Securities and Exchange Commission v. Johnson et al
Filing
187
OPINION AND ORDER re: 168 MOTION in Limine filed by American Growth Funding II, LLC, Ralph C Johnson, 166 MOTION in Limine filed by Securities and Exchange Commission. This Order resolves docket numbers 166 and 168. SO ORDERED. (Signed by Judge Kimba M. Wood on 12/4/2018) (ne)
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USDSSDNY
DOCUMENT
ELECTRONICALLY FILED
SECURITIES & EXCHANGE
COMMISSION,
Plaintiff,
DOC#:-- -------~
DATE FILED: / Q /
1 ct'
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
Lt /
V.
AMERICAN GROWTH FUNDING II, LLC,
PORTFOLIO ADVISORS ALLIANCE, INC. ,
RALPH C. JOHNSON,
HOW ARD J. ALLEN III, and
KERRIL. WASSERMAN
16-CV-828 (KMW)
OPINION AND ORDER
Defendants.
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KIMBA M. WOOD, United States District Judge:
The Securities and Exchange Commission ("SEC" or "the Commission") brought this
action against American Growth Funding II and Ralph C. Johnson ("the AGF II Defendants")
and Portfolio Advisors Alliance, Howard J. Allen III, and Kerri L. Wasserman ("the PAA
Defendants") (collectively, "the Defendants") for securities fraud under Sectionl0(b) of the
Exchange Act and Rulel 0b-5 thereunder, and Sections l 7(a)(l), (2), and (3) of the Securities
Act. The SEC filed motions in limine on August 8, 2018 (ECF No. 166), and the AGF II
Defendants filed motions in limine on August 9, 2018 (ECF No. 168). This Court's rulings on
these motions are stated below.
I.
RULINGS
A.
SEC Motions in Limine
1.
Motion I: Evidence Related to Investor Losses and Profits
The SEC first seeks to exclude evidence related to the pecuniary losses (or profits) of
AGF II investors because such evidence is irrelevant. (SEC Mem. Supp., ECF No. 167, at 4-5.)
Thi:i i~ ~o, ~~~Qr~in 0 to the SEC, because the Commission need not demonstrate the AGF II
investors suffered a monetary loss to succeed in this enforcement action. (Id.) The question here
is whether the Defendants defrauded the AGF II investors through material misrepresentations,
not whether those misrepresentations resulted in monetary injury to the AGF II investors. (Id.)
Apart from the irrelevance of evidence related to investor loss, the SEC also argues such
evidence will confuse the jury and "improperly inject issues of causation into the case." (Id. at
5.) Finally, the SEC contends evidence of investor loss would be prejudicial by suggesting any
misrepresentation was not material because "these victims 'made out well.'" (Id.)
In response, the Defendants contend evidence of investor loss is relevant to scienter.
(AGF II Defs. Mem. Opp'n, ECF No.174, at 3 ("Whether investor funds have been misused,
misappropriated, or losses have been incurred is directly relevant to the mental state of the
defendants at the time the alleged misrepresentations were made."); PAA Defs. Mem. Opp'n,
ECF No. 172, at 20 ("[T]he fact that this was not a scheme to defraud investors, but rather, a
legitimate investment in which no investors lost any of their investment, also goes to the issue of
whether the PAA Defendants intended to harm investors.").) The Defendants further argue
evidence of investor loss is relevant to materiality. (AGF II Defs. Mem. Opp'n at 2 ("[I]nvestor
profits are directly relevant to [the] issue[] of materiality."); PAA Defs. Opp'n at 20 ("[T]he fact
that investors did not incur any losses-and in fact, profited off the transaction-is relevant to
the total mix of information that a reasonable investor would be interested in knowing in
deciding whether to invest").) Finally, the AGF II Defendants assert that "evidence regarding
investor profits/losses is directly relevant to the Court's determination as to the appropriate level
of penalties to be imposed." (AGF II Defs. Mem. Opp'n at 3.)
This Court agrees with the SEC that the monetary losses or profits of AGF II investors
are not relevant. The enforcement action here is similar to that in In re Reserve Fund Securities
2
and Derivative Litigation, No. 9-CV-4346 (PGG), 2012 WL 12354220, at* 1-2 (S.D.N.Y. Sept.
