1. Complaint by SEC over a law firm’s opinion
The SEC filed a civil complaint against a Canadian lawyer, William Lawler, and another person named Natalie Bannister, for alleged violations of the Securities Act of 1933 involving the offer and sale of securities of three little public companies that was done allegedly in violation of the Securities Act. The three companies are Broke Out, Inc., Immage Therapeutics Corp., and Nami Corp. and it is alleged that the shares were sold to the public that were not registered, and that trades were manipulated for one of the companies by William Lawler.
Lawler, although Canadian, is called to the bar in Arizona and California and he acted for the three companies as counsel. Bannister is from Missouri and she allegedly acted as an agent selling shell companies and participating in the sale of the shares to the public of the three companies.
According to the SEC, Broke Out and Immage Therapeutics Corp. were shell companies with little activity, whose purpose was to be used to transfer control through share sales to be re-sold to the public. In order to do that, Lawler is alleged to have deposited shares in brokerage accounts for resale to the public. In order to get brokers to accept the shares for re-sale to the public, Lawler is alleged to have provided legal opinions that contained untrue statements, opining that the shares were free-trading when they were restricted from trade and to have omitted material information in the legal opinions.
Bannister is alleged to have conducted fake purchases of the shares of those two companies to help establish their eligibility for public trading and to have made untrue statements in furtherance of getting the shares sold. Certain participants, unnamed in the claim, then allegedly sold those shares in tandem with a hyper promotional campaign to pump the price up, selling millions of shares to the public in a pumped-up phase and without telling the public that there were control persons dumping the shares. The participants allegedly made US$3.2 million in profit from the pump & dump scheme.
With respect to Nami Corp., Lawler is alleged to have engaged in wash trading, described in the complaint as a practice whereby a person pumps up the price of shares fakely by manipulative trading. To do this, he allegedly used two brokerage accounts to buy and sell shares to himself so that it had the appearance of a series of active trades when in reality, the same person was trading.
2. Why the complaint in respect of the law firm’s opinion is important
A legal opinion versus a closing opinion
The SEC alleges that Lawler, the lawyer, prepared and submitted a fraudulent legal opinion to the broker. The complaint is interesting for this point because it is rare to see a securities commission go after a gate-keeper’s opinion. The SEC alleges that Lawler’s opinion was false because, among other things, it contained a statement that was untrue as to the date of the sale of securities and it stated that there was no material information omitted. The SEC alleges that the opinion was either recklessly fraudulent and misleading or intentionally so. The brokers relied upon Lawler’s opinion.
For clarity, there are two types of opinions that lawyers write.
(a) Legal opinions – opinions on the law by a lawyer
The first type is a opinion written for a client and it involves the lawyer opining on a matter of law in writing. These opinions may be privileged. They are usually 25 – 100 pages in length and therein, the lawyer sets out facts, assumptions, the law and then his or her opinion on the law based on the facts. This type of opinion is written by an individual lawyer, and not a firm. This is not the type of opinion implicated in the SEC complaint and this type of opinion does not serve a gate-keeping function.
Some lawyers get their opinions wrong. For example, according to the indictment of Switzerland’s oldest private bank, Wegelin Bank, the bank obtained a legal opinion from lawyers as to its exposure in the US which was wrong – its lawyers told it that it was protected from indictment in the US because it had no physical office there. Wegelin Bank ceased operations after 272 years after handing over $74 million to the US over what amounted to reliance on an incorrect opinion.
An arm of Wedelin Bank helped wealthy foreign politically exposed persons set up trusts, bank accounts and private companies in well-known tax avoidance islands which resulted in the evasion of taxes and facilitated the hiding of $1.2 billion for its clients.
(b) Closing opinions - opinions as to matters of fact by a law firm
The second type, relevant to the SEC complaint, is a non-privileged opinion prepared for M&A deals or financings. These opinions are not privileged because they are for third parties. Financings or M&A deals, to close, involve the issuance by counsel of closing opinions. Because M&A deals cannot close without legal opinions, the role of lawyers in securities law who do financings is critical. Such lawyers gate-keep the integrity of the securities law regime and that gate-keeping function involves the use of closing opinions because participants rely on the veracity of closing opinions to close.
A closing opinion is executed by a firm, and not a lawyer at that firm. It is usually about 8 – 20 pages long. It sets out with precise language for whom the firm acted (e.g., “We acted as specialized gaming counsel to Marx Brothers Casinos and certain of its subsidiaries listed in Schedule “A” in connection with the issuance and the purchase by Goldman, Sachs & Co. of $700 million aggregate principal amount of 5.25% senior subordinated notes due in 2024… This opinion is delivered to you pursuant to §27(c) of the Agreement.”). It then sets out the work the firm did in order to put a circle around potential scope liability (“As counsel, we participated in the preparation of the indenture, the preliminary offering circular and the global certificates representing the notes”). Then it sets out what documents the firm consulted (“We have consulted … and examined a certificate of officers and guarantors”). Then it sets out for each opinion of factual matters, who else the firm relied upon (“In expressing the opinions in paragraph 65, we have relied on the opinions of X law firm in X city”). And it concludes with stating the opinion as to certain facts. For typical financings, opinions say : “the issue and sale of the securities and the compliance by the Company and each of the guarantors, including the consummation of the transactions, will not result in any violation of federal or provincial statute, or any order, rule or regulation of any federal or provincial court or governmental agency …”).
