Securities and Exchange Commisison v. Pentagon Capital Management PLC et al

Filing 214

OPINION: The evidence presented at trial established that defendants engaged in an intentional and egregious fraudulent late trading scheme over the course of several years, involving thousands of transactions violative of the federal securities laws. In light of the facts and circumstances of this case, civil penalties of $38,416,500 are assessed jointly and severally on defendants PCM and Chester. (Signed by Judge Robert W. Sweet on 3/28/2012) (mro)

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK SECURITIES AND EXCHANGE COMMISSION, 08 Civ. 3324 (RWS) Plaintiff, OPINION -againstPENTAGON CAPITAL MANAGEMENT PLC and LEWIS CHESTER, Defendants, -and PENTAGON SPECIAL PURPOSE FUND, LTD., Relief Defendant. -­ -----­ --------­ -----­ -­ --­ ------X A P PEA RAN C E S: At intiff SECURITIES AND EXCHANGE COMMISSION New York Regional Office 3 World Financial Center, Suite 400 New York, NY 10281 By: Paul G. zzi, Esq. Christopher J. Dunnigan, Esq. John C. Lehmann Jr., Esq. At s PEPPER HAMILTON LLP Hamilton Square 600 Fourteenth Street, N.W. Washington, DC 20005-20004 By: Frank C. Razzano, Esq. Ivan B. Knauer, Esq. Matthew D. Foster, Esq. Sweet, D. J. On April Management PLC Exchange the instant Pentagon Capital commenced "SEC") defendants against action enforcement the or ("Plaintiff" Commission and Securities the 3, ("PCM"), Lewis Chester ("Chester") (collectively, leging that Defendants had orchestrated a "Defendants"), scheme to defraud mutual funds in the United States through late trading 17(a) and of U.S.C. 1934 deceptive the market Securities of in 1933 violation of ("Securities Section Act"), 15 77q(a), Section 10(b) of the Securities Exchange Act of § ("Exchange Act"), C.F.R. Act timing § 240.10b-5, 15 U.S.C. thereunder. 78j(b), § In the and Rule 10b-5, ternative, the 17 SEC asserted that Defendants aided and abetted violations of Section 10(b) and Rule 10b-5. Following a February 14, 2012 Court granted the SEC. The broad ranging funds but that seventeen-day bench trial, (Dkt. No. 205) (the "Merits by opinion of Opinion"), the part and denied in part the relief sought by Court determined fraudulent the rules scheme that of Defendants late trading surrounding market engaged in U.S. mutual timing of a mutual funds during the period in question were not sufficiently clear to permit liability as to Defendants' market timing activities. 1 Due to the level of scienter, the fraud, and the likelihood of (Op . Defendants executed engaged through in due approximately to over formerly Wasserman & Company avoided In 114 16). the addition, 10,000 the the Court found late broker-dealer that trades Trautman, and that the profi ts and losses trading (Id. $38,416,500. Court fraudulent registered ("TW&Co. ") late future violations, was appropriate as to PCM and determined that injunctive reI Chester. the extensive nature of scheme at through The 124.) TW&Co. Court was found Defendants and Relief Defendant Pentagon Special Purpose Fund, Ltd. ("PSPF") joint and severally that sum plus pre-judgment liable interest. for (Id.) disgorgement The Court in further held that civil penalties of an equal sum, $38,416,500, would be imposed, without stating under which of the two prongs of the relevant statutory provisions, § 78u (d) (3), whether 15 U.S.C. § 77t(d) and 15 U.S.C. authority to do so existed or explicitly stating such penal ty was joint and severally. proposed forms of to be imposed on each Defendant or The Court instructed the parties to submit final judgment on notice the Merits Opinion. 2 in conformity with On final February judgment to be 17 , 2012 , the submitted SEC entered pursuant to proposed Merits the a Opinion. The SEC's proposed final judgment reflected separate $38,416,500 civil penal ties as to each of PCM and Chester, On February 21, $76,833,000. 2012, for a total of Defendants requested, and the SEC consented to, an extension until March 2, 2012 to submit a counter-proposed final judgment to permit Defendants to retain additional counsel. (Dkt. No. Defendants wrote the Court to On 206.) to contest February the 29, 2012, imposition of roughly $38 million in civil penalties on the Defendants on the grounds that Relief Defendant "PSPF directly received all proceeds from the trading at Trautman Wasserman" and requesting the civil penalty issue be further briefed. Following briefing on the scope of the final and submission of a proposed final judgment by judgment Defendants, argument was heard on March 21, 2012. In short, the parties disagree as to the maximum civil penalty permissible by statute and the appropriate penalty to be assessed thereunder. The SEC contends that pursuant to the Merits Opinion, civil penalties of $38,416,500 should be imposed individually on both PCM and Chester 3 and that the statutory maximum is far penal permissible Defendants greater. by statute is assert $1.62 that the million for maximum PCM and $372,000 for Chester. I. CIVIL PENALITES A. Legal Standard Under Section 20(d) of the Securities Act, 77t (d), and Section 21 (d) (3) of the Exchange Act, 15 U.S.C. § 15 U.S.C. § 78u(d) (3), courts must determine the civil penalty to be imposed to punish wrongdoers violations of the securities laws. SEC v. and Hal ___________ Civil deter future _ _ _ ___ s, 470 F. penalty, courts - designed L are ~ penalties of the case. ~ "in light of the facts and circumstances" Supp. 2d 373, 386 (S.D.N.Y. 2007). In weighing the appropriate civil consider a number of factors including: (1) the egregiousness of the defendant's conduct; (2) the degree of the defendant's scienter; (3) whether the defendant's conduct created substantial losses or the risk of substantial losses to other persons; (4) whether the defendant's conduct was isolated or recurrent; and (5) whether the penalty should be reduced due to the defendant's demonstrated current and future financial condition. 