11, 2012) (Gardephe, J.), in which the court rejected the defendants' attempts to present evidence
showing "investors recouped most of their investment . .. . [b]ecause investor loss is irrelevant to
the jury's resolution of the Commission's claims, [and] evidence and argument concerning this
subject is likewise irrelevant." This reasoning is compelling. The SEC does not need to
demonstrate investor loss to succeed on its claims. "[I]n an enforcement action, civil or criminal,
there is no requirement that the government prove injury, because the purpose of such actions is
deterrence, not compensation." SEC v. Apuzzo, 689 F.3d 204,212 (2d Cir. 2012); see also SEC
v. Kelly, 765 F. Supp. 2d 301,319 (S.D.N.Y. 2011) (McMahon, J.) (" [U]nlike a private plaintiff,
the SEC need not allege or prove reliance, causation, or damages in an action under Section
IO(b) or Rule lOb-5." (citing SEC v. Credit Bancorp, Ltd., 195 F. Supp. 2d 475, 490-91
(S.D.N.Y. 2002)). Investor losses or profits are thus irrelevant.
Moreover, exclusion of evidence related to investor losses or profits comports with the
"major congressional policy behind the securities laws in general, and the antifraud provisions in
particular," which is "the protection of investors who rely on the completeness and accuracy of
information made available to them." Chris-Craft Indus. v. Piper-Aircraft Corp., 480 F.2d 341,
363 (2d Cir. 1973) (emphasis added). Indeed, the SEC brings enforcement actions to deter
fraudulent misrepresentations and omissions, thus ensuring investors are provided the
information needed to make informed investment decisions. Put another way, the harm to be
deterred is not pecuniary-it is informational. See United States v. Leonard, 529 F.3d 83, 91 (2d
Cir. 2008) ("[I]nsofar as [defendants] intended to deprive investors of the 'full information' they
needed to 'make refined, discretionary judgments,' they intended to harm the investors."
(quoting United States v. Rossomando, 144 F.3d 197,201 n.5 (2d Cir. 1998))).
3
The Defendants' arguments, which attempt to show investor profits are relevant to
scienter, materiality, and civil penalties, are not persuasive. Each argument is addressed below.
1.
Scienter
The Defendants first argue evidence of investor profits is relevant to scienter because the
fact that investors profited suggests that the Defendants did not intend to 'harm' the investors.
(See PAA Defs. Mem. Opp'n at 20; AGF II Defs. Mem. Opp ' n at 3.) This argument, however,
conflates intent to cause investors pecuniary harm and intent to mislead investors by depriving
them of full information. The SEC need demonstrate scienter only as to the latter to succeed in
its enforcement action. See Abrahamson v. Flescher, 568 F.2d 862, 878 n.27 (2d Cir. 1997)
("Sci enter does not require a showing of intent to cause a loss to a plaintiff' (citing SEC v.
Capital Gains Research Bureau, Inc., 375 U.S. 180, 192 n.39 (1963)). Investor profits are not
relevant to whether the Defendants intended to deprive investors of material information. This
argument therefore fails.
11.
Materiality
The Defendants next argue evidence of the profits investors ultimately realized is relevant
to the materiality of earlier misrepresentations. (See PAA Defs. Mem. Opp'n at 20; AGF II
Defs. Mem. Opp'n at 2.) This contention is plainly wrong. "Materiality is determined in light of
the circumstances existing at the time the alleged misstatement occurred." Ganino v. Citizens
Util. Co., 228 F.3d 154, 165 (2d Cir. 2000) (emphasis added); see also Spielman v. Gen. Host
Corp., 402 F. Supp. 190, 194 (S.D.N.Y. 1975) (Weinfeld, J.) ("The determination of materiality
is to be made upon all the facts as of the time of the transaction and not upon a 20-20 hindsight
view long after the event."). Whether investors later did or did not profit was not known at the
time of the alleged misrepresentations, and therefore this fact is not relevant to the materiality of
4
the misrepresentations at the time they were made. See Kaiser-Frazer Corp. v. Otis & Co., 195
F.2d 838, 843 (2d Cir. 1952) (concluding an overstatement of earnings in a quarterly report was
not rendered immaterial simply because in the end "profits for the year as a whole were
substantially unaffected by the overstatement").
Furthermore, allowing evidence of subsequent investor profits to color the materiality
analysis would-as touched on above-undermine the "major congressional policy" behind the
antifraud provisions, which is safeguarding "the completeness and accuracy of information made
available to [investors] ." Chris-Craft, 480 F .2d at 363. If Congress intended to target only those
fraudulent misrepresentations resulting in a monetary loss, it would have required the SEC to
show loss causation. Congress did not do so. See Apuzzo, 689 F.3d at 212 (" [I]n an enforcement
action, civil or criminal, there is no requirement that the government prove injury, because the
purpose of such actions is deterrence, not compensation." (emphasis added)).
