Securities And Exchange Commission v. Ehrenkrantz King Nussbaum, Inc. et al

Filing 90

MEMORANDUM & ORDER [ADOPTING REPORT AND RECOMMENDATION]: Having considered Magistrate Judge Brown's Report & Recommendation and the accompanying objections, the Court adopts the 88 Report & Recommendation in its entirety. The Court orders that Defendant is permanently enjoined from future violations of Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1094 and Rule 10 b-5 thereunder and Section 15(c)(1) of the Exchange Act. The C ourt further orders disgorgement in the amount of $ 90, 183 and civil penalties in the amount of $ 90, 183 against Defendant. The Clerk of Court is directed to enter judgment and close this case. SO ORDERED by Judge Margo K. Brodie, on 3/6/2013. C/mailed. (Forwarded for Judgment.) (Latka-Mucha, Wieslawa)

FU-ED

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
----------------------------------------------------------------}C
SECURITIES AND EXCHANGE
COMMISSION,

u.s.

IN CLERK'S OFFICe
DISTRICT COURT E.D.N.V.

* MAR 0 6 2013

*

BROOKLYN OFFICE

Plaintiff,

MEMORANDUM & ORDER
v.

OS-CV-4643 (MKB)

BRENDAN MURRAY,
Defendant.
----------------------------------------------------------------}C
MARGO K. BRODIE, United States District Judge:
On September 30, 200S, Plaintiff Securities and E}Cchange Commission ("SEC")
commenced this enforcement action against Defendant Brendan Murray.l On March IS, 2012,
Judge Denis R. Hurley2 granted Plaintiffs motion for summary judgment as to its claims that
Defendant violated Section 17(a) of the Securities Act, Section lOeb) of the E}Cchange Act and
Rule 10b-S, as well as its claims that Defendant aided and abetted Ehrenkrantz King Nussbaum,
Inc. ("EKN") in violating Section IS(c)(I) of the E}Cchange Act. Judge Hurley denied Plaintiffs
motion for summary judgment with regard to Count Seven, which alleged that Defendant aided
and abetted EKN in violating Section IS(b)(7) of the E}Cchange Act and Rule ISb7-1. Judge
Hurley deferred ruling on damages until after a determination of Defendant's liability on Count
Seven. Plaintiff then moved to dismiss Count Seven with prejudice. The Court granted
Plaintiffs motion over Defendant's objection and referred Plaintiffs motion for damages to
Magistrate Judge Gary R. Brown for a report and recommendation. On February 14,2013,

Ehrenkrantz King Nussbaum, Inc. ("EKN") and Anthony Ottimo were also named as
defendants in the Complaint, but Plaintiffs claims against EKN and Ottimo were dismissed on
June 9, 2008 pursuant to a settlement.
1

2 This action was transferred to the undersigned on March 26, 2012.

Magistrate Judge Brown issued a report and recommendation (the "Report &
Recommendation"), recommending a permanent injunction, disgorgement in the amount of
$90,183 and civil penalties in the amount of$90,183. Defendant timely filed objections. For the
reasons set forth below, the Report & Recommendation is adopted in its entirety.

I.

Discussion
The Court assumes familiarity with the background of this case, which is set forth in

detail in Judge Hurley's 2012 decision. See SEC v. Ehrenkrantz King Nussbaum, No. 05 Civ.
4643,2012 WL 893917 (E.D.N.Y. Mar. 15,2012).

a. Standard of Review
A district court reviewing a magistrate judge's recommended ruling "may accept, reject,
or modity, in whole or in part, the findings or recommendations made by the magistrate judge."
28 U.S.C. § 636(b)(1)(C). When a party submits a timely objection to a report and
recommendation, the district court reviews the parts of the report and recommendation to which
the party objected under a de novo standard of review. Id; see also Larocco v. Jackson, No. 10
Civ. 1651,2010 WL 5068006, at *2 (E.D.N.Y. Dec. 6,2010). The district court may adopt those
portions of the recommended ruling to which no timely objections have been made, provided no
clear error is apparent from the face of the record. 28 U.S.C. § 636(b)(I)(C); see also Larocco,
2010 WL 5068006, at *2.

b. Objections to the Report & Recommendation
Defendant objects to Magistrate Judge Brown's recommendation of disgorgement and
civil penalties in the amount of$90,183 each.3 (Def. Obj. 4-5.)

