Summary
In Gane, the Court found that the defendant's unlawful activities did not increase the price of the company's stock that defendants sold so there was no ill-gotten gain to warrant disgorgement.
Summary of this case from S.E.C. v. LauerOpinion
Case No. 03-61553-CIV-SEITZ/Bandstra/Gonzalez.
January 4, 2005
FINDINGS OF FACT AND CONCLUSIONS OF LAW
THIS CAUSE came on for trial before the Court beginning on December 6, 2004. The Court having heard the testimony of the witnesses, the evidence of the parties and being otherwise fully advised in the premises makes the following findings of fact and conclusions of law.
PRIOR RULINGS AND ISSUES PRESENTED
1. On October 12, 2003, this Court entered its Order Granting In Part and Denying In Part Motions for Summary Judgment (the "Summary Judgement Order") where it held that (i) defendants, Charles T. Tamburello ("Tamburello") and Capital Research Group, Inc.'s ("CRG"), written statements that they "may" buy or sell Dicom stock did not provide adequate disclosure to investors and (ii) that said Defendants failed to fully disclose their compensation in the Dicom Investment Opinions issued from December, 1999 through February, 2000. (DE 104.) The Court also held that said Defendants' statements that "Dicom is on the ball and growing at a rapid rate" are legally immaterial and therefore denied the SEC's motion on Counts I and III with regard to these statements. ( Id.) Finally, the Court denied the SEC's Second and Fifth Prayers for Relief seeking injunctions and civil penalties. ( Id.)
2. On November 1, 2004, the Court entered its Order on the October 28, 2004 Pretrial Conference which vacated the portions of the Summary Judgment Order relating to the appropriate remedies to be applied as to the Defendants. (DE 122.) All other portions of the Summary Judgment Order, however, including those regarding the nature of the violations by Defendants as to Dicom, remained in force. Thereinafter in the parties stipulated that the remaining Issues for Trial were as follows: ( Id.)
ISSUES AS TO DR. GANE
1. (A.) Whether the Due Diligence Package failed to disclose that at least $4.2 million, or 17%, of the $24.7 million in projected revenues contained in the Due Diligence package, were revenues from products still in development?
(B.) Whether that omission was material?
(C.) Whether Dr. Gane was responsible for this omission?
(D.) Whether Dr. Gane acted with severe recklessness as tho this omission?
2. (A.) Whether Dr. Gane's Statement about Dicom's revenue goals — $50 million in 36 months — in his Emerging Company Reports interview of January 13, 2000 was material? and
(B.) Whether he made this statement with severe recklessness.
3. (A.) Whether Dr. Gane made a revenue goal statement — $60 million in 24 months — in a Wall Street Reporter interview on January 13, 2000? and
(B.) If he did, whether that statement was material? and
(C.) Whether he made the statement with severe recklessness?
(D.) $60 million in 36 months? and
(E.) Whether he made that statement with severe recklessness?
(F.) Civil penalties
ISSUES AS TO CRG AND TAMBURELLO
1. Whether CRG and/or Tamburello ever received any ill-gotten gains on Dicom stock? And if so, what if any, is the proper amount of ill-gotten gains attributable to Tamburello?
2. Assuming the Court finds that CRG and/or Tamburello received ill-gotten gains on Dicom stock, what, if any, is the amount of prejudgment interest on the amount of ill-gotten gains attributable to Tamburello and CRG as determined by the Court.
3. Whether, unless enjoined, there is a reasonable likelihood of future violations of the securities laws by CRG and/or Tamburello?
4. Whether the violations of the securities laws by CRG and/or Tamburello warrant the imposition of civil penalties, and if so in what amount?
ISSUES AS TO WELSH
1. Whether Welsh ever received any ill-gotten gains on Dicom stock? And, if so, what, if any, is the proper amount of ill-gotten gains attributable to Welsh.
2. Assuming the Court finds that Welsh received ill-gotten gains on Dicom stock, what, if any, is the amount of prejudgment interest on the amount of ill-gotten gains attributable to Welsh as determined by the Court.
3. Whether, unless enjoined, there is a reasonable likelihood of future violations of the securities laws by Welsh?
4. Whether the violations of the securities laws by Welsh warrant the imposition of civil penalties, and if so in what amount?
Based on the record in this case and the evidence presented at trial, the Court is of the opinion that although the Defendants issued investment opinions for Dicom and certain other clients that were technically violative of the federal securities laws, Defendants' conduct does not warrant the imposition of a permanent injunction and/or civil penalties. Moreover, there is simply no evidence of any causal link between CRG and Tamburello's violations and an increase in the price of Dicom's stock, and, therefore, there were no ill-gotten gains by Defendants.
FINDINGS OF FACT
A. THE DEFENDANTS
1. David Gane, D.D.S. ("Dr. Gane"), age 50, is a licensed dentist and a Canadian citizen who resides in Atlanta, Georgia. Gane was the president and director of Dicom Imaging Systems, Inc. ("Dicom") from March 17, 1999 until September 4, 2001. In 1999 and 2000, Dr. owned 100 Dicom shares and had rights to acquire 333,333 Dicom shares. (Ex. J9, J10, 400.). He is now employed at, and an officer of, PracticeWorks, Inc., a subsidiary of Eastman Kodak. At PracticeWorks, Dr. Gane's responsibilities include sales and marketing of dental imaging hardware and software and the preparation of product-related press releases.
2. Jeffrey D. Welsh ("Welsh"), age 53, resides in Atlanta, Georgia. Welsh was the president of defendant Southern Financial Services, Inc. ("Southern Financial"). He was also the president of defendant Southern Waste, Inc., dba Strategic Investors Group ("Strategic Investors") and one of its directors. Welsh was a member of the New York and New Jersey bars. He has not maintained active bar status in New York, and he has retired from the New Jersey bar. Welsh is now the Chief Executive Officer of Operant Material Solutions LLC, a private company in the equipment leasing business.
3. Southern Financial Services, Inc. ("Southern Financial"), is a Florida corporation that had offices in Fort Lauderdale, Florida. Southern Financial is a financial consulting firm that advises start up companies on how to raise equity capital and become listed on the Over-The-Counter Bulletin Board. Welsh was Southern Financial's president. It was administratively dissolved in 2001 for failure to make timely filings.
4. Southern Waste, Inc., dba Strategic Investors Group ("Strategic Investors"), is a Florida corporation that had offices in Fort Lauderdale, Florida. It is a financial public relations firm. Southern Financial owned at least a 50% interest in Strategic Investors, and the two entities were affiliates. Welsh was Strategic Investors' president. Strategic Investors was administratively dissolved in 2001 for failure to make timely filings.
5. Charles T. Tamburello ("Tamburello"), age 31, resides in Weston, Florida. Tamburello is the founder, president, and CEO of defendant Capital Research Group, Inc. ("Capital Research"). He formerly held Series 7 and 63 licenses until he allowed them to lapse in 1994.
6. Capital Research Group, Inc. ("Capital Research" or "CRG") is a Florida corporation that has its sole place of business in Weston, Florida. Capital Research is an financial public relations firm that represents companies whose stock is publicly traded. Capital Research maintains a website at www.thesubway.com. During the relevant time period, Capital Research provided publicity by listing its client companies, and providing information about them, on the website and sending news alerts (i.e., company profiles and press releases) to individuals who signed up for the service. In 1999, Capital Research began disseminating Investment Opinions. B. DICOM IMAGING SYSTEMS, INC.
Welsh, Southern Financial, Strategic Investors, Tamburello, and Capital Research are collectively referred to as the "Stock Promoters."
7. Dicom Imaging Systems, Inc. ("Dicom") was a Nevada corporation incorporated on March 17, 1999. Dicom's principal offices were located in Las Vegas, Nevada and White Rock, Vancouver, British Columbia. Dicom was a provider of dental imaging software, hardware, and support services. Dicom's stock was registered pursuant to Section 12(g) of the Securities Exchange Act of 1934 ("Exchange Act"). 15 U.S.C. § 781(g) (2004). From November 12, 1999 through at least December 2000, Dicom's stock was quoted on the Over-The-Counter Bulletin Board under the ticker symbol DCIM. In 1999 and 2000, Dicom officers and directors owned approximately 33.4% of Dicom's stock. (Ex. J9, J10.)
