U.S. Sec. & Exch. Comm'n v. Kahlon

• Decision Date: 30 September 2015
• Docket Number: Case No. 4:12–cv–517
• Citation: 141 F.Supp.3d 675
• Parties: United States Securities and Exchange Commission, Plaintiff, v. Yossef Kahlon, TJ Management Group, LLC, Defendants.
• Court: U.S. District Court — Eastern District of Texas

141 F.Supp.3d 675

United States Securities and Exchange Commission, Plaintiff,

v.Yossef Kahlon, TJ Management Group, LLC, Defendants.

Case No. 4:12–cv–517

United States District Court, E.D. Texas, Sherman Division.

Signed September 30, 2015

John E. Birkenheier, Jonathan Stephen Polish, Timothy S. Leiman, U.S. Securities & Exchange Commission, Chicago, IL, for Plaintiff.

David Steven Coale, Jeffrey Mark Tillotson, Lynn Tillotson Pinker & Cox, LLP, Dallas, TX, for Defendants.

MEMORANDUM OPINION AND ORDER DENYING CROSS MOTIONS FOR SUMMARY JUDGMENT

RICHARD A. SCHELL, UNITED STATES DISTRICT JUDGE

Pending before the court are Plaintiff's Motion for Summary Judgment (Dkt.43), Defendants' Amended Response (Dkt.55–1), and Plaintiff's Reply (Dkt.52); and Defendants' Motion for Summary Judgment (Dkt.46), Plaintiff's Response (Dkt.49), Defendants' Reply (Dkt.50), and Plaintiff's Sur–Reply (Dkt.54).

For the reasons set forth herein, Plaintiff's Motion for Summary Judgment (Dkt.43) is GRANTED IN PART AND DENIED IN PART and Defendant's Motion for Summary Judgment (Dkt.46) is DENIED.

I. BACKGROUND

Jossef Kahlon a/k/a Yossef Kahlon, a resident of New York, is the sole owner and managing member of TJ Management Group, LLC (TJM), a New York limited liability company with its principal place of business in New York, New York.¹ Around 2005, TJM began functioning as a private equity group that purchased stock in private offerings and then sold the shares on the public market. In August 2005, TJM registered in Texas as a foreign limited liability company. TJM has a registered agent in Texas and a Texas mailing address, but the only business TJM transacted in Texas was the purchase of a piece of vacant property near downtown Dallas on which it facilitated maintenance and repairs. Between June 2008 and July 2010, TJM purchased penny stocks from eleven companies at a price below market rate and then expeditiously sold those stocks in the public market at market rates. Neither the initial purchase nor the re-sales of the stocks were registered in accordance with the Securities Act of 1933.² The SEC contends that the sales violated Sections 5(a) and 5(c) of the Securities Act, "which prohibit selling or offering to sell unregistered securities unless an exemption from the registration requirement applies."³ The SEC moves for summary judgment and seeks a permanent injunction "(a) permanently restraining and enjoining Defendants from violating Section 5; (b) ordering Defendants to disgorge their ill-gotten gains with prejudgment interest thereon; (c) ordering Defendants to pay civil money penalties pursuant to Section 20(d) of the Securities Act of 1933 (the 'Securities Act') [15 U.S.C. § 77t(d) ]; and (d) permanently prohibiting Defendants from participating in an offering of penny stock, pursuant to Section 20(g) of the Securities Act of 1933 [15 U.S.C. § 77t(g) ]."⁴ Defendants contend the transactions are exempt from registration requirements under Rule 504 of Regulation D (17 C.F.R. § 230.504(b)(1)(iii) ) and the Texas Securities Act⁵ and move for summary judgment on this affirmative defense.

II. LEGAL STANDARD

Summary judgment shall be granted "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."⁶ Substantive law identifies which facts are material.⁷ A dispute about a material fact is genuine "if the evidence is such that a reasonable jury could return a verdict for the nonmoving party."⁸ "One of the principal purposes of the summary judgment rule is to isolate and dispose of factually unsupported claims or defenses."⁹ Therefore, in deciding whether to grant a motion for summary judgment, the court must consider if "there are any genuine factual issues that properly can be resolved only by a finder of fact because they may reasonably be resolved in favor of either party."¹⁰ The court must construe all facts and inferences in the light most favorable to the nonmoving party.¹¹ When the nonmovant bears the burden of proof, the movant may meet its burden by showing that there is no admissible evidence to support the nonmovant's claim.¹² Once the movant has met this burden, the burden shifts to the nonmovant to offer evidence to show there is a genuine dispute as to a material fact with respect to the claims raised. The nonmoving party "must set forth specific facts showing that there is a genuine issue for trial" and "may not rest upon the mere allegations or denials of his pleading."¹³ "Neither conclusory allegations nor unsubstantiated assertions will satisfy the nonmovant's burden."¹⁴ The nonmovant must look beyond the pleadings and designate specific evidence in the record to show that there is a genuine issue for trial.¹⁵ The citations must be specific because the district court is not required to "scour the record" to determine whether the evidence raises a genuine issue of material fact.¹⁶