3 Defendant did not raise any specific objections to Magistrate Judge Brown's
recommendation of a permanent injunction. The Court has reviewed this portion of the report
and recommendation and, finding no clear error, adopts the recommendation of a permanent
2

i. Disgorgement

"Once the district court has found federal securities law violations, it has broad equitable
power to fashion appropriate remedies, including ordering that culpable defendants disgorge
their profits." SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1474 (2d Cir. 1996). The district
court has "broad discretion" in both determining whether or not to order disgorgement and in
calculating the appropriate amount to be disgorged. Id. at 1474-75; see also SEC v. Rosenthal,
426 F. App'x 1,3 (2d Cir. 2011). "The primary purpose of disgorgement ... is to deprive
violators of their ill-gotten gains, thereby effectuating the deterrence objectives of those laws."
First Jersey Sec., 101 F.3d at 1474. Therefore, "the amount of disgorgement, as an equitable

remedy, is determined by the amount of profit realized by the defendant." SEC v.
AbsoluteFuture.com, 393 F.3d 94,96 (2d Cir. 2004). Any uncertainty in the disgorgement

calculation is resolved against the wrongdoer. See SEC v. Milligan, 436 F. App'x 1,3 (2d Cir.
2011) (noting that any "risk of uncertainty in calculating disgorgement should fall on the
wrongdoer whose illegal conduct created that uncertainty" (quoting SEC v. Patel, 61 F.3d 137,
140 (2d Cir. 1995))).
Magistrate Judge Brown recommended disgorgement in the amount of$90,183. (Report
& Recommendation 7-8.) Defendant argues that disgorgement in an amount equal to the profits

of White Star Capital ("White Star") is "flawed and unjuSt.,,4 (Def. Obj. 5.) Judge Hurley found
in his 2012 decision that:

injunction. See Larocco v. Jackson, No. 10 Civ. 1651,2010 WL 5068006, at *2 (E.D.N.Y. Dec.
6,2010) ("The court reviews unobjected-to portions of the R & R for clear error.").
4 Defendant also argues that the Court cannot impose any damages because "[t]he
assignment of damages requires a finding of fault." (Def. Obj. 4.) Defendant maintains that he
did not violate any securities laws and, ifhe were permitted to go to trial, he would be
exonerated. Id. Judge Hurley found that Defendant committed numerous violations of the
3

Between 2002 and 2004, Murray was the chief executive, sole owner, and only
employee of White Star Capital ("White Star"), a corporation Murray formed for
the purpose of "becom[ing] involved in the mutual fund industry." (PI.' s 56.1 ~ 2;
Murray Dep. at 6; Murray's Opp'n ~ 8.) Murray intended that White Star would
serve as a "conduit for investment advisors engaged in market timing, to find
venues for the execution and clearance of their mutual fund trades." (Murray
Dep. at 7.)
Ehrenkrantz King Nussbaum, 2012 WL 893917, at *2. Moreover, Judge Hurley found that

"Murray, through Whitestar, received $75,183 in compensation from EKN in 2003, and he
received approximately $15,000 in residual compensation in 2004." Id at *8. Based on the
foregoing, Magistrate Judge Brown found that White Star could be treated as an alter ego of
Defendant for disgorgement purposes. (Report & Recommendation 7.) This Court agrees.
The purpose of disgorgement is to "deprive wrongdoers of the gains resulting from their
illicit conduct and to deter others from engaging in similar unlawful actions." SEC v. Milligan,
No. 99 Civ. 7357,2009 WL 1162633, at *1 (E.D.N.Y. Apr. 29, 2009), aff'd, 436 F. App'x 1 (2d
Cir. 2011) (citing SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971)); see also
FTC v. Bronson Partners, LLC, 654 F.3d 359,372 (2d Cir. 2011) (noting that disgorgement is "a

method of forcing a defendant to give up the amount by which he was unjustly enriched."
(quoting SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978))). "The
relevant inquiry is, thus, whether the defendant was unjustly enriched by his illegal conduct."
SEC v. Razmilovic, 822 F. Supp. 2d 234,252 (E.D.N.Y. 2011) (citing SEC v. DiBella, 587 F.3d

