Clinton D. Brown v. Earthboard Sports Usa, Inc. Hugh Jeffreys Jeffrey A. Vaughn Lincoln Financial Advisors Corporation, D/B/A Sagemark Consulting

Plaintiff-Appellant Clinton Brown, a wealthy businessman, made a risky investment in the securities of a small privately-held California company called Earthboard Sports USA ("Earthboard"). He was induced to embark on such a course of action by the "tip" he had received from Defendant-Appellee Jeffrey Vaughn, an acquaintance and financial advisor who considered Brown to be a prospective client, that a large public company was about to acquire Earthboard on extremely, even ridiculously, favorable terms. However, the promised acquisition turned out to be an entirely fictitious creation of Earthboard's president, one Hugh Jeffreys, a felon. When the truth was finally revealed, Brown and many others lost their investments. Brown then sued Earthboard, Jeffreys, Vaughn, and Vaughn's employer Lincoln Financial Advisors Corp. ("Lincoln") in federal court, claiming a variety of federal and state securities violations. The district court entered default judgment against Earthboard and Jeffreys.

Subsequently, the district court granted summary judgment in favor of Vaughn and Lincoln. Relevant to the appeal before us now, the district court held that (1) Brown's complaint that the parties had sold him unlawfully unregistered shares under Kentucky's Blue Sky law was preempted by the National Securities Markets Improvement Act of 1996, Pub.L. No. 104-290, 110 Stat. 3416 ("NSMIA"), because the securities had been sold "pursuant to" a valid federal registration exemption; and (2) Brown did not adduce sufficient evidence to create a genuine issue of material fact with respect to two vital elements of a securities fraud suit: scienter and loss causation. Brown filed a timely notice of appeal. For the reasons stated below, we reverse the district court with respect to the claims against Vaughn, but affirm summary judgment in favor of Lincoln.

* As Brown appeals from summary judgment, we review the adduced evidence in the light most favorable to him. Earthboard is a privately-held Cosa Mesa, California corporation that designs and manufactures all-terrain "extreme" skateboards and related equipment. In 1999, it offered subscriptions in certain of its securities and filed for an exemption from federal registration requirements with the United States Securities and Exchange Commission ("SEC"). Specifically, the company filed for a federal registration exemption pursuant to Rule 506 of Regulation D, 17 C.F.R. § 230.506, a safe harbor provision authorized by Section 4(2) of the 1933 Securities Act, 15 U.S.C. § 77d(2), for limited private placements. Rule 506 permits a private issuer to sell unregistered securities to any "accredited investor" and up to thirty-five other unaccredited purchasers, so long as certain requirements are met. Such a filing is generally intended to exempt the sale from federal and state registration requirements pursuant to NSMIA. Earthboard did not file any amendments to its 1999 filing or file for a new exemption. Thus, the company continued to offer subscriptions in its securities until about 2003, all purportedly pursuant to its 1999 filing.

Brown ran his own marketing firm from 1988 until 1999. In 1998, Brown's accountant, Gene Schindler, introduced him to Vaughn, a financial advisor and registered representative employed by Lincoln. Vaughn solicited 401(k) business from Brown's marketing firm, "ask[ing] to be one of [Brown's] investment advisors." Vaughn viewed Brown as a prospective client, and knew that Brown would received a large sum of money if he sold his firm. When Brown finally sold his company in 1999, Vaughn "wanted to know what [Brown's] plans were for the earn-out money." Thereafter, Vaughn contacted Brown periodically. During that time, it seems that Brown and Vaughn met on social occasions, playing golf occasionally, taking a golf vacation together at Brown's Arizona home, and enjoying Brown's time-share jet. They were both fans of Indiana University's basketball team, and they attended an Indiana/Kentucky game together. Brown dined at Vaughn's home at least once, Vaughn attended a Christmas party at Brown's home, and they attended a few charity-benefit dinners together.

Apparently, in August 2001, Vaughn first heard about Earthboard from his builder, who told him that the company was raising capital for expansion and put him in contact with the company's president, Jeffreys. Vaughn spoke with Jeffreys by telephone in August 2001, and again in late September 2001. They apparently did not meet each other in person until March 2002. According to Brown, Jeffreys told Vaughn on the telephone that Earthboard was involved in acquisition negotiations with VANS, a publicly-traded footwear company, and that, according to the terms of the deal, one share of Earthboard's securities would be exchanged for one share of VANS when the transaction finally closed. At that time, VANS shares were trading at about $12, but Jeffreys offered his company's shares to Vaughn for just $1 apiece. Thus, Vaughn stood to realize a 1100% capital gain when and if the promised transaction was closed. It was almost too good to be true.

