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UNITED STATES DISTRICT COURT SOUTHERN DISTIUCf OF NEW YORK


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SECURITIES AND EXCHANGE COMMISSION, 12 Civ. 6421 (KMK) Plaintiff, ECFCASE

v.
EDWARD BRONSON and E-LIONHEART ASSOCIATES, LLC, d/b/a F AIRHILLS CAPITAL, Defendants and FAIRHILLS CAPITAL, INC.,

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Relief Defendant.
-nun

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PLAINTIFF SECURITIES AND EXCHANGE COMMISSION'S OPPOSITION TO DEFENDANTS' MOTION TO DISMISS

Kevin McGrath Wendy Tepperman William Edwards Attorneys for Plaintiff Securities and Exchange Comniission New York Regional Office 3 World Financial Center- Suite 400 New York, New York 10281 (212) 336-1100

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TABLE OF CONTENTS
INTRODUCTION ........................................................................................................................... 1 THE COMMISSION'S ALLEGATIONS ....................................................................................... 3 ALLEGATIONS CONCERNING RELIEF DEFENDANT........................................................... 6 ARGUMENT................................................................................................................................... ? I. II. Standard of Review ....................................................................................................... 7 Defendants Do Not Contest That The Commission Has Established A Prima Facie Case That Defendants Violated Section 5 ..................................................................... 8 No Valid Registration Exemption Applies To Defendants' Resale Transactions ......... 9 A. The Commission Adopted SEC Rule 504(b)(l)(iii) to Carve Out A Federal Exemption For State Law Exemptions Based On, Or Analogous To, The Model Accredited Investor Exemption ............................................................................... 9 B. Delaware Section 7309(b)(8) Does Not Satisfy The Requirements Of SEC Rule 504(b)( 1)(iii) .......................................................................................................... 11 C. Bronson And E-Lionheart Lack A Sufficient Nexus With Delaware To Invoke A Delaware Exemption ............................................................................................. 13 D. Defendants' Argument That SEC Rule 504(b)(l)(iii) Does Not Require A Nexus Between The State Whose Exemptions Is Invoked And The Securities Transactions At Issue Ignores The Plain Language OfRule 504(b)(l)(iii) .......... 16 IV. The Commission Has Stated A Cause Of Action Against Fairhills Capital, Inc., As Related To Certain Automobiles ................................................................................. l9

III.

CONCLUSION ............................................................................................................................. 20

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TABLI1: OF AUTHOIUTU:S
Cases

ABRY Partners V. L.P. v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006) ...................... 15 Aeroglobal Capital Mgmt., LLC v. Cirrus Indus., Inc., 871 A.2d 428 (Del 2005) ....................... 15 Bowsher v. Merck & Co., 460 U.S. 824 (1983) ............................................................................. 18 Chapman v. New York State Div. for Youth, 546 F.3d 230 (2d Cir. 2008) ..................................... 7 Coface Collections N. Am. Inc. v. Newton, 430 Fed. App'x 162 (3d Cir. 2011)........................... 15 Compudyne Corp. v. Shane, 453 F. Supp. 2d 807 (S.D.N.Y. 2006) ............................................... 7 Courtenay Commc'ns Corp. v. Hall, 334 F.3d 210 (2d Cir. 2003).................................................. 8 Dofflemeyer v. WF. Hall Printing Co., 558 F. Supp. 372 (D. Del. 1983) .............................. 14-15 In Re Norte[ Networks Corp. Sec. Lilig., 238 F.Supp.2d 613 (S.D.N.Y. 2003) .............................. 7 Iowa Pub. Emp. Ret. System v. MF Global, Ltd, 620 F.3d 137 (2d Cir. 2010) .............................. 9 McKenna v. Wright, 386 F.3d 432 (2d Cir. 2004) ...........................................................................9 SEC v. Cavanagh, 1 F. Supp. 2d 337 (S.D.N. Y.). affd, 155 F.3d 129 (2d Cir. 1998) ................... 8 SEC v. Ralston Purina Co., 346 U.S. 119 (1953) ............................................................................ 9 SEC v. Softpoint, .Inc., 958 F.Supp.846 (S.D.N.Y. 1997}, a.ff'd, 159 F.3d 1348 (2d Cir. 1998) ...... 8 Singer v. Magnavox, 380 A.2d 969 (Del. 1977), overruled on other grounds, Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) .................................................................................. 14, 15 Total Holdings USA, Inc. v. Curran Composites, Inc., 999 A.2d 873 (Del. Ch. 2009) ................ 15 US. v. Space Hunters, Inc., 429 F.3d 416 (2d Cir.2005) ................................................................ 9 Vichi v. Koninkl(jke Philips Electronics, N. V., 2009 WL 4345724 (Del. Ch. Ct. Dec. 1, 2009) .. 14

ii

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Statutes
Del. Code Ann. tit. 6, 73-103(a)(l7) .......................................................................................... 13 DeL Code Ann. tit. 6, 73-202 ..................................................................................................... 12 Del. Code Ann. tit. 6, 73-207(b)(8) ..................................................................................... passim Del. Code Ann. tit. 6, 2708(c) .................................................................................................... 15 Section 5, Securities Act of 1933, 15 U.S.C. 77e ............................................................. 1, 4, 7, 8 Section 7309(b)(8) of the Delaware Securities Act [Redesignated as Del. code Ann. tit. 6, 73207(b)(8) of the Delaware Securities Act on November 14, 2011] ("Delaware Section 73207(b)(8)") ................................................................................................................................... 1