553,572 (2d Cir. 2009)). Defendant argues that Plaintiff was obligated to seek disgorgement
directly from White Star, and, having failed to bring an action against White Star, Plaintiff has

securities laws. Ehrenkrantz King Nussbaum, 2012 WL 893917, at *10-13. Defendant's alleged
innocence is not a basis for rejecting the Report & Recommendation. Rather, Defendant's
insistence that he did not do anything wrong is further evidence of the necessity of civil
penalties. See SEC v. Razmilovic, 822 F. Supp. 2d 234,280 (E.D.N.Y. 2011) (finding the
imposition of civil penalties appropriate where the defendant "continues to refuse to admit any
wrongdoing ... and has never expressed any remorse for his conduct").
4

waived any right to recover White Star's profits and cannot now recover those profits directly
from Defendant. (Def. Obj. 7-8.) As an initial matter, the Second Circuit has held that
disgorgement of profits is permissible "against a person who is not accused of wrongdoing in a
securities enforcement," where that person "has received ill-gotten funds" and "does not have a
legitimate claim to those funds." SEC v. Cavanagh, 155 F.3d 129, 136 (2d Cir. 1998).
Accordingly, failure to bring a proceeding against White Star does not preclude Plaintiff from
recovering White Star's ill-gotten gains.
Moreover, Judge Hurley found that Defendant, the sole owner and employee of White
Star, used White Star as a "conduit" for his illegal scheme. Ehrenkrantz King Nussbaum, 2012
WL 893917, at *2. Where, as here, a defendant uses an entity as the vehicle for his or her fraud,
the court may use that entity's profits as a measure of the appropriate disgorgement. SEC v.

Pentagon Capital Mgmt. PLC, 844 F. Supp. 2d 377, 427 (S.D.N.Y. 2012) (where the defendants
illegal actions were taken through a separate entity, "disgorgement of the sum of all profits
Defendants accrued through [that entity] is the appropriate measure of Defendants' illegal
profits"). The undisputed facts establish that Defendant received, through White Star, $90,183 in
ill-gotten gains. Accordingly, disgorgement in the amount of$90,183 is appropriate.
ii. Civil Penalties
Section 20(d) of the Securities Act and Section 21 (d) of the Exchange Act authorize the
imposition of civil monetary penalties. SEC v. E. Delta Res. Corp., No. 10 Civ. 310, 2012 WL
3903478, at *8 (E.D.N.Y. Aug. 31,2012); see also Pentagon Capital Mgmt., 2012 WL 1036087,
at *2 ("Under 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), courts must determine the civil penalty to be imposed 'in
light of the facts and circumstances' of the case"). The maximum penalty is the "greater of the

5

figure reached under either the statutes' per-violation or gross pecuniary gain prongs." Pentagon

Capital Mgmt., 2012 WL 1036087, at *2. "Under the per-violation prong, the penalty is
calculated by multiplying the number of violations by a dollar amount provided by statute." Id
Section 20(d) establishes three tiers of penalties: the first-tier penalty allows up to $6,500 per
violation for any securities violation; the second-tier penalty allows up to $60,000 per violation if
the violation "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a
regulatory requirement;" and the third-tier penalty allows up to $120,000 per violation if the
violation, in addition to the second tier factors, "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);
17 C.F.R. § 201.1002. The court may impose a penalty based on each of the defendant's
violations. See E. Delta Res. Corp., 2012 WL 3903478, at *9; Pentagon Capital Mgmt., 2012
WL 1036087, at *2.
The tier determines the maximum penalty, but the "actual amount of the penalty [is] left
up to the discretion of the district court." SEC v. Kern, 425 F.3d 143, 153 (2d Cir. 2005). The
civil penalties serve a dual purpose -

"to both punish the individual violator for his past

violations and deter future violations of the securities laws." Razmilovic, 822 F. Supp. 2d at 280.
In determining the appropriate civil penalty, courts consider the following factors:
(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.

Pentagon Capital Mgmt., 2012 WL 1036087, at *2 (quoting SEC v. Haligiannis, 470 F. Supp.
2d 373,386 (S.D.N.Y. 2007)). In addition, courts look at whether the defendant has admitted
any wrongdoing. Razmilovic, 822 F. Supp. 2d at 280; SEC v. One Wall St., Inc., No. 06 Civ.

