Securities & Exchange Commission v. McGinnis et al

Filing 86

ORDER granting in part and denying in part 3 motion for preliminary injunction. Signed by Judge Alfred V. Covello on December 11, 2013. (Meskill, J)

UNITED STATES DISTRICT COURT
DISTRICT OF CONNECTICUT
SECURITIES AND EXCHANGE
COMMISSION
Plaintiff,

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: Civ. No. 13-CV-1047(AVC)
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v.
CHAD C. McGINNIS and SERGEY
PUGACH
Defendants,
BELLA PUGACH,
Relief Defendant.

RULING ON THE PLAINTIFF’S MOTION FOR PRELIMINARY INJUNCTION
This is an action for equitable relief filed pursuant
to Section 21(d) of the Securities Exchange Act of 1934
(hereinafter the “Exchange Act”) in which the Securities
and Exchange Commission (hereinafter the “SEC”) seeks
disgorgement of all ill-gotten gains, prejudgment interest,
and civil penalties pursuant to Section 21A of the Exchange
Act. The SEC asserts that the defendants, Chad C. McGinnis
and Sergey Pugach, executed an insider-trading scheme using
Green Mountain Coffee Roasters, Inc.‟s (hereinafter “GMCR”)
nonpublic information ahead of earnings announcements.1
On July 24, 2013, this court granted an ex parte
emergency temporary restraining order filed by the SEC
Additionally, trades were made ahead of an earnings
announcement in a trading account of the relief defendant,
Bella Pugach, Sergey Pugach‟s mother.
1

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which: (1) enjoined the defendants, Chad McGinnis, and
Sergey Pugach, from violations of federal securities laws;
(2) froze funds and other assets of the defendants and the
relief defendant, Bella Pugach; (3) provided for expedited
discovery; (4) provided for alternative service by the
Commission; (5) prohibited the destruction or alteration of
documents; and (6) set the matter for a preliminary
injunction hearing.
On October 29-31, 2013, the court conducted the
preliminary injunction hearing and heard testimony as well
as arguments of counsel. The SEC, in its motion for
preliminary injunction, requests the court enter an order
continuing the current freeze on the defendant‟s assets, to
enjoin the defendants from continuing to violate the
securities laws, and obtaining other equitable relief,
including expedited discovery.
For the reasons that follow, the SEC‟s motion for
preliminary injunction is GRANTED in part and DENIED in
part.
FACTS
The court finds:
Chad McGinnis lives in Morrisville, VT; Sergey Pugach
lives in Hamden, CT; Bella Pugach lives in Brooklyn, NY;

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and GMCR is a Delaware corporation with its headquarters in
Waterbury, VT.
By virtue of his position at GMCR, McGinnis was
provided access to material, nonpublic information about
GMCR‟s upcoming earnings announcements days before the
information was released to the public. One of McGinnis‟s
assignments at GMCR was to work on an internal GMCR site,
referred to as the “Sales Portal,” containing some sales
data for the company. McGinnis would also have needed to
know the “User-A”2 login and password, giving him access to
all of GMCR‟s computer files, in order to do his job.3
However, it is unknown specifically at what point McGinnis
received this password.
There is no direct evidence that McGinnis accessed
insider information. McGinnis and the SEC stipulated that
“[t]he SEC‟s forensics analyst has performed searches of
the GMCR data in an attempt to identify forensic evidence
[that] Mr. McGinnis accessed material nonpublic information

2

The User-A account is an account that was created within GMCR‟s
security administration domain for protecting file shares,
administering e-mail accounts, and for administering systems and
servers related to SharePoint file systems within GMCR. The permissions
for the User-A account were “domain administrator level permissions,”
which is the highest level permissions within the entire computing
system domain, giving a user control of all servers and systems.
3
In order to access certain blocked information with a User-A account, a
GMCR employee would also have to know how to “override” the access of
the User-A account.

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of GMCR. Those searches are not yet complete . . . At the
present time, the SEC‟s forensic analysis has not uncovered
any forensic evidence that Mr. McGinnis accessed any
specific material nonpublic information of GMCR at any
specific time on the private shared folders of GMCR‟s
Finance and Legal Departments or on GMCR‟s Exchange Server,
as alleged in the Complaint.”
GMCR maintains an insider trading policy that would
have applied to McGinnis. The policy states that a GMCR
employee “may not trade in the securities of the Company,
directly or through family members or other persons or
entities, if [the employee is] aware of material, nonpublic information (“inside information”) relating to the
Company.” The insider trading policy also contains a
section entitled “Additional Guidance,” which states that
GMCR “considers it improper and inappropriate for those
employed by or associated with the Company to engage in
short term or speculative transactions in the Company‟s
securities or in other transactions in the Company‟s
securities that may lead to inadvertent violations of the
insider trading laws.” McGinnis admitted that he violated
this latter provision. His employment at GMCR was
subsequently terminated.