C. DICOM'S FORMATION
8. In late 1998 or early 1999, Dr. Gane and his colleagues met with Ron Kalfon ("Kalfon"), who Dr. Gane understood was a potential investor. Some time in late 1998 or early 1999, Kalfon responded that he would be interested in investing in the project. Dicom was then incorporated on March 17, 1999. On June 15, 1999, Dicom filed a registration statement on Form 10-SB with the Commission ("Form 10-SB"), which Dr. Gane signed on June 11, 1999. (Ex. J9.)
D. RETAINING THE SOUTHERN FINANCIAL AND STRATEGIC INVESTORS AND PREPARING THE DUE DILIGENCE PACKAGE
9. In late 1998 or 1999, Kalfon introduced Dr. Gane to Southern Financial as a good company to provide investor relations services to Dicom. Dr. Gane understood that Kalfon believed that it was important for Dicom to become known in the investment community.
10. On or about June 29, 1999, Dicom, through Dr. Gane, entered into an agreement with Southern Financial under which Southern Financial would, among other things, act as financial public relations counsel and make Dicom known to the financial community and the public generally through press releases, faxes, and a telemarketing campaign. (Ex. 28) Southern Financial further agreed to retain an investor relations firm, Strategic Investors. (Ex. 28) Southern Financial agreed to prepare and distribute a Dicom financial information package ("due diligence package") to stock brokers and potential investors. ( Id.) Dicom agreed to pay Southern Financial $5,000 for the due diligence package and $5,000 per month for acting as financial public relations counsel. (Ex. 28) Welsh and Dr. Gane signed the agreement. (Ex. 28.) Pursuant to a Side Letter Agreement between Southern Financial and Kalfon, Southern Financial also received 30,000 Dicom shares and options for up to 100,000 more Dicom shares from Kalfon. (Ex. 28)
11. By July 13, 1999, Southern Financial had received a copy of Dicom's business plan, which included pro forma financial statements, and Dicom's Form 10-SB. (Ex. 50.) Southern Financial then began to prepare the due diligence package. Dicom's Form 10-SB stated that Dicom's Image Explorer, Image Editor, and Whitener were all ready for distribution, but certain other products — LabRX, X-Ray, and Simulator — were still in development. (Ex. 50.)
12. Southern Financial reviewed Dicom's Form 10-SB and reviewed and edited the due diligence package. Dr. Gane reviewed the due diligence package, including the cover letter, which was addressed to "Dicom Shareholder or Potential Investor." (Ex. 405, p. 15, Response 6.) Dr. Gane edited the cover letter. (Ex. 405, p. 15, Response 6.) The due diligence package contained projected financials for Dicom for its first three years of operation. (Ex. 30.) As set forth in the due diligence package, Dicom projected to generate approximately $24.7 million in revenues in its first three years. (Ex. 30) Dr. Gane believed those figures, at the time he reviewed them, to accurately set forth Dicom's projections.
13. The due diligence package did not state that as of September 1999, that three of its products — Simulator, LabRX, and X-Ray — were still in development. (Ex. 30.) Further, Dr. Gane failed to notice that there was no such statement in the due diligence package. The due diligence package did not disclose that at least $4.2 million, or 17%, of the revenue projections were based upon the products still in development. (Ex. 30.) Indeed, the due diligence package attributed approximately $13.4 million of the $24.7 million in revenues to these three products. (Ex. 30.) Simulator was not released until December 15, 1999. Furthermore, LabRx and X-Ray were still in development as of at least May 15, 2000. (Ex. 438) Dr. Gane signed the September 1999 cover letter to the due diligence package. (Ex. 30) Dicom's projections remained the same through at least June 2000. (Ex. 401.)
14. Southern Financial distributed the due diligence package from at least November 1999 onwards to stock brokers and potential investors who requested the information, and at least 1,200 packages were distributed by November 12, 1999. (Ex. 29)
15. On November 12, 1999, the Over-The-Counter Bulletin Board received its first quote for Dicom stock, which was $15.25 per share. (Ex. J10.) Dicom effected two 3-for-1 stock splits, thereby tripling the number of Dicom shares each time; the first split on December 27, 1999; the second on April 6, 2000. (Ex. J10.)
16. On or about November 23, 1999, Dicom terminated its agreement with Southern Financial, effective November 30, 1999. (Ex. 54.) Kalfon and Southern Financial, through Welsh, subsequently agreed that Kalfon would compensate Southern Financial 1,500 Dicom shares per month on a month-to-month basis. Southern Financial and Strategic Investors continued to distribute the due diligence package to brokers and prospective investors. They also issued stock recommendations and investment opinions (collectively, "Investment Opinions"). On January 11, 2000, Welsh also sent Dr. Gane, and others, a planning memo regarding the Dicom promotional campaign. (Ex. 360.)
E. DICOM'S JANUARY 11 AND 13, 2000 PRESS RELEASES AND DR. GANE'S JANUARY 13, 2000 INTERVIEWS
17. On January 11, 2000, Dicom issued a press release, entitled "Dicom Restates 3rd Quarter Earnings." (Ex. 424, at Ex. 1.) The press release stated, among other things, that Dicom had "removed the revenues generated from a $600,000 License Agreement, dated September 29, 1999", from the third quarter 1999 financial statements and instead will reflect them in the first quarter 2000. Thus, in the third quarter 1999, Dicom had a loss of $351,495 or $0.15 per share as opposed to the gain of $248,505 or $0.10 per share as originally reported. Dr. Gane reviewed the press release before it was distributed publicly and received a copy of the final press release. (Ex. 358.)
18. On January 13, 2000, Dicom issued another press release, entitled "Dicom Restates 3rd Quarter Earnings." (Ex. 424, at Ex. 1.) The press release stated, among other things, "The revenue for the quarter will be restated to remove the revenue from the $600,000 License Agreement, dated September 29, 1999, from the unaudited financial statements for the third quarter of 1999. Instead, Dicom intends to reflect the revenue in the first quarter 2000". Dicom made the change to correct an error in its revenue recognition practices under generally accepted accounting principles. Thus, in the 3rd Quarter 1999, Dicom had a loss of $351,495 or $0.15 per share as opposed to the gain of $248,505 or $0.10 per share as originally reported. (Ex. 424, at Ex. 1.) Dr. Gane reviewed the press release before it was distributed publicly and received a copy of the final press release. (Ex. 382.)
19. On January 13, 2000, Emerging Company Reports interviewed Dr. Gane. Emerging Company Reports at the time was a syndicated television program broadcast nationally to at least 24 million cable television homes in over 150 cities. The Emerging Company Reports interview was televised nationally over the weekend of January 14-16, 2000, and was available on Emerging Company Report's website for thirteen weeks (www.emergingcompany.com).
20. During the interview, the following exchange took place:
Mr. Lindeman: Now, as I understand, David, there are something like 170,000 dentists in the US and Canada —Dr. Gane: That's right.
Mr. Lindeman: — with the dental products and services industry achieving in excess of $40 billion in sales per year. What kind of revenue goals does your company set for itself and when, over what time table? (Emphasis supplied)
Dr. Gane: What we've set for ourself is we've — we've looked at capturing 20 percent market share over the next 24 months, and you know, at — at an average cost or average sale price of $2,000 per dentist, we're looking at generating $50 million in revenue over the next 36 months.
(Ex. 395)
21. On January 13, 2000, Wall Street Reporter conducted another interview of Dr. Gane. (Internet Archive Dec, Ex. A, pp. 22, 27, 29, 32-35.) Wall Street Reporter at the time had a website (www.wallstreetreporter.com), which featured interviews of chief executive officers of various companies. During the interview, the following exchange took place:
WSR: Currently, there are about 170,000 dentists in the US and Canada, with the dental products and services industry achieving in excess of $40 billion in sales per year. What kind of revenue goals has your company set for itself and over what timetable?
