Securities and Exchange Commission v. Lek Securities Corporation et al

Filing 101

OPINION AND ORDER......Lek and Samuel Leks June 2, 2017 motion to dismiss the complaint is denied. (Signed by Judge Denise L. Cote on 8/25/2017) (gr)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
-------------------------------------- X
:
SECURITIES AND EXCHANGE COMMISSION,
:
:
Plaintiff,
:
:
-v:
:
LEK SECURITIES CORPORATION, SAMUEL
:
LEK, VALI MANAGEMENT PARTNERS d/b/a
:
AVALON FA LTD, NATHAN FAYYER, and
:
SERGEY PUSTELNIK a/k/a SERGE PUSTELNIK :
:
Defendants.
:
-------------------------------------- X

17cv1789 (DLC)
OPINION AND ORDER

APPEARANCES
For the Securities and Exchange Commission:
David J. Gottesman
Robert A. Cohen
Olivia S. Choe
Sarah S. Nilson
U.S. Securities and Exchange Commission
100 F Street N.E.
Washington, DC 20549
For Lek Securities Corporation and Samuel Lek:
Steve M. Dollar
David B. Schwartz
Norton Rose Fulbright US LLP
1301 Avenue of the Americas
New York, New York 10103
For Lek Securities Corporation and Samuel Lek:
Kevin J. Harnisch
Norton Rose Fulbright US LLP
799 9th Street N.W., Suite 1000
Washington, DC 20001-4501
DENISE COTE, District Judge:
Broker-dealer Lek Securities Corporation (“Lek”) and its
principal Samuel Lek (collectively “the Lek Defendants”) have

moved to dismiss the securities fraud action filed against them
by the Securities and Exchange Commission (“SEC”).

The SEC

alleges that these defendants participated in unlawful layering
and cross-market manipulation schemes.
In their motion to dismiss, the Lek Defendants do not
contend that the complaint’s allegations lack sufficient detail
to give them fair notice of the SEC’s theory of wrongdoing.
Instead, they principally argue that neither the layering nor
the cross-market trading described in the complaint can
constitute market manipulation in violation of federal
securities laws.

They are wrong.

For the following reasons,

the motion to dismiss is denied.
BACKGROUND
The following facts are taken from the complaint.
New York based registered broker-dealer.

Lek is a

It provides foreign

trading firms, including co-defendant Vali Management Partners
d/b/a Avalon FA LTD (“Avalon”), with access to U.S. securities
markets.

The conduct at issue in this case occurred in large

part through trading in the Avalon account at Lek (“Avalon
Account”).

Samuel Lek is Lek’s Chief Executive Officer and

Chief Compliance Officer.
Samuel Lek supervised his co-defendant Sergey Pustelnik
(“Pustelnik”), who referred foreign customers to Lek, including

2

Avalon.

Pustelnik later became a registered representative at

Lek and worked on the Avalon Account.

He received commissions

and other payments from Lek on Avalon’s trades through Lek.
Pustelnik is also alleged to be an undisclosed control
person of Avalon.

Pustelnik was significantly involved in

Avalon’s management and operations and shares in Avalon’s
revenue or profits with Avalon’s principal Nathan Fayyer
(“Fayyer”), who is also a named defendant in this action.
Avalon is a foreign day-trading firm that uses mostly
foreign traders based in Eastern Europe and Asia to conduct its
trading.

Avalon is not registered with the SEC.

Avalon’s sole disclosed owner and director.

Fayyer is

During the relevant

period, Fayyer oversaw Avalon’s trade groups and had authority
to restrict or terminate their trading in the Avalon Account.
The SEC’s allegations concern two schemes to manipulate
U.S. securities markets.

The first scheme involved Avalon’s use

of a trading strategy typically referred to as “layering” or
“spoofing.”

The second was a cross-market manipulation scheme.

Together, Avalon’s layering and cross-market manipulation
activity generated profits of more than $28 million.