4 rd. The statutes provide jurisdiction to impose, to be U.S.C. paid by 77t (d) (1) , §§ "the court upon a proper showing, person the that who violation." statutes provide The the maximum penalty is the greater of the figure either the statutes' Under prongs. per-violation the or per-violation have civil penalty such committed 78u (d) (3) (A) . a shall gross that reached under pecuniary the prong, 15 gain penalty is calculated by mUltiplying the number of violations by a dollar amount provided by statutei under the other, second prong, figure is the gross amount of pecuniary gain. See, Credit 31422602, Bancorp, No. 99 Civ. 11395, 2002 WL id. i the SEC v. at *2 (S.D.N.Y. Oct. 29, 2002). The statutory maximum for the per-violation approach is determined by a three tiered system. showing of involving scienter "fraud, is requiredi deceit, tier manipulation, er one, two, for which no for deliberate or reckless disregard of a regulatory requirement"i tier three, for violations involving such factors plus or violations direct or indirect substantial loss or significant risk of loss to other persons. 15 U.S.C. §§ 77t(d), 78U(d) (3). 5 appropriate in this involved "fraud, regulatory in sk of significant substant ial regard to Defendants' requirement" substantial 77 t (d), 78 u ( d) (3) With the penalties tier are violations manipulation or deliberate or reckless a of indirectly §§ because resulted disregard u . S . C. case deceit, third found, previously As i losses "directly and losses or created to other persons." or a 15 see Op. 124 2 5 . third tier penalties, the statutes provide that: the amount of penalty for not exceed the greater of each such violation shall (i) $100,000 for a natural person or $500,000 for any other person, or (ii) the gross amount of pecuniary gain defendant as a result of the violation, i to such (I) the violation described in paragraph (1) involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; and (II) such violation directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons. 15 U.S.C. §§ 77t (d), 78u(d) (3). Improvement Act of 1996, Pursuant to the Debt Collection the SEC has adopted rules that adjust the maximum penalty pursuant to these provisions for inflation. 6 See 1 7 C. F . R. § time the period, For 2001 through 2003, 201. 1002 . maximum civil penalty under the relevant prong one is $120,000 for natural persons and $600,000 for any other persons per violation. Id. B. Civil Penalties of $38,416,500 Are Assessed Jointly and Severally on PCM and Chester As applicable U.S.C. here, Act, 15 Act, 15 U.S.C. § 78u(d) (3), § 77t(d), Section and Section 20 (d) of 21(d) (3) of 17(a) late trade, Securit the s Exchange authorize a maximum civil penalty of $120,000 for natural persons and $600,000 for per fraudulent the 1 other persons as each late trade violated Section of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 by fraudulently representing to the mutual funds that such trades were made prior to the 4 p. m. markets when, after 4 p.m. in fact, ( Op . engaged in 123-24.)1 Accordingly, As 10,052 the this late Court previously found, trades through TW&Co. maximum civil penalty that (Op. may be imposed on each Defendant under the per violation prong of statutes, 15 U.S.C. the the operative trading decisions occurred 98 - 112 . ) Defendants closing of §§ Defendants additionally through broker-dealer Concord. 77t(d) (2) (C) (i) executed a (Op. 73.) 7 & limited the 78u(d) (3) (B) (iii) (I), number of late trades are $1.206 billion for Chester (10,052 late trades x $120,000) and $6.03 billion for PCM (10,052 late trades x $600,000). Numerous other courts have interpreted the statutes to permit a maximum penalty under the per-violation prong in this way, based securities upon the number of See, e.g., laws. 2011 WL 723600, at *5 (N.D. acts SEC v. Cal. taken that Pattison, Feb. violate No. 23,2011) the C-08 4238, (holding that " [t] he Court may assess a penalty for each distinct violation, each time Defendant falsified a (citations record" omitted) but exercising discretion to impose a lesser penalty) SEC Ame v. first Inc., No. --------------------------------,~------- 1959843, at investment *9 (N.D. Tex. defendants May 5, 2008) received 07-CV-1188, penalty for penalty of 2006 WL separate each of $1.178 2053379, million); at penalties from defrauded 2001) *10 SEC v. 69 F. 137 F. $10,000 statements 2d 8 No. 24, research a Coates, Supp. July investors and assessing a for Johnson, (S.D.N.Y. (assessing a separate, misleading investments SEC v. against