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

http://sec.gov/litigation/opinions/2009/33­

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