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U.S. Securities and Exchange Commission v. Quan

United States District Court, D. Minnesota

September 19, 2014

U.S. Securities and Exchange Commission, Plaintiff,
Marlon Quan; Acorn Capital Group, LLC; Stewardship Investment Advisors, LLC; Stewardship Credit Arbitrage Fund, LLC; Putnam Green, LLC; Livingston Acres, LLC; and ACG II, LLC, Defendants, Florene Quan, Relief Defendant, Nigel Chatterjee; DZ Bank AG Deutsche Zentral-Genossenschaftsbank, Frankfurt am Main; Sovereign Bank; Topwater Exclusive Fund III, LLC; Freestone Low volatility Partners, LP; and Freestone Low Volatility Qualified Partners, LP; Intervenors, and Gary Hansen, Receiver.

John E. Birkenheier, Esq., Charles J. Kerstetter, Esq., Michael J. Mueller, Esq., Sally J. Hewitt, Esq., and Timothy S. Leiman, Esq., U.S. Securities and Exchange Commission, Chicago, IL, and James Alexander, Esq., United States Attorney's Office, Minneapolis, MN, on behalf of Plaintiff U.S. Securities and Exchange Commission.

Bruce E. Coolidge, Esq., and Laura Schwalbe, Esq., Wilmer Cutler Pickering Hale and Dorr LLP, Washington, D.C., and Christopher T. Casamassima, Esq., Wilmer Cutler Pickering Hale and Dorr LLP, Los Angeles, CA, on behalf of Defendants Marlon Quan, Stewardship Investment Advisors, LLC, Acorn Capital Group, LLC, ACG II, LLC, and Relief Defendant Florene Quan.


ANN D. MONTGOMERY, District Judge.


On June 26, 2014, the undersigned United States District Judge heard oral argument on Defendants Marlon Quan ("Quan"), Acorn Capital Group, LLC ("Acorn"), Stewardship Investment Advisors, LLC ("SIA"), and ACG II, LLC's ("ACG II") (collectively, "Defendants") Renewed Motion for Judgment as a Matter of Law and Motion for a New Trial ("Post-Trial Motion") [Docket No. 517]; Plaintiff United States Securities and Exchange Commission's ("SEC") Motion for Remedies and Final Judgment ("Motion for Remedies") [Docket No. 532]; and the previously stayed portion of Relief Defendant Florene Quan's Motion for Summary Judgment [Docket No. 269]. For the reasons set forth below, Defendants' Post-Trial Motion is denied, the SEC's Motion for Remedies is granted in part and denied in part, and the stayed portion of Florene Quan's Motion for Summary Judgment is granted.


On February 11, 2014, afer a nine day trial, a jury found Marlon Quan and three entities owned and controlled by Quan liable for securities fraud. The SEC's claims at trial were that Defendants violated securities laws by: (1) fraudulently selling interests in two hedge funds, Stewardship Credit Arbitrage Fund LLC ("SCAF LLC") and Stewardship Credit Arbitrage Fund, Ltd. ("SCAF Ltd.") (together the "SCAF Funds"), through the use of offering and marketing materials that included materially false or misleading representations; and (2) concealing defaults on the SCAF Funds' core investments-promissory notes issued by Thomas J. Petters (the "Petters Notes")-when those investments began failing in December 2007. See generally Am. Compl. [Docket No. 160].

Quan founded the SCAF Funds in 2001 and operated the hedge funds through Defendants SIA and Acorn. SIA served as the investment advisor to the SCAF Funds. Acorn was a commercial finance business that used the money invested in the SCAF Funds to finance loans to companies. Stipulated Facts [Docket No. 475] ¶ 37. Defendant ACG II is a subsidiary of Acorn. From 2001 to 2009, more than 100 investors invested a total of over $500 million in the SCAF Funds. Trial Tr. vol. VIII [Docket No. 549] at 1172. During this period, the SCAF Funds paid SIA performance and management fees, and paid Acorn interest, origination, and consulting fees. The total fees paid by the SCAF Funds to Acorn and SIA exceeded $95 million, $33 million of which was distributed to Quan. Pl.'s Mem. Supp. Mot. Remedies [Docket No. 534] Ex. B.

