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Securities and Exchange Commission v. North Star Finance, LLC

United States District Court, D. Maryland, Southern Division

November 8, 2017

NORTH STAR FINANCE, LLC, et al., Defendants.



         This is a civil enforcement action brought by Plaintiff Securities and Exchange Commission ("SEC") against Capital Source Funding. LLC. Capital Source Lending. LLC (the "Capital Source Defendants"). Michael K. Martin and a number of other Defendants, for violations of the Securities Act and Exchange Act[1] arising from an allegedly fraudulent "prime bank" investment scheme perpetrated by Defendants. ECF No. 1. This Memorandum Opinion and attached Order address the following Motions: SEC's Motion for Judgment as to Defendants Capital Source Funding. LLC and Capital Source Lending. LLC, ECF No. 270 (construed as a Motion for Default Judgment): SEC's Application for an Order Requiring Compliance with Administrative Subpoena. ECF No. 275; Martin's Motion to Recuse. ECF No. 325: Martin's Motion for Approval of Defense Funds. ECF No. 326: Martin's Motion for an Order Modifying the Freezing of Assets for Payments of Legal Fees and Expenses. ECF No. 328; Martin's Supplemental Motion to Support Request for Funds for Council [sic] and Expert Witnesses. ECF No. 333; Martin's Emergency Reconsideration of Reinstating Chapter 7, ECF No. 345: and Martin's Emergency Reconsider [sic] of Resuming Bk 7 for Chronic Illness. ECF No. 346. No hearing is necessary. See Loc. R. 105.6 (D. Md. 2016).

         I. BACKGROUND

         The SEC initiated this civil enforcement action on May 11. 2015. against a number of defendants, including Martin and the Capital Source Defendants. ECF No. 1. The SEC alleges that the Defendants took part in an "investment scam known as a 'prime bank' fraud" to defraud victims of nearly $5 million. Id. ¶¶ 1, 21. Put briefly, the SEC alleges that Defendants convinced victims of their scheme to "invest" in securities related to international banks; these securities, however, did not exist, and the substantial returns promised by Defendants did not materialize. Id. ¶ 4. The SEC claims that Defendants violated and aided and abetted violations of the Exchange Act Section 10(b) and Rule 10b-5. id at 19.[2] the Securities Act Section 17(a). id at 20-21, the Securities Act Section 5, id, at 20 21. and the Securities Act Section 15(a), id at 22-23.


         A number of motions filed by the SEC and Martin are currently pending before the Court. which the Court addresses below in turn.

         A. Motion for Default Judgment Against the Capital Source Defendants (ECF No. 270)

         The SEC asks the Court to grant an "entry of final judgments . . . establishing injunctions and ordering disgorgement and civil penalties as to defendants Capital Source Lending. LLC and Capital Source Funding. LLC." ECF No. 270 at 1. On February 3, 2017, the Court granted the SEC's Motion for Entry of Default against the Capital Source Defendants. ECF No. 253. As the Court noted at the time, the Capital Source Defendants" counsel withdrew as attorneys of record on March 1, 2016. ECF No. 252 at 5. Pursuant to Loc. R. 101(2)(b), the Court ordered Defendants to show cause as to why default should not be entered against them within 30 days, which they did not; therefore, the Court granted the SEC's Motion. Id.

         In its Motion for Default Judgment, the SEC argues that its Complaint pleads sufficient facts which, accepted as true, constitute a legitimate cause of action. ECF No. 270 at 7. The SEC provides the Court with additional affidavits and documentary evidence, which it argues are sufficient for the Court to enter damages against the Capital Source Defendants. Id. at 11. While the Capital Source Defendants did not respond to the SEC's Motion, on April 12, 2017. Martin filed an Opposition in which he asks for "a 90 day stay so that we can bring on an experienced attorney familiar with the SEC and the experience in knowing correctly how these private deals are set up." ECF No. 273 at 1. Although the Court did not grant the stay, seven months have passed since Martin filed his Opposition and the Capital Source Defendants are still not represented.[3] As such, the Court sees no reason to further delay consideration of the SEC's Motion for Default Judgment.

