Securities Exchange Commission et al v. River North Equity LLC et al

MEMORANDUM by Edward M Liceaga, River North Equity LLC in support of Motion to Dismiss for Failure to State a Claim 36 as to Counts VII, VIII, and IX

Northern District of Illinois, ilnd-1:2019-cv-01711

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Case: 1:19-cv-01711 Document IN THE UNITED#: STATES 37 Filed: DISTRICT 05/10/19 Page 1 of 16 PageID #:128 COURT FOR THE NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION ---------------------------------------------------------------- SECURITIES AND EXCHANGE) COMMISSION,)) Plaintiff,) Case No. 19-cv-01711) v.) Honorable Thomas M. Durkin) RIVER NORTH EQUITY LLC,) EDWARD M. LICEAGA,) MICHAEL A. CHAVEZ,) NANOTECH ENTERTAINMENT, INC.,) NANOTECH GAMING, INC.,) DAVID R. FOLEY, LISA L. FOLEY,) JEFFREY A. FOLEY, and) BENNIE L. BLANKENSHIP,)) Defendants.) ---------------------------------------------------------------- DEFENDANTS RIVER NORTH EQUITY LLC AND EDWARD M. LICEAGA'S MEMORANDUM IN SUPPORT OF MOTION FOR PARTIAL DISMISSAL OF PLAINTIFF'S COMPLAINT Case: 1:19-cv-01711 Document #: 37 Filed: 05/10/19 Page 2 of 16 PageID #:128 Defendants River North Equity LLC ("River North") and Edward M. Liceaga ("Mr. Liceaga"), by and through their undersigned counsel, hereby respectfully move this Court to partially dismiss Plaintiff Securities and Exchange Commission's ("Plaintiff," "SEC," or the "Commission") Complaint (Docket Entry 1), pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, on the ground that Count VII (against River North), Count VIII (against Mr. Liceaga), and Count IX (against Mr. Liceaga) of the Complaint fail to state a claim against either River North or Mr. Liceaga upon which relief may be granted. In furtherance of the same, River North and Mr. Liceaga respectfully state as follows: I. INTRODUCTION This is a matter wherein Plaintiff has alleged that Defendants David R. Foley ("Defendant Foley") and Bennie L. Blankenship ("Defendant Blankenship") orchestrated an illegal market manipulation scheme so that Defenant Foley could sell shares of Nanotech Entertainment, Inc. ("NTEK") and Nanotech Gaming, Inc. ("NTGL") to River North. Although Plaintiff's Complaint does not allege that either River North or Mr. Liceaga was aware of such illegal market manipulation scheme, Plaintiff has charged River North with purportedly acting as an unregistered securities dealer in violation of the federal securities laws for purchasing and selling the NTEK and NTGL shares at issue in this matter, and has charged Mr. Liceaga with purportedly (1) aiding and abetting River North's purportedly violative conduct and (2) acting as a control person over River North in connection with its purportedly violative conduct.1 With sparse factual allegations, which appear to present a case of first impression in this Circuit, the SEC is attempting to expand the registration requirements under the Securities 1 Count I of the Commission's Complaint also charges River North and Mr. Liceaga with violating Sections 5(a) and 5(c) of the Securities Act of 1933. Such allegations are not addressed in this Motion to Dismiss, and River North and Mr. Liceaga will both seek dismissal of Count 1 at the summary judgment stage in this matter. Case: 1:19-cv-01711 Document #: 37 Filed: 05/10/19 Page 3 of 16 PageID #:128 Exchange Act of 1934 (the "Exchange Act") far beyond the scope for which they were intended. More importantly, the Commission's claims directly contrast long-established guidance set forth in prior SEC pronouncements, which make a distinction between a "trader," who is not required to be licensed with the Commission, and a "dealer," who is subject to Commission registration. If the Commission's attempt in this matter is successful, then every day trader, hedge fund, or other market participant who purchased and sold securities for a profit would be acting as an unregistered dealer and subject to sanctions. Such an outcome is unjust on its face because Congress, and not the federal courts, is the proper forum for the Commission to engage in rulemaking. Indeed, due process forbids the Commission from doing so. As set forth herein, Counts VII, VIII, and IX of the Commission's Complaint fail to state a cause of action against either River North or Mr. Liceaga upon which relief may be granted. II. THE COMMISSION'S ALLEGATIONS Plaintiff's allegations in its Complaint relevant to this Motion to Dismiss are as follows: River North is based in Chicago, and has operated as an investment firm that buys and sells penny stocks through the conversion of promissory notes since 2013. Complaint at ¶19. According to its website, River North invests in small and microcap businesses, and purchases penny stocks from certain holders of convertible debt instruments and then sells those shares. Id. at ¶44 During the time period at issue in this matter, River North purchased and sold 60 other microcap securities, acquiring more than 9 billion shares from these companies and obtaining more than $14 million from the sale of those shares. Id. at ¶45. "River North operated as a [securities] dealer, and as part of its regular business regularly engaged in buying and selling securities for its own account. . . without being registered with the SEC." Id. at ¶134 Mr. Liceaga is River North's President and sole manager. Id. at ¶20. He "has testified that he 2 Case: 1:19-cv-01711 Document #: 37 Filed: 05/10/19 Page 4 of 16 PageID #:128 specialized in purchasing convertible debt and aged debt instruments." Id. at ¶45. Based upon the foregoing allegations, the Commission has charged River North with acting as an unregistered securities dealer in violation of Section 15(a) of the Exchange Act (Count VII) for buying and selling the NTEK and NTGL shares for River North's own accounts, and has charged Mr. Liceaga with (1) aiding and abetting River North's violations of Section 15(a) of the Exchange Act (Count VIII) and (2) acting as a control person over River North in connection with its buying and selling the NTEK and NTGL