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United States Securities and Exchange Commission v. Sierra Brokerage Services

April 5, 2007

UNITED STATES SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
SIERRA BROKERAGE SERVICES, INC., ET AL., DEFENDANTS.



The opinion of the court was delivered by: John D. Holschuh, Judge United States District Court

Magistrate Judge Abel

MEMORANDUM OPINION AND ORDER

This matter is currently before the Court on the Motion of Defendants Michael M. Markow ("Markow") and Global Guarantee Corp. ("Global Guarantee") (collectively, "the Markow Defendants") to Set Aside Entry of Default (R. at 185) and Plaintiff's Motion for Default Judgment (R. at 187).*fn1 For the reasons set forth below, the Court grants the Markow Defendants' Motion to Set Aside Entry of Default and denies Plaintiff's Motion for Default Judgment.

I. Background

On April 11, 2003, Plaintiff Securities and Exchange Commission ("SEC") filed its Complaint in this action against twelve defendants alleging several violations of securities laws. As to the Markow Defendants, in Count I the SEC alleges violations of section 5(a) and (c) of the Securities Act of 1933 ("Securities Act"), which prohibits the offering or selling of securities when no registration statement for those securities is in effect and when no exemption from registration is available. Counts VIII and IX allege that the Markow Defendants failed to report their beneficial ownership of a security in violation of multiple sections of the Securities Exchange Act of 1934 ("Exchange Act") and rules promulgated by the SEC thereunder. Violations of the Securities Act's general anti-fraud provision, section 17(a), are alleged in Counts II (section 17(a)(1)) and III (section 17(a)(2) and (a)(3)). Count IV alleges that the Markow Defendants employed a manipulative or deceptive device or contrivance in connection with the sale or purchase of a security, in violation of section 10(b) of the Exchange Act and SEC Rule 10b-5.

A. Creation of MAS XI and the Distribution of Its Shares

Defendant Aaron Tsai created MAS Acquisition XI Corporation ("MAS XI") in October 1996. When MAS XI was formed, Tsai was the corporation's chairman, president, and treasurer. Tsai caused MAS XI to issue him 8.5 million shares of the corporation's common stock. (MAS XI Form 10-SB, at 26 (Apr. 16, 1999), Pl.'s Mem. Supp. Ex. 21, July 20, 2005.) MAS XI was a shell corporation, and it hoped to complete a "reverse merger" with a private company.*fn2 MAS XI issued shares of stock to five "former directors" both in January 1997 and September 1998. (Id.) These "former directors" were friends and acquaintances of Tsai, and at least three of the five never performed any services for MAS XI. (Tsai Dep. 92-93, Oct. 19, 2004, R. at 121.) Tsai gifted 50,000 of his own shares of MAS XI to each of the five "former directors." (MAS XI Form 10-SB/A, at 27 (June 22, 1999), Pl.'s Mem. Supp. Ex. 22, July 20, 2005.) Tsai transferred these shares to expand the corporation's shareholder base so as to improve the possibility of the shares being sold to the public in the future. (Tsai Dep. 30:19-31:17, Mar. 25, 2002, Pl.'s Mem. Supp. Ex. 3, July 20, 2005.)

The five "former directors" never received issued stock certificates for the shares that they owned as required by MAS XI's bylaws. (Tsai Dep. 65:8-66:13, Oct. 19, 2004.) Tsai did not follow other formalities of the corporation as well. For instance, Tsai held annual shareholders' meetings to elect directors, but only he attended. (Id. at 181:4-182:9.)

Using blank stock power forms signed by the five shareholders, Tsai transferred some of the shares of the "former directors" to an additional 28 individuals. (Id. at 104:14-105:22, 120:23-121:20.) The additional 28 people were either a friend of Tsai or a person that Tsai had met at Bible study. (Id. at 121:8-10.) Tsai executed these transfers "to further the purpose of the company . . . to become publicly traded." (Id. at 110:11-111:14.) The five "former directors" were unaware to whom they transferred their shares. Tsai determined the number of shares that were transferred from the "former directors" to each of the additional 28 (and from whom each transferee would receive his or her shares) on a "more or less arbitrary" basis. (Id. at 108:8-12, 109:3-6, 110:3-6.)