Beginning in 2001 and continuing unil 2009, Quan met with investors and distributed Preferred Placement Memoranda ("PPMs") and marketing materials touting the risk management techniques that would be used to protect the SCAF Funds' investments. The promised safeguards included the use of a lock box account, "full due diligence" on loan transactions, audits of "intermediaries, " and the retention of cash collateral in a blocked account. See, e.g., Pl.'s Trial Exs. 52, 54, 91.

More than half of the SCAF Funds' portfolio was invested in loans to PAC Funding, LLC ("PAC Funding"), a company owned by Petters. Pl.'s Trial Ex. 40. PAC Funding purportedly used the borrowed funds to purchase electronic merchandise and resell it to "big box" retailers such as Costco and Sam's Club for a substantial profit. Stipulated Facts ¶¶ 2, 8, 37.

In September 2008, a Petters employee and confidant confessed to law enforcement that Petters had been operating a multi-billion Ponzi scheme for over ten years. Id . The money that PAC Funding had received from Acorn, using funds from the SCAF Funds, was never used to buy real merchandise. Id . ¶ 37. Instead, Petters used the majority of the money to repay other investors. Id . ¶ 31. When the Ponzi scheme collapsed, many investors, including the SCAF Funds, suffered severe losses.

The SEC filed this enforcement action in March 2011, alleging securities fraud. The SEC's allegations were not that Quan knew of Petters's fraud. Rather, the SEC alleged Quan and his entities committed a separate fraud by lying to existing and prospective investors in the SCAF Funds about anti-fraud measures and other risk management techniques that were never implemented. The SEC further alleged that when the Petters Notes began to fail, Quan and his entities concealed the defaults by secretly restructuring the Petters Notes while continuing to inform investors through newsletters that all was well. See generally Am. Compl.

The SEC claimed Defendants' misrepresentations and deceptive conduct violated Section 17(a) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. §§ 77q(a)]; Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78j(b), 78t(a)]; Rule 10b-5 promulgated under the Exchange Act [17 C.F.R. § 240.10b-5]; Section 206(4) of the Investment Advisers Act of 1940 ("Advisers Act") [15 U.S.C. § 80b-6(4)]; and Rule 206(4)-8 promulgated under the Advisers Act [17 C.F.R. § 275.206(4)-8]. The SEC also alleged Quan was liable for aiding and abetting violations of the Exchange Act and Advisers Act. Am. Compl. ¶¶ 195-235.[1]

The SEC named Quan's wife Florene Quan as a relief defendant, seeking disgorgement of two Hawaiian properties worth over $3 million that were purchased by Quan in 2004 and 2006. The properties were transferred to Florene Quan for $20 in July 2008 through two separate warranty deeds. Am. Compl. ¶¶ 236-239.

On October 8, 2013, this Court issued an Order denying the SEC and Defendants' motions for partial summary judgment. See Summ. J. Order. In the same Order, the Court also denied a motion to exclude the expert opinion testimony of the SEC's retained expert, Michael Mayer. Id. at 35-38. The Court also denied in part and stayed in part Florene Quan's summary judgment motion, reserving for after trial the issue of whether Florene Quan is a proper relief defendant. Id. at 34-35.

The jury trial commenced on January 29, 2014. At the close of the SEC's case-in-chief, Defendants moved for judgment as a matter of law. Trial Tr. vol. VI [Docket No. 547] 1004-05. The Court denied the motion, finding that if the jury were to accord full credibility to the SEC's fourteen witnesses and hundreds of trial exhibits, the evidence would be sufficient to support the SEC's claims. Id.

The jury reached a verdict on February 11, 2014. The Special Verdict Form addressed seven claims. See Special Verdict Form [Docket No. 501].[2] The jury found liability on all of the SEC's claims except the alleged violation of Section 17(a)(1), and the claim of Quan's aiding and abetting violations of Section 10(b) and Rule 10b-5 by SCAF. Id . Judgment consistent with the jury's verdict was entered on February 19, 2014. See Judgment [Docket No. 505].

Defendants now renew their motion for judgment as a matter of law and also move for a new trial, arguing the verdict cannot be sustained because it is inconsistent, non-unanimous, against the greater weight of the evidence, and based on inadmissible testimony by the SEC's expert witness.

