## Facts

- Clinton D. Brown invested in Earthboard Sports USA, Inc., after receiving a purported investment “tip” from Jeffrey A. Vaughn, a financial advisor who viewed Brown as a prospective client.
- Vaughn relayed representations originating with Earthboard’s president, Hugh Jeffreys, that a large public company (VANS, Inc.) was about to acquire Earthboard on exceptionally favorable terms for investors.
- The acquisition story was false; when the falsity became known, Brown and others lost their investments.
- Earthboard’s securities were not registered under state securities (blue-sky) law; Earthboard claimed the offering was exempt under SEC Rule 506 of Regulation D and therefore immune from state registration requirements under the National Securities Markets Improvement Act of 1996 (NSMIA).
- In the district court, default judgments were entered against Earthboard and Jeffreys, while Vaughn and his employer, Lincoln Financial Advisors Corp., obtained summary judgment on Brown’s federal and state claims.
- Brown appealed only the summary judgment rulings as to Vaughn and Lincoln.

## Issues

1. Whether NSMIA preempted Brown’s state-law registration claims based solely on Earthboard’s filing or assertion that the offering relied on Rule 506, without proof of actual compliance with Rule 506 conditions.
2. Whether Brown produced sufficient evidence to create a triable issue that Vaughn committed securities fraud, including scienter (at least recklessness) and loss causation.
3. Whether Lincoln could be held liable for Vaughn’s conduct on the record presented (e.g., participation, authorization, knowledge, agency/control-person theories).

## Decision

- The Sixth Circuit reversed summary judgment insofar as it held Brown’s state-law registration claims were preempted by NSMIA.
- The Sixth Circuit reversed summary judgment for Vaughn on Brown’s fraud-based claims, holding a reasonable factfinder could find scienter and loss causation.
- The Sixth Circuit affirmed summary judgment for Lincoln, finding insufficient evidence that Lincoln participated in, authorized, knew of, or induced Vaughn’s alleged misconduct.
- The case was remanded for further proceedings consistent with these rulings; the defaults against Earthboard and Jeffreys were not disturbed.

## Legal Principles

- NSMIA preempts state registration requirements only for securities that are actually “covered securities”; an issuer’s Form D filing or self-characterization of an offering as Rule 506 does not, by itself, establish covered-security status.
- If there are genuine disputes about whether an offering complied with Rule 506’s substantive conditions, preemption cannot be resolved as a matter of law at summary judgment.
- In securities fraud actions, scienter may be shown through recklessness, including disseminating highly implausible investment claims without verification under circumstances indicating an obvious risk of misleading investors.
- Loss causation may be satisfied where the investor’s loss flows directly from the specific misrepresentation that induced the investment.
- An employer is not liable for an employee’s alleged fraudulent solicitations absent evidence of the employer’s participation, authorization, ratification, or knowledge sufficient to support the asserted derivative-liability theory.

## Conclusion

The Sixth Circuit held that NSMIA preemption required proof of actual Rule 506 compliance rather than a mere regulatory filing, reinstated Brown’s fraud claims against the financial advisor due to triable issues on scienter and loss causation, and left the advisor’s employer dismissed because the record did not show employer involvement or awareness.


Brown v. Earthboard Sports USA, Inc., 481 F.3d 901 (6th Cir. 2007)