Securities and Exchange Commission v. Wall Street Capital Funding LLC et al

Filing 28

SUBSTANTIVE ORDER on 19 Initial Discovery Dispute. Signed by Magistrate Judge Jonathan Goodman on 6/10/2011. (dkc)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF FLORIDA
MIAMI DIVISION
Case No. 11-20413-CIV-GRAHAM/GOODMAN

SECURITIES AND EXCHANGE COMMISSION,
Plaintiff,
vs.
WALL STREET CAPITAL FUNDING, LLC, et al.,
Defendants.
_______________________________________
SUBSTANTIVE ORDER ON INITIAL DISCOVERY DISPUTE
This cause is before me on the discovery disputes at issue in Defendants’ Notice of
Hearing. (DE# 19.) I held a hearing on the discovery dispute detailed in Defendants’ notice on
May 20, 2011. (DE# 20.) The hearing focused on Defendants’ objections to a Request for
Production propounded by the SEC and an SEC-issued duces tecum subpoena served on
Defendants’ former securities counsel, Joseph Emas, Esq.
Because the parties adopted diametrically opposed views on the scope of discovery, the
Court asked them to submit post-hearing memoranda (See DE# 23; DE# 24), which the Court
has now reviewed.
For the reasons outlined below, Defendants’ objections to the SEC’s Request for
Production are overruled and their objections to the duces tecum subpoena served on their
former counsel are overruled in part and sustained in part. In particular, the SEC’s discovery
is not limited in scope to the four companies listed in its Complaint. The SEC should, however,
narrow the scope of the duces tecum subpoena served on Mr. Emas, though it is entitled to seek

Case No. 11-20413-CIV-GRAHAM/GOODMAN
from Mr. Emas documents relating to his securities advice to Defendants for all companies
which received Defendants’ promotional services, not merely the four listed in the Complaint.
I.

General Background
In its Complaint, the SEC alleges, in general, that defendants were engaged in what is

informally called a “pump and dump” scheme. The SEC claims that Defendants, who are stock
promoters, committed myriad federal securities laws violations.
At bottom, the SEC alleges that Defendants distribute promotional materials which take
the form of “investment opinions” and which typically express a positive opinion about the
company being promoted, its revenues and the future direction of its stock. But, according to the
SEC, Defendants have no reasonable basis for these opinions and even publish the favorable
opinions when they know of warning signs suggesting the existence of a scam concerning the
penny stock company being promoted.

The SEC accuses Defendants of performing no

independent research to support the enthusiastic comments in their investment opinions.
In their answer, Defendants assert the advice of counsel defense as their 18th affirmative
defense. At the hearing, defense counsel advised that Mr. Emas is the attorney upon whom
Defendants relied.
Significantly (for purposes of the discovery dispute), the SEC alleges that Defendants
engaged in this misconduct over the course of their long careers. The SEC contends that
Defendants have disseminated misinformation about hundreds of penny stocks and that their
improper activities are part of a practice and pattern which uses the same or identical protocol.
Nevertheless, the SEC’s complaint names only four penny stock companies. The SEC
contends that these four companies are merely examples or illustrations of the Defendants’
standard practices.

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The SEC seeks a permanent injunction against Defendants, as well as other relief, such as
the disgorgement of ill-gotten gains (with pre-judgment interest) and civil monetary penalties.
In its request for production, the SEC seeks several categories of documents concerning
Defendants’ research, investigation or inquiry into any company for which Defendants rendered
promotional services from January 1, 2008 to date. In other categories in the request, the SEC
seeks other documents concerning Defendants’ activities with all companies for which they
provided promotional services from January 1, 2008 to date.
The SEC also seeks, in its document request, “all documents concerning Joseph Emas,
including, without limitation, all documents concerning all communications with Joseph Emas.”
Likewise, in its subpoena to Mr. Emas, the SEC seeks “all documents concerning WSCF,
SMA, Philip Cardwell, Roy Campbell or Aaron Hume.”
II.

