Summary
In McCaskey, the SEC calculated disgorgement by focusing on sixteen particular transactions, "ignoring all other transactions during the more than six month manipulation scheme."
Summary of this case from Sec. & Exch. Comm'n v. NadelOpinion
98 Civ. 6153 (SWK) (AJP).
March 26, 2002
REPORT AND RECOMMENDATION
Plaintiff Securities and Exchange Commission ("SEC") brought this action against, inter alia, Douglas G. McCaskey for manipulating the market for Marcorp, Inc. common stock in violation of federal securities laws. Judge Kram granted partial summary judgment for the SEC against McCaskey, and referred to me for a Report and Recommendation the issues of whether and if so in what amounts McCaskey should be ordered to (1) disgorge any ill-gotten gains, and (2) pay a civil monetary penalty. For the reasons set forth below, (1) the SEC's request for disgorgement should be denied, and (2) McCaskey should be ordered to pay a civil monetary penalty of $100,000.
BACKGROUND
"The S.E.C. filed the complaint in the instant case on September 1, 1998 alleging that from in or about May 1994 through December [7,] 1994, McCaskey violated the anti-fraud provisions of the federal securities laws in connection with a scheme to manipulate the marks for Marcorp, Inc. ('Marcorp') common stock." SEC v. McCaskey, 98 Civ. 6153, 2001 WL 1029053 at *1 (S.D.N.Y. Sept. 6, 2001) (Kram, D.J). The SEC alleged that during the manipulation period, "McCaskey bought and sold Marcorp stock through accounts he controlled at various broker dealers . . . During this period, McCaskey allegedly traded shares of Marcorp stock to and from his accounts through 'wash sales' 'matched orders' and other transactions designed to create the illusion of active trading, and in this fashion artificially affected the price of Marcorp shares" Id. (fn. omitted). According to the SEC, McCaskey's manipulation ("together with Marcorp's one-for-six share reverse split which became effective on December 7, 1994") "caused Marcorp's share price to [rise] from $1.25 on May 31, 1994 to $12 on December 6, 1994," with McCaskey accounting for 99% of the trading volume in Marcorp stock in the week before the SEC suspended trading in Marcorp stock on December 8, 1994. (Dkt No. 1: Compl. ¶ ¶ 1, 31, 32.)
As Judge Kram noted, "[w]ash sales are defined as 'transactions having no change in beneficial ownership,' and matched orders are defined 'orders for the purchase/sale of a security that are entered with the knowledge that orders of substantially the same size, at substantially the same time and price, have been or will be entered by the same or different persons for the sale/purchase of such security.'" SEC v. McCaskey, 2001 WL 1029053 at * 1 n. 1 (quoting Ernst Ernst v. Hochfelder, 425 U.S. 185, 205 n. 25, 96 S.Ct. 1375, 1387 n. 25 (1976)). For simplicity, the Court in this Report Recommendation will refer to the wash sales and/or matched orders collectively as "Wash Trades."
"On October 13, 2000, McCaskey pleaded guilty to a one count information in the parallel criminal case [in the District of Connecticut] and was adjudged guilty of violating Section 10(b) of the Securities Exchange Act of 1934 ('Section 10(b)' and Rule 10b-5 promulgated thereunder ('Rule 10b-5'). On April 30, 2001, McCaskey was sentenced to five years probation, a thirty thousand dollar fine and a one hundred dollar special assessment." SEC v. McCaskey, 2001 WL 1029053 a *1 (citation omitted).
"On April 18, 2001 the S.E.C. moved for partial summary judgment on the violations charged in the Second Claim for Relief of their complaint, which is based upon violations of Section 10(b), Rule 10b-5, and Section 17(a) of the Securities Act of 1933 . . . ." SEC v. McCaskey, 2001 WL 1029053 a * 1. The SEC sought "an injunction against future statutory violations, an order enjoining McCaskey from serving as an officer or director of a public company, disgorgement of illegal profits, and civil monetary penalties" Id.
Judge Kram granted summary judgment for the SEC, holding that, because "McCaskey was convicted by guilty plea on [criminal] securities-fraud charges related to the same activities at issue" in this civil action, "[a]ll questions of fact material to and underlying McCaskey's criminal conviction, as established during the plea allocution, [bound] McCaskey in this subsequent civil action." Id. at *3. Judge Kram stated:
With respect to the S.E.C.'s claim involving Section 10(b)and Rule [10b-5], the fact that McCaskey all ocuted to these very offenses in his criminal prosecution has a binding estoppel effect against him in the instant civil action. The factual background set forth by McCaskey during his allocution describes his involvement in the same activities alleged by the S.E.C. in the instant action. McCaskey admitted that he "was trying to stabilize the stock and keep it from going down and then in order to do that [McCaskey] was moving the stock from one brokerage account to another . . . ." In his opposition to the instant motion McCaskey further concedes that his "trading activities did have an impact on the value of Marcorp stock," and that he "commenced buying and selling Marcorp shares" in order "[t]o stabilize the price of its stock."SEC v. McCaskey, 2001 WL 1029053 at *3 (record citations omitted). Judge Kram thus granted the SEC's motion for summary judgment on the claims relating to McCaskey's Section 10(b) and Rule 10b-5 violations. SEC v. McCaskey, 2001 WL 1029053 at *3.
The Court also granted summary judgment for the SEC as to the Section 17(a) violation, holding that while McCaskey did not explicitly plead to a Section 17(a) violation i n the Connecticut criminal action, his allocution provided the factual foundation to support such a civil claim. SEC v. McCaskey, 2001 WL 1029053 at *4.
Based in part on the "egregious" nature of McCaskey's violations, Judge Kram permanently enjoined McCaskey from violating Section 10(b) Rule 10b-5, and Section 17(a), and barred McCaskey from serving as an officer or director of a pubic company for six years SEC v. McCaskey, 2001 WL 1029053 at *5-7. Because "[t]he question of whether disgorgement is warranted, as well as the amount of disgorgement, is not sufficiently free from doubt to be resolved on a motion for summary judgment," Judge Kram referred that issue to me for a Report and Recommendation. Id. at *7. Judge Kram similarly referred the question "of whether a civil monetary fine is appropriate, and if necessary the amount of the fine."Id.
Subsequently, the parties submitted supplementary affidavits and briefs on the issues of disgorgement and civil penalties (Dkt. Nos. 82-84, 87-94.) At McCaskey's request, so that the Court could judge his demeanor and credibility (see Dkt. No. 95: 2/7/02 Conf. Tr. at 5-7, 12-14, 18), and with the SEC's consent (id. at 14, 18), a hearing was held on February 22, 2002 at which McCaskey testified and was cross-examined by the SEC (see Dkt. No. 96: 2/22/02 Hearing Tr. at 2-53), and at which counsel orally argued their positions (id. at 53-77).
ANALYSIS
I. THE SEC'S REQUEST FOR DISGORGEMENT SHOULD BE DENIED A. Applicable Law Regarding Disgorgement
"Once the district court has found federal securities law violations, it has broad equitable power to fashion appropriate remedies, including ordering that culpable defendants disgorge their profits" SEC v. First Jersey Sec. Inc., 101 F.3d 1450, 1474 (2d Cir. 1996), cert. denied, 522 U.S. 812, 118 S.Ct. 57 (1997); see also, e.g., SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997); SEC v. Lorin, 76 F.3d 458, 462 (2d Cir. 1996) (district court "must be given wide latitude in these matters") (quoting SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995)); SEC v. Rosenfeld, 97 Civ. 1467, 2001 WL 118612 at *1 (S.D.N.Y. Jan. 9, 2001).