Other Authorities
Proposed Rule Release No. 33-7541 (May 21, 1998) ("1998 Proposing Release") ....................... 9 Robert T. Willis, Jr., P.C., SEC No-Action Letter, (Jan. 18, 1988), 1988 SEC No-Act. LEXIS 34 .................................................................................................................................................... 13 Model Accredited Investor Exemption (1997) ...................................................... 10, 11

Rules
Fed. R. Civ. P. Rule 12(b)(6) ....................................................................................................... 1, 7 Revision of Rule 504 of Regulation D, the "Seed Capital" Exemption, SEC Release No. 33-7644 (Feb. 25, 1999) ("1999 Adopting Release") .................................................................... 9-10, 11 Revisions of Limited Offering Exemptions in Regulation D, SEC Release No. 33-8828 (Aug. 3, 2007) ................................................................................................................................ 10 Rule 501(a) of Regulation D, 17 CFR 230.50l(a) .................................................... .4, 10, 12, 17 Rule 502(c) of Regulation D, 17 CFR 230.502(c) ..................................................................... 13 Rule 504(b)(1 )(iii) of Regulation D, 17 C.F .R. 230.504(b)( 1)(iii) ..................................... passim Section 503 of PartE, Delaware Rules and Regulations Pursuant to the Delaware Securities Act ("Delaware Rule 503") ............................................................................................... 2, 11, 12, 13 Section 510(a)(1) of the Delaware Rules and Regulations ............................................................ l2

lll

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INTRODUCTION

Plaintiff Securities and Exchange Commission (the "Commission") submits this Memorandum of Law in opposition to the motion of defendants Edward Bronson ("Bronson"), E-Lionheart Associates, LLC, d/b/a Fairhills Capital ("E-Lionheart") (collectively, "Defendants") and relief defendant Fairhills Capital, Inc. ("FCI") to dismiss the Commission's complaint, pursuant to Fed. R. Civ. P. Rule 12(b)(6}, for failure to state a claim. The complaint alleges that since at least August 2009, Bronson, through his company, ELionheart, has engaged in a massive scheme to purchase millions of shares at a time in over 100 companies and almost immediately resell them to the public without complying with the registration requirements of Section 5 of the Securities Act of 1933. Defendants do not contest
that the complaint establishes a prima facie case that they violated Section 5, in that: (1) no

registration statement was filed or was in effect as to the securities; (2) the Defendants, directly or indirectly, sold or offered to sell these securities; and (3) in connection with the offer or sale, there was a use of interstate transportation, or conununication in interstate commerce, or of the mails. Instead, they assert an affirmative defense that the offers and sales were exempt from registration under Rule 504(b)(l)(iii) of Regulation D, 17 C.F.R. 230.501 et seq. (1999) ("SEC Rule 504(b)(l)(iii)"}, which provides an exemption for certain limited offers and sales of securities only if made "(e]xclusively according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to 'accredited investors' ...." Defendants argue that all of the charged sales were exempt from registration under SEC Rule 504(b)(l)(iii) pursuant to Section 7309(b)(8) of the Delaware Securities Act [Redesignated as 73-207(b)(8) of the Delaware Securities Act on November 14, 2011] ("Delaware Section

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73-207(b)(8)"), even though all of Defendants' activities took place in New York, and irrespective of the state where the issuers were incorporated, did business or sold the securities. However, the Delaware exemption Defendants rely upon is inapplicable for numerous reasons, including that they are wholly contrary to the plain language of the claimed exemptions. First, Delaware Section 73-207(b)(8) does not pennit general solicitation and general advertising as required by SEC Rule 504(b)(l)(iii). Instead, it only permits solicitation of certain specifically enumerated institutions and entities that are not natural persons. It does not permit any offers or sales to any individuals and certainly does not permit general solicitation and general advertising to the entire public. Furthermore, Defendants' sales violated the only relevant Delaware exemption meeting the requirements of SEC Rule 504(b)(I )(iii), Section 503 of Part E under the Delaware Rules and Regulations Pursuant to the Delaware Securities Act ("Delaware Rule 503"), which expressly permits general solicitation and general advertising provided that sales are only made to accredited investors and that shares are held for one year before resale. Defendants' resale activities plainly run afoul of Delaware Rule 503 because their sales occurred within days or, at most, weeks of their initial stock acquisitions. In addition, Delaware Section 73-207(b)(8), even if applicable to offers and sales made in Delaware, would not apply to offers and sales made outside of Delaware. Defendants argue that SEC Rule 504(b)(l)(iii) does not require a nexus between the securities transactions and the state under whose laws the exemption is claimed but instead permits the Defendants and the issuers they collaborated with to simply "choose" which state's exemption applies regardless of whether any offers or sales actually took place in that state. This argument fails for several reasons. Most importantly, SEC Rule 504(b)(l)(iii) requires that the offers and sales be made "exclusively according to state law exemptions from

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registration that permit general solicitation and general advertising ...." Both on its face and when read with the rest of SEC Rule 504(b)(l), the word "exclusively'' makes clear that this provision only exempts offers and sales made in states which actually permit general solicitation and general advertising, not in any state. Defendants' argument is inconsistent with the plain language of, and intent behind, SEC Rule 504(b)(l). Finally, Defendants argue that the complaint fails to state a claim for unjust enrichment as to certain automobiles now held in the name of FCI because it does not allege that the automobiles were purchased with any ill-gotten gains. However, the complaint alleges facts sufficient to support a plausible inference that FCI received ill-gotten proceeds of Bronson's illegal stock distribution scheme and that the automobiles were among those ill-gotten proceeds.

