USA v. Richard Bailey

Filing

FILED OPINION (BETTY BINNS FLETCHER, ANDREW J. KLEINFELD and MILAN D. SMITH, JR.)REVERSED and REMANDED for a new trial. Judge: BBF Authoring, Judge: MDS Dissenting. FILED AND ENTERED JUDGMENT. [8299664]

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FOR PUBLICATION

UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
UNITED STATES OF AMERICA,
Plaintiff-Appellee,
v.
RICHARD A. BAILEY, AKA Richard
Allen Bailey, AKA Rick Bailey,
Defendant-Appellant.





No. 11-50132
D.C. No.
2:09-cr-00327ODW-1
OPINION

Appeal from the United States District Court
for the Central District of California
Otis D. Wright, District Judge, Presiding
Argued and Submitted
April 12, 2012—Pasadena, California
Filed August 27, 2012
Before: Betty B. Fletcher, Andrew J. Kleinfeld, and
Milan D. Smith, Jr., Circuit Judges.
Opinion by Judge B. Fletcher;
Dissent by Judge M. Smith

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UNITED STATES v. BAILEY

COUNSEL
Stanley I. Greenberg, Law Offices of Stanley Greenberg, Los
Angeles, California, for the defendant-appellant.
André Birotte Jr., United States Attorney; Robert E. Dugdale,
Chief, Criminal Division, Assistant United States Attorney;
Stephen I. Goorvitch, Major Frauds Section, Assistant United
States Attorney; Los Angeles, California, for the appellee.

OPINION
B. FLETCHER, Circuit Judge:
A jury convicted Richard A. Bailey of two counts of securities fraud. Bailey appeals his conviction arguing that he was
prejudiced by the trial court’s improper admission of a prior
civil complaint filed by the SEC against Bailey. We agree and
vacate Bailey’s conviction and remand for a new trial.

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UNITED STATES v. BAILEY

I.

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BACKGROUND

Bailey was the President, Chief Executive Officer, and
Chairman of the Board of Directors of Gateway, a small, public company involved in selling health and dietary supplements.1
In 2002, Bailey met Richard Owens, another businessman,
and the two began doing business together. The nature and
legitimacy of some of their business deals was the critical
issue at trial.
According to the prosecution, Bailey did not comply with
the Securities and Exchange Commission’s rules on stock
issuances. The SEC requires public companies to disclose
voluminous information before issuing stock (e.g. details
regarding past performance; information about executives;
intended use of the sale proceeds). This process can be timeconsuming and expensive. Without these disclosures, the SEC
allows public companies to issue stock to employees, consultants, or advisors who provide bona fide services to the company. The issuance cannot be used merely to raise capital for
the company and must be in exchange for legitimate services.
In 2003, the SEC filed a civil complaint against Bailey and
his company for violating Rule S-8, the rule that requires the
distribution of stock to be in exchange for bona fide services.
Bailey settled the lawsuit with no admission of liability.
In 2004, Bailey was criminally charged for issuing stock to
Owens in order to raise capital for Gateway and for Bailey
and the company’s personal benefit, both of which are proscribed by Rule S-8. Bailey pled not guilty and proceeded to
trial. His current appeal is from the jury conviction.
Prior to trial, the prosecution filed a motion in limine seek1

Gateway’s Chief Operating Officer, Florian R. Ternes was tried
together with Bailey and also convicted. Ternes does not participate in
Bailey’s evidentiary challenge on appeal.

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ing permission to introduce the fact that the SEC filed a civil
complaint against Bailey in 2003. The prosecution argued that
the 2003 complaint would show that Bailey knew that his
conduct in 2004 was unlawful. The prosecution also argued
that the prior complaint would establish that Bailey knew that
he was required to comply with Rule S-8. The district court
permitted the prosecutor to “introduce just the fact of the SEC
complaint” but warned not to get “any deeper into it.”
At trial, the prosecution presented witnesses who testified
about the business dealings between Bailey and Owens. FBI
Agent Scott Schofield provided extensive testimony about the
numerous transactions between Gateway and Owens between
April and June 2004, the time frame of the indictment. Specifically, Schofield testified that Owens received a total of
$661,000 in S-8 stock in April and May of 2004 but that no
documentation existed detailing the exchange of services for
stock. Schofield testified that he believed that the lack of a
written agreement and invoices between Owens and Gateway
suggested that the arrangement was merely a ruse for unlawful activity. He admitted that there was a written agreement
for the years 2002-03, but testified that no such agreement
existed for 2004, the time frame at issue in this criminal case.
On cross-examination, Schofield appeared to admit that verbal agreements would likely be sufficient for S-8 purposes
and that written documentation was not necessary to comply
with Rule S-8.2
Margaret Nelson, an attorney with the SEC’s division of
enforcement, testified that she deposed Bailey in 2006 and
asked him about the S-8 issuances to Owens. Nelson read into
evidence portions of Bailey’s deposition where he testified
that no time sheets or invoices existed that reflected the work
2

A review of Nelson’s testimony indicates that she too was skeptical
about the transactions in large part because Bailey could not provide
invoices or agreements delineating the consulting arrangement between
Bailey and Owens.

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Owens performed, Gateway’s accounting documents showed
that Owens received $505,000 in stock, and Bailey did not
believe Owens performed that amount in services. Nelson
also testified that in 2003, the SEC filed a civil enforcement
action against Bailey, Gateway, and others, alleging that they
violated SEC rules by using S-8 to raise capital instead of
exchanging stock for bona fide services.
The prosecution’s star witness was Owens. Owens testified
that in the spring of 2004, Bailey and Ternes asked him to
accompany them on a trip to Utah to look at some real estate.
One of the properties they viewed was Aspen Cove, a hunting
and fishing lodge. Owens testified that Bailey and Ternes
were interested in purchasing the property and began negotiating terms. Owens testified that Bailey and Ternes wanted to
make a down payment between $400,000 and $600,000, and
in order to come up with the funds, they planned to issue
Owens S-8 stock, which he would trade through his brokerage
account and send them back the proceeds to use for the down
payment. In exchange, Owens would receive the difference
between the proceeds from the sale of the stock and the down
payment and also be able to use the lodge at his pleasure.
Owens testified that they had engaged in this type of transaction “several times prior” and that he knew at the time that the
proposal was not legitimate. When asked why Owens went
along with the plan knowing that it was not legitimate, he said
that “[g]reed overtook the need” and that he viewed the transaction as “help[ing] a brother out.”
Owens testified that there was a written consulting agreement delineating the terms of the agreement, but that it was
entered into “after the fact, after [the SEC] investigation started” and that the document was “[a]ll just smoke and mirrors.”
Owens testified that he “may have signed a consulting agreement or papers that stated that [he was] a consultant for Gateway” but that those documents were not at all “real or
legitimate.”