Armed with what he probably took to be illicit or illegal "insider information," Vaughn allegedly decided to reap the rewards. Of course, the essential value of such an illicit "tip" lies in its concealment from the public eye, so it was probably impossible for Vaughn or anyone else to conduct any proper investigation of the transaction. But Vaughn allegedly did not allow his fundamental ignorance about Jeffreys, a felon previously convicted of fraud, or about the supposed Earthboard-VANS transaction, to govern his decisions. Of course, there was apparently not an ounce of truth to Jeffreys's "tips."1

According to the evidence adduced by Brown, Vaughn started by investing his own money in this scheme, and he ultimately purchased about $228,000 worth of Earthboard shares. He signed a subscription agreement on September 25, 2001, and purchased 100,000 shares for $1 per share. The company seems to have accidentally sent him an extra 100,000 shares around that time, though it rescinded those surplus shares some time later. After introducing investors such as Brown to the "opportunity," he purchased another 99,000 shares on his own account for $99,000 on March 3, 2002, and the company gave him an additional 7,000 shares for free at that time "in lieu of [paying] me a commission," presumably to thank him for advising investors like Brown about the opportunity. He purchased another 29,000 shares on his own account in December 2002 for $1 per share.

After deciding to invest for himself, Vaughn began to solicit friends and acquaintances to participate in this "opportunity." Taking the evidence in the light most favorable to Brown, Vaughn contacted Brown in late November or early December 2001 to tell him that he "wanted the opportunity to prove to . . . [Brown] how valuable he could be as a financial advisor and that he had an investment opportunity." Vaughn "wanted to meet [Brown] to discuss it." Due to "a sense of urgency in the phone call," Brown agreed to meet Vaughn for lunch about two days later. At that meeting, Vaughn "shared with . . . [Brown] the details of this privately held enterprise called Earthboard, [and] its imminent sale to a publicly traded firm called VANS." To bolster the story's veracity, Vaughn allegedly lied to Brown by claiming that Earthboard's president, Jeffreys, was "a personal friend or acquaintance of his, that they had done business before in some way, shape or form and that [Jeffreys] owed him a favor." Vaughn then explained that subscriptions in Earthboard stock were available to a limited group of investors at $6 per share, and that the purported one-for-one stock swap upon the transaction's closing offered Brown the prospect of doubling his investment overnight. But Vaughn warned that time was pressing, for the VANS transaction was "imminent and . . . [Brown] needed to move quickly if [he] wanted to be a part of it."

Brown said he was interested, and Vaughn replied "I need to get you a subscription agreement." Vaughn made arrangements to have a subscription agreement sent to Brown by fax. Earthboard sent the subscription agreement to Brown on December 5, 2001. Brown consulted his financial advisors, two of whom specifically questioned how Vaughn could have access to such inside information about an unannounced transaction involving a public company, but Brown would not be deterred. Relying entirely on Vaughn's "tip," Brown saw this as an opportunity to invest in VANS, a company he found to be "solid," though he did not independently investigate Earthboard.

Brown received his subscription agreement and wire transfer instructions directly from Earthboard. Brown claims that Vaughn assisted him in completing the form. He clearly saw "$1" listed as the original share price, and it had been marked out and replaced by "$6." Brown assumed the stock price had risen because of the imminent transaction. He neither saw nor asked for a Private Placement Memorandum ("PPM"), though it was referenced in the subscription agreement he had signed. He faxed the completed subscription form directly to Earthboard on December 13, 2001, requesting 100,000 shares. Vaughn then faxed wire instructions to Brown from Lincoln's fax machine, and Brown finally wired $600,000 to Earthboard.

