Securities and Exchange Commission v. Garber et al
MEMORANDUM AND ORDER: For the reasons discussed above, the SEC's application is granted and the defendants' objections to producing their complete tax returns are overruled. The defendants shall therefore produce the returns within five days of the date of this order, subject to any confidentiality order agreed upon by the parties and entered by the Court. (Signed by Magistrate Judge James C. Francis on 1/7/2014) Copies Mailed By Chambers. (tn)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
- - - - - - - - - - - - - - - - - -:
SECURITIES AND EXCHANGE COMMISSION,: 12 Civ. 9339 (SAS) (JCF)
- against :
DANNY GARBER, MICHAEL MANIS,
KENNETH YELLIN, JORDAN FEINSTEIN, :
ALUMA HOLDINGS LLC, COASTAL GROUP :
HOLDINGS, INC., GREYHAWK EQUITIES :
LLC, LEONIDAS GROUP HOLDINGS LLC, :
THE LEONIDAS GROUP LLC, NISMIC
SALES CORP., THE OGP GROUP LLC,
PERLINDA ENTERPREISES LLC, RIO
STERLING HOLDINGS LLC, SLOW TRAIN :
HOLDINGS LLC, and SPARTAN GROUP
- - - - - - - - - - - - - - - - - -:
JAMES C. FRANCIS IV
UNITED STATES MAGISTRATE JUDGE
The Securities and Exchange Commission (the “SEC”) brings this
action against, among others, Danny Garber, Kenneth Yellin, and
Jordan Feinstein (the “individual defendants”) and certain entities
that they control, specifically the OGP Group LLC, Rio Sterling
The SEC now seeks production of the federal tax
returns of the individual defendants.
These defendants oppose the
SEC’s application on the ground that the documents are protected
from disclosure by the quasi-privilege accorded to tax returns.
The factual background of the case is set forth at length in
the decision of the Honorable Shira A. Scheindlin, U.S.D.J.,
denying the defendants’ motion to dismiss the complaint.
Garber, __ F. Supp. 2d __, 2013 WL 1732571 (S.D.N.Y. April 22,
I will highlight here only those facts relevant to the
According to the Complaint, between January 2007 and early
2010, “the [d]efendants purchased over a billion unregistered
shares in dozens of penny stock companies . . . and illegally
resold the shares to the investing public without complying with
the registration provisions of the federal securities laws.”
(Complaint (“Compl.”), ¶ 1).
In part, this scheme involved false
representations by the defendants that their purchases of the
504(b)(1)(iii) of Regulation D, 17 C.F.R. § 230.504(b)(1)(iii), of
the Securities Act of 1933, 15 U.S.C. § 77a et seq. (Compl., ¶ 3).
On the basis of these false statements, along with others, the
defendants were able to obtain shares without restrictive legends
that would have prevented them from immediately dumping the newly
acquired shares on the market.
(Compl., ¶¶ 5-6).
“[e]clusively according to state law exemptions from registration
that permit general solicitation and general advertising so long as
the sales are made only to ‘accredited investors . . . .’”
C.F.R. § 504(b)(1)(iii).
Accredited investors, in turn, include
“[a]ny natural person whose individual net worth, or joint net
worth with that person’s spouse, exceeds $1,000,000” or “[a]ny
natural person who had an individual income in excess of $200,000
in each of the two most recent years or joint income with that
person’s spouse of $300,000 in each of those years and has a
reasonable expectation of reaching the same income level in the
17 C.F.R. § 230.501(a)(5), (6).
entity may be an accredited investor if “all of the equity owners
are accredited investors.”
17 C.F.R. § 230.501(a)(8).
In its Request for Production No. 13, the SEC sought, among
other things, the tax returns of the individual defendants.
(Letter of Paul G. Gizzi dated May 31, 2013 (“Gizzi 5/31/13 Letter)
at 3 & attached chart at 3-4).
The defendants objected on the
irrelevant, and argued that the SEC could not overcome the quasiprivilege
(Gizzi 5/31/13 Letter, attached chart at 3-5).