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Owens testified that he did the same type of deal with Bailey and Ternes using S-8 stock for another parcel (the “Pepper
Lane” building).
On cross-examination, defense counsel attacked Owens’s
credibility. Owens admitted that he had been charged with
federal crimes relating to the improper issuance of S-8 stock
and was facing thirteen years in prison. He admitted that his
sentencing date had been continued several times so that he
could testify at Bailey’s trial, and that he was cooperating
with the prosecutor in the hopes of receiving a lower sentence. Owens admitted that he had perjured himself on his tax
return, raising doubts about whether he was telling the truth
since he had lied before. Defense counsel also impeached
Owens’s credibility by eliciting evidence of an assault on his
ex-wife, his excessive use of drugs and alcohol, and the circumstances leading to the decline of his relationship with Bailey.3
Bailey did not testify. His defense was that he did nothing
illegal because the S-8 stock issuances were for legitimate
consulting services. Bailey’s daughter testified that through
Owens’s business contacts, she and other Gateway employees
flew to New York to meet with executives at the Home Shopping Network and the corporate office of Nathan’s Hot Dogs
about potential business endeavors.
Defense counsel argued that Bailey issued the stock to
Owens in exchange for bona fide services. First, Owens provided connections to important business people—connections
that were supposed to allow Bailey to grow his business. Second, Owens helped locate and negotiate the Aspen Cove deal,
and was ultimately able to secure an additional 36 acres of
land for the original asking price. Bailey’s counsel argued that
3

Bailey’s relationship with Owens allegedly soured after he made a pass
at Bailey’s daughter, and after learning that Bailey wanted to use the
Aspen Cove lodge for Mormon religious activities.

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simply because Bailey may not have ultimately received the
full value of the stock issuance does not mean that when he
entered into the transaction, he did so with an unlawful purpose. And of course, defense counsel argued that Owens was
a crook, that he had lied before and was lying now to obtain
leniency in his sentencing.
The prosecutor’s closing tracked each of the four elements
of the crime.4 He repeatedly argued that willfulness was the
most important element the government had to prove. In order
to prove that willfulness was satisfied, the prosecutor highlighted the prior SEC complaint, and argued that Bailey had
broken the law before and then done it again.
After deliberating for one day, the jury returned a guilty
verdict against Bailey and Ternes. Bailey was sentenced to 30
months’ imprisonment.
II.

DISCUSSION

The issue on appeal is whether the trial court erred by
allowing evidence of the prior civil complaint filed by the
SEC in 2003 which named Bailey and his company for
improper use of Rule S-8.
4

The elements of the crime are:
First, the defendant directly or indirectly sold securities or offered
to sell securities. Second, no registration statement was filed and
in effect with the Securities and Exchange Commission as to such
securities. Third, interstate transportation or communication of
the mails were used in connection with the sale or offer of sale
of the securities, and, fourth, defendant acted willfully. A person
acts willfully under the federal securities laws by intentionally
undertaking an act that one knows to be wrongful. Willfully does
not require that the person know specifically that the conduct was
unlawful.

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(A)

Standard of Review

Whether the district court erred in permitting the government to introduce the prior civil complaint because it did not
satisfy Rule 404(b)’s admissibility requirements is reviewed
for abuse of discretion. United States v. Romero, 282 F.3d
683, 688 (9th Cir. 2002).
(B)

Rule 404(b)

(1)

Applicable Legal Standards

[1] Bailey argues that the prior civil complaint amounted
to impermissible “other act evidence” barred by Federal Rule
of Evidence 404. “Evidence of a person’s character or a trait
of character is not admissible for the purpose of proving
action in conformity therewith on a particular occasion.”
Romero, 282 F.3d at 688 (citing FED. R. EVID. 404(a)); see
also United States v. Derington, 229 F.3d 1243, 1247 (9th
Cir. 2000). “However, Rule 404(b) permits evidence of prior
wrongs or acts to show proof of motive, opportunity, intent,
preparation, plan, knowledge, identity, or absence of mistake
or accident.” Romero, 282 F.3d at 688. The government
argues that the evidence was used to show proof of intent and
knowledge.
[2] In the Ninth Circuit, a four-part test is used to determine the admissibility of evidence pursuant to Rule 404(b):
Such evidence may be admitted if: (1) the evidence
tends to prove a material point; (2) the other act is
not too remote in time; (3) the evidence is sufficient
to support a finding that defendant committed the
other act; and (4) (in certain cases) the act is similar
to the offense charged.
Romero, 282 F.3d at 688 (citation omitted). The government
“has the burden of proving that the evidence meets all of the

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above requirements.” United States v. Arambula-Ruiz, 987
F.2d 599, 602 (9th Cir. 1993). “If the evidence meets this test
under Rule 404(b), the court must then decide whether the
probative value is substantially outweighed by the prejudicial
impact under Rule 403.” Romero, 282 F.3d at 688 (citation omitted).5
(2)

Analysis

Bailey primarily challenges the admissibility of the complaint under the third prong of the FRE 404(b) test: the evidence must be “sufficient to support a finding that defendant
committed the other act.” Romero, 282 F.3d at 688. In Huddleston, the Supreme Court clarified that the government need
not prove Rule 404(b) evidence by a preponderance of the
evidence; rather, “such evidence should be admitted if there
is sufficient evidence to support a finding by the jury that the
defendant committed the similar act.” 485 U.S. 681, 685
(1988); see also Verduzco, 373 F.3d at 1027.
[3] We conclude this standard was not met in Bailey’s
case. In order for the government to introduce the prior SEC
complaint, there must have been sufficient evidence from
which the jury could reasonably conclude that Bailey actually
committed the allegedly-similar bad acts. See Huddleston,
485 U.S. at 685. The only evidence offered to meet this standard was the complaint itself.
[4] As an initial matter, none of the facts alleged in the
complaint were admitted to by Bailey or proven. In fact, Bailey settled the civil action with no admission of liability. The
out-of-circuit cases are clear that where a defendant admits
5

Rule 403 provides that relevant evidence “may be excluded if its probative value is substantially outweighed by the danger of unfair prejudice,
confusion of the issues, or misleading the jury, or by considerations of
undue delay, waste of time, or needless presentation of cumulative evidence.” FED. R. EVID. 403.