THE COMMISSION'S ALLEGATIONS


The complaint alleges, inter alia, that Bronson resides in Ossining, New York. He is the sole managing member ofE-Lionheart, a company he used to facilitate his illegal stock sales. Compl. ~ 7. E-Lionheart, formed in 2005 as a Delaware limited liability company, also does business as "Fairhills Capital." E-Lionheart is registered in the State ofNew York as a foreign limited liability company. Bronson is the sole managing member ofE-Lionheart. At all times, E-Lionheart has maintained its sole physical office in White Plains, New York. Compl. ~ 8. FCI was formed in 2010 as a Delaware corporation, and maintains a registered business address in White Plains, New York at the same location as E-Lionheart. Bronson is the President and owner ofFCI. FCI was unjustly enriched by Bronson's transfer to FCI of at least $600,000 of the proceeds from the illegal stock sales described herein. Compl., 9. The Defendants obtained and illegally resold the stock of approximately l 00 companies, reaping profits of more than $10 million while depriving the investing public of the protections

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of the registration requirements of the securities laws. The stocks of these issuers traded only in the "over-the-counter" market and were quoted on OTC Link, an electronic quotation and trading system. The stocks of these issuers were ''penny stocks,'' meaning that, among other things, they traded below five dollars per share and were not listed on a national securities exchange. Compl. ~ 10. Section 5 of the Securities Act prohibits any person, directly or indirectly, from offering or selling any security unless a registration statement is filed as to such offer, and is in effect as to such sale, or unless an exemption from registration is available. A registration statement is made publicly available and is required to include disclosures of financial and business information about the company and the particular securities that are being offered and sold. Compl. ~ 11. Unless an exemption from registration is available, a registration statement is required for each new offer or sale of securities by any person. In this case, no registration statements were filed or in effect in connection with either the initial issuance of shares to Defendants or Defendants' sales of those shares to the public and no exemptions from registration were available to Defendants for their sales of those securities to the public. Comp. ~ 12. Defendants purported to rely upon the exemption set forth in SEC Rule 504(b)(l)(iii), which provides an exemption for certain limited offers and sales of securities only if the offers and sales are made "[e]xclusively according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to 'accredited investors' as defined in [Rule] 501 (a)." Accredited investors arc investors who meet certain income or net worth requirements. Compl. ~~ 13-14. However, the state law exemption Defendants purportedly relied upon, Delaware Section

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73207(b)(8), does not meet the requirements of SEC Rule 504(b)(1 )(iii) and the offerings at issue did not have a sufficient nexus to Delaware to entitle the Defendants to rely upon any Delaware exemptions from registration. Accordingly, SEC Rule 504(b)(l){iii) did not provide an exemption from registration for either the issuers' initial offers and sales to Defendants nor Defendants' subsequent offers and sales to the investing public. Compl. ~,14; 1924. Defendants' illegal operation typically followed the same pattern. Operating from E Lionheart's office in White Plains, New York, Bronson, or ELionheart personnel acting at Bronson's direction, "cold called" OTC Link quoted companies to ask if they were interested in obtaining capital. If the company was interested, Bronson, or ELionheart personnel acting at his direction, would offer to buy stock in the company at a rate that was deeply discounted from the price the company's stock was then trading. Compl. ~ 15. Bronson (or ELionheart personnel acting at his direction) prepared a subscription agreement and other documents to effect the transaction. Compl. ~ 16. Bronson and E Lionheart, both residents ofNew York State, did not prepare, negotiate or execute any of the subscription agreements or other transactional documents in Delaware, and the securities were directed to be sent to ELionheart's business address in White Plains, New York. Compl. ~ 22. An attorney referred and/or paid by Bronson, but purportedly acting on the issuing company's behalf, who was not licensed to practice law in Delaware, provided an opinion letter to the company's transfer agent, also not located in Delaware, asserting that the securities could be issued without a restrictive legend because the offering was purportedly exempt from registration pursuant to Delaware Section 73207(b)(8) and SEC Rule 504(b)(l)(iii). This was despite the fact that all of Defendants' activities took place in New York, and irrespective of the location of the company's business. Compl. ,, 1922.

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Typically, Defendants began immediately reselling the shares to the investing public through a broker within days of receiving the shares from the company. Given that no registration statements were filed or in effect as to any of these sales, investors did not have access to all of the information that a registration statement would have provided and in many instances were deprived of even the basic infonnation of the new issuance of millions of shares by the company and the dilution effect thereof. On average, the Defendants were able to generate proceeds from their illegal resales that were approximately double the price at which ELionheart had acquired the shares. Compl. ~ 17. Since August 2009, Defendants have engaged in similar illegal resales of the stock of over one hundred companies, involving the sale of billions of shares to the investing public, without a registration statement being filed or in effect and with no valid exemption from registration available. Compl. ~, 18; 25-31.
Allegations Concerning Relief Defendant

Bronson registered FCI to do business in New York on December 14, 20 I0. Less than one week later, on December 20,2010, Bronson transferred $10,000 from the E-Lionheart brokerage account he used to custody the proceeds of his illegal transactions to a bank account maintained in the name ofFCI. Compl. ~ 32. In December 2010, Bronson also transferred title to a 2011 Mercedes Benz SUV from his name to FCI 's name. FCI also holds title to a 2011 Land Rover, a 2007 Ferrari 599 and a 1982 Rolls Royce Silver Spur. Compl., 33. On February 10,2011, Bronson transferred an additional $600,000 from E-Lionheart's custodial brokerage account to FCI 's bank account. FCI , however, does not have any legitimate claim to the more than $600,000 in unlawful profits Bronson transferred to this entity's bank account. Compl. ~
34.

