Securities and Exchange Commission v. Credit Bancorp

Full title: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. CREDIT BANCORP, LTD.…

Court: United States District Court, S.D. New York

Date published: Oct 29, 2002

99 Civ. 11395 (RWS) (S.D.N.Y. Oct. 29, 2002)

Opinion

99 Civ. 11395 (RWS)

October 29, 2002

THOMAS M. MELTON, ESQ., Salt Lake City, UT, ROBERT BLACKBURN, ESQ., New York, NY, Attorneys for Plaintiff, SECURITIES AND EXCHANGE COMMISSION.

RICHARD A. GETTY, ESQ., JASON L. HARGADON, ESQ., GETTY, KEYSER MAYO, Lexington, KY, Attorneys for Defendant Douglas C. Brandon.

OPINION

ROBERT W. SWEET, District Judge

Plaintiff Securities Exchange Commission (the "SEC") has moved for an award of a civil penalty against defendant Douglas C. Brandon ("Brandon") in the amount of $425,949.07 as a result of this Court's March 26, 2002 ruling granting the SEC summary judgment against Brandon. Brandon urges that he should be liable for a civil penalty of less than $25,000 or, in the alternative, the SEC's figure should be reduced to $170,342.50.

For the following reasons, the civil penalty shall be in the amount of $200,000.

Facts

The parties and events discussed herein are described in greater detail in SEC v. Credit Bancorp Ltd., 195 F. Supp.2d 475 (S.D.N.Y. 2001) (the "March 26, 2002 Opinion"). The opinion granted the SEC's motion for summary judgment against Brandon, finding Brandon liable for violations of Sections 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. In addition, a permanent injunction against future infractions of those provisions was granted. Finally, the Court held, "Brandon will be held liable for a civil penalty, but the quantification of that amount will be delayed pending the submission of additional evidence submitted by the parties." Id. at 496. In reaching this determination, it was concluded that:

It is undisputed that Brandon promised to act as a trustee when managing investor custodial accounts. He promised that the securities would be put in custodial accounts, of which he would be the sole signatory, and the he would have the power to return the securities to investors. Further, he pledged that the securities would not be disposed of without the investors' permission, and that he was representing the investors' best interests. The undisputed facts reveal that he acted recklessly in the extreme after a series of events should have shown him that these representations were false.

Id. at 490.

The SEC submitted the instant motion on June 5, 2002. The motion was considered fully submitted on September 6, 2002.¹

1 Brandon had moved to strike the SEC's reply brief or, in the alternative, for leave to file a sur-reply. Leave to file a sur-reply was granted, and Brandon filed that sur-reply on September 6, 2002.

Discussion I. A Third Tier Civil Penalty Is Appropriate

The SEC seeks a civil penalty pursuant to Section 20(d)(2)(C) of the Securities Act, 15 U.S.C. § 77t(d)(2)(C) and Section 21(d)(3)(B)(iii) of the Exchange Act, 15 U.S.C. § 78u(d)(3)(B)(iii). These sections were promulgated by Congress pursuant to the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the "Penalty Act"). "By enacting the Penalty Act, Congress sought to achieve the dual goals of punishment of the individual violator and deterrence of future violations." SEC v. Moran, 944 F. Supp. 286, 296 (S.D.N.Y. 1996); see also SEC v. Coates, 137 F. Supp.2d 413, 428 (S.D.N.Y. 2001); SEC v. Kenton Capital Ltd., 69 F. Supp.2d 1, 17 (D.D.C. 1998). The statute provides that any civil penalty is to be determined by the Court "in light of the facts and circumstances" of the particular case. Securities Act § 20(d)(2); Exchange Act § 21(d)(3).

Section 20(d)(2) of the Securities Act and Section 21(d)(3) of the Exchange Act provide for three tiers of maximum penalties for specified degrees of culpability. The third tier allows for a penalty for each violation of the Act of up to $100,000 for a natural person or the gross amount of pecuniary gain to a defendant as a result of the violation if the violation (1) involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; and (2) such violation directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons. Section 20(d)(2)(C) of the Securities Act, 15 U.S.C. § 77t(d)(2)(C), and Section 21(d)(3)(B)(iii) of the Exchange Act, 15 U.S.C. § 78u(d)(3)(B)(iii).

The first prong is satisfied as the March 26, 2002 Opinion held that Brandon acted "recklessly in the extreme," 195 F. Supp.2d at 490.² With regard to the second prong, investors lost tens of millions of dollars as a result of the violations. The fact that the money was insured does not affect this conclusion. Of the $110 million that was eligible under the policies, only $58 million was received from the insurers. Further, the Receiver has expanded considerable resources in marshalling and pursuing other assets secured by CBL. Therefore, Brandon's actions at the very least created a "significant risk" of loss, and the second prong also is satisfied. Therefore, it is appropriate that a third-tier penalty apply in the form of an amount up to the gross amount of pecuniary gain to Brandon.³

2 Although Brandon argues that he was not the mastermind of the scheme and that he acted recklessly as opposed to intentionally, the Court does not construe the argument to suggest that a third-tier civil penalty should not apply as a result. Rather, these arguments appear to address reasons for mitigating what Brandon deems a harsh civil penalty in light of those factors.

3 The SEC does not seek a civil penalty of up to $100,000 for each violation. The SEC estimates that there are at least 27 such violations, representing each investor for whom Brandon acted as Trustee. The resulting penalty would be $2.7 million. Brandon disputes this conclusion.

