CMKM says SEC used tainted evidence, case still failed
2005-06-20 20:27 ET - Street Wire
Also Street Wire (U-*SEC) U.S. Securities and Exchange Commission
by Lee M. Webb
CMKM Diamonds Inc., a massively diluted pink sheet company headed by Saskatchewan native Urban Casavant, filed a Jun. 17 posthearing brief claiming that the U.S. Securities and Exchange Commission used tainted evidence in a May 10 hearing, but still failed to make its case for revocation of the company's stock registration.
Rather than suspending or revoking the company's stock registration, CMKM lawyer Donald Stoecklein is asking Chief Administrative Law Judge Brenda P. Murray to issue an order allowing the company time to compile auditable financial statements and prepare annual and quarterly reports.
According to the SEC, CMKM filed a fraudulent Form 15 on July 22, 2003, claiming that it had less than 300 shareholders of record and was suspending its reporting obligations. In fact, CMKM had 698 shareholders of record as of that date.
In a June 2 posthearing brief, SEC lawyers Leslie Hakala and Gregory Glynn claim that CMKM used the fraudulent Form 15 to duck its reporting obligations and "operate in shadows and in secret."
Considering the relevant Steadman factors, a guide to determine the appropriate sanction, the U.S. regulator argues that CMKM's stock registration should be revoked.
According to the SEC, CMKM's actions were egregious; the company's breaches of securities regulations were recurring; its misconduct was knowing or reckless; assurances against future violations cannot be trusted; the company either does not appreciate the magnitude and potential consequences of its misconduct or is misrepresenting them; and the company's reporting violations are highly likely to continue.
Mr. Stoecklein argues otherwise.
Tainted
According to CMKM's lawyer, there were not any violations for failing to file periodic reports between July of 2003 and April of 2005 because, pursuant to the July 22, 2003, Form 15, the company was not required to file such reports.
Mr. Stoecklein argues that an amended Form 15 filed on Feb. 17 of this year reinstated CMKM's reporting obligations, but "within 60 days" of that filing. Therefore, says Mr. Stoecklein, the company's obligations did not start until April 17, so CMKM could not have been in violation of its reporting obligations when the SEC instituted proceedings on March 16.
CMKM's lawyer argues that the original Form 15 incorrectly claiming the company had less than 300 shareholders of record "was filed in good faith and the SEC has not demonstrated any facts to the contrary."
Mr. Stoecklein goes on to claim that he is appalled that the SEC used some correspondence between the regulator and CMKM's former counsel as support for its allegation that the company was aware of its reporting obligations in December of 2004 and that the original Form 15 filing was made in "bad faith."
According to Mr. Stoecklein, that correspondence is tainted evidence because, contrary to the doctrine of Brady v. Maryland and Judge Murray's prehearing instructions, that exculpatory material from an investigative file involving associated company U.S. Canadian Minerals Inc. was not provided to CMKM until "a couple of days prior to the hearing."
Moreover, the lawyer argues, that correspondence does not support the SEC's claim that the original Form 15 was fraudulent. Rather, says Mr. Stoecklein, the correspondence asserts the position "that the then counsel for CMKM believed that the filing of the Form 15 was made in good faith."
"The Division leans heavily on this correspondence to assert the position that CMKM has continued to act in bad faith," Mr. Stoecklein argues. "Even if we allow the argument based upon this Brady tainted evidence to reflect that CMKM knew in December of 2004 that there was an issue over the Form 15, the statements in the exhibits reflect that CMKM did nothing about the filing because it believed the original Form 15 was filed in good faith and the Division produced no evidence at the hearing to the contrary."
According to Mr. Stoecklein, Judge Murray clearly indicated in the prehearing conference that unless she had some evidence that the Form 15 was "a bad faith filing," she was "going to have to take it was a good faith failing."
"The Division has failed to produce such evidence of a bad faith filing," Mr. Stoecklein claims.
Turning to his review of the relevant Steadman factors, Mr. Stoecklein argues that the SEC has not shown specific facts to warrant "such a harsh punishment of revocation."
"More specifically, the facts argued by the Division and presented by CMKM Diamonds suggest a concerted effort made on the behalf of the respondent to regain compliance and provide public information to its investing stockholders," Mr. Stoecklein claims.
Not egregious
Contrary to the SEC's claim, Mr. Stoecklein argues that CMKM's conduct was not egregious.
According to Mr. Stoecklein, the SEC "continually relies on the argument that CMKM filed a fraudulent Form 15 merely because the party filing the document typed in the number 300" as the approximate number of holders of record.
"No testimony has been presented that either supports or confirms fraudulent or bad faith filing other than the Division's own evidence," Mr. Stoecklein states. "The Division had the burden of proof in establishing such fraudulent filing and did not meet the burden."
