfy Yang's request he orally modified the agreement on behalf of the company, by waiving the prepayment requirement and instead allowing Wu to receive the shares in exchange for a promissory note to pay Hartcourt $1.25 million.³ Hartcourt did not note this modification in its S-8 form, so the supposedly superseded terms were the only publicly disclosed information about the arrangement between Hartcourt and Wu.

Within months, Wu resold most of the one million shares. The bulk of the shares were sold to Rubin Investment Group ("Rubin") in a November 1, 1999 transaction involving 500,000 shares and a November 4, 1999 transaction involving 300,000 shares. The sales were at prices well below the $1.25 per share that Wu supposedly was obligated to repay Hartcourt. Phan stated in his declaration that he suggested Yang contact Rubin and that he directed Hartcourt's lawyer to draft a contract for one of these stock sales. Phan also acknowledged that Hartcourt's demand in October 1999 that Wu repay the $1.25 million promissory note generated Wu's decision to sell the shares.⁴ Yang likewise stated in his declaration that he informed Phan that Wu would be forced to sell the shares if Hartcourt demanded repayment of the loan, and "Phan insisted that if that was the only way we could pay Hartcourt, then we should sell the shares and get Hartcourt paid."

At Phan's direction, Wu wired the approximately $680,000 in proceeds of these two sales to Hartcourt's investment partners in China and Hong Kong, to pay Hartcourt's outstanding debts. On December 8, 1999, she also wired one of these partners more than $81,000, from money she received upon selling Hartcourt shares. Phan characterized these transactions as an arrangement "to avoid delay" by "eliminat[ing] the middleman," because Hartcourt would have immediately wired Wu's payments to its creditors. Wu also transferred 36,400 shares on November 4, 1999 directly to Perfect Data Corporation, another creditor of Hartcourt.

Yang made a number of smaller purchases and sales of Hartcourt's stock during the fall of 1999, primarily for his own benefit. During the same period, Hartcourt promised Yang that he would receive 100,000 shares in exchange for helping Hartcourt enter into a joint venture with Chinese technology company Innostar. The defendants explain that this promise caused Hartcourt to forgive Wu's debt for the purchase price of 100,000 of the original one million shares in lieu of issuing additional shares.

After conducting an investigation, the SEC filed a civil complaint against Phan, Yang, and Hartcourt, exercising its power to...