Lek also

profited significantly from commissions and other fees it earned
from Avalon’s layering and cross-market manipulation activity.
Between 2012 and 2016, Avalon produced more commissions, fees,
and rebates for Lek than any other customer.
3

I.

The Layering Scheme

In the alleged layering scheme, Avalon placed “non-bona
fide orders” through Lek to buy or sell stock with the intent of
injecting false information into the market about supply or
demand for the stock.

The complaint characterizes non-bona fide

orders as orders that Avalon did not intend to execute and that
had no legitimate economic reason.

Avalon placed these orders

to trick and induce other market participants to execute against
orders that Avalon did intend to execute for the same stock on
the opposite side of the market, which the complaint describes
as its bona fide orders.

Through this scheme, Avalon obtained

more favorable prices on the executions of its bona fide orders
than otherwise would have been available.

Between December 2010

and September 2016 Avalon engaged in hundreds of thousands of
instances of layering, involving hundreds of securities traded
on U.S. exchanges.

The complaint describes three specific

instances of layering in detail.
As described by a trader who later became one of Avalon’s
trade group leaders in a 2012 email to Samuel Lek, layering is a
“special” trading strategy:
For example, the bid and ask of symbol X is 90.09 and
90.14, we put buy orders in 90.10, 90.11, 90.12, 90.13
and so on, then push the price to 90.20, right now the
bid and ask is 90.20 and 90.21, we put a big size
short order in 90.20 to get a short position, then we
cancel all of the buy orders in 90.10, 90.11, 90.12
and so on. And we put sell orders in 90.20, 90.19,
4

90.18, 90.17 and so on, to push the price to 90.05,
then put a big size buy order in 90.05 to cover
position, and cancel all of the sell orders . . so we
will put hundre[d]s of orders to push stock price and
then cancel them.
(Emphasis supplied.)
As described in the complaint, Samuel Lek had ample notice
that regulators considered layering a manipulative practice.
Indeed, in response to the email quoted above Samuel Lek stated,
“regulators have argued that your trading strategy ‘layering’ is
manipulative and illegal.

This is of concern to us even though

I do not agree with their position.”

Between 2012 and 2016,

regulators, exchanges, and other market participants repeatedly
notified the Lek Defendants that Avalon may be engaged in
manipulative layering through its trading at Lek.

In September

2012, the Financial Industry Regulatory Authority (“FINRA”)
informed Lek that Avalon’s trading “appears consistent with a
manipulative practice called layering.”

In July 2013, Bats

Global Markets exchange (“BATS”) advised the Lek Defendants that
it was seeing a “clear-cut cross-market layering strategy” by
Avalon, including “1,700 instances [of layering] over the last
two days.”

BATS later sent Lek a letter identifying specific

instances of Avalon’s layering activity.

Following these

communications, Lek stopped sending Avalon’s orders to BATS and
instead routed Avalon’s orders to other exchanges and venues.
In November 2013, a New York Stock Exchange (“NYSE”) Hearing
5

Board found that Lek had violated various exchange rules by,
among other things, failing to supervise and implement adequate
risk controls for trading strategies including spoofing and
layering.

The Lek Defendants continued to receive numerous

regulatory inquiries and warnings through 2016.

Samuel Lek and

others at Lek informed Pustelnik of a number of these
communications.
Fayyer was also well aware of the regulatory disapproval of
layering, or as he sometimes termed it, multi-key trading.

He

marketed Avalon to prospective traders as one of the few
remaining destinations willing to allow layering and touted
Avalon’s relationship with Lek, one of the only brokers that
still permitted layering.

For example, in March 2013, Fayyer

explained:
the broker is not a cheap one, but this is because
they do tolerate and protect us from many issues such
as multi-key trading, which is not allowed anywhere
pretty much anymore, and other dark pool and scalping
strategies which can be described as wash orders by
many other firms. So you get what you pay for here.
The Lek Defendants never instituted effective controls to
prevent layering from occurring, and quickly relaxed any
controls Lek did implement in response to Avalon’s, Fayyer’s,
and Pustelnik’s requests.