Subsequently, the individual defendants produced the first page of
the tax returns, which summarize the taxpayer’s income and adjusted
gross income, and maintained that these documents demonstrated that
transactions at issue.
(Letter of Ira Lee Sorkin dated Sept. 16,
2013 (“Sorkin 9/16/13 Letter”) at 2-3). The SEC, however, objected
to the use of the first page of each return as evidence because
they had not been authenticated and were incomplete and unreliable.
(Sorkin 9/16/13 Letter at 3; Letter of Paul G. Gizzi dated Sept.
19, 2013, at 2).
Judge Scheindlin then agreed to review the
first pages together with the full returns in camera, along with
affidavits addressing the authenticity of the documents.
order dated November 13, 2013, she summarized her review.
dated Nov. 13, 2013 (“November 13 Order”)).
She noted that in all
cases, the defendants attested that the returns provided were their
accountants corroborated this.
(November 13 Order at 1-2).
further observed that Mr. Garber’s returns showed both total income
and adjusted gross income (“AGI”) in excess of $300,000 for the
years 2005-2010; that Mr. Feinstein’s returns showed both total
income and AGI in excess of $300,000 for the years 2006-2010; and
that Mr. Yellin’s returns showed both total income and AGI in
excess of $300,000 for the years 2006-2009, but total income of
$187,388 and AGI of $144,904 for 2010. (November 13 Order at 1-2).
Judge Scheindlin noted that this “review was conducted in response
to the SEC’s concern about the authenticity of the first page of
the tax returns,” and she emphasized that she “has not yet ruled on
the legal question of whether the [individual defendants] qualify
as accredited investors.” (November 13 Order at 2-3). Finally, in
light of the SEC’s arguments with respect to the reliability of the
documents, she directed the parties to brief the issue of whether
the SEC should be permitted to examine the complete tax returns.
(November 13 Order at 3).
The parties then submitted additional
letter briefs, and the issue was referred to me for determination.
While tax returns are not formally privileged, courts exercise
discretion in ordering their disclosure.
See Michelman v. Ricoh
Americas Corp., No. 11 CV 3633, 2013 WL 664893, at *2 (E.D.N.Y.
Feb. 22, 2013) (finding courts “reluctant” to order discovery of
tax returns); GMA Accessories, Inc. v. Electric Wonderland, Inc.,
No. 07 Civ. 3219, 2012 WL 1933558, at *8 (S.D.N.Y. May 22, 2012)
(same); Chen v. Republic Restaurant Corp., No. 07 Civ. 3307, 2008
WL 793686, at *2 (S.D.N.Y. March 26, 2008) (same); Carmody v.
Village of Rockville Centre, No. 05 CV 4907, 2007 WL 2042807, at *2
(E.D.N.Y. July 13, 2007) (same); Rahman v. Smith & Wollensky
Restaurant Group, Inc., No. 06 Civ. 6198, 2007 WL 1521117, at *7
(S.D.N.Y. May 24, 2007) (same); SEC v. Militano, No. 89 Civ. 572,
1991 WL 270449, at *3 (S.D.N.Y. Dec. 12, 1991) (finding courts
“cautious” in ordering production).
This caution is based on both
“the private nature of the sensitive information” and “the public
Smith v. Bader, 83 F.R.D. 437, 438 (S.D.N.Y.
1979); accord Fierro v. Gallucci, No. 06 CV 5189, 2009 WL 606191,
at *1 (E.D.N.Y. March 9, 2009); Chen, 2008 WL 793686, at *2; Ellis
v. City of New York, 243 F.R.D. 109, 111 (S.D.N.Y. 2007);
Accordingly, in order to reconcile these concerns with liberal
pretrial discovery, courts have developed a two-prong test: tax
returns may be ordered disclosed where (1) they are relevant to the
subject matter of the action, and (2) there is a compelling need
for their disclosure because the information is not otherwise
Trilegiant Corp v. Sitel Corp., 272 F.R.D.