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GMCR‟s stock price often moves significantly upwards
or downwards after earnings announcements for the company
are released.
McGinnis and Pugach are longtime friends and consider
themselves to be trading partners. The two “religiously”
discussed trading. It became a ritual for Pugach to travel
to McGinnis‟s home in Vermont in advance of GMCR earnings
announcements to trade in GMCR stock.
At least one of the defendants profited from GMCR
trades in 12 of the 13 earning events from July of 2010
through 2013. The defendants often took either heavy
bearish or bullish positions prior to the earnings
announcements. Much of the defendants‟ profit came from
trades around earnings events. However, there were also
several trades made by Pugach around earnings announcements
in which he lost significant sums of money. Additionally,
McGinnis had a significant amount of trading and profit
which occurred outside earnings announcements.
Overall, the defendants profited enormously. McGinnis
started in January of 2010 with a balance of $33,000 in his
trading account. By the end of the period in June of 2013,
he turned the balance into about $1.8 million in gains, for
a rate of return of 12,857 percent. Mr. Pugach, who started

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with a balance of $249,000, turned it into roughly $4.9
million in gains, for an overall rate of return of 2,001
percent.
The SEC did not compare the returns to investors
starting with similar amounts of money as the defendants,
or investors trading nearly exclusively in GMCR as the
defendants did. The SEC could have done a comparison in
this manner by obtaining “blue sheets:” trading records
from broker-dealers in specific securities and specific
times.
McGinnis and Pugach conducted extensive research on
GMCR and devoted a significant amount of time to trading
the company‟s stock. The defendants employed a “straddle”
strategy at times, whereby an investor buys an equal amount
of put4 and call5 options at the same price and expiration
date. When an investor uses a straddle strategy, he is
4

“Call options” provide the holder the right (but not the obligation) to
purchase an underlying asset at a specified price (the strike price),
for a certain period of time. If the stock fails to meet the strike
price before the expiration date, the option expires and becomes
worthless. Investors buy calls when they think the share price of the
underlying security will rise or sell a call if they think it will
fall. Call Option Definition, INVESTOPEDIA.COM,
http://www.investopedia.com/exam-guide/cfa-level-1/derivatives/optionscalls-puts.asp (last visited Nov. 8, 2013)
5
“Put options” give the holder the right to sell an underlying asset at
a specified price (the strike price). The seller (or writer) of the put
option is obligated to buy the stock at the strike price. Put options
can be exercised at any time before the option expires. Investors buy
puts if they think the share price of the underlying stock will fall,
or sell one if they think it will rise. Put Option Definition,
INVESTOPEDIA.COM, http://www.investopedia.com/exam-guide/cfa-level1/derivatives/options-calls-puts.asp (last visited Nov. 8, 2013)

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playing both sides of the market, to allow the investor to
profit regardless of the direction that a stock price
moves. Pugach also employed a “strangle”6 strategy at times
in his investing. By employing a strangle strategy, an
investor can profit if there is a large price movement in
either direction in the near future.
STANDARD
Section 20(b) of the Securities Act and Section
21(d)(1)7 of the Exchange Act empower the SEC, “upon a
proper showing,” to seek the Court‟s issuance of a
“temporary injunction or restraining order.” 15 U.S.C. §
77t(b); 15 U.S.C. § 78u(d)(1). The SEC, unlike a private
litigant, need not show risk of irreparable injury to
obtain an injunction, nor the unavailability of remedies at

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An options strategy where the investor holds a position in both a call
and put with different strike prices but with the same maturity and
underlying asset. This option strategy is profitable only if there are
large movements in the price of the underlying asset. Strangle
Definition, INVESTOPEDIA.COM, http://www.investopedia.com/examguide/cfa-level-1/derivatives/options-calls-puts.asp (last visited Nov.
8, 2013)
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Section 21(d) of the Exchange Act provides: Whenever it shall appear
to the Commission that any person is engaged or is about to engage in
acts or practices constituting a violation of any provision of this
chapter, the rules or regulations thereunder, it may in its discretion
bring an action in the proper district court ... to enjoin such acts or
practices, and upon a proper showing a permanent or temporary
injunction or restraining order shall be granted without bond. 15
U.S.C. § 78u(d) (1988); S.E.C. v. Unifund SAL, 910 F.2d 1028, 1035 (2d
Cir. 1990)