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None of the shares illegally sold by Bronson and E-Lionheart were transactions on FCI's behalf and none of the proceeds transferred to FCI were in return for any other consideration. The overwhelming majority of transactions in FCI's bank account, from the account's inception through at least JUQe 30,2011, were transfers to-and-from E-Lionheart's principal bank account. One of the few transfers out ofFCI's bank account not directed at E-Lionheart's bank account concerned a $35,000 payment to an attorney acting on behalf ofGoiP Global, Inc. in connection with its sale of$35,000 ofits securities to E-Lionheart, not FCI. This payment to GoiP Global, Inc.'s attorney came just one day after Bronson seeded FCI's bank account with $600,000 in illegal profits from E-Lionheart's custodial brokerage. account. Bronson is using the FCI bank account to hold certain proceeds of his illegal trading activity and to facilitate that activity. Compl. ~~ 35-36. The complaint, inter alia, charges the Defendants with violations of Sections 5(a) and S(c) of the Securities Act of 1933, 15 U.S.C. 77e(a) and 77e(c). ARGUMENT
I. Standard of Review

A defendant's "burden on a motion to dismiss pursuant to Rule 12(b)(6) is indeed substantial, as '[i]t has been said that the motion to dismiss for failure to state a claim is disfavored and is seldom granted."' Compudyne Corp. v. Shane. 453 F. Supp. 2d 807, 817 (S.D.N.Y. 2006) (quoting In re Norte[ Networks C01p. Sec. Litig., 238 F.Supp.2d 613,621 (S.D.N.Y. 2003)). A defendant's burden is substantial because a court, when considering a motion to dismiss, must "accept all well-pleaded facts as true and consider those facts in the light most favorable to the plaintiff." Chapman v. New York State Div. for Youth, 546 F.3d 230, 235 (2d Cir. 2008). Thus, a complaint will not be dismissed "unless it appears beyond doubt, even

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when the complaint is liberally construed, that the plaintiff can prove no set of facts which would entitle him to relief." Courtenay Communications Corp. v. Hall, 334 F.3d 210,213 (2d Cir. 2003). The allegations in the complaint easily meet the standard to survive Defendants' motion
to dismiss. II. Defendants Do Not Contest that the Commission Has Established a Prima Facie Case that Defendants Violated Section 5

The complaint establishes a prima facie case that Defendants violated Section 5(a) and 5(c) of the Securities Act. To establish a prima facie case for a violation of Section 5, the Commission need only allege that: ( 1) no registration statement was filed or was in effect as to the securities in question; (2) that the defendant, directly or indirectly, sold or offered to sell these securities; and (3) that in connection with the ofl'er or sale, there was a use of interstate transportation, or communication in interstate commerce, or of the mails. SEC v. Cavanagh, 1 F. Supp. 2d 337,361 (S.D.N.Y.), aff'd, 155 F.3d 129 (2d Cir. 1998). Scienter is not required to establish a violation of Section 5 of the Securities Act. SEC v. Softpoint, Inc., 958 F. Supp. 846, 859-60 (S.D.N.Y. 1997), aff'd, 159 F.3d 1348 (2d Cir. 1998). The complaint includes allegations that satisfy each of the required clements to plead a

primafacie case for a Section 5 violation. The complaint alleges: (1) that no registration
statements were ftled or in effect with the Commission for any of Defendants' securities sales (Compl. ~ 12); (2) that Defendants' effectuated the sale of the unregistered securities (Compl. ,, 15-18); and (3) that Defendants used instruments of interstate commerce and communication, including telephones and the mails, in connection with the sale of these secwities in the "overthe-counter" market (Com pl. ,~ 5, 15, 22). Accordingly, the Commission has stated a prima

facie Section 5 claim against the Defendants and Defendants do not dispute this point.

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III.

No Valid Registration Exemption Applies to Defendants' Resale Transactions


Instead, Defendants assert an affirmative defense that the complaint should be dismissed

because the securities at issue were allegedly exempt from registration pursuant to SEC Rule 504(b)(l)(iii) and Delaware Section 73-207(b)(8), and therefore freely tradable by Defendants.

See Def. Mem. 1. 1 However, Delaware Section 73"207(b)(8) does not provide cover for their
resale activities for at least two reasons. First, Delaware Section 73"207(b)(8) fails to meet the requirements of SEC Rule 504(b)(l)(iii) and Defendants failed to satisfy the applicable Delaware state law exemption that does meet the requirements of SEC Rule 504(b)(1 )(iii). Second, as discussed below, even if Delaware Section 73"207(b)(8) was somehow sufficient to meet the requirements of SEC Rule 504(b)(l)(iii), the issuers' sales to Defendants, and Defendants' resales, did not have a sufficient nexus to Delaware to rely on that provision.

A.