6

4217,2008 WL 5082294, at *9 (E.D.N.Y. Nov. 26, 2008). Although these factors provide
guidance, ''the civil penalty framework is of a 'discretionary nature' and each case' has its own
particular facts and circumstances which determine the appropriate penalty to be imposed. '"
SEC v. Opuientica, LLC, 479 F. Supp. 2d 319,331 (S.D.N.Y. 2007) (quoting SEC v. Moran, 944
F. Supp. 286, 296-97 (S.D.N.Y. 1996)).
Judge Hurley found that Defendant had committed four securities violations, and,
therefore, Plaintiff argues that the Court could impose four second-tier penalties for a total of
$240,000. (Docket No. 84, PI. Damages Mem. 16.) However, Plaintiff only seeks civil penalties
for two second-tier violations in the amount of$120,000. Id. at 16-17. Magistrate Judge Brown
did not address the maximum penalty permitted under the statute and, instead, focused on the
five factors that guide the court's exercise of its discretion in imposing civil penalties. (Report &
Recommendation 10-13.) Magistrate Judge Brown found that the first four factors weighed in
favor of the imposition of civil penalties. Id. at 10-12. First, Defendant's multifaceted
participation in the market timing scheme, "including finding and bringing several customers to
engage in market timing trading, devising ways to circumvent mutual funds' prohibitions against
market timing, and opening or directing the opening of multiple mirror accounts with deceptive
account representative and branch identification codes, constitutes egregious conduct." Id. at
10-11. Second, "Murray's intent to deceive the mutual funds is clear and undisputed." Id. at 11
(quoting Ehrenkrantz King Nussbaum, 2012 WL 893917, at * 13). Third, "Murray's conduct did
create at least the risk of substantial losses to others." Id. Fourth, Defendant's conduct was not
isolated. Id. at 12 ("Murray worked on multiple fronts throughout 2002 into early 2004 to
execute the market timing scheme against numerous mutual funds.").

7

Magistrate Judge Brown noted, however, that Defendant's current financial situation
weighs against the imposition of a civil penalty. Id Defendant claims that he is "totally
disabled" and that his monthly income is $1,800 in disability benefits and $1,300 in survivor
benefits, which he receives on behalf of his son as a result of the death of his son's mother.
(Docket No. 85, Def. Opp'n Damages ~ 7.) Although Magistrate Judge Brown noted that
Defendant's financial situation was compelling, he concluded that "Murray's largely undisputed
claim of poverty cannot defeat the imposition ofa civil penalty, as imposing no penalty 'would
not serve the purposes of the securities law. '" (Report & Recommendation 12 (quoting SEC v.
Inorganic Recycling Corp., No. 99 Civ. 10159,2002 WL 1968341, at *4 (S.D.N.Y. Aug. 23,

2002))). Weighing both Defendant's financial situation and his egregious conduct, Magistrate
Judge Brown recommended a civil penalty of$90,183. Id at 12-13.
Defendant objects to the imposition of a civil penalty equal to the disgorgement, arguing
that "assessing a penalty equal to the amount paid to White Star is . .. flawed and unjust. (Def.
Obj. 5.) Defendant also argues that "there is absolutely no proof to show that anyone suffered
any loss, dilution of share value, excessive expense charges or any harm" by Defendant. Id at 8.
In other words, Defendant objects to Magistrate Judge Brown's conclusion with regard to the
third factor that his conduct created a risk of substantial losses to others, as well as Magistrate
Judge Brown's ultimate conclusion that civil penalties should be imposed equal to the profits
Defendant received through the scheme. For the following reasons, the Court agrees with
Magistrate Judge Brown's recommendation and finds that civil penalties should be imposed in
the amount of$90,183.
Judge Hurley found that Defendant had committed four violations of the securities laws.
Ehrenkrantz King Nussbaum, 2012 WL 893917, at *16. Each violation involved fraud or deceit

8

and, therefore, the statutory maximum penalty against Defendant is $240,000. See 15 V.S.C §
77t(d)(2); 17 C.F .R. § 201.1002. The determination of the appropriate penalty is within the
discretion of this Court. Kern, 425 F.3d at 153. This Court agrees with Magistrate Judge Brown
that the first four factors way in favor of the imposition of a significant civil penalty. As set forth
in Judge Hurley's 2012 decision and the Report & Recommendation, Defendant's multifaceted
and continuous participation in the marketing scheme was egregious, and his intent to deceive
the mutual funds is undisputed. (Report & Recommendation 11-12 (citing Ehrenkrantz King
Nussbaum, 2012 WL 893917, at * 13)). With respect to the third factor, Defendant argues that
Plaintiff has failed to establish that the mutual funds experienced any harm as a result of the
market timing scheme. (Def. Obj. 8.) Defendant is correct that Plaintiff did not present any
evidence in support of its motion for damages "to show that anyone suffered any loss, dilution of
share value, excessive expense charges or any harm by the Plaintiff." Id. In fact, Plaintiff fails
to even address this factor in its motion. Still, the undisputed facts demonstrate that Defendant's
conduct created a risk of substantial losses to others.
In Judge Hurley's 2012 decision, he detailed not only Defendant's involvement in the
market timing scheme but also the actions that the mutual fund families had taken during the
relevant time period to detect and prevent market timing activity. See Ehrenkrantz King
Nussbaum, 2012 WL 893917, at *3-8. In 2002 and 2003, various mutual funds issued
statements indicating that frequent trading might be disruptive to the funds and, therefore, market
timing was "frowned upon." Id at *3. Several mutual fund families then limited the exchanges
a customer could make to ten exchanges per account. Id As Judge Hurley noted, the mutual
fund families promulgated this policy in an attempt to "prevent market timing and its attendant
negative potential impact on shareholders, including higher administrative costs and lower

