Securities & Exchange Commission v. Sg Ltd.

265 F.3d 42 (1st Cir. 2001)

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Nature of the Case

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Facts

D operated a 'Stock Generation' website offering online denizens an opportunity to purchase shares in eleven different 'virtual companies' listed on the website's 'virtual stock exchange.' D arbitrarily set the purchase and sale prices of each of these imaginary companies in biweekly 'rounds,' and guaranteed that investors could buy or sell any quantity of shares at posted prices. D placed no upper limit on the amount of funds that an investor could squirrel away in its virtual offerings. D advised potential purchasers to pay 'particular attention' to shares in the privileged company and boasted that investing in those shares was a 'game without any risk.' To this end, its website announced that the privileged company's shares would unfailingly appreciate, boldly proclaiming that 'the share price of [the privileged company] is supported by the owners of D, this is why its value constantly rises; on average at a rate of 10% monthly (this is approximately 215% annually).' To add plausibility to this representation and to allay anxiety about future pricing, D published prices of the privileged company's shares one month in advance. D conceded that a decline in the share price was theoretically possible, it assured prospective participants that 'under the rules governing the fall in prices, [the share price for the privileged company] cannot fall by more than 5% in a round.' To bolster this claim, it vouchsafed that shares in the privileged company were supported by several distinct revenue streams. Capital inflow from new participants provided liquidity for existing participants who might choose to sell their virtual shareholdings. As a backstop, D pledged to allocate an indeterminate portion of the profits derived from its website operations to a special reserve fund designed to maintain the price of the privileged company's shares. D asserted that these profits emanated from four sources: (1) the collection of a 1.5% commission on each transaction conducted on its virtual stock exchange; (2) the bid-ask spread on the virtual shares; (3) the 'skillful manipulation' of the share prices of eight particular imaginary companies, not including the privileged company, listed on the virtual stock exchange; and (4) D's right to sell shares of three other virtual companies (including the privileged company). As a further hedge against adversity, D alluded to the availability of auxiliary stabilization funds which could be tapped to ensure the continued operation of its virtual stock exchange. At least 800 suckers in the U.S., paying real cash, purchased virtual shares in the virtual companies listed on Ds' virtual stock exchange. In the fall of 1999, over $4,700,000 in participants' funds was deposited into a Latvian bank account in the name of SG Trading Ltd. The following spring, more than $2,700,000 was deposited in Estonian bank accounts standing in the names of SG Ltd. and SG Perfect Ltd., respectively. In late 1999, participants began to experience difficulties in redeeming their virtual shares. On March 20, 2000, D unilaterally suspended all pending requests to withdraw funds and sharply reduced participants' account balances in all companies except the privileged company. D announced a reverse stock split, which caused the share prices of all companies listed on the virtual stock exchange, including the privileged company, to plummet to 1/10,000 of their previous values. D stopped responding to participant requests for the return of funds, yet continued to solicit new participants through its website. P filed a civil action in federal district court: D's operations constituted a fraudulent scheme in violation of the registration and antifraud provisions of the federal securities laws. A TRO was issued blocking D's operation of the website pendente lite. The court also instituted an asset freeze that encompassed approximately $5,500,000. The district court granted D's motion to dismiss the complaint for failure to state a cognizable claim on the ground that the virtual shares were a clearly marked and defined game lacking a business context. D appealed, and we issued a stay keeping both the preliminary injunction and the asset freeze in place for the time being.