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law. S.E.C. v. Cavanagh, 1 F. Supp.2d 337, 359-60 (S.D.N.Y.
1998) aff'd, 155 F.3d 129 (2d Cir. 1998).
In Unifund SAL, the second circuit held that the
“proper showing” required of the SEC is analogous to the
traditional “likelihood of success” standard regularly
applied to private litigants. Unifund SAL, 910 F.2d

at

1037. The court, however, in applying the “likelihood of
success” standard, must consider the nature of relief
sought by the SEC. “Like any litigant, the Commission
should be obliged to make a more persuasive showing of its
entitlement to a preliminary injunction the more onerous
are the burdens of the injunction it seeks.” S.E.C. v.
Unifund SAL, 910 F.2d 1028, 1039 (2d Cir. 1990).
With respect to a “traditional” SEC injunction, which
enjoins a defendant from future violations of securities
laws, a proper showing requires the SEC to demonstrate a
prima facie case that a violation of the securities laws
has occurred; and (2) a likelihood that a violation will
occur again in the future. See SEC v. Cavanagh, 155 F.3d
129, 132, 135 (2d Cir. 1998); SEC v. Unifund SAL, 910 F.2d
1028, 1037 (2d Cir. 1990).

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With respect to an ancillary remedy, such as the
freezing of a defendant‟s assets, a proper showing does not
require proof of the elements of a traditional SEC
injunction. S.E.C. v. Unifund SAL, 910 F.2d at 1041
(internal citations omitted); see also SEC v. Commonwealth
Chemical Securities, Inc., 574 F.2d 90, 103 n. 13 (2d. Cir.
1978) (approving disgorgement remedy despite failure to
show likelihood of recurring violation). “The decision to
continue a temporary freeze on [the] Defendants' assets
requires particularly careful consideration by the Court.”
S.E.C. v. Prater, 289 F. Supp.2d 39, 49-50 (D. Conn. 2003)
(citing SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082,
1105 (2d. Cir. 1972)). “District Courts have broad
equitable powers to grant ancillary relief ... where
necessary and proper to effectuate the purposes of the
securities laws.” Id (quoting SEC v. Economou, 830 F.2d
431, 438 (2d. Cir. 1987)(internal quotation marks omitted).
The court must balance the necessity to freeze assets so as
to prevent disgorgement against the possibility that the
freeze itself will cause a disruption to the defendants'
legitimate business affairs. Prater, 289 F. Supp. 2d at 50;
Manor Nursing, 458 F.2d at 1086.

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DISCUSSION
I.

Traditional SEC Injunction
A. Prima Facie Case of Violations of the Securities Laws.
The SEC argues that four points tip the scale in their

favor of a proper showing for a prima facie case that
McGinnis and Pugach violated the securities laws by insider
trading: 1) McGinnis had access to and did access material
non-public information at GMCR; 2) the defendants were
longstanding friends and “trading partners” who often
communicated through their cell phones and Facebook pages
as well as in person; 3) the defendants shared investment
strategies; and 4) the defendants realized extraordinary
profits through risky and suspicious trading in GMCR stock.
McGinnis responds that the SEC has failed to establish
its prima facie case because there is a huge gap in the
evidence. Specifically, McGinnis makes five points that he
argues are inconsistent with the actions of one who has
inside information: 1) the defendants conducted extensive
research; 2) the defendants employed hedging strategies
such as “straddling” and “strangling;” 3) the defendants
lost money in some quarters; 4) McGinnis conducted more
trading outside of earnings than inside; and 5) McGinnis

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made money outside earnings, which showed trading skills.
Pugach also responds, stating that the SEC has put
forward complex, circumstantial evidence without evincing a
“smoking gun.” Pugach states that negative injunctions,
like the one at issue here, require a high standard of a
strong likelihood of success on the merits and a likelihood
of repetition of violating securities laws, which, in this
case, is virtually nonexistent. In terms of the asset
freeze, Pugach argues that the interest of the government
does not outweigh the extreme burden placed upon the
defendants.
To demonstrate a prima facie case, the plaintiff must
demonstrate the defendants: 1) obtained material, nonpublic
information8 intended to be used only for a proper purpose
and 2) misappropriated9 or otherwise misused that
information with 3) scienter,10 in breach of a fiduciary
duty, or other duty arising out of a relationship of trust
and confidence, to make “secret profits” by trading or
8

Information is material “if there is a substantial likelihood that a
reasonable investor would view it as significantly altering the „total
mix‟ of information available.” S.E.C. v. Gonzalez de Castilla, 145 F.
Supp.2d 402, 411-14.
9
Liability attached when a defendant “misappropriates material
nonpublic information in breach of a fiduciary duty or similar
relationship of trust and confidence and uses that information in a
securities transaction.” S.E.C. v. Falbo, 14 F. Supp.2d 508, 519
(S.D.N.Y. 1998).
10
Scienter is a state of mind that embraces the intent to deceive,
manipulate or defraud. Gonzalez de Castilla, 145 F. Supp.2d at 414.

