United States v. Bailey, 696 F.3d 794 (9th Cir 2012):

Bailey was the President, Chief Executive Officer, and Chairman of the Board of Directors of Gateway, a small, public company involved in selling health and dietary supplements. In 2002, Bailey met Richard Owens, another businessman, and the two began doing business together. The nature and legitimacy of some of their business deals was the critical issue at trial.

According to the prosecution, Bailey did not comply with the Securities and Exchange Commission's rules on stock issuances. The SEC requires public companies to disclose voluminous information before issuing stock (e.g. details regarding past performance; information about executives; intended use of the sale proceeds). This process can be time-consuming and expensive. Without these disclosures, the SEC allows public companies to issue stock to employees, consultants, or advisors who provide bona fide services to the company. The issuance cannot be used merely to raise capital for the company and must be in exchange for legitimate services.

In 2003, the SEC filed a civil complaint against Bailey and his company for violating Rule S-8, the rule that requires the distribution of stock to be in exchange for bona fide services. Bailey settled the lawsuit with no admission of liability.

In 2004, Bailey was criminally charged for issuing stock to Owens in order to raise capital for Gateway and for Bailey and the company's personal benefit, both of which are proscribed by Rule S-8. Bailey pled not guilty and proceeded to trial. His current appeal is from the jury conviction.

Prior to trial, the prosecution filed a motion in limine seeking permission to introduce the fact that the SEC filed a civil complaint against Bailey in 2003. The prosecution argued that the 2003 complaint would show that Bailey knew that his conduct in 2004 was unlawful. The prosecution also argued that the prior complaint would establish that Bailey knew that he was required to comply with Rule S-8. The district court permitted the prosecutor to "introduce just the fact of the SEC complaint" but warned not to get "any deeper into it."

At trial, the prosecution presented witnesses who testified about the business dealings between Bailey and Owens. FBI Agent Scott Schofield provided extensive testimony about the numerous transactions between Gateway and Owens between April and June 2004, the time frame of the indictment. Specifically, Schofield testified that Owens received a total of $661,000 in S-8 stock in April and May of 2004 but that no documentation existed detailing the exchange of services for stock. Schofield testified that he believed that the lack of a written agreement and invoices between Owens and Gateway suggested that the arrangement was merely a ruse for unlawful activity. He admitted that there was a written agreement for the years 2002-03, but testified that no such agreement existed for 2004, the time frame at issue in this criminal case. On cross-examination, Schofield appeared to admit that verbal agreements would likely be sufficient for S-8 purposes and that written documentation was not necessary to comply with Rule S-8.

Margaret Nelson, an attorney with the SEC's division of enforcement, testified that she deposed Bailey in 2006 and asked him about the S-8 issuances to Owens. Nelson read into evidence portions of Bailey's deposition where he testified that no time sheets or invoices existed that reflected the work Owens performed, Gateway's accounting documents showed that Owens received $505,000 in stock, and Bailey did not believe Owens performed that amount in services. Nelson also testified that in 2003, the SEC filed a civil enforcement action against Bailey, Gateway, and others, alleging that they violated SEC rules by using S-8 to raise capital instead of exchanging stock for bona fide services.

The prosecution's star witness was Owens.***

Owens testified that there was a written consulting agreement delineating the terms of the agreement, but that it was entered into "after the fact, after [the SEC] investigation started" and that the document was "[a]ll just smoke and mirrors." Owens testified that he "may have signed a consulting agreement or papers that stated that [he was] a consultant for Gateway" but that those documents were not at all "real or legitimate."

Owens testified that he did the same type of deal with Bailey and Ternes using S-8 stock for another parcel (the "Pepper Lane" building).

n cross-examination, defense counsel attacked Owens's credibility. Owens admitted that he had been charged with federal crimes relating to the improper issuance of S-8 stock and was facing thirteen years in prison. He admitted that his sentencing date had been continued several times so that he could testify at Bailey's trial, and that he was cooperating with the prosecutor in the hopes of receiving a lower sentence. Owens admitted that he had perjured himself on his tax return, raising doubts about whether he was telling the truth since he had lied before. Defense counsel also impeached Owens's credibility by eliciting evidence of an assault on his ex-wife, his excessive use of drugs and alcohol, and the circumstances leading to the decline of his relationship with Bailey.