The Discovery Dispute
Framed by this procedural background, the discovery disputes can be summarized as

follows:
First, Defendants are willing to produce responsive documents concerning the four
companies named in the Complaint but contend that a document request for materials concerning
“all” companies for which Defendants issued investment opinions is overbroad and beyond the
scope of permissible discovery. Defendants also argue that Federal Rule of Civil Procedure
9(b)’s pleadings specificity requirement (i.e., that fraud allegations be asserted with
“particularity”) would be undermined if a party could demand discovery of all transactions even
though the complaint alleged with particularity only activities concerning a far-smaller group of
transactions and activities.

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Case No. 11-20413-CIV-GRAHAM/GOODMAN
The SEC, on the other hand, contends that materials concerning all companies are
discoverable because it alleged a pattern and practice and that the four companies mentioned are
only illustrations of a broader and larger scheme. In addition, it says it would be unreasonable to
require a plaintiff to allege with particularity all the alleged frauds in a complex, multi-year,
ongoing scheme.

According to the SEC, it is entitled to discovery about Defendants’

involvement with other companies once it has sufficiently alleged specifics about the fraud
allegations concerning the four companies it is using as examples in its Complaint.
This controversy – whether discovery should be limited to the four companies or
expanded to all companies receiving promotional services from Defendants – is the deepest and
most strident controversy between the parties on threshold discovery issues. There appears to be
little chance of a compromise here, as the Parties adopt fundamentally different views on the
basic approach – which then creates other, related disputes. 1
Second, concerning the request for documents reflecting Defendants’ communications
with their lawyer, Defendants are willing to produce communications concerning the four
companies mentioned in the Complaint but object to producing further communications, which
they say are covered by the attorney-client privilege. The SEC contends that the documents are
all relevant and discoverable (because it alleged a practice and pattern). It also contends that the
documents are discoverable because the advice-of-counsel defense triggers a subject matter

1

Metaphorically speaking, the Parties’ positions here are akin to contemporary, litigationbased versions of the opposing views taken by the persons described in the famous 1967 song
“Hello, Goodbye,” by The Beatles. In that song, there were opposite perspectives and statements
over almost everything: hello vs. goodbye, yes vs. no, stop vs. go, high vs. low, etc. Although
songwriter Paul McCartney did not resolve the always-present differences of opinion in his song
(which was released as a single but later included on the Magical Mystery Tour album released
in the United States), this Court will stray from the song’s storyline and decide the dispute. See
www.elyrics.net/read/b/beatles-lyrics/hello,-goodbye-lyrics.html (last visited June 9, 2011) and
http://en.wikipedia.org/wiki/Hello,_Goodbye (last visited June 9, 2011).
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waiver and that the documents cannot remain covered by the attorney-client privilege when
Defendants assert an advice-of-counsel defense.
Third, Defendants also object to the language of the document demand in the duces
tecum subpoena to Mr. Emas. The one-sentence document demand purports to require Mr. Emas
to produce “all documents” concerning the Defendants and one other entity. At the hearing, SEC
counsel argued that this request was “broad, but not too broad.” The SEC conceded at the
hearing that it does not actually want “all” documents and suggested that the Defendants and Mr.
Emas should understand that materials which did not concern promotional activities need not be
produced. 2 In its post-hearing memorandum, the SEC, while opining that a narrowed request is
unnecessary because of the likely de minimis amount of irrelevant documents encompassed by
the broad language of the request, advised that it is willing to reformulate its requests in order to
obviate any concerns over overbreadth.
III.

Legal Analysis
Federal Rule of Civil Procedure 26(b) governs the scope of discovery.

That rule

provides, in relevant part, that “[p]arties may obtain discovery regarding any non-privileged
2