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tipping others. S.E.C. v. Gonzalez de Castilla, 145 F.
Supp.2d 402, 411-14 modified in part sub nom. S.E.C. v.
Duclaud Gonzalez de Castilla, 170 F. Supp.2d 427 (S.D.N.Y.
2001) (citing Dirks v. SEC, 463 U.S. 646, 654 (1983);
United States v. Newman, 664 F.2d 12 (2d Cir.1981)).
Here, the defendants do not contest the fact that the
GMCR computer system contained material, nonpublic
information if used when trading.11 Information to which
McGinnis conceded he had access, and to which he is alleged
to have accessed by the SEC, was, inter alia, final drafts
of GMCR earnings announcements. When these earnings
announcements were published there was a high probability
that stock price of GMCR would react in a significant way.
Additionally, while there may be some disagreement about
the information of the sales portal page, McGinnis does not
argue that information the SEC alleges that he accessed was
nonpublic. The earnings announcement drafts, for example,
would have not been widely disclosed before the official
announcement and were only known to some GMCR employees.
At the very least, the SEC has shown that: 1) as an
employee of GMCR, McGinnis had access to material, non11

However, McGinnis argues that some information on the “sales portal”
page may not be nonpublic information, and even it is, would only be a
“tiny piece of the picture” for GMCR sales information.

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public information; 2) McGinnis traded GMCR stock in
violation of GMCR policy; 3) McGinnis and Pugach
communicated frequently, often discussing trading
strategies, which included conversations in the days
leading up to GMCR earnings announcements; and 4) the
defendants realized extreme profits as a result of trading
in GMCR. Thus, the court concludes that the evidence is
sufficient to establish a likelihood of success on the
merits.
B. Reasonable Likelihood that the Defendants will
Continue to Commit Violations
The SEC argues “the illegal conduct has been repeated
for thirteen quarters going back to the summer of 2010.”
The plaintiff cites S.E.C. v. Mgmt. Dynamics, Inc., 515
F.2d 801, 807 (2d Cir. 1975), for support of their
proposition that the defendants will continue to commit
violations. Specifically, the plaintiffs argue “the conduct
involved the highest degree of scienter: Mr. McGinnis has
secretly stolen information from his long-time employer in
order to make millions of dollars of illegal profits.” The
SEC contends that these actions show a likelihood of future
violations because the defendants will likely use any
inside information they can lay their hands on.

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The defendants respond that where the alleged tipper,
McGinnis, who is only alleged to have had access to GMCR
inside information, but is no longer employed by GMCR, and
no longer has such access, there is no likelihood of
repetition in this case.
In analyzing a likelihood of committing future
violations, a court should consider several factors,
including: (1) the degree of scienter; (2) the isolated or
recurrent nature of the infraction(s); (3) the defendant's
recognition of the wrongful nature of his conduct; and (4)
the likelihood that the defendant will have the opportunity
to commit future violations. S.E.C. v. Falbo, 14 F. Supp.
2d 508, 529 (S.D.N.Y. 1998). “[F]actors suggesting that the
infraction might not have been an isolated occurrence” are
relevant in determining whether the defendant is “likely to
repeat the wrong”. Mgmt. Dynamics, Inc., 515 F.2d 801, 807
Here, while there is a reasonable inference for the
court to conclude that the defendants operated with a
reasonable degree of scienter in making vast profits with
GMCR inside information on several occasions; the act was
isolated in the sense that it was in one stock, in a
company in which McGinnis is no longer employed. In other
words, the fox is out of the henhouse and the henhouse is
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now locked. The defendants in this case, as the government
itself argues, are not Wall Street big shots with vast
connections, but are amateurs, successful in one
corporation‟s stock because one of them allegedly had
inside information in that corporation.
The court concludes that the SEC has failed to prove a
reasonable likelihood that the defendants will continue to
commit the alleged violations. Therefore, the traditional
SEC injunction in this case, enjoining the defendants from
violations of federal securities laws, is hereby lifted.
Specifically, the court amends the TRO such that sections I
and II are no longer in effect. Section IV, involving the
destruction of records, shall remain in full force and
effect.
II.

