Opinion
NO. CIV. S-09-0665 LKK/DAD
08-31-2011
SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. ANTHONY VASSALLO, KENNETH KENITZER, and EQUITY INVESTMENT MANAGEMENT AND TRAINING, INC., Defendants.
ORDER
The Receiver in this SEC enforcement action has moved for the disgorgement of $2.5 million from non-parties J.R. Trust, Global Mergers & Acquisitions, Inc., William A. Hayward, RAAR Investments, Ltd., Jack Miller and Richard J. Schotts, Jr. (collectively, "the non-parties"). The Receiver alleges that $2.5 million in investor funds were transferred, without consideration, from Equity Investment Management and Trading, Inc. ("EIMT"), to J.R. Trust and from there, to other non-parties. None of the non-parties has appeared or opposed the motion.
Securities & Exchange Commission.
SUMMARY
1. The Receiver has made a prima facie showing that J.R. Trust, RAAR Investments, Jack Miller and Richard J. Schott, Jr., each received or controlled defrauded investor funds, and that none of the four had any legitimate claim to the money. The Ninth Circuit authorizes summary proceedings to recover defrauded investor funds in this way. See SEC v. Wencke, 783 F.2d 829 (9th Cir. 1986) (Wencke III) (authorizing summary proceedings instituted by receiver), cert. denied sub nom. DeLusignan v. Gould, 479 U.S. 818 (1986); SEC v. Colello, 139 F.3d 674 (9th Cir. 1998) (authorizing SEC recovery of defrauded investor funds from non-culpable "nominal defendants"). Accordingly, the Receiver's motion is GRANTED as to these four non-parties.
There are three Wencke's (so far). The cited case is the third in the series.
2. However, the Receiver has not alleged, nor made a prima facie showing, that Global Mergers & Acquisitions, Inc. or William A. Hayward ever received or controlled any investor funds. Rather, the Receiver alleges that these two (with Schott), "swindled" Vassallo and EIMT out of the $2.5 million. The remedy of disgorgement only applies to avoid unjust enrichment, and can only be imposed on a person who has, at least at some point, possessed or controlled the funds to be disgorged. Accordingly, the Receiver's motion is DENIED WITHOUT PREJUDICE as to these two non-parties.
I. BACKGROUND
According to the complaint, EIMT was a company operated by defendants Anthony Vassallo and Kenneth Kenitzer. The company collected $40 million from investors, who were told they were investing in a "hedge fund." The company did some securities trading for a time, but ultimately stopped trading entirely. In an all-too-familiar story, the company nevertheless reported fictional "returns" to its investors. Like any "Ponzi scheme," the company's pay-outs to investors came from other investors' money, not from investment returns.
Vassallo and Kenitzer have both consented to permanent "obey-the-law" injunctions (Dkt. Nos. 127 & 228), in which they "neither admit nor deny" the allegations of the complaint, from which the following account is taken.
At some point, William A. Hayward (on behalf of Global Mergers & Acquisitions, Inc.), and Richard J. Schotts, Jr. (on behalf of J.R. Trust), "convinced Vassallo to transfer $2.5 million" of EIMT funds - the money the Receiver now seeks to recover - to J.R. Trust. Vassallo transferred the funds, apparently believing that he was investing in a "Private Placement Trade Program," but which turned out to be just another investment scam. Upon receiving EITM's funds, J.R. Trust at Schotts's direction, spent the money, or transferred it to RAAR, Miller and others, none of whom had any right to EIMT's funds. EIMT got nothing for the $2.5 million transferred to the non-parties. On March 11, 2009, the SEC filed this civil enforcement action against Vassallo, Kenitzer and EIMT, alleging sales of unregistered securities, securities fraud, and other charges.
The Receiver refers to it as a "Prime Bank" securities scam. It is unclear if defendant Vassallo was himself the victim of a scam, or if he was a party to it.
The Receiver could not locate some of the transferees, and they are not involved in this motion.
On July 31, 2009, this court appointed a permanent Receiver for EIMT, to marshal and recover its assets, namely, the defrauded investor funds. See SEC v. Wencke, 577 F.2d 619, 623 (9th Cir. 1978) (Wenke I) (district court acted within its discretion in appointing a receiver to protect the public investors); 15 U.S.C. § 78u(d)(5) (authoring the district court to grant equitable relief necessary for the benefit of investors); 28 U.S.C. § 754 (governing the appointment of receivers in federal courts).
On July 28, 2011, the Receiver filed this motion seeking disgorgement of the $2.5 million that was initially transferred to J.R. Trust. The motion is supported by declarations showing what happened to the $2.5 million, and the role of the non-parties. It is also supported by the Receiver's Certificate of Service averring that each of the non-parties had been served with the motion and its accompanying papers. To date, none of the non-parties has appeared or otherwise opposed the motion.