CMKM's lawyer goes on to say that the only evidence submitted in reference to whether the Form 15 was filed in good faith or fraudulently was a statement made in the correspondence introduced by the SEC by the company's former securities counsel Roger Glenn to lawyer David Liston "that he believed 'the company believed in good faith that it had too few shareholders to require the filing of periodic reports.'"
According to Mr. Stoecklein, there is no testimony that supports the SEC's position that the only reason CMKM wanted to bring its reports current was that it knew it was violating securities laws.
CMKM's lawyer claims that the testimony of the company's auditor Neil Levine, who quit effective the end of the hearing, was that CMKM wanted to file periodic reports so that it could move from the pink sheets to the OTC Bulletin Board or higher.
"Furthermore, the inferences made by the Division of CMKM's knowing or should have known the filing to be false are purely circumstantial and not based on logical inferences," Mr. Stoecklein claims.
The lawyer says that the SEC "alludes to CMKM's knowledge of more than 300 shareholders" by reference to a Jan. 12, 2003, board resolution authorizing the issuance of 994 million shares to 360 individuals, a press release that same month regarding an audit of the shareholders and the company's failure to contact the transfer agent.
Mr. Stoecklein claims that no evidence was produced that those 360 people received the shares, did not transfer the shares following receipt, still held the shares as of July 22, 2003, or that the shareholder list had not changed between January of 2003 and July of 2003.
CMKM's lawyer goes on to argue that the transfer agent could not recall anyone from the company contacting the firm regarding the shareholders list for July of 2003 "and therefore should not impart any such knowledge that CMKM knew or should have known that they had more than 300 shareholders."
"The conclusion made by the Commission is simply an inference that is not substantiated by any direct evidence," Mr. Stoecklein states. "The conduct of CMKM is clearly not the egregious conduct referenced in Steadman."
Not recurring
Turning to the second Steadman factor, Mr. Stoecklein claims that CMKM's conduct cannot be considered recurring because the company was not obligated to file periodic reports until April 17, 2005, 60 days after it filed an amended Form 15 correcting the inaccurate original filing.
"Since there was no duty to file, there was no recurring failure to file," the lawyer argues.
Not knowing or reckless
Mr. Stoecklein claims that CMKM did not have "scienter," nor is there any direct evidence that the company acted in bad faith.
Scienter is defined as "a mental state embracing intent to deceive, manipulate or defraud" established by knowing or reckless conduct. It can also be established by "willful blindness," a deliberate refusal to acquire information.
According to Mr. Stoecklein, the SEC would like the court to believe that Mr. Casavant asserting his Fifth Amendment privilege, the correspondence produced in violation of Brady and the testimony of the company's transfer agent Helen Bagley "provide sufficient scienter to generate fraudulent conduct."
Not so, says Mr. Stoecklein. CMKM's lawyer again refers to the "Brady tainted" correspondence as evidence that the Form 15 was filed in good faith because Mr. Glenn reportedly made that statement to Mr. Liston.
"We take issue at the implied accusation that either present counsel for CMKM or present management for CMKM had knowledge of the Division's correspondence with CMKM's prior counsel two month's earlier, when the evidence obtained on cross-examination at the hearing clearly indicated that the new counsel was unaware of the correspondence until the 'last couple of days' prior to the hearing," Mr. Stoecklein adds.
Sincerity
According to Mr. Stoecklein, the sincerity of CMKM's assurances against future violations is established by the retention of professionals to "complete the initial updated filings" and "incur the substantial costs associated with the filings."
"The testimony at the hearing is inconsistent with the view by the Division that CMKM is somehow not sincere in its assurances against future violations," Mr. Stoecklein states. "In fact, CMKM has expended significant resources in an effort to produce the appropriate legal documentation, accounting and audit functions."
Mr. Stoecklein goes on to argue that the SEC "continuously utilizes statements of CMKM as to its intentions of reinstating it reporting obligations in an attempt to persuade us that CMKM knew that it in fact had an obligation to be reporting with the Commission."
"We cannot be persuaded by this approach, since there is a lack of clarity as to why CMKM was making the statements," Mr. Stoecklein suggests.
As an example of the lack of clarity, Mr. Stoecklein points to testimony from Rendal Williams, chief executive officer of U.S. Canadian Minerals, who testified that Mr. Casavant said "he needed to be reporting" and "indicated that he was close to reporting a number of times."
The lawyer offered Mr. Levine's testimony that CMKM "wanted to get compliant and move up to the Bulletin Board or higher" as another example of lack of clarity.
"Until the filing of the Form 15/A, CMKM felt no rush to commence its reporting obligations, since it did not know it had such an obligation," Mr. Stoecklein says. "Therefore, any statements relating to CMKM's movement toward reporting have been taken out of context by the Division.
"We do not find any significant evidence that CMKM was under the belief that it was violating the federal securities laws; therefore, we do not believe the statements made by CMKM can infer a lack of assurance that it intends to maintain a reporting status once it is current in its reports."