Asset Freeze
The SEC argues that the defendants can, and would have

an incentive to, move their assets beyond the reach of the
court, which is why the asset freeze needs to continue in
place. Regardless, the SEC argues its “burden to obtain an
asset freeze – which merely preserves the status quo – is
lower.”

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Pugach responds that the SEC carelessly listed
$1,250,000 in withdrawals to show that Pugach would
dissipate his money without researching where nearly all
that money withdrawn went – to pay his state and federal
taxes on trading gains. Specifically, Pugach argues he has
no intent to dissipate his assets, and has submitted to the
jurisdiction of the court, responding honestly to the
merits of the case, and has gone beyond what was required
of him in discovery. Likewise, McGinnis argues he has no
intent to dissipate his assets.
“Unlike the injunction against securities law
violations, the freeze order does not place appellants at
risk of contempt in all future securities transactions. It
simply assures that any funds that may become due can be
collected.” Unifund SAL, 910 F.2d at 1041. Thus, “Congress
has authorized the Commission to obtain preliminary
injunctive relief upon a „proper showing,‟ and it is a
matter of federal law whether the showing the Commission
has made is sufficient to support an interlocutory freeze
order. Id. (quoting Cf. FTC v. H.N. Singer, Inc., 668 F.2d
1107, 1112 (9th Cir. 1982) (finding unavailability of
attachment did not preclude other provisional remedies).

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The asset freeze contained in section III of the TRO,
which the SEC seeks to continue, provides as follows:
“The assets, funds, or other property of Defendant
McGinnis up to the amount of $15,434,506,12 wherever
located, are frozen. The assets, funds, or other
property of Defendant Pugach up to the amount of
$20,369,352,13 wherever located, are frozen. The
assets, funds, or other property of Relief Defendant
Pugach up to the amount of $38,56514 wherever located,
are frozen.”
Two modifications to the TRO have been proposed and
granted by the court for each of the defendants. The
first and second modifications15 of the TRO for McGinnis
included, inter alia, the release of $75,000 and
$100,000 for reasonable attorneys‟ fees; $4,490 and
$6,586.53 for necessary ordinary living expenses;
$6,765.22 for health insurance; and $247,555.38 for
necessary construction expenses. The first and second
modifications16 of the TRO for Pugach included, inter
alia, the release of $75,000 and $100,000 for reasonable
attorneys‟ fees, and $4,031 and for necessary ordinary
12

As the tipper, the amount reflects what the SEC alleges is equal to
Mr. McGinnis and Mr. Pugach‟s illegal profits ($7,677,880) added to a
civil penalty of three times the amount of his profits ($7,756,626).
13
As the tippee, the amount reflects what the SEC alleges is equal to
Mr. Pugach‟s illegal profits ($5,092,338) added to a civil penalty of
three times the amount of his profits ($15,277,014).
14
As the relief defendant, the amount reflects what the SEC alleges are
her ill-gotten gains of $38,565.
15
These modifications were ordered on August 15, 2013, and October 22,
2013, respectively.
16
These modifications were ordered on August 19, 2013, and October 22,
2013, respectively.

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living expenses.
The SEC certainly has a legitimate interest in
ensuring the alleged ill-gotten profits are not dissipated
beyond the reach of the court. However, the court balances
the equities in ruling on this preliminary injunction, and
considers the extreme burden that the asset freeze places
on the defendants and their families. The court concludes
that the TRO shall remain in effect, with the aforesaid
funds and other assets in section III of the TRO remaining
frozen, subject to the previous modifications by the court
(docket numbers 30, 34, 59, and 60). The TRO, however,
should not be so onerous. Specifically, the court amends
section III and releases $7,500 in funds to each defendant
on a monthly basis so that they have the ability to
maintain their necessities of living during the pendency of
this case. Further, Pugach shall be given immediate access
to $75,500.89, the amount of funds indicated in his motion
for modification of the TRO required for unpaid balance of
legal fees and costs (docket number 78). McGinnis shall
file, within 10 days of this order, an affidavit as to
reasonable counsel fees due and owing.

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CONCLUSION
For the foregoing reasons, the SEC‟s motion for
preliminary injunction (document no. 3) is GRANTED in part
and DENIED in part. The preliminary injunction shall remain
in effect until entry of a final judgment in, or other
disposition of, the action.
It is so ordered this eleventh day of December, 2013,
at Hartford, Connecticut.
________/s/_________________
Alfred V. Covello,
United States District Judge

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