fraudulent report); (S.D.N.Y. 589 WL (determining that each constituted a violation of the securities laws, $2,000 2008 i a total 03 2006) analyst Supp. civil Civ. (assessing for 2d 413, each 428-30 penalty for each of to investors) I, 17 i & n.15 SEC 177, v. (D.D.C. four Kenton 1998) (assessing a $1.2 million penalty calculated by "multiplying the maximum third tier penalty for natural persons number of investors v. (12)"); cf. WL 2385452, at *5 who offerings investors" sent Invest Better 2001, (S.D.N.Y. May 4, "violated Sections 5(a) IB2001 actually and 5(c) which were ($100,000) by the money No. 2005) to [defendant] 01 Civ. 11427, 2005 (noting that defendant of the Securities Act, purchased by at through least 5,000 and "committed numerous violations of the antifraud provisions of Section 17(a) of the Securities Act and Rule 10(b) of the Exchange Act" and imposing a penalty in the gross amount of pecuniary gain as a result of the total violations because "[t]he exact number of violations committed by the Defendants is nearly impossible penalties on the to determine.") basis of the While number of imposition of civil statutory provisions violated may be appropriate in some cases, the plain language of the statute does not call for such a result. To limit the maximum penalty authorized under the per-violation prong other than by resul t the that number of a defendant violative acts who engaged would also in thousands produce of the repeated violations could be penalized under this provision no more than one who committed a handful of violations. 9 Defendants argue that to penalty based upon the Court's the calculate authorized Defendants executed 10,052 ill maximum that finding late trades would violate due s because Defendants were only on notice that the SEC had them with two violations of Mem. 10) 2 al in mul ti year securities laws This argument is unpersuas detail Defendants an extensive, through TW&Co." (Am. Compl. 19; see also at 2-3, 22,3135 (Dkt. No. 15)). As Defendants understood that late scienter, structure, accepting going to found in trading was great ir late trades (Op. 45-76, illegal I calculat the number of De of trades 6-10, 14­ Opinion, and acted to seek out, the 98-112) ir late trading after the fact of Merits maintain the ability to dece to cover up such, scheme in "thousands marked trading The amended complaint involving with late that (Defs. funds into and attempting (Op. 104 - 0) . As the maximum statutory penalty based upon late trades poses no such due process concern. The Court notes that the amended complaint alleges that Defendants violated Section 17 (a) of the Securities Act, Section 10 (b) of the Exchange Act, and Rule lOb-5 thereunder or in the alternative aided and abetted violations of Sections 10(b) and Rule 10b-5. (Am. Compl. 33 35.) Defendants were found to have violated three securities fraud provisions, Section 17(a), Section lOb, and Rule lOb 5. 10 Defendants further argue that calculating the maximum civil penalty by this approach is not permissible because it would permit civil penalties of $1.206 billion as to Chester and That $6.03 billion as to PCM. the statute might permit such large fines does not render the imposition of a fine many times Moreover, below such maximum unjust or impermissible. that the statutes might permit severe penalties does not mean that such a fine, in this case or any other, would be appropriate or The statutory maximum is not the constitutionally permissible. only limiting factor on the imposition of civil penalties. Within light of those limits, facts and the 77t (d) (2) (A) , 78u the Court must circumstances," (d) (3) (B) (i), the precise determine, 15 U.S.C. amount of " §§ civil penalty warranted to be paid by the persons who committed such violations. Supp. See 2d 552, 567 e. ;;:.S-=E=-=C=--v~._U.:....n=-:ci=.-:.v-=e:...:r.:....s.:....a=l--===-=-=s:.::s:...!----=I:.:n.:..:c=--=-., (S.D.N.Y. 2009) 646 F. (assessing third tier civil penalties of $1 million and $500,000 and noting that "[a]lthough each tier established a maximum penalty per violation, the amount of any civil penalty rests squarely in the discretion of the court") . 11 For the reasons set forth below, a sum equivalent to the amount of profits gained and loss avoided due to Defendants' thousands of violations of the securities laws is imposed, which is below the maximum authorized by statute and is proportionate to the pecuniary gain from Defendants' repeated violations well as the harm caused by them. (1) The ousness of the defendant's conduct As found in the Merits Opinion: the Defendants intentionally, and egregiously, violated the federal securities laws through a scheme of late trading. This scheme was broad ranging over the course of several years and in no sense isolated. Following the filing of the action by the [New York Attorney General] against Edward Stern and Canary Capital, as found above, Defendants attempted to cover up their conduct. While Defendants have since admitted to late trading, as on this evidence they must, neither Chester nor PCM have accepted blame for their conduct. (Op. 115-16 (citations omitted).) (2) The degree of the defendant's scienter 12 as As found in the Merits Opinion, Defendants acted with extreme