U.S. S.E.C. v. Lyttle, 07-2466.

• Citation: 538 F.3d 601
• Decision Date: 07 August 2008
• Docket Number: No. 07-2467.,No. 07-2466.,07-2466.,07-2467.
• Parties: UNITED STATES SECURITIES and EXCHANGE COMMISSION, Plaintiff-Appellee, v. Melvin R. LYTTLE and Paul E. Knight, Defendants-Appellants.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

538 F.3d 601

UNITED STATES SECURITIES and EXCHANGE COMMISSION, Plaintiff-Appellee, v. Melvin R. LYTTLE and Paul E. Knight, Defendants-Appellants.

No. 07-2466.

No. 07-2467.

United States Court of Appeals, Seventh Circuit.

Argued May 16, 2008.

Decided August 7, 2008.

Christopher Paik (argued), Securities & Exchange Commission, Washington, DC, for Plaintiff-Appellee.

Paul A. Greenberg (argued), Aronberg, Goldgehn, Davis & Garmisa, Chicago, IL, Paul E. Knight, Kodak, TN for Defendants-Appellants.

Before BAUER, POSNER, and WOOD, Circuit Judges.

POSNER, Circuit Judge.

Melvin R. Lyttle and Paul E. Knight were charged (along with others, not before us) in a civil case brought by the SEC with perpetrating a "prime bank" fraud. This is a common fraud in which the perpetrators solicit investments by telling prospective investors that the investors' money will be invested in high-yield bank-issued securities not available or even known to the general public. (For further description, see SEC, "Investor Alert: How Prime Bank Frauds Work," Sept. 15 2000, www.sec.gov/divisions/enforce/ primebank/howtheywork.shtml (visited July 21, 2008); SEC, "Investor Alert: Warning to All Investors About Bogus `Prime Bank' and Other Banking-Related Investment Schemes," www.sec.gov/ divisions/enforce/primebank.shtml (visited July 21, 2008).) The district judge granted summary judgment for the SEC on a variety of counts, awarded injunctive relief, and assessed monetary penalties.

Lyttle and Knight appeal only from the imposition of the penalties, $110,000 on each of them. That amount was proper only if the SEC proved that these defendants engaged in fraud, 15 U.S.C. §§ 77t(d)(2)(C)(i), 78u(d)(3)(B)(iii)(aa); 17 C.F.R. § 201.1001 and pt. 201, subpt. E, tab. I; see SEC v. Kern, 425 F.3d 143, 153 (2d Cir.2005); Rockies Fund, Inc. v. SEC, 428 F.3d 1088, 1099 (D.C.Cir.2005) — that is, if it proved "scienter," Aaron v. SEC, 446 U.S. 680, 697, 100 S.Ct. 1945, 64 L.Ed.2d 611 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), meaning that the defendants either knew that the representations they made to investors were false or were reckless in disregarding a substantial risk that they were false. Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 704 (7th Cir.2008); see also Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1044 (7th Cir.1977) ("a reckless omission of material facts upon which the plaintiff put justifiable reliance in connection with a sale or purchase of securities is actionable under Section 10(b) as fleshed out by Rule 10b-5"); SEC v. Infinity Group Co., 212 F.3d 180, 192 (3d Cir.2000); Meadows v. SEC, 119 F.3d 1219, 1226-27 (5th Cir.1997). Although the Supreme Court has "previously reserved the question whether reckless behavior is sufficient for civil liability under § 10(b) and Rule 10b-5," it has noted that "every Court of Appeals that has considered the issue has held that a plaintiff may meet the scienter requirement by showing that the defendant acted intentionally or recklessly, though the Circuits differ on the degree of recklessness required." Tellabs, Inc. v. Makor Issues & Rights, Ltd., ___ U.S. ___, 127 S.Ct. 2499, 2507 n. 3, 168 L.Ed.2d 179 (2007).

The defendants argue that because scienter is a state of mind, summary judgment can almost never be granted in favor of a plaintiff who has the burden of proving scienter, as the SEC did. For it is always possible, they say, that a reasonable jury would credit a defendant's testimony that he believed the representations were true. The premise of the argument — that scienter is a state of mind — requires qualification. In our recent Makor decision (cited earlier), elaborating on the proposition stated in earlier cases that proof of recklessness can establish scienter, we noted that "a popular definition of reck-lessness in this context [proof of scienter in a securities fraud case] is `an extreme departure from the standards of ordinary care ... to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.' This looks like two criteria-knowledge of the risk and how big the risk is — but as a practical matter it is only one because knowledge is inferable from gravity (`the danger was either known to the defendant or so obvious that the defendant must have been aware of it'). When the facts known to a person place him on notice of a risk, he cannot ignore the facts and plead ignorance of the risk." 513 F.3d at 704 (citations omitted).

Even when a party's subjective beliefs are critical to liability, it is not always true that the case cannot be decided on summary judgment — as the present case illustrates. The defendants are under indictment for fraud and refused to testify in this case. Their refusal is privileged by the self-incrimination clause of the Fifth Amendment. But the consequence of their refusal is that they cannot testify to their state of mind. Without such testimony to contradict the mountain of circumstantial evidence (circumstantial with regard to the defendants' inmost beliefs, at any rate) that the SEC presented, evidence reinforced by the inference (permissible in a civil case) of guilt from their refusal to testify, as in SEC v. Colello, 139 F.3d 674, 677-78 (9th Cir.1998), no reasonable jury could doubt that they had acted with scienter, see LaSalle Bank Lake View v. Seguban, 54 F.3d 387, 391-92 (7th Cir. 1995); Doe ex rel. Rudy-Glanzer v. Glanzer, 232 F.3d 1258, 1264 (9th Cir.2000), whatever the precise definition of the word.

To begin with, they extracted the remarkable total of $32 million from 31 investors (the minimum investment was $1 million) with typical "prime bank" representations. Not only did they pocket several million dollars of the invested money for their personal use (personal use that included the purchase by one of the defendants of a gazebo and a custom-built piano) rather than investing the money in the no-risk trading program that they had promised the investors they would invest it in; but what they did invest they invested in a company that engaged in high-risk, not no-risk, trading. They falsely stated to the investors that the investments were insured — up to 196 percent of the original investment. They were not insured. One of the defendants promised...