shares at issue in this matter (Count IX). Id. at ¶¶133-145.2 For the purposes of the instant motion, it is important to note the absence of certain allegations in the Commission's Complaint. For example, the Complaint correctly does not allege that River North or Mr. Liceaga ever (a) advertised or otherwise held itself out publicly as willing to buy or sell securities for or from its own account on a continuing basis (contemporaneously), (b) purchased or sold securities as principal from or to customers, (c) carried a dealer inventory in securities, (d) quoted a market in any securities, (e) provided investment advice, (f) extended or arranged for the extension of credit in connection with securities transactions, (g) ran a book of repurchase and/or reverse repurchase agreements, (h) used an interdealer broker for securities transactions, (i) loaned securities to customers, (j) issued or originated securities, (k) guaranteed contract performance or indemnified parties for any loss or liability from the failure of a transaction to be successfully consummated, or (l) participated in a selling group or acted as an underwriter. As detailed more fully herein, the absence of such allegations is significant in connection with this Court's review of the conclusory allegations in the Commission's Complaint. 2 See supra note 1. 3 Case: 1:19-cv-01711 Document #: 37 Filed: 05/10/19 Page 5 of 16 PageID #:128 III. ARGUMENT In this matter, the Commission is essentially attempting to cast River North and Mr. Liceaga in the same mold as a Merrill Lynch, UBS, or the numerous other securities dealers who buy and sell securities contemporaneously, make markets in securities issued by public companies, and engage in numerous other activities common to securities dealers. After engaging in a lengthy investigation into River North's and Mr. Liceaga's activities and finding no fraudulent conduct, the Commission is now attempting to use this Court to reverse its longstanding public policy against taking enforcement actions against "traders," who simply buy and sell securities for their own benefit and self-interest but who are not in the business of providing services to third-parties. As set forth below, the Commission's Complaint is vague and conclusory, and fails to meet the requirements of Rule 12(b)(6). A. THE SEC IS AN ORDINARY LITIGANT WHEN IT INVOKES THE PROCESSES OF THE COURTS As a preliminary matter – and at the risk of stating the obvious – although the SEC is a governmental agency, once it becomes a litigant and seeks redress from the court, it is subject to the same pleading and discovery standards as any other litigant. See SEC v. Collins & Aikman Corp., 256 F.R.D. 403, 414 (S.D.N.Y. Jan. 13, 2009) ("Like any ordinary litigant, the Government must abide by the Federal Rules of Civil Procedure."). Accordingly, the Commission is not entitled to any leniency from this Court for its pleading deficiencies detailed herein. B. STANDARD OF REVIEW – MOTIONS TO DISMISS UNDER RULE 12(b)(6) Under Fed. R. Civ. P. 12(b)(6), a complaint that fails to plead facts sufficient to "state a claim to relief that is plausible on its face" should be dismissed. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 570 (2007)). Moreover, even 4 Case: 1:19-cv-01711 Document #: 37 Filed: 05/10/19 Page 6 of 16 PageID #:128 though the Court must accept the Plaintiff's allegations as true at the pleading stage, "allegations in the form of legal conclusions are insufficient to survive a Rule 12(b)(6) motion." Iqbal, 556 U.S. at 678. "[T]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice." Shield Tech. Corp. v. Paradigm Positioning, LLC, 908 F. Supp. 2d 915, 917 (N.D. Ill. 2002). To survive a Rule 12(b)(6) motion, the Commission's Complaint "must not only provide defendant[s] with fair notice of a claim's basis but must also be facially plausible." See SEC v. Ustian, 229 F.Supp.3d 739, 760 (Jan. 24, 2017 N.D. Ill.). As further articulated herein, Plaintiff has failed to state a claim against either River North or Mr. Liceaga with respect to Counts VII, VIII, and IX of its Complaint, and dismissal of such claims is appropriate. C. RIVER NORTH ACTED AS A TRADER, AS OPPOSED TO A DEALER, AND THE COMMISSION HAS NOT ALLEGED OTHERWISE 1. The SEC has Long Recognized the Distinction Between "Dealers" and "Traders" Count VII of the Complaint alleges that River North acted as an unregistered securities dealer. Complaint at ¶¶133-136. Section 3(a)(5)(A) of the Exchange Act defines "dealer" as, in pertinent part, "any person engaged in the business of buying and selling securities (not including security-based swaps, other than security-based swaps with or for persons that are not eligible contract participants) for such person's own account through a broker or otherwise." 15 U.S.C. §78c(a)(5)(A). The primary factors in determining whether a person is a "dealer" are whether the person trades for his or her own account and whether he or she does so "as part of a regular business." Robert L.D. Colby, Lanny A. Schwartz, and Zachary J. Zweilhorn, Broker-Dealer Regulation, Chapter 2, at §2.3.1.A. (Practicing Law Institute, 2016) (relevant portion attached 5 Case: 1:19-cv-01711 Document #: 37 Filed: 05/10/19 Page 7 of 16 PageID #:128 hereto as "Exhibit A"). Unless an exemption is available, dealers must register with the SEC pursuant to Section 15(a) of the Exchange Act. Section 3(a)(5)(B) of the Exchange Act contains an exemption for "a person that buys or sells securities (not including security-based swaps, other than security-based swaps with or for persons that are not eligible contract participants) for such person's own account, either individually or in a fiduciary capacity, but not as part of a regular business." 15 U.S.C. §78c(a)(5)(A). The SEC has taken the position that a person must buy and sell securities – or be willing to do so – contemporaneously to be considered a "dealer." See, e.g., National Council of Savings Institutions, SEC No-Action Letter, 1986 SEC No-Act. LEXIS 2609 (July 27, 1986) (discussing the distinction between