On March 21, 2017, the Ninth Circuit Court of Appeals held that “[i]n a civil enforcement action by the Securities and Exchange Commission (SEC), relief defendants cannot defeat subject-matter jurisdiction simply by asserting an ownership interest in the disputed funds; rather, they must assert an interest both recognized in law and valid in fact.” SEC v. World Capital Market, Inc., No. 15-55325, 2017 WL 1055590 (9th Cir. 2017).
Relief defendants are nominal, innocent parties who hold funds traceable to the receivership but have no legitimate claim or ownership interest in them. In the context of an SEC enforcement action, a relief defendant “is a person who holds the subject matter of the litigation in a subordinate or possessory capacity as to which there is no dispute.” SEC v. Cherif, 933 F.2d 403, 414 (7th Cir. 1991). Accordingly, a relief defendant is not a real party in interest and “can be joined to aid the recovery of relief without the assertion of subject matter jurisdiction” because he or she “has no ownership interest in the property which is the subject of litigation.” Id.
In this case, the SEC brought a civil enforcement action against Phil Ming Xu and his corporations, including World Capital Market (“WMC”), which allegedly operated a Ponzi scheme by running a multilevel-marketing business ostensibly selling investors membership units providing access to cloud computing services. When Xu was under investigation, he transferred $5 million to his attorney, Vincent J. Messina. As a result, the SEC sought equitable disgorgement from Messina as a relief defendant.
The District Court for the Central District of California granted the SEC’s motion for disgorgement from Messina, finding he had no legitimate claim to disputed funds. Messina appealed.
On review to the Ninth Circuit, the central question was whether a relief defendant may divest a district court of jurisdiction simply by asserting a claim of entitlement to the disputed funds in their possession. To assert jurisdiction over Messina as a relief defendant, the SEC was required to demonstrate that Messina (1) received ill-gotten funds and (2) that Messina had no legitimate claim to those funds. Messina’s primary contention on appeal was that the district court lacked subject matter jurisdiction to determine the legitimacy of his claim to the $5 million.
The Ninth Circuit affirmed the district court decision, holding that, as matter of first impression, “relief defendants asserting claims that they had legitimate right to funds did not divest District Court of subject-matter jurisdiction.” The Ninth Circuit reasoned that “if the existence of jurisdiction turns on disputed factual issues, the district court may resolve those factual disputes itself.” This opinion will help the SEC and securities law practitioners counter groundless claims to disputed funds made by relief defendants seeking to divest a court of subject matter jurisdiction.