scienter in carrying out what was an egregious scheme to defraud. Describing this, the Court found in part: The evidence establishes that Defendants knew that late trading was impermissible and that they were obtaining an advantage over other investors contrary to the mutual funds' rules and SEC regulation. Defendants were repeatedly made aware, and acknowledged, that the cut-off for trading in U.S. mutual funds in order to receive the same day NAV was 4:00 p.m. ET. Late trading capacity was valuable to Defendants. Indeed, Defendants paid more for late trading capacity through TW&Co. As found above, Defendants sought late trading through other broker-dealers but were repeatedly denied. PCM discussed late trading with at least four of these broker-dealers who refused to them that capacity, while at least three others informed Defendants that their orders had to be placed by 4:00 p.m. ET. Defendants further received and reviewed multiple academic articles that stated that U. S. mutual fund trades must be submitted prior to 4:00 p.m. ET order to receive the same day NAV. The Sassano voicemail in 2001 telling Chester that late trading through TW&Co. was "crap" and that Chester should not "pressure anybody to do something stupid" was an additional red flag that late trading was illegal, and Chester's testimony that he "couldn't really understand what [Sassano] was referring to" was not credible. That Chester cautioned Tran to be discreet when inquiring regarding late trading capacity and advised him that "[0] bviously late trading is key . don't know how you find out about this without actually saying it" further establishes Chester's knowledge that late trading was impermiss e. Chester was also aware that TW&Co. lsely stamped timesheets as if orders were placed before 4 p.m. and 13 recognized that this gave Defendants "the ability to place a buy order after the bell, even if we haven't done so before the bell." Given Chester's intelligence, training, and experience both as a hedge fund manager whose business model was premised on the timing of trades and as an attorney, the evidence establishes he knew that false stamps were fraudulent and misleading. Following the announcement of the Canary enforcement action, Chester responded to a request for a letter stating that "Pentagon has not engaged late trading or any other illegal activity," to which he responded "not a problem. That same day, Chester provided a letter stating that PCM has "never entered into arrangements with any US onshore Mutual Fund in order to trade post-4:00pm EST for same-day NAV." At that time, Chester knew that he could not confirm that Pentagon had not late traded and that the comfort letter was deliberately misleading or false. Those statements and the fact that Defendants did not turn over the Sassano voicemail or SEC Ex. 2 (the "smoking gun" email) to the [Financial Services Authority of the United Kingdom] when prompted by document requests that should have produced them further establish that Defendants knew that their late trading was illegal. II (Op. 101-04 (citations omitted).) (3) Whether the defendant's conduct created substantial losses or the risk substantial losses to other persons SEC Defendants' of at Professor Harris demonstrated that fraudulent late trading created losses and the risk substantial traded expert losses least in to other the dilution to their shares. tens investors of millions in of the mutual dollars (Op. 121-22; SEC Ex. 420.) 14 funds through the (4) Whe recurrent Far persisted over from isolated, approximately was conduct defendant's isolated Defendant's late trading two half years, and a or scheme through thousands of repeated and knowing violations. (5) Whether defendan t' s condition Defendants seek ability to pay the civil to raise at trial, not an post judgment. The civil penalty of evidence their current their Merits does not or future nor do they contend that they are in fact unable to pay the civil penalty imposed. a regarding such a claim should have been contain documentation or estimates of financial condition, issue penalties anticipated by the As an initial matter, Opinion. raised should be reduced due to the current and future financial the penalty demons tra ted Defendants argue that $38 million should not be Relief Defendant PSPF received much of this gain. imposed because However, this does not demonstrate that the penalty should be reduced due to Defendants' financial condition. Further, to the degree that Defendants' argument relies on Defendants' decision to wind down PCM, PCM's status is self inflicted, 15 and Defendants have long been aware of this action, their late trading, and their potential liability. Moreover, in imposing monetary sanctions, the Court is not required to assess Defendants' current ability to payor the collectability of any judgment. As Judge Lynch has aptly observed: [Defendant's] claims of poverty cannot defeat the imposition of a disgorgement order or civil penalty. Perhaps, if [the defendant] is indeed impecunious, the SEC will eventually prove unable to collect on any judgment. But to withhold the remedy of disgorgement or penalty simply because a swindler claims that she has already spent all the loot and cannot pay would