With the assistance of Kensington Capital Corporation ("Kensington"), Tsai sought to have the shares held by the 33 shareholders cleared for public trading by the National Association of Securities Dealers ("NASD"). Kensington had submitted a Form 211 application to NASD earlier, but it was deemed deficient by NASD because the tradeable shares were concentrated in the hands of only five shareholders. After Tsai expanded the number of shareholders to 33, Kensington sent a list to NASD showing that the original five shareholders had further distributed their shares. (Letter from Julio Serrano, Trader, Kensington, to David W. McClarin, Compliance Examiner, NASD Regulation, Inc. (Sept. 1, 1999), Pl.'s Mem. Supp. Ex. 28, July 20, 2005.) On December 13, 1999, NASD cleared the MAS XI shares for trading on the Over-the-Counter Bulletin Board. (Letter from David W. McClarin, Compliance Examiner, NASD Regulation, Inc., to Julio Serrano, Trader, Kensington (Dec. 13, 1999), Pl.'s Mem. Supp. Ex. 29, July 20, 2005.)

B. Reverse Merger Between MAS XI and Bluepoint Linux Software Company

Beginning in 1999, Defendant Yongzhi Yang worked as a consultant for Shenzhen Sinx Software Company ("Shenzhen Sinx"), a Chinese company.*fn3 (Yang Dep. 16:22-23, 51:11-23, Dec. 1, 2004, R. at 113.) Shenzhen Sinx had developed a Chinese version of the Linux computer operating system. However, because Shenzhen Sinx was required to publish the source code for their software, competitors were able to copy Shenzhen Sinx's source code and integrate it into their own products. (Shenzen Sinx Software Co., Ltd. Business Plan at AT000226, Pl.'s Mem. Supp. Ex. 31, July 20, 2005.) This business risk was identified in Shenzhen Sinx's business plan, to which Yang, Markow, and Tsai all had access. (Yang Dep. 61:18-25, Dec. 1, 2004; Tsai Dep. 189:3-14, 191:4-7, Oct. 19, 2004; Markow Dep. 70:15-19, Dec. 3, 2004, R at. 122.) At the end of 1999, the company had total net sales of $23,027.

As a consultant for Shenzhen Sinx, Yang sought out a public shell corporation with which the company could merge. (Yang Dep. 46:12-19, Dec. 1, 2004.) Yang was introduced to Markow through Defendant François Goelo, a resident of the Cayman Islands whom Yang had met through Internet sites related to investing. (Goelo Dep. 12-14, May 24, 2004, R. at 118.) Goelo has described Markow as a "professional" in completing reverse mergers. (Id. at 14:4-20.) Through the execution of a "Plan and Agreement of Reorganization," MAS XI and Shenzhen Sinx on January 7, 2000 agreed to a reverse merger of the two companies. (Plan and Agreement of Reorganization, Pl.'s Mem. Supp. Ex. 30, July 20, 2005.) Markow states that he facilitated the reverse merger between MAS XI and Shenzhen Sinx by identifying the shell corporation, overseeing the creation of the share exchange agreement, and lining up market makers for the merged corporation's stock, as well as engaging in other coordination activities. (Markow Dep. 103:12-16, Mar. 1, 2002, Pl.'s Mem. Supp. Ex. 6, July 20, 2005.)