The Second Circuit has held that:
The primary purpose of disgorgement as a remedy for violation of the securities laws is to deprive violators of their ill-gotten gains, thereby effectuating the deterrence objectives of those laws. See, e.g. SEC v. Wang, 944 F.2d 80, 85 (2d Cir. 1991); SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir. 1978). "The effective enforcement of the federal securities laws requires that the SEC be able to make violations unprofitable. The deterrent effect of an SEC enforcement action would be greatly undermined if securities law violators were not required to disgorge illicit profits." SEC v. Manor Nursing Centers Inc., 458 F.2d [1082,] 1104 [(2d Cir. 1972)]; see SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971) ("It would severely defeat the purposes of the Act if a violator of Rule 10b-5 were allowed to retain the profits from his violation.").SEC v. First Jersey Sec., Inc., 101 F.3d at 1474; see also, e.g., SEC v. Fischbach Corp., 133 F.3d at 175 ("The primary purpose of disgorgement orders is to deter violations of the securities laws by depriving violators of their ill-gotten gains."); SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987), cert. denied, 486 U.S. 1014, 108 S.Ct. 1751 (1988); SEC v. McCaskey, 98 Civ. 6153, 2001 WL 1029053 at *7 (S.D.N.Y. Sept. 6, 2001) (Kram, D.J.) ("Disgorgement of illicit profits is a proper equitable remedy for securities fraud, designed to deprive wrongdoers of the profits of their wrongdoing.") (citations omitted); SEC v. Rosenfeld, 2001 WL 118612 at *1; SEC v. Bilzerian, 814 F. Supp. 116, 121 (D.D.C. 1993),aff'd, 29 F.3d 689 (D.C. Cir. 1994).
Unlike damages, "the primary purpose of disgorgement [to the SEC] is not to compensate investors," but rather to force "a defendant to give up the amount by which he was unjustly enriched." SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978) (Friendly, C.J); accord, e.g., SEC v. Tome, 833 F.2d at 1096; SEC v. McCaskey, 2001 WL 1029053 *7 ("[T]he proper measure of disgorgement is the amount of the wrongdoer's unjust enrichment."); SEC v. Rosenfeld, 2001 WL 118612 at *1; SEC v. Bilzerian, 814 F. Supp. at 120-21. "Thus, the measure of disgorgement need not be tied to the losses suffered by defrauded investors, and a district court may order disgorgement regardless of whether the disgorged funds will be paid to such investors as restitution." SEC v. Fischbach Corp., 133 F.3d at 175-76 (citations omitted); accord, e.g., SEC v. Tome, 833 F.2d at 1096 ("'[o]nce the Commission has established that a defendant has violated the securities laws, the district court possesses the equitable power to grant disgorgement without inquiring whether, or to what extent, identifiable private parties have been damaged by [the] fraud'"); see also, e.g., SEC v. First Jersey Sec., Inc., 101 F.3d at 1475 (disgorgement is "neither foreclosed nor confined by an amount for which injured parties were willing to settle").
"A settlement payment may properly, however, be taken into account by the court in calculating the amount to be disgorged . . . ." SEC v. First Jersey Sec., Inc., 101 F.3d at 1475.
"It is well established that disgorgement is remedial rather than punitive, since a fundamental policy underlying disgorgement is to prevent the unjust enrichment of the wrongdoer rather than to punish him." SEC v. Grossman, 87 Civ. 1031, 1997 WL 231167 at *9 (S.D.N.Y. May 6, 1997) (Kram, D.J.), aff'd in part, vacated in part on other grounds sub nom. SEC v. Hirshberg, No. 97-6171, 97-6259, 173 F.3d 846 (table), 1999 WL 163992 (2d Cir. Mar. 18, 1999).
Accord, e.g., United States v. Carson, 52 F.3d 1173, 1183 (2d Cir. 1995) ("The Supreme Court has specifically identified an order of disgorgement as compensatory, as opposed to punitive, in nature."),cert. denied, 516 U.S. 1122, 116 S.Ct. 934 (1996); SEC v. First City Fin. Corp., 890 F.2d 1215, 1231 (D.C. Cir. 1989) ("disgorgement may not be used punitively"); SEC v. Shapiro, 494 F.2d 1301, 1309 (2d Cir. 1974); SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1104 (2d Cir. 1972); SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir.) ("the SEC may seek other than injunctive relief in order to effectuate the purposes of [the federal securities laws], so long as such relief is remedial relief and is not a penalty assessment"), cert. denied, 404 U.S. 1005, 92 S. Ct. 561 (1971); SEC v. Bilzerian, 814 F. Supp. at 120 ("Disgorgement has consistently been recognized as remedial rather than punitive. Furthermore, disgorgement may not be used punitively.") (citations omitted).
"The district court has broad discretion not only in determining whether or not to order disgorgement but also in calculating the amount to be disgorged." SEC v. First Jersey Sec., Inc., 101 F.3d at 1474-75;see also, e.g., SEC v. Lorin, 76 F.3d at 462; SEC v. Rosenfeld, 2001 WL 118612 at *2. The disgorged amount must be "'causally connected to the violation,'" but it need not be figured with exactitude. SEC v. First Jersey Sec., Inc., 101 F.3d at 1475 (quoting SEC v. Patel, 61 F.3d at 139). The only requirement is that the disgorgement sought be a reasonable approximation of the profits causally related to the wrongdoing. SEC v. First Jersey Sec., Inc., 101 F.3d 1475; see also, e.g., SEC v. Patel, 61 F.3d 139; SEC v. Rosenfeld, 2001 WL 118612 at *2;SEC v. Bilzerian, 814 F. Supp. at 121-22.
"Where disgorgement calculations cannot be exact, 'any risk of uncertainty . . . should fall on the wrongdoer whose illegal conduct created that uncertainty.'" SEC v. Lorin, 76 F.3d at 462 (quoting SEC v. Patel, 61 F.3d at 140); see also, e.g., SEC v. First Jersey Sec., Inc., 101 F.3d at 1475; SEC v. First City Fin. Corp., 890 F.2d at 1232 (burden shifts to wrongdoer to show what transactions were unaffected by his offenses); SEC v. Bilzerian, 814 F. Supp. at 121. "Thus, once the Commission shows the existence of a fraudulent scheme in violation of federal securities laws, the burden shifts to the defendant to 'demonstrat[e] that he received less than the full amount allegedly misappropriated and sought to be disgorged.'" SEC v. Rosenfeld, 2001 WL 118612 at *2 (quoting SEC v. Benson, 657 F. Supp. 1122, 1133 (S.D.N.Y. 1987) (Leval, D.J.)); accord, e.g., SEC v. Grossman, 1997 WL 231167 at *8 ("The SEC bears the burden of persuasion that its proposed disgorgement figure reasonably approximates the amount of unjust enrichment. . . [O]nce the SEC has established that the proposed amount is reasonable, the burden shifts to the defendant to demonstrate that the amount requested is not a reasonable approximation of the unlawfully obtained profits."); SEC v. Bilzerian, 814 F. Supp. at 121.
1. Brokerage Commissions Should Be Deducted from the Wrongdoer's Profit in Any Disgorgement Award
Courts in this Circuit consistently hold that a court may, in its discretion, deduct from the disgorgement amount any direct transaction costs, such as brokerage commissions, that plainly reduce the wrongdoer's actual profit. See, e.g., SEC v. Rosenfeld, 97 Civ. 1467, 2001 WL 118612 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 the illegal profits, including . . . transaction costs such as brokerage commissions."); SEC v. Shah, 92 Civ. 1952, 1993 WL 288285 at * 5 (S.D.N.Y. July 28, 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.") (citations omitted); SEC v. Thomas James Assoc., Inc., 738 F. Supp. 88, 94 (W.D.N.Y. 1990) ("In determining the proper amount of restitution, a Court may consider as an offset the sums which a defendant paid to effect a fraudulent transaction."); Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb, Inc., 734 F. Supp. 1071, 1077 (S.D.N.Y. 1990) ("To require disgorgement of all fees and commissions without permitting a reduction for associate expenses and costs constitutes a penalty assessment and goes beyond the restitutionary purpose of the disgorgement doctrine. Therefore, transaction costs such as brokerage commissions incurred by [defendant] in executing trades in [the company's] securities should be deducted from any fees and commissions disgorged as profit."); see also 2 A. Bromberg L. Lowenfels, Securities Fraud Commodities Fraud § 7.4 (1023) (2d ed. 2001) ("Commissions should be added to purchase prices and subtracted from sale proceeds in calculating disgorgeable profits.") (citing cases). 2. Losses After the Scheme Collapses Cannot Offset Gains
The SEC's assertion that the "overwhelming weight of authority" is that brokerage commissions should not be offset against any disgorgement amount therefore is incorrect. (Dkt. No. 82: SEC 11/7/01 Br. at 7 n. 5, Dkt. No. 93: SEC 2/1/02 Reply Br at 4 n. 8, both citing three district court cases from outside the Second Circuit.)
