Monday, June 8, 2015
Sixth Circuit Affirms Decision on Securities Fraud
On May 21, the Sixth Circuit Court of Appeals upheld the determination of securities fraud brought by the Securities Exchange Commission against Joseph Paul Zada and his controlled entity Zada Enterprises, LLC. United States Securities and Exchange Commission v. Zada, No. 14-1346 (6th Cir. May 21, 2015).
Zada had structured an apparent Ponzi scheme on the notion that he would collect investments, combine those investments with funds made available by members of the Saudi Arabian royal family, buy oil at low prices, store it and resell at high prices. It was all a scam; Zada had no connection to the Saudi Arabian royal family, but he did go so far as to hire actors willing to pretend to be members of the Saudi royal family at a party thrown for his investors. Even as Zada promised incredibly high rates of return, the monies he received from his various investors were reflected in promissory notes. He alleged that these notes were necessary in order to protect the interests of the investors should Zada pass away.
On appeal, one argument made by Zada was that the promissory notes were not themselves “securities” subject to the Securities Act of 1933 and the Securities Exchange Act of 1934. In response to this position, the court undertook an analysis of the definition of what is a “security”, which under both the ‘33 and ‘34 Acts include a “note.” That said, not every “note" is a “security”; for example, the note executed in connection with financing a house, linked as it is typically with a mortgage or deed of trust, is not treated as a “security.” Explicating the test employed as to determining when a note is or is not to be treated as a security, the Sixth Circuit determined that all of the factors tended to support the characterization of these notes as securities. Zada, having not registered the securities or structured the transaction in a way to avoid the requirement that their sale be registered, had thus violated the federal securities laws.
That left open the question of fraud. As Zada had assured their investors that their money would be used to buy and hold oil, when in fact the proceeds had been used largely to fund Zada’s highflying lifestyle, it was clear that he had “lied to the investors” and as such committed securities fraud.
At the trial court, Zada was ordered to pay to the SEC some $56,000,000 in disgorgement damages, plus an equal amount of $56,000,000 as a civil penalty. Zada challenged the civil penalty, noting that it had in part been based upon his “lack of acceptance of responsibility”; he alleged that this filing was inappropriate in that it ran afoul of his invocation of his Fifth Amendment privilege against self-incrimination. The Sixth Circuit found that the various factors identified by the trial court cumulatively justified the civil penalty notwithstanding the interface of his refusal to accept responsibility and his Fifth Amendment rights.