Securities Regulation Daily Misrepresentations can be made to non-market participants
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Thursday, June 30, 2016

Misrepresentations can be made to non-market participants

By Rodney F. Tonkovic, J.D.

Misrepresentations do not have to be directed at the investing public, an Eleventh Circuit panel has confirmed. The district court had found that Radius Capital Corp. and its founder and CEO Robert A. DiGiorgio made misrepresentations to mortgage borrowers and the Government National Mortgage Association. On appeal, DiGiorgio argued that Ginnie Mae was not covered by the antifraud provisions because, as a non-market participant, it was not involved in any transaction. In an unpublished opinion, the panel concluded that misrepresentations do not need to be explicitly directed at investors or occur during the transaction to be "in connection with the purchase or sale of" any security (SEC v. Radius Capital Corp., June 29, 2016, per curiam).

Radius was a mortgage lender and issuer of mortgage-backed securities. According to the Commission, in order to obtain guarantees from Ginnie Mae, Radius falsely represented that the loans backing its MBS were eligible for FHA insurance, despite knowing that this was not the case for the majority of the loans. These misrepresentations were made in forms submitted to Ginnie Mae and in the prospectuses made available to the public. Because the loans were not FHA-insured, Ginnie Mae suffered over $5 million in losses when the mortgages backing Radius' MBS defaulted.

The Commission sued DiGiorgio and Radius under the antifraud provisions of the securities laws. A jury eventually found in favor of the Commission on all claims. The court then enjoined DiGiorgio from committing future violations of the securities laws and ordered the payment of almost $3 million in disgorgement and penalties.

Non-market participants. On appeal, DiGiorgio argued that, to meet the "in connection with" requirement, Securities Act Section 17(a) and Rule 10b-5 under the Exchange Act require that a material misrepresentation be communicated directly to the investing public. In this case, the alleged misrepresentations were only disseminated to Ginnie Mae. And, Ginnie Mae is not covered by these provisions, DiGiorgio maintained, because it, as a non-market participant, was not involved in any securities transactions.

The panel disagreed, concluding that the misrepresentations themselves do not need to be explicitly directed at the investing public or occur during the transaction to be "in connection with the purchase or sale of" or "in the offer or sale of" any security. To illuminate its point, the panel pointed to Supreme Court precedent counseling a broad reading of these requirements in order to effectuate Congress's intent to protect investors.

The panel also distinguished Chadbourne & Parke LLP v. Troice, which DiGiorgio argued required the public dissemination of misrepresentations. Troice, however, involved a private action, which requires actual reliance by the person defrauded, the panel said. An SEC civil enforcement action, on the other hand, does not require actual reliance.

Making a statement. Next, DiGiorgio asserted that Section 17(a) and Rule 10b–5 require that he be the person who "made" the misrepresentations in the prospectuses. Because the district court applied the Janus requirement only to Rule 10b-5(b), DiGiorgio contended, it erred in not dismissing the civil enforcement claims in their entirety. The panel said, however, that the law in the Eleventh Circuit is clear that the requirement only applied to Rule 10b-5(b) and accordingly rejected DiGiorgio's argument as applied to Section 17(a).

Remaining issues. DiGiorgio also filed various motions in limine that sought to prohibit the admission at trial of Radius's application to become a Ginnie Mae-approved issuer, GinnieNET forms, and the prospectuses. These motions were rejected by the district court, and DiGiorgio argued that the documents were not material because they were not publicly-disseminated and that the admission of the prospectuses was substantially prejudicial.

The panel stated that, in the antifraud context, the materiality of a misrepresentation is an objective determination. Moreover, in this case, the documents at issue were at the core of the enforcement action. In short, the panel said, the district court did not abuse its discretion.

Finally, DiGiorgio challenged the district court's denial of his proposed jury instructions that would have required the jury to find that the alleged misrepresentations had been made to public investors. Since dissemination is not a legal prerequisite to liability under the antifraud provisions, the panel found no plain error. The panel also found no evidence that the jury instructions as given affected the outcome of the proceedings and that the jury’s verdict was not against the great weight of the evidence.

The case is No. 15-12004.

Attorneys: Susan S. McDonald for the SEC. Robert A. DiGiorgio, pro se.

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