Commissions should be distinguished from general business expenses, such as overhead expenses, which should not reduce the disgorgement amount. See, e.g., SEC v. Rosenfeld, 2001 WL 118612 at *2;SEC v. Benson, 657 F. Supp. at 1133-34; SEC v. World Gambling Corp., 555 F. Supp. 930, 934-35 (S.D.N.Y.) (offsetting "transfer taxes" but not overhead costs), aff'd, 742 F.2d 1440 (2d Cir. 1983), cert. denied, 465 U.S. 1112, 104 S.Ct. 1620 (1984).
The disgorgement amount should not be offset by any losses incurred by the wrongdoer when the scheme collapsed. See, e.g., SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978) (Friendly, C.J);accord, e.g., SEC v. First Pacific Bancorp, 142 F.3d 1186, 1192 n. 6 (9th Cir. 1998) (defendant's disgorgement obligations were not affected by fact that the "scheme ultimately failed and [defendant] lost . . . $1,000,000 of his own funds"), cert. denied, 525 U.S. 1121, 119 S.Ct. 902 (1999); SEC v. Shapiro, 494 F.2d 1301, 1309 (2d Cir. 1974) (defendant's "additional losses resulted not from any penalty imposed by the court but from his unwise investment decision to keep the stock after" the date the positive inside information became public); In re L.C. Wegard Co., SEC Release No. 34-40046, 67 S.E.C. 552, 1998 WL 275929 at *6 (SEC May 29, 1998) ("We consider that the amount of disgorgement was properly computed on the basis of [defendant's] profits, realized and unrealized, at the time it completed its participation in the [stock] manipulation. Disgorgement is an equitable remedy. A manipulator is not relieved of its disgorgement obligation simply because it chooses, for whatever reason, to retain manipulated securities until their subsequent drop in price dissipates some or all of the manipulator's ill-gotten gains."), aff'd, 189 F.3d 461 (2d Cir. 1999).
3. Present Financial Hardship Does Not Preclude Disgorgement
Finally, financial hardship is not grounds for denying disgorgement. The "Court may order disgorgement in the amount of the wrongdoer's total gross profits, without giving consideration to whether or not the defendant may have squandered and/or hidden the ill-gotten profits." SEC v. Rosenfeld, 97 Civ. 1467, 2001 WL 118612 at *2 (S.D.N.Y. Jan. 9, 2001); accord, e.g., CFTC v. Avco Financial Corp., 97 Civ. 3119, 1998 WL 524901 at *1 (S.D.N.Y. Aug. 21, 1998) ("dedin[ing] to take into consideration Defendant's . . . claim of an inability to pay" disgorgement under Commodities Exhange Act), aff'd in part rev'd in part on other grounds sub nom. CFTC v. Vartuli, 228 F.3d 94 (2d Cir. 2000); SEC v. Grossman, 87 Civ. 1031, 1997 WL 231167 at *10 (S.D.N.Y. May 6, 1997) (Kram, D.J) ("there is no legal support for [defendant's] assertion that his financial hardship preludes the imposition of an order of disgorgement"), aff'd in part, vacated in part on other grounds sub nom. SEC v. Hirshberg, No. 97-6171, 97-6259, 173 F.3d 846 (table), 1999 WL 163992 (2d Cir. Mar. 18, 1999); SEC v. Thomas James Assoc., Inc., 738 F. Supp. 88, 95 (W.D.N.Y. 1990) ("Nor may a securities law violator avoid or diminish his responsibility to return his ill-gotten gains by establishing that he is no longer in possession of such funds due to subsequent, unsuccessful investments or other forms of discretionary spending."). As Judge Kram explained in SEC v. Grossman entry of a disgorgement judgment is appropriate "despite a defendant's inability to pay, given that the defendant may subsequently acquire the means to satisfy the judgment." 1997 WL 231167 at *10 (citing cases). Although "'the Commission may choose to waive disgorgement upon satisfactory proof of inability to pay, it nonetheless is entitled to an order of disgorgement.'" Id. at *4.
B. Application of Disgorgement Law to McCaskey's Case 1. McCaskey's Threshold Arguments Lack Merit
McCaskey proffers two threshold issues, both meritless. First he asserts that the SEC failed to sustain its burden of proving the amount of McCaskey's unjust enrichment, because it submitted only the "declaration of a [SEC] staff attorney" sponsoring evidence of McCaskey's trades (Dkt. No. 87: McCaskey 1/22/02 Br. at 2-3, 10.) McCaskey alleges that the SEC's declarant lacks personal knowledge of the trades at issue and could not swear to the "completeness," "accuracy," or "meaning" of the trading documents attached as exhibits to the affidavit. (Id.) Yet, McCaskey himself submitted a declaration analyzing all of his trades during the manipulation period and attaching as exhibits his trading records for the manipulation period. (Dkt. No. 91: McCaskey 1/19/02 Aff. ¶ 8 Exs. 1-3.) Indeed, McCaskey's affidavit also recalculated his profit on the trades on the particular days on which the SEC's submission is focused. (Compare Dkt. No. 91: McCaskey 1/19/02 Aff. ¶ 11 Ex. 2, with Dkt. No. 84: Markowitz 11/7/01 Aff. ¶ 21 Ex. S; see also Dkt. No. 97: Miller Supp. 2/8/02 Aff. ¶ ¶ 3-4.) McCaskey thus provided, or at least confirmed, the data necessary to support the SEC's disgorgement theory.
Counsel for both parties also conceded the authenticity of the brokerage statements that provide the factual basis for the SEC's and McCaskey's theories for and against disgorgement. (See Dkt. No. 96: 2/22/02 Hearing Tr. at 8, 11, 13-15.)
Second, McCaskey urges that the SEC is estopped from seeking disgorgement as a remedy because the U.S. Attorney's Office conceded in the Connecticut criminal action that McCaskey's manipulative scheme did not cause damage to the investing public. (Dkt. No. 87: McCaskey Br. at 4-5, 8-9, 13-15.) The Court rejects McCaskey's argument because it confuses restitution with disgorgement. It is well-settled that "'[o]nce the Commission has established that a defendant has violated the securities laws, the district court possesses the equitable power to grant disgorgement without inquiring whether, or to what extent, identifiable private parties have been dammed by [the] fraud.'" SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987) (citation omitted); cert. denied, 486 U.S. 1014, 108 S.Ct. 1751 (1988); accord, e.g., SEC v. Fischbach Corp., 133 F.3d 170, 175-76 (2d Cir. 1997) ("the measure of disgorgement need not be tied to the losses suffered by defrauded investors, and a district court may order disgorgement regardless of whether the disgorged funds will be paid to such investors as restitution") (citations omitted).
2. The SEC's Disgorgement Theory Should Be Rejected on the Particular Facts of This Case
The SEC's disgorgement theory is based solely on McCaskey's sales on sixteen days, ignoring all other transactions during the more than six-month manipulation scheme. The SEC's disgorgement theory utilizes
the net proceeds of McCaskey's sales of Marcorp stock on the eighteen [modified to sixteen] days during the manipulation period (May to December 7, 1994) that McCaskey sold more Marcorp stock than he purchased, and reaped profits from his scheme. It is a measured approach that recognizes that the essence of McCaskey's scheme involved matched sales and purchases of Marcorp stock of substantially the same size, at substantially the same time and price, which artificially stabilized the market for Marcorp stock. [SEC v.] McCaskey, 2001 WL 1029053, at *1 n. 1. But to the extent McCaskey sold more Marcorp stock than he purchased on particular trading days, and profited from doing so, he reaped profits by selling stock to unwitting investors who paid too much for their shares in the artificially stabilized market for Marcorp stock created by McCaskey. McCaskey was free to use, and did in fact use, those ill-gotten gains for the purposes he liked. He now should be required to disgorge those gains
McCaskey admitted on cross-examination during the hearing that, during the manipulation period, he drew on the proceeds of his Marcorp stock sales to pay for substantial personal expenses (Dkt. No. 96: 2/22/02 Hearing Tr. at 46-52.)