The Commission Adopted SEC Rule 504(b)(1 )(iii) to Carve Out a Federal Exemption for State Law Exemptions Based On, or Analogous to, the Model Accredited Investor Exemption

SEC Rule 504, known as the "seed capital" exemption, generally exempts from registration the offer and sale of up to $1 million of securities by a non-reporting issuer that is not a development stage or investment company. In 1998, in response to abuses involving Rule 504 offerings in the microcap secondary markets, the Commission proposed amendments to the rule to eliminate the freely tradable nature of the securities issued and to prohibit public offerings that had been permitted by prior.amcndments to the rule in effect since 1992. See Proposed Rule

A court may dismiss a claim on the basis of an affirmative defense raised in a motion to dismiss, only if 'the facts supporting the defense appear on the face of the complaint,' and 'it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim that would entitle him to relief."' US. v. Space Hunters, Inc., 429 F.3d 416,426 (2d Cir.2005) (quoting McKenna v. Wright, 386 F.3d 432,436 (2d Cir. 2004) (internal quotation marks omitted)). The defendant bears the burden of proving the applicability of its affirmative defense. See Iowa P11b. Emp. Ret. System v. MFG/obal, Ltd., 620 F.3d 137, 145 (2d Cir. 2010); see also SECv. Ralston l'urina Co., 346 U.S. 119, 126 (1953) (noting that a defendant bears the burden of proving the applicability of an exemption from registration).

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Release No. 33-7541 (May 21, 1998) ("1998 Proposing Release"); see also Revision of Rule 504 ofRegulation D, the "Seed Capital" Exemption, SEC Release No. 33-7644 (Feb. 25, 1999) (" 1999 Adopting Release") (explaining that, between 1992 and 1999, the Rule 504 exemption permitted general solicitation and general advertising (though a majority of states still required registration for such public offerings) and provided that "securities sold under Rule 504 were not 'restricted' securities and thus were available for immediate resale by non-affiliates of the issuer, so long as they were not otherwise 'underwriters' of the offering."). In 1999, the Commission ultimately adopted amendments that "establish[ed) the general principle that securities issued under the [Rule 504] exemption, just like the other Regulation D exemptions, will be restricted, and prohibit[ed] general solicitation and general advertising, unless the specified conditions permitting a public offering are mel" 1999 Adopting Release. The "specified conditions" that permit a public Rule 504 offering, and the issuance of unrestricted securities, are set forth in SEC Rules 504(b)(l)(i), {ii), and (iii). The exemption that is relevant here is SEC Rule 504(b)(l)(iii). It requires that, to be exempt, the offer and sale of securities must be made "[e]xclusivcly according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to 'accredited investors' as defined in [Rule] SOI(a) [of Regulation D]." The Commission adopted this exemption, which did not exist prior to 1992, primarily to carve out a federal exemption under Rule 504 for state law exemptions that were adopted based on, or were analogous to, the model exemption developed by the North American Securities Administrators Association in 1997, the "Model Accredited Investor Exemption" ("MAIE").2

In the I998 Proposing Release, the Commission solicited comment on the appropriate treatment for offerings made under certain state Jaw exemptions such as the then-recently developed MAlE. The Commission repeatedly cited the MAlE as an example of the type of state law exemption to which Rule 504(b)(l)(iii) would apply. See 1999 Adopting Release at n.24 & 38; see also Revisions of Limited Offering Exemptions in Regulation

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Under the MAlE, "(a] general announcement of the proposed offering [can] be made by any means" with certain enumerated restrictions so long as the "[s]ales of securities [are] made only to persons who are ... accredited investors." The MAlE also restricts resale ofthc securities for 12 months, absent registration, except for a transfer to another accredited investor.3 Delaware's version of the MAlE is contained in Delaware Rule 503, its so-called "Accredited Investor Exemption." Delaware Rule 503, like the MAlE, expressly permits forms of general solicitation and general advertising provided that sales are only made to accredited investors. See Delaware Rule 503(a) ("[s]ales of securities shall be made only to persons who are ... 'accredited investors"') and 503(e) ("[a] general announcement of the proposed offering may be made by any means" provided compliance with restrictions substantially similar to MAlE). Delaware Rule 503 also imposes the same restriction on resale as the MAlE, namely a one-year holding period. Delaware Rule 503(c). Defendants, tellingly, make no reference to Delaware Rule 503, the very type of state law exemption the Commission had in mind when it enacted SEC Rule 504(b)( 1)(iii). Defendants ignore Delaware Rule 503 because their resale activities, occurring as they did within days or, at most, weeks of their initial stock acquisitions, plainly run afoul of Delaware's 12-month holding requirement. Compl. ~ 24.

B.

Delaware Section 7309(b)(8) Does Not Satisfy the Requirements of SEC Rule 504(b)(1 )(iii)

Defendants pointedly ignore Delaware Rule 503, the one provision of Delaware law that clearly addresses general solicitation and general advertising but which also prohibits immediate
0, SEC Release No. 33-8828 (Aug. 3, 2007) ("We added Rule 504(b)(I)(iii) as a new exemption to Rule 504 in 1999 .... As an example of these exemptions, we cited the Model Accredited Investor Exemption.'').
If the Commission had not adopted the SEC Rule 504(bXl)(iii) exemption, state law exemptions similar to the MAlE would have limited utility because Rule 504 otherwise restricts general solicitation and general advertising.