not serve the purposes of the securities laws. An order of disgorgement and civil penalty are both proper remedies in this case i the future will tell whether the SEC can find assets to levy upon. SEC v. Inorganic Recycling Corp., 1968341, at *4 (S.D.N.Y. Aug. 23, No. 99 Civ. 2002) No. 97 Civ. 2931, 2003 WL 1741293, at *4 10159, 2002 see also SEC v. i WL Kane, (S.D.N.Y. Apr. 1, 2003) ("[A] defendant's claims of poverty cannot defeat the imposition of a civil penalty impecunious, the a court. If the defendant is indeed the SEC will ultimately not be able to collect on judgment. Commission by that In it addition, should not the ignore 16 court the agrees with possibility the that a defendant's fortunes will improve, and that one day the SEC will be able to collect on even a severe judgment."). Defendants argue that the civil penal ties sought by the SEC and those anticipated by the Merits Opinion are unj ust because they are significantly TW&Co. and Gregory Trautman against The them. larger than ("Trautman") Commission those imposed in the SEC proceedings ordered to TW&Co. disgorge $9,040,000 and assessed a $500,000 civil penalty on TW&Co., re Trautman Wasserman & Co., SEC Release No. 340, 1156, 2008 penalty WL 149120 initially (Jan. imposed administrative appeal to 14 on 2008), and Trautman $120,000, on was the 92 SEC Docket $500,000 later In re In civil reduced O. by Trautman, -----------~~-~--~------~~- Admin. Proc. File No. 3 12559 (Commission Opinion Dec. 15, 2009) at available­ 9088a.pdf. rst, significantly Defendants here would imposition be of because TW&Co. was "the primary mal feasor in the present case." (Defs. 12.) penalties that unjust Mem. greater argue This contention is directly contrary to the Court's finding that merely in "as the reliance facts on establish, their Defendants did not broker-dealers, 17 as they act have Defendants directed, as that "Defendants TW&Co.'s awareness TW&Co. TW&Co. sought performed on out late to place personnel of indeed micromanaged, TW&Co.' s trading late false time with detailed instructions according to Defendants' authorization their precise (Op. behal f . " through trades TW&Co., on stamps, the 105. ) di their and late behalf in indeed provided for how and when to do so, specifications, Defendants [ had] ult met cs, and authori ty over both the content of and the decision to make late trades as if they had been placed before 4 p. m. ET . As detailed above, the evidence as a Defendants were the creators, whole demonstrates directors, scheme. s of the fraudulent (Op. III 12 (citations omitted) .) " In and chief benefic addition, Defendants that the Commission concluded on review of Trautman's case that through, among other things, his extensive late trading, Trautman had committed but a single "violation" penalties deference. and for that (Defs. purposes a Mem. 13; of the calculation determination Defs. Reply is 2.) of civil entitled However, to the Commission did not address the issue, analogous to that here, of what the maximum civil Trautman, only the ty was that could penalty to impose. 18 be imposed on In re Gregory O. Trautman, Admin. Ie Proc. No. at 3-12559, 41-42. 3 The "We have decided to impose Commission held in relevant civil penalties based on the totality of Trautman's fraudulent misconduct. . We consider a total penalty of $120,000, along with other sanctions violations of the future Additionally, Trautman's the reduced penalties. Id. We at 42 45 pay have submitted by Trautman. we find that the discretionary interest, and/or of be sufficient be it, supporting reviewed $608,886, of for or is civil statements statements at face Trautman's disgorgement, though conduct prejudgment Trautman prejudgment The ALJ conducted a similar inquiry, to impose a greater penalty: to t, and II 2008 WL 149120, at *25-*26. pay a the author i ty The Division recommends third-tier penalties against TWCO in the amount 00,000, against Trautman in the amount of $1,373,799, and Wasserman in the amount of $511,000. The Division notes that a per-occurrence calculation would result in an astronomical result, and that TWCO "is defunct and has negl assets. The conduct of TWCO and Trautman merits a third tier penalty, however, given their financial condition I find it appropriate to assess a $500,000 civil penalty against TWCO and the same amount against Trautman. 19 42. request financial Ordering plus his at considered, interest, egregiousness penalties. and deter ("Trautman argues that he disgorgement, waiver to Id. laws." Even accepting outwe di had information cannot ties. to ties the Commission financial titute' and imposed, single third-tier others from through $120,000 is necessary funds and ir ng deceptive pract to deter shareholders (citations II As the Commission faced a different question, omitted) ) . before and of mutual defrauding illegal different penalty defendants, and the Court, this upon a different record with than that is Defendants deference the This is particularly the case in light inappropriate. , which establishes Defendant's leadership and indeed record (Op. 105.) "micromanage[ment]" of the late trading scheme. Defendants additional argue that civil penal ties of $38 million are inconsistent with those recently