Appeal from the United States District Court for the Central District of California Otis D. Wright, District Judge, Presiding D.C. No. 2:09-cr-00327- ODW-1
The opinion of the court was delivered by: B. Fletcher, Circuit Judge:
April 12, 2012-Pasadena, California
Before: Betty B. Fletcher, Andrew J. Kleinfeld, and Milan D. Smith, Jr., Circuit Judges.
Opinion by Judge B. Fletcher; Dissent by Judge M. Smith
A jury convicted Richard A. Bailey of two counts of securities fraud. Bailey appeals his conviction arguing that he was prejudiced by the trial court's improper admission of a prior civil complaint filed by the SEC against Bailey. We agree and vacate Bailey's conviction and remand for a new trial.
Bailey was the President, Chief Executive Officer, and Chairman of the Board of Directors of Gateway, a small, public company involved in selling health and dietary supplements.*fn1
In 2002, Bailey met Richard Owens, another businessman, and the two began doing business together. The nature and legitimacy of some of their business deals was the critical issue at trial.
According to the prosecution, Bailey did not comply with the Securities and Exchange Commission's rules on stock issuances. The SEC requires public companies to disclose voluminous information before issuing stock (e.g. details regarding past performance; information about executives; intended use of the sale proceeds). This process can be time-consuming and expensive. Without these disclosures, the SEC allows public companies to issue stock to employees, consultants, or advisors who provide bona fide services to the company. The issuance cannot be used merely to raise capital for the company and must be in exchange for legitimate services.
In 2003, the SEC filed a civil complaint against Bailey and his company for violating Rule S-8, the rule that requires the distribution of stock to be in exchange for bona fide services. Bailey settled the lawsuit with no admission of liability.
In 2004, Bailey was criminally charged for issuing stock to Owens in order to raise capital for Gateway and for Bailey and the company's personal benefit, both of which are proscribed by Rule S-8. Bailey pled not guilty and proceeded to trial. His current appeal is from the jury conviction.
Prior to trial, the prosecution filed a motion in limine seek-ing permission to introduce the fact that the SEC filed a civil complaint against Bailey in 2003. The prosecution argued that the 2003 complaint would show that Bailey knew that his conduct in 2004 was unlawful. The prosecution also argued that the prior complaint would establish that Bailey knew that he was required to comply with Rule S-8. The district court permitted the prosecutor to "introduce just the fact of the SEC complaint" but warned not to get "any deeper into it."
At trial, the prosecution presented witnesses who testified about the business dealings between Bailey and Owens. FBI Agent Scott Schofield provided extensive testimony about the numerous transactions between Gateway and Owens between April and June 2004, the time frame of the indictment. Specifically, Schofield testified that Owens received a total of $661,000 in S-8 stock in April and May of 2004 but that no documentation existed detailing the exchange of services for stock. Schofield testified that he believed that the lack of a written agreement and invoices between Owens and Gateway suggested that the arrangement was merely a ruse for unlawful activity. He admitted that there was a written agreement for the years 2002-03, but testified that no such agreement existed for 2004, the time frame at issue in this criminal case. On cross-examination, Schofield appeared to admit that verbal agreements would likely be sufficient for S-8 purposes and that written documentation was not necessary to comply with Rule S-8.*fn2
Margaret Nelson, an attorney with the SEC's division of enforcement, testified that she deposed Bailey in 2006 and asked him about the S-8 issuances to Owens. Nelson read into evidence portions of Bailey's deposition where he testified that no time sheets or invoices existed that reflected the work Owens performed, Gateway's accounting documents showed that Owens received $505,000 in stock, and Bailey did not believe Owens performed that amount in services. Nelson also testified that in 2003, the SEC filed a civil enforcement action against Bailey, Gateway, and others, alleging that they violated SEC rules by using S-8 to raise capital instead of exchanging stock for bona fide services.
The prosecution's star witness was Owens. Owens testified that in the spring of 2004, Bailey and Ternes asked him to accompany them on a trip to Utah to look at some real estate. One of the properties they viewed was Aspen Cove, a hunting and fishing lodge. Owens testified that Bailey and Ternes were interested in purchasing the property and began negotiating terms. Owens testified that Bailey and Ternes wanted to make a down payment between $400,000 and $600,000, and in order to come up with the funds, they planned to issue Owens S-8 stock, which he would trade through his brokerage account and send them back the proceeds to use for the down payment. In exchange, Owens would receive the difference between the proceeds from the sale of the stock and the down payment and also be able to use the lodge at his pleasure. Owens testified that they had engaged in this type of transaction "several times prior" and that he knew at the time that the proposal was not legitimate. When asked why Owens went along with the plan knowing that it was not legitimate, he said that "[g]reed overtook the need" and that he viewed the transaction as "help[ing] a brother out."
Owens testified that there was a written consulting agreement delineating the terms of the agreement, but that it was entered into "after the fact, after [the SEC] investigation started" and that the document was "[a]ll just smoke and mirrors." Owens testified that he "may have signed a consulting agreement or papers that stated that [he was] a consultant for Gateway" but that those documents were not at all "real or legitimate."
Owens testified that he did the same type of deal with Bailey and Ternes using S-8 stock for another parcel (the "Pepper Lane" building).
On cross-examination, defense counsel attacked Owens's credibility. Owens admitted that he had been charged with federal crimes relating to the improper issuance of S-8 stock and was facing thirteen years in prison. He admitted that his sentencing date had been continued several times so that he could testify at Bailey's trial, and that he was cooperating with the prosecutor in the hopes of receiving a lower sentence. Owens admitted that he had perjured himself on his tax return, raising doubts about whether he was telling the truth since he had lied before. Defense counsel also impeached Owens's credibility by eliciting evidence of an assault on his ex-wife, his excessive use of drugs and alcohol, and the circumstances leading to the decline of his relationship with Bailey.*fn3
Bailey did not testify. His defense was that he did nothing illegal because the S-8 stock issuances were for legitimate consulting services. Bailey's daughter testified that through Owens's business contacts, she and other Gateway employees flew to New York to meet with executives at the Home Shopping Network and the corporate office of Nathan's Hot Dogs about potential business endeavors.
Defense counsel argued that Bailey issued the stock to Owens in exchange for bona fide services. First, Owens provided connections to important business people-connections that were supposed to allow Bailey to grow his business. Second, Owens helped locate and negotiate the Aspen Cove deal, and was ultimately able to secure an additional 36 acres of land for the original asking price. Bailey's counsel argued that simply because Bailey may not have ultimately received the full value of the stock issuance does not mean that when he entered into the transaction, he did so with an unlawful purpose. And of course, defense counsel argued that Owens was a crook, that he had lied before and was lying now to obtain leniency in his sentencing.
The prosecutor's closing tracked each of the four elements of the crime.*fn4 He repeatedly argued that willfulness was the most important element the government had to prove. In order to prove that willfulness was satisfied, the prosecutor highlighted the prior SEC complaint, and argued that Bailey had broken the law before and then done it again.
After deliberating for one day, the jury returned a guilty verdict against Bailey and Ternes. Bailey was sentenced to 30 months' imprisonment.
The issue on appeal is whether the trial court erred by allowing evidence of the prior civil complaint filed by the SEC in 2003 which named Bailey and his company for improper use of Rule S-8.
Whether the district court erred in permitting the government to introduce the prior civil complaint because it did not satisfy Rule 404(b)'s admissibility requirements is reviewed for abuse of discretion. ...