(Dkt. No. 82: SEC 11/7/01 Br. at 5-6.)
While the parties dispute whether the SEC's disgorgement theory is valid as a matter of law, the parties agree that McCaskey's profits from sales on those sixteen days amount to $306,086.05 (after setting off brokerage commissions). (Dkt. No. 97: Supp. Miller 2/8/02 Aff. ¶ ¶ 2, 4; Dkt No. 91: McCaskey 1/19/02 Aff. ¶ 11 Ex 2; see also Dkt No. 95: 2/7/02 Conf. Tr. at 3-4, 9-10.)
If brokerage commissions were not offset, the parties agree that the profit figure is $384,450.75. (Dkt. No. 97: Supp. Miller 2/8/02 Aff. ¶ 4.)
The legal issue, then, is whether the $306,086.05 in profits from McCaskey's excess sales on sixteen days during the manipulation period should be considered in isolation from McCaskey's other transactions during the manipulation period. Although the issue is not free from doubt, and the parties have not cited any on point decisions, on the particular facts here, the Court does not believe the SEC's theory is appropriate.
McCaskey did cite to The Securities Enforcement Manual, A.B.A. Business Law Section at 197 (1997) ("The SEC often takes a broad view as to what constitutes illicit profits. Thus, in negotiating a disgorgement remedy with the staff, counsel may find that the staff argues for a very broad loss causation concept, refuses to recognize the fairness of netting profits and losses from allegedly illegal transactions, and resists the deductibility of various expenses. In contrast, the courts tend to take a more realistic approach as to what constitutes 'illegal' profits, and have accepted the propriety of netting gains against losses") (fn. omitted). (Dkt. No. 87: McCaskey 1/22/02 Br. at 10-11 n. 5.)
The SEC's "sixteen days" approach totally ignores McCaskey's Wash Trades during the manipulation period. McCaskey submitted a schedule (the accuracy of which the SEC has not disputed) of all his trades in Marcorp stock during the June 1, 1994 to December 7, 1994 manipulation period. (Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1.) Many of these transactions involved Wash Trades, in which McCaskey both bought and sold the same number of Marcorp shares on the same day. The SEC does not dispute that McCaskey lost money on his Wash Trades (See Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1; Dkt. No. 1: Compl. ¶ 35.) McCaskey lost $420,871.28 on Wash Trades during the manipulation period, including commission costs (Dkt. No. 91: McCaskey Aff. Ex. 1 at 12.) Thus, comparing McCaskey's profits of $306,086.05 on the "sixteen days" with his losses of $420,871.28 on the Wash Trades during the manipulation period, McCaskey clearly lost money.
The SEC contends that McCaskey should not be credited with having paid brokerage commissions. (Dkt. No. 82: SEC 11/7/01 Br. at 7 n. 5.) To the contrary, any direct transaction costs, such as brokerage commissions, that reduce a wrongdoer's actual profits should be considered an offset to disgorgement. See cases cited at pages 9-10 above.
The issue is whether those losses should be considered in determining whether to order disgorgement. On the facts of this case, the Court believes the losses should be considered. This case does not involve the more common "pump and dump" scheme where a defendant inflates a stock's price through manipulative means in order to sell his shares at a large profit once the stock reaches a high enough price. Here, McCaskey testified that the purpose of his manipulation was to stabilize Marcorp's stock price for the benefit of Marcorp and its shareholders: "To stabilize the price of [Marcorp] stock, I commenced buying and selling Marcorp shares . . . I wanted to save the company, investments made in Marcorp['s] shareholders and the efforts we had undertaken to see what promised to be an extraordinary technology come to fruition." (Dkt. No. 90: Israel 1/14/02 Aff. Ex. 8: McCaskey 5/24/01 Aff. ¶ 8; see also id. ¶ 16.) McCaskey added that nothing "in the record substantiate[s] the contention that I sought to deceive investors so as to unload my stock at a higher price." (Id. ¶ 15.) McCaskey swore that "[t]he proceeds from my sales of Marcorp securities during the late 1994 period were intended to enable Marcorp to weather what I viewed as artificial forces threatening the company . . . I did not profit from my trades in Marcorp stock, nor did I intend to profit from those trades I was trying to keep my company afloat. . . . While I will never do anything like that again, my intentions were not to pump and dump, but to build a successful enterprise and salvage the investments of Marcorp shareholders" (Dkt. No. 91: McCaskey 1/19/02 Aff. ¶ ¶ 3, 6.)
At McCaskey's criminal guilty plea allocution, the Government asserted, and McCaskey admitted, that when, as a result of Regilation S stock sales by others, "the price of the Marcorp shares began to decline, . . . Mr. McCaskey took action, . . . to reverse the stock price decline and bolster the price of the Marcorp stock." (Dkt No. 83: Miller 11/7/01 Aff. Ex. B: 10/13/00 Plea Allocution at 32; see also Dkt. No. 96: 2/22/02 Hearing Tr. at 5 (where McCaskey testified that the purpose of his wash sales was "to support the market price of Marcorp share" after the "market became flooded with shares from" the initial Regulation S offering).)
The SEC also has argued throughout this case that all of McCaskey's transactions during the manipulation period, including the Wash Trades and McCaskey's unmatched stock sales, were part and parcel of the same scheme to stabilize or raise the price of Marcorp stock. (Dkt. No. 82: SEC 11/7/01 Br. at 5-6; Dkt. No. 1: Compl. ¶ ¶ 30-36, 65, 68; Dkt. No. 83: Miller 11/7/01 Aff. Ex. B: McCaskey Plea Allocution at 33-34; Dkt. No. 71: SEC 56.1 Stmt. ¶¶ 4-5.) Under the SEC's theory of the case, the Wash Trades were central to the effectuation of any scheme to sell stock at a profit: the Wash Trades stabilized or raised the Marcorp stock price, and then McCaskey's unmatched sales reaped profits; the Wash Trade losses were a necessary and integral predicate to the unmatched sale gains. In light of the SEC's treatment of all these transactions as a unitary scheme, and particularly here where McCaskey was trying to stabilize Marcorp's stock price, not "pump and dump," it would ignore reality to arbitrarily separate the Wash Trades from the sixteen days of sales.
Contrary to the SEC's argument, disgorgement in the context of an SEC enforcement proceeding is primarily concerned not with the amount "unwitting investors" have lost, but with (1) deterring wrongdoing, and (2) preventing the defendant's unjust enrichment. See, e.g., SEC v. Fischbach Corp., 133 F.3d 170, 175-76 (2d Cir. 1997); see also cases cited at pages 5-7 above. Rather than preventing unjust enrichment and compelling the return of "ill-gotten gains," a disgorgement order that ignored McCaskey's Wash Trade losses would work a punishment, contrary to well-settled law. See, e.g., SEC v. Grossman, 87 Civ. 1031, 1997 WL 231167 at * 9 (S.D.N.Y. May 6, 1997) (Kram, D.J.) ("a fundamental policy underlying disgorgement is to prevent the unjust enrichment of the wrongdoer rather than to punish him"), aff'd in part, vacated in part on other grounds sub nom. SEC v. Hirshberg, 173 F.3d 846 (2d Cir. 1999); see also cases cited at page 7 n. 4 above. Moreover, deterrence can be furthered in this case by the imposition of a substantial civil monetary penalty, which the Court recommends in Section II below.