DCIM: It is our goal (Emphasis supplied) to achieve a 20% share of the dental market in the next 36 months. With an average order value of $2000 [sic] that translates into approximately $60 million in revenue over the next three years.
(Ex. 427, at Ex. A, p. 33.)
22. Dr. Gane's interview was rebroadcast on Wall Street Reporter's website. (Ex. 427, Exh. A, pp. 32-35.) In addition, Capital Research's website, www.thesubway.com, provided a link to the interview. (Ex. 373, Ex. 427, at Exh. A, pp. 9, 14.) Dr. Gane's interview remained on Wall Street Reporter's website for at least three months. (Ex. 422, at Ex. 1.) The interview was also featured on two investor services, MULTEX, The Online Investment Research Network and Zacks Investment Research. (Ex. 422, at Ex. 1)
23. It is questionable whether there was a reasonable basis for Dr. Gane's statements regarding Dicom's revenue goals. Specifically, some of the products upon which Dicom based its revenue projection, LabRX and X-Ray, were still in development, and accounted for $7.2 million in projected revenues. (Ex. 400, Ex. 30) Until at least April 14, 2000, Dicom stated — in its Form 10-KSB signed by Dr. Gane and filed with the Commission on April 17, 2000 — that "Application software products currently under development and planned for future release include: LabRX and Xray [sic]. No assurance can be given concerning the successful development of enhancements or new modules, the specific timing of completing new releases or new features of software products or the level of their acceptance in the marketplace." (Ex. 400) F. THE STOCK PROMOTERS ISSUE THEIR INVESTMENT OPINIONS AND SELL THEIR SHARES OF DICOM STOCK 1. INVESTMENT OPINIONS BY WELSH, SOUTHERN FINANCIAL, AND STRATEGIC INVESTORS
24. From November 23, 1999 through at least February 29, 2000, Welsh, Southern Financial, and Strategic Investors issued Investment Opinions regarding Dicom through the Internet, Business Wire, and facsimile transmission. Strategic Investors issued Investment Opinions publicly on November 23 and December 28, 1999 through the Internet by e-mail, and it issued Investment Opinions on February 16 and 29, 2000, through Business Wire. (Ex. 43); Ex. 384 (February 16, 2000); Ex. 37 (February 29, 2004).) Southern Financial issued Investment Opinions on December 20, 1999, through Business Wire, on January 5, 2000 through facsimile transmission, and January 25, 2000. (Ex. 380 (December 20, 1999); Ex. 34 (January 5, 2000); and Ex. 36 (January 25, 2000).)
25. Welsh wrote the Southern Financial Investment Opinions, and reviewed the Strategic Investors Investment Opinions. Southern Financial and Strategic Investors sent some of the Investment Opinions to Dr. Gane, and they occasionally informed him of when they would issue Investment Opinions. (Exs. 85-86, 372, 385-86, 388-89.)
26. Each of the Investment Opinions contained a target price for Dicom's stock, ranging from $15 per share on November 23, 1999 (which, adjusted for the December 27 stock split, was for $5 per share) to $30 per share on February 29, 2000. (Ex. 43; (November 23, 1999); Ex. 280 (December 20, 1999); Ex. 43, p. DICOM LA2404 0000351 (December 28, 1999); Ex. 36 (January 25, 2000); Ex. 384 (February 16, 2000); Ex. 37 (February 29, 2000).)
27. Strategic Investors' November 23 Investment Opinion selected Dicom as its "Pick of the Month" and predicted that its stock price would go significantly higher in the next ninety days. (Ex. 43) Southern Financial's December 20 Investment Opinion contained a "STRONG BUY" recommendation. (Ex. 380.) Strategic Investors' December 28 Investment Opinion hailed Dicom's marketing plan. (Ex. 43)
28. Southern Financial's January 5, 2000 Investment Opinion contained a "STRONG BUY" recommendation and stated that revenue was generated by LabRX and X-Ray, among other products, even though those products remained in development. (Ex. 34.) Southern Financial's January 25, 2000 Investment Opinion repeated Southern Financial's "STRONG BUY" recommendation. (Ex. 36.) The Investment Opinion also stated that Dicom anticipated, "generating $50,000,000 in revenues over the next thirty-six (36) months." (Ex. 36.)
29. Strategic Investors' February 16, 2000 Investment Opinion stated that Dicom's trading price at the time offered, "investors substantial upside potential from holdings in Dicom Imaging Systems, Inc. (Ex. 384.) Strategic Investors' February 29, 2000 Investment Opinion contained a "STRONG BUY" recommendation. (Ex. 37.)
2. DISCLOSURE IN WELSH'S, SOUTHERN FINANCIAL'S AND STRATEGIC INVESTORS' INVESTMENT OPINIONS AND THEIR DICOM STOCK SALES
30. Strategic Investors' November 23 and December 28 Investment Opinions did not disclose any of the compensation that it received, and the Investment Opinions contained no disclosure regarding the sale of Dicom stock.
31. Southern Financial's December 20, January 5, and January 25 Investment Opinions did not disclose that Southern Financial was receiving 1,500 Dicom shares (4,500 shares after the December 27 split), that Southern Financial was splitting the shares with its affiliate, Strategic Investors; or that Southern Financial had a month-to-month arrangement with Kalfon regarding its receipt of shares. Instead, the Investment Opinions only disclosed Southern Financial's receipt of 750 shares per month. Southern Financial's December 20, January 5, and January 25 Investment Opinions only disclosed that Southern Financial or its affiliates, officers, directors, and employees may have stock positions in Dicom and that they may buy or sell shares. (Ex. 380.) The Investment Opinions contained this limited disclosure even though Southern Financial sold Dicom shares before and just after it issued the Investment Opinion. (Ex. 45)
32. The February 16 and 29 Investment Opinions also did not disclose that Southern Financial received 1,500 shares following the December 27, 1999 stock split; that Southern Financial split the shares with Strategic Investors; or that Southern Financial had a month-to-month arrangement with Kalfon regarding its receipt of shares. In addition, the February 29 Investment Opinion only disclosed that Strategic Investors, or its affiliates, officers, directors, or employees may have stock positions in Dicom and that they may buy or sell shares. (Ex. 37.) Strategic Investors contained only this limited disclosure even though its affiliate, Southern Financial, was selling Dicom shares as it and Strategic Investors were issuing Investment Opinions. (Ex. 45)
33. As a result of Welsh's, SFS's, and SIG's trading in the SFS account, they received $102,958 in trading proceeds from their trading of Dicom stock. (Ex. 45) 3. INVESTMENT OPINIONS BY TAMBURELLO AND CAPITAL RESEARCH
34. On or about November 23, 1999, Dicom entered into a six-month consulting agreement with Capital Research, which Dr. Gane signed. (Ex. 76; Ex. 420, ¶ 15.) The agreement stated that Capital Research sought to make Dicom's "products and financial prospects known not only to individual investors but also broker-dealers, market makers, and other members of the financial community." (Ex. 76) In return, Dicom agreed to pay Capital Research $5,000 upon execution of the agreement and $5,000 on the first day of each month for the next five months. (Ex. 76) Pursuant to a Consulting Agreement between Capital Research and Kalfon, which Tamburello and Kalfon executed on or about November 29, 1999, Capital Research was also to receive 25,000 Dicom shares from one or more third parties. (Ex. 76)
35. Tamburello received a copy of the due diligence package. Dr. Gane also sent Tamburello a copy of Dicom's business plan but without the projected financials or any statement that certain products were still in development. (Ex. 82.)