III. ANALYSIS

To establish a prima facie violation of 15 U.S.C. § 77e(a) and (c), the SEC must show that "(1) no registration statement was in effect as to the securities, (2) the defendant sold or offered to sell these securities, and (3) interstate transportation or communication and the mails were used in connection with the sale or offer of sale."¹⁷ Once the SEC establishes its prima facie case, the burden shifts to Defendant to prove that the offer or sale falls under an exemption to the registration requirements.¹⁸

It is undisputed that Defendants bought and sold stocks that were not registered utilizing the facilities of interstate commerce. Therefore, the SEC has made out its prima facie case of a violation of Section 5 of the Securities Act, and the court considers Defendants' affirmative defense. Defendants assert that the transactions at issue are exempt from the Securities' Act registration requirements under Rule 504(b)(1)(iii) of Regulation D and Texas law. The SEC contends that as applied by Defendants no such exemption exists under these facts. "Because defendants bear the burden of proof of establishing an exemption, for the SEC to prevail on [its] summary judgment motion, it need only point to a lack of evidence that would enable a reasonable jury to find that defendants qualify for an exemption."¹⁹

"A defendant can prove an exemption applies by showing either (1) the intrastate exemption applies under section 3(a)(11) of the Securities Act, 15 U.S.C. § 77c(a)(11), (2) the private placement exemption applies under section 4(2) of the Securities Act, 15 U.S.C. § 77d(2), or (3) that an exemption under Regulation D, 17 C.F.R. § 230.504 –6, applies."²⁰ Exemptions are narrowly construed to further the purpose of the Act, which is "[t]o provide full and fair disclosure of the character of the securities, and to prevent frauds in the sale thereof."²¹ The court "evaluates form over substance and looks to the economic reality of the transactions at issue."²²

Rule 504(b)(1)(iii) provides an exemption from registration for offers and sales of securities that are conducted "[e]xclusively according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to 'accredited investors' as defined in § 230.501(a)".²³ "Thus, for a Rule 504(b)(1)(iii) exemption to apply, (a) a security sale or offer must be made exclusively according to state law exemptions from registration; (b) these state law exemptions must permit general solicitation and general advertising; and (c) the purchasers of the securities must be 'accredited investors.' "²⁴ "Securities sold without registration in reliance on this provision are not subject to the limitations on resale established in Rule 502(d) and, as such, are not 'restricted securities.' "²⁵ But "Regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with Regulation D, is part of a plan or scheme to evade the registration provisions of the [Securities] Act."²⁶

Defendant argues that the exemptions found in 504(b)(1)(iii) and Sections 107.2 and 109.4 of Title 7 of the Texas Administrative Code"mean that an accredited institutional investor, or investors in aggregate, may invest up to $1,000,000 per twelvemonth period in non-reporting companies, which equity investment results in freely-trading shares."²⁷ The SEC does not dispute the existence of an exemption based on the statutes cited by Defendant, but it does dispute Defendant's interpretation and application of the exemption to these transactions.

There is no evidence put forth by Defendant to show that these transactions fall within the exemption from registration under Rule 504(b)(1)(iii). Even though Defendant registered TJM as a foreign corporation in Texas and conducted some business here related to the purchase of a single parcel of real property, there is no evidence that the transactions at issue took place exclusively under Texas law such that the transactions would be eligible for a Rule 504 exemption. The exemption upon which Defendants rely applies to the offers and sales (or the transactions) themselves, not to the individuals involved in executing the transactions.²⁸ This court agrees with the analysis of the court in S.E.C. v. Bronson, holding that "the language of Rule 504(b)(1)(iii) requires compliance with those state-law exemptions where the securities are offered or sold, and rejects Defendants' contention that compliance with one state's exemption requirements is sufficient for federal exemption purposes."²⁹ The Supreme Court has upheld individual states' authority to enact securities laws precisely because "they only regulated transactions occurring within the regulating States."³⁰ With the exception of My Vintage Baby, there is no evidence that any of the companies from which Defendant purchased and resold stock has any connection to Texas.³¹

Further, even if the court were to find that the transactions occurred...