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Ninth Circuit Reverses Securities Fraud Conviction Based on Admission of Prior Complaint

Rather than attempt to prove their claims with facts and evidence that relate to their own dealings with their brokers, securities claimants far too often instead seek to smear respondents by parading before the arbitrators (or the judge or jury) unrelated past complaints and settlements — regardless of their merits or relevance or whether any factual findings were ever made or admitted. While such gamesmanship can be rebutted with citations to Rule 408 of the Federal Rules of Evidence or its state counterparts, a recent federal appellate decision should prove useful in defending against such improper tactics in the future. Specifically, the United States Court of Appeals for the Ninth Circuit, in United States v. Bailey, 2012 WL 3641747 (9th Cir. Aug. 27, 2012), ruled that it was reversible error for the trial court to admit into evidence a prior civil complaint involving related misconduct that had been filed by the SEC against the defendant, Richard A. Bailey (“Bailey”), and subsequently settled. Based on this ruling, the Ninth Circuit vacated Bailey’s securities fraud conviction and remanded for a new trial.

Bailey was the President, Chief Executive Officer, and Chairman of the Board of Directors of Gateway, a small, public company involved in selling health and dietary supplements. In 2003, the SEC filed a civil complaint against Bailey and Gateway for violating Rule S-8, which requires the distribution of stock to be in exchange for bona fide services. Bailey settled the lawsuit with no admission of liability. In 2004, Bailey was criminally charged for issuing stock to Richard Owens, another businessman, in order to raise capital for Gateway and for Bailey and Gateway’s personal benefit, both of which are proscribed by Rule S-8.

Prior to trial, the prosecution filed a motion in limine seeking permission to introduce the fact that the SEC had filed a civil complaint against Bailey in 2003. The prosecution argued that the 2003 complaint would show that Bailey knew that his conduct in 2004 was unlawful. The prosecution also argued that the prior complaint would establish that Bailey knew that he was required to comply with Rule S–8. The district court permitted the prosecutor to “introduce just the fact of the SEC complaint” but warned not to get “any deeper into it.” After deliberating for one day, a jury returned a guilty verdict against Bailey, who was sentenced to 30 months' imprisonment.

On appeal, the Ninth Circuit ruled that SEC complaint was not admissible under Rule 404 of the Federal Rules of Evidence because it was not “sufficient to support a finding that [Bailey] had committed the other act.”  The court held:

A defendant may settle a case for a variety of reasons. He may have committed the conduct alleged in the complaint or he may not have — but having settled the claim, there is no way to know. Admitting prior conduct charged but settled with no admission of liability is not probative of whether the defendant committed the prior conduct, much less whether he committed the conduct in question. There is no logical relevancy to admitting this type of evidence.


We risk stating the obvious here: a complaint is merely an accusation of conduct and not, of course, proof that the conduct alleged occurred.

2012 WL 3651747 at *5 (footnote omitted).

The Ninth Circuit acknowledged “some logic to the argument that evidence that Bailey had previously been accused of violating Rule S-8 shows that he was on notice of the type of prohibited conduct. But this is not enough. The prosecution was still required to prove that the evidence was sufficient to support a finding that Bailey committed the act charged in the complaint. This a mere complaint cannot do.” Id. at *5.

The Ninth Circuit further disputed that the government’s use of the SEC complaint had been “narrowly offered for the purpose of proving that Bailey knew it was illegal to issue unregistered stock without receiving bona fide services in return.” Nevertheless, even if the SEC complaint had been offered for such a narrow purpose, the Ninth Circuit ruled that it still would have been error for the trial court to admit it:

[A] complaint would not establish knowledge even if the prosecution had purported to use it only for that reason. All a complaint establishes is knowledge of what a plaintiff claims. It does not establish the truth of either the facts asserted in the complaint, or of the law asserted in the complaint. Since the previous complaint was never proved, nor was the truth of any of it conceded, it could not have established knowledge of the law. A complaint may state that cars driving southbound are required to stop at the intersection of 1st and Main, and that the defendant did not stop. But such a complaint establishes neither that southbound vehicles have a duty to stop, nor that the defendant failed to stop. Likewise, the SEC complaint establishes neither knowledge of the law nor a past wrongful act.