After completing this transaction, Vaughn and Brown engaged in numerous conversations regarding their investments in Earthboard, and both spoke about the fluctuating price of VANS stock. Brown asked Vaughn to "[s]end me whatever you get" from Earthboard, and Vaughn sent press releases and announcements from Earthboard to Brown, who apparently did not receive them directly from Earthboard. On January 9, 2002, Vaughn faxed an Earthboard press release to Brown from Lincoln's fax machine, wherein Earthboard announced a "definitive agreement" to have "its stock acquired by a publicly traded major footwear company." According to this "press release," Earthboard stock would be exchanged on a "one for one basis," apparently confirming the lies told to Brown. Brown continued to follow VANS stock, assuming that the transaction was complete and awaiting only public announcement. Brown and Vaughn even discussed whether to sell or hold the VANS stock after the merger. Vaughn kept assuring Brown that the transaction with VANS was "imminent," and so Brown continued to believe that Vaughn remained in constant contact with Earthboard's management. In fact, however, as of January 2002, Vaughn had allegedly not yet even met with Earthboard's president in person, and there is a genuine issue of material fact with respect to the question of whether had he conducted any due diligence about Earthboard or the rumored transaction prior to soliciting Brown: in his deposition, Vaughn at first claims that he personally met Jeffreys and toured Earthboard's factory in early 2001, but almost immediately he seems to have corrected himself by admitting that the meeting and tour did not occur until March 2002.

VANS shares having risen to $14, Brown decided to purchase an additional 40,000 shares of Earthboard at $6 per share on February 28, 2002. For this investment, he signed a new subscription agreement for his entire purchase of 140,000 shares (for a total investment of $840,000), which contained more complete and legible disclosures than the subscription agreement that he had received in December 2001. This agreement warned that the securities "have not been registered" and that the securities were offered pursuant to Section 4(2) of the 1933 Securities Act. To make this purchase, Brown again acknowledged that he was an "accredited investor" and that he had relied solely on his own independent investigation in making the investment decision. Brown claims that he asked for, but never received, Earthboard's financial statements, the offering circular, the PPM, and any other disclosures about the company.

Meanwhile, as we noted above, Vaughn himself purchased another 99,000 shares of Earthboard on March 3, 2002, and received an additional 7,000 shares from Earthboard "in lieu of" commission. In December 2002, Vaughn sent a letter of instruction on Lincoln stationary to Earthboard's transfer agent, purchasing another 29,000 shares. In July 2003, Vaughn seems to have purchased another 16,500 shares from his neighbor, Charles Goebel, who had earlier purchased the shares in response to Vaughn's pitch.

Time passed, but the fictitious transaction never closed, and it was finally revealed that the whole scheme was fraudulent. Brown filed a complaint against all defendants in September 2003, raising a host of federal and state claims, and filed an amended complaint on November 8, 2004. On May 27, 2005, the district court entered default judgment against Earthboard and Jeffreys, holding them jointly and severally liable for $840,000 plus pre-and post-judgment interest (representing Brown's entire investment) even though those parties are almost certainly judgment-proof. On August 2, 2005, the district court entered summary judgment in favor of Vaughn and Lincoln, holding, in relevant part, that (1) the Kentucky Blue Sky law is preempted by federal securities regulations respecting covered offerings filed pursuant to the NSMIA, and (2) Brown could not prove loss causation and scienter for his claims against Vaughn. The claim against Lincoln was dismissed because it depended entirely on the claim against Vaughn. Brown filed a timely appeal.

The district court exercised federal question jurisdiction with respect to Brown's federal claims, 28 U.S.C. § 1331, and took supplemental jurisdiction over the Kentucky claims pursuant to 28 U.S.C. § 1367(a). The district court granted summary judgment based on its analysis and application of federal law. We review de novo the district court's legal conclusions, including matters of statutory interpretation. Johnson v. Karnes, 398 F.3d 868, 873 (6th Cir.2005); Hoffman v. Comshare, Inc. (In re Comshare, Inc. Sec. Lit.), 183 F.3d 542, 547 (6th Cir.1999).

* Brown's first claim on appeal is that the district court erred in holding that federal law preempts his state Blue Sky law claims.2 NSMIA, which in pertinent part amended Section 18(a)(1)(A) of the 1933 Securities Act, 15 U.S.C. § 77r(a)(1)(A), preempts state regulation with respect to "covered securities."3 "The States cannot, in the exercise of control over local laws and practice, vest state courts with power to violate the supreme law of the land." Kalb v. Feuerstein, 308 U.S. 433, 439, 60 S.Ct. 343, 84 L.Ed. 370 (1940). According to Section 18(b)(4)(D) of the 1933 Securities Act, 15 U.S.C. § 77r(b)(4)(D), a "covered security" is, inter alia, any security exempt from federal securities registration "pursuant to — . . . Commission rules or regulations issued under § 4(2)" of the 1933 Act. See 15 U.S.C. § 77d(2). The parties agree that the offering was purportedly made "pursuant to" Rule 506 based on Earthboard's 1999 filing.