Bailey did not testify. His defense was that he did nothing illegal because the S-8 stock issuances were for legitimate consulting services. Bailey's daughter testified that through Owens's business contacts, she and other Gateway employees flew to New York to meet with executives at the Home Shopping Network and the corporate office of Nathan's Hot Dogs about potential business endeavors. ***

(B) Rule 404(b)

(1) Applicable Legal Standards

Bailey argues that the prior civil complaint amounted to impermissible "other act evidence" barred by Federal Rule of Evidence 404. "Evidence of a person's character or a trait of character is not admissible for the purpose of proving action in conformity therewith on a particular occasion." Romero, 282 F.3d at 688 (citing Fed. R. Evid. 404(a)); see also United States v. Derington, 229 F.3d 1243, 1247 (9th Cir. 2000). "However, Rule 404(b) permits evidence of prior wrongs or acts to show proof of motive, opportunity, intent, preparation, plan, knowledge, identity, or absence of mistake or accident." Romero, 282 F.3d at 688. The government argues that the evidence was used to show proof of intent and knowledge.

In the Ninth Circuit, a four-part test is used to determine the admissibility of evidence pursuant to Rule 404(b):

Such evidence may be admitted if: (1) the evidence tends to prove a material point; (2) the other act is not too remote in time; (3) the evidence is sufficient to support a finding that defendant committed the other act; and (4) (in certain cases) the act is similar to the offense charged.

Romero, 282 F.3d at 688 (citation omitted). The government "has the burden of proving that the evidence meets all of the above requirements." United States v. Arambula-Ruiz, 987 F.2d 599, 602 (9th Cir. 1993). "If the evidence meets this test under Rule 404(b), the court must then decide whether the probative value is substantially outweighed by the prejudicial impact under Rule 403." Romero, 282 F.3d at 688 (citation omitted).

(2) Analysis

Bailey primarily challenges the admissibility of the complaint under the third prong of the FRE 404(b) test: the evidence must be "sufficient to support a finding that defendant committed the other act." Romero, 282 F.3d at 688. In Huddleston, the Supreme Court clarified that the government need not prove Rule 404(b) evidence by a preponderance of the evidence; rather, "such evidence should be admitted if there is sufficient evidence to support a finding by the jury that the defendant committed the similar act." 485 U.S. 681, 685, 108 S. Ct. 1496, 99 L. Ed. 2d 771 (1988); see also Verduzco, 373 F.3d at 1027.

We conclude this standard was not met in Bailey's case. In order for the government to introduce the prior SEC complaint, there must have been sufficient evidence from which the jury could reasonably conclude that Bailey actually committed the allegedly-similar bad acts. See Huddleston, 485 U.S. at 685. The only evidence offered to meet this standard was the complaint itself.

As an initial matter, none of the facts alleged in the complaint were admitted to by Bailey or proven. In fact, Bailey settled the civil action with no admission of liability. The out-of-circuit cases are clear that where a defendant admits nothing, the evidence of the prior conduct is inadmissible. In United States v. Cook, 557 F.2d 1149 (5th Cir. 1977), defendants were charged for their participation in selling oil and gas drilling ventures that violated SEC Rules. Id. at 1150-1151. A year before, the SEC had filed a civil enforcement action against defendants alleging violations of the same rules. Id. at 1151. The district court admitted evidence of injunction documents resulting from a settlement in the prior civil case. The Fifth Circuit reversed finding that because the defendant neither admitted nor denied the fraud alleged in the injunction, offering the documents themselves would cause the jury "to infer that prior wrongful acts had been committed, an inference impermissible." Id. at 1153. In the case of In re Adler, Coleman Clearing Corp., the defendants were charged with fraud. 1998 Bankr. LEXIS 406, 1998 WL 160036, at *4 (Bkrtcy. S.D.N.Y 1998). The government sought to introduce evidence of an SEC Administrative Release which stated that members of the defendant-broker company had previously violated federal securities laws for the purpose of showing knowledge and intent to commit fraudulent securities transactions. 1998 Bankr. LEXIS 406, [WL] at *4, *8. The court refused to admit the evidence because the affected defendants accepted an offer of settlement but "neither admitted nor denied the findings made therein," and thus could not be used to show that the defendants "actually engaged in the conduct alleged." 1998 Bankr. LEXIS 406, [WL] at *8.

Footnote 6. We find additional support for the notion that inconclusive allegations of prior similar behavior is not useful. In the civil rights context, courts are reluctant to admit evidence of prior excessive force complaints against a police officer if the complaints are unsubstantiated. For example, in Sibrian v. City of Los Angeles, No. 06-56532, 288 Fed.Appx. 385, (9th Cir. Aug. 1, 2008), an unpublished disposition, the panel upheld the district court's decision to exclude evidence of prior complaints involving the defendant police officer stating that the officer was exonerated on three of the prior incidents and that the evidence was inconclusive on the fourth incident. See also Hopkins v. Andaya, 29 F.3d 632, 1994 WL 396202, at *2 (9th Cir.1994) (unfounded citizen complaints were not relevant in Section 1983 action). Other circuits have reached the same conclusion. See United States v. Taylor, 417 F.3d 1176, 1179 (11th Cir.2005) (district court did not abuse discretion in denying plaintiff's request to offer unfounded citizen complaints to prove police officer's bias and motive). Even where the defendant police officer had not been exonerated on a civilian complaint, the Second Circuit stated that "the relevance of a single unsubstantiated charge is obviously limited." Berkovich v. Hicks, 922 F.2d 1018, 1023 (2d Cir.1991).