36. Tamburello and Capital Research publicly issued nineteen Investment Opinions regarding Dicom through Business Wire from December 2, 1999 through February 29, 2000. (Ex. 344, pp. 9-51.) They also distributed some of the Investment Opinions by e-mail directly and through others with whom they contracted for distribution. (Exs. 351, 361-63.) Tamburello wrote each of the Investment Opinions. On four occasions, two Investment Opinions were issued the same day, one as the Investment Opinion of Capital Research and the other of TheSubway.com. (Ex. 344, pp. 27-30, 35-47.) Fourteen of the Investment Opinions state that "CRG feels the stock is a great buy." (Ex. 344, pp. 9-36, 40-41, 44-45 (which states, "CRG feels that with these new developments, the stock is a great buy"), 50-51.) Each of the Investment Opinions, except one on February 22, contained a short-term price target for Dicom's stock, ranging from "$20.00+" to "$25.00+" before the stock split on December 27, 1999, and from "$12.00+" to $40.00 after the split. (Ex. 344, pp. 9-51.) Tamburello and Capital Research identified other stocks, including their trading symbols, in the Investment Opinions in part for additional exposure.
4. DISCLOSURE IN TAMBURELLO'S AND CAPITAL RESEARCH'S INVESTMENT OPINIONS AND THEIR SALES OF DICOM STOCK
37. None of the Investment Opinions that Tamburello and Capital Research issued from December 2, 1999 through February 29, 2000, stated that Capital Research received $5,000 upon signing the consulting agreement with Dicom and would receive $5,000 per month for five months from Dicom. (Ex. 344, pp. 9-51.)
38. From December 2, 1999 through February 29, 2000, Tamburello and Capital Research only disclosed in their Investment Opinions that Capital Research or its affiliates, and/or officers, directors, and employees "may" have stock positions in Dicom and that they "may" buy or sell shares.
39. Tamburello sold Capital Research's Dicom stock before and after Tamburello and Capital Research issued Investment Opinions about Dicom. (Ex. 95) As a result of Tamburello's and CRG's trading in the CRG account, they received $1,155,625 in proceeds from their trading of Dicom stock. ( Id.)
40. Tamburello and Capital Research in April 1999 sought advice of counsel regarding their disclosure in their Investment Opinions. Tamburello and Capital Research did not inform counsel that they would be selling their shares within one day, two days, or a week following issuance of an Investment Opinion. Tamburello and Capital Research did not discuss Dicom with counsel when seeking legal advice.
41. On March 6, 2000, Tamburello's and Capital Research's counsel provided them with a revised disclosure for their Investment Opinions and for Capital Research's thesubway.com website, which was as follows: "CRG HAS BEEN COMPENSATED BY ONE OR MORE OF THE COMPANIES LISTED HEREIN WITH SHARES OF STOCK (NO. SHARES AND CO SYMBOL) FOR THE PREPARATION AND DISTRIBUTION OF THIS REPORT. CRG INTENDS TO SELL THESE COMPENSATION SHARES AND WILL PROFIT IN THE EVENT THESE SHARES RISE IN VALUE. CRG, ITS AFFILIATES, AND OR ITS OFFICERS, DIRECTORS AND EMPLOYEES MAY ALSO BUY, SELL OR HAVE A POSITION IN THE SECURITIES DISCUSSED IN THIS REPORT AND MAY PROFIT IN THE EVENT THE SHARES OF THE COMPANIES DISCUSSED IN THIS REPORT RISE IN VALUE." (Ex. 342, pp. 9-10.)
42. Dicom's stock price increased from a closing price of $5.08 per share on November 12, 2000, when Dicom's stock was first quoted on the Over-The-Counter Bulletin Board, to a high closing price of $36 per share on March 1, 2000.
43. Dicom's stock did not respond rapidly to news about the company. There were no independent analysts that covered or followed Dicom's stock and there was little press coverage of Dicom in 1999 and 2000. There was minor evidence of either institutional or arbitrageur interest in Dicom stock.
44. On August 3, 2000, Tamburello's and Capital Research's counsel provided them with updated disclosure for their Investment Opinions and their thesubway.com website, which was as follows: "ALL MATERIAL HEREIN WAS PREPARED BY CAPITAL RESEARCH GROUP, INC. (CRG) BASED UPON INFORMATION SUPPLIED BY THE COMPANY OR OTHER SOURCES BELIEVED TO BE RELIABLE. THE INFORMATION CONTAINED HEREIN IS NOT GUARANTEED BY CRG TO BE ACCURATE, AND SHOULD NOT BE CONSIDERED TO BE ALL-INCLUSIVE. THE COMPANIES THAT ARE DISCUSSED IN THIS OPINION, HAVE NOT APPROVED THE STATEMENTS MADE IN THIS OPINION. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. A COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DESCRIBED IN ANY FORWARD-LOOKING STATEMENTS OR ANNOUNCEMENT DISCUSSED WITHIN. THIS MATERIAL IS FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS AN OFFER OR SOLICITATION OF AN OFFER TO BUY OR SELL SECURITIES. CRG IS NOT A LICENSED BROKER, BROKER DEALER, MARKET MAKER, INVESTMENT BANKER, INVESTMENT ADVISOR, ANALYST OR UNDERWRITER. PLEASE CONSULT A BROKER BEFORE PURCHASING OR SELLING ANY SECURITIES VIEWED WWW.THESUBWAY.COM. CRG HAS BEEN COMPENSATED BY THIRD PARTY SHAREHOLDERS ON BEHALF OF ONE OR MORE OF THE COMPANIES MENTIONED IN THIS OPINION. (LIST NO. OF SHARES AND COMPANY) CRG INTENDS TO SELL ITS SHARES . TO DATE, CRG HAS SOLD APPROXIMATELY ____ SHARES. CRG MAY SELL ITS SHARES FOR LESS THAN THE TARGET PRICE GIVEN IN THIS OPINION. CRG'S AFFILIATES, OFFICERS, DIRECTOR AND EMPLOYEES MAY ALSO HAVE BOUGHT OR MAY BUY THE SHARES DISCUSSED IN THIS OPINION AND MAY PROFIT IN THE EVENT THOSE SHARES RISE IN VALUE. CRG WILL NOT ADVISE AS TO WHEN IT DECIDES TO SELL AND DOES NOT AND WILL NOT OFFER ANY OPINION AS TO WHEN OTHERS SHOULD SELL; EACH INVESTOR MUST MAKE THAT DECISION BASED ON HIS OR HER JUDGMENT OF THE MARKET." (ORIGINAL EMPHASIS) (EX. 342, P. 11.)
45. Tamburello and CRG are still in the financial public relations business, and have continued to issue Investment Opinions.
CONCLUSIONS OF LAW
A. JURISDICTION
46. This Court has Jurisdiction over this action pursuant to Sections 20(b), 20(d)(1), and 22(a) of the Securities Act of 1933 ("Securities Act") and 27 of the Exchange Act. 15 U.S.C. §§ 77t(b), 77t(d)(1) 77v(a), and Sections 21(d)(1), 21(d)(1)(3)(A), 21(e) (2004); 15 U.S.C. §§ 78u(d)(1), 78u(d) (3) (A), 78u(e) 78aa (2004).
B. ANTIFRAUD VIOLATIONS: SECTION 17(A) OF THE SECURITIES ACT, SECTION 10(B) OF THE EXCHANGE ACT AND RULE 10B-5 THEREUNDER.
47. Section 17(a) of the Securities Act prohibits fraud in the offer and sale of securities while Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraud in connection with the purchase and sale of securities. 15 U.S.C. § 77q(a) (2004); 15 U.S.C. § 78j(b) (2004); 17 C.F.R. § 240.10b-5 (2004).
48. A violation under occurs under Section 17(a)(1), Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder when there is (1) a misrepresentation or omission, (2) that was material, (3) which was made in the offer and sale of a security (Section 17(a)(1)) or in connection with the purchase or sale of securities (Section 10(b) and Rule 10b-5), (4) scienter, and (5) the involvement of interstate commerce, the mails, or a national securities exchange. 15 U.S.C. § 77q(a)(1) (2004); 15 U.S.C. § 78j(b) (2004); 17 C.F.R. § 240.10b-5 (2004); SEC v. Corporate Relations Group, Inc., 2003 U.S. Dist. Lexis 24925, at *24 (M.D. Fla. 2003); see also SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2nd 1999) (noting that essentially the same elements are required under Section 17(a) and Rule 10b-5). Negligence, rather than scienter, may shown to prove violations of Sections 17(a)(2) and (a)(3) of the Securities Act. 15 U.S.C. §§ 77q(a)(2) and (a) (3) (2004); Aaron v. SEC, 446 U.S. 680, 697 (1980).