II. Brandon's Gross Pecuniary Gain Is $254,523.35

Because the civil penalty may only be an amount up to the amount of gross pecuniary gain and because the parties dispute the amount of this figure, it is first necessary to arrive at this figure.

The SEC argues that the "gross" amount is the entire $425,949.07 that was wired from CBL to Brandon's account. Brandon is persuasive in arguing, however, that he should not be responsible for parts of the $425,949.07 that were set aside for CBL expenditures. According to the SEC's exhibit, Brandon received money that was earmarked for certain expenses, namely: (1) Brandon's "services;" (2) the salary of another CBL employee; (3) rent on the CBL offices; and (4) other CBL expenses. Of these four categories, only the money that went specifically from CBL to Brandon for his services should be considered gross pecuniary gain. The other funds were never intended to pay Brandon, nor did he have any control over those funds. He did not choose whether to pay the CBL employee's salary, the CBL rent or the expenses. Instead, CBL made those decisions and Brandon was a mere conduit for paying CBL's bills. As a result, these three categories cannot contribute to Brandon's gross pecuniary gain. Therefore, of the $425,949.07, the maximum amount of pecuniary gain is the amount of money that Brandon received for his services. Brandon represents that that figure is $280,602.85, $26,079.50 of which was received for matters not related to CBL or the securities violation at issue.⁴ Thus, Brandon received a gross pecuniary gain of $254,523.35.

4 The SEC's record of wire and check transfers place the amount that Brandon received for "services" at approximately $230,000. Apparently, Brandon received money that was not recorded in these transfers, and the Court will use the higher figure as supplied by Brandon.

The SEC cites a number of cases for the proposition that in disgorgement cases (as opposed to civil penalty cases) only certain expenses, such as brokerage commissions, may be deducted from the amount to be disgorged. E.g., SEC v. Rosenfeld, 2001 U.S. Dist. LEXIS 166, at *2 (S.D.N.Y. Jan. 9, 2001) ("A court may, in its discretion, deduct from the defendant's gross profits certain expenses incurred while garnering illegal profits, including . . . transaction costs such as brokerage commissions."); SEC v. Shah, 1993 U.S. Dist. LEXIS 10347, at *14 (S.D.N.Y. July 26, 1993) ("Allowing a deduction for reasonable brokers' commissions incurred in making insider trades is consistent with the view in the Second Circuit that disgorgement is not a penalty assessment, but merely a means of divesting a wrongdoer of ill-gotten gains. [Defendant] has already paid the commissions to his broker. Requiring him now to disgorge an amount equal to those commissions would penalize him by compelling him to pay the commissions twice."). Moreover, general business expenses may not be subtracted from the amount to be disgorged. E.g., SEC v. McCaskey, 2002 U.S. Dist. LEXIS 4915, at *16 n. 6 (S.D.N.Y. March 26, 2002). As discussed above, the CBL expenses and salary of the CBL employee were not Brandon's expenses and thus the case law is inapplicable. However, Brandon does seek to reduce the figure by $7,589.62 in reimbursed out-of-pocket expenses, and that request shall be rejected as "overhead business expenses" that should not be considered.

Brandon finally argues that the $254,523.35 figure should be reduced by $84,180.85 paid in taxes. This argument ignores the clear dictate of the statute that the gross amount of pecuniary gain be paid and thus must be rejected. Therefore, the highest civil penalty that may be imposed in this case is $254,523.35.

III. The Amount of the Fine Shall Be $200,000

As noted above, this Court has discretion to impose a fine up to $254,523.35 based on the "particular facts and circumstances" of this case. Securities Act § 20(d)(2); Exchange Act § 21(d)(3); see also Moran, 944 F. Supp. at 296-97 ("Considering the discretionary nature of the civil penalty framework, prior decisions and consent decrees are of little comparative value for any individual matter. Each case, of course, has its own particular facts and circumstances which determine the appropriate penalty to be imposed."). Various factors may be considered in determining the appropriate amount of the fine, including (1) the egregiousness of the defendant's conduct; (2) the degree of the defendant's scienter; (3) whether the defendant's conduct created substantial losses or the risk of substantial losses to other persons; (4) whether the defendant's conduct was isolated or recurrent; and (5) whether the penalty should be reduced due to the defendant's demonstrated current and future financial condition. E.g., Coates, 137 F. Supp.2d at 428 (listing factors); McCaskey, 2002 U.S. Dist. LEXIS 4915, at *54 (looking to financial impecuniosity as factor but rejecting credibility of defendant's contention of negative net worth).

Brandon faces a criminal prosecution and at least seven different civil actions by former Credit Bancorp customers. While the existence of these cases does not vitiate Brandon's responsibility to pay a fine, e.g., McCaskey, 2002 U.S. Dist. LEXIS 4915, at *52 ("The assessment of a $30,000 penalty in the Connecticut criminal action does not bar a civil penalty here.") (citing SEC v. Palmisano, 135 F.3d 860, 866 (2d Cir. 1998) (finding Double Jeopardy clause not applicable)), they certainly lessen the responsibility of the fine to provide a retributive and deterrent effect. Further, this is Brandon's first offense, and while he played a central role in the fraud, he neither masterminded the scheme, nor made off with the bulk of the profits. Brandon has also asserted that he has no unencumbered assets and has a negative net worth. At the same time, however, Brandon acted recklessly in the extreme after a series of events that should have shown him that the representations that he made to investors were false.

In light of the above factors, a civil penalty of $200,000 is appropriate.

Conclusion

Brandon shall pay a civil penalty of $200,000.

It is so ordered.