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nothing, the evidence of the prior conduct is inadmissible. In
United States v. Cook, 557 F.2d 1149 (5th Cir. 1977), defendants were charged for their participation in selling oil and
gas drilling ventures that violated SEC Rules. Id. at 11501151. A year before, the SEC had filed a civil enforcement
action against defendants alleging violations of the same
rules. Id. at 1151. The district court admitted evidence of
injunction documents resulting from a settlement in the prior
civil case. The Fifth Circuit reversed finding that because the
defendant neither admitted nor denied the fraud alleged in the
injunction, offering the documents themselves would cause
the jury “to infer that prior wrongful acts had been committed,
an inference impermissible.” Id. at 1153. In the case of In re
Adler, Coleman Clearing Corp., the defendants were charged
with fraud. 1998 WL 160036, at *4 (Bkrtcy. S.D.N.Y 1998).
The government sought to introduce evidence of an SEC
Administrative Release which stated that members of the
defendant-broker company had previously violated federal
securities laws for the purpose of showing knowledge and
intent to commit fraudulent securities transactions. Id. at *4,
*8. The court refused to admit the evidence because the
affected defendants accepted an offer of settlement but “neither admitted nor denied the findings made therein,” and thus
could not be used to show that the defendants “actually
engaged in the conduct alleged.” Id. at *8.6
6
We find additional support for the notion that inconclusive allegations
of prior similar behavior is not useful. In the civil rights context, courts are
reluctant to admit evidence of prior excessive force complaints against a
police officer if the complaints are unsubstantiated. For example, in
Sibrian v. City of Los Angeles, No. 06-56532, 288 Fed.Appx. 385, (9th
Cir. Aug. 1, 2008), an unpublished disposition, the panel upheld the district court’s decision to exclude evidence of prior complaints involving the
defendant police officer stating that the officer was exonerated on three of
the prior incidents and that the evidence was inconclusive on the fourth
incident. See also Hopkins v. Andaya, 29 F.3d 632, 1994 WL 396202, at
*2 (9th Cir.1994) (unfounded citizen complaints were not relevant in Section 1983 action). Other circuits have reached the same conclusion. See
United States v. Taylor, 417 F.3d 1176, 1179 (11th Cir.2005) (district
court did not abuse discretion in denying plaintiff’s request to offer

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[5] We agree with the reasoning of these cases.7 A defendant may settle a case for a variety of reasons. He may have
committed the conduct alleged in the complaint or he may not
have—but having settled the claim, there is no way to know.
Admitting prior conduct charged but settled with no admission of liability is not probative of whether the defendant
committed the prior conduct, much less whether he committed the conduct in question. There is no logical relevancy to
admitting this type of evidence.8
[6] A second and more basic reason leads us to conclude
the disputed evidence was improperly admitted. We risk stating the obvious here: a complaint is merely an accusation of
conduct and not, of course, proof that the conduct alleged
occurred. The prosecution did not introduce evidence that
Bailey misused the SEC rules—rather, the prosecution offered
only the complaint, which is far from evidence of anything.
Admitting the complaint may have permitted the jurors to
succumb to the simplistic reasoning that if the defendant was
unfounded citizen complaints to prove police officer’s bias and motive).
Even where the defendant police officer had not been exonerated on a
civilian complaint, the Second Circuit stated that “the relevance of a single
unsubstantiated charge is obviously limited.” Berkovich v. Hicks, 922 F.2d
1018, 1023 (2d Cir.1991).
7
The dissent states that our “discussion of settlement evidence is a red
herring because whether Bailey accepted or denied responsibility in the
settlement is not at issue in this case, and was not raised on appeal.” Dissent at 9747. However, Bailey did raise this issue—his opening brief states
that the complaint should not have been admitted because it was “unverified, never proven to a judge, never proven to a jury, and never admitted
by Mr. Bailey” and because Bailey settled the case “with no admission of
liability.” That Bailey never admitted responsibility is entirely relevant
here because the government used the complaint to argue that Bailey had
“broken the law before” when there was no such evidence.
8
It is a well-established principle that in order to be properly admitted,
other-acts evidence, like all evidence, must be relevant. See Fed.R.Evid.
401.

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accused of the conduct, it probably or actually occurred. Such
inferences are impermissible.
[7] The government barely addresses this issue but instead
leans heavily on the purpose for which the evidence was
offered, i.e., “to prove that defendant acted intentionally,
knowing that his actions were wrong.” There is some logic to
the argument that evidence that Bailey had previously been
accused of violating Rule S-8 shows that he was on notice of
the type of prohibited conduct. But this is not enough. The
prosecution was still required to prove that the evidence was
sufficient to support a finding that Bailey committed the act
charged in the complaint. This a mere complaint cannot do.
The government argues that courts routinely admit evidence of mere accusations, i.e., prior arrests. We agree that
courts permit evidence of prior arrests, but such evidence
must still satisfy the four-part test for admissibility. In the
cases we have found where evidence of a prior arrest is admitted, a person with knowledge of the crime testifies to the circumstances of the prior offense. See United States v.
Basinger, 60 F.3d 1400, 1408 (9th Cir. 1995) (arresting officer’s testimony is sufficient to establish that the prior act
occurred); United States v. Hinton, 31 F.3d 817, 823 (9th
Cir.1994) (uncorroborated testimony by victim is sufficient
evidence that the prior act occurred).
Where a prior arrest is insufficient to prove commission of
the offense, it does not satisfy the third prong of the test, and
therefore should not be admitted. In United States v. Marshall, the defendants were convicted on multiple drug
charges. 173 F.3d 1312, 1313 (11th Cir. 1999). A search of
their homes revealed a factory equipped to produce cocaine,
but no actual cocaine. Id. at 1314. The government sought to
introduce evidence that the defendants were previously
arrested based on their presence in a house where cocaine paraphernalia was present. The police investigation revealed no
evidence linking the defendants to cocaine production, so the