49. Plaintiff has the burden of proof as to each and every element of this cause of action. Failure to prove any one of these elements by a preponderance of the evidence mandates entry of judgment in favor of the defendant. See Herman MacLean v. Huddleston, 459 U.S. 375, 387-88 (1983). 1. MISREPRESENTATION OR OMISSION.
50. Liability under the Section 17(a), Section 10(b), and Rule 10b-5 arises not only from affirmative misrepresentations but also from failures to disclose material information. SEC v. GLT Dain Rauscher, 254 F.3d 852, 855-56 (9th Cir. 2001). Rule 10b-5 expressly makes it unlawful "to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." 17 C.F.R. § 240.10b-5 (2004); see also Ackerman v. Schwartz, 947 F.2d 841 (7th Cir. 1991) ("Federal [securities] law requires persons to tell the truth about material facts once they commence speaking").
51. Even a statement of optimism or belief is actionable under the federal securities laws, if (1) the statement is not genuinely believed, (2) there is no reasonable basis for the statement or belief, or (3) the speaker is aware of undisclosed facts tending to undermine the accuracy of the statement. In re John Alden Fin. Corp., 249 F.Supp.2d 1273, 1277 (S.D. Fla. 2003) (citing In re Apple Computer Securities Litigation, 886 F.2d 1109, 1113 (9th Cir. 1989)); In re Burlington Coat Factory Sec. Lit., 114 F.3d 1410, 1427 (3rd Cir. 1997) (stating "if a company voluntarily chooses to disclose a forecast or projection, that disclosure is susceptible to attack on the ground that it was issued without a reasonable basis"). And "an opinion or prediction is actionable if there is a gross disparity between prediction and fact." Cutsforth v. Renschler, 235 F. Supp. 2d 1216, 1231 (M.D. Fla. 2003). Nevertheless, "[A]n inability to foresee the future does not constitute fraud, because the securities laws approach matters from the ex ante perspective. Therefore, as long as those statements had a reasonable basis when made, they do not constitute fraud." Searls v. Glasser, 64 F.3d 1061, 1066 (7th Cir. 1995) (citations omitted).
52. "[N]ot every mixture with the true will neutralize the deceptive. If it would take a financial analyst to spot the tension between the one and the other, whatever is misleading will remain materially so, and liability should follow." Virginia Bankshares v. Sandberg, 501 U.S. 1083, 1097, 111 S.Ct. 2749, 2760 (1991). Fraudulent omissions will only be "neutralized" when the omitted information is conveyed to the public "with a degree of intensity and credibility sufficient to counter-balance effectively any misleading information created by" the alleged misstatements. Ganino v. Citizens Utilities Co., 228 F.3d 154, 167 (2d. Cir. 2000).
53. Violations of the antifraud provisions include undisclosed scalping, the practice of, without disclosure, recommending a stock while and after selling one's shares. SEC v. Corporate Relations Group, 2003 U.S. Dist. Lexis 24925, at *25-30; SEC v. Huttoe, 1998 U.S. Dist. Lexis 23211, *27-28 (D.D.C. Sept. 14, 1998). "The fraud lies not in [the] practice of selling stocks contrary to [the newsletter's] recommendations, but in the failure to disclose that practice to potential investors and readers." Corporate Relations Group, 2003 U.S. Dist. Lexis 24925, at *30-31 (citing Huttoe, at *29.); see also Zweig v. Hearst Corp., 594 F.2d, 1261, 1270 n. 16 (9th Cir. 1979).
2. MATERIALITY AND MARKET EFFICIENCY.
54. A misrepresentation or omission is material when there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); SEC v. Carriba Air, Inc., 681 F.2d 1318, 1323 (11th Cir. 1982).
55. Statements of a company's goals without a reasonable basis, or with knowledge of undisclosed facts which undermine the accuracy of the projections, are materially misleading. Roots Partnership v. Land's End, Inc., 965 F.2d 1411, 1417-18 (7th Cir. 1991); see also In re Staffmark Sec. Litig., 123 F.Supp.2d 1160, 1170 (E.D. Ark. 2000), dismissed on other grounds, 123 F.Supp.2d 1174, 1177-78 (E.D. Ark. 2000).
56. The failure to disclose scalping is also important to investors' decisions whether to purchase or sell a stock. "The practice reflects on the objectiveness of the investment advice and is therefore material." Corporate Relations Group, 2003 U.S. Dist. Lexis 24925, at *30-31 (citing Huttoe, at *29); see Zweig, 594 F.2d, at 1270 n. 16.
57. An efficient market is one that obtains material information about a company and rapidly reflects that new information in the price of the stock. Cheney v. Cyberguard Corp., 213 F.R.D. 484, 498 (S.D. Fla. 2003).
58. Whether a market for a stock is efficient, and whether the "fraud on the market theory" applies, is determined by the presence of market analysts, institutional investors, arbitrageurs, the speed that a stock's price reacts to unexpected news, whether the issuer of the stock in question can use an S-3 registration statement, the percentage of stock held by insiders, the bid-ask spread, and trading volume. Cheney, 213 F.R.D. at 498-502; Krogman v. Sterritt, 202 F.R.D. 467, 475-76 (N.D. Tex. 2001). "[T]he existence of a significant number of analysts implies that company reports are closely reviewed by investment professionals, who, in turn, make buy/sell recommendations to client investors." Cheney, 213 F.R.D. at 499 (2 analysts do not favor efficiency); Griffin v. GK Intelligent Systems, Inc., 196 F.R.D. 298, 303 (S.D. Texas 2000) (holding no efficient market where there was no evidence regarding analysts); Krogman v. Sterritt, 202 F.R.D. at 475 (inefficiency found, in part, with only two analysts and few reports).
a. THE MARKET FOR DICOM'S STOCK WAS EFFICIENT.
59. Dicom's stock traded in an efficient market. The stock price did react rapidly to unexpected news, for example, the announcement of the three for one stock split on February 22, 2000. Furthermore, the stock traded in an efficient market because and there is evidence regarding how market makers reacted to information, such as financial reports. Indeed, the narrowness of the spread between the "bid-ask" price reflects not only the true value of the stock in the opinion of a sophisticated investor, to wit: the market maker, but also proves that Dicom traded in an efficient market. (Ex. J105).
60. On balance, the evidence shows that the market in which Dicom's stock traded was efficient at the time Dr. Gane made his revenue goal statement. The SEC's expert's report confirms that Dicom's trading volume was high. (Dr. Comment's Expert Report, Jul. 2, 2004, at 52, ¶¶ 90-91.) Dr. Gane's expert, Charles Lundelius, studied Dicom's trading activity during the period January 2000 through April 2000, and found that the average daily dollar volume in Dicom stock was about $2.46 million. This was more than twice as large as the average dollar volume of stocks traded on the NASDAQ Small Cap Market during that same period of time. For the same time period, the average daily share volume for Dicom's stock was about 113,000 shares. Also, Dicom's average weekly turnover rate was 3.13% — much higher than the 2% benchmark. (Charles Lundelius's Expert Report ("Lundelius Report"), July 19, 2004, at 20, ¶¶ 11-12, 14.)
61. Stock splits are associated with a positive and significant stock market response, and stock split announcements are considered "material." The market's reaction to the two 3-for-1 stock splits that Dicom announced demonstrated that Dicom's stock was indeed trading in an efficient market. The day after Dicom announced its first 3-for-1 split of Dicom's outstanding shares of common stock on December 21, 1999, Dicom's stock price increased from $15.25 per share to $18.00 per share, closing $2.75 higher. The day after Dicom announced its 3-for-1 stock split on February 22, 2000, Dicom's stock price increased from $13.75 per share to $16.625 per share, closing $2.875 higher again reflecting the response of an efficient market.