In an attempt to salvage their materiality argument, the AFG II Defendants cite United
States v. Forbes, 249 F. App 'x 233 , 237 (2d Cir. 2007), in which the Second Circuit held that
"investor losses were probative on the issue of materiality." But the "investor losses" referenced
in Forbes related to a precipitous decline in the stock price of Cendant Corporation that
immediately followed a public disclosure of its "accounting irregularities." United States v.
Forbes, No. 3:08-CV-933 (JBA), 2009 WL 1011475, at* 1 (D. Conn. Apr. 15, 2009). In the
context of public filings, it is well-established that movement in stock price shortly after
disclosure of a misrepresentation (or lack of the same) is some evidence of materiality. See
Veleron Holding, B. V v. Morgan Stanley, 117 F. Supp. 3d 404,433 (S.D.N.Y. 2015)
(McMahon, J.) ("Stock price movement is some evidence of materiality, but it is not in and of
itself conclusive"). In such cases, however, there is a close proximity in time between disclosure
5
of the misrepresentation to investors and the movement in stock price. A decline in stock price
soon after the disclosure of a misrepresentation suggests the misrepresentation mattered to
investors. In the same vein, the absence of stock price movement soon after disclosure of a
misrepresentation suggests the misrepresentation was not material to investors. But that is not
what the Defendants contend in this case. Here, the Defendants argue investor profits realized
long after the alleged misrepresentations are relevant to materiality. Forbes does not support this
proposition.
This Court thus rejects the Defendants' materiality argument that subsequent investor
profits are relevant to earlier misrepresentations.
m.
Civil Penalties
Finally, the AGF II Defendants contend evidence of investor profits and losses is relevant
to the determination of appropriate civil penalties. (AGF II Defs. Mem. Opp'n at 3.) This
argument is correct, but beside the point. The jury determines liability. The court determines
penalties. See 15 U.S .C. § 78u(d)(3) ("The amount of the penalty shall be determined by the
court."); SECv. Castaldo, No. 8-CV-8397 (JSR), 2009 WL 2591376, at *1 (S.D.N.Y. Aug. 19,
2009) (Rakoff, J.) ("The jury was not asked to determine the relief warranted by these
determinations of liability, because, as both sides agreed, the relief here sought by the SEC ... is
allocated by statute to determination by the Court, as in the case of civil money penalties."
(citing 15 U.S.C. § 78u(d)(3)).
***
This Court therefore GRANTS the motion. No evidence related to investor loss or profit
will be admitted at trial, and no argument concerning this subject will be permitted.
2.
Motion II: Evidence Related to Reliance on and Involvement of Counsel
6
The SEC next moves to exclude evidence related to the involvement of or reliance on
counsel because, according to the SEC, the Defendants have not proffered sufficient evidence to
warrant a reliance on advice of counsel jury instruction. (SEC Mem. Supp. at 11.) The SEC
argues that because the Defendants cannot establish an advice of counsel defense, this Court
should exclude "any evidence or argument that counsel was 'involved' or 'present' in the PPM
preparation or amendment process" because such evidence would be "unduly and irreparably
prejudicial." (Id. at 14- 15 (emphasis in original).) In response, the PAA Defendants argue there
is compelling evidence in the record to support their reliance on the advice of counsel defense.
(PAA Defs. Mem. Opp'n at 7-13.) 1 The PAA Defendants also contend exclusion of any
evidence related to the reliance on and involvement of counsel is premature. (Id. at 16-19.)
As an initial matter, this Court is not persuaded the SEC's motion is appropriate for
resolution at this stage of the litigation. The SEC argues "courts do not hesitate to preclude a
jury from hearing evidence about advice of counsel where there is insufficient evidence to
ground the claim." (SEC Mem. Supp. at 13-14.) However, none of the decisions the SEC cites
to support this proposit!ion actually does so. In fact, the decisions the SEC cites support the
contrary conclusion- that is, courts routinely allow the jury to hear evidence about interactions
with and advice of counsel even if ultimately there is insufficient evidence for an advice of
counsel instruction. For example, the SEC cites United States v. Hill, 643 F.3d 807, 850-51
(11th Cir. 2011), in which the Eleventh Circuit affirmed the district court's refusal to give an
advice of counsel instruction because the evidence presented at trial, including testimony from
several of the involved attorneys, did not support the instruction. Similarly, the SEC cites United
States v. Travers, 114 F. App'x 283,288 (9th Cir. 2004), in which the Ninth Circuit affirmed the
1
The AGF II Defendants take no position as to the evidence related to the reliance on and involvement of counsel.
(SlW AGF II Defg_Mem. Opp'n at X.)
