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United States Securities and Exchange Commission v. Mack

United States District Court, D. Minnesota

July 23, 2019

United States Securities and Exchange Commission, Plaintiff,
v.
Jeffrey C. Mack, and Lawrence C. Blaney, Defendants.

          MEMORANDUM AND ORDER

          PAUL A. MAGNUSON UNITED STATES DISTRICT JUDGE

         This matter is before the Court on Defendant Lawrence C. Blaney's Motion to Dismiss. For the following reasons, the Motion is denied.

         BACKGROUND

         Defendants Jeffrey Mack and Lawrence Blaney were officers of a now-defunct corporation, Digiliti Money Group, Inc. (Compl. (Docket No. 1) ¶ 2.) Digiliti was a financial technology company, providing small banks, credit unions, and other financial services companies with software and technology for mobile banking services. (Id. ¶ 17.) Mack was Digitili's CEO, President, and Chair of the Board of Directors. (Id. ¶ 14.) Blaney was Digitili's Executive Vice President of Sales. (Id. ¶ 15.)

         The SEC alleges that Digitili fraudulently inflated its revenue in order to appear profitable, so that the company could attract outside investors. (See id. ¶ 1.) Specifically, the SEC contends that Mack and Blaney developed a scheme to offer side agreements to Digitili's biggest customer, referred to in the pleadings as Customer Number 1. These side agreements allowed the customer to cancel preexisting contracts with Digitili without any payment or penalty. (Id. ¶¶3-4.) Because the side agreements were not disclosed, it appeared to auditors and members of the public that the customer had non-revocable contracts. Thus, Digitili recognized revenue from the contracts, even though the contracts could be, and ultimately were, cancelled. (Id. ¶ 4.)

         In October 2016, Digitili attempted a public offering. Because Digitili did not achieve its revenue targets for the previous quarter, however, the public offering was unsuccessful. (Id. ¶ 31.) After this failure, Blaney communicated with the customer, attaching a new contract with a total price of nearly $400, 000. The email stated that the customer could terminate the contract “without any obligation to pay or without any penalty.” (Id. ¶ 32.) Blaney told Mack that he valued the contract at nearly $400, 000 “to make sure we hit our number.” (Id. ¶ 33.) The customer signed the contract, but the terms of the email were not disclosed in the contract or provided to Digitili's finance and accounting department. (Id. ¶ 35.) Although the customer executed the contract on October 21, 2016, Blaney dated the contract September 30, 2016, so that the contract could be included in Digitili's third-quarter revenue. (Id. ¶ 37.) Digitili's SEC forms and revenue statements included the revenue from this contract, though accounting rules prohibit a company from claiming revenue from contracts that are cancellable without payment or penalty.

         After the initial offering failure, Digitili raised more than $7 million in a private placement of convertible notes in late 2016 and early 2017. (Id. ¶ 54.) Digitali provided its financial statements and SEC-required financial forms to potential investors, all of which contained the overstated revenue figures. (Id.) At the same time, Digitali was preparing another public offering, but was nearly $1 million short of its 4th-quarter revenue targets. Blaney told Mack that Digitili would “probably need to do a similar deal [with Customer Number 1] to hit the Q4 number.” (Id. ¶ 59.) Three days later, Blaney again emailed the customer, proposing a new contract worth $800, 000 that could be canceled without payment or penalty. (Id. ¶ 60.) Blaney emailed proposed cancellation language to Mack, who sent it on to the customer. (Id. ¶ 62.) When the customer requested that terms in the email be included in the new contract, Blaney replied that Digitili “cannot put this in the amendment as [the auditors] wouldn't let us take any revenue which is what this is about.” (Id. ¶ 66.) He assured the customer that “[a]n email is a binding agreement and you have the agreement via email from our CEO.” (Id.) The customer signed the new contract, with a total price of $870, 000. (Id. ¶ 67.) Again, Blaney pre-dated the contract, which was signed on January 31, 2017, to a date within the previous quarter, December 16, 2016. (Id. ¶ 70.) The contract price allowed Digitili to reach its revenue targets.

         Digitili completed the public offering on March 10, 2017, and the company was listed on the Nasdaq. In April, the customer sought to cancel the October 2016 contract. Blaney asked the customer to postpone any cancellation until June, and further asked the customer not to let Digitili's finance and accounting department know about its intent to cancel the contracts. (Id. ¶¶ 92-93.) The same day, Blaney and Mack communicated about sending the customer a third contract, worth approximately $1 million, because Digitili was once again behind on its revenue targets. (Id. ¶ 94.) The customer initially declined to execute the new contract, but after Mack proposed giving the customer shares of Digitili stock, the customer agreed. (Id. ¶¶ 98-100.) The customer signed a $550, 000 contract on April 26, 2017, but Blaney again back-dated it to March 23, 2017. (Id. ¶¶ 101-02.) Digitili issued first-quarter financial statements containing the inflated revenue figures and issued press releases that falsely stated Digitili's revenue.

         The customer cancelled all of its new contracts in July 2017, causing Digitili to write off more than $1.8 million. (Id. ¶ 121.) The scheme was uncovered after Digitili terminated Mack and Blaney and discovered emails related to the side agreements. (Id. ¶ 7.) Digitili was forced to re-state its financial reports and filings, and eventually went out of business. (Id. ¶¶ 124, 126.)

         The Complaint contains 15 counts, all alleging either substantive or aiding-and-abetting violations of various securities laws. Blaney seeks dismissal of the counts alleging violations of § 17(a)(1)-(3) of the Securities Act of 1933 and accompanying rules, and those alleging violations of §§ 10(b) and 13(a) of the Securities Exchange Act of 1934 and accompanying rules. He does not move to dismiss three counts alleging violations of Exchange Act § 13(b)(5) and its rules.

         DISCUSSION

         To survive a motion to dismiss under Rule 12(b)(6), a complaint need only “contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.'” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)); see also Fed.R.Civ.P. 12(b)(6). A claim bears facial plausibility when it allows the Court “to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Iqbal, 556 U.S. at 678. When evaluating a motion to dismiss under Rule 12(b)(6), the Court must accept plausible factual allegations as true. Gomez v. Wells Fargo Bank, N.A., 676 F.3d 655, 660 (8th Cir. 2012). But “[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, ” are insufficient to support a claim. Iqbal, 556 U.S. at 678.

         Blaney first argues that the Complaint is replete with “group pleading” so that he does not know how he is alleged to have participated in the fraud. But the Complaint outlines specifically Blaney's conduct, as discussed above: he sent multiple emails to both the customer and Mack, setting up and carrying out the alleged fraudulent scheme. This is not group pleading.

         He also complains that the Complaint is a “shotgun” pleading because the counts incorporate all of the factual allegations. A shotgun pleading is one which is so scattershot that a defendant cannot discern what facts are connected to what cause of action. Here, the causes of action all sound in securities fraud, so all factual ...


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