62. Mr. Lundelius' expert report analyzed other factors delineated in Cammer and further concluded that the market for Dicom's stock was efficient since (a) the stock reacted to material information in a way consistent with an efficient market; (b) the percentage bid-ask quote spread was lower than that of an average stock listed on the NASDAQ Small Cap Market; and (c) Dicom had significant press coverage. (Lundelius Report at 20-28.)
b. MATERIAL OMISSIONS IN THE DUE DILIGENCE PACKAGE: DR. GANE, WELSH, AND SOUTHERN FINANCIAL.
63. The due diligence package projected that Dicom would generate $24.7 million in revenues in its first three years of operation, but it did not state that at least $4.2 million, or 17%, of the revenues come from products still in development, namely LabRX, X-Ray, and Simulator. Indeed, the due diligence package attributed approximately $13.4 million of the $24.7 million in revenues to these three products. Southern Financial prepared and Welsh edited the due diligence package. Dr. Gane reviewed the due diligence package, and signed the cover letter, but did not identify this omission.
64. This omission from the due diligence package was material. The main source of Dicom's revenues come from LabRX, X-Ray, and Simulator, products still in development. Any reasonable investor would consider that fact in deciding whether to buy or sell Dicom stock. The omission was not rendered immaterial by Dicom's Commission filings. Omissions will only be "neutralized" when the omitted information is conveyed to the public "with a degree of intensity and credibility sufficient to counter-balance effectively any misleading information created by" the alleged misstatements. Ganino v. Citizens Utilities Co., 228 F.3d at 167. The due diligence package was sent directly to brokers and potential investors. The Commission filings were not hence the omission was material.
c. MATERIAL OMISSIONS IN DR. GANE'S REVENUE GOAL STATEMENTS.
65. Forward-looking statements, like Dr. Gane's January 13, 2000 revenue goals remark, are not material unless they are worded as guarantees. In re IBM Corp. Sec. Litig., 163 F.3d 102, 107 (2d Cir. 1998) (projections of future performance "may be actionable . . . if they are worded as guarantees"); Searls v. Glasser, 64 F.3d 1061, 1067 (7th Cir. 1995); In re Browning-Ferris Indus. Inc. Sec. Litig., 876 F. Supp. 870, 897 (S.D. Tex. 1994) (holding statements predicting growth that are "not worded as guarantees, are not actionable under the federal securities laws"); In re Duane Reade Inc. Sec. Litig., No. 02 Civ. 6478 (NRB), 2003 U.S. Dist. LEXIS 21319, at *17 (S.D.N.Y. Nov. 25, 2003) (projections of future performance are actionable only if worded as guarantees).
66. Dr. Gane's January 2000 revenue goal statements — $50 million in thirty-six months and $60 million in three years — were not materially misleading. No reasonable investor would have relyed on these statements in arriving at an investment decision. When Dr. Gane made his revenue goal statements, Dicom was planning to increase its activities and revenue by (1) expanding its product market beyond software to include hardware, and (2) expanding its geographic markets beyond North America.
d. MATERIAL OMISSIONS IN SOUTHERN FINANCIAL'S AND STRATEGIC INVESTORS' INVESTMENT OPINIONS.
67. Southern Financial and Strategic Investors made material omissions of fact by failing to disclose that they were selling Dicom shares during and after the time that they were recommending Dicom in their Investment Opinions. By stating that they, their affiliates, officers, directors, or employees "may" buy or sell Dicom stock in their Investment Opinions, Southern Financial and Strategic investors failed to provide adequate disclosure. Blavin, 760 F.2d at 711; Corporate Relations Group, 2003 U.S. Dist. Lexis 24925 at *27. Having chosen to speak to the investing public through Investment Opinions, Southern Financial and Strategic Investors had an obligation to disclose all material information. Because a reasonable investor would find such an omission important in evaluating the veracity of Southern Financial's and Strategic Investors' beliefs that Dicom was a good investment, the omission is material. See Corporate Relations Group, 2003 U.S. Dist. Lexis 24925 at *28.
3. SCIENTER.
68. Scienter is defined as a "mental state embracing intent to deceive, manipulate, or defraud." Aaron v. SEC, 446 U.S. at 686 n. 5. In the Eleventh Circuit, scienter may be established by a showing of severe recklessness. SEC v. Carriba Air, 681 F.2d at 1324. Severe recklessness is
Limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.Theoharous v. Fong, 256 F.3d 1219, 1225 (11th Cir. 2001). A. DR. GANE'S SCIENTER.
69. Dr. Gane was not severely reckless regarding the due diligence package and the revenue goals statements made therein. Although material, his conduct did not demonstrate severe recklessness or willfulness on his part as those terms are defined. Even though Dr. Gane reviewed the due diligence package, his failure to notice this omission was surely negligent but not willful or severely reckless. SEC v. Carriba Air, 681 F.2d, at 1324.
70. To prove scienter with respect to a non-disclosure, it is not enough to simply show that the defendant was aware of an undisclosed fact that a court later determines is material. Rather, a plaintiff must show "that the defendant must have been aware of both of [the] materiality [of the undisclosed fact] and that its non-disclosure would likely mislead investors." See City of Philadelphia v. Fleming Cos., 264 F.3d 1245. 1260-61 (10th Cir. 2001).
71. Here, the SEC proved that Dr. Gane's omission in the Due Diligence package was material, however, it failed to prove that Dr. Gane acted with severe recklessness.
72. Further, Dr. Gane's revenue goal statements during the interviews on Emerging Company Reports and Wall Street Reporter were not material and hence the question of severe recklessness does not arise.
73. Dr. Gane's statement about Dicom's revenue goals may have "proved incorrect," but "hindsight does not establish fraud," and "[e]very prediction of success that fails to materialize cannot create on that account an action for securities fraud." Raab v. Gen. Physics Corp., 4 F.3d 286, 291 (4th Cir. 1993).
74. Also relevant to the issue of scienter is the issue of Dr. Gane's motive. While proof of motive is not an element of a cause of action for securities fraud, courts routinely, and properly, look to evidence of motive when evaluating what inference to draw from the facts. See Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1286-87 (11th Cir. 1999) (recognizing that motive and opportunity are specific kinds of evidence that together with other evidence may contribute to an inference of recklessness or willfulness).
75. Here, Dr. Gane never sold, or attempted to sell, any Dicom stock that he owned even though he could have made a profit of $32,400 if he had sold his 900 shares of Dicom stock on March 1, 2000, when Dicom's stock traded at $36.00 per share. He was paid a modest salary of $54,000 in 1999 and $76,700 in 2000. He received no bonus or other form of cash compensation. Unlike many securities fraud cases where senior executives of a public company engage in significant sales of their stock and/or obtain significant compensation or bonuses tied to the performance of the company's stock price, there is no evidence here of any motivation for Dr. Gane to have committed securities fraud.
4. "IN CONNECTION WITH" REQUIREMENT.
76. The "in connection with" requirement is met when the fraudulent statements coincided with Dicom stock transactions. SEC v. Zandford, 535 U.S. 813, 822 (2002); see Buffo v. Gradick, 742 F.2d 592, 596 (11th Cir. 1984). Indeed, the "in connection with" requirement is met "when the device employed, whatever it may be, be of a sort that would cause reasonable investors to rely thereon, and, in connection therewith, so relying, cause them to purchase or sell securities." SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 860 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976 (1969); SEC v. Warner, 652 F. Supp. 647, 651 (S.D. Fla. 1987).
77. The due diligence package and the materially false and misleading statements they contain, were made in connection with the purchase and sale of securities. However, because Plaintiff has failed to establish by a preponderance of the evidence that Dr. Gane acted willfully and with severe recklessness, the Court finds based upon the foregoing, that Dr. Gane did not violate Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. 15 U.S.C. § 78j(b) (2004); 17 C.F.R. § 240.10b-5 (2004).