9

returns." Id. Moreover, Judge Hurley noted that the mutual fund families dedicated a "number
of employees to the task of reviewing accounts and trading information in order to detect market
timing activity." Id. Defendant engaged in a scheme to open mirror accounts, which were
created to avoid detection so that his clients could engage in market timing activity. Id. at *6-7.
The mutual fund families determined that shareholders could be harmed as a result of
market timing, and, "if the mutual funds had detected the market timing activity carried out by
Murray's clients via their mirror accounts, they would have stopped it." Id. at *7, II.
Accordingly, the Court agrees with Magistrate Judge Brown that Defendant's conduct "create[d]
at least the risk of substantial losses to others," (Report & Recommendation 11), which weighs in
favor of the imposition of civil penalties. See E. Delta Res. Corp., 2012 WL 3903478, at *9
("Although plaintiff does not attempt to quantify the amount of loss to others, defendants'
activities had the effect of raising East Delta's share price for the investing public. Thus, the
Court finds that defendants' conduct, at minimum, directly or indirectly ... created a significant
risk of substantial losses to other persons." (alteration in original) (citation and internal
quotation marks omitted)). Finally, Defendant is disabled and has limited monthly income;
therefore, his current financial condition weighs in favor of a reduction of the civil penalty
imposed. (Docket No. 85, Def. Opp'n Damages ~ 7.) Nevertheless, "claims of poverty cannot
defeat the imposition of a disgorgement order or civil penalty." Inorganic Recycling Corp., 2002
WL 1968341, at *4; see also Opulentica, 479 F. Supp. 2d at 331-32 ("Disgorgement alone is an

insufficient remedy, since there is little deterrent in a rule that allows a violator to keep the
profits if [he] is not detected, and requires only a return of ill-gotten gains if [he] is caught."
(citation omitted)).

10

Considering the relevant factors, including Defendant's current financial situation, the
Court finds that a civil penalty should be imposed but the penalty should be below the maximum
penalty available. Magistrate Judge Brown recommended the imposition of sanctions equal to
Defendant's ill-gotten gains. (Report & Recommendation 12-13.) Although Defendant argues
that the imposition of a civil penalty equal to the disgorgement amount is not just, (Def. Obj. 5),
courts have recognized that "the amount of the regulatory penalty assessed should have some
relationship to the amount of ill-gotten gains," One Wall St., 2008 WL 5082294, at *9 (collecting
cases). Recognizing the punitive aspect of civil penalties, Magistrate Judge Brown
recommended a civil penalty equal to the disgorged profit. (Report & Recommendation 12-13.)
Such a penalty recognizes the need to "deter and punish" Defendant's securities law violations,
while recognizing that a statutory maximum penalty is not appropriate in this case. See SEC v.
Kapur, No. 11 Civ. 8094,2012 WL 5964389, at *7 (S.D.N.Y. Nov. 29, 2012); see also One Wall
St., 2008 WL 5082294, at *9 (imposing a civil penalty "equal to the amount of [the defendant's]

ill-gotten gains"). Accordingly, the Court imposes a civil penalty in the amount of $90, 183.
II.

Conclusion

Having considered Magistrate Judge Brown's Report & Recommendation and the
accompanying objections, the Court adopts the Report & Recommendation in its entirety. The
Court orders that Defendant is permanently enjoined from future violations of Section 17(a)(l)
of the Securities Act of 1933, Section 1O(b) of the Securities Exchange Act of 1094 and Rule
lOb-5 thereunder and Section 15(c)(I) of the Exchange Act. The Court further orders

11

disgorgement in the amount of $90, 183 and civil penalties in the amount of $90, 183 against
Defendant. The Clerk of Court is directed to enter judgment and close this case.

/S/ Judge Margo K. Brodie
MAR

Dated: March 6, 2013
Brooklyn, New York

12

DIE