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charges were dismissed. The Eleventh Circuit reversed the
district court’s decision to admit the evidence of the prior
arrest stating:
. . . [T]here was nothing in the evidence presented
that tended to prove intent to distribute. In order for
the evidence to be probative of intent, the jury would
have to believe that [defendants] previously committed the offense of possession with intent to distribute
(or conspiracy to do the same). The evidence of the
arrest was insufficient to prove commission of the
offense; other evidence had to be presented from
which the jury reasonably could conclude that the
offense was committed . . . Consequently, the jury
could not have reasonably concluded—based on the
evidence before it—that [defendants] had been
involved in crack distribution, and therefore the prior
arrest and the circumstances surrounding it were not
probative of intent.
Id. at 1317.
In Bruce v. City of Chicago, the defendant-City did not
even object to the civil rights plaintiff’s request that evidence
of his prior arrests that did not lead to a conviction be
excluded. No. 09 C 4837, 2011 WL 3471074, at *9 (N.D.Ill.
July 29, 2011). In United States v. Donnell, the defendant
objected to the admission of evidence of his prior arrests for
which he was neither charged nor convicted, but the court
declined to address the issue, instead concluding that any
error was harmless. 596 F.3d 913, 922 (8th Cir. 2010).
The dissent attempts to recast the government’s use of the
complaint as being “narrowly offered for the purpose of proving that Bailey knew it was illegal to issue unregistered stock
without receiving bona fide services in return.” This characterization of how the government used the evidence is simply
not so—the government used the complaint to prove intent.

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Even the government concedes this point. At the ruling on the
motion in limine, the prosecutor stated “I think the fact of the
complaint in 2003 is relevant to establishing their intent in
2004.” And in the government’s response brief, it states “[i]n
order to prove that defendant acted intentionally, knowing
that his actions were wrong, the government relied on evidence that the SEC had sued defendant in 2003 for essentially
identical conduct.” Indeed, the prosecutor admitted intent was
the crucial element in the case and highlighted the complaint
to show the element satisfied. The prosecutor said, referring
to the complaint, that the SEC had told Bailey “don’t break
the law anymore” and “stop, don’t do this again.” The clear
implication of the statement “don’t break the law anymore”
is: he broke the law before. Similarly, the unmistakable implication of “stop, don’t do this again” is: he did this before.
Those statements by the prosecutor were not merely meant to
prove that Bailey had knowledge of Rule S-8’s prohibitions.
Rather, the statements go directly to the only element at issue
in the case: Bailey’s intent to violate Rule S-8 based on his
alleged previous conduct, of which he had been accused but
never admitted.
It must be said, though, that a complaint would not establish knowledge even if the prosecution had purported to use
it only for that reason. All a complaint establishes is knowledge of what a plaintiff claims. It does not establish the truth
of either the facts asserted in the complaint, or of the law
asserted in the complaint. Since the previous complaint was
never proved, nor was the truth of any of it conceded, it could
not have established knowledge of the law. A complaint may
state that cars driving southbound are required to stop at the
intersection of 1st and Main, and that the defendant did not
stop. But such a complaint establishes neither that southbound
vehicles have a duty to stop, nor that the defendant failed to
stop. Likewise, the SEC complaint establishes neither knowledge of the law nor a past wrongful act.

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[8] We hold that a mere accusation of prior conduct is
insufficient to support a finding that the prior act was committed and, therefore, does not tend to prove that the defendant
committed the act for which he is on trial. In order for evidence of a prior accusation to be admissible, there must be
sufficient, independent evidence (besides the accusation
alone) to support a finding that the prior conduct occurred. No
such evidence was introduced here9 and, therefore, the complaint should not have been admitted.
(C)

Harmlessness

[9] Having concluded that the complaint was improperly
admitted, we consider whether the error was harmless. Where,
as here, the district court’s error is of a nonconstitutional magnitude, “[w]e must reverse unless there is a ‘fair assurance’ of
harmlessness or, stated otherwise, unless it is more probable
than not that the error did not materially affect the verdict.”
United States v. Morales, 108 F.3d 1031, 1040 (9th Cir.1997)
(en banc) (quoting United States v. Crosby, 75 F.3d 1343,
1349 (9th Cir.1996)). The burden to show the harmlessness of
the error is on the party benefitting from the error, Obrey v.
Johnson, 400 F.3d 691, 701 (9th Cir. 2005), in this case, the
government. United States v. Gonzalez-Flores, 418 F.3d
1093, 1099 (9th Cir. 2005). Therefore, our review begins with
“a presumption of prejudice.” Obrey, 400 F.3d at 701.
The prosecution’s case turned almost exclusively on the
testimony of one witness, Owens, who was trading his testimony in the hopes of a lesser sentence. Although FBI Agent
Schofield’s testimony about the number of transactions and
money exchanged between Owens and Bailey in April
through June 2004 provided some independent, unbiased cor9

Owens testified generally that he and Bailey had previously engaged
in the type of transaction charged in the 2004 complaint, but he did not
provide any specifics about that alleged conduct, much less discuss the
specific acts charged in the 2003 complaint.