* The parties differ in their interpretation of the effect of Earthboard's 1999 filing for Rule 506 exemption. Brown claims that an offering must actually meet the conditions established by the SEC regulation in order to qualify as a "covered security" exempted from state registration requirements by NSMIA. He further claims that Earthboard's offering did not, in fact, qualify as a "covered security" under Rule 506. The defendants answer that NSMIA exempts, inter alia, all non-public securities from state regulation so long as the company has attempted to qualify for a valid federal exemption or has purported that the securities are offered "pursuant to" an exemption. Moreover, they argue that the Earthboard offering actually qualified for Rule 506 exemption. The district court held that the simple fact that the 1999 filing had been entered under the rubric of a federal exemption entitled it to federal preemption pursuant to NSMIA. District courts and state courts have split on the question of whether filings must actually qualify for a federal securities registration exemption in order to be entitled to NSMIA preemption. To the best of our knowledge, no federal appeals court has yet ruled on this question. We now agree with those courts that have held that offerings must actually qualify for a valid federal securities registration exemption in order to enjoy NSMIA preemption.

In Temple v. Gorman, 201 F.Supp.2d 1238 (S.D.Fla.2002), the district court held that Congress broadly preempted state law registration actions in passing NSMIA. In that case, the plaintiffs asserted that their state law claims were not preempted as the securities were not actually exempt because they did not meet Rule 506's (or any other exemption's) requirements. Id. at 1243. The district court did not dispute that allegation, but noted that Congress's purpose in passing NSMIA was "to further and advance the development of national securities markets and eliminate the costs and burdens of duplicative and unnecessary regulation by, as a general rule, designating the Federal government as the exclusive regulator of national offerings of securities." Ibid (quoting H.R. REP. No. 104-622, at 16 (1996)). Based on this "purpose," as stated in the legislative gloss, the Temple court held that

the securities in this case were offered or sold pursuant to a Commission rule or regulation adopted under section 4(2) . . . . [and][r]egardless of whether the private placement actually complied with the substantive requirements of Regulation D or Rule 506, the securities sold to Plaintiffs are federal covered securities because they were sold pursuant to those rules.

Id. at 1243-44 (internal quotation marks omitted). As such, the Temple court held that the state's Blue Sky law was preempted by the fact that the defendants had attempted or purported to qualify for a legitimate federal exemption. Several district courts have followed Temple's reasoning. See Lillard v. Stockton, 267 F.Supp.2d 1081, 1116 (N.D.Okla.2003); Pinnacle Commc'ns. Int'l, Inc. v. Am. Family Mortgage Corp., 417 F.Supp.2d 1073, 1087 (D.Minn.2006) ("When an offering purports to be exempt under federal Regulation D, any allegation of improper registration is covered exclusively by federal law.").

Other courts have roundly rejected Temple's reasoning. The Supreme Court of Alabama raised the first challenge to Temple's broad-preemption reasoning when it required the defendants claiming NSMIA preemption for their offering, which had been sold pursuant to Rule 506 exemption, to prove that the challenged securities actually qualified for a valid federal exemption. Buist v. Time Domain Corp., 926 So.2d 290, 295-98 (Ala.2005).

Several federal district courts have approved Buist's line of reasoning. One district court noted that the "plain language" of the securities laws defines a "covered security" as "one that `is exempt from registration under this title pursuant to . . . Commission rules or regulations.'" AFA Private Equity Fund 1 v. Miresco Inv. Servs., No. 02-74650, 2005 WL 2417116, at *9, 2005 U.S. Dist. LEXIS 22071, at *26 (E.D.Mich. Sept. 30, 2005). The Miresco court required defendants to "present evidence showing that the securities at issue here are exempt from registration under the rules adopted by the SEC under § 4(2)" and held that "it is [defendant's] burden, as the party relying on the exemption, to establish that the exemption applies and that all conditions of the exemption had been satisfied." Ibid. Another court noted that

[t]o the extent that Temple can be read to support the principle of broad pre-emption that the defendants urge, this Court declines to follow that case. . . . This Court has found no authority for [the broad preemption principle] . . . . [and c]ontrary to Temple, most commentators have stated the obvious: a security has to actually be a `covered security' before federal preemption applies.

