In S.E.C. v. Stoker, No. 11 Civ. 7388(JSR), 2012 WL 2017736 (S.D.N.Y. June 6, 2012), the Southern District of New York reaffirmed its earlier order denying defendant Brian Stoker’s motion to dismiss after concluding that the Securities and Exchange Commission (“SEC”) adequately stated claims for relief under the Securities Act of 1933.  The SEC alleged that Stoker, in his capacity as director in a division of Citigroup, negligently violated §§ 17(a)(2) and (3) of the Securities Act of 1933. 

Citigroup Inc.’s primary broker-dealer is Citigroup Global Markets Inc. (“Citigroup”). Brian Stoker was a Citigroup director responsible for constructing and marketing securities known as collaterized debt obligations (“CDOs”), and, specifically, the Class V Funding III (the “Fund”).  Section 17(a)(2) prohibits “obtain[ing] money or property by means of any untrue statement [or omission] of a material fact [in connection with the sale of securities].”  Furthermore, subsection (3) prohibits “engag[ing] in a course of business which operates … as a fraud or deceit upon the purchaser [in connection with the sale of securities].”  The SEC alleged that Stoker negligently violated both subsections because he was responsible for ensuring the accuracy of the marketing materials that were sent out to potential CDO investors.

Stoker made two arguments as to why the SEC’s claim that he violated § 17(a)(2) should be dismissed.  First, Stoker conceded that his bonus increased “around the time of the fraud,” but he argued that the two occurrences were not sufficiently linked to qualify under § 17(a)(2).  The court reasoned that under a plain reading of the statute, § 17(a)(2) imposes liability where the benefit is obtained either “directly or indirectly.”  Therefore, it was sufficient that Stoker, acting as an agent of Citigroup, facilitated a fraud, which made Citigroup millions of dollars by means of  “…untrue statement[s] of a material fact or any omission[s].”  The court then concluded that the SEC’s allegations were enough to impose liability regardless of whether Stoker obtained compensation for his employer, or if Stoker himself financially benefited indirectly from the fraud.

Next, Stoker argued the SEC failed to allege that he be held solely responsible for “making” the omissions and false statements contained within the marketing materials.  Stoker analogized the “by means of” language of § 17 to the “to make” language in Rule 10-b5 of the Securities and Exchange Act of 1934.  The court reasoned that § 17(a)(2), unlike Rule 10-b5, imposes liability where money or property is obtained “by use of a false statement,” regardless of the source.  Alternatively, Stoker argued that the court should apply the KPMG standard, which requires plaintiffs to argue that the actor was “sufficiently responsible for the statement … and knew or had reason to know that the statement would be disseminated to investors.”  The court found that even this more stringent KPMG standard was met; Stoker made “substantial edits” to the marketing materials given to investors, and he knew the statements included in the marketing materials would be given to investors.

Lastly, Stoker argued that the SEC’s § 17(a)(3) claim is duplicative of the § 17(a)(2) claim. A defendant may be held liable under both subsections, so long as the plaintiff alleges that the defendant “undertook a deceptive scheme or course of conduct that went beyond the misrepresentations.”  The court found that the misrepresentations and omissions within the marketing materials constituted a portion of the alleged misconduct, but not the entirety of it.  Stoker and Citigroup were on notice that certain CDOs were going to perform poorly, but they sought to include as many of these assets in the Fund as possible.  Furthermore, the two engaged Credit Suisse Alternative Capital as their collateral manager, knowing investors would not be interested in the Fund unless they thought a reputable third party would choose the assets.  Finally, they represented to one particular investor that the Fund was a “top-of-the-line CDO squared.”  The court found this more than sufficient to state a claim under § 17(a)(3). 

After this decision, the case went to trial on July 31, 2012 and the jury acquitted Stoker.  The SEC was unsuccessful in proving that Stoker was primarily responsible for the perpetrated fraud, primarily because Stoker’s lawyer, John Keker, successfully questioned why Stoker, a relatively low-level executive was targeted by the SEC instead of the CEOs in decision-making levels above him.

The primary materials for this case may be found on the DU Corporate Governance website.