The SEC opposes Defendants' motion, and has filed a motion for remedies and a final judgment against Defendants. The SEC requests injunctive relief, disgorgement of ill-gotten gains, prejudgment interest, and a civil penalty against Defendants.

Also before the Court is the stayed portion of Florene Quan's summary judgment motion. Florene Quan argues she is not properly named as a relief defendant as she has a legitimate interest in the two Hawaiian properties titled in her name. The SEC alleges the properties may be disgorged as proceeds of Marlon Quan's fraud.


A. Defendants' Motion for Judgment as a Matter of Law and New Trial

1. Consistency of Verdict

The decision whether to grant a new trial under Federal Rule of Civil Procedure 59(a) is committed to the discretion of the district court. Pulla v. Amoco Oil Co. , 72 F.3d 648, 656 (8th Cir. 1995). A motion for a new trial based on an inconsistent verdict shall be granted "only if there was no principled basis upon which to reconcile the jury's inconsistent findings.'" Top of Iowa Coop. v. Schewe , 324 F.3d 627, 633 (8th Cir. 2003) (quoting Bird v. John Chezik Homerun, Inc. , 152 F.3d 1014, 1017 (8th Cir. 1998)). Courts have a "duty to harmonize inconsistent verdicts, viewing the case in any reasonable way that makes the verdicts consistent." Anheuser-Busch, Inc. v. John Labatt Ltd. , 89 F.3d 1339, 1347 (8th Cir. 1996) (citing Gallick v. Baltimore & Ohio R.R. Co. , 372 U.S. 108, 119 (1963)).

Defendants argue a new trial is required because the jury's findings are irreconcilably inconsistent in two respects: (1) the finding that Defendants violated Section 10(b) cannot be harmonized with the finding that Defendants did not violate Section 17(a)(1); and (2) the finding that Quan violated Section 10(b) cannot be reconciled with the finding that he did not assist SCAF LLC in a violation of Section 10(b).

a. Liability under Section 10(b) but not Section 17(a)(1)

Defendants contend the jury's findings of liability under Section 10(b) and Rule 10b-5 but not under Section 17(a)(1) are irreconcilable because the same standard applies to claims. Thus, Defendants argue they should have been liable under both or neither of these claims.

The language of Rule 10b-5[3] is nearly identical to that of Section 17(a). Both provisions prohibit securities fraud by forbidding three categories of deceptive behavior. Specifically, Rule 10b-5 makes it unlawful:

for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5. Similarly, Section 17(a) makes it unlawful:

for any person in the offer or sale of any securities... by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly
(1) to employ any device, scheme, or artifice to defraud, or
(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

15 U.S.C. § 77q(a).

Thus, to establish a violation under either of these anti-fraud provisions, the SEC must prove a defendant: (1) engaged in prohibited conduct (i.e., employed a fraudulent scheme, made a material misstatement or omission, or engaged in a fraudulent business practice); (2) in connection with the offer, sale, or purchase of a security; (3) by means of interstate commerce. See SEC v. Shanahan , 646 F.3d 536, 541 (8th Cir. 2011) (involving misstatements and omissions); SEC v. Lucent Techs., Inc. , 610 F.Supp.2d 342, 350 (D.N.J. 2009) (involving deceptive conduct). Further, scienter is required to prove a violation of Section 10(b), Rule 10b-5, and Section 17(a)(1), while Sections 17(a)(2) and (3) are proven by showing a defendant acted at least negligently. Shanahan , 646 F.3d at 541 (citing Aaron v. SEC , 446 U.S. 680, 695 (1980)); SEC v. True North Fin. Corp. , 909 F.Supp.2d 1073, 1122 (D. Minn. 2012). Scienter requires proof of intent to deceive or severe recklessness. Shanahan , 646 F.3d at 543.