The SEC, however, argues that "McCaskey was free to spend his net profits from his excess sales of Marcorp stock on anything he liked at the time they were earned. McCaskey certainly should not be rewarded if he applied those [stock sale] profits to further and continue his manipulative scheme" through the Wash Trades (Dkt. No. 93: SEC Reply Br. at 3, citing SEC v. Benson, 657 F. Supp. 1122, 1134 (S.D.N.Y. 1987).) ButBenson and decisions like it merely stand for the twin propositions that a defendant's disgorgement should not be reduced by (1) general business expenses that were ancillary to the fraudulent scheme, or (2) the defendant's subsequent waste of the profits in outside activities. See e.g., SEC v. Rosenfeld, 97 Civ. 1467, 2001 WL 118612 at *2 (S.D.N.Y. Jan. 9, 2001); SEC v. Shah, 92 Civ. 1952, 1993 WL 288285 at *5 (S.D.N.Y. July 28, 1993); Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb, Inc., 734 F. Supp. 1071, 1076 (S.D.N.Y. 1990), rev'd on other grounds, 967 F.2d 742 (2d Cir. 1992); SEC v. Benson, 657 F. Supp. at 1133-34. Here, in contrast, the Wash Trades were the very transactions on which the SEC sued — not some ancillary cost or outside activity.
Finally, the SEC cites SEC v. Commonwealth Chem. Sec., Inc., 410 F. Supp. 1002, 1021 (S.D.N.Y. 1976), aff'd in part modified on other grounds, 574 F.2d 90, 102 (2d Cir. 1978), for the proposition that any disgorgement should not be offset by "subsequent losses." (Dkt. No. 93: SEC Reply Br. at 4.) Commonwealth, however, involved the more common situation in which the wrongdoer incurred losses when the SEC suspended trading, causing the scheme to collapse, 410 F. Supp. at 1021, in contrast to McCaskey's Wash Trade losses which were incurred incidental to, and as part and parcel of, the intended scheme. As noted above, applying Commonwealth, this Court has already rejected McCaskey's effort to offset losses he incurred when the SEC suspended trading.
The SEC also cites SEC v. Grossman, 1997 WL 231167 at *10, for the proposition that "a defendant's claim that his profits were wiped out by subsequent losses is no defense to disgorgement." (Dkt. No. 93: SEC Reply Br. at 4.) That statement, however, appears to have been made in response to defendant's plea of poverty, as it followed the earlier statement that "there is no legal support for [defendant]'s assertion that his financial hardship preludes the imposition of an order of disgorgement." SEC v. Grossman, 1997 WL 231167 at * 10.
While not cited by the parties, this Court's research has found only one decision that declined to net out gains and losses from the same trading period for purposes of disgorgement. SEC v. Mayhew, 916 F. Supp. 123, 132 (D. Conn. 1995), aff'd on other grounds, 121 F.3d 44 (2d Cir. 1997). That decision, however, contains no explanation for not netting out the losses, and the Court declines to follow it. In Mayhew, the defendant was convicted of insider trading. SEC v. Mayhew, 916 F. Supp. at 132. The Court ordered disgorgement of $255,550.01 in profits that defendant had amassed in trading the company's stock and options, but expressly rejected an offset for the defendant's trading losses during the same time period. Id. (citing SEC v. Shapiro, 494 F.2d 1301, 1309 (2d Cir. 1974)). Shapiro, however, does not support the Mayhew court's decision. In Shapiro, the defendant bought stock based on inside information about a possible merger. SEC v. Shapiro, 494 F.2d at 1303-05. The stock price rose when the merger information was disclosed to the public. Id. Although defendant held on to the stock after the public disclosure, and later sold it at a lower price, the district court ordered that defendant disgorge all of his "paper profits" — as if he had sold when the merger information was publicly disclosed. See Id. at 1309. The Second Circuit explained:
The district court's approach was reasonable. A violator of the securities laws should disgorge profits earned by trading on non-public information. Once public disclosure is made and all investors are trading on an equal footing, the violator should take the risks of the market himself. Moreover, a contrary holding would create a serious anomaly that might encourage insider trading. To require disgorgement only of actual profits in cases where the price of the stock subsequently fell would create a heads-I-win tails-you-lose opportunity for the violator: he could keep subsequent profits but not suffer subsequent losses. Such a rule would emasculate the deterrent effect of Rule 10b-5.Id. at 1309. Shapiro's point is that the amount of an inside trader's disgorgement should be calculated as of the date the positive inside information is publicly disclosed, regardless of whether, in a choice "made entirely independent of the fraud," the wrongdoer held onto the stock and it subsequently rose or dropped. See also, e.g., SEC v. MacDonald, 699 F.2d 47, 54-55 (1st Cir. 1983). In contrast to Shapiro, (1) McCaskey's Wash Trade losses were not incurred after the conclusion of the fraudulent scheme but as part of the scheme, and (2) because of the very nature of the Wash Trades, there was no danger of McCaskey holding the securities essentially risk-free after the scheme had been discovered, and thus no danger of a "heads-I-win tails-you-lose opportunity."
In short, McCaskey's profits from the "sixteen days" on which the SEC has focused are more than offset by his Wash Trade losses for the entire period of the manipulation scheme (and not having McCaskey credit for any losses incurred on or after December 8, 1994 when the SEC stopped trading in Marcorp stock). Thus, in my view, on the facts of this case, disgorgement is not appropriate.
3. If Judge Kram Were to Order Disgorgement, However, the Amount Should Only be $54,432.67
I recognize, however, that this is a Report and Recommendation, and there are no binding cases directly on point. If Judge Kram in the exercise of her discretion were to hold (contrary to my recommendation) that profits from unmatched sales on the SEC's "sixteen days" should be disgorged without offset from Wash Trade losses, such disgorgement would be far lower than the $306,086.05 amount requested by the SEC, however, because: (1) most of McCaskey's sales on the sixteen days can be matched with purchases, albeit not on the same trade data and (2) McCaskey's basis for stock he sold in unmatched sales should be set at the $1.25 per share market price before his manipulation scheme began, not at zero as the SEC's calculations assume, thus sharply reducing disgorgeable profits
The SEC incorrectly assumes that any excess sales on each of the sixteen days must have been "unmatched" and therefore profitable. The SEC, however, essentially relies on something akin to an insider trading theory, arguing that McCaskey sold to an unsuspecting public after raising the price of the shares through manipulative trades (See, e.g., Dkt. No. 1: Compl. ¶ ¶ 36, 65, 68.) Under an insider trading disgorgement theory, the wrongdoer's profits should be measured by matching up all purchases and sales that take place within a few days of each other:
The logical measure of insider trading disgorgement is the amount of profit made (or loss avoided) by the use of MNPI (material nonpublic information). Determination of this amount depends on the nature of the trading. A "pocket measure" is used (and reasonably appropriate) if there is a promptly offsetting trade, a "market measure" if there is not.
(1) Pocket Measure. If there is a promptly offsetting trade, the disgorgeable profit is the profit that goes to the violator's pocket; it is easily computed. Thus, if a buyer promptly resells the securities (or a seller promptly rebuys), the profit i s the price difference between the two transactions.
2 A. Bromberg L. Lowenfels, Securities Fraud Commodities Fraud § 7.4 (1023) (2d ed. 2001).
Ten of the "sixteen days" excess sales highlighted by the SEC (Dkt. No. 84: Markowitz 11/7/01 Aff. Ex. S; Dkt. No. 91: McCaskey 1/19/02 Aff. ¶ 11 Ex. 2; Dkt. No. 97: Supp. Miller 2/8/02 Aff. ¶ ¶ 3-4) can be matched up with roughly contemporaneous excess purchases, converting a disgorgeable profit into a loss.
Over the course of the six month manipulation period, McCaskey purchased $759,416, or 531,004 shares, more of Marcorp stock than he sold. (Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1 at 12.) McCaskey appears to assert that because he continued to hold this $759,416 in excess purchases when the SEC suspended trading on December 8, 1994, all such holdings should be considered a "loss," further reducing any disgorgement. (See Dkt. No. 87: McCaskey Br. at 11; Dkt. No. 91: McCaskey 1/19/02 Aff. ¶¶ 8-10 Ex. 1 at 12.) Judge Friendly rejected this very argument, holding that there is "no reason why, in determining how much should be disgorged in a case where defendants have manipulated securities so as to mulct the public, the court must give them credit for the fact that they had not succeeded in unloading all their purchases at the time when the scheme collapsed." SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978); see also cases cited at page 11 above.
For example, although McCaskey had excess sales of 41,000 shares and 2,000 shares on September 19 and 20, 1994, respectively, he had an excess purchase of 43,000 shares on September 21, 1994, covering his sales of the previous two days, albeit at a higher cost. (Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1 at 7-8; see also Dkt. No. 84: Markowitz 11/7/01 Aff. Ex. S at 2.)