On the day that the merger agreement was executed, MAS XI effected a 15-for-1 forward stock split such that at the time of the merger, MAS XI had 20 million shares of common stock outstanding. (BluePoint Linux Software Corp. Form 8-K at 2 (Feb. 18, 2000), Pl.'s Mem. Supp. Ex. 32, July 20, 2005.) Per the merger agreement, the directors of Shenzen Sinx received 15.5 million of these shares, which were restricted as to resale, as consideration for delivering all of the Chinese company's shares of common stock to MAS XI.*fn4 (Plan and Agreement of Reorganization art. I, §§ 1.01 to 1.02; see BluePoint Linux Software Corp. Schedule 14f-1 at AT000295 (Feb. 18, 2000), Pl.'s Mem. Supp. Ex. 39, July 20, 2005.) Thus, after the merger was completed, Shenzen Sinx was a wholly-owned subsidiary of MAS XI with MAS XI controlled by the former directors of Shenzen Sinx. (See Schedule 14f-1 at AT000294-AT000295.) MAS XI changed its name to BluePoint Linux Software Corp. ("BluePoint") on February 17, 2000. (Id. at AT000294.)

The merger agreement does not provide for any transactions involving the 4.5 million shares that reflect the difference between the 20 million shares outstanding and the 15.5 million shares delivered to the former directors of Shenzen Sinx. After the 15-for-1 forward split on January 7, 2000, 3.75 million of the shares were held by Tsai's 33 friends and acquaintances.*fn5 (MAS Acquisition XI Corp. Transaction List (Feb. 24, 2000), Pl.'s Mem. Supp. Ex. 27, July 20, 2005.) Coincident to the reverse merger, Tsai arranged for the sale of the shares held by the 33 shareholders using stock power forms signed by the shareholders. (Tsai Dep. 77, Mar. 25, 2002.) The parties offer differing accounts of this transaction.

By February 7, 2000, Markow had received just under $250,000 in wire transfers from Yang, Luo, and Goelo. (Wire Transfers from Goelo, Yang, and Luo, Pl.'s Mem. Supp. Ex. 34, July 20, 2005.) Goelo sent $91,250 and Yang and Luo both sent $79,365. (Id.) Yang and Goelo both testified that the $250,000 that Markow received was the price to obtain the shares from the 33 MAS XI shareholders. (Yang Dep. 30-31, Feb. 28, 2002, Pl.'s Mem. Supp. Ex. 12, July 20, 2005; Goelo Dep. 21-23, May 24, 2004.) Markow sent a cashier's check dated February 8, 2000 in the amount of $250,000 to Tsai. Markow originally testified that the $250,000 that he collected from Yang, Luo, and Goelo was payment for his work in completing the transaction and that the $250,000 that he sent to Tsai was payment to acquire the 3.75 million shares held in the names of the 33 shareholders. (Markow Dep. 56-57, 69, 74, Mar. 1, 2002.) Markow now contends, as does Tsai, that the $250,000 that Tsai received from Markow was Tsai's finder's fee. (Markow Dep. 136, Dec. 3, 2004; Markow Decl. ¶ 2, Nov. 12, 2004, attached to Defs.' Br. Opp'n, Nov. 12, 2004.) Tsai testified that the $250,000 was compensation for his role in the reverse merger. (Tsai Dep. 19-20, Mar. 25, 2002.)

Tsai delivered the 3.75 million shares held by the 33 shareholders to Markow in certificate form, along with stock power forms signed by the shareholders. (Id. at 107:24-108:6.) Afterwards, Markow sent a $100 check, dated February 14, 2000, to each of the 33 shareholders for payment of their shares, regardless of the number of shares that they held. (Markow Dep. 97:10-98:19, Mar. 1, 2002.) At the time that they signed the stock power forms, the 33 shareholders did not know how much money that they would receive for their shares. (Tsai Dep. 75:4-14, Mar. 25, 2002.) Tsai has acknowledged that most of the shareholders were not aware of the merger of MAS XI and Shenzen Sinx at the time that their shares were transferred to Markow. (Tsai Dep. 227:11-228:20, Oct. 19, 2004.)

