The whole brouhaha that has erupted over the “Townhouse” email from Markos Moulitsas that was published by Jason Zengerle of The New Republic has been conflated by the right side of the blogosphere into some sort of bizarre payola scandal involving Jerome Armstrong (formerly of MyDD), Markos, various politicians represented by Armstrong (among them Mark Warner) and various other elite bloggers supposedly beholden to Markos because they are dependent upon their income from Blogads (that or Kos has pictures of them cheating on their spouses).

I’m not a big fan of Markos, or the way he runs his blog, but so far, the only claim made in connection with these alleged nefarious schemes to control the liberal blogosphere by Kos and Jerome that seems to have any basis in fact is the SEC civil enforcement action that was filed against Jerome and 11 other defendants in April, 2003. For that reason, I thought I’d take a look at the available pleadings regarding that lawsuit to try to make sense out of them, and how they relate to the charges of Markos’s improper financial dealings with Jerome and his clients now being thrown about by Jason Zengerle of The New Republic.

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Relevant Pleadings

There are four pleadings from the SEC action against Jerome and the other 11 defendants for which I’ve been able to find links:

The SEC Complaint (SEC v. Sierra Brokerage Services, et al., Case No. C2-03-326, UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF OHIO, EASTERN DIVISION).

Jerome Armstrong’s Answer to the Complaint. In this one page pleading, Jerome denied all allegations of “stock touting” in the SEC’s complaint.

Consent of Defendant Jerome Armstrong. In this consent agreement with the SEC, Jerome agreed to the entry of a consent order by the court waiving his right to contest the SEC’s allegations of stock touting, and to a lifetime ban against making any communications regarding the promotion, offer or sale of securities.

Consent Order w/ Permanent Injunction This was the order signed by the Judge that officially incorporated the terms of the consent agreement between the SEC and Jerome.

Let’s take these in order, shall we? First up, the complaint by the SEC.

SEC Complaint

The complaint initiated a civil action by the SEC against Jerome, not a criminal action. The Securities laws of the United States allow the SEC to commence civil actions to enforce their provisions. Starting a civil enforcement action doesn’t preclude a later criminal indictment for securities fraud by the Justice Department, but generally speaking mere “stock touting” is not prosecuted as a criminal offense.

What the complaint alleges is a scheme by various individuals and their organization to pump up the price of a certain tech stock, BluePoint Linux Software Corporation (“Bluepoint”) in 1999. Once the price had been artificially manipulated upwards, the defendants who owned Bluepoint shares sold them at a profit. The defendant shareholders/promoters of Bluepoint were charged with price manipulation, unregistered sales, and unreported stock ownership with the intent to defraud the public. The broker/dealer defendants were charged with participation in this scheme to manipulate Bluepoint’s share price.

Jerome was the only individual who was charged with stock touting. Specifically, he was charged with promoting the purchase of Bluepoint shares in various internet chat rooms and forums without disclosing the fact that he had been compensated for touting Bluepoint as a good investment (it was claimed he received shares in 3 other companies from the other defendants at below market prices). The SEC claimed that Jerome was not the only person involved in this scheme to tout Bluepoint to the investment public, but he was the only individual charged in the complaint for doing so.

From reading the complaint, it becomes quite clear that Jerome was the smallest fish caught in the SEC’s net. The other defendants were charged with 8 separate counts of violations of the securities laws in connection with this scheme. Jerome was charged with one count, all of which related to his posting activity at the Raging Bull website promoting Bluepoint. The complaint never alleges that Jerome had any specific knowledge of the deception and price manipulation by the other defendants.

Jerome’s Answer to the Complaint

In his one page answer to the SEC complaint, Jerome denied all the allegations made against him. There are several things to note about the answer. First it was made pro se, that is, without benefit of legal representation. In short, Jerome was representing himself. Never a good idea in any lawsuit, but particularly so in the case involving charges of securities laws violations brought by the SEC. It’s safe to say that Jerome was in over his head.

Second, the answer refers to a request Jerome made to have the court appoint an attorney for him, as he could not afford legal representation. Jerome was obviously under the mistaken impression that the rules which apply to criminal matters also applied to an enforcement case brought by the SEC. They do not. As previously noted, an SEC action is not criminal in nature, but is a civil matter. There are no criminal penalties imposed against defendants in these cases, and no threat of imprisonment. Thus, there is no right to an attorney.

However, the fact that Jerome had not retained an attorney to represent his interest in the case, and the fact he felt compelled to answer the complaint by himself, without legal counsel, does argue for the truth of Markos’ claim that at the time of the action Jerome was struggling financially.