The Court used hypothetical illustrations at the hearing to address the overbreadth
concern. For example, (hypothetical) invitations to attend a barbecue, sent from Defendants to
Mr. Emas, would be covered by the subpoena, as would (for argument sake) photographs of
Defendants and Mr. Emas at a social gathering. The SEC’s counsel agreed that these materials
are not being sought even though they are covered by the “broad” demand for “all” documents
concerning the Defendants and Mr. Emas. The SEC, however, did not offer a suggestion as to
how Defendants are supposed to know or intuit which materials are not actually being demanded
in the “all” category.
In its post-hearing memorandum, the SEC attempts to justify its use of a request for
communications which “may on their face appear relatively broad” by explaining that (1) it
understands the volume of responsive documents to be “tiny,” (2) the volume of “truly
irrelevant” documents is “likely to be de minimis”, and (3) Defendants’ objection during the
meet-and-confer process was not driven by a concern that the language of the request was
overbroad in any way other than seeking documents concerning more than the four companies
named in the Complaint. (DE 23, p. 10, n.5)
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matter that is relevant to any party's claim or defense . . . Relevant information need not be
admissible at the trial if the discovery appears reasonably calculated to lead to the discovery of
admissible evidence.” Subdivision (b) to the 1946 Advisory Committee Notes to Rule 26
indicates that “[t]he purpose of discovery is to allow a broad search for facts, the names of
witnesses, or any other matters which may aid a party in the preparation or presentation of his
case.” (citations omitted). Indeed, the Advisory Committee Notes approvingly quotes language
from a case stating that “the Rules . . . permit ‘fishing for evidence as they should.’” Id. (citation
omitted). See also Hickman v. Taylor, 329 U.S. 495, 507 (1947) (“No longer can the timehonored cry of ‘fishing expedition’ serve to preclude a party from inquiring into the facts
underlying his opponent's case”).
As summarized recently by United States Magistrate Judge Robin Rosenbaum in AIG
Centennial Ins. Co. v. O’Neill, Case 09-60551, 2010 WL 4116555 (S.D. Fla. Oct. 18, 2010):
The courts have long recognized the wide scope of discovery
allowed under the Federal Rules of Civil Procedure. As the
Eleventh Circuit's predecessor court noted, “The discovery
provisions of the Federal Rules of Civil Procedure allow the parties
to develop fully and crystalize concise factual issues for trial.
Properly used, they prevent prejudicial surprises and conserve
precious judicial energies.” The United States Supreme Court has
said that they are to be broadly and liberally construed. Burns v.
Thiokol Chem. Corp., 483 F.2d 300, 304 (5th Cir.1973) (citing
Hickman v. Taylor, 329 U.S. 495, 507, 67 S.Ct. 385, 91 L.Ed. 451
(1947); Schlagenhauf v. Holder, 379 U.S. 104, 114–115, 85 S.Ct.
234, 13 L.Ed.2d 152 (1964)).
(internal quotation marks added to preserve the significance of original formatting).
Courts in this Circuit have often noted the basic rule that the scope of discovery is broad
and that the discovery rules generally favor complete discovery. United States Magistrate Judge
Linnea Johnson outlined these overarching principles in Donahay v. Palm Beach Tours &
Transp., Inc., 242 F.R.D. 685, 687 (S.D. Fla. 2007):
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Case No. 11-20413-CIV-GRAHAM/GOODMAN
Rule 33 of the Federal Rules of Civil Procedure allow any party to
serve on any other party written interrogatories concerning matters
within the scope of Federal Rule Civil Procedure 26(b). The scope
of discovery under Rule 26(b) is broad: “parties may obtain
discovery regarding any matter, not privileged, which is relevant to
the claims or defense of any party involved in the pending action.”
Id.; Hickman v. Taylor, 329 U.S. 495, 507-508, 67 S.Ct. 385, 91
L.Ed. 451 (1947). See also Farnsworth v. Procter and Gamble Co.,
758 F.2d 1545, 1547 (11th Cir.1985)(the Federal Rules of Civil
Procedure “strongly favor full discovery whenever possible”);
Canal Authority v. Froehlke, 81 F.R.D. 609, 611 (M.D.Fla.1979).
Information is relevant if it is “germane, conceivably helpful to
plaintiff, or reasonably calculated to lead to admissible evidence.”
Parsons v. General Motors Corp., 85 F.R.D. 724 (N.D.Ga.1980).
See also Hickman, 329 U.S. at 501, 67 S.Ct. 385. Thus, under Rule
26 relevancy is “construed broadly to encompass any matter that
bears on, or that reasonably could lead to another matter that could
bear on any issue that is or may be in the case.” Oppenheimer
Fund, Inc. v. Sanders, 437 U.S. 340, 352, 98 S.Ct. 2380, 57
L.Ed.2d 253 (1978). Discovery is not limited to the issues raised
by the pleadings because “discovery itself is designed to help
define and clarify the issues.” Id. at 352, 98 S.Ct. 2380. In short,
information can be relevant and therefore discoverable, even if not
admissible at trial, so long as the information is reasonably
calculated to lead to the discovery of admissible evidence. Dunbar
v. United States, 502 F.2d 506 (5th Cir.1974).
Framed by these rules, it is no surprise that “[t]he party resisting discovery has a heavy
burden of showing why discovery should be denied.” Principe v. Seacoast Banking Corp. of
Fla., No. 09-14428-CIV, 2010 WL 2976766, at *2 (S.D. Fla. July 20, 2010) (emphasis supplied)
(internal citations and quotation marks omitted). Phrased differently, Defendants here must
demonstrate specifically how the objected-to requests from the SEC are unreasonable or unduly
burdensome. See generally Panola Land Buyers Ass’n v. Shuman, 762 F.2d 1550, 1559 (11th
Cir. 1985). See also Dunkin’ Donuts, Inc. v. Mary’s Donuts, Inc., No. 01-0392-CIV-GOLD,
2001 WL 34079319, at *2 (S.D. Fla. 2001) (noting burden on party resisting discovery and
explaining that “[d]iscovery should ordinarily be allowed under the concept of relevancy unless
it is clear that the information sought has no bearing on the subject matter of the action”).
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Given this framework of, in general, broadly-authorized discovery, the Eleventh Circuit
has noted that a district court’s discretion in shaping discovery is “not entirely sacrosanct” and
that an appellate court will reverse if the trial judge “fails to adhere to the liberal spirit of the
Rules.” Williams v. City of Dothan, 745 F.2d 1406, 1415 (11th Cir. 1984). See also Milinazzo v.
State Farm Ins. Co., 247 F.R.D. 691, 695 (S.D. Fla. 2007) (“Courts must employ a liberal
discovery standard in keeping with the spirit and purpose of the discovery rules”).
As noted, Defendants’ primary objection is that the SEC’s allegations do not contain any
specific allegations concerning their activities with entities other than the four mentioned in the
Complaint – a scenario which, according to Defendants, triggers Rule 9(b) concerns.
However, Rule 9(b)’s directive to plead fraud with particularity is a pleading rule, not a
limitation on discovery and not the standard for the scope of discovery. Fein v. Numex Corp., 92
F.R.D. 94, 97 (S.D.N.Y. 1981) (rejecting the position urged by Defendants here and noting that
“the flaw in this argument is that Rule 9(b) tests only the sufficiency of the pleadings and not the
perimeters [sic] of discovery”). In Numex, the court noted that Defendants had not moved under
Rule 9(b) to dismiss the allegations for failure to meet the particularity requirement -- a scenario
identical to the procedural posture here, where Defendants answered the SEC’s complaint and
did not file a motion challenging the purported lack of particularity for the alleged pattern of
financial misconduct.
In effect, Defendants argue that a party in a fraud-related lawsuit may not obtain
discovery on any matters not specifically alleged with the requisite particularity in the complaint.
For the most part, Defendants do not cite discovery cases to support their crabbed view of
discovery. Instead, they primarily cite pleadings-related cases concerning the sufficiency of
fraud allegations in the motion to dismiss context. Thus, to use a well-publicized illustration