360, 368 (S.D.N.Y. 2010); Fierro, 2009 WL 606191, at *1; Chen, 2008
WL 793686, at *2; Rahman, 2007 WL 1521117, at *7.
The party seeking disclosure bears the burden of demonstrating
relevance, and the SEC has met that burden here.
It is undisputed
that one of the key issues in this case is whether the entity
unregistered securities, and the determination of that question
turn, on whether the individual defendants were
(Sorkin 9/16/13 Letter at 2).
their status as accredited investors relates to an exemption from
the registration requirements, the ultimate burden of proof will be
on the defendants.
See SEC v. Ralston Purina Co., 346 U.S. 119,
126 (1953); SEC v. Cavanagh, 445 F.3d 105, 111 n.13 (2d Cir. 2006);
SEC v. Mattera, No. 11 Civ. 8323, 2013 WL 6485949, at *11 (S.D.N.Y.
Dec. 9, 2013).
The individual defendants have sought to satisfy
that burden by proffering the first page of their respective
returns to prove their income.
(Sorkin 9/16/13 Letter at 2-3).
The balance of each tax return likewise reflects their income and
so is equally relevant.1
Analysis of the second prong is more complex.
Who bears the
burden on this prong is a matter of some dispute.
One court has
suggested that while “some courts shift the burden to the party
opposing the discovery to establish the existence of alternative
sources for the information . . . the modern trend appears to
require the party seeking discovery to demonstrate both relevancy
and a compelling need.” Carmody, 2007 WL 2042807, at *2 (citations
The defendants argue that the returns (apart from the first
page) are “inherently irrelevant” because only the amount of income
is pertinent to accredited investor status, not how the income was
(Sorkin 9/16/13 Letter at 2-3).
But there is ample
information throughout the returns that directly reflects the
amount of each defendant’s income.
In effect, the defendant’s
argument more properly goes to the second prong -- whether there is
a compelling need for the entire return once the first page has
I respectfully disagree.
While the cases indeed
diverge, it is hard to discern any trend. Some cases clearly place
the burden on the party resisting disclosure. See Rahman, 2007 WL
1521117, at *7; United States v. Bonanno Organized Crime Family of
La Cosa Nostra, 119 F.R.D. 625, 627 (E.D.N.Y. 1988); SEC v.
Cymaticolor Corp., 106 F.R.D. 545, 548 (S.D.N.Y. 1985).
just as plainly impose the burden on the discovering party.
Fierro, 2009 WL 606191, at *1; Hamm v. Potamkin, No. 98 Civ. 7425,
1999 WL 249721, at *2 (S.D.N.Y. April 28, 1999).
And some cases
that state that the burden is on the discovering party do so
because they misread earlier precedent. See GMA Accessories, Inc.,
2012 WL 1933558, at *8 (citing Ellis, 243 F.R.D. at 111, for
proposition that burden is on discovering party); Ellis, 243 F.R.D.
at 111 (mistakenly citing Rahman, 2007 WL 1521117, at *7 for same
In any event, the courts that place the burden on the party
resisting disclosure have the better of the argument. Because that
party is the originator of tax returns, it is generally in a better
position to suggest alternative sources for the information they
Once it has done so, of course, the requesting party is
free to argue that the proposed alternative is in some respect
See Sabatelli v. Allied Interstate, Inc., No. 05 CV
3205, 2006 WL 2620385, at *1 (E.D.N.Y. Sept. 13, 2006) (finding no
compelling need where information sought could be obtained through
That is, in effect, what has occurred here.
defendants contend that the first page of the tax returns is a
sufficient alternative to producing the returns in their entirety,
while the SEC maintains that it is not.
The tenuousness of the defendants’ argument is most apparent
with respect to Mr. Yellin’s returns.
The defendants contend that
“[a]lthough Mr. Yellin and his then wife only reported $187,388 in
total income for 2010, Mr. Yellin reasonably anticipated making
over $300,000 jointly with his spouse in 2010 based on prior years’
income, and thus Mr. Yellin still met the accredited investor
(Letter of Ira Lee Sorkin dated Nov. 21, 2013, at 2 n.1).