In any event, he surely hadn’t made the type of killing off his involvement in this scheme that the other defendants were alleged to have made. The complaint states that Jerome had made a profit of $20,000 from the sale of the stocks he had received from his co-defendants. To give you an example of what I’m talking about, here’s an the relevant excerpt from the complaint regarding the profits the other defendants allegedly made:

71. Tsai received $250,000 from the Promoter Defendants when they bought the nominee shares from him.

72. To date, the Promoter Defendants’ approximate profits from selling BluePoint are as follows: Yang $1.27 million; Luo $1.24 million; Markow $1.23 million; and Goelo $300,000.

73. Sierra’s profits from BluePoint were about $570,000 on March 6, 2000 and about $40,000 thereafter. Sierra paid 60% of its March 6 BluePoint profits to Geiger, per his usual compensation program. Richardson has made about $90,000 in profits from trading BluePoint in his personal account, most of which he made on March 6.

A very small fish, indeed.

The Consent Decree

On August 29, 2003, Jerome essentially caved in. He entered into a consent agreement whereby he agreed not to contest the allegations of stock touting, and agreed to a permanent injunction that would ban him from ever touting stocks in the future. He also agreed not to make any public statements denying any of the allegations the SEC had made against him in the complaint, except as required when giving testimony under oath. Lastly, he consented to appear and give testimony under oath at any deposition, hearing or trial regarding the Bluepoint case or any other investigation into securities law violations commenced by the SEC. The issue of damages was not resolved by the consent decree, but was held over to be determined in future proceeding before the court.

Why would Jerome do this?

Why would he consent to these conditions, essentially admitting he violated the securities laws by touting Bluepoint without disclosing the compensation he had allegedly received? There are two possibilities.

One, he may have been guilty of the charges in the complaint. However, he may have done so because he lacked the means to continue with the litigation. Without the ability to fund his defense, he may have decided to bite the bullet and accept liability, while contesting damages in the future. It’s impossible to know simply from a review of the provisions of his consent agreement and the accompanying order.

He was in a very difficult spot, after all. The SEC had chosen him as the representative from the group that had been touting Bluepoint stock online of whom an example was to be made. Remember, the complaint specified that the defendants had engaged a number of individuals to “talk up” Bluepoint’s stock. However, it wouldn’t be cost effective for the SEC to go after all the small fry who benefited from such alleged “stock touting” on behalf of the defendants. So one person was chosen to put the fear of God into the rest of them. Unfortunately for Jerome, he won the SEC’s version of the lottery. Indeed, his precarious financial condition may (and this is purely speculation on my part) have been a factor in why he was chosen. A man without the financial means to contest the lawsuit is more likely to have a default judgment entered against him, or to consent to such a judgment.

You have to keep in mind, that the potential fine involved in Jerome’s case ($20,000) is essentially meaningless as far as the SEC is concerned. That amount won’t even cover the overhead of bringing the action. What they want is the intimidation factor that a judgment for stock touting will bring to the community who chat online about stocks.

So what does this have to do with Kos and the charges of a political payola scheme that have been made by Jason Zengerle of The New Republic?

Absolutely nothing. This is purely an example of a journalist attempting to imply some sort of wrongdoing because a current business associate of Kos was previously involved in shady activities. As far as I can tell, there isn’t any substance to the purely speculative allegations that Kos has benefited financially by selling his support and influence to politicians for whom Jerome is acting as a consultant. Nothing. Nada. Zip. Zilch.

All we have is this guilt by association. I’m not saying that evidence of impropriety may not come to light at a later date regarding Kos’ and Jerome’s business dealings with one another, but so far I don’t see it. All that we have is the record of Jerome’s litigation with the SEC, which has no connection to Kos whatsoever, since it predates his relationship with Jerome. We have no evidence of any financial reward flowing to Kos from Jerome’s political consulting clients. To suggest such an arrangement on nothing firmer than Jerome’s past troubles with the SEC seems the height of absurdity to me, and calls into question the motives of those who are making these accusations.

What is becoming more and more apparent, is that Jason Zengerle and The New Republic are willing to publish the rankest speculation about this so-called “payola” scheme without any factual basis for their claims of wrongdoing. To me that bespeaks of recklessness and malice on their part. Indeed, this is exactly the type of behavior in which smear merchants, like the Swift Boat Vets, have engaged in the past. Frankly, if I were the publisher for The New Republic I’d be a little nervous right now. I’d take Kos’s claims of potential defamation actions very seriously. Because I don’t see Markos rolling over and taking it in the gut like John Kerry did.

Quite the contrary.