         "A defendant's default does not automatically entitle the plaintiff to entry of a default judgment: rather, that decision is left to the discretion of the court." Educ. Credit Mgmt. Corp. v. Optimum Welding, 285 F.R.D. 371. 373 (D. Md. 2012). Generally. "[t]he Fourth Circuit has a 'strong policy' that "cases be decided on their merits."" Choice Hotels Intern, Inc. v. Savannah Shakti Carp., no. DKC-11-0438. 2011 WL 5118328 at *2 (D. Md. Oct. 25. 2011) (citing United States v. Shaffer Equip. Co., 11 F.3d 450. 453 (4th Cir. 1993)), although “default judgment may be appropriate when the adversary process has been hailed because of an essentially unresponsive party[.]" Id. (citing S.E.C. v. Lawbaugh, 359 F.Supp.2d 418. 421 (D. Md. 2005)).

         In a case with multiple defendants where fewer than all of the defendants have defaulted, it may not be appropriate for the Court to enter default judgment. Under the Federal Rules of Civil Procedure, final judgment can be entered as to one of multiple defendants only if the court "expressly determines that there is no just reason for delay." fed. R. Civ. P. 54(b). In the Supreme Court case of Frow v. De La Vega, 82 U.S. 552 (1872). the Court was confronted with a situation where one of several defendants had defaulted and had a final judgment entered against him. The Court found it "unseemly and absurd" that a final judgment could be entered against one defendant, while other defendants may ultimately be found to be not liable on the same charge. Id. at 554. See also Farm Fresh Direct By a Cut Above. LLC v. Downey, No. ELH-17-1760. 2017 WL 4516548. *3 (D. Md. Oct. 6. 2017) (hereinafter"Farm Fresh"). The Supreme Court instructed that the proper course in such a situation would be “simply to enter a default" against the defaulting party, and to "proceed with the cause upon the answers of the other defendants." Id. See also WRIGHT AND MILLER § 2690 ("As a general rule . . .. when one of several defendants who is alleged to be jointly liable defaults, judgment should not be entered against that defendant until the matter has been adjudicated with regard to all defendants, or all defendants have defaulted."). The Fourth Circuit in U.S. for Use of Hudson v. Peerless Ins. Co. recognized that Frow "was a case of joint liability" but found Frow's reasoning "applicable not only to situations of joint liability but to those where the liability is joint and/or several." 374 F.2d 942. 944 (4th Cir. 1967).

         In a recent, similar case, this Court dismissed without prejudice a plaintiffs motion for default judgment against a defaulting defendant where several defendants remained. Farm Fresh, 2017 WL 4516548 (Hollander, J.). There, the plaintiff sued two individual defendants and two corporate defendants. Id. at * 1. Neither corporate defendant entered an appearance, and the Clerk entered an order of default as to the corporate defendants. Id. The plaintiff subsequently filed a motion for default judgment against the corporate defendants. The court denied the plaintiffs motion without prejudice, reiterating the facts and reasoning of Frow, and pointing out that "plaintiff has not provided this Court with any explanation as to why defendants' liability is unrelated, or why, at this juncture, it is appropriate to enter default judgement against just one of four parties." Id. at *4.

         Here, as in Frow and in Farm Fresh, it would be inappropriate to grant default judgment as to the Capital Source Defendants, with claims still pending against numerous related defendants. As in Farm Fresh, the SEC has not "provided this Court with any explanation as to why defendants' liability is unrelated, or why, at this juncture, it is appropriate to enter default judgement against just one of four parties." In fact, throughout the SEC's Motion for Default Judgment and in their accompanying materials it is quite clear that the Capital Source Defendants" liability is deeply intertwined with Defendants Martin's and Salinas's liability. See. e.g., ECF No. 270 at 4 (as basis for Capital Source Defendants" liability, describing the conduct of "Michael Martin, CEO of Capital Source Lending"): id. at 9 ("Martin and Salinas made material misstatements and omissions on behalf of the Capital Source entities"); id. at 10 ("Martin. acting on behalf of Capital Source Lending.. . . knew or was reckless in not knowing his claims of past success were false.....that the money collected from investors would be used for purposes other than promised, . . . and that his "updates"' to investors were bogus"). The nature of the bank accounts that the SEC now seeks to disgorge makes the interrelatedness of the liability between the Capital Source Defendants, Salinas and Martin all the more clear. Every account from which the SEC seeks to disgorge funds is under the name of either Martin or Salinas. In sum, the SEC alleges that the Capital Source Defendants are liable only because of the conduct of Salinas and Martin, who are still defendants in this case. As such, the Court will deny the SEC's Motion for Default Judgment without prejudice to the SEC re-filing the motion at an appropriate juncture.

         B. Motions to Release Frozen Assets (ECF No. 326, ECF ...

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