The SEC also asserts that McCaskey reaped a profit on September 22, 1994 of $18,279, because he sold 15,000 shares more than he bought that day. (Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1 at 8; Dkt. No. 84: Markowitz 11/7/01 Aff. Ex. Sat 2.) However, on September 23, 1994, McCaskey bought 25,000 shares more than he sold, easily covering the prior day's sales, again at a greater cost. (Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1 at 8.)
Similarly, McCaskey's excess sales of 20,000 shares and 4,000 shares on May 31 and June 7, 1994, respectively (Dkt No. 84: Markowitz 11/7/01 Aff. Ex. S; Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1) can be matched with his excess purchase of 25,000 shares on June 6, 1994, and again McCaskey paid substantially more per share than he received. (Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1.)
In addition, excess sales on September 8 can be matched with excess purchases on September 13; excess sales on October 4 can be matched with excess purchases on October 3 and October 6; excess sales on October 19 and October 20 can be matched with excess purchases on October 17; and excess sales on October 31 can be matched with excess purchases on November 8. (Dkt. No. 91: McCaskey 1/19/02 Aff. Exs 1-2; Dkt. No. 84: Markowitz 11/7/01 Aff. Ex. 5) These dates are sufficiently contemporaneous to be appropriate for matching.
However, on August 5, 11, 29 and 30, 1994, September 1, 1994, and October 28, 1994 (six of the SEC's "sixteen days"), McCaskey sold 142,500 Marcorp shares that cannot be matched (even under the more lement insider trading theory) with roughly contemporaneous purchases. A case therefore could be made for requiring disgorgement of McCaskey's profits on these unmatched sales (again, assuming that Wash Trade losses were not to be offset); Such disgorgeable profits, however, would be far lower than the SEC has asserted. The SEC simply assumes, without explanation, that McCaskey should be credited with a zero capital basis on the unmatched stock sales (see Dkt. No 84: Markowitz 11/7/01 Aff. Ex. 5), presumably because the stock price plummeted when trading was suspended. The SEC thus posits that McCaskey should have to disgorge all proceeds of such sales (Id.)
The SEC ignores the doctrine that wrongdoers are only required to disgorge their illegal or ill-gotten gains. See, e.g., SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir.), cert. denied, 404 U.S. 1005, 92 S. Ct. 561 (1971). The appropriate beds for disgorgement calculations should therefore be the price of Marcorp stock before McCaskey's manipulation began. SEC v. Bilzerian, 29 F.3d 689 (D.C. Cir. 1994), is on all fours, as it involved a scheme in which the defendant manipulated the stock price and then sold shares at a profit:
We find that the district court' s disgorgement order reasonably approximated Bilzerian's illicit profits. The court was careful to order disgorgement of the profits caused by Bilzerian's securities violations only. For the shares Bilzerian purchased after his securities violations occurred, the court subtracted Bilzerian's purchase price from the price at which he later sold the stocks based on the theory that all appreciation occurring after his violations was due to his illegal actions. For the shares purchased before his violations, the court subtracted from the sales price the market price on the first day of his violations, thereby ensuring that any pre-violation appreciation was not disgorged.Id. at 697.
Here, McCaskey's guilty plea, Judge Kram's grant of summary judgment, and the SEC's disgorgement application all are based on a manipulation period beginning in late May 1994. Accordingly, because Marcorp stock was selling at $1.25 per share in late May (and early June) 1994 (Dkt. No. 91: McCaskey 1/19/02 Aff. Exs 1 3; Dkt. No. 90: Israel 1/19/02 Aff. Ex. 4), McCaskey's beds for the purpose of calculating disgorgeable profits should be $1.25 — the price just before McCaskey's manipulative scheme commenced.
Based on a $125 basis, assuming Wash Trade losses are not netted out and granting McCaskey credit for brokerage commissions on his sales (see pages 9-10 above), McCaskey's disgorgeable profits from the only truly "unmatched" sales from the SEC's "sixteen days" theory, that is, the unmatched excess sales on August 5, 11, 29 and 30, 1994, September 1, 1994, and October 28, 1994, would be $54,432.67.
In sum, although the question is a close one, this Court recommends that disgorgement not be ordered. However, should Judge Kram decide to order disgorgement, this Court recommends disgorgement in the amount of $54,432.67 (plus prejudgment interest). II. McCASKEY SHOULD BE ORDERED TO PAY A CIVIL MONETARY PENALTY OF $100,000
If disgorgement is ordered, prejudgment interest on the amount disgorged also should be awarded. The decision of whether to order prejudgment interest, like the decision to grant disgorgement and in what amount, is left to the district court's "broad discretion." SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1476 (2d Cir. 1996); see also, e.g., Rolf v. Blyth, Eastman Dillon Co., 637 F.2d 77, 86 (2d Cir. 1980); SEC v. Grossman, 87 Civ. 1031, 1997 WL 231167 at *11 (S.D.N.Y. May 6, 1997) (Kram, D.J.). "[R]equiring the payment of interest prevents a defendant from obtaining the benefit of 'what amounts to an interest free loan procured as a result of illegal activity.'" SEC v. Grossman, 1997 WL 231167 at * 11 (quoting SEC v. Moran, 944 F. Supp. 286, 295 (S.D.N.Y. 1996)). "In deciding whether an award of prejudgment interest is warranted, a court should consider'(i) the need to fully compensate the wronged party for actual damages suffered, (ii) considerations of fairness and the relative equities of the award, (iii) the remedial purpose of the statute involved, and/or (iv) such other general principles as are deemed relevant by the court.' In an enforcement action brought by a regulatory agency, the remedial purpose of the statute takes on special importance." SEC v. First Jersey Sec., Inc., 101 F.3d at 1476 (citations omitted). In light of that remedial purpose, and considering the "egregious" nature of McCaskey's manipulation, SEC v. McCaskey, 98 Civ. 6153, 2001 WL 1029053 at *6 (S.D.N Y Sept. 6, 2001) (Kram, D.J), an award of interest would be appropriate here if the Court were to order disgorgement. See SEC v. Grossman, 1997 WL 231167 at * 11 ("In determining the appropriateness of an interest award, courts rely heavily on the level of the defendant's culpability."). As the SEC suggested (Dkt. No. 82: SEC 11/17/01 Br. at 9-10), such interest should be calculated at the IRS underpayment rate, see SEC v. First Jersey Sec., Inc., 101 F.3d at 1476, commencing December 8, 1994, the date trading was suspended.
The SEC also seeks an order requiring McCaskey to pay a $100,000 civil monetary 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). (Dkt. No. 82: SEC 11/7/01 Br. at 11-14.)
Civil penalties were enacted by Congress to deter securities law violations. See e.g., SEC v. Palmisano, 135 F.3d 860, 866 (2d Cir.),cert. denied, 525 U.S. 1023, 119 S.Ct. 555 (1998); SEC v. Coates, 137 F. Supp.2d 413, 428 (S.D.N.Y. 2001); SEC v. Rosenfeld, 97 Civ. 1467, 2001 WL 118612 at *4 (S.D.N.Y. Jan. 9, 2001) (quoting SEC v. Moran, 944 F. Supp. 286, 296 (S.D.N.Y. 1996)). The relevant House Report stated:
"The Committee believes that the money penalties proposed in this legislation are needed to provide financial disincentives to securities law violations other than insider trading. . . . Absent a criminal prosecution or a private suit for damages . . . even the defendant who makes a deli berate decision to violate the law and causes significant harm to the markets does not risk any monetary sanction more severe than an order of disgorgement. Disgorgement merely requires the return of wrongfully obtained profits; it does not result in any actual economic penalty or act as a financial disincentive to engage in securities fraud. A violator who avoids detection is able to keep the profits resulting from illicit activities. Currently, even a violator who is caught is required merely to give back his gains with interest, leaving him no worse off financially than if he had not violated the law. The Committee therefore concluded that authority to seek or impose substantial money penalties, in addition to the disgorgement of profits, is necessary for the deterrence of securities law violations that otherwise may provide great financial returns to the violator."SEC v. Coates, 137 F. Supp. 2d at 428-29 (quoting H.R Rep. No. 101-616 (1990)); accord, e.g., SEC v. Moran, 944 F. Supp. at 296 (quoting same House Report).