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resales, and instead argue that another Delaware exemption, Delaware Section 73-207(b)(8), which makes no reference to general solicitation or general advertising, not only authorizes general solicitation and general advertising but does so without any resale restrictions. Defendants' strained reading of Delaware Section 73-207(b)(8) fails on its face and is entirely inconsistent with Delaware's statutory scheme. Delaware Section 73-207(b)(8) provides that "[t)he following transactions are exempted from [the registration provisions] ... of this title: ... (8) Any otler or sale to a bank, savings institution, trust company, insurance company, investment company as defined in the Investment Company Act of 1940, person or profit-sharing trust, or other financial institution or institutional buyer, 4 or to a broker-dealer, whether the purchaser is acting for itself or in some fiduciary capacity." Defendants argue that because Delaware Section 73-207(b)(8) does not explicitly prohibit general solicitation and advertising, it therefore must permit general solicitation and general advertising. See Def. Mem. 16. This reading is incorrect. By its plain terms, Delaware Section 73-207(b)(8) does not permit general solicitation. The only solicitation it permits is that of certain specifically enumerated institutions and entities that are not natural persons. Absent an explicit exception, the Delaware Securities Act makes it "unlawful for any person to offer or sell any security" in Delaware unless it is registered, is an exempted security or transaction, or is a federal covered security. Delaware Securities Act Section 73-202. The Delaware Securities Act clearly defines "offer" to "includ[e] every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for

Section 510(a)(l) of the Delaware Rules and Regulations defines the term "institutional buyer" to include some, but not all, components of the definition of "accredited investor" found in SEC Rule 50 I. Notably, Delaware Section 51 O(a)(l )'s definition of"institutional buyer" excludes natural persons - the type of accredited investors referenced in SEC Rule 501(a)(l)(5)-(6). Thus, Delaware Section 73-207(bX8) does not permit any. offers or sales to individuals.

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value." Delaware Securities Act Section 73-103(a)(l7). Because Delaware Section 73207(b)(8) exempts only "offers or sales" to several specifically enumerated types ofinstitutions, and because the definition of an "offer" includes solicitation, Delaware Section 73-207(b)(8) therefore only permits solicitation of certain accredited investors and other specifically enumerated types of institutions. A general solicitation, by contrast, is one directed at the public at large, which means that it may reach both accredited and non-accredited investors. s Accordingly, the Delaware statutory scheme prohibits general solicitation and general advertising unless in accordance with the resale provisions of Delaware Rule 503 - which Defendants did not meet. In contrast, Delaware Section 73-207(b)(8) does not pe~it general solicitation and general advertising to the public at large or indeed to any individuals at all. Accordingly, Defendants cannot rely upon Delaware Section 73-207(b)(8) to argue that their sales were exempt pursuant to SEC Rule 504(b)(l)(iii).6

C.

Bronson and E-Lionheart Lack a Sufficient Nexus with Delaware to Invoke a Delaware Exemption

Even ifDelaware Section 73-207(b)(8) met the requirements of SEC Rule 504(b)(l)(iii), the securities transactions at issue lacked any meaningful nexus to the State of Delaware and, therefore, Defendants' cannot avail themselves of the Delaware Securities Act. Defendants'
' SEC Rule 502(c) of Regulation D provides, in relevant part, that the tenns "general solicitation" and "general advertising'' include, but arc not limited to, "[a]ny advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio." As a general matter, in order for a communication to a potential investor to not be considered a general solicitation or advertisement, the Commission demands that there be a preexisting, substantive relationship between the solicitor and the potential investor. See, e.g., Robert T. Willis, Jr., P.C., SEC No-Action Letter, (Jan. 18, 1988), 1988 SEC No-Act. LEXIS 34, at *2.
6 In addition, Defendants have not shown, based on allegations on the face of the Commission's complaint, that the offers and sales of the securities at issue, which Defendants orchestrated, complied with all relevant provisions of the Delaware statutory registration scheme applicable to their claimed exemption. For example, Delaware Section 73-207(b)(8) does not exempt resales absent another exemption applying to those sales. No such possible further exemption is identified in the complaint. Also, there is no allegation in the complaint that ELionheart qualified as an accredited investor, as required by SEC Rule 504(b)(1)(iii). As such, Defendants cannot rely upon the complaint to support an affirmative defense that their sules were exclusively in accordance with a qualifYing state exemption.

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assertion that "[n]othing in Rule 504(b)(l){iii) requires that the offer or sale occur in, or have any connection to, the state in which the issuer is claiming an exemption," Def. Mem. 11, fails for many reasons, not least because Defendants' reading of the rule is at odds with its plain language. SEC Rule 504(b)(l)(iii) requires that the relevant offers and sales be made "[e]xclusively according to state law exemptions from registration that permit general solicitation and advertising ...." An offer or sale cannot be made "according to" a Delaware registration exemption unless, as an initial matter, Delaware's securities laws actually apply to the offer or sale. Delaware courts have held that "[t]he [Delaware Securities] Act only applies where there is a sufficient nexus between Delaware and the transaction at issue." Vichi v. Koninklijke Philips

Electronics, N. V., 2009 WL 4345724, at*19 (Del. Ch. Ct. Dec. 1, 2009). Delaware courts also
have made clear that the fact that a party to a securities transaction is incorporated in Delaware is not alone a sufficient nexus to bring the transaction within the scope of the Delaware Securities Act. See Vichi, 2009 WL 4345724, at *19 ("Neither Vichi nor Philips is a Delaware resident, and the solicitation, negotiation, and closing of the Notes transaction all took place outside of Delaware ... the only Delaware connection in this matter is the Delaware organization of[the company]. Such a tenuous connection with Delaware is not enough"); Singer v. Magnavox, 380 A.2d 969, 981 (Del. 1977) (no nexus where Delaware corporation solicited Pennsylvania residents, "[n]or does it appear that the contract was made in Delaware nor that any part of the 'sale' occurred here. It follows that the Delaware Securities Act does not apply"), overruled on

other grounds by Weinberger v. UOP, Inc., 457 A.2d 701,715 (Del. 1983);7 Dofflemeyer v. W.F.