imposed in this Dist Defendants contend that in the majority of cases in t. which courts in this District have awarded a third tier civil penal the amount. penalty assessed was (Defs. Mem. 12. ) courts routine disgorgement. See U.S. Dist. tier LEXIS 52623 penalty disgorgement equal ordered) ., i impose c May 28, SEC v. disgorgement SEC v. Aimsi Technol 20 far (imposing third pecuniary gain Techs. Great Am. es that 09 Civ. 5707, 2010 2010) defendants' Civ. 10694, 2010 U.S. Dist. LEXIS 34830 (same); the 1 penalties equal to SEC v. Becker, No. (S.D.N.Y. to than The caselaw demonstrates from uncommon, e. less ., I (S . D . N . Y. Apr. Inc., 650 F. Supp. and No. 8, 07 2010 ) 2d 296 (S . D . N . Y. Supp. 2009) 2d 574 2d 1356, F. Supp. 2385452 Dist. (S.D.N.Y. 1368 2d (S.D. 373 Rosenfeld, No. 2008) v SEC 2001 (affirming imposition plus prejudgment interest, SEC v. Koenig, to treat the as [defendant's] 2d -, No. 30, 2011) (finding $20.8 of Defendants' that than those actions amount 'pecuniary involved SEC v. in U. S. (S.D.N.Y. Jan 9, 744-45 to disgorgement court plus and at *35 (7th Cir. was prejudgment to impose -- F. an Supp. (E.D.N.Y. Sept. disgorgement of more civil penalty of approximately one-half were WL v. Razmilovic, liable 2005 2002 district gain' 470 SEC equal bonuses, Supp. (same); 118612 "the 2001, 7525, 2002) 2011 WL 4629022, here of Civ. penalty imposing a to WL holding defendant million equal 98 8, disgorged 04 Civ. 2276, million and 590 F. igiannis, 557 F.3d 736, equal penalty in 2009 dollarsll); than $41 No. 1467, 2009) interest, 554 F. Better Nov. (same); led Solow, SEC v. v. (S.D.N.Y. 2001) ent Inc., SEC v. i (same) i Bocchino, 97 cf. (same) 2008) (same) i 22047 Tech. ~~------------------------~----- Fla. (same); LEXIS World Info. (same); of the gross extensive, illegal nearly all some by many orders of magnitude. 21 ins as in cases pecuniary gain). evidenced s case is Defendants by the larger cite, Defendants contend that $38 million in civil penalties should not be imposed because gain went to PSPF, Defendants argue "the bulk of the $38 million in and not to Chester or PCM. that they should only be (Def s. II Mem. 14) to the penalized extent of their individual gain as currently established by the With record. evidence regard in the record exceed the amount annum, plus to of Chester, indicates his that salary of car allowance. (Jan. 17, 2011)).) Defendants that "the Chester's gains did not approximately £150,000 (rd. II urge (citing Chester Dep. per 222-24 Defendants argue that, based on this salary, the amount of Chester's gain attributable to late trades through TW&Co. during the period in question is $372,000. not contend that such a Chester's pecuniary gain the evidence received in more the than contextually for record this his small illegal does not figure. Defendants do sum was conduct, The fact simply that demonstrate (rd. ) in that record Chester does not establish that Chester's gain due to the late trading scheme was limited to $372,000, the salary Professor to which Harris individual gain only that he received at least as much as did he testified not (SEC Ex. by estimate 420). deposition. the amount SEC of expert Chester's The record does not establish the pecuniary gain Chester received from the scheme. As to PCM, while Professor Harris estimated the fees PCM received from both 22 late trading and market timing at approximately $14 million, this figure was based not on knowledge of PCM's fee rates, as they were not established, 2% but instead assumed rates of a rd. management fee and a 20% performance fee. The evidence is s were higher or lower than these silent as to whether PCM's estimates during the period in question. Defendants point to the testimony of Jafar Omid for the proposition that PCM earned only $4.2 Omid in fees from 1999 to 2003. testified as to net, not (Tr. gross, However, 2031 34.) s (id.), while the statutes specifically call for "gross pecuniary gain." 15 U.S.C. §§ 77t (d) , Omid's 78u Cd) (3) . sufficient to establish purposes. PCW estimates s pecuniary ga are therefore not for civil penalty Additionally, Omid's testimony does not address PCM's gain specifically due to Defendants' late trades. Defendants have not sought to provide any additional financial information to establish Chester's individual gain or that of PCM nor have they agreed to open their finances to determine such figures. Thus, the record does not establish with sufficient reliability either Defendant's individual pecuniary gain. is established, avoided, Defendants due however, to executed the is over the amount 10 / 000 through TW&Co. 23 gained, fraudulent $38,416,500 What and losses late trades and the resulting loss and risk of loss of tens of millions of dollars thereby imposed upon other investors. 