Hamby v. Clearwater Consulting Concepts, LLP, 428 F.Supp.2d 915, 921 n. 2 (E.D. Ark.2006) (citations omitted). This general line of reasoning has been repeated even more recently:

The Temple court read language into the statute that does not appear there. A security is covered if it is exempt from registration. . . . Nowhere does the statute indicate that a security may satisfy the definition if it is sold pursuant to a putative exemption. If Congress had intended that an offeror's representation of exemption should suffice it could have said so, but did not. Such an intent seems unlikely, in any event; that a defendant could avoid liability under state law simply by declaiming its alleged compliance with Regulation D is an unsavory proposition and would eviscerate the statute. Nor is it necessary to look to the legislative history; the statute is unambiguous.

Grubka v. WebAccess Int'l, 445 F.Supp.2d 1259, 1269-71 (D.Colo.2006) (citations and internal quotation marks omitted). See also Myers v. OTR Media, Inc., No. 1:05CV-101-M, 2005 WL 2100996, at *5-6, 2005 U.S. Dist. LEXIS 18779, at * 15 (W.D.Ky. Aug.30, 2005) (denying plaintiff's motion for summary judgment where defendants claim NSMIA preemption because "Defendants have proffered evidence sufficient to create a question of fact as to whether they are exempt under Rule 506.").

We likewise reject Temple's approach. Under the prevailing view of the Commerce Clause's grant of authority, Gonzales v. Raich, 545 U.S. 1, 125 S.Ct. 2195, 2205-09, 162 L.Ed.2d 1 (2005), Congress has clearly been authorized to regulate the trading of securities. This includes the power to preempt contravening state regulations. Congress could in fact decide to occupy the entire field of securities regulation and preempt all state laws as they pertain to securities.4 Appellees urge us to believe that Congress actually performed a feat only slightly narrower, for to hold that NSMIA preempts state regulation wherever offerings merely purport to be filed pursuant to a valid federal registration exemption, or where parties have filed for, but fail to qualify for, an SEC registration exemption, would effectively eviscerate state registration requirements. In such a world, state registration requirements could be avoided merely by adding spurious boilerplate language to subscription agreements suggesting that the offerings were "covered," or by filing bogus documents with the SEC. Congress indubitably possesses the power to accomplish that end.

However, it is dispositive to our inquiry that Congress chose not to include broadly preemptive language when it enacted NSMIA. Instead, the statute plainly restricts its preemptive scope to "covered securities," and it neither defines, nor requires the SEC to define, "covered securities" in a fashion that would actually include all securities. The statute thus does not expressly preempt state laws with respect to non-"covered" securities, nor does the statute's text reveal an implied intent to preempt all state statutes in the field. Geier v. Am. Honda Motor Co., 529 U.S. 861, 884, 120 S.Ct. 1913, 146 L.Ed.2d 914 (2000). Moreover, far from defining "covered securities" in a manner that generally incorporates all securities, the SEC has promulgated specific requirements that must be met in order for a security to be "covered." Therefore, we hold that NSMIA preempts state securities registration laws with respect only to those offerings that actually qualify as "covered securities" according to the regulations that the SEC has promulgated.

Next, the appellees urge us to avert our eyes from the statute's plain language and look instead to legislative intent as supposedly espoused by the gloss on which they, and the district court, rely. But resorting to legislative history is always a risky endeavor, subject to manipulation by individual legislators and by simple mistakes of fact by the courts. While legislative history may sometimes usefully add to our understanding of a statute where the statutory language is ambiguous, it cannot alter the plain meaning of the text. "To avoid a law's plain meaning in the absence of ambiguity would trench upon the legislative powers vested in Congress by Art. I, § 1, of the Constitution." Violette v. P.A. Days, Inc., 427 F.3d 1015, 1017 (6th Cir. 2005) (quoting in part Dep't of Housing and Urban Dev. v. Rucker, 535 U.S. 125, 134-35, 122 S.Ct. 1230, 152 L.Ed.2d 258 (2002)). See Hamdan v. Rumsfeld, ___ U.S. ___, 126 S.Ct. 2749, 2815, 165 L.Ed.2d 723 (2006) (Scalia, J., dissenting) ("We have repeatedly held that [ ] reliance [on legislative history] is impermissible where . . . the statutory language is unambiguous."). Here, the statute is not ambiguous. Had Congress possessed the political will to preempt state Blue Sky laws in their practical entirety, it would have expressed that decision in the statute's plain text. Therefore, we reverse the district court, and hold that NSMIA preempts state securities registration requirements only with respect to securities that actually qualify as "covered securities" under federal law.

