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Securities & Exchange Commission v. Mahabub

United States District Court, D. Colorado

September 5, 2019



          William J. Martinez, United States District Judge.

         This is a securities fraud case that Plaintiff Securities and Exchange Commission (“SEC”) brought against Taj “Jerry” Mahabub (“Mahabub”) and the company he founded, GenAudio, Inc. (“GenAudio”) (together, “Defendants”). The SEC asserted various theories of liability under the Securities Act of 1933 (“Securities Act”), 15 U.S.C. §§ 77a et seq., and the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. §§ 78a et seq. The SEC moved for summary judgment on all theories of liability, and the Court granted that motion in part (“Summary Judgment Order”). See SEC v. Mahabub, 343 F.Supp.3d 1022 (D. Colo. 2018) (ECF No. 95). The Court then ordered the SEC to state “whether it wishes to go to trial to establish Defendants' liability on claims for which the Court has not granted summary judgment and/or on a broader base of facts than the Court accepted when granting summary judgment, ” or, on the other hand, “whether it is willing to proceed directly to the remedies phase of this case (abandoning those claims that would otherwise need to go to trial on liability).” Id. at 1050. The SEC chose the latter course. (See ECF No. 99.)

         Currently before the Court is the SEC's Motion for Final Judgment Seeking Remedies Against Defendants Taj Jerry Mahabub and GenAudio, Inc. and to Establish a Fair Fund. (ECF No. 110.) Defendants, represented separately, each filed a response (ECF Nos. 111, 112), and the SEC then filed separate replies (ECF Nos. 113, 114). For the reasons explained below, the Court grants the remedies the SEC requests except that the Court will limit Mahabub's joint and several liability with GenAudio to the amounts the SEC has shown to be Mahabub's profits from GenAudio's stock sales. The Court will also require the SEC to submit a new prejudgment interest calculation.

         I. BACKGROUND

         The Court's findings of fact and conclusions of law in the Summary Judgment Order are extensive and need not be repeated here. The Court incorporates them by reference and offers the following summary, for context.

         GenAudio developed and marketed “AstoundSound, ” a software-based system for processing normal stereo audio to make it sound three-dimensional (e.g., as if the sound is coming from behind listener, from far away, etc.). Summary Judgment Order, 343 F.Supp.3d at 1028. Mahabub is GenAudio's founder and served as its CEO and Chairman of the Board from 2009 to 2012. Id.

         Beginning in July 2009 or thereabouts, and continuing for roughly the next three years, Mahabub had various levels of discussions with engineers at Apple, Inc., about integrating AstoundSound into Apple's computers and portable devices. Id. at 1029-37. No one higher than mid-level executives at Apple ever became aware of these discussions. Id. at 1032-36. However, when communicating with GenAudio employees, investors, and prospective investors, Mahabub routinely exaggerated or fabricated details about Apple's interest. See id. Mahabub claimed, for example, that Apple's senior vice president of worldwide marketing, Phil Schiller, was making specific plans to incorporate AstoundSound into particular product rollouts, and that CEO Steve Jobs had taken a personal interest in AstoundSound. Id. at 1030-36. Ultimately, Apple and GenAudio never reached any deal. Id. at 1037.

         In the Summary Judgment Order, the Court found no genuine dispute that Mahabub, acting on GenAudio's behalf, knowingly or recklessly made six materially false or misleading statements in connection with two offerings of GenAudio securities, in violation of Exchange Act § 10(b) (15 U.S.C. § 78j(b)), and Rule 10b-5(b) (17 C.F.R. § 240.10b-5(b)). Because this is an SEC enforcement action, the SEC did not need to prove that anyone relied to his or her detriment on those statements. See SEC v. Wolfson, 539 F.3d 1249, 1256 (10th Cir. 2008). However, the SEC nonetheless demonstrated a lack of genuine dispute that one of those six misrepresentations prompted a $15, 000 investment in GenAudio. Summary Judgment Order, 343 F.Supp.3d at 1046. That representation was therefore also a violation of Securities Act § 17(a)(2) (15 U.S.C. § 77q(a)(2)). See id. at 1042-43 (holding that Securities Act § 17(a)(2) contains a causation requirement, even in an SEC enforcement action). The SEC claimed that numerous other statements made by Mahabub were likewise violations of the Exchange Act or the Securities Act, or both, but the Court found that all statements beyond the six just noted raised genuine, material factual disputes. Id. at 1043-44 nn.11-12.

         Finally, the Court held that GenAudio and Mahabub had both sold unregistered GenAudio securities without qualifying for any registration exemption. Id. at 1039-41. Accordingly, they had violated Securities Act § 5(a) and (c) (15 U.S.C. §§ 77e(a) & 77e(c)). These unregistered securities offerings were the same securities offerings that the Court found to be infected by the misleading statements for which Defendants were liable under Exchange Act § 10(b), Rule 10b-5(b), and Securities Act § 17(a)(2). See Summary Judgment Order, 343 F.Supp.3d at 1039-41.