B. WELSH'S, SOUTHERN FINANCIAL'S AND STRATEGIC INVESTORS' SCIENTER.
78. Welsh, Southern Financial's and Strategic Investors' repeated practice of promoting Dicom stock while failing to disclose their interest in and sale of Dicom stock was done in violation of the securities laws. Corporate Relations Group, 2003 U.S. Dist. Lexis 24925, at *27-28 (holding that a company's disclosure that it "may from time to time have a position" in the subject securities did not "convey the reality of . . . Defendant's stock sales, which were intentionally timed rather than coincidental with the publications"). Furthermore, as the principal of SFS and SIG, Welsh's scienter is imputed to them. SEC v. Manor Nursing, 458 F.2d at 1096 n. 16.
79. Based upon the foregoing, the Court finds Welsh, Southern Financial, and Strategic Investors violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. 15 U.S.C. §§ 77q(a), 78j(b) (2004); 17 C.F.R. § 240.10b-5 (2004). C. ANTITOUTING VIOLATIONS: SECTION 17 (B) OF THE SECURITIES ACT: SOUTHERN FINANCIAL AND STRATEGIC INVESTORS.
80. Section 17(b) of the Securities Act makes it unlawful for any person to tout a stock for compensation without fully disclosing the receipt, either past or prospective, of compensation. 15 U.S.C. § 77q(b) (2004) (emphasis added). A per se violation of Section 17(b) occurs when a promoter fails to disclose fully its compensation. Scienter is not required to establish a violation of the statute. SEC v. Liberty Capital Group, Inc., 75 F. Supp. 2d 1160, 1161, 1164 (W.D. Wash. 1999).
81. Here, Southern Financial and Strategic Investors did not fully disclose their compensation in their Investment Opinions, which touted Dicom's stock. Southern Financial, and Strategic Investors disclosed that one of the two entities received 750 Dicom shares per month even though Southern Financial actually received 1,500 shares that it split with Strategic Investors. In addition, Tamburello and Capital Research failed to reveal that Capital Research was to receive $5,000 per month for six months as part of its compensation from Dicom. Southern Financial and Strategic Investors, therefore, violated Section 17(b) of the Securities Act. 15 U.S.C. § 77q(b) (2004). D. REMEDIES. 1. PERMANENT INJUNCTIVE RELIEF.
82. Section 20(b) of the Securities Act, 15 U.S.C. § 77t(b), and Section 21(d) of the Exchange Act, 15 U.S.C. § 78u(d) (1), provide that, upon a proper showing, a permanent injunction shall be granted in enforcement actions brought by the Commission. "`[T]he function of a court in deciding whether to issue an injunction authorized by a statute of the United States to enforce and implement congressional policy is a different one from that of the court when weighing claims of private litigants . . . The passage of the statute is in a sense an implied finding that violations will harm the public and ought to, if necessary, be restrained.'" SEC v. Friendly Power Company LLC, 49 F. Supp. 2d 1363, 1372 (S.D. Fla. 1999) (citations omitted).
83. The Commission is entitled to injunctive relief when it establishes (1) a prima facie case of previous violations of the federal securities laws and (2) a reasonable likelihood that the wrong will be repeated. SEC v. Calvo, 378 F.3d 1211, 1216 (11th Cir. 2004). "Indicia that a wrong will be repeated include" (1) the egregiousness of the defendant's violations, (2) the isolated or recurrent nature of the infraction, (3) the degree of scienter involved, (4) the sincerity of the defendant's assurances against future violations, (5) the defendant's recognition of the wrongful nature of his conduct, and (6) the likelihood that the defendant's occupation will present opportunities for future violations. SEC v. Calvo, 378 F.3d at 1216; SEC v. Ginsburg, 362 F.3d 1292, 1304 (11th Cir. 2004). The Commission need not prove every factor in order to obtain permanent injunctive relief. Calvo, 378 F.3d at 1216; Ginsburg, 362 F.3d at 1305. Permanent injunctive relief may issue for nonscienter-based violations. Calvo, 378 F.3d at 1216.
In the instant case, Tamburello's and CRG's violations of the securities laws do not warrant the entry of a permanent injunction. First, as the Court found in its Summary Judgment Order and it now also finds from the evidence at trial, the Defendants' failure to fully disclose their compensation wasnot egregious in nature. Dicom investors were put on notice by the Investment Opinions that the Defendants were compensated for their touting Dicom stock. Similarly, investors were later put on notice that Defendants were mot only being compensated but that they were, in fact, selling the stock that they were promoting. Indeed, the fact that the Defendants did disclose a significant portion of their compensation from Dicom negates any conclusion that there was a fraudulent intent to not disclose that they were being paid by the company it was promoting. Moreover, it remains undisputed that before even knowing of the SEC's investigation into Dicom, Defendants had continuously been consulting counsel and had changed the disclaimers in their disclosures to state that they intended to sell their shares, to state how many shares they had, in fact, sold, etc. As a result, the Defendants actually cured their disclosure violations before ever knowing (or the SEC alleging) that there were any. See SEC v. Koracorp Industries, Inc., CCH Fed.Sec.L.Rep. P. 95,532 (1975-1976 Transfer Binder) (N.D. Cal., 3/26/76) (court refused to issue the injunction because, inter alia, the alleged violations had been halted and corrected).
Moreover, the Defendants' violations were not recurrent. Defendants have been stock promoters since 1999, and have issued more than five thousand investment opinions. Of those, only twenty — the 20 Dicom Investment Opinions here at issue — have been prosecuted, and it should be noted that these twenty Investment Opinions were issued over a very short period of time (i.e., barely three months) and were swiftly revised upon the advice of Defendants' counsel. Accordingly, this Court finds that these were mere technical violations. Although the SEC has pointed to another handful of investment opinions issued by CRG for four other companies as purported subsequent violations, a closer examination of these adds little credence to the SEC's argument that a permanent injunction is warranted.
A. INJUNCTIVE RELIEF IS NOT APPROPRIATE AGAINST CERTAIN OF THE STOCK PROMOTERS.
84. Permanent injunctive relief against the Stock Promoters is not appropriate. Their actions though unlawful were not egregious. Although they failed to disclose any stock sales to investors and likewise failed to disclose all of their compensation, nevertheless this conduct was not egregious nature.
85. Welsh, Tamburello and Capital Research have provided assurances against future violations, although denying in good faith the wrongful nature of their past conduct. Defaults have been entered against Southern Financial and Strategic Investors and they have long since ceased doing business.
86. Permanent injunctive relief against Welsh, Tamburello and Capital Research is not appropriate since there is no reasonable likelihood of future violations on their part.
87. Permanent injunctive relief is appropriate against Southern Financial and Strategic Investors, default judgment having been entered against them. The Eleventh Circuit recently approved permanent injunctive relief against a corporation that had been administratively dissolved, like Southern Financial and Strategic Investors. SEC v. Diversified, 378 F.3d at 1228. Permanent injunctive relief against them here is, therefore, appropriate.
88. Southern Financial and Strategic Investors, therefore, are permanently restrained and enjoined from future violations of Sections 17(a) and 17(b) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. 15 U.S.C. §§ 77q(a) 77q(b) (2004); 15 U.S.C. § 78j(b) (2004); 17 C.F.R. § 240.10b-5 (2004).
2. DISGORGEMENT WITH PREJUDGMENT INTEREST IS NOT WARRANTED.
89. "[D]isgorgement is designed both to deprive a wrongdoer of his unjust enrichment and to deter others from violating the securities laws." SEC v. Friendly Power, 49 F.Supp.2d at 1372-73; see SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978). The violator bears the risk of uncertainty as to the enrichment caused by his violation. SEC v. Friendly Power, 49 F.Supp.2d at 1372-73. The Commission "is entitled to disgorgement upon producing a reasonable approximation of a defendant's ill-gotten gains." SEC v. Calvo, 378 F.3d at 1217; SEC v. First City Fin. Corp., 890 F.2d 1215, 1231-32 (D.C. Cir. 1989).