Id. at *6.

This new decision is consistent with the long line of rulings from other courts that have similarly held that prior complaints and settlements are not admissible. [1]  This decision may prove useful in educating arbitrators (and courts) that the mudslinging often engaged in by securities claimants is not only improper but also has been deemed to be grounds to overturn an otherwise valid conviction.

 [1] See, e.g., In re Prudential Secs. Inc. Limited P’ship Litig., No. 95-9209, 1996 WL 739258 at *8 (2d Cir. Dec. 27 1996) (affirming district court’s conclusion that a consent decree, and the fine imposed pursuant to it, did not constitute a “determination” because “a consent decree does not result in an adjudication against consenting party”); United States v. Austin, 54 F.3d 394, 400 (7th Cir. 1995) (stating the general rule that Rule 408 prohibits admission of a consent decree to prove liability); Johnson v. Hugo’s Skateway, 974 F.2d 1408, 1413 (4th Cir. 1992) (same); Klospfer v. Honda Motor Co., 898 F.2d 1452, 1456 (10th Cir. 1990) (affirming district court’s refusal to admit a consent decree because it was entered into “without litigation, adjudication, or an admission of liability”); Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893-94 (2d Cir. 1976) (holding SEC complaint and consent decree were inadmissible); RSM Production Corp. v. Fridman, 2009 WL 424540, at *12 (S.D.N.Y. 2009) (stating general rule that paragraphs in a complaint that are either based on, or rely on, complaints in other actions that have been settled are, as a matter of law, immaterial); In re Merrill Lynch & Co, Inc. Research Reports Secs. Litig., 218 F.R.D. 76, 78 (S.D.N.Y. 2003) (striking regulatory settlement and report from pleadings); In re Blech Secs. Litig., 2003 WL 1610775, at *9-11 (S.D.N.Y. Mar. 26, 2003) (holding SEC consent orders were inadmissible); Zivitz v. Greenburg, 1999 WL 1129605, at *3 (N.D. Ill. Dec. 3, 1999) (indicating that evidence of an SEC cease and desist order and related press release and settlement agreement stemming from the same underlying events as plaintiff’s allegations would be inadmissible under Rule 408); Berke v. Presstek, Inc., 188 F.R.D. 179 (D.N.H. 1998) (striking references to factual references contained in SEC consent decree from plaintiff’s pleading); In re Catanella and E.F. Hutton and Co., Inc. Sec. Litig., 1988 WL 33440, at *2 (E.D. Pa. Apr. 8, 1988) (“Unproven accusations by other customers would do nothing to prove plaintiff's allegations.”); Beck v. Cantor Fitzgerald & Co., Inc., 621 F. Supp. 1547, 1565-66 (N.D. Ill. 1985) (party’s acquiescence to SEC opinion is irrelevant and not admissible to establish wrongdoing); Seidman & Seidman v. Cenco Inc., 601 F. Supp. 336, 337 n.3 (N. D. Ill. 1984) (SEC consent decree settlement not admissible to support liability); In re Cenco Inc. Secs. Litig., 601 F. Supp. 336, 337 n.3 (N.D. Ill. 1982) (noting agreement with an earlier decision by a different judge that settlement agreement between defendant and SEC is a consent decree and therefore inadmissible to prove defendant’s liability); Marshall Field & Co. v. Icahn, No. 1982 WL 1292, at *4 (S.D.N.Y. Mar. 22, 1982) (ruling prior settlements with SEC are not admissible evidence).

©2023 Greenberg Traurig, LLP. All rights reserved. National Law Review, Volume II, Number 259

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Greenberg Traurig's Securities Litigation Practice is one of the largest in the United States. We have been lead defense counsel in hundreds of securities class actions, derivative actions, and investigations and enforcement actions by the SEC, FINRA, and state regulators, including some of the largest, most complex, and highly publicized regulatory actions and securities fraud cases filed in recent times. We have also defended the largest broker-dealers on Wall Street in high stakes customer and industry arbitrations; our broker-dealer lawyers have collectively tried to...