         II. ANALYSIS

         A. Injunction Against Further Violations

         The SEC first asks the Court to enjoin Defendants from further violations of federal securities laws. (ECF No. 110 at 9-11.)[1]

         1. Legal Standard

         Securities Act 20(b) states that, “upon a proper showing, a permanent or temporary injunction or restraining order shall be granted without bond” against a person whom the SEC proves to have “engaged . . . in any acts or practices which constitute or will constitute a violation of the provisions of [the Securities Act].” 15 U.S.C. § 77t(b). Using materially identical language, Exchange Act § 21(d)(1) similarly authorizes an injunction against violations of the Exchange Act and its implementing regulations. See 15 U.S.C. § 77u(d)(1).

         The “proper showing” required by these statutes places the burden on the SEC to demonstrate

a reasonable and substantial likelihood that the defendant, if not enjoined, will violate securities laws in the future. Determination of the likelihood of future violations requires analysis of several factors, such as the seriousness of the violation, the degree of scienter, whether defendant's occupation will present opportunities for future violations and whether defendant has recognized his wrongful conduct and gives sincere assurances against future violations. Although no single factor is determinative, [the Tenth Circuit has] previously held that the degree of scienter bears heavily on the decision. A knowing violation of [Exchange Act §] 10(b) or [Securities Act §] 17(a)(1) will justify an injunction more readily than a negligent violation of [Securities Act] § 17(a)(2) or (3). However, if there is a sufficient showing that the violation is likely to recur, an injunction may be justified even for a negligent violation of § 17(a)(2) or (3).

SEC v. Pros Int'l, Inc., 994 F.2d 767, 769 (10th Cir. 1993) (citations and internal quotation marks omitted).

         2. Application to Mahabub

         The SEC argues:

• Mahabub's violations were “serious and repeated, ” given the multiplicity of false statements and the length of time over which he made them;
• the sale of unregistered securities was also serious given that it had been ongoing for many years;
• Mahabub's misrepresentations were “calculated”;
• Mahabub continues to serve as GenAudio's CEO, and he is now also the CEO of a new company for which he has solicited investment; and
• Mahabub has never acknowledged his wrongful conduct or given assurances against future violations.

(ECF No. 110 at 10-11.)

         Mahabub never directly responds to any of these accusations. The only portion of his response brief that comes close is an argument related to the penalties the SEC seeks (addressed in Part II.C.2, below), where admission of wrongdoing is also a factor. (See ECF No. 112 at 4.) In that context, he notes that he “does not oppose” the director-officer bar (another remedy the SEC seeks, addressed in Part II.D, below). (Id.) This non-opposition, he says, shows that “he understands and accepts that [the director-officer bar] appropriately follows the Court's order on the SEC's summary [judgment] motion.” (Id.)

         To the extent this was also meant to address (indirectly) the request for an injunction, it is decidedly not an acknowledgment of wrongful conduct. It is, rather, a carefully worded attempt to sound contrite without admitting anything other than uncontroversial proposition that a director-officer bar is often an appropriate remedy against those who violate securities laws.

         Given Mahabub's failure to address the factors relevant to an injunction, or to contest the SEC's argument in this regard, the Court finds that Mahabub has conceded that the SEC has made a proper showing for an injunction against him. The Court will therefore award the requested injunction against Mahabub.

         3. Application to GenAudio

         The SEC argues that its showing as to Mahabub applies equally to GenAudio because Mahabub acted on GenAudio's behalf and can continue to do so, as its CEO. (ECF No. 110 at 10-11.) GenAudio responds that there can be no reasonable likelihood of a future violation because “GenAudio is a defunct corporation that has ceased operations and is no longer engaged in the sale of securities.” (ECF No. 111 at 10.) GenAudio supports this assertion with a declaration from Mahabub explaining that he is the only remaining GenAudio employee, that GenAudio does not have any open bank accounts, and that GenAudio is no longer operating or engaging in the sale of securities. (ECF No. 111-1.) The SEC replies with a declaration from GenAudio shareholder Dell Skluzak that no one from GenAudio has ever notified him that “the company is defunct and no longer has any ongoing operations.” (ECF No. 113-1 ¶ 7.) Moreover, Skluzak says that GenAudio still has assets (at least three recently-issued patents) and that a third-party valuation report from 2010 values a non-exclusive AstoundSound licensing regime at slightly more than $1 billion. (Id. ¶¶ 3-5.)

         Although the 2010 valuation report is of questionable value today, the Court is persuaded that there remains at least a reasonable probability that GenAudio will operate again and will sell securities. Accordingly, the Court will issue the requested injunction against GenAudio.

         B. Disgorgement & Prejudgment Interest

         The SEC next seeks disgorgement and prejudgment interest on the disgorged amounts. (ECF No. 110 at 11-14.)

         1. Disgorgement, ...

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