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from current cases, Defendants’ discovery theory would prevent any plaintiff pursuing claims
against Bernard Madoff from obtaining discovery from Mr. Madoff on any of his activities other
than those alleged with Rule 9(b) particularity. Given that Mr. Madoff received a 150-year
sentence after entering a guilty plea to eleven (11) counts of fraud and fraud-related crimes and
given that thousands of investors invested in his Ponzi scheme, 3 a plaintiff operating under the
discovery philosophy advocated by Defendants here would need to file a lawsuit of several
thousand pages and include myriad allegations meeting the particularity rule for pleading fraud if
he wished to obtain discovery on the full scope of Mr. Madoff’s Ponzi scheme activities.
This impractical result is illogical, of course, but it would be required by Defendants’
argument. The Court is not inclined to adopt a theory which would lead to such far-fetched
results, and other courts have declined to do so, as well. E.g., Rorer Int’l Cosmetics, Ltd. v.
Halpern, 85 F.R.D. 43, 45 (E.D. Pa. 1979) (noting that the policies underlying Rule 9(b)’s
particularity requirement are inapplicable once a plaintiff demonstrates some specific basis for
his fraud charges, and permitting discovery of information relating to alleged kickbacks even
though the complaint contained no allegations of kickbacks). “Once a plaintiff has shown that
his charges are not frivolous or totally unsubstantiated, his suit, like any other suit, becomes
subject to the Federal Rules of Civil Procedure.” Halpern, 85 F.R.D. at 45.
In its Complaint, which seeks, inter alia, injunctive relief, the SEC makes many specific
allegations about Defendants’ involvement with four companies. Apparently, Defendants do not
challenge the SEC’s compliance with Rule 9(b)’s particularity requirement for these allegations,
and such an argument would be unpersuasive if made.

