Securities and Exchange Commission v. Lek Securities Corporation

Background

The Securities and Exchange Commission (SEC) filed a motion in limine, meaning a request for a pretrial ruling about what evidence or arguments could be presented at trial. The SEC asked the court to prohibit Vali Management Partners doing business as Avalon FA Ltd., Nathan Fayyer, and Sergey Pustelnik—the “Avalon Defendants”—and their attorneys from offering evidence or making arguments that the Avalon Defendants relied on advice from attorneys representing codefendants Samuel Lek and Lek Securities Corporation—the “Lek Defendants.”

During an October 2017 discovery conference, the court asked whether the Avalon Defendants intended to rely on an advice-of-counsel defense or a similar defense. The Avalon Defendants were given two weeks to respond, but they never notified the court or the SEC that they intended to assert such a defense. At a March 2018 conference, the Lek Defendants stated that they would not waive the attorney-client privilege and would not assert an advice-of-counsel defense. Counsel for the Avalon Defendants attended that conference and did not object to the arrangements discussed there.

The SEC identified two anticipated ways the Avalon Defendants might try to raise the issue at trial: reliance on a letter from counsel for the Lek Defendants and reliance on the Lek Defendants’ representation that their counsel had approved the trading at issue. The opinion states that the letter was not sent to any Avalon Defendant and that none of the Avalon Defendants discussed its subject with counsel for the Lek Defendants.

Court’s analysis

The court explained that Section 20(a) of the Securities Exchange Act provides a good-faith defense to control-person liability. For other securities-law claims discussed in the opinion, including claims under Sections 10(b) and 9(a)(2) of the Exchange Act and Section 17(a)(1) of the Securities Act, the defendant’s state of mind is part of what the SEC must prove. Evidence that a defendant relied on legal advice may therefore be relevant to whether the defendant acted with fraudulent intent, manipulative purpose, or the required knowledge or recklessness.

The court stated that an advice-of-counsel defense requires proof that the defendant made a complete disclosure to counsel, sought advice about whether the conduct was legal, received advice that the conduct was legal, and relied on that advice in good faith. Even when supported by evidence, the defense is not a complete defense; it is one factor for the factfinder to consider.

The court identified three reasons the Avalon Defendants could not refer to the Lek Defendants’ consultations with counsel:

1. Failure to disclose the defense during discovery. A party cannot use the attorney-client privilege to prevent disclosure of legal communications while also relying on those communications as a defense. Because the Avalon Defendants did not identify an advice-of-counsel defense during discovery, the SEC had no opportunity to obtain the discovery needed to examine that defense. The court concluded that the Avalon Defendants had waived the defense.

2. Risk of irrelevance, unfair prejudice, and jury confusion. Without an advice-of-counsel defense, references to counsel’s communications were not relevant. Under Federal Rule of Evidence 403, the court also found that such references could give the Avalon Defendants the benefit of suggesting that counsel approved the trading without requiring them to prove the elements of the defense. The references could unfairly prejudice the SEC, confuse or mislead the jury, and suggest that the Avalon Defendants had no independent responsibility to comply with federal securities laws.

3. Advice given to another does not establish the Avalon Defendants’ good faith. The Avalon Defendants did not have access to what the Lek Defendants told their attorneys or what those attorneys told the Lek Defendants. The court held that a defendant cannot claim good faith or reasonable reliance based on another person’s account of legal advice that the defendant did not receive or access.

Ruling

The SEC’s motion was granted. The order prohibited the Avalon Defendants from relying on or referring in any way to the Lek Defendants’ consultations with counsel. The opinion states that the motion was granted at the October 11, 2019 final pretrial conference. It also notes that, on the eve of trial, the Lek Defendants settled the lawsuit with the SEC.