In February 2013, Lek implemented a

layering control that would block certain trading through its
proprietary Q6 program (“Q6 Control”).

6

The complaint asserts

that Q6 Control was “mere window-dressing.”

Q6 Control was

triggered when a trader traded or attempted to trade on both
sides of the market with a disproportionate number of orders on
one side.

The difference in the number of orders between the

two sides was referred to as the delta.
initially triggered by a delta of 10.
to relax the Q6 Control for Avalon.

Q6 Control was
Pustelnik encouraged Lek

On February 6, 2013,

Pustelnik urged a Lek officer to increase the delta on the
Avalon Account to 75.

Within a week of implementing Q6 Control,

Lek relaxed the delta on the Avalon Account to 100.

At all

times thereafter the delta on the Avalon Account remained
between 50 and 100.
II.

The Cross-Market Manipulation Scheme

In a cross-market manipulation scheme that it began to
execute in August 2012, Avalon purchased and sold U.S. stock at
a loss to move the prices of corresponding options, so that
Avalon could make a profit by trading those options at prices
that it would not otherwise have been able to obtain.

The

profits that Avalon achieved through its options trading more
than offset the losses it sustained on its allegedly
manipulative trading of stock.

The SEC alleges that Avalon

engaged in over 600 instances of cross-market manipulation
through Lek between August 2012 and December 2015.

7

The

complaint describes in detail a specific example of Avalon’s
cross-market manipulation activity.
The Lek Defendants and Pustelnik were well aware that
regulators objected to Avalon’s cross-market trading activity as
potentially manipulative.

For example, within a week of Avalon

initiating its cross-market strategy through Lek, FINRA advised
the Lek Defendants that it viewed the trading as potentially
manipulative.

In June 2014, FINRA again requested that Lek

“continue to review activity [of the cross-market strategy] and
address any potential manipulative activity involving both
option and stock trading in the same underlying effected by the
same account holder.”

Fayyer was also aware of regulatory

inquiries involving Avalon’s cross-market manipulation activity.
The Lek Defendants and Pustelnik not only permitted Avalon
to engage in cross-market manipulation activity through Lek but
took steps to advance it.

For instance, at the request of

Fayyer and Pustelnik, Lek undertook significant work and expense
to improve the speed of its options trading technology.
PROCEDURAL HISTORY
The SEC filed this action on March 10, 2017.

That same

day, it obtained an ex parte temporary restraining order (“TRO”)
against Avalon.

On March 29, the Court denied Avalon’s request

8

to modify the TRO.

SEC v. Lek Sec. Corp., 17cv1789 (DLC), 2017

WL 1184318 (S.D.N.Y. Mar. 29, 2017).
At a conference held with all of the parties on March 13, a
schedule was set for discovery and pretrial proceedings.

The

SEC and Avalon agreed to a preliminary injunction hearing to
begin on August 2.
On July 7, the SEC and Avalon filed their preliminary
injunction papers, which included the direct testimony of the
SEC’s hearing witnesses and its hearing exhibits.

Avalon

declined to offer any witnesses at the hearing, but presented
legal arguments in opposition to the motion.

On July 28, Avalon

withdrew its opposition to the SEC’s motion for a preliminary
injunction.

A July 31 preliminary injunction continued the

March 10 freeze of Avalon’s assets pending trial.
Meanwhile, the Lek Defendants filed this motion on dismiss
on June 2.

It became fully submitted on July 31.

Discovery in

this action is scheduled to conclude on May 18, 2018.
DISCUSSION
When deciding a motion to dismiss under Rule 12(b)(6), a
court must accept all factual allegations in the complaint as
true and draw all reasonable inferences in the non-moving
party’s favor.

Loginovskaya v. Batratchenko, 764 F.3d 266, 269–

70 (2d Cir. 2014).

“To survive a motion to dismiss under Rule

9

12(b)(6), a complaint must allege sufficient facts which, taken
as true, state a plausible claim for relief.”

Keiler v.