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roboration of the prosecution’s theory, Schofield admitted that
he did not know for certain whether Bailey’s stock issuances
to Owens were made in exchange for bona fide services.
Instead, Schofield simply believed that the lack of a written
agreement and invoices between Owens and Gateway suggested that the arrangement was a sham.
Schofield, however, acknowledged that there was a written
agreement for the years 2002-03. By 2004, Bailey and Owens
had been involved in various business dealings and it is
entirely plausible that the April through June stock issuances
were for Owens’s business services, but there was simply no
written agreement that memorialized the arrangement. Indeed,
Schofield appeared to admit that verbal agreements to
exchange services for stock would not likely violate Rule S-8,
provided, of course, the agreement was legitimate.
Bailey’s deposition testimony proffers a plausible, lawful
explanation for the transactions.10 He asserted that the S-8
shares issued to Gateway consultants were generally commensurate with the services they rendered. When asked what
type of services Owens provided to Gateway, Bailey
responded that Owens “had a lot of connections” and
“[s]eemed to know what he was doing in marketing.” Because
Gateway’s success depended on marketing its products, paying Owens for his connections to people in the marketing
industry would allow Gateway to grow its business and thus
issuing stock for such services is entirely legitimate. For
example, Bailey testified that Owens helped Gateway launch
a new product, the Pete Rose grill, just before Pete Rose was
to be inducted into the baseball Hall of Fame. Specifically,
Owens worked directly with Pete Rose and others to manufacture and market the product. When asked whether Owens
performed services commensurate with the shares he received
10

Nelson, the SEC attorney who deposed Bailey, testified about portions
of Bailey’s deposition testimony and the relevant pages were admitted as
a trial exhibit.

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for his work on the Pete Rose grill, Bailey justified the issuance of shares as follows: if Pete Rose had been inducted into
the Hall of Fame, the shares issued to Owens would no doubt
be considered fair. Of course, a retrospective view of the
stock issuances to Owens made them appear suspect because
the project was eventually a bust. That the project was a bust
does not mean that Gateway’s stock issuance to Owens was
a sham, it merely means that the business risk Gateway took
on Owens’s ability to turn a profit on the project failed.
Bailey also testified that Owens provided bona fide services
on the Aspen Cove and Pepper Lane deals. Specifically, Bailey said that Owens “suggested the purchase of [Aspen Cove]
and helped negotiate the purchase.” This testimony was corroborated by John Boschetto, the seller of the Aspen Cove
property, who testified that Owens was one of the people
interested in the property, and helped negotiate the deal.
In short, there was ample evidence to corroborate Bailey’s
defense that the stock issuances to Owens were compensation
for services rendered.
The damaging testimony came from Owens himself.
Owens admitted that he “might have” signed a consulting
agreement but insisted that those agreements were not legitimate, but were “just smoke and mirrors.” With respect to the
Aspen Cove deal, Owens testified that they discussed how the
deal would transpire: Gateway would issue Owens S-8 stock,
Owens would trade the stock through his brokerage account,
keep some of the proceeds himself and wire the remaining
balance to whatever entity Bailey designated. Owens knew at
the time that the transaction was not legitimate and just
viewed it as trying to help Bailey. Owens testified that they
had engaged in this type of transaction several times before.
Owens testified that he expected to have no part of the Aspen
Cove deal other than to be permitted to stay at the lodge for
free whenever he desired. Owens testified that in order to pur-

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chase the Pepper Lane property, he and Bailey engaged in the
same type of transaction.
Clearly, the jury had to believe either an admitted crook
hoping for leniency (Owens: This was all a sham and everyone knew it) or an accused crook (Bailey: I was issuing stock
to Owens for his real services) and his surrogates.
We do not suggest that a jury could never find a defendant
guilty based on the testimony of a cooperating witness who is
trading testimony in the hopes of a lesser sentence. But when
the government’s case is built around a single witness with
questionable motives, it can hardly be said that the government’s case was strong. In most cases where courts have
found harmless error despite the erroneous admission of evidence, the properly admitted evidence was highly persuasive
and overwhelmingly pointed to guilt. See United States v.
Rendon-Duarte, 490 F.3d 1142, 1145 (9th Cir. 2007) (evidentiary error harmless in light of police officer’s testimony and
physical evidence of the crime); United States v. Rowe, 92
F.3d 928 (9th Cir. 1996) (assuming, arguendo, that district
court committed evidentiary error, such error was harmless in
light of other evidence including defendant’s confession and
weapon found in his possession); United States v. Yazzie, 59
F.3d 807 (9th Cir. 1995) (district court’s evidentiary error
harmless because of abundant, independent evidence including the victim’s detailed statements implicating the defendant); United States v. Gonzalez-Sandoval, 894 F.2d 1043,
1047 (9th Cir.1990) (finding evidentiary error was harmless
where defendant made incriminating statements that were
properly admitted). Here, there was no confession by Bailey,
no audiotape or videotape of Bailey discussing the misuse of
Rule S-8, no emails or other documentary evidence, and no
direct evidence from unbiased witnesses. There simply was
no substantial evidence of Bailey’s guilt other than Owens’s
say so. We conclude that the testimony of just one witness
who has a great deal of incentive to lie cannot alone constitute
overwhelming evidence of Bailey’s guilt.

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We must therefore evaluate the potential impact of the
improperly admitted evidence keeping in mind that the government’s case against Bailey was weak. The prosecutor
made numerous references to the prior complaint during his
closing argument, and as this court has recognized, “closing
argument matters . . . a great deal.” United States v. Kojayan,
8 F.3d 1315, 1323 (9th Cir. 1993).
[10] The prosecutor recognized that Bailey’s intent to
commit the crime was the sole issue in the case. He stated that
there was “an extraordinary amount of evidence to show that
[Bailey] acted willfully.” He then highlighted the prior complaint. Bailey had been told, argued the prosecutor: “don’t
break the law anymore. . . . Pay us for your deliberate violations of the law.” The prosecutor emphasized the temporal
proximity between the prior SEC complaint and the conduct
at issue in this litigation when he said: “. . . the fact that [the
SEC had sued Gateway] a year before all this nonsense with
Owens, that is crucial. That is important because when the
SEC filed this lawsuit, they were just telling them straight out,
stop, don’t do this again. They blew through this stop sign just
as sure as if they were driving down the street.” At this point,
the prosecutor displayed a red stop sign which served as a
graphic depiction of Bailey’s alleged abuse of Rule S-8, and
likely seared in the jury members’ minds the warning given
Bailey by the SEC. Indeed, the government’s references to the
SEC Complaint, both orally and visually, went to the heart of
the case.
[11] Beginning, as we must, with a “presumption of prejudice,” we conclude that the introduction of the prior SEC
complaint was not harmless. The record reveals this was a
close case. There was considerable evidence supporting Bailey’s defense. The government’s case turned entirely on
Owens’s testimony; he had obvious credibility issues.
Improperly admitted evidence, intended to show that Bailey
had broken the law before and knew it, could have tipped the
jury in the government’s favor.

