Securities and Exchange Commission v. Medley
Filed August 12, 2008,
Cite as 06-15165

Judgment on Company Selling Unregistered Securities Vacated, Case Remanded

This case arose from the activities of M&A West, Inc. (MAWI), a company that the district court described as “a sham incubator for startup companies.” This appeal concerns the charges against Medley only.

The Securities and Exchange Commission has charged the company of being a self-proclaimed "Internet incubator" engaged in developing Internet-related technology companies. According to the Commission, since 1999, the company and various persons affiliated with it have reaped more than $20 million in illegal profits by selling unregistered securities to investors, in violation of the registration provisions of the federal securities laws.

According to the SEC complaint, the company has “funneled millions of dollars through various secret accounts back to MAWI, which fraudulently reported the funds as revenue from operations which did not in fact exist”.

Further, the claims against Medley also arose from a series of “reverse merger” transactions. A reverse merger is “a transaction in which a privately held corporation acquires a publicly trade corporation, thereby allowing the private corporation to transform into a publicly-traded corporation without the necessity of making an initial stock offering”.

According to court records, in three reverse mergers at issue, the public corporation is a shell company with minimal assets and liabilities and no actual operations. To effect the reverse merger, the shell public corporation exchanged its treasury stock for all outstanding shares of the privately held corporation.

This appeal was the result of a lawsuit filed by the Securities and Exchange Commission against Stanley Medley and five co-defendants, who were charged with violating Section 5 of the Securities Act of 1933, 15 U.S.C. sections 77e, for selling unregistered securities.

On summary judgment, the district court held that Stanley was an underwriter under Section 2(11) of the Act, 15 U.S.C. section 77b(11), and therefore not exempt from Section 5’s registration requirements under Section 4(1), 15 U.S.C. sections 77(d)(1). The court also imposed remedies in the form of a five-year injunction, civil penalties, disgorgement and prejudgment interest.

In his appeal, Medley argued that he acted according to Rule 144(k), 17 C.F.R. sections 230.144(k), a safe harbor under which persons are deemed not to be underwriters as the term is used in Section 2(11).

However, during appeal, the appeals court held that the district court properly held that Medley was an underwriter, and therefore not exempt from the registration requirements. The court also concluded that the district court was right in ordering that Medley disgorge all profits, with interest, he obtained from these transactions.

However, the court concluded that genuine issues of material fact precluded the entry of summary judgment in relation to the imposition of the civil sanctions—specifically, the second-tier penalties and the five-year injunction.

The appeals court therefore vacated the summary judgment on civil sanctions and remand for an evidentiary hearing.