Harlequin Enters. Ltd., 751 F.3d 64, 68 (2d Cir. 2014).

A claim

has facial plausibility when the factual content of the
complaint “allows the court to draw the reasonable inference
that the defendant is liable for the misconduct alleged.”
Tongue v. Sanofi, 816 F.3d 199, 209 (2d Cir. 2016) (citation
omitted).

A complaint must do more, however, than offer “naked

assertions devoid of further factual enhancement.”

Ashcroft v.

Iqbal, 556 U.S. 662, 678 (2009) (citation omitted).
Rule 9(b) of the Federal Rules of Civil Procedure imposes a
heightened pleading standard on complaints alleging fraud.

ATSI

Commc’ns., Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir.
2007).

Under Rule 9(b), parties alleging fraud must “state with

particularity the circumstances constituting fraud.”
Civ. P. 9(b).

Fed. R.

“Malice, intent, knowledge, and other conditions

of a person’s mind,” however, “may be alleged generally.”

Id.

Because market manipulation claims can involve facts that are
“solely within the defendant’s knowledge,” the Second Circuit
has recognized that the plaintiff “need not plead manipulation
to the same degree of specificity as a plain misrepresentation
claim.”

ATSI, 493 F.3d at 102.

A plaintiff alleging market

manipulation need only “plead with particularity the nature,
purpose, and effect of the fraudulent conduct and the roles of
10

the defendants.”

Id.

The complaint must set forth, to the

extent possible, “what manipulative acts were performed, which
defendants performed them, when the manipulative acts were
performed, and what effect the scheme had on the market for the
securities at issue.”

Id. (citation omitted).

“General

allegations not tied to the defendants or resting upon
speculation are insufficient.”

Id.

The SEC asserts five claims against the Lek Defendants.1
First, the SEC alleges that the Lek Defendants violated § 20(e)
of the Securities Exchange Act of 1934 (“§ 20(e)” and “Exchange
Act”), 15 U.S.C. § 78t(e), by aiding and abetting Avalon’s,
Fayyer’s, and Pustelnik’s violations of § 10(b) of the Exchange
Act (”§ 10(b)”), 15 U.S.C. § 78j(b), and Rule 10b-5(a) and (c)
promulgated thereunder (“Rule 10b-5”), 17 C.F.R. § 240.10b-5(a)
and (c).

Second, the SEC alleges that the Lek Defendants

violated § 15(b) of the Securities Act of 1933 (“§ 15(b)” and
“Securities Act”), 15 U.S.C. § 77o(b), by aiding and abetting
Avalon’s, Fayyer’s, and Pustelnik’s violations of §§ 17(a)(1)
and (3) of the Securities Act (“§ 17(a)”), 15 U.S.C. §§
77q(a)(1) and (3).

Third, the SEC alleges that the Lek

Defendants violated § 20(e) by aiding and abetting Avalon’s
violations of § 9(a)(2) of the Exchange Act (“§ 9(a)(2)”), 15
As addressed below, they appear in claims 6, 8, 9, 3, and 11
of the SEC’s complaint.
1

11

U.S.C. § 78i(a)(2).

Fourth, the SEC alleges that the Lek

Defendants violated § 17(a)(3) of the Securities Act.

Finally,

the SEC alleges that Lek is liable for Pustelnik’s violations of
§ 10(b) and Rule 10b-5 under § 20(a) of the Exchange Act (“§
20(a)”), 15 U.S.C. § 78t(a).
In their motion to dismiss, the Lek Defendants largely make
blanket objections that apply across the board to each of the
five claims against them.

Those objections are addressed at the

conclusion of this Opinion.
objections.

They also make two claim-specific

The first is to the third claim described here: the

claim that they violated § 20(e) by aiding and abetting Avalon’s
violation of § 9(a)(2).

The second is to the claim against Lek

for its control of Pustelnik.