2001, 2005 WL 2385452, gross amount of at *5 Cf. (assessing a SEC v. Invest Better penalty equal to t the pecuniary gain because "[t] he exact number violations committed by the Defendants is nearly impossible to determine.") Defendants cannot wash their hands grounds that and not ill "the bulk of the $38 million to Chester or PCM." advisors, Defendants ga I fraudulent this fact on the are which as acts l well (Defs. directly were as caused to other investors. Mem. 14.) As hedge responsible acquired for gain went to PSPF, the for the through significant fund fund's Defendants' harm thereby Defendants cannot isolate themselves from the ill-gotten gains they created on the grounds that they took illegal the Civil fund's. intended not violations laws. SEC acts not only but See l v. only e.g., penalties to also their own benefit but deter SEC v. fraud cases are the individual violator for past future violations of Razmilovic 1 Universal Inc' ------------------------~----~------- deterring of future "encouraging violations l investor for securit punish in also l civil 24 2011 WL 4629022 646 F. penalties confidence 1 the Supp. at further increasing the securities 1 at 561. *34; By the goals efficiency of financial markets, securities industry." Cir. 1998). and SEC v. Congress disgorgement alone promoting Palmisano, enacted did the not the stability an penalties adequate disincentives to securities law violations." 616 (1990), reprinted "authority to seek or in, 1990 impose U.S.C.C.A.N. substantial addition to the disgorgement of profits, deterrence of securities law the 866 135 F. 3d 860, civil provide of (2d because "financial H.R.Rep. No. 1384 1379, 101­ (the money penalties, in is necessary for the violations") Were disgorgement alone imposed jointly and severally on Defendants and the Relief Defendant fund, and the advisors to bear no penalty in relation to the illegal gains their acts produced, little incentive would exist for advisors like Defendants not to violate the securities laws. This is securities traders particularly the such Defendants, case for who are sophisticated highly skilled in statistical analysis of risk and gain, as no doubt all violators are not caught and the potential gains to illegal trading, this case amply demonstrates, are staggeringly large. as On the record established, a penalty of $372,000 for Chester and $1.62 million for PCM is plainly insufficient to Defendants or deter those similarly situated. deter or punish As fund advisors, Defendants are responsible for the gains achieved through their illegal conduct, and their penalty should reflect this fact. 25 For the reasons set forth above, findings of fact Opinion, and conclusions of and pursuant to the law reached in the Merits a civil penalty of $38,416,500 joint and several as to PCM and Chester is warranted. Finally, here. joint and The SEC argues that imposed separately punishment and accomplished. courts on several the each liability appropriate $38 million penalty should be Defendant in order purposes deterrent is of the to ensure penalties the are For support, the SEC points to two cases in which assessed civil penalties individually. (citing SEC v. Forest Res. Mgmt. 2077202, at *2 (S.D.N.Y. May 18, 2010) Corp., i 09 Civ. (SEC Mem. 903, 2010 WL 6 SEC v. One Wall Street, Inc., No. 06 Civ. 4217, 2008 WL 5082294, at *9 10 (E.D.N.Y. Nov. 26, 2008).) Defendants argue that joint and several liability for civil penalties is impermissible on the ground that the SEC has argued severally. that civil (De f s. Mem. penal ties 3- 4 . ) cannot here, civil the penalties penalty is is j oint and joint and several liability impermissible, imposed assessed However, neither party cites any authority for the proposition that for be pursuant prong, and the Court is aware of none. 26 particularly to the per where, as violation As detailed in the Merits Opinion and evidenced in l particular through the record extensive email communications PCM l and Chester trading scheme. jointly (Op. created 45-76 led 98-112.) 1 and l executed the jointly violating the timing CSI securities Supp. penalties 2d 373 386 jointly and that disgorged interest 1 1 n.13 severallYI a the Court holds all 2011) (holding sum annis million roughly several in l 470 civil equivalent to four defendants to be j oint and civil penalties 2011 7594 1 $15 thereby l and See SEC v. Hal (imposing difference in their culpability. II) Civ. Joint to the l holding "[a] s with disgorgement and prejudgment l severally liable 09 and procedures l laws. liability is therefore appropriate. F. late PCM and Chester intimately collaborated in leading and carrying out the late trades finest details of their met I two WL 3586454 1 sets of i at as there is no meaningful l _s_e_e_ _s_o_ SEC v. *19-*20 defendants No. Aug. (S.D.N.Y. jointly l 111 liot and severally liable for civil penalties in sums equal to disgorgement) . In and light knowing substantial shareholders the seriousness violations losses I of those pursuant to the U. S. C. 27 Defendants securities violations 15 of laws created § for 77t (d) and repeated l and the 15 U. the funds S. C. I § 78u(d) (3), civil penalties in the amount equal to the pecuniary gain for late trades through TW&Co., imposed j a sum of $38,416,500, are ly and severally on Defendants PCM and Chester. C. The Civil Penalties Imposed Do Not Violate the Excessive Fines Clause Defendants contend that a civil penalty of $38 million as to either Amendment's or both prohibition Defendants on would excessive Court's decision in United States v. (1998) . not be unusual nor punishments the with Bajakajian which Court reporting, excessive as determined that attempted required to by the Supreme 