Securities Regulation Daily Investment group stated claim against attorney in pre-IPO Facebook purchase
Monday, July 11, 2016

Investment group stated claim against attorney in pre-IPO Facebook purchase

By Kevin Kulling, J.D.

An investment group sufficiently stated a claim for securities fraud against an attorney who represented an individual claiming to be a middle man in a Facebook pre-IPO purchase, the Ninth Circuit Court of Appeals has held. The court, reversing and remanding to the lower court, found that the investment partners not only showed the attorney made false statements, but he also failed to reveal that there was no Facebook deal and that the group’s deposit would be immediately dispersed (ESG Capital Partners, LP v. Stratos, July 11, 2016, Pregerson, H.).

Pre-IPO Facebook. The action was brought by ESG Capital Partners, L.P., against an individual they believed to be Ken Dennis, actually an alias for a man named Troy Stratos. ESG was a group of investors formed to purchase pre-IPO Facebook shares.

ESG also alleged that law firm Venable LLP and attorney David Meyer represented Stratos in the Facebook deal and was Stratos’ principal contact at Venable throughout their negotiations.

According to the court, attorney Meyer told ESG that Stratos, who was introduced as "Ken Dennis," is "who he says he is." Meyer also represented that Stratos/Dennis and Soumaya Securities, a Stratos entity that Meyer helped create, were affiliates of billionaire Carlos Slim, which was not true. Meyer represented that the sale of Facebook was legitimate, and that he would provide deal documentation. ESG initially wired $2.8 million to Venable’s trust account as a deposit. Later that day, the entire amount was deposited into Stratos’ trust fund account, not to Soumaya Securities.

Venable assisted in opening a Bank of America account for Stratos, who had been "black listed" from several banks due to his notoriety, poor credit, and outstanding judgments, the court said. ESG was told that they needed to wire an additional $7.2 million to complete the deal. Just days after the wire transfer, Bank of America froze the Soumaya Securities account and eventually closed it. Venable arranged to transfer the funds to a third party, but did not inform ESG, according to the court.

Attorney Meyer assisted Stratos in opening another bank account, and ESG wired an additional $1.25 million, bringing its total payments to $11.25 million.

When ESG did not receive the Facebook shares by the end of 2011, ESG threatened Venable with legal action. Counsel for Venable told ESG that Venable received no transfer of funds and had no knowledge of the alleged transfer. The firm said that it did not represent any party in the transactions between ESG and Soumaya Securities.

Misrepresentations and Omissions. In dismissing the complaint, the district court said Meyer was not the maker of any material representations or omissions because he only communicated Soumaya Securities’ understanding of the deal, not his own.

But the appellate court said that Meyer told ESG that he represented Ken Dennis and Soumaya in connection with the Facebook transactions, that Dennis was affiliated with Carlos Slim, and that Dennis "is who he says he is." In addition, attorney Meyer was copied on emails so he must have known that ESG believed it was communicating with Ken Dennis, when it was actually emailing Stratos. Meyer also told ESG that its $2.8 million deposit would be released to Soumaya Securities, when in fact it was put into Stratos’ personal client trust account.

Not only did attorney Meyer make false statements to managing agent Burns, the court said, he also made material omissions when he failed to reveal that there was no Facebook deal, that Stratos, not Soumaya Securities, was Venable’s client, and that ESG’s deposit would be immediately dispersed to Stratos.

The court also said that it was irrelevant whether the attorney had an attorney-client relationship with the seller of securities. Instead, it was relevant that an attorney who undertakes to make representations to prospective purchasers of securities is under an obligation, imposed by Section 10(b), to tell the truth about those securities.

Scienter. The appellate court said the district court applied the scienter pleading standard too stringently when it found inadequate evidence of scienter. While no single factual allegation substantiates an inference of attorney Meyers’ scienter, ESG provided a narrative that strongly pointed to the existence of scienter, the court said. ESG sufficiently pleaded facts supporting a strong inference that attorney Meyer knew that Stratos was using the alias Ken Dennis, and that ESG believed it was communicating with Dennis and not Stratos. ESG also provided facts sufficient to support the inference that attorney Meyer knew Stratos’ identity and scheme. There were more than 100 phone conversations and in-person meetings, according to ESG. Meyer also authorized payments from Stratos’ client trust account. Venable also opened bank accounts for Stratos and provided thousands of dollars of non-legal services, such as buying office supplies and car insurance.

The case is No. 13-56684.

Attorneys: Eugene Ashley, III (Hopkins & Carley), William C. Nystrom (Nystrom Beckman & Paris LLP) and Margaret Anne Grignon (Grignon Law Firm LLP) for ESG Capital Partners, LP. Matthew Stewart Kahn (Gibson Dunn & Crutcher LLP) for Venable LLP.

Companies: ESG Capital Partners, LP; Venable LLP

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