These components of the

defendants’ motion are addressed in the context of the
discussion of § 9(a)(2) and § 20(a).
III. Claim under § 20(e) of the Exchange Act for Aiding and
Abetting Avalon’s, Fayyer’s, and Pustelnik’s
Violations of § 10(b) and Rule 10b-5
Section 20(e) of the Exchange Act establishes liability for
those who aid and abet others in securities violations.
U.S.C. § 78t(e).

15

Section 20(e) provides:

any person that knowingly or recklessly provides
substantial assistance to another person in violation
of a provision of this chapter, or of any rule or
regulation issued under this chapter, shall be deemed
to be in violation of such provision to the same

12

extent as the person to whom such assistance is
provided.
15 U.S.C. § 78t(e) (emphasis supplied).

To survive a motion to

dismiss a claim of aiding and abetting liability, the SEC must
allege: “(1) the existence of a securities law violation by the
primary (as opposed to the aiding and abetting) party; (2)
knowledge of this violation on the part of the aider and
abettor; and (3) substantial assistance by the aider and abettor
in the achievement of the primary violation.”

SEC v. Apuzzo,

689 F.3d 204, 211 (2d Cir. 2012) (citation omitted).
Substantial assistance, in turn, requires that the aider and
abettor “in some sort associated himself with the venture, that
he participated in it as in something that he wished to bring
about, and that he sought by his action to make it succeed.”
Id. at 206 (citation omitted).
Section 10(b) and Rule 10b-5 thereunder prohibit
manipulative practices in connection with the purchase and sale
of securities.

Section 10(b) states:

It shall be unlawful for any person, directly or
indirectly, by the use of any means or instrumentality
of interstate commerce or of the mails, or of any
facility of any national securities exchange -. . .
(b) To use or employ, in connection with the purchase
or sale of any security registered on a national
securities exchange or any security not so registered,
or any securities-based swap agreement any
manipulative or deceptive device or contrivance in
13

contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate
in the public interest or for the protection of
investors.
15 U.S.C. § 78j(b) (emphasis supplied).
Rule 10b-5, in turn, provides in pertinent part:
It shall be unlawful for any person, directly or
indirectly, by the use of any means or instrumentality
of interstate commerce, or of the mails or of any
facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to
defraud,
. . .
(c) To engage in any act, practice, or course of
business which operates or would operate as a fraud or
deceit upon any person,
in connection with the purchase or sale of any
security.
17 C.F.R. § 240.10b-5 (emphasis supplied).
To prevail on a claim of market manipulation under § 10(b)
and Rule 10b-5, the SEC must demonstrate that the defendant
engaged in manipulative acts with scienter in connection with
the purchase or sale of securities on any facility of a national
securities exchange.

Unlike private plaintiffs, the SEC is not

required to prove investor reliance, loss causation, or damages.
SEC v. Boock, 09cv8261 (DLC), 2011 WL 3792819, at *21 (S.D.N.Y.
Aug. 25, 2011); SEC v. Credit Bancorp, Ltd., 195 F. Supp. 2d
475, 490–91 (S.D.N.Y. 2002).

14

In determining whether an act is manipulative, the Second
Circuit requires “a showing that an alleged manipulator engaged
in market activity aimed at deceiving investors as to how other
market participants have valued a security.”

Wilson v. Merrill

Lynch & Co., Inc., 671 F.3d 120, 130 (2d Cir. 2011) (citation
omitted).

“The gravamen of manipulation is deception of

investors into believing that prices at which they purchase and
sell securities are determined by the natural interplay of
supply and demand, not rigged by manipulators.”
omitted).

Id. (citation

In determining whether activity falls outside the

natural interplay of supply and demand, courts generally
consider whether it sends “a false pricing signal to the
market.”

Id. (citation omitted).

While market manipulation has traditionally encompassed
practices such as wash sales, matched orders, or rigged prices,
manipulation is not limited to these practices.

Id.

It more

broadly includes those practices “that are intended to mislead
investors by artificially affecting market activity.”
(citation omitted).

Id.

For instance, the Second Circuit has noted

that “trading engineered to stimulate demand can mislead
investors into believing that the market has discovered some
positive news and seeks to exploit it; the duped investors then
transact accordingly.”

