Friday, November 04, 2022

COO should have known to disclose beneficial ownership

By Anne Sherry, J.D.

An executive was on notice, objectively if not subjectively, that his power to direct voting of shares owned by other entities amounted to beneficial ownership. While the defendant disclosed beneficially owning more than 30 percent of his company, he failed to disclose additional shares that he controlled through relationships and agreements with other companies. The district court in Maryland rejected the executive’s argument that the SEC did not give fair notice before bringing the civil action (SEC v. Miller, November 1, 2022, Boardman, D.).

The defendant is the former COO of Abakan, Inc., a publicly traded manufacturing company. In 2013 he disclosed beneficially owning 22 million shares in Abakan, more than 30 percent of its outstanding common stock. However, the SEC took action for his failure to disclose that he beneficially owned additional shares through relationships and agreements with three Uruguayan entities and individuals affiliated with those entities. These relationships allowed the defendant to direct that shares be sold and the proceeds sent to himself or entities he controlled.

The COO moved for summary judgment on the SEC’s claims. As a factual matter, he disputed that he beneficially owned the securities. As a legal matter, he argued that the SEC deprived him of due process by failing to warn him ahead of filing suit that his conduct amounted to beneficial ownership. The court denied summary judgment.

According to the defendant, the rule that defines beneficial ownership does not provide adequate notice of the conduct it reaches, and the SEC opted in his case to rely on the “totality of the circumstances” to prove the defendant was a beneficial owner, a standard too vague and imprecise to be permissible under the Constitution. But the court said that a rule does not have to clear a very high bar: it must give fair warning of the proscribed conduct and a reasonably clear standard of culpability, but it does not need to use mathematical precision.

Here, the SEC rule defining beneficial ownership refers to “voting power” and “investment power,” but does not itself identify or explain conduct that would constitute “power.” Turning to dictionary definitions, the court found that they comported with the commonly understood use of the word to mean “ability,” which was more than sufficient clarity to provide fair notice and a standard of culpability.

Furthermore, even if the defendant did not subjectively understand his conduct amounted to beneficial ownership, a person of ordinary intelligence, especially with experience in the securities industry, would have understood that the reporting rule reaches the ability to direct the disposition of shares. Previous cases consistent with this understanding also put the defendant on notice of the rule’s meaning. The defendant also provided no authority for his assertion that the SEC departed from its previous stance of evaluating beneficial ownership by “objective indicia of ownership” rather than, in his case, a “totality of the circumstances.”

Finally, the court denied summary judgment on the defendant’s factual defenses, which the SEC countered with opposing evidence. Because there was a genuine dispute of material fact, summary judgment was not appropriate.

The case is No. 19-cv-02810.