The appellees next argue that Earthboard's 1999 offering actually qualified for Rule 506 exemption, thereby triggering NSMIA preemption of state regulation respecting "covered securities." 15 U.S.C. § 77r(a)(1)(A) ("no law, rule, regulation, or order, or other administrative action of any State or any political subdivision thereof — (1) requiring, or with respect to, registration or qualification of securities, or registration or qualification of securities transactions, shall directly or indirectly apply to a security that — (A) is a covered security . . . ."). In assessing their claim, we note that "[f]ederal preemption is an affirmative defense upon which the defendants bear the burden of proof." Fifth Third Bank v. CSX Corp., 415 F.3d 741, 745 (7th Cir.2005). See Caterpillar, Inc. v. Williams, 482 U.S. 386, 392, 107 S.Ct. 2425, 96 L.Ed.2d 318 (1987). As the Supreme Court has held in the specific context of the National Labor Relations Act:

The precondition for pre-emption, that the conduct be "arguably" protected or prohibited, is not without substance. It is not satisfied by a conclusory assertion of pre-emption and would therefore not be satisfied in this case by a claim, without more, that Davis was an employee rather than a supervisor. If the word "arguably" is to mean anything, it must mean that the party claiming pre-emption is required to demonstrate that his case is one that the Board could legally decide in his favor. That is, a party asserting pre-emption must advance an interpretation of the Act that is not plainly contrary to its language and that has not been "authoritatively rejected" by the courts or the Board. The party must then put forth enough evidence to enable the court to find that the Board reasonably could uphold a claim based on such an interpretation. In this case, therefore, because the pre-emption issue turns on Davis' status, the Union's claim of pre-emption must be supported by a showing sufficient to permit the Board to find that Davis was an employee, not a supervisor. Our examination of the record leads us to conclude that the Union has not carried its burden in this case.

Int'l Longshoremen's Ass'n v. Davis, 476 U.S. at 394-95, 106 S.Ct. 1904 (citations omitted). Although Davis was a labor case and did not arise from an appeal of a federal court's grant of summary judgment, the basic principles for successfully asserting federal preemption as an affirmative defense on summary judgment are sufficiently clear: it is first incumbent on the party moving for summary judgment to demonstrate that federal preemption potentially applies to the facts and circumstances of the suit, and, if so, the movants must adduce sufficient evidence, interpreted in a light most favorable to the non-moving party, to prove that there is no genuine issue of material fact contradicting the claim that the case at bar actually and unquestionably qualifies for federal preemption. The first step presents a purely legal determination, but the second raises a mixed question. Should the movants fail to meet their burden with respect to the latter step, such as if a genuine issue of material fact exists regarding the claim's actual qualification for federal preemption, the matter must be determined by the factfinder. See id.

In this case, the parties agree that the Earthboard offering was made pursuant to the company's 1999 filing for a registration exemption under Rule 506, 17 C.F.R. § 230.506, and so preemption potentially applies because NSMIA preempts state registration requirements with respect to securities "covered" by such exemptions. To meet the remainder of their burden on summary judgment, the movants' "claim of pre-emption must be supported by a showing sufficient to permit" us to find that no genuine issue of material fact exists contradicting their claim that Earthboard's offering was actually a "covered security." Int'l Longshoremen's Ass'n v. Davis, 476 U.S. at 395, 106 S.Ct. 1904. Rule 506 was promulgated pursuant to Section 4(2) of the 1933 Securities Act, 15 U.S.C. § 77d(2), and exempts certain "limited offers and sales" so long as the rule's conditions are met: (1) all terms and conditions of Rules 501 and 502, 17 C.F.R. §§ 230.501-502, must be met, including the provision of audited balance sheets to unaccredited investors; (2) the issuer "must reasonably believe that there are no more than 35 purchasers of securities" who are not "accredited investors" as defined by Rule 501, 17 C.F.R. § 230.501, though there are no limits on the number of accredited investors;5 (3) each non-accredited investor must meet certain qualifications as recited in 17 C.F.R. § 230.506(a)(2)(ii);6 and (4) the offers or sales of securities registered under Regulation D must be integrated as part of a single offering, and so no offers or sales may be made more than six months before, or six months after, the offering itself. 17 C.F.R. § 230.502(a).7

The appellees assert that they have demonstrated that the offer actually qualified for Rule 506 exemption, but the only concrete evidence that they introduce to demonstrate actual compliance indicates that there were fewer than 35 non-accredited investors involved in the purchase, thereby satisfying the rule's numerosity requirement. Although the appellees argue that the sales to Brown were sufficiently integrated with the 1999 filing so as to meet Rule 506's integration requirement, the appellees leave unexplained precisely how a sale of securities three years after the filing nevertheless remains integrated with the original filing, and so we find that there remains a genuine issue of material fact with respect to the Rule's integration requirement.