But the reasonableness of Mr. Yellin’s expectations depends not
only on the amount of income he earned in prior years, but also on
the nature and sources of that income.
If some sources were
destined to expire, for example, then it would not have been
reasonable for Mr. Yellin to anticipate equivalent income in 2010.
Indeed, if demonstrating qualifying income alone in the prior two
years were enough to qualify an accredited investor in the third
substitute for the full returns of Mr. Garber and Mr. Feinstein.
By raising the accredited investor defense, the defendants have
placed their income in issue. Some courts have suggested that this
provides an alternative ground for requiring disclosure of tax
returns, independent of the two-prong test.
See Hazeldine v.
Beverage Media, Ltd., No. 94 Civ. 3466, 1997 WL 362229, at *4 n.1
Cymaticolor, 106 F.R.D. at 548 n.2. But the protection afforded to
tax returns should not depend on the fortuity of which party raised
the issue to which they might be relevant.
Rather, it should turn
on whether the party seeking discovery has an adequate ability to
address that issue without obtaining the returns.
Here, the SEC might be unable to demonstrate compelling need
if accredited investor status were defined according to a specific
line on the first page of the tax returns.
But it is not.
According to the SEC release discussing the adoption of the current
rules, “[t]he test is no longer keyed to the federal tax return.”
Revision of Certain Exemptions from Registration for Transactions
Involving Limited Offers and Sales, SEC Release No. 6389, 24 SEC
Docket 1166, 1982 WL 35662, at *9 (March 8, 1982).
rejected in favor of a standard based on “income.”
As the SEC
release states, “[t]he rule as adopted does not define the term
Rather than adopting a definition, the Commission has
determined to utilize a flexible approach, thereby avoiding the
Since determining income, and thereby evaluating
accomplished merely by reference to a particular figure on the
first page of the tax returns, it would be fundamentally unfair to
foreclose the SEC from access to the balance of the returns.
To be sure, if an individual’s adjusted gross income exceeds
the level to qualify as an accredited investor, then his income is
likely to as well, since AGI generally reflects total income minus
Nevertheless, because “income” for purposes
of the SEC rule is not moored to the tax law, the SEC should be
free to argue that particular items appearing as income in the tax
returns should not be counted toward accredited investor status.
Unless it can gain access to the full returns, it is deprived of
identically for tax and accredited investor purposes, the SEC
should not be precluded from exploring the reliability of the
information contained on the first page of the returns.
defendants argue that no one would rationally overstate their
income on their tax returns.
This is, of course, generally true.
potentially lucrative as the SEC alleges,
they would have had a
substantial incentive to appear to qualify as accredited investors,
even at the cost of paying some additional taxes.
It simply cannot
be assumed that the income figures reflected on the first page of
the defendants' tax returns are accurate, and the SEC is entitled
to the balance of the returns to test their reliability.
reasons discussed above,
the SEC's application is
granted and the defendants' objections to producing their complete
tax returns are overruled.
The defendants shall therefore produce
the returns within five days of the date of this order, subject to
any confidentiality order agreed upon by the parties and entered by
~ e·~~ if
C. FRANCIS IV
UNITED STATES MAGISTRATE JUDGE
Dated: New York, New York
January 7, 2014
Copies mailed this date:
Paul G. Gizzi, Esq.
Andrew Matthew Calamari, Esq.
Haimavathi Vardan Marlier, Esq.
Michael David Paley, Esq.
U.S. Securities and Exchange Commission
3 World Financial Center, Suite 400
New York, NY 10281
Kevin P. McGrath, Esq.
Securities and Exchange Commission
New York Regional Office
Brookfield Place, 200 Vesey Street, Suite 400
New York, NY 10281
Ira Lee Sorkin, Esq.
Amit Sondhi, Esq.
Lowenstain Sandler PC
1251 Avenue of the Americas
New York, NY 10020
Edward J.M. Little, Esq.
David B. Shanies, Esq.
Hughes Hubbard & Reed LLP
One Battery Park Plaza
New York, NY 10004
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