7
district court's refusal to give an advice of counsel instruction because the defendant 's testimony
at trial as to his interactions with counsel was insufficient to support the instruction. Thus, not
only do Hill and Travers fail to support the contention that "courts do not hesitate to preclude a
jury from hearing evidence about advice of counsel," both decisions are at odds this contention. 2
The SEC next argues that a blanket pre-trial exclusion is warranted because the
Defendants "have not and cannot set forth any evidence to establish any of the four elements of
the [reliance on counsel] defense." (SEC Mem. Supp. at 11.) To be entitled to the reliance on
the advice of counsel defense, the PAA Defendants must show that they "made a complete
disclosure to counsel, sought advice as to the legality of [their] conduct, received advice that
[their] conduct was legal, and relied on that advice in good faith." Markowski v. SEC, 34 F.3d
99, 105 (2d Cir. 1994) (citing SEC v. Savoy Indus. , Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir.
1981)).
The SEC is wrong. The SEC states that with respect to Timothy Kahler, the attorney the
PAA Defendants engaged in 2013:
[T]here is no testimony or documentary evidence showing that
anyone disclosed to Kahler the inaccuracy of the audit
representations in the 2011 and 2012 PP Ms or that PAA was
continuing to sell AGF II units despite the PAA Defendants'
knowledge of the falsity of the PPMs. As a result, Kahler never
advised that AGF II or PAA could continue selling securities using
an inaccurate PPM, or that either could fail to tell previous AGF II
investors that the PPM was inaccurate.
(SEC Mem. Supp. at 13.) This is inaccurate. As the PAA Defendants point out, Allen testified
as follows in his declaration:
In late September 2013, after learning that AGF II had not retained
Citrin Cooperman to perform an audit, I reached out to Timothy
2
The SEC also cites SEC v. Tourre , 950 F. Supp. 2d 666 (S.D.N.Y. 2013) (Forrest, J.), and SEC v. Mapp, No. 16CV-246, 2017 WL 8780604 (E.D. Tex. Dec. 04, 2017). The defendants in both ofthese cases presented little, if
any, evidence to support a reliance on the idvice of counsel defense. As explained below, the 5ame i~ not true here.
8
Kahler, Esq., from the law firm Troutman Sanders LLP to advise
PAA (including myself) how to proceed. Mr. Kahler had previously
represented PAA and I knew and respected him and his firm
To be clear, I contacted Mr. Kahler for the specific purpose of
obtaining legal advice regarding what PAA and its registered
representatives had to do since AGF II had not yet performed an
audit. Mr. Kahler was provided with a copy of the 2012 PPM
(including, specifically, the audit language contained therein) and he
was also specifically informed that as of September 2013, no audit
had been performed. I also informed Mr. Kahler that any other
document that he needed to review would be provided to him, as I
am not familiar with what he needed to perform a review and form
conclusions on how to proceed. After reviewing the documents he
sought and received, Mr. Kahler informed me that this was an "easy
fix," explaining that if AGF II received consent from over 50% of
the investors, the Operating Agreement could be amended to
dispense with the audit requirement completely.
Upon receipt of Mr. Kahler's explicit advice and instruction on how
to proceed, PAA sent correspondence to its top fifteen investors
seeking consent to amend the Operating Agreement. After receiving
two objections from investors we informed Mr. Kahler, who then
advised that the 2012 PPM need not be revised since there would be
no amendment to the Operating Agreement, but that AGF II should
perform an audit.
PAA immediately informed Mr. Johnson of Mr. Kahler' s legal
advice and, in November 2013, Mr. Johnson sent an email to me
confirming that he had hired Evangelista and Co., CPA,
("Evangelista") to complete the audits from the previous two years.
Accordingly, at Mr. Kahler 's direction and instruction, PAA
forwarded an email to AGF II to inform the fifteen investors that
AGF II hired Evangelista to perform the audit.
(PAA Defs. Mem. Opp'n at 8-9 (emphasis in original).) The SEC may view Allen's testimony
as self-serving and uncorroborated, but that argument goes to the weight of the evidence, not its
admissibility. See United States v. Scully, 877 F.3d 464,475 (2d Cir. 2017) ("One party to a trial
will frequently believe that testimony offered by the other side is false or misleading. That,
however, is not a factor to be weighed against the receipt of otherwise admissible testimony.")