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III.

CONCLUSION

[12] The trial court erred by admitting the prior civil complaint. That evidentiary error was not harmless. We therefore
vacate Bailey’s conviction and remand for a new trial.
REVERSED and REMANDED for a new trial.

M. SMITH, Circuit Judge, dissenting:
I respectfully dissent. I would uphold the district court’s
admission of the SEC’s Complaint, under Rule 404(b),
because the Complaint showed that Bailey knew that he had
been previously sued for issuing unregistered securities, in
violation of SEC Rule S-8. Because the Complaint was admitted for the purpose of showing Bailey’s knowledge, it is not,
as the majority contends, necessary that the Complaint, in and
of itself, be “sufficient to support a finding that Bailey committed the act charged [therein].” Bailey’s knowledge of Rule
S-8 was conditioned upon the fact that he had been named as
a defendant in the prior Complaint, not whether he actually
committed the acts alleged therein. Accordingly, I would hold
that the district court did not err, let alone abuse its discretion,
in admitting the Complaint as evidence, under Rule 404(b).
Because I would find that the evidence was properly admitted under Rule 404(b), I believe that the majority should have
applied a Rule 403(b) balancing analysis to determine
whether the probative value of the Complaint was substantially outweighed by its prejudicial effect. Nonetheless, even
assuming error, as did the majority, I would hold that such
error was harmless in light of the abundance of evidence
admitted concerning the series of highly suspicious transactions between Bailey and Owens involving unregistered S-8
stock.

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I.

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Rule 404(b)

We review the district court’s decision to admit evidence
under Rule 404(b) for an abuse of discretion. United States v.
Khan, 993 F.2d 1368, 1376 (9th Cir. 1993). Federal Rule of
Evidence 404(b) provides that “evidence of other crimes,
wrongs or acts is not admissible to prove the character of a
person in order to show action in conformity therewith.” Fed.
R. Evid. 404(b). However, such evidence may be introduced
for “other purposes,” including intent, knowledge, notice, and
absence of mistake or accident. Id. Evidence of other acts may
be admitted if:
(1) the evidence tends to prove a material point; (2)
the prior act is not too remote in time; (3) the evidence is sufficient to support a finding that the
defendant committed the other act; and (4) (in cases
where knowledge and intent are at issue) the act is
similar to the offense charged.
United States v. Flores-Blanco, 623 F.3d 912, 919 (9th Cir.
2010) (emphasis added.).
Rule 404(b) has thus long been characterized as “a rule of
inclusion—not exclusion.” United States v. Cherer, 513 F.3d
1150, 1157 (9th Cir. 2008). Indeed “[u]nless the evidence of
other acts only tends to prove propensity, it is admissible.”
United States v. Castillo, 181 F.3d 1129, 1134 (9th Cir. 1999)
(emphasis added). We have also repeatedly emphasized the
“low threshold” for finding Rule 404(b) evidence to be “sufficient proof” of a prior act. See, e.g., United States v. Houser,
929 F.2d 1369, 1373 (9th Cir. 1990); United States v.
Romero, 282 F.3d 683, 688. Thus, Rule 404(b) “is not so
much a character rule as a special aspect of relevance because
it does not prohibit character evidence generally, only that
which lacks any purpose but proving character.” United States
v. Douglas, 482 F.3d 591 (D.C. Cir. 2007) (emphasis added).

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It is true that the Supreme Court, in Huddleston, cautioned
against reading the sufficiency of evidence of requirement
under Rule 404(b) as carte blanche for the Government to
introduce “a litany of potentially prejudicial similar acts that
have been established or connected to the defendant only by
unsubstantiated innuendo.” Huddleston v. United States, 485
U.S. 681, 689 (1988). However, the Court clarified, in Huddleston, that the sufficiency requirement of Rule 404(b) was
tied to the relevancy requirements of Rule 402 and 104,
explaining: “Evidence is admissible under Rule 404(b) only
if it is relevant. ‘Relevancy is not an inherent characteristic of
any item of evidence but exists only as a relation between an
item of evidence and a matter properly provable in the
case.’ ” Id. (citing Fed. R. Evid. 401, advisory committee’s
notes, 688) (emphasis added); id. at 690, 691.
The majority reasons that the district court abused its discretion in admitting the Complaint because a complaint “is
merely an accusation of conduct and not of course, proof that
the conduct alleged occurred.” As an initial matter, the majority cites no authority for the proposition that a civil complaint
is insufficient proof of conduct. Instead, it devotes a significant portion of its discussion to whether documents arising
out of settlements, in which the defendant neither admitted
nor denied the findings therein, could be admitted under Rule
404(b). The majority relies upon a Fifth Circuit case from
1977, United States v. Cook, 557 F.2d 1149 (5th Cir. 1977)
and an unpublished bankruptcy case from the Southern District of New York, In re Adler, Coleman Clearing Corp., No.
95-08203/JLG, 1998 WL 160036 (Bankr. S.D.N.Y. Apr. 3,
1998), to conclude that a complaint is inadmissible proof of
prior bad acts when the case is subsequently settled with no
admission of guilt. Cook is completely inapposite, and
involved the admissibility of injunctive relief to prove the
scheme, motive, and knowledge of the defendant. 557 F.2d at
1152. Nowhere in Cook did the court examine the potential
admissibility of a prior civil complaint. In re Adler is equally
unhelpful to the majority’s position; there, the court rejected