3

Http://online.wsj.com/article/SB124604151653862301.html (last visited June 9, 2011),
http://s.wsj.net/public/resources/documents/st_madoff_victimes_20091215.html (last visited
June 9, 2011), http://www.justice.gov/usao/nys/madoff.html (last visited June 9, 2011).
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For example, concerning Defendants’ representations about PrimeGen Energy
Corporation (OTC: PGNE), the SEC quotes investment opinions, provides the specific dates of
the opinions, attaches examples of investment opinions as exhibits, quotes language from mass
emails, attaches copies of the emails as exhibits, explains the Defendants’ webpage material,
attaches images of a web profile for PrimeGen on two specific dates in 2009, pinpoints the
precise number of shares of PrimeGen stock which Defendant WCST obtained in exchange for
its promotional activities and explains why the representations about PrimeGen were false (e.g.,
PrimeGen had no drilling operations or revenues and did not even have an office at the address
where it claimed to be headquartered).
The SEC also alleges that the corporate Defendant existed for approximately ten years
and is believed to have disseminated information relating to hundreds of penny stocks. The SEC
alleges that Defendants “typically” engage in certain unlawful practices and its complaint
pinpoints activities concerning four penny stock companies for illustrative purposes.
Based on this core allegation, discovery concerning other companies is within the broad
scope of Rule 26.

Eastman Kodak Co. v. Camarata, 238 F.R.D. 372 (W.D. N.Y. 2006)

(permitting discovery of documents dating back 14 years, including discovery concerning
additional money laundering violations involving transactions in additional, personal bank
accounts at other banks). See also United States v. Bledsoe, 501 F.3d. 493, 509-511 (6th Cir.
2008) (holding that “where a [party] pleads a complex and far-reaching fraudulent scheme with
particularity, and provides examples of specific false claims . . . a [party] may proceed to
discovery on the entire fraudulent scheme”) (emphasis added). 4 The SEC’s allegations about
4

The Bledsoe Court also held that a party pursuing fraud claims will be permitted to
proceed to discovery on the entire fraudulent scheme when the claims which are pled with
specificity are “characteristic examples” “illustrative of the class” of claims covered by the
fraudulent scheme. Id. at 511. In the instant case, the SEC alleged that “Defendants always do
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the Defendants’ alleged fraud in connection with the four companies meets Rule 9(b)’s
particularity requirement and it would be illogical and impractical to require the SEC to meet the
particularity requirement for each and every other company which Defendants promoted in order
to obtain discovery about their similar activities in a practice and pattern of purported
misconduct.
In addition to the well-established rule of broad discovery, there is another reason to
permit the SEC to obtain discovery about the Defendants’ activities with other penny stock
companies beyond the four mentioned in the complaint: the SEC is seeking injunctive relief, and
as a result may have a need to demonstrate future violations of the securities laws with evidence
of a recurring and ongoing pattern of violations. See SEC v. Carriba Air, Inc., 681 F.2d 1318,
1322 (11th Cir. 1982).
The Court therefore overrules Defendants’ objections and their contention that the SEC’s
discovery is limited to information concerning their activities with only the four companies
mentioned for illustrative purposes in the SEC’s complaint.
Concerning the duces tecum subpoena to Mr. Emas, Defendants have asserted the advice
of counsel defense as an affirmative defense, which therefore leads to a waiver of the attorneyclient privilege. Defendants concede that waiver is a natural consequence of their defense but
they believe that the waiver should be limited to the subject matter -- which they have defined
narrowly as “legal advice regarding the defendants’ disclosures, statements and omissions, and
contracts used, or intended to be used, for the promotions of the Named Companies.” (emphasis
added) (DE# 24, p. 9).

the same thing” and that they “commonly” take “typical” steps (e.g., expressing “a positive
opinion about the company being promoted” even though they have “no reasonable basis for
those opinions”).
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Defendants’ requested limitation on the application of the advice of counsel defense is
not reflected in the actual affirmative defense, however.