Contrary to Defendants' assertion, the Singer court does "further elaborate" on what it means when it writes that the Delaware Securities Act governs "transactions which are subject to Delaware jurisdiction under traditional tests." Def. Mem. 14 n.8. In the sentence that immediately follows, the court writes: "To state it another way, we do not read the Act as an attempt to introduce Delaware commercial law into the internal affairs of

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Hall Printing Co., 558 F. Supp. 372, 377 (D. Del. 1983) (Delaware Securities Act inapplicable
where negotiation, solicitation, and sale occurred outside of Delaware). 8 Here, the complaint contains no allegations identifying where any of the issuers were in fact incorporated or did business. Although it alleges that E-Lionheart was incorporated in Delaware, Compl. '11 8, it further alleges that E-Lionheart maintains its principal place of business
in White Plains, New York. Compl. ft 8, 22, and that (1) none of the subscription agreements or

other transactional documents were prepared, negotiated or executed in Delaware; (2) none of the opinion letters accompanying the issuance of securities to E-Lionheart were prepared by attorneys licensed to practice law in Delaware; (3) the issued shares were sent to E-Lionheart's New York address, and (4) none of the transfer agents were located in Delaware. Compl. '1! 22. Accordingly, given that the mere fact that E-Lionheart was incorporated in Delaware is not sufficient to establish nexus there, and given that all other facts pled in the complaint are

corporations merely because they are chartered here." Singer, 380 A.2d at 981. Incorporation simply does not provide a sufficient basis on which to claim an entitlement to Delaware's securities laws. Defendants' reliance on Coface Collections N. Am. Inc. v. Newton, 430 Fed. App'x 162 (3d Cir. 2011), Total Holdings USA, Inc. v. Curran Composites, Inc., 999 A.2d 873 (Del. Ch. 2009), ABRY Partners V. L.P. v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006), andAeroglobal Capital Mgml., LLCv. Cirrus Indus., Inc., 871 A.2d 428 (Del 2005}, is misplaced. All three cases deal with choice-of-law provisions between consenting parties and are inapposite to the instant case dealing with the application of a state's regulatory authority. Defendants cite no cases for the novel proposition that a party can choose which state's regulatory scheme it will be subject to. Likewise, Defendants' reference to Title 6, Section 2708(c) of the Delaware Code, which provides that contracts for $100,000 or more that adopt a Delaware choice-of-law provision presumptively relate to Delaware, Def. Mem. 14, is also inapposite because it deals with choice-of-law provisions, not Delaware's regulatory authority. Also, there are no allegations in the complaint that transactions between the issuers and Defendants involved "amounts of$100,000 or more" and thus Defendants' cannot predicate an affirmative defense that a Delaware exemption applied to their transaction based on such an unsupported factual argument. Moreover, this is not an academic objection as the Commission submits, based on its current understanding, that most of the transactions were for less than $100,000. Tellingly, New York, where E-Lionheart actually conducts business, does not have a state law exemption that would apply to the transactions at issue.
8

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contrary to a Delaware nexus for the securities transactions at issue here, Defendants are not entitled to rely on Delaware Section 73-207(b)(8) or any other purported Delaware exemption. 9

D.

Defendants, Argument that SEC Rule 504(b)(l)(iii) Does Not Require a Nexus Between the State Whose Exemption is Invoked and the Securities Transactions at Issue Ignores the Plain Language of Rule 504(b)(l)(iii)

Not surprisingly, Defendants do not invoke a traditional nexus analysis to support the application of Delaware law. Instead, they make the novel argwnent that 'Rule 504(b)(l)(iii) does not require that the sale or offer occur within the state. Rather, it requires that the partiesthe Issuer and E-Lionheart- agree that the offer or sale is being made in confonnity with or according to an exemption from registration pursuant to the Delaware Securities Act." Def. Mem. at 13. In essence, Defendants argue that saying it is so makes it so. Specifically, Defendants argue that SEC Rule 504(b)(l)(iii) does not require a nexus between where offers and sales are made and the state whose exemption is invoked because subsection (iii), unlike subsections (i) and (ii), does not use the phrase "in one or more states." This argument is contrary to the plain language and intent of the statute. SEC Rule 504(b)(l)(i) and (ii) provide for certain.exemptions from registration where the offers or sales under Rule 504 are made: (i) Exclusively in one or more states that provide for the registmtion of the securities, and require the public filing and delivery to investors of a substantive disclosure document before sale, and are made in accordance with those state provisions;

Moreover, Defendants cannot ac;k the court to engage in a nexus balancing test analysis at the motion to dismiss stage limited solely to the facts alleged in the complaint. A plaintiff is not required to anticipate and plead in the complaint all facts that cou1d rebut an affirmative defense. Here, there are facts not pled in the complaint, such as whether and how many securities were sold in Delaware, how many issuers did business in Delaware, etc, that would be relevant to a nexus analysis and that could further rebut a Delaware nexus argument. In other words, while the court can, and should, find that the facts as pled are insufficient to support Defendants' affirmative defense, as Defendants are limited to the facts in the complaint, it would be improper to dismiss the complaint where, as here, there are additional facts that the Commission could subsequently adduce that would further rebut that defense.

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(ii)

In one or more states that have no provision for the registration of the securities or the public filing or delivery of a disclosure docwnent before sale, if the securities have been registered in at least one state that provides for such registration, public filing and delivery before sale, offers and sales are made in that state in accordance with such provisions, and the disclosure document is delivered before sale to all purchasers (including those in states that have no such procedure);

Subsections (i) and (ii) use the phrase "in one more states" because they address situations where a registration statement has been filed in one or more states. In contrast, subsection (iii) provides:
(iii)

Exclusively according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to "accredited investors" as defined in Rule SOl(a).