9
The SEC advances a similar argument with respect to Andrew Russell, the attorney the
PAA Defendants engaged in 2011. (SEC Mem. Supp. at 11-12.) Based on Russell's deposition
testimony, the SEC argues Russell was asked to conduct a superficial review of the 2011 PPMakin to a proofread-and not to provide legal advice as to the content of the document. (Id. at
12.) The SEC also argues that the Defendants' disclosures were deficient-that they did not
"completely disclose ... that there was any issue, let alone any inaccuracy, with the audit
representations in the drafts or the final 2011 PPM." (Id. at 11-12.)
But, as the PAA Defendants again point out, Allen testified that Russell was tasked with
reviewing the entire 2011 PPM, and Allen stated Russell "was hired specifically for that
purpose." (PAA Defs. Mem. Opp 'n at 7-8.) Russell himself testified that his firm was engaged
to "prepare private placement documents" for AFG II. (PAA Defs. Mem. Opp'n 8.) The PAA
Defendants also contend the 2011 PPM fully disclosed to Russell that AFG II was a newly
formed entity and, as such, AGF II could not possibly have been audited in previous years . For
example, although the 2011 PPM states "annual financial statements will continue to be
audited," it also states:
The Company and the Manager are newly formed entities with no
operating histories, and, accordingly, no performance histories to
which a potential Investor may refer in determining whether to
invest in the Company. The Company' s prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by new ventures, including the reliance of the Company
on the Manager and its key personnel and other factors.
(PAA Defs. Mem. Opp 'n at 11 (emphasis in original).) Whether these facts support an advice of
counsel defense is a question for the fact-finder. 3
3
Regardless of whether the PAA Defendants are entitled to a reliance on counsel instruction, they also argue
evidence related to their interactions with counsel is admissible because that evidence is relevant to scienter, an
element the SEC must establish to succeed in this enforcement action. (PAA Defs. Mem. Opp'n at 13- 16).
Relevunce, however, is not sufficient. This Court must also weigh the probative value of the evictenGe 11g11irnt itB
10
In sum, this Court views exclusion of evidence related to reliance on counsel to be
premature at this stage of the litigation. This Court therefore DENIES the motion. It does so,
however, without prejudice.
The SEC also moves for an evidentiary hearing in the event the Court denies its motion to
exclude. (SEC Mem. Supp. at 15 n.11.) The SEC argues an evidentiary hearing is "required to
determine whether the Defendants can, in fact, establish the factual predicates" to assert a
reliance on the advice of counsel defense. (Id.) As explained above, however, the Defendants
have offered an evidentiary foundation for the defense. An evidentiary hearing would also not
be useful given that resolution of the disputed issues requires determinations of credibility.
3.
Motion III: Evidence Related to the Actions of the SEC
The SEC next moves to exclude evidence related to the "unclean hands" and Privacy Act
violation affirmative defenses this Court previously struck from the AGF II Defendants' answer.
(SEC Mem. Supp. at 6-7.) Specifically, the SEC seeks to exclude evidence related to "a
supposed 'undercover operation' by two staff accountants from the SEC's Broker-Dealer
Inspection Program and [] supposed false statements to witnesses by SEC Division of
Enforcement attorneys." (Id. at 6.) This Court agrees with the SEC that evidence related to the
stricken affirmative defenses is not relevant to any issue at trial. No evidence concerning the
alleged "unclean hands" or Privacy Act violations will be permitted at trial.
The SEC also appears to make a far broader argument: that any evidence of its own
actions should be precluded because such evidence simply "repackages" the stricken affirmative
potential prejudicial impact. If the PAA Defendants did not make a full disclosure to counsel, did not seek advice as
to the legality of their conduct, did not receive advice that their conduct was legal, or did not rely on that advice in
good faith- that is, if the PAA Defendants do not satisfy any of the requisite elements for a reliance on counsel
instruction- the probative value (as to scienter) of the evidence related to interactions with counsel is significantly
Jggg 9.nd thll pornnti9.I
for prejudice ig gignificantly more.
11
defenses and is irrelevant and prejudicial. (SEC Mem. Supp. at 8-10.)4 But the SEC mentions
evidence of only one of its actions: subpoenaing the accounting firm Frazier & Evangelista
(F&E). (Id. at 5-6.) Apart from that subpoena, the SEC does not explain which of its other
actions are at issue. A blanket exclusion would thus be premature at this stage. The Court
addresses the subpoena question below.
The SEC seeks to preclude evidence showing the Defendants originally engaged F&E
to perform the needed audits, but F&E reneged on the agreement after receiving a subpoena from
the SEC. (Id.) The SEC contends "there is not even an attenuated connection between the
reason one auditor did not conduct an audit and the quality of an audit performed by an entirely
different auditor." (SEC Reply Mem Supp. at 5.) This argument confuses the issues. Even if the
reason F&E decided not to perform the audits is not relevant to the quality of the audits
Weinberg performed, the reason the Defendants turned to Weinberg to begin with is relevant to
their scienter. The fact that the Defendants originally retained F&E to perform the needed audits
undermines the inference that the Defendants intentionally sought out an unscrupulous auditor
and chose Weinberg for that reason. The SEC makes no argument to the contrary.