Even assuming arguendo that the appellees successfully demonstrated integration, they still have not adduced any evidence with respect to the requirements mandating that the company provide certain information to unaccredited investors and that the company evaluate all unaccredited investors as being sufficiently sophisticated. Moreover, we find it highly persuasive, albeit not dispositive, that in 2005 the SEC filed a still-pending civil suit against Earthboard and Jeffreys in which it specifically complained that the company had offered unlawfully unregistered shares for sale, and that the offering did not qualify for a federal registration exemption under Rule 506. The SEC alleged that the offering did not satisfy Rule 506 because (1) Earthboard had failed to supply every unaccredited investor with audited copies of the company's financial statements and (2) Earthboard had failed to comply with the requirement that all unaccredited investors actually have, or that the company "reasonably believe[d]" them to have "such knowledge and experience of financial and business matters" as to be capable of evaluating the merits of risks of their prospective investment. Securities and Exchange Comm'n v. Jeffreys et al., 1:05-cv-00372-RWR-DAR (D.D.C.). Therefore we hold that the appellees have failed to meet their burden because a genuine issue of material fact exists as to whether the shares sold to Brown were "covered securities" warranting NSMIA preemption from state law, and so summary judgment was not warranted.

The appellees raise two other arguments in support of their claims to preemption. They are both specious. First, Vaughn notes that the preliminary notes to Regulation D state that the

[a]ttempted compliance with any rule in Regulation D does not act as an exclusive election; the issuer can also claim the availability of any other applicable exemption. For instance, an issuer's failure to satisfy all the terms and conditions of Rule 506 shall not raise any presumption that the exemption provided by section 4(2) of the Act is not available.

17 C.F.R. §§ 230.501-508, Preliminary Notes, n. 3 (2005). But see id. at n. 6 ("regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with these rules, is part of a plan or scheme to evade the registration provisions of the Act."). Vaughn also notes that Rule 508(a) provides a safeguard for insignificant deviations from the express terms of Regulation D if the error was made in good faith. 17 C.F.R. § 230.508(a). Based on this, Vaughn seems to argue that Earthboard's noncompliance was subject to the safe harbor provided by Rule 508; that he is not liable under state law because he is not an underwriter, issuer, or dealer subject to federal registration requirements; and that he was not a "seller" under Kentucky law. We disagree. With respect to the Rule 508 claim, the appellees have not adduced any evidence that Earthboard even attempted to comply with all of the strictures of Rule 506, much less that the company's deviation from the rule's strictures was both insignificant and done in good faith. We do not reach the merits of Vaughn's claim that he was not liable as a seller under the federal registration requirements because it is immaterial to the question of his liability under Kentucky law, and because he stipulated to his federal "seller" status for the purposes of summary judgment.8

We also disagree with Vaughn's contention that he was not, as an unavoidable matter of law, a "seller" under Kentucky law. Although he cites a recent Sixth Circuit opinion wherein we quoted the state trial court for the proposition that "a stock broker who merely executes a trade and has no other interest in the stock other than his commission is not a `seller'" under Ky.Rev.Stat. Ann. § 292.480, he mistakes the provenance of that opinion. Excel Energy, Inc. v. Smith (In re Commonwealth Inst. Secs., Inc.), 394 F.3d 401, 404 (6th Cir.2005). That case arose from state securities litigation, but reached the federal courts only with respect to a bankruptcy issue. In that context, both we and the federal district court were estopped from reviewing or re-litigating the state trial court's determinations as to securities fraud liability. Moreover, the state's court of appeals and supreme court both dismissed the plaintiff's appeal in Excel only because of a timeliness issue, so those courts had no opportunity to review the merits of the state trial court's interpretation of Section 292.480. Excel Energy, Inc. v. Commonwealth Inst. Secs., Inc.,