"Disgorgement is an equitable remedy designed to deprive a wrongdoer of his unjust enrichment and to deter others from violating the securities laws." SEC v. First City Financial Corp. Ltd., 890 F.2d 1215, 1230 (D.D.C. 1989). However, "[s]ince disgorgement primarily serves to prevent unjust enrichment, the Court may exercise its equitable power only over property causally related to the wrongdoing. " Id. at 1231 (emphasis supplied). In other words, the SEC must (I) establish a causal relationship between CRG and Tamburello's wrongdoing and the effect on Dicom's stock price and (ii) distinguish between legally and illegally obtained profits. SEC vs. Collins, 2003 WL 21196236, *5-7 (W.D. Ill. 2003). The SEC bears the burden of persuasion that its disgorgement figure reasonably approximates the amount of unjust enrichment casually related to the violation. Id. at 1231-32.
In this case, the SEC has failed to establish a causal relationship between CRG and Tamburello's wrongdoing and the inflation of Dicom's stock price. Where a defendant demonstrates considerable attenuation of the casual connection between the illegality and the ultimate profits, courts refuse to extend and/or limit the remedy of disgorgement. SEC v. MacDonald, 699 F. 2d 47 (1st Cir. 1983) (where defendant had held on to stock for more than one year, the court restricted the disgorgement amount to a figure based on the price of the stock "a reasonable time after public dissemination of the insider information"). In this case, not only was the causal connection between the illegality and the purported inflation of Dicom stock "attenuated", there is no record evidence of any causal connection at all.
90. The Court finds that all profits gained while the defendants were in violation of the law do not constitute ill-gotten gains because they are not causally related to the defendant's violation. First City, 890 F.2d at 1232; SEC v. Drexel Burnham Lambert, Inc., 837 F. Supp. 587, 612 (S.D.N.Y. 1993), aff'd, 16 F.3d 520, 522 (2d Cir. 1994), cert. denied, 513 U.S. 1077 (1995).
91. The profits of Welsh, Southern Financial, Strategic Investors, Tamburello and Capital Research Group gained while they committed their violations not being causally related to their illegal conduct, disgorgement and prejudgment interest will be denied in this case.
3. CIVIL PENALTIES.
92. Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d), and Section 21(d)(3) of the Exchange Act, 15 U.S.C. § 78u(d) (3), provide that the Commission may seek monetary civil penalties for Securities Act and Exchange Act violations. These provisions provide three tiers of penalty amounts for specified degrees of culpability. The third-tier applies to violations which: (1) involved "fraud, deceit, manipulation or reckless disregard for a regulatory requirement;" and (2) which "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons." 15 U.S.C. §§ 77t(d)(2)(C) and 78u(d)(3)(B)(iii).
93. Civil penalties are meant to punish the individual wrongdoer as well deter him and others from future securities law violations. SEC v. Kenton Capital, Ltd., 69 F.Supp.2d 1, 17 (D.D.C. 1998); SEC v. Friendly Power, 49 F.Supp.2d at 1373. Because civil penalties, like a permanent injunction, are imposed in part to deter the wrongdoer from similar conduct in the future, courts apply the same factors for determining injunctive relief in assessing civil penalties. SEC v. Kane, 2003 U.S. Dist. Lexis 5043, *11 (S.D.N.Y. 2003). The imposition of civil penalties is a discretionary matter left to the court. In the instant case, the imposition of minor penalties against Defendants seems warranted.
Whether penalties should be imposed is an analysis (unlike the analysis incident to the issue of whether a permanent injunction is warranted) focused on the particular violation(s) at issue. In this case, the Defendants' use of the "may" disclaimer and their failure to fully disclose their compensation in the 20 Dicom Investment Opinions were minor, technical violations of the securities laws. It is also undisputed that before even knowing and/or there being an SEC investigation into Dicom, the Defendants recognized the need for fuller disclosures and altered their Investment Opinions upon the advice of counsel. Indeed, their subsequent conduct, although technically flawed at times, clearly aimed at full compliance.
87. For the reasons set fort above, first tier civil penalties are appropriate against the defendants. The Commission does not seek civil penalties against Southern Financial and Strategic Investors. Therefore, the following defendants are liable for civil penalties in the following amounts: Welsh — $500; Tamburello — $500; and Capital Research $500.
Findings of Fact and Conclusions of Law As To The Stipulated Issues for Trial ISSUES AS TO DR. GANE
1. A. Whether the Due Diligence Package failed to disclose that at least $4.2 million, or 17%, of the $24.7 million in projected revenues contained in the Due Diligence package, were revenues from products still in development? YES
B. Whether that omission was material? YES
C. Whether Dr. Gane was responsible for this omission? YES
D. Whether Dr. Gane acted with severe recklessness as to this omission? NO
2. A. Whether Dr. Gane's Statement about Dicom's revenue goals — $50 million in 36 months — in his Emerging Company Reports interview of January 13, 2000 was material? NO
B. Whether he made this statement with severe recklessness.
MOOT
3. A. Whether Dr. Gane made a revenue goal statement — $60 million in 24 months — in a Wall Street Reporter interview on January 13, 2000? NO
B. If he did, whether that statement was material? MOOT
C. Whether he made the statement with severe recklessness?
MOOT
D. $60 million in 36 months? (Amended issue based on the evidence) YES
E. Was this statement material? NO
F. Whether he made that statement with severe recklessness?
MOOT
G. Civil penalties? MOOT
ISSUES AS TO CRG AND TAMBURELLO
1. Whether CRG and/or Tamburello ever received any ill-gotten gains on Dicom stock? NO. And if so, what if any, is the proper amount of ill-gotten gains attributable to Tamburello? MOOT.
2. Assuming the Court finds that CRG and/or Tamburello received ill-gotten gains on Dicom stock, what, if any, is the amount of prejudgment interest on the amount of ill-gotten gains attributable to Tamburello and CRG as determined by the Court. MOOT.
3. Whether, unless enjoined, there is a reasonable likelihood of future violations of the securities laws by CRG and/or Tamburello? NO
4. Whether the violations of the securities laws by CRG and/or Tamburello warrant the imposition of civil penalties, and if so in what amount? YES. Tamburello $500; CRG $500.
ISSUES AS TO WELSH
1. Whether Welsh ever received any ill-gotten gains on Dicom stock? And, if so, what, if any, is the proper amount of ill-gotten gains attributable to Welsh. NO2. Assuming the Court finds that Welsh received ill-gotten gains on Dicom stock, what, if any, is the amount of prejudgment interest on the amount of ill-gotten gains attributable to Welsh as determined bu the Court. MOOT
3. Whether, unless enjoined, there is a reasonable likelihood of future violations of the securities laws by Welsh?
NO
4. Whether the violations of the securities laws by Welsh warrant the imposition of civil penalties, and if so in what amount? YES. $500
For the reasons set forth above, it is hereby ORDERED as follows:
(1) The SEC's Second Prayer for Relief, seeking permanent injunctions against, inter alia,
Gane, Welsh, Tamburello and CRG, for violations of Sections 17(a) and 17(b) of the Securities Act and
Section 10(b) and Rule 10b-5 thereunder is DENIED;
(2) The SEC's Third Prayer for Relief seeking an order prohibiting Gane from acting as an officer or director of any issuer that has a class of registered securities is DENIED.
(3) The SEC's Fourth Prayer for Relief, seeking disgorgement of all ill-gotten gains by, inter
alia, Welsh, Tamburello and CRG, is DENIED; and
(4) The SEC's Fifth Prayer for Relief, seeking civil penalties against Gane under Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d) and Section 22(d)(3) of the Securities Act, 15 U.S.C. § 78u(d)(3) is DENIED.
(5) The SEC's Fifth Prayer for Relief, seeking civil penalties against, inter alia, Welsh, Tamburello and CRG, under Section 20(d) of the Securities Act, 15 USC § 77t(d) and Section 21(d)(3) of the Exchange Act, 15 USC § 78u(d)(3) is GRANTED and Judgment will issue as against Welsh in the sum of $500; Tamburello in the sum of $500; and Capital Research in the sum of $500.
(6) Default Judgment will be entered herein as against Southern Financial and Strategic investors as outlined above.
(7) Costs may be taxed herein upon appropriate application will be entered.
(8) The parties are directed to provide proposed forms of Final Judgement to the undersigned judge for entry herein within 15 days from the date of this order.