Furthermore, in both its complaint and summary judgment motion, the SEC argues an
October 2018 email sent to investors, which stated audits were "being done" by F &E, contained
fraudulent misrepresentations. (SEC Surnm. J. Mot., ECF No. 120, at 9.) Specifically, the SEC
argues F&E "never agreed to perform an audit for AGF II nor did it ever conduct any audit work
for AGF II." (Id.) Thus, the nature and extent of the relationship between F&E and the
Defendants is directly relevant to whether the October 2018 statement that audits were "being
4
The SEC cites a number of cases that stand for the uncontroversial proposition that the collateral consequences of
an SEC enforcement action- including monetary and reputational harm to businesses or individual defendants- is
irrelevant and prejudicial. (SEC Mem. Supp. at 8- 10.) These cases do not hold, however, that any and all actions
thB ~EC undBrt9lrng 9rB irrelevant and prejudicial.
12
done" by F&E was false. The receipt of a subpoena, which the Defendants argue led F&E to
back away from their agreement, is highly probative of the answer to this question. The
subpoena could explain, for example, the reason F &E might have agreed to perform the audits
and then abruptly changed course.
But this Court also recognizes the potential for prejudice and the need to balance this
potential against the relevance of the evidence. Therefore, although this Court will permit the
Defendants to introduce evidence of the fact of a subpoena, the Defendants will not be allowed
to introduce evidence showing the subpoena came from the SEC. Receipt of a subpoena is
relevant, to the extent it motivated F&E to decline to perform an audit of AGF II. But the source
of the subpoena is of minimal relevance, and any relevance is substantially outweighed by the
risk of prejudice.
In sum, to the extent the SEC seeks to preclude evidence introduced to show "unclean
hands" or Privacy Act violations, its motion is GRANTED. To the extent the SEC seeks to
preclude any evidence related to its own actions, its motion is DENIED as premature. The SEC
has not explained what actions are at issue. The SEC is free to renew its objections to particular
evidence at trial.
B.
AGF II Defendants' Motions in Limine
1.
Motion I: Evidence Related to the Devor Supplemental Export Report
The AGF II Defendants first move to exclude portions of the supplemental expert report
prepared by Harris L. Devor. (AGF Defs. Mem. Supp., ECF No. 167, at 2.) 5 The AGF II
Defendants advance a number of arguments in support of that motion, although many of them
5 The AGF II Defendants also move to exclude portions of the original Devor expert report. This Court already
denied the AGF II Defendants ' motion to exclude portions of the original report, see SEC v. Am. Growth Funding II,
20 I&WL l l3JJ64, and the AGr II Defendants offer no reason for this Court to revisit its ecrrlier deGi5ion.
13
are not clear or developed. This Court views four arguments as appropriate for resolution.
Those arguments are addressed below.
1.
Materiality of an Audit
The AGF II Defendants argue Devor addressed the materiality of an audit to investors
"without any basis for the testimony." (AGF II Defs. Mem. Supp. at 6.) Devor stated the
following:
[I]n the absence of an audit conducted, and related audit report
prepared, in accordance with GAAS, investors may be left with no
assurance beyond that presented by management itself that the
financial information presented in subject financial statements
materially conforms with GAAP and is, therefore, free from
material misstatements or misrepresentations.
(Devor Suppl. Expert Rep., ECF No. 162-2, at 19.) The AGF II Defendants contend that
whether an audit is important to an investor is a factual question for the jury, and therefore Devor
should be precluded from testifying on this point. (AGF II Defs. Mem. Supp. at 6.) This
argument is not persuasive. Although an expert "may not give testimony stating ultimate legal
conclusions," he "may opine on an issue of fact within the jury's province." United States v.
Bilzerian, 926 F.2d 1285, 1294 (2d Cir. 1991). This is precisely what Devor does in the quoted
passage of his supplemental report. Furthermore, as this Court previously concluded, Devor' s
anticipated testimony as to the importance of an audit "will help the jury understand why an
investor would want to know that a company has had its financials audited." SEC v. Am. Growth
Funding II, 2018 WL 1135564, at *2.
To the extent the AGF II Defendants move to preclude Devor from testifying as to the
materiality of an audit to investors, their motion is DENIED.