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the admissibility of an SEC Administrative Release, a type of
agency news document, which reported and described the
proceedings and settlement of an earlier SEC case, under Rule
404(b). 1998 WL 160036, at *8. And notably, while the court
deciding In re Adler rejected the admissibility of the SEC
Administrative Release, it held that a prior grand jury indictment was admissible under Rule 404(b), further undercutting
the majority’s argument that charging documents such as a
complaint or an indictment, are insufficient evidence of prior
acts. Id. at *4, *8. Ultimately, however, the majority’s discussion of settlement evidence is a red herring because whether
Bailey accepted or denied responsibility in the settlement is
not at issue in this case, and was not raised on appeal. Moreover, the settlement agreement was not offered as evidence,
and whether Bailey accepted liability in the previous suit does
not bear on whether the suit informed Bailey’s knowledge of
Rule S-8 regulations.
The Government proffered the Complaint as evidence of
Bailey’s knowledge of Rule S-8’s prohibition on trading in
unregistered stock. Thus, the crux of this appeal turns on
whether the Complaint constituted sufficient evidence, under
Huddleston and its progeny, of a prior act that would have
apprised Bailey of the pertinent prohibitions and requirements
of Rule S-8. Contrary to the majority’s contentions, I would
hold that it is not necessary that the allegations in the Complaint be true in order for the previous suit to have informed
Bailey of Rule S-8’s requirements.
Under Huddleston, “[w]hen the relevancy of evidence
depends upon the fulfillment of a condition of fact, the court
shall admit upon, or subject to, the introduction of evidence
sufficient to support a finding of the fulfillment of the condition.” 485 U.S. at 690.1 Here, evidence was relevant insofar
as it bore upon Bailey’s knowledge of Rule S-8. The condi1

Huddleston rooted the relevancy requirement of Rule 404(b) in “Rule
402—as enforced through Rule 104(b).” 485 U.S. at 691.

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tional fact upon which the Complaint was proffered was that
Bailey knew that the prior Complaint accused him of knowingly violating Rule S-8. Thus, the “prior act” at issue under
the third prong of Rule 404(b) was not that Bailey committed
the acts alleged in the Complaint, but the fact and extent of
Bailey’s knowledge of the Rule S-8 claims, as alleged in the
Complaint. The Complaint need only be sufficient evidence
of Bailey’s knowledge of his involvement in the civil suit—
not the veracity of the claims against him—in order for it to
be admissible.
The majority maintains that the government “concede[d]”
that the Complaint was offered to prove intent. This is simply
incorrect. The government’s response brief explains that the
Complaint was offered to prove the knowledge component of
willfulness, as defined under 15 U.S.C. §§ 77e, 77x.2 The
transcript from the court’s ruling on Bailey’s motion in limine
proves that the government offered the Complaint for the purpose of establishing the “knowing” element of willfulness:
“One way I intend to show [willfulness] is the fact that they
were sued by the federal securities regulators in 2003 knowing
that this is perceived to be wrongful, knowing that it is perceived to be serious enough to merit federal action.” (emphases added). Indeed, it was Bailey’s counsel who conceded that
it believed the government’s argument was that the Complaint
showed “that the defendants knew that someone from the SEC
could file such a complaint . . . .” (emphasis added). The
court’s ruling on the motion in limine further confirms that,
“without getting any deeper into it,” the Complaint was
offered only for the legitimate purpose of proving Bailey’s
knowledge: “. . .we are simply going to introduce this for the
2

We have defined willfulness in the context of federal securities laws
as “intentionally undertaking an act that one knows to be wrongful.”
United States v. Tarallo, 380 F.3d 1174, 1188 (9th Cir. 2004) (emphasis
added). Thus, in order to prove the “willfulness” requirement of the registration provisions of 15 U.S.C. §§ 77e, 77x, the government had to prove
Bailey’s knowledge.

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purpose of showing that he certainly knew what he was doing,
that it was illegal.” Thus, the majority incorrectly conflates
the concepts of intent and knowledge to argue that the Complaint was used essentially as propensity evidence. In reality,
the statements of the government, defense counsel and the
court expressly demonstrate that the Complaint was offered
for the purpose of proving Bailey’s knowledge.
Indeed, it is the majority who concedes: “All a complaint
establishes is knowledge of what a plaintiff claims.” This is
exactly the point. The Complaint stated the precise code sections of Securities Act at issue, and literally quoted the duties
imposed by Rule S-8:
The Instructions to Commission Form S-8 state that
Form S-8 is available to register securities offered
and sold to the Issuer’s consultants and employees
‘only if (i) they are natural persons; (ii) they provide
bona fide services to the registrant; and (iii) the services are not in connection with the offer or sale of
securities in a capital raising transaction, and do not
directly or indirectly promote or maintain a market
for the registrant’s securities . . .’
Likewise the Complaint expressly identified the specific
actions that violated Rule S-8: “. . . the issuers either obtained
little or no bona fide services in exchange for the stock, or
issued the stock in connection with a capital-raising transaction.” Thus, contrary to the majority’s representations, not
only did the Complaint specifically state the duties imposed
by law under Rule S-8, but also the very type of conduct that
would violate it. This alone should constitute a sufficient basis
to affirm the district court’s discretion in admitting the Complaint.
We have repeatedly held under Huddleston that Rule
404(b) is an inclusive rule designed to permit the admissibility of prior act evidence when it is offered for any other legiti-

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mate basis than to prove propensity. See generally Cherer,
513 F.3d at 1147. Rule 404(b) admissibility reflects the
court’s acknowledgment that “[e]xtrinsic acts evidence may
be critical to the establishment of a truth as to a disputed
issue, especially when that issue involves the actor’s state of
mind and the only means of ascertaining that mental state is
by drawing inferences from conduct.” Huddleston, 485 U.S.
at 685. Since Bailey confirmed his knowledge and awareness
of the SEC Rule S-8 suit against him during his deposition,
the Complaint constituted sufficient evidence of the prior act
(that Bailey was previously sued by the SEC for trading in
unregistered securities) and the conditional fact of the Complaint’s relevance (Bailey’s knowledge). Accordingly, I
would hold the district court did not err, let alone abuse its
discretion, in admitting the Complaint under Rule 404(b).
II.

Rule 403(b)

We review the district court’s balancing analysis under
Rule 403(b) for an abuse of discretion standard. United States
v. Khan, 993 F.2d 1368, 1376 (9th Cir. 1993). “Once it has
been established that the evidence offered serves one of the
[404(b)] purposes, the . . . ‘only’ conditions justifying the
exclusion of the evidence are those described in Rule 403:
unfair prejudice, confusion of the issues, misleading the jury,
undue delay, waste of time, or needless presentation of cumulative evidence. United States v. Curtin, 89 F.3d 935, 944 (9th
Cir. 2007). Limiting instructions are generally sufficient to
cure any prospective prejudicial impact. See Dubria v. Smith,
224 F.3d 995, 1002 (9th Cir. 2001).
To prove its case, the Government was required to establish
that Bailey acted “willfully” in violating the registration provisions of the Securities Act of 1933. See 15 U.S.C. §§ 77e,
77x. We have held that willfulness may be proven under
securities laws by showing that a defendant “intentionally
under[took] an act that one kn[e]w[ ] to be wrongful.” United
States v. Tarallo, 380 F.3d 1174, 1188 (9th Cir. 2004).

