Wednesday, May 12, 2021

Liability for fraudulent securities offering was incurred in the U.S.

By Rodney F. Tonkovic, J.D.

In a matter of first impression, a First Circuit panel applied Morrison to determine whether a transaction was domestic. The panel agreed with the reasoning of the Second, Third, and Ninth circuits, which have held that a transaction is domestic under Morrison if irrevocable liability occurs in the United States. In this case, the panel said, it was clear that the defendants became irrevocably liable to deliver shares in Boston, Massachusetts (SEC v. Morrone, May 10, 2021, Lynch, S.).

Stop Spreading the Disease. The appellants, Jonathan Morrone and Z. Paul Jurberg, were senior officers at Bio Defense Corporation. That company made the MailDefender, a machine intended to decontaminate mail possibly containing biological pathogens, such as anthrax. Between 2004 and 2010, Bio Defense stock was not registered with the SEC.

In October 2007, Morrone, Jurberg, and two other defendants participated in a conference call for prospective investors. During the call, the officers told investors that U.S. federal agencies were committed to purchasing 300 MailDefenders and that the military wanted the company to make 250 units each month. As part of investigation, an attorney from the Texas State Securities Board participated in the conference call, and after being contacted by the Board, the Morrone and Jurberg agreed to the entry of a cease and desist order for offering unregistered shares through unregistered agents. After a similar investigation by Massachusetts in 2008, Bio Defense decided to stop selling to U.S.-based investors.

International fundraising. In 2008, Bio Defense entered into an agreement with a call center targeting investors in Europe. Acting against the advice of their outside counsel, who questioned the legitimacy of the call center, the defendants sent scripts to the call center, which began soliciting investors. The names of interested investors were sent to the defendants, who then sent subscription agreements, which were ultimately processed in the U.S.; the stock certificates were then sent from the U.S. to the investors. After paying the call center a 75 percent commission (which was not disclosed to investors) and the defendants' commissions, Bio Defense was left with less than 25 percent of the invested funds. Between late 2008 and late 2010, Bio Defense engaged in three other similar schemes.

While these schemes were ongoing, Bio Defense received numerous complaints about its solicitation practices, including the "boiler room tactics" used by the call centers. According to the Commission, Bio Defense never earned a profit and lost at least $2 million each year. It sold only ten MailDefender machines, bringing in $430,000 from these sales over a six-year period, while raising almost $25 million from stock sales to private investors over the same period.

Procedural history. The Commission alleged that Morrone and Jurberg offered and sold unregistered securities without registering as brokers and committed fraud under the securities laws. As relevant to the appeal, the district court held that the federal securities laws applied because Bio Defense received the subscription agreements from overseas which were then signed before mailing the stock certificates from the U.S. to the investors. The court granted partial summary judgment to the SEC and permanently enjoined Morrone and Jurberg from violating the federal securities laws in the future, ordered disgorgement of their commission payments, imposed civil monetary penalties, and barred them from serving as officers or directors of public companies.

U.S. securities laws apply. On appeal, Morrone and Jurberg argued, based on Morrison, that the district court erred in applying U.S. law. The panel noted at the outset that the First Circuit has not yet applied Morrison to determine whether a transaction is domestic, but agreed with the reasoning of the Second, Third, and Ninth circuits, which have held that a transaction is domestic under Morrison if irrevocable liability occurs in the United States. Applying that test, it was "clear" that Bio Defense incurred irrevocable liability in the U.S.—there was no dispute that the subscription agreements were executed in Boston and that the shares were issued from there. The panel rejected the argument, based on the Second Circuit's Parkcentral decision, that the claims were "predominantly foreign" as inconsistent with Morrison (agreeing here with the Ninth Circuit in Stoyas ). Even if Parkcentral were applied, the panel said that there were significant U.S. connections that rendered the fraud domestic.

The panel went on to affirm the district court's grant of partial summary judgment in the SEC's favor. Morrone and Jurberg, the panel said, were instrumental in the scheme's planning and execution and effected transactions in Bio Defense stock. So, the district court was correct in finding that they acted as brokers. Morrone also contended that he did not act with the requisite scienter, but the panel found ample evidence that he was integral to the fraud and acted with scienter.

The case is No. 19-2006.