11.
Ability of AGF to Repay its Loans
14
The AGF II Defendants next contend Devor "provides a completely inappropriate
opinion as to whether AGF LLC could repay its loans, a conclusion far beyond his assignment as
an expert on auditing procedures [] while he admits to no expertise in running a business like
AGF's business." (AGF II Mem. Supp. at 7.) This argument is also unpersuasive. It is well
within the purview of an auditor (or accountant) to evaluate accounts receivable, including
outstanding loans. Such an evaluation is necessary to determine the accuracy and completeness
of the financial statements provided to investors. Devor is thus qualified to opine as to whether
AGF could repay its loans. See Wechsler v. Hunt Health Sys., Ltd., 38.1 F. Supp. 2d 135, 143
(S.D.N.Y. 2003) (Leisure, J.) (concluding a certified public account with seventeen years of
experience was qualified to testify as to accounts receivable). The AGF II Defendants may
challenge Devor' s familiarity with "running a business like AGF ' s business," but this dispute
goes to the weight, not the admissibility of the testimony. See McCullock v. HB. Fuller Co., 61
F.3d 1038, 1043-1044 (2d Cir. 1995) (rejecting a challenge to the testimony of a qualified expert
as to the "breathing zone" of glue fumes, notwithstanding the expert' s alleged lack of "academic
training in fume dispersal and air quality studies," which was "properly explored on crossexamination").
To the extent the AGF II Defendants seek to exclude testimony as to whether-in
Devor's expert opinion-AGF could repay its loans, their motion is DENIED.
m.
Credibility of Defendant Johnson
The AGF II Defendants next argue Devor improperly commented on the credibility of
Defendant Johnson in two passages of the supplemental expert report. (AGF II Defs. Mem.
Supp. at 7.) First, the AGF II Defendants point to Devor's conclusion that "Johnson had never
previously prepared the required analysis to determine the quality, performance and collectability
15
of AGF LLC's loans to third parties in accordance with GAAP." (Devor Suppl. Expert Rep.
,r
42.) In this passage, however, Devor is not commenting on Johnson's credibility, but instead
stating that Johnson (and by extension AGF II) did not analyze their doubtful accounts in a way
consistent with GAAP. Devor is qualified to testify as to this opinion.
Second, the AGF II Defendants contend Devor impugns Johnson's credibility in
concluding "Johnson's assertions in deposition regarding the nature of the allowance recorded
and the related collectability of AGF LLC's loans to third parties are unfounded." But whether a
statement lacks credibility is separate from whether it lacks a factual foundation. In this passage,
Devor is commenting on whether a conclusion is supported by the facts, and this is properly the
subject of expert testimony.
This Court therefore DENIES the motion to exclude the cited passages of the
supplemental report.
1v.
Testimony of Lawrence Meri!
Finally, the AGF II Defendants argue Devor relies on "inadmissible testimony of nonparty witnesses" and "hearsay." (AGF II Defs. Mem. Supp. at 4.) The hearsay arguments the
AGF II Defendants advance are vague and conclusory. The AGF II Defendants do not point to
specific passages in the supplemental report as examples of inadmissible hearsay.
· Notwithstanding that lack of specificity, the Court notes that Devor's references to the deposition
testimony of Lawrence Meri!, who performed an audit of AGF II's 2015 financial statements, are
inadmissible hearsay.
"Experts can testify to opinions based on inadmissible evidence, including hearsay, if
'experts in the field reasonably rely on such evidence in forming their opinions."' United States
v. Mejia, 545 F.3d 179, 197 (2d Cir. 2008) (quoting United States v. Locascio, 6 F.3d 924, 938
16
(2d Cir. 1993)). "The expert may not, however, simply transmit hearsay to the jury .... [but]
must form his own opinions by 'applying his extensive experience and a reliable methodology'
to the inadmissible materials." Id. (quoting United States v. Dukagjini, 326 F.3d 45, 58 (2d Cir.
2003)). If the expert does not do so, he "is simply 'repeating hearsay evidence without applying
any expertise whatsoever,' a practice that allows the Government to 'circumvent the rules
prohibiting hearsay."' Id. (quoting Dukagjini, 326 F.3d at 58-59).
Devor's references to the deposition testimony of Meril simply repeat Meril's hearsay
testimony in an attempt to buttress Devor's expert opinion. For example, Devor states:
In concurrence with my opinion, Mr. Meril testified that he
determined Rotenberg Meril could not conduct an audit of the
Company's financial statements in accordance with GAAS without
evaluating the collectability of AGF LLC's receivables. (Meril, pp.