Where a securities law violation has been proven, the Court is authorized to impose such civil monetary penalties, with the amount of any penalty to be "determined by the court in light of the facts and circumstances." 15 U.S.C. § 77t(d)(2)(A), 78u(d)(3)(B)(i). Sections 20(d) and 21(d) establish three tiers of penalties. A first tier penalty of up to $5,000 per violation is appropriate for any securities law violation. Id. If however, the violation "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement," second tier penalties of up to $50,000 per violation apply. 15 U.S.C. § 77t (d)(2)(B), 78u(d)(3)(B)(ii). If the violation, in addition to second tier factors, "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons," third tier penalties of up to $100,000 per violation are appropriate. 15 U.S.C. § 77t (d)(2)(C), 78u(d)(3)(B)(iii).
The SEC's request for a "third tier" penalty in the amount of $100,000 should be granted, for the following reasons. First, Judge Kram's summary judgment opinion found violations of both Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act, SEC v. McCaskey, 98 Civ. 6153, 2001 WL 1029053 at *3-4 (S.D.N.Y. Sept. 6, 2001) (Kram, D.J.), thus establishing the predicate for civil monetary penalties. See, e.g. SEC v. Todt, 7 Fed. Appx. 98, 99 (2d Cir. 2001) (affirming civil monetary penalties of $200,000 and $100,000 against two defendants for violations of Section 17(a)).
Second, McCaskey pleaded guilty to manipulating Marcorp stock so as to "stabilize" or artificially raise its price. SEC v. McCaskey, 2001 WL 1029053 at * 3. His efforts did, in fact, succeed in artificially inflating the stock's price. (Dkt. No. 90: Israel 1/19/02 Aff. Ex. 4: NASD Trade Report Overview.) See SEC v. McCaskey, 2001 WL 1029053 at *3 ("McCaskey further concedes that his 'trading activities did have an impact on the value of Marcorp stock'"). Even though McCaskey accounted for most of the trading volume in Marcorp stock during the manipulation period, he sold at least some of his stock to unwitting members of the investing public. Thus, at minimum, McCaskey's artificial inflation of Marcorp's publicly traded stock "directly or indirectly . . . created a significant risk of substantial losses to other persons" 15 U.S.C. § 77t(d)(2)(C), 78u(d)(3)(B)(iii) (emphasis added). Whether or not McCaskey himself incurred a net loss or gain over the manipulation period is entirely irrelevant to the infliction of losses, or the "risk" of loss, on others.
For example, all of McCaskey's unmatched sales must have been bought by third parties. (See Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 1.) Further, even some of his sales pursuant to "matched order" may have been bought by third parties, as only "wash sale" ensure unchanged beneficial ownership Ernst Ernst v. Hochfelder, 425 U.S. 185, 205 n. 25, 96 S. Ct 1375, 1387 n. 25 (1976).
See e.g., SEC v. Friendly Power Co., 49 F. Supp.2d 1363, 1373 (S.D. Fla. 1999) (ordering civil monetary penalty of $100,000 because defendant "failure to register their securities with the SEC created a substantial risk that the investors would lose their investments"); SEC v. Softpoint, Inc., 958 F. Supp. 846, 868 (S.D.N.Y. 1997) (assessing third tier $100,000 civil monetary penalty because defendant's "conduct created a significant risk of substantial losses to others" by selling unregistered common stock and deceiving the public as to the company's true financial status"), aff'd, 159 F.3d 1348 (2d Cir. 1998); compare, SEC v. Todt, 98 Civ. 3980, 2000 WL 223836 at *12 (S.D.N.Y. Feb. 25, 2000) (rejecting third tier penalty but assessing second tier penalty, because no evidence that defendant caused risk of loss or that any victim relied on misrepresentations), aff'd, 7 Fed. Appx. 98 (2d Cir. 2001).
Nor are the actions taken in the Connecticut criminal action to the contrary. Satements made by the Connecticut district court at the sentencing hearing appear to concern McCaskey's relations with his brokerage houses, rather than the effect of his scheme on the investing public. (Dkt. No. 90: Israel 1/19/02 Aff. Ex. 1: McCaskey Plea Allocution Tr. at 31-36.) In any event, the Government's decision (for whatever reasons) not to seek restitution damages in the Connecticut action (Id. at 35-36) should not bar this Court from assessing a monetary penalty based on "risk" of loss
Third, as Judge Kram noted:
The record reflects that McCaskey acted willingly and knowingly as his stock manipulation scheme involved wash sales and matched orders conducted through 22 accounts held in misleading names or the names of nominees at 14 different firms. McCaskey's fraudulent behavior did not arise from a single, isolated incident, but rather represented a continuing course of wrongful conduct lasting approximately seven monthsSEC v. McCaskey, 2001 WL 1029053 at *5 (citations omitted). A third tier penalty in the amount of $100,000 is entirely appropriate in light of the magnitude, duration, and "egregious" nature of McCaskey's scheme, and is commensurate with penalties assessed by other courts. See, e.g., SEC v. Berger, 00 Civ. 333, 2001 WL 1403028 at * 10 (S.D.N.Y. Nov. 13, 2001) ("In light of the magnitude and duration of the fraud at issue, as well as the degree of scienter involved, the imposition of a civil penalty in the amount of $100,000 is appropriate in this case"); SEC v. Milan Capital Group, Inc., 00 Civ. 0108, 2001 WL 921169 at *3 (S.D.N.Y. Aug. 14, 2001) ($50,000 per violation for each of 200 violations, for a total penalty of $10 million); SEC v. Enterprises Solutions, Inc., 142 F. Supp.2d 561, 579 (S.D.N.Y. 2001) ($100,000 third tier penalty);SEC v. Todt, 2000 WL 223836 at *13 ("the audacity of the fraud, the magnitude of the sums involved, the repeated nature of the offenses, and the egregious explanations under oath all warrant the imposition of the maximum penalty allowed"; $200,000 penalty imposed, based on $50,000 times four violations).
Even if McCaskey's violations did not create a significant risk of loss so as to qualify for third-tier penalties, 15 U.S.C. § 77t(d)(2)(C); 78u(d)(3)(B)(ii), his actions certainly qualify for second tier penalties, as they "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement," 15 U.S.C. § 77t(d)(2)(B), 78u(d)(3)(B)(ii). At $50,000 per second-tier violation, McCaskey's many trading violations clearly qualify for the $100,000 total penalty requested by the SEC. See e.g., SEC v. Todt, 2000 WL 223836 at *12 (rejecting third tier penalty, but granting second-tier penalty of $200,000 based on four violations).
Fourth, McCaskey's failure promptly to own up to his wrongdoing lends further support to the penalty. See SEC v. Coates, 137 F. Supp. 2d at 430 (defendant's failure to take responsibility for his actions was factor in civil penalty); SEC v. Moran, 944 F. Supp. 286, 297 (S.D.N.Y. 1996) (defendant's "failure to recognize the harm that his negligence caused, coupled with apparent lack of understanding of the significance of his actions, warrant the imposition of the maximum penalty permitted").
"McCaskey's guilty plea in the parallel criminal case does not conclusively establish his appreciation of his past wrongdoing. McCaskey pled guilty only after a 3-1/2 year investigation, the filing of the instant enforcement action, and a criminal grand jury investigation. Moreover, when the SEC. filed the instant enforcement action, McCaskey filed a counterclaim against the S.E.C. claiming that the S.E.C.'s investigation 'could only be deemed to have arisen from an invidious intent.'" SEC v. McCaskey, 2001 WL 1029053 at *5.
Since this Court recommends that Judge Kram not order disgorgement, a substantial penalty would be especially appropriate to further the deterrence goals of the securities laws.
A civil penalty may, of course, be assessed in addition to disgorgement, see, e.g., SEC v. Rosenfeld, 2001 WL 118612 at *4; SEC v. Berger, 2001 WL 1403028 at *10-11.