We agree with the reasoning of these cases. A defendant may settle a case for a variety of reasons. He may have committed the conduct alleged in the complaint or he may not have--but having settled the claim, there is no way to know. Admitting prior conduct charged but settled with no admission of liability is not probative of whether the defendant committed the prior conduct, much less whether he committed the conduct in question. There is no logical relevancy to admitting this type of evidence.

A second and more basic reason leads us to conclude the disputed evidence was improperly admitted. We risk stating the obvious here: a complaint is merely an accusation of conduct and not, of course, proof that the conduct alleged occurred. The prosecution did not introduce evidence that Bailey misused the SEC rules--rather, the prosecution offered only the complaint, which is far from evidence of anything. Admitting the complaint may have permitted the jurors to succumb to the simplistic reasoning that if the defendant was accused of the conduct, it probably or actually occurred. Such inferences are impermissible.

The government barely addresses this issue but instead leans heavily on the purpose for which the evidence was offered, i.e., "to prove that defendant acted intentionally, knowing that his actions were wrong." There is some logic to the argument that evidence that Bailey had previously been accused of violating Rule S-8 shows that he was on notice of the type of prohibited conduct. But this is not enough. The prosecution was still required to prove that the evidence was sufficient to support a finding that Bailey committed the act charged in the complaint. This a mere complaint cannot do.

The government argues that courts routinely admit evidence of mere accusations, i.e., prior arrests. We agree that courts permit evidence of prior arrests, but such evidence must still satisfy the four-part test for admissibility. In the cases we have found where evidence of a prior arrest is admitted, a person with knowledge of the crime testifies to the circumstances of the prior offense. See United States v. Basinger, 60 F.3d 1400, 1408 (9th Cir. 1995) (arresting officer's testimony is sufficient to establish that the prior act occurred); United States v. Hinton, 31 F.3d 817, 823 (9th Cir.1994) (uncorroborated testimony by victim is sufficient evidence that the prior act occurred).

Where a prior arrest is insufficient to prove commission of the offense, it does not satisfy the third prong of the test, and therefore should not be admitted. ***

The dissent attempts to recast the government's use of the complaint as being "narrowly offered for the purpose of proving that Bailey knew it was illegal to issue unregistered stock without receiving bona fide services in return." This characterization of how the government used the evidence is simply not so--the government used the complaint to prove intent. Even the government concedes this point. At the ruling on the motion in limine, the prosecutor stated "I think the fact of the complaint in 2003 is relevant to establishing their intent in 2004." And in the government's response brief, it states "[i]n order to prove that defendant acted intentionally, knowing that his actions were wrong, the government relied on evidence that the SEC had sued defendant in 2003 for essentially identical conduct." Indeed, the prosecutor admitted intent was the crucial element in the case and highlighted the complaint to show the element satisfied. The prosecutor said, referring to the complaint, that the SEC had told Bailey "don't break the law anymore" and "stop, don't do this again." The clear implication of the statement "don't break the law anymore" is: he broke the law before. Similarly, the unmistakable implication of "stop, don't do this again" is: he did this before. Those statements by the prosecutor were not merely meant to prove that Bailey had knowledge of Rule S-8's prohibitions. Rather, the statements go directly to the only element at issue in the case: Bailey's intent to violate Rule S-8 based on his alleged previous conduct, of which he had been accused but never admitted.

It must be said, though, that a complaint would not establish knowledge even if the prosecution had purported to use it only for that reason. All a complaint establishes is knowledge of what a plaintiff claims. It does not establish the truth of either the facts asserted in the complaint, or of the law asserted in the complaint. Since the previous complaint was never proved, nor was the truth of any of it conceded, it could not have established knowledge of the law. A complaint may state that cars driving southbound are required to stop at the intersection of 1st and Main, and that the defendant did not stop. But such a complaint establishes neither that southbound vehicles have a duty to stop, nor that the defendant failed to stop. Likewise, the SEC complaint establishes neither knowledge of the law nor a past wrongful act.

We hold that a mere accusation of prior conduct is insufficient to support a finding that the prior act was committed and, therefore, does not tend to prove that the defendant committed the act for which he is on trial. In order for evidence of a prior accusation to be admissible, there must be sufficient, independent evidence (besides the accusation alone) to support a finding that the prior conduct occurred. No such evidence was introduced here9 and, therefore, the complaint should not have been admitted.