After receiving the 3.75 million shares from Tsai, Markow had the stock certificates in the names of the 33 shareholders cancelled and had new certificates issued in the names of 14 new shareholders. (Letter from Markow to Signature Stock Transfer (Feb. 22, 2000), Pl.'s Mem. Supp. Ex. 41, July 20, 2005.) These 14 shareholders were Yang, Luo, family members of Yang and Luo, Goelo's then-girlfriend, and entities controlled by Yang, Luo, Goelo, and Markow. (Id.) Of the 3.75 million shares of BluePoint held by the 14 new shareholders, 2.43 million were deposited into accounts at Defendant Sierra Brokerage Services, Inc. ("Sierra"). (See Helpingstine Decl. ¶¶ 17, 24, 34, 41, Pl.'s Mem. Supp. Ex. 1, July 20, 2005.)

C. Alleged Price Manipulation

The SEC alleges that Yang, Luo, Goelo, Markow, and the entities that they control (collectively, the "Promoter Defendants"), together with Sierra and Sierra traders Richard Geiger and Jeffrey Richardson, engaged in a scheme known as a "pump and dump" whereby the Promoter Defendants and the Sierra traders artificially inflated the price of BluePoint stock, sold their shares when the price was high, and profited millions of dollars. To facilitate the scheme, the SEC asserts that the Promoter Defendants promoted the stock on Internet message boards related to investing and through emails to individual investors. These messages provided information about BluePoint, indicated that the float (the shares that could be publically traded) was tightly controlled, apprised recipients of the day on which trading would commence, and advised as to what the opening price of the stock would be. The SEC contends that the Promoters disseminated this information to increase the demand for the stock.

Trading of BluePoint stock on the Over-the-Counter Bulletin Board began on Monday, March 6, 2000. The initial trading in BluePoint involved the Promoter Defendants. Before trading began, Geiger committed Sierra to purchasing 100,000 shares from Yang. (Geiger Dep. 34:20-35:6, Jan. 29, 2002, Pl.'s Mem. Opp'n Ex. 2, Aug. 15, 2005.) Sierra bought these shares from Defendant K & J Consulting, a corporation controlled by Yang, at 9:46 a.m. for $6 per share. (Sierra Order Tickets for BluePoint (Mar. 6, 2000), Pl.'s Mem. Supp. Ex. 57, July 20, 2005.) More trades followed, and the price of BluePoint quickly surged, reaching a price of $21 per share by 10:28 a.m. (Trade Inquiry Report 5, Rosen Decl. Ex. 2, July 18, 2005, R. at 120-3.)

The SEC alleges that the Promoter Defendants and Sierra structured transactions that allowed them to set the initial price of the stock. The transactions also allegedly increased demand for the stock, which influenced the price of the stock. Further, the SEC asserts that the Promoter Defendants controlled the float and that this allowed them to dominate the market on the first day of trading. Finally, the Promoter Defendants allegedly had an understanding to not sell their shares, and this control of the supply kept the price of the stock from falling during the early days of trading of BluePoint.

Defendants deny that they engaged in any efforts to manipulate the price of BluePoint stock; instead, they maintain that the undisputed facts establish that they did not interfere with the forces of supply and demand of BluePoint stock. They argue that there was significant demand for shares of BluePoint and that other market participants were responsible for the price surge on the first day of trading. Defendants also state that Sierra did not dominate or control the volume of shares sold on the market such that it was able to artificially increase the price of BluePoint stock.

II. Relevant Procedural History

Baker & Hostetler LLP represented both Markow and Global Guarantee from the inception of this action until the Court granted its motion to withdraw as counsel in its Order of February 17, 2006. (R. at 156.) In this Order, the Court directed both Markow and Global Guarantee to retain new counsel and have counsel enter an appearance within thirty days.*fn6 The Court also ordered the Clerk to serve a copy of the order on both Markow and Global Guarantee.*fn7 By March 27, 2006, neither Markow nor Global Guarantee had responded to the Court's February 17 Order. By that date, the Court had noticed that the docket reflected that S. Lee Terry Jr. represented Markow and Global Guarantee but that Terry had neither made an appearance nor moved for admission to the bar of the Southern District of Ohio pro hac vice. The Court ordered Terry to make an ...


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