321 "Excessive bail shall Const., nor leave the U.S.C. cruel Arndt. forfeiture 31 Eighth 524 U.S. imposed, U.S. the under Bajakajian, fines inflicted./I Baj akaj ian, without fines The Eighth Amendment provides: required, violate § 8. and In $357,144, United States 5316(a) (1) (A), that he was transporting more than $10,000 in currency, violated the Excessive Fines Clause. proposition that ian does not stand for the --=---"'--­ Defendants assert, that "civil fines be strictly proportional to any gain realized by unlawful conduct." (Defs. Mem. 14. ) Instead, the constitutional touchstone Fines Clause is principle Baljakajian inquiry held under proportionality: 28 that the "[t]he Excess The amount of the forfeiture must bear some relationship to the gravity of the offense that it is designed to punish." inquiry under is 524 U.S. at 334. thus not whether a Thus, f is "strictly proportional to any gain realized" but instead whether it is disproportionate fense." Id. at 335. of "strict to "gravity fendant's a Second, the Court rejected a requirement proportionality grossly disproportionate, the criminal of a punitive the standard of gross disproportionality." whether a amount "adopt [ing] assessing of the and In gravity between forfeiture 336. the the forfeiture offense," in instead Id. at Bajakajian was the Court noted that the Bajakajian's violation was unrelated to any other illegal activities, that he was "not a money launderer, a drug trafficker, or a tax evader," the class designed, of but culpability. If persons for whom the statute instead deemed him to have Id. at 337-39i see ("Respondent owed no customs dut ies also was principally "a minimal id. at level 339 to the Government, of n.13 and it him to possess the $357,144 in cash and was perfectly legal remove it from the United States. His crime was simply failing to report the wholly legal act of transporting his currency. ") As the Court found, minimal. 1f "[t]he harm that respondent caused was also Id. at 339. The Court reasoned: 29 Failure to report his currency af cted only one party, the Government, and in a relatively minor way. There was no fraud on the United States, and respondent caused no loss to the public fist. Had his crime gone undetected the Government would have been deprived only of the information that $357,144 had 1 t the country. The Government and the dissent contend that there is a correlation between the amount forfeited and the harm that the Government would have suffered had the crime gone undetected. We disagree. There is no inherent proportionality in such a forfeiture. It is impossible to conclude, example, that the harm responded caused is anywhere near 30 times greater than that caused by a hypothetical drug dealer who willfully fails to report taking $12,000 out of the country in order to purchase drugs. Id.i see also 532 U.S. 424, ("We 434-35 constitutional line is 'marked by a simple have recognized that \ inherently imprecise,' formula. mathemati I the relevant rather than one But in deciding whether that line has been crossed, we have focused on the same general criteria: the degree of the defendantls reprehensibili or culpability; the relationship between harm to the victim caused by the sanctions other imposed the penalty and fendant's actions i cases for comparable the and the misconduct. II Defendants I (citations omitted)) Here l by contrast fraudulent conduct was establishes extensive to from minimal or harmless. nature 30 the fraud on The record the mutual funds, loss Defendants' high degree of scienter, and sk of loss of tens of and the substantial millions of Defendants' illegal trades imposed on the funds' dollars that many investors. Defendants quite clearly fall into the class of persons for whom the securities civil fraud penalties routinely statutes equivalent to The imposed. were principally the civiI designed, and ordered are disgorgement penalty assessed here is proportionate to the harm Defendants caused, and, as key to the constitutional inqui grossly disproportionate to the ir offenses. gravity of Moreover, "because not the as factors the for Second Circuit has 'proportionality' recently under Amendment are substantially similar to those that" the Id, Eighth courts must consider when imposing civil penal ties pursuant to the federal securities fraud statutes, where a court properly considers such factors, "no constitutional violation" Rosenthal, 426 Fed. Appx. I, States Sabhnani, F.3d v. 599 4-5 (2d Cir. 215, 262 exists. 2011) (2d SEC v. (citing United Cir. 2010), and firming award of two times the illegal profits generated from the violations) . 31 the reasons set forth above, and conclusions of law reached in the Merits findings 1 penalty of $38,416,500 is well supported by the Opinion, a and constitutionally permissible. evidence of II. and pursuant to the CONCLUSION The presented at established t Defendants in an late trading over the course of several thousands laws. civil of intentional transactions In light of the penalties violative facts and egregious of are the assessed severally on Defendants PCM and Chester. It is so New York, NY March 2012 'h'f' U.S.D.J. 32 fraudulent involving securities and circumstances of $38,416,500 that this jointly case, and