The drafting of closing opinions requires lawyers to undertake transactional due diligence and to be satisfied in respect thereof, a precursor necessary to drafting a competent closing opinion. That’s because closing opinions also opine as to other general and corporate matters. For example, opinions opine as to the accuracy, completeness and fairness of the risk factors disclosed by the offerer of securities in the offering documentation provided to prospective investors, as well as opine that shares issued are duly authorized, fully paid and non-assessable. To make such representations knowing that they serve a gate-keeping function and will be relied upon by the investing public, as well as regulators, requires that the lawyers involved in drafting the closing opinion for the law firm, undertake examinations, inter alia, of records and conduct minute book reviews of directors resolutions and such to make such representations.
Drafting this type of legal opinion when you are working with a book-runner like Goldman Sachs, lets say, can take weeks to draft for complex financings – not because the opinion is complex but because every word the lawyer drafts in such an opinion matters because of the reliance placed on an opinion by the third party to whom it is addressed, and because of the gate-keeping function it serves for securities regulators and the investing public.
Only law firms prepare these types of opinions – never an individual lawyer for obvious client, liability and third party reliance reasons. These opinions usually go through several trusted and competent lawyers at a firm before they are signed by the firm and can be released (because of liability reasons). These opinions can be general or can be for specific areas – for example, if gaming counsel is retained, an opinion is sought by specialized counsel as to gaming regulatory matters.
As noted above, closing opinions close with the material representation: “the issue and sale of the securities and the compliance by the Company and each of the guarantors, including the consummation of the transactions, will not result in any violation of federal or provincial statute, or any order, rule or regulation of any federal or provincial court or governmental agency.” To make such a representation, the law firm must first be satisfied that it is true, and must have undertaken due diligence on the law and the transactions to be comforted as to the representation.
Brokers solely rely upon the law firm’s opinion – it does no due diligence of its own on those matters opined upon in the closing opinion and therefore, the representations of a law firm (called the opinions) in a closing opinion are critically important. If a law firm issues a closing opinion that is untrue, as alleged in this case, the integrity of the security law regime is impacted because it raises the question of whether the public can or cannot rely on law firm closing opinions 100% of the time. The SEC and the public it protects, obviously need to be able to rely on the closing opinions of law firms 100% of the time.
Interestingly, lawyer regulatory bodies teach new lawyers over the course of weeks, about the first type of opinion – the legal opinion – but not about how to undertake due diligence, how to draft, and the liability exposure in respect of, the second more important type of opinion – the closing opinion – that only lawyers can prepare for their law firms. These opinions are more important because they are relied upon by the investing public; they protect the public; and they protect the integrity of the securities law regime. New lawyers are also not taught about the gate-keeping function these opinions serve, and nor how fundamentally important the role of the lawyer is in respect of these types of opinions to both the integrity of the legal profession and the public markets.
3. Why the lawyer and not the law firm?
You may be wondering about jurisdiction, namely how the SEC has jurisdiction to file a complaint against a lawyer over a closing opinion when such opinions are executed by a law firm and not a lawyer, and when the representations therein that form the opinions are those of a law firm and not any individual lawyer, and bearing in mind that clients are always only clients of a law firm and never of a lawyer, unless a lawyer does not work under the umbrella of a law firm but in securities law, that is rare. It’s because, although the law firm holds the liability in respect of closing opinions, and not a lawyer, if there is a lawyer who can be identified as the sole author of a closing opinion and who signed off on it, that would give jurisdiction over that lawyer for SEC purposes. It is also possible in this case, that the lawyer personally executed the opinion qua lawyer rather than qua law firm. Unlikely though, because a brokerage firm will usually reject a closing opinion that is issued by a lawyer and not a law firm. So while a law society or bar association has jurisdiction over an opinion attributable to a lawyer, or if none, to the managing partner of the issuing firm if issues arise as to competence or misrepresentations in the matters opined upon, the SEC also has jurisdiction over the lawyer for breaching his or her gate-keeping duty as the agency responsible in the US for preserving the integrity of the securities law regime.
4. Another Canadian securities lawyer allegedly facing charges over closing opinions allegedly used in furtherance of pump & dumps to defraud the public
This is not the first time the SEC comes after a Canadian securities lawyer over alleged incompetence in connection with closing opinions.
Another Canadian securities lawyer, Faiyaz Dean, from Vancouver, is alleged to have provided closing opinions from his law firm for securities law purposes as to factual matters for third party reliance that the SEC says were questionable. To wit, a Russian company with one employee, a 79-year-old message therapist and less than $100 in revenues was allegedly able to obtain opinions from Faiyaz Dean’s law firm sufficient to become a listed entity. Dean’s firm allegedly opined on a handful of other Eastern European companies under similar circumstances for US securities law purposes.
According to an article written by David Bains in 2009, who was a well-known reporter in Vancouver, Faiyaz Dean was trained to practice law by a securities law firm called Bacchus Law in Vancouver. In 2009, Mr. Bains wrote that he was concerned with these deals being shams and he identified that the handful of so-called Eastern European companies actually were Vancouver connected, and were each inner-connected to each other, and some were connected to Bacchus Law, as well as to Faiyaz Dean.
Faiyaz Dean is alleged to have moved on to bigger fish, and to have allegedly helped perpetrate a $34 million pump and dump involving a company called Biozoom with another lawyer, James Schneider, who was recently convicted of money laundering in Florida in connection with the Biozoom matter. That other lawyer wrote false closing opinions in furtherance of a dump and dump, which were relied upon by third parties which generated proceeds of crime, securities fraud being the predicate offence, hence the money laundering charge resulting in his conviction as a money launderer.
This 2018 article, published nine years after David Bains expressed concerns, explains a civil complaint filed by the SEC against Faiyaz Dean wherein the SEC alleged wrongful conduct by the lawyer that caused harm to the public and to the capital markets. Seems like Mr. Bains believed that harm to the public by Faiyaz Dean was a clearly foreseeable event.