Wrongful recognition
"CMKM recognizes the wrongful nature of the failure to confirm its outstanding stockholders in July of 2003, and its failure to maintain accurate accounting records allowing for its paid professionals to complete the preparation of annual and quarterly reports," Mr. Stoecklein claims.
CMKM's lawyer takes issue with the SEC's claim that statements made by the company in February and March lead to the conclusion that the company does not recognize the wrongfulness of its conduct.
In particular, Mr. Stoecklein addresses a February press release in which the company claimed that it was currently working toward completing an audit of its financial statements. In fact, an audit had not even started as of the date of the press release, nor had it begun by the time the May 10 hearing rolled around.
"There is no indication that CMKM believed differently than what was stated in the press release," Mr. Stoecklein says. "In fact at the time of the release, CMKM believed it was working toward producing an audit of its financial statements, in that it believed David DeSormeau, CMKM's accountant was working with Neil Levine of the firm of Bagell Josephs LLC, which firm acknowledged that it had been paid $100,000 toward the audit work after being engaged on January 10, 2005." (All amounts are in U.S. dollars.)
Mr. Stoecklein finishes his discussion of the matter with a rather awkward statement.
"We do not believe this statement in any way demonstrates a lack of wrongfulness of conduct," Mr. Stoecklein fumbles.
No more violations
"Reporting violations are not likely to occur again, once the financials are compiled and audits are completed," Mr. Stoecklein says. "CMKM is willing and able to spend the capital required to regain compliance."
According to Mr. Stoecklein, who offers no indication of when the financial statements or audits might be completed, the company is "expending significant amounts of money" to compile the financial statements, engage an auditor and prepare annual and quarterly reports.
"There is no evidence from the testimony presented that once CMKM is able to generate the reports that it will fall out of compliance," Mr. Stoecklein says.
No revocation
Wrapping up his assessment of the Steadman factors, Mr. Stoecklein argues that the SEC did not provide enough facts to support the revocation of CMKM's stock.
"The Division has not met its burden of particularity and revocation should not be granted for a company that wants to become fully compliant and has shown this desire through various testimony and tremendous resources spent on achieving this goal," Mr. Stoecklein argues.
According to CMKM's lawyer, the public interest is best served by allowing CMKM to become fully reporting again.
More time
In his concluding remarks, Mr. Stoecklein again says that the SEC did not meet its burden of proof in establishing that CMKM acted in bad faith in filing the original Form 15.
The lawyer claims that no evidence was introduced that the Form 15 was not valid, denied or withdrawn prior to Feb. 15, 2004.
According to Mr. Stoecklein, then, the proceeding cannot reach the egregiousness, recurrent nature of the infraction, obtain the scienter or determine that CMKM's conduct was wrongful as required by Steadman.
"We find no evidence to support a position that CMKM, once reporting, will succumb to future violations," Mr. Stoecklein argues.
"To the contrary, actions do speak louder than words," Mr. Stoecklein remarks before posing a rhetorical question. "Why is CMKM spending so many resources on generating compliancy with the reporting requirements of the Exchange Act?"
CMKM's lawyer goes on to say that the company has revenues, has spent significant money to once again be reporting and in good faith believed that its reporting obligations were terminated when it filed its original Form 15.
"CMKM does not believe it in the best interest of either its existing stockholder base, approximately 59,000 stockholders, or the public in general," Mr. Stoecklein says in yet another awkward statement.
"The public is well aware that CMKM trades on the Pink Sheets, and it is not required to supply audited financial statements, but for its large number of stockholders," the lawyer adds.
Mr. Stoecklein goes on to note that, in addition to suspension or revocation of registration to address reporting violations, securities laws allow the SEC to issue an order requiring the issuer to comply with reporting requirements, upon specified terms and conditions and within a specified time.
"For the reasons stated above, CMKM respectfully requests that this Court not revoke the registration of the common stock of CMKM Diamonds pursuant to Section 12(J) of the Exchange Act, however fashion an order that allows for CMKM to complete the process of compiling financial statements upon which an auditor can issue an audit report, and allow for the concurrent preparation of the annual and quarterly reports," Mr. Stoecklein says in concluding his brief.
The SEC has until June 29 to file a rebuttal brief.
Meanwhile, Bill Frizzell, a Texas lawyer representing a number of CMKM shareholders known as the Owners Group, filed something in the nature of a posthearing amicus curae brief on June 20.
Stockwatch will review Mr. Frizzell's brief in a following article.
The saga continues.
Comments regarding this article may be sent to lwebb@stockwatch.com.
(More information regarding CMKM Diamonds and associated companies can be found in Stockwatch articles dated Oct. 21, 2003; June 22; Sept. 16 and 24; Oct. 1, 15 and 20, 2004; Feb. 11, 14, 18, 22 and 23; March 1, 3, 4, 7, 14, 15, 16 and 21; and June 6, 8, 9, 10, 13, 14, 15, 16 and 17, 2005.)
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