Here, the jury found Quan liable under Section10(b) and Rule 10b-5, and also liable under Section 17(a)(2)-(3), but not liable under Section 17(a)(1). These findings can be harmonized by interpreting the jury's verdict as finding that Defendants did not employ a fraudulent scheme, which is prohibited under Rule 10b-5(a) and Section 17(a)(1), but Defendants did make a material misrepresentation or omission, which is prohibited under Rule 10b-5(b) and Section 17(a)(2), and did engage in fraudulent business practices, which are prohibited under Rule 10b-5(c) and Section 17(a)(3), and Defendants did act with scienter. This rationale by the jury would have resulted in liability in Claim I of the Special Verdict Form for violating Rule 10b-5, no liability in Claim IV for violating Section 17(a)(1), and liability in Claim V for violating Sections 17(a)(2) and (3).[4]

Defendants argue that a finding of no liability for employing a fraudulent scheme under Section 17(a)(1) cannot be reconciled with a finding of liability for material misrepresentations made with scienter under Section 17(a)(2), because a fraudulent scheme may be effectuated solely by fraudulent statements. Defs.' Reply Mem. Supp. J. Matter Law New Trial [Docket No. 536] at 5-6. However, the Eighth Circuit has specifically considered whether a defendant may be liable for a fraudulent scheme based solely on misrepresentations or omissions, and has held that "a scheme liability claim must be based on conduct beyond misrepresentations or omissions." Pub. Pension Fund Grp. v. KV Pharm. Co. , 679 F.3d 972, 987 (8th Cir. 2012). Defendants recognized this principal in their proposed jury instructions, which state in relevant part that Section 17(a)(1) "applies to deceptive conduct, not deceptive statements, " and that "a single material misstatement or omission, standing alone, is insufficient to establish a device, scheme, or artifice to defraud." Defs.' Proposed Jury Instructions [Docket No. 439] at 24-25 (emphasis in original). Therefore, the jury's finding of no liability under Section 17(a)(1) is not inconsistent with the findings of liability under Section 10(b), Rule 10b-5, and Section 17(a)(2)-(3).

b. Primary Section 10(b) Liability but not Aiding and Abetting

Defendants also argue the verdict is inconsistent because the jury found Quan liable for violating Section 10(b), but not liable for aiding and abetting a Section 10(b) violation by SCAF LLC. To find Quan liable for aiding and abetting a Section 10(b) violation by SCAF LLC, the jury would have had to find that: (1) SCAF LLC violated Section 10(b) and Rule 10b-5; (2) Quan had knowledge that SCAF LLC was violating Section 10(b) and Rule 10b-5; and (3) Quan provided substantial assistance to SCAF LLC in its violation. See Jury Instructions [Docket No. 491] at Jury Instruction No. 23. Defendants argue Quan controlled SCAF LLC, and if SCAF LLC did not violate Section 10(b), then Quan cannot have violated Section 10(b). Conversely, if SCAF LLC did violate Section 10(b), then Quan should have been held liable for aiding and abetting SCAF LLC's violation.

The jury's findings can be reasonably reconciled on the basis that SCAF LLC was not a defendant at trial, and thus the SEC's evidentiary focus during trial was on Quan's role at SIA and Acorn, rather his role at SCAF LLC. As a result, the jury may have concluded that they lacked sufficient evidence to determine Quan's role in SCAF LLC or that Quan had aided and abetted a Section 10(b) violation by SCAF LLC. Therefore, the jury's verdict is consistent and does not warrant a new trial.

c. Waiver of Right to Seek New Trial Based on Inconsistent Jury Verdict

Furthermore, even if the verdict is found to be inconsistent, Defendants waived their right to seek a new trial by failing to move for resubmission of the verdict to the jury before the jury was discharged. The Eighth Circuit has repeatedly held that "[i]f a party feels that a jury verdict is inconsistent, it must object to the asserted inconsistency and move for resubmission of the inconsistent verdict before the jury is discharged or the party's right to seek a new trial is waived." Parrish v. Luckie , 963 F.2d 201, 207 (8th Cir. 1992); see also Lockard v. Mo. P. R.R. , 894 F.2d 299, 304 (8th Cir. 1990), cert. denied, 498 U.S. 847 (1990); Brode v. Cohn , 966 F.2d 1237, 1239 (8th Cir. 1992) (noting possibility that plaintiff waived right to seek new trial because there was "no indication in the record on appeal that [plaintiff] moved to have the alleged inconsistencies resubmitted to the jury before entry of judgment."). "The purpose of the rule is to allow the original jury to eliminate any ...

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