Thus, because subsection (iii)'s exemption is not predicated on the registration of a security in one or more states, there is simply no need to reference that phrase in that subsection and its omission has no more import than that. It certainly does not support Defendants' argument that subsection (iii) does not require any connection between the state whose exemption is invoked and where the offers and sales occur. Defendants next argue that Subsection (iii) "merely provides that the offers and sales be made 'according to state law exemptions"' (which they argue means simply "in conformity with") but not in the state whose exemption is invoked. Def. Mem. at 12. (emphasis in original). Defendants blatantly ignore the immediately preceding word in the quoted subsection "exclusively." Subsection (iii) in fact only exempts offers and sales made "[e]xclusively according to state law exemptions from registration that permit general solicitation and advertising ... " (emphasis added). The use of the word "exclusively'' plainly requires that in
each state where offers or sales are made, they must be in accordance with the provisions of that

particular state's exemption from registration. The Defendants' interpretation of this subsection reads the term "exclusively" out of SEC Rule 504(b)(I )(iii). This they cannot do. See, e.g.,

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Bowsher v. Merck & Co., 460 U.S. 824, 833 (1983) (applying the "settled principle of statutory
construction that we must give effect, if possible, to every word of the statute"). 10 Indeed, the use of the word "exclusively" in subsection (i) further supports the conclusion that a nexus is required to the state whose exemption is invoked. Subsection (i) provides an exemption for offers and sales made "exclusively in one or more states that provide for the registration of securities . . . and are made in accordance with those states exemptions." Subsection (ii), in contrast, permits sales in states other than the one where the registration statement is filed, as long as a registration statement is filed in at least one state and all investors receive the required disclosure documents, and therefore docs not use the term "exclusively." Thus, just as subsection (i) exempts only those offers and sales made "exclusively" in the states in which a registration statement is filed, so too subsection (iii) exempts only those offers and sales made "exclusively" in those states with exemptions that permit general solicitation and general advertising. Indeed, if subsection (iii) were intended to permit offers or sales in any state as long as one state permitted general solicitation, as Defendants argue, it would have read more like subsection (ii) and omitted the word "exclusively." In addition, Defendants' reading of subsection (iii) would provide a gaping regulatory loophole for issuers to make offers and sales in one state using another state's exemption while the state with the claimed exemptive provision would lack jurisdiction to enforce its statutory registration scheme as to that transaction. It is inconsistent with SEC Rule 504' s regulatory intent of investor protection through state regulation and oversight to permit state law exemptions to be manipulated in this manner.

Defendants' suggestion that the complaint somehow concedes that the offers and sales were made "according to" the state law exemption is simply incorrect. Def. Mem. at 2-3. The cited paragraph of the complaint ('I[ 19) merely alleges that "the subscription agreement represented" that the offering was exempt from registration pursuant to SEC Rule 504(b) (i)(iii) and Delaware Section 73-207(b)(8). Nowhere does the complaint allege that the offers were in fact exempt under these provisions.

ICI

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IV.

The Commission Has Stated a Cause of Action Against Fairhills Capital, Inc., as Related to Certain Automobiles
Defendants contend that the Commission has failed to state a claim for unjust enrichment

as to certain automobiles now held in the name of FCI. See Def. Mem. 20-21. In particular, Defendants argue that "[n]owhere does the SEC allege that the source of the money to purchase these automobiles came from ill-gotten proceeds, let alone the alleged profits of the Rule 504 transactions." /d. The Defendants ask too much. In its complaint, the Commission only needs

to allege, and it has alleged, facts sufficient to support a plausible inference that FCJ received illgotten proceeds of Bronson's illegal stock distribution scheme and that the automobiles were among the ill-gotten proceeds transferred to it. The Commission has sufficiently alleged a plausible basis for its claim as to these automobiles. 11

Finally, Defendants argue that the Commission has previously considered placing resale restrictions on all offers and sales made under SEC Rule 504(b)(l)(iii), instead of leaving it to the states to impose such restrictions, but declined to do so. De f. Mem. 18-20. However, even if true, this does not change the fact that Delaware in fact has imposed a one-year resale restriction on securities sold pursuant to general solicitation and general advertising. Moreover, Defendants' fail to cite any instance where the Commission has either tacitly or implicitly endorsed conduct similar to Defendants' in this case. Finally, even if, argue11do, securities acquired pursuant to offerings that actually satisfy all of the requirements of SEC Rule 504(b)(J)(iii) are then "freely tradable," this point is moot given that Defendants' offerings did not satisfy SEC Rule 504(b)(l)(iii), for all of the reasons set forth above.

11

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CONCLUSION

For all the foregoing reasons, the Commission respectfully requests that the Defendants' motion to dismiss be denied in its entirety. Dated: March 1, 2013 New York, New York

Kevin McGrath Wendy Tepperman William Edwards Attorneys for Plaintiff Securities and Exchange Commission New York Regional Office 3 World Financial Center- Suite 400 New York, New York 10281 (212) 336-1100

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CERTIFICATE OF SERVICE

I certify that on March I, 2013, I caused to be served by email and UPS overnight delivery a true and correct copy of the Securities and Exchange Commission's Memorandum of Law in Opposition to Defendants' Motion to Dismiss on the following attorney: Alex Lipman Nixon Peabody LLP 437 Madison Ave. New York, New York I 0022 (212) 940-3000 alipman@nixonpeabody.com Kevin McGrath