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Here, the Complaint was highly probative of Bailey’s
knowledge of federal securities laws. The Complaint not only
apprised Bailey of Rule S-8 generally; it expressly articulated
the SEC’s prohibition against issuing S-8 stock except in
return for bona fide services. The probativeness of the Complaint is highlighted by the fact that defense counsel repeatedly put Bailey’s intent at issue during the course of the trial,
including statements to the jury such as, “Well, by definition,
I haven’t gotten bona fide services, but did I commit a crime?
I think not because it wasn’t wrongful. It wasn’t intentional,
wrongful.” The Government thus used the Complaint, including the type of relief sought therein (permanent injunctive
relief, disgorgement of ill-gotten gains, payment of civil
money penalties, and officer-director bar), to show that Bailey
was on notice concerning the requirements of Rule S-8, and
specifically, that Bailey was aware of the bona fide services
requirement for the issuance of S-8 stock.
Since the Complaint is highly probative of Bailey’s knowledge, we must next determine whether the risk of unfair prejudice, undue delay, and confusion of the issues substantially
outweighs the probative value. Curtin, 89 F.3d at 944. It is
clear to me that it does not, given the Court’s multiple limiting instructions to the parties and to the jury. The Court
strictly limited the purposes for which the jury could consider
the Complaint, both in verbal instructions to the parties and
in its formal written instructions to the jury. Indeed, the district court expressly instructed that the evidence of unproven
conduct may be considered “only for its bearing, if any, on
the question of the defendant’s intent, plan, knowledge,
absence of mistake, and absence of accident, and for no other
purpose.” The district court specifically instructed the jury
“not [to] consider this evidence as evidence of guilt of the
crime for which the defendants are now on trial.” Accordingly, I would hold that the district court did not abuse its discretion in admitting the prior act evidence under Rule 403(b)
because any prejudicial effect was cured by the district court’s
cautionary instructions to the jury. See Dubria, 224 F.3d at

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1002 (“Ordinarily, a cautionary instruction is presumed to
have cured prejudicial impact.”) (internal citations omitted).
III.

Harmless Error Analysis

Finally, even assuming error in admitting the Complaint, I
would hold that any error was harmless given the overwhelming evidence against Bailey. We review erroneous evidentiary
rulings with a presumption of prejudice which may be rebutted by “a showing that it is more probable than not that the
jury would have reached the same verdict even if the evidence
had not been admitted.” Obrey v. Johnson, 400 F.3d 691, 701
(9th Cir. 2005).
At trial, the Government presented the following evidence
to prove that Bailey violated federal securities laws by issuing
and selling shares to Owens in order to raise capital for the
Aspen Cove and Pepper Lane ventures, and for Bailey’s personal gain:
•

Physical Form S8 documents, Finance 500 documents and spreadsheets showing that Bailey
issued over 1.1 billion shares ($600,000 value) to
Owens without any consulting agreement for
bona fide services, despite past similar deals.

•

Monthly statements from Owens showing that
upon receipt of those shares, Owens immediately
sold them.

•

Monthly statements showing that upon Owen’s
payment for the sale of the shares, that rather
than reinvesting the money personally, Owens
transferred the money through a series of transactions, back to finance the acquisition of Aspen
Cove and Pepper Lane on Gateway’s behalf (and
ultimately, Bailey).

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•

Gateway’s form 10-K showing that the company
had acquired Aspen Cove and Pepper Lane, but
never once mentioning Owens’ role as a consultant.

•

Documentary evidence that Owens was absent so
frequently from Bailey’s real estate operations
that Bailey assumed power of attorney for Owens
when completing various real estate transactions.

•

Prior “2002” Consulting Agreement” in which
Owens had agreed to provide consulting services
for earlier work with Bailey.

•

9753

Testimony from Boschetto, a seller of the Utah
property, who testified that he never met or negotiated with Owens, despite the alleged consultative agreement, and Owens provision of the funds
for the sale.

•

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Owen’s testimony, offering no exculpatory
explanation for why he had no contract with
Gateway, or Bailey, in the 2004 consulting transactions, or for why he had immediately funneled
the stock sale money back to Gateway (despite
the fact that this was purportedly his “compensation” for bona fide services rendered).

The majority discusses at length the plausible explanations
proffered by Bailey for issuing the stock to Owens, and contends that the Government’s case was “built around a single
witness with questionable motives.” The majority’s analysis
ignores the ample record evidence above that proves the
strength of the Government’s case. The majority opinion also
fails to acknowledge, let alone refute, an abundance of documentary and demonstrative evidence introduced at trial—
particularly the unexplained transfers and recirculation of the
original stock funds back into the Aspen Cove and Pepper

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Lane projects. The majority’s conclusion that the Government’s case “turned entirely on Owens’ testimony” and the
Complaint “could have tipped the jury in the government’s
favor” [sic] is further undercut by the fact that the Complaint
and Owens’ testimony bore upon completely different elements of the crime. Specifically, Owens’ testimony primarily
concerned whether he provided bona fide services to Bailey,
but the Complaint was narrowly offered for the purpose of
proving that Bailey knew it was illegal to issue unregistered
stock without receiving bona fide services in return.
The Government presented ample documentary, testimonial
and demonstrative evidence, in addition to Owens’ testimony,
showing that Bailey issued the unregistered for the purpose of
generating funds for the Aspen Cove and Pepper Lane purchases. The evidence proving that series of events, as corroborated by Owens’ testimony, was unaffected by the state of
mind issues raised by the Complaint. Thus, I would hold that
it is more probable than not that the jury would have reached
the same verdict had the Complaint not been introduced.
CONCLUSION
For the reasons indicated, I would affirm the district court’s
admission of the Complaint, under Rule 404(b), and Bailey’s
conviction.