II. DISGORGEMENT: AUTHORITY AND STANDARD
"[T]he district court has broad equity powers to order the disgorgement of 'ill-gotten gains' obtained through the violation of federal securities laws." S.E.C. v. JT Wallenbrock & Associates, 440 F.3d 1109, 1113-14 (9th Cir. 2006). These powers come expressly from the federal securities laws, 15 U.S.C. § 78u(d)(5) (district court may grant "any equitable relief that may be appropriate or necessary for the benefit of investors"), but more generally, from "common law principles of equity." See FTC v. Network Services Depot, Inc., 617 F.3d 1127, 1141-1142 (9th Cir. 2010).
Citing SEC v. First Pacific Bancorp, 142 F.3d 1186, 1191 (9th Cir. 1998), cert. denied, 525 U.S. 1121 (1999).
In the Ninth Circuit, this equity power extends to non-parties, often called "nominal defendants," who are "in possession of funds to which they have no rightful claim, such as money that has been fraudulently transferred by the defendant in the underlying securities enforcement action." SEC v. Ross, 504 F.3d 1130, 1141 (9th Cir. 2007).
Citing SEC v. Colello, 139 F.3d 674, 675 (9th Cir. 1998) (SEC may sue "nominal defendants"). Ross also helpfully cites "SEC v. Hickey, 322 F.3d 1123, 1130-32 (9th Cir. 2003) (upholding the district court's exercise of jurisdiction over a corporation nominally owned by the defendant's mother and into which the defendant had channeled proceeds of his securities law violations); Wencke III, 783 F.2d 829, 838 (9th Cir. 1986) (holding that the district court had jurisdiction over the assets of a corporation into which the defendant in the underlying enforcement action had funneled proceeds of his securities law violations)," and SEC v. Cherif, 933 F.2d 403, 414 (7th Cir. 1991) (discussing "nominal defendants").
A disgorgement order will issue against a non-party "if it is established that the non-party possesses illegally obtained profits but has no legitimate claim to them." SEC v. Ross, 504 F.3d 1130, 1144 (9th Cir. 2007) (citation and internal quotations omitted). Although the federal securities laws expressly provide for whatever "equitable remedy" is needed to benefit the defrauded investors, the Ninth Circuit looks to the principles of the common law in determining whether disgorgement is appropriate. See FTC v. Network Services Depot, Inc., 617 F.3d at 1141-1142. The remedy applicable in these cases is the "constructive trust":
In Ross, the Ninth Circuit found that summary proceedings were not proper because the sole basis for the disgorgement was the wrong-doing of the non-parties. 504 F.3d at 1144 (the purpose of summary proceedings is "simply to 'obtain equitable relief from a non-party against whom no wrongdoing is alleged'").
Constructive trust is a form of remedy that is "flexibly fashioned in equity to provide relief where a balancing of interests in the context of a particular case seems to call for it." In re N. Am. Coin & Currency, Ltd., 767 F.2d 1573, 1575 (9th Cir. 1985). It is a creature of the common law, rather than any federal statute.FTC v. Network Services Depot, Inc., 617 F.3d 1127, 1141-1142 (9th Cir. 2010). As applicable to these cases,
At common law, where property has been obtained by fraud, a court in equity "has jurisdiction to reach the propertyId., 617 F.3d at 1141-1142.
either in the hands of the original wrong-doer, or in the hands of any subsequent holder" and to convey that property to "the one who is truly and equitably entitled to the same." Harris Trust & Sav. Bank v. Salomon Smith Barney, Inc., 530 U.S. 238, 251 (2000).
The non-parties have not appeared or responded to the motion for disgorgement. Accordingly, as in a default judgment situation, it will be sufficient for the Receiver to make a prima facie showing of his entitlement to the disgorgement: that defendants committed a securities law violation; that defrauded investor funds from that violation were transferred to the non-parties; and that the non-parties have no legitimate claim to the funds.
III. SUMMARY PROCEEDINGS
The Ninth Circuit has recognized "a truncated form of process vis-a-vis 'a non-party depository as a nominal defendant to effect full relief in the marshaling of assets that are the fruit of the underlying fraud.'" Ross, 504 F.3d at 1141; Wencke III, 783 F.2d 829 (confirming the district court's authority to use summary disgorgement proceedings, initiated by the receiver, to marshal investor assets - namely, defrauded investor funds - in hands of non-parties). In upholding the use of this type of summary proceeding, the Ninth Circuit has relied on the fact that the district courts have afforded the non-party from whom disgorgement is sought, substantially all of the procedural and evidentiary protections that would be provided in a plenary proceeding. See CFTC v. Topworth Intern., Ltd., 205 F.3d 1107, 1113 (9th Cir. 1999); SEC v. Universal Financial, 760 F.2d 1034, 1037 (9th Cir. 1985).
In any event, this court has already ruled on the sufficiency of summary proceedings, see also SEC v. Vassallo, 2010 WL 3835729 at *2 (E.D. Cal. September 29, 2010) (Karlton, J.) (unpublished) (citing Topworth), and it is now the law of the case.
On August 20, 2009, this court established a standard for summary proceedings for the recovery of EIMT assets by the Receiver. Dkt. No. 116. First, the Receiver shall file a noticed motion for disgorgement and serve said motion upon all interested parties. Interested parties may file an opposition brief, in response to which the Receiver may file a reply brief. The order also provides that, "Upon a showing of good cause, the Court may order limited discovery concerning the particular asset." Additionally, if "the Court determines there is a disputed issue(s) of fact concerning the disgorgement of a particular asset, the Court shall set an evidentiary hearing to resolve the issue(s)." The court orders disgorgement of an asset where the Receiver shows that the asset belongs to EIMT.