Finally, McCaskey asserts defenses sounding in "double jeopardy" and "financial hardship" (Dkt. No. 87: McCaskey 1/22/02 Br. at 16-18), neither of which has merit. The assessment of a $30,000 penalty in the Connecticut criminal action does not bar a civil monetary penalty here. The Second Circuit has explained that "there is little indication. that disgorgement and the fines provided by the Remedies Act are criminal punishments. The Double Jeopardy Clause is therefore inapplicable." SEC v. Palmisano, 135 F.3d at 866; see also United States v. Lamanna, 114 F. Supp.2d 193, 197-98 (W.D.N.Y. 2000) (action for civil damages and fines under the False Claims Act, following defendant's payment of fine and restitution in criminal action for the same conduct, did not constitute double jeopardy). McCaskey argues that because Palmisano involved a civil monetary penalty and criminal restitution and forfeiture, but no criminal fine, it did not, as here, implicate "duplicative remedies," i.e., a criminal fine and a civil monetary penalty. (Dkt. No. 87: McCaskey 1/22/02 Br. at 16-17.) The Second Circuit, however, rejected the double jeopardy defense, not because the remedies were or were not duplicative, but because the civil monetary penalty was not a "criminal punishment." SEC v. Palmisano, 135 F.3d at 863-66. The Palmisano court's separate holding that the civil disgorgement amount should be reduced by the amount already paid in restitution, 135 F.3d at 863-64, simply applied the longstanding doctrine that the purpose of civil disgorgement is not to punish wrongdoers but to deprive them of "unlawful gains" See SEC v. Risman, 7 Fed. Appx. 30, 31 (2d Cir. 2001) ("If portions of the disgorgement fund remain after full restitution has been made to the victims, the remainder must be returned to the defendant."); SEC v. First Jersey Sec., Inc., 101 F.3d 1470, 1475 (2d Cir. 1996) (settlement payment may properly "be taken into account by the court in calculating the amount to be disgorged"), cert. denied, 522 U.S. 812, 118 S. Ct. 57 (1997).
McCaskey also cites United States v. Morse, 96 Cr. 732, 1997 WL 181043 at *2 (S.D.N.Y. Apr. 14, 1997), which itself quotes United States v. Halper, 490 U.S. 435, 449-50, 109 S.Ct. 1892, 1902 (1989), to the effect that a civil monetary penalty can constitute an improper second punishment. (Dkt. No. 87: McCaskey 1/22/02 Br. at 17 n. 8.) In Hudson v. United States, 522 U.S. 93, 118 S. Ct. 488 (1997), however, "the Supreme Court largely 'disavow[ed] the method of analysis used in United States v. Halper,' and reaffirmed the traditional rule that the Double Jeopardy Clause prohibits multi pie sanctions for the same offense only if those sanctions are 'criminal punishments'" SEC v. Palmisano, 135 F.3d at 864 (quoting Hudson v. United States, 522 U.S. at 96, 98-99, 118 S.Ct. at 491, 493). The Morse decision, issued prior to both Hudson andPalmisano, thus has been effectively overruled.
McCaskey asserts that no monetary penalty should be assessed because he has no assets and no prospects (Dkt. No. 87: McCaskey 1/22/02 Br. at 18.) A defendant's finances are relevant to the size of a civil penalty. See, e.g. SEC v. Rubin, 91 Civ. 6531, 1993 WL 405428 at *7 (S.D.N.Y. Oct. 8, 1993) (court considers defendant's "impecunious . . . financial condition" in imposing only a $1,000 penalty). McCaskey claims that "he has zero income, sustained extraordinary losses last year and has a negative net worth." (Dkt. No. 87: McCaskey 1/22/02 Br. at 18.) McCaskey has not made an adequate showing; based on his February 22, 2002, hearing testimony, I find his assertion that he cannot afford to pay a civil penalty entirely lacking in credibility. (Dkt. No. 96: 2/22/02 Hearing Tr. at 2642, 46-52.)
McCaskey's testimony revealed a history of using shell companies and other people's bank accounts to hide or disguise his assets from creditors. For example, he testified that since his 1992 bankruptcy filing he "never had any personal money," he never maintained a personal checking account, and instead consistently paid substantial personal expenses from the checking account of what appears to be a shell corporation in which he allegedly had no ownership interest, IMM International, Inc. (Id. at 26-40.) When asked why he maintained this unusual arrangement, he answered:
I had left over — there was some litigation going on from the bankruptcy case. I had the couple of brokerage firms were chasing me. And I was advised by counsel not to maintain any money really —.
(Id. at 39.) Thus, while avoiding his creditors, McCaskey drew on the IMM International account during the period May 1, 1998 through December, 2000 to pay for, inter alia, his Woodway Country Club dues, his car payments (possibly on his Mercedes Benz), his wife's dues at the Fairfield County Hunt Club, his daughter's tuition at the Hunt Ridge Montessori School, and loan payments on a 32-foot cabin cruiser that he purchased but which was registered in the name a friend to enable McCaskey, through the friend, to obtain a loan on the boat. (Id. at 33-36.) In light of this history of financial deception, McCaskey's cries of poverty ring exceptionally hollow. The Court found McCaskey's testimony on his financial condition to be evasive and lacking in credibility. McCaskey has not sustained his burden of showing that he is financially unable to pay a civil penalty. The Court therefore should impose a civil monetary penalty of $100,000.
As another example, McCaskey's testimony about his efforts to find employment in the past two years (or, as further cross-examination revealed, his lack of effort), was quite evasive. (Id. at 4647.)
CONCLUSION
For the reasons set forth above, (1) the SEC's request for disgorgement from McCaskey should be denied, and (2) McCaskey should be ordered to pay a civil monetary penalty of $100,000.
FILING OF OBJECTIONS TO THIS REPORT AND RECOMMENDATION
Pursuant to 28 U.S.C. § 636 (b)(1) and Rule 72(b) of the Federal Rules of Civil Procedure, the parties shall have ten (10) days from service of this Report to file written objections. See also Fed. R Civ. P. 6. Such objections (and any responses to objections) shall be filed with the Clerk of the Court, with courtesy copies delivered to the chambers of the Honorable Shirley Wohl Kram, 40 Centre Sreet, Room 2101, and to my chambers, 500 Pearl Sreet, Room 1370. Any requests for an extension of time for filing objections must be directed to Judge Kram. Failure to file objections will result i n a waiver of those objections for purposes of appeal. Thomas v. Arn, 474 U.S. 140, 106 S. Ct. 466 (1985); IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d 1049, 1054 (2d Cir. 1993), cert. denied, 513 U.S. 822, 115 S.Ct. 86 (1994); Roldan v. Racette, 984 F.2d 85, 89 (2d Cir. 1993); Frank v. Johnson, 968 F.2d 298, 300 (2d Cir.), cert. denied, 506 U.S. 1038, 113 S. Ct. 825 (1992); Small v. Secretary of Health Human Servs., 892 F.2d 15, 16 (2d Cir. 1989);Wesolek v. Canadair Ltd., 838 F.2d 55, 57-59 (2d Cir. 1988); McCarthy v. Manson, 714 F.2d 234, 237-38 (2d Cir. 1983); 28 U.S.C. § 636 (b)(1); Fed.R.Civ.P. 72, ¶ (a), ¶ (e).
$1.25/Share No. Shares Sale Price Basis x No. Date Sold Less Comm. Shares Profit 8/05/94 20,000 $36,720. $25,000. $11,720. 8/11/94 2,000 3,400. 2,500. 900. 8/29/94 45,000 73,687.50 56,250. 17,437.50 8/30/94 55,000 87,863.15 68,750. 19,113.15 9/01/94 3,000 4,345. 3,750. 595. 10/28/94 17,500 26,542.02 21,875. 4,667.02 TOTAL $54,432.67 (Derived from: Dkt. No. 84: Markowitz 11/7/01 Aff. Ex. Sand Dkt. No. 91: McCaskey 1/19/02 Aff. Ex. 2.) To be consistent, brokerage commissions should be added to McCaskey's $1.25 purchase price beds, thus further reducing any disgorgeable profit. However, because such commissions are not in the record, the Court has simply set McCaskey's purchase price beds at $1.25.