Specifically, Defendants’ 18th

Affirmative Defense broadly says: “Defendants have relied in good faith on the advice of
counsel in making their disclosures and statements or omissions.”

(DE# 5, p. 16).

The

affirmative defense does not state or even suggest that it applies only to Defendants’ former
attorney’s advice on the four companies mentioned as examples of a pattern of conduct in the
complaint.

Defendants did not move to dismiss the complaint or carve out allegations

concerning all entities other than the four discussed in the complaint. Instead, the affirmative
defense applies to disclosures (plural), statements (plural) and omissions (plural). Because the
defense is not restricted to activities concerning only four companies, it must logically be
construed to apply to activities relating to all companies for which Defendants provided
promotional services (and which are alleged generally in the Complaint, as part of a typical
pattern of identical or nearly identical activity).
Defendants cannot assert the advice of counsel advice while simultaneously and
strategically selecting which communications to disclose for self-serving purposes and which
communications to retain as confidential. United States v. Bilzerian, 926 F.2d 1285, 1292 (2d
Cir. 1991); Immuno Vital, Inc. v. Telemundo Group, Inc., 203 F.R.D. 561, 564 (S.D. Fla. 2001)
(explaining that the advice of counsel defense leads to waiver for advice by both in-house and
outside counsel because the party raising the defense “must permit discovery of any and all legal
advice rendered on the disputed issue”).
Defendants cannot prejudice the SEC by using the attorney-client privilege as a sword
and a shield, and their effort to narrow the subject matter of the waiver to only communications
concerning four companies is unreasonable and unfair to the SEC. In fact, a similar strategy was

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rejected in United States v. Locasio, 357 F. Supp. 2d 536, 548-53 (E.D.N.Y. 2004). In Locasio,
the court required the disclosure of not only communications concerning the advertisements at
issue in the case but also as to communications with a different attorney regarding the
compliance of a previous set of advertisements to which a Federal Trade Commission standard
applied. Id.
Therefore, the Court overrules Defendants’ objections to the scope of the waiver
generated by their assertion of the advice of counsel defense. Defendants and Mr. Emas may not
withhold responsive documents on the grounds of the attorney-client privilege. The waiver does
not mean that all communications between Defendants and their former counsel, Mr. Emas, are
discoverable. Rather, it means that all communications concerning his advice about disclosures,
statements and omissions concerning the promotional activities Defendants provided for any
penny stock company during the designated time period are no longer privileged.
Communications between Defendants and Mr. Emas about other unrelated subjects remain
privileged, however.
Nevertheless, notwithstanding their unsuccessful argument on the scope of discovery and
the subject matter of the attorney-client privilege waiver, Defendants have asserted a different
and legitimate objection to the SEC’s subpoena to Mr. Emas: it is overly broad, and the Court
therefore sustains Defendants’ overbreadth objection. As phrased, the document component of
the duces tecum subpoena concerns all communications, regardless of subject matter, and would,
for example, encompass emails about a barbecue, wedding invitations, exchanges of articles
concerning professional sports teams, memoranda about the parties’ favorite movies, etc.
Under these circumstances, the Court believes it is logical to accept the SEC’s offer to
“reformulate” the document list in the subpoena so that it pinpoints only those documents to

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which the SEC is entitled. The SEC shall cooperate with defense counsel in limiting the scope of
materials encompassed by the subpoena.

Counsel are directed to agree upon a narrowed

subpoena within seven (7) days of entry of this Order. If the Parties are unable to agree, then
they may contact chambers and schedule a hearing on my discovery calendar. The Parties need
not submit the modified, narrowed list to the Court if there is an agreement on the revised scope.
Although the Parties and the Court (and its staff) have expended a significant amount of
time and energy on this discovery dispute, the Court is not awarding fees and costs to the SEC,
as the Defendants were substantially justified in asserting their objections.
DONE AND ORDERED, in Chambers, in Miami, Florida, this 10th day of June, 2011.

Copies furnished to:
The Honorable Donald Graham
All counsel of record

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