Accordingly, the summary proceeding order provides the due process protections that the Ninth Circuit has identified as important in such proceedings: notice, discovery, participation in briefing and oral argument, and application of the Federal Rules of Evidence and Civil Procedure. See Wencke III, 783 F.2d at 836-837. In addition, the order provides for an evidentiary hearing to resolve disputed issues of fact.
IV. ANALYSIS
A. Recipients of EIMT Funds
The Receiver has made a prima facie showing that defendant Vassallo solicited investors for a fraudulent securities investment scheme, obtained investor funds by means of these solicitations and lied to the investors about their "returns,"all in violation of the federal securities laws as set forth in the complaint. See Anderson Decl. ¶¶ 3-5 (Dkt. No. 417). The Receiver's evidence further shows the following: (i) Vassallo transferred $2.5 million of the investors' funds to non-party J.R. Trust in August 2008; (ii) at Schott's direction, J.R. Trust transferred $1,879,000 to an account in the United Kingdom; (iii) J.R. Trust transferred $228,387.50 of those funds to non-party RAAR; (iv) J.R. Trust, of whom Schott was a Trustee, and RAAR, for which Schott was a bank signatory, transferred $167,317.01 of those funds to non-party Jack Miller. The evidence further shows that none of the above non-parties did anything to earn the funds or otherwise justify the transfer of the funds to them. See Anderson Decl. ¶¶ 6-18.
Even if the "hedge fund" did trade at the beginning, the Receiver's evidence shows that at some point there was no trading, no returns, and only fraudulent representations about the investors' non-existent "returns."
The Receiver views this evidence as supporting a constructive trust under California law. The court has no reason to doubt that it does, nor to question whether such an approach would be proper. However, since this is an SEC enforcement case, the court believes that it is more appropriate to examine the evidence in light of the federal securities laws and the law of disgorgement applicable specifically to SEC enforcement cases.
See Anderson Decl. ¶ 10.
See Anderson Decl. ¶¶ 12-13.
See Anderson Decl. ¶ 14.
Accordingly, the Receiver has shown his entitlement to: (i) disgorgement of the $2.5 million in defrauded investor funds from J.R. Trust; (ii) disgorgement of $228,387.50 from non-party RAAR; and (iii) disgorgement of $167,317.01 from non-party Jack Miller.
B. Non-Recipients of EIMT Funds
The Receiver also seeks disgorgement from non-parties Global Mergers & Acquisitions, Inc. and William A. Hayward. However, the Receiver's evidence does not make a prima facie showing that either of these two non-parties received or controlled defrauded investor funds from EIMT. Instead, these non-parties are alleged to be wrong-doers who "swindled" Vassallo into transferring EIMT funds to J.R. Trust. See Anderson Decl. ¶ 7.
The problem for the Receiver is that whether he proceeds under federal law or California law of "disgorgement" or "constructive trust," the basic requirement of the remedy of disgorgement is that the person against whom the order would issue be, or at some point have been, in possession or control of the funds to be disgorged. There is at present no showing that Global Mergers or Hayward ever possessed or controlled any defrauded investor funds, and accordingly, no order of disgorgement can issue against them at this time.
V. CONCLUSION
For the foregoing reasons:
(1) The Receiver's motion for disgorgement as to J.R. Trust, RAAR Investments, Ltd., Jack Miller and Richard J. Schott, Jr., is GRANTED;
(2) The Receiver's motion for disgorgement as to Global Mergers & Acquisitions, Inc. and William A. Hayward is DENIED WITHOUT PREJUDICE.
If the Receiver obtains evidence that Global Mergers and/or Hayward received or controlled defrauded investor funds, he may renew his motion as to them. Otherwise, he is free to file a motion seeking relief other than disgorgement, if he believes it is appropriate for resolution in a summary proceeding. Of course, he is always free to file a plenary action to recover the funds he alleges these two "swindled" out of Vassallo.
The court further orders that within twenty (20) days of the issuance of this order:
(3) Non-parties J.R. Trust and Richard J. Schott, Jr. shall DISGORGE to the Receiver the $2.5 million transferred to J.R. Trust by defendant EIMT, including but not limited to, anything purchased with that $2.5 million and any profits therefrom, but subject to an offset of any amounts actually disgorged by RAAR and Miller;
(4) Non-party RAAR Investments, Ltd. shall DISGORGE to the Receiver the $228,387.50 of EIMT funds it received from J.R. Trust;
(5) Non-party Jack Miller shall DISGORGE to the Receiver the $167,317.01 of EIMT funds he received from J.R. Trust and RAAR; and
(6) J.R. Trust, RAAR, Miller and Schott shall each provide a full accounting of all funds they received from EIMT or from any recipient of EIMT funds.
IT IS SO ORDERED.
LAWRENCE K. KARLTON
SENIOR JUDGE
UNITED STATES DISTRICT COURT