38-39).
Mr. Meril further testified that, after obtaining an
understanding of the operations of the Company and AGF LLC, he
determined "on day one with the engagement letter" that it was
necessary to "evaluate the status of the loans at AGF LLC" as a
component of Rotenberg Meril's audit of the Company's 2015
financial statements. (Meril, p. 38). Indeed, Mr. Meril agreed with
an assertion made by the Commission that Rotenberg Meril first had
to audit AGF LLC before it could conclude its audit of the Company,
as reflected in the following excerpt from Mr. Meril's deposition:
Q: First, you did the audit report for AGF LLC, right?
A: That's correct.
Q: And that's dated February 8th, 2018, right?
A: Yes.
Q: And then you did the audit report for AGF II for
2015, right?
A: That's correct.
Q: And did you do them in that order because before
you could do the audit report for AGF II, you needed
to figure out what the audit was going to be for the
entity that made the loans?
A: Correct.
17
Q: Because one audit's results, AGF LLC's, those
results would flow into the analysis for AGF II?
A: Correct. It would impact our analysis.
(Meril, p. 99).
(Devor Suppl. Expert Rep.
iI 31 .)
Devor is not applying his expertise here, and he is not relying
on hearsay evidence to form his own expert opinion. Instead, Devor is simply repeating hearsay
testimony. 6 The SEC, of course, is free to elicit Meril's live testimony at trial. 7 It cannot,
however, "circumvent the rules prohibiting hearsay" by having Devor repeat Meril's deposition
testimony. Mejia, 545 F.3d 179, 197 (quoting Dukagjini, 326 F.3d at 59).
This Court therefore GRANTS the motion. The portions of the supplemental expert
report that reference Meril's deposition testimony will not be admitted.
2.
Motion II: Evidence Related to SEC Investigative Testimony 8
The AGF II Defendants move to exclude as inadmissible hearsay sworn statements made
to SEC investigators during their investigation. (AGF II Defs. Mem. Supp. at 8-10.) A blanket
exclusion is inappropriate. The sworn statements qualify as hearsay only if offered to prove the
truth of the matter asserted. See Fed. R. Evid. (801)(c)(2). It is not yet clear for what purpose
the statements will be offered. For example, if a statement is used to impeach a witness or to
refresh a witness' s recollection, it may be admissible. See Fed. R. Evid. 801(d)(l), 803(5). The
Court also notes that two of the transcripts the AGF II Defendants seek to exclude are transcripts
of testimony from the AGF II Defendants' codefendants, Howard Allen and Kerri Wasserman.
6
Although only one example is provided here, this Court has reviewed all of the references to Meril ' s deposition
testimony in the supplemental expert report and finds each reference suffers from the same flaw.
7
This Court notes the SEC has not made any argument as to Meril's unavailability.
8
The " investigative testimony" the AGF II Defendants refer to includes affidavits, declarations, and transcripts of
sworn interviews the SEC obtained throughout the course of its investigation from both party and non-party
WitMMM.
18
Their testimony could be admissible on a number of different grounds, most obviously as
statements of party opponents. See Fed. R. Evid. 80l(d)(2)(A).
This Court therefore DENIES the motion without prejudice. The AGF II Defendants
may renew their objections at trial if the SEC attempts to use testimony for an impermissible
purpose.
3.
Evidence Related to Previous Arrest, Charges and Acquittal
Finally, the AGF II Defendants seek to preclude the SEC from introducing "any
evidence" related to Johnson's previous acquittal "for unrelated criminal charges." (AGF II
Defs. Mem. Supp. at 10.) The SEC, however, contends exclusion would be premature because
"the AGF Defendants have merely provided a conclusory one-paragraph statement without any
additional details or documentation to clarify the exact nature of the circumstances of such
alleged misconduct." (SEC Mem. Opp' n at 13.) In their reply, the AGF II Defendants do not
mention the nature or circumstances of the previous arrest, the charges against Johnson, or his
acquittal. Instead, the AGF II Defendants simply restate that "the SEC should be precluded from
offering any evidence related to Mr. Johnson's years old arrest and acquittal." (AGF Reply
Mem. Supp. at 5.)
This does not provide sufficient information for this Court to determine the admissibility
of evidence related to Johnson's previous arrest, the charges against him, or his acquittal. This
Court therefore agrees with the SEC that exclusion would be premature at this stage and
DENIES the motion without prejudice.
19
II.
CONCLUSION
This Order resolves docket numbers 166 and 168.
SO ORDERED.
Dated: New York, New York
December 4, 2018
KIMBA M. WOOD
United States District Judge
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