ATSI, 493 F.3d at 101.

15

In considering whether an act injects false pricing signals
into the market, courts recognize that one of the fundamental
goals of the federal securities laws is to promote transparency
-- that is, “to prevent practices that impair the function of
stock markets in enabling people to buy and sell securities at
prices that reflect undistorted (though not necessarily
accurate) estimates of the underlying economic value of the
securities traded.”

Id. at 100 (citation omitted).

As the

Supreme Court has repeatedly recognized, the “fundamental”
purpose of the securities laws is “to substitute a philosophy of
full disclosure for the philosophy of caveat emptor.”

Santa Fe

Indus., Inc. v. Green, 430 U.S. 462, 477 (1977) (citation
omitted); see Basic Inc. v. Levinson, 485 U.S. 224, 230 (1988).
In passing securities laws, “Congress meant to prohibit the full
range of ingenious devices that might be used to manipulate
securities prices.”

Santa Fe Indus., 430 U.S. at 477.

Market manipulation can be accomplished through otherwise
legal means.

As the Second Circuit has noted, “in some cases

scienter is the only factor that distinguishes legitimate
trading from improper manipulation.”

ATSI, 493 F.3d at 102.

Nor does manipulative conduct need to be successful in order to
violate the securities laws.

As the D.C. Circuit has noted,

“intent -- not success -- is all that must accompany
manipulative conduct to prove a violation of the Exchange Act.”
16

Koch v. SEC, 793 F.3d 147, 153-54 (D.C. Cir. 2015); see also
United States v. Weaver, 860 F.3d 90, 97 (2d Cir. 2017)
(rejecting argument that liability under criminal mail and wire
fraud statutes required fraudulent scheme to be successful).
At least one district court has found that a complaint
against defendants engaged in layering sufficiently alleged
manipulative conduct in violation of § 10(b) and Rule 10b-5.

CP

Stone Fort Holdings, LLC v. Doe(s), No. 16 C 4991, 2017 WL
1093166, at *4 (N.D. Ill. Mar. 22, 2017).

Another district

court has accepted a plea agreement in which a defendant engaged
in layering pled guilty to a conspiracy to commit securities
fraud in violation of 18 U.S.C. § 371.

Plea Agreement, United

States v. Milrud, No. 2:15-cr-00455-JLL (D.N.J. Sept. 10, 2015).
The SEC has consistently found layering and spoofing activity to
violate § 10(b) and Rule 10b-5.

See In the Matter of the

Application of Terrance Yoshikawa for Review of Disciplinary
Action Taken by NASD, SEC Release No. 53731, 87 S.E.C. Docket
2580, 2006 WL 1113518, at *7 n.36 (Apr. 26, 2006) (describing
the SEC’s history since 1998 of finding spoofing/layering to
violate § 10(b) and Rule 10b-5).
Liability for securities fraud under § 10(b) and Rule 10b-5
also requires proof of scienter, which the Supreme Court has
defined as an “intent to deceive, manipulate or defraud” or
“knowing or intentional misconduct.”
17

Ernst & Ernst v.

Hochfelder, 425 U.S. 185, 194 n.12, 197 (1976); see Grandon v.
Merrill Lynch & Co., 147 F.3d 184, 194 (2d Cir. 1998).

The

Second Circuit has held that reckless conduct -- i.e. “conduct
which is highly unreasonable and which represents an extreme
departure from the standards of ordinary care” -- satisfies the
scienter requirement.

SEC v. Obus, 693 F.3d 276, 286 (2d Cir.

2012) (citation omitted).
insufficient.

Id.

Mere negligence, however, is

“Proof of scienter need not be direct, but

may be a matter of inference from circumstantial evidence.”
Wechsler v. Steinberg, 733 F.2d 1054, 1058 (2d Cir. 1984)
(citation omitted).
The SEC has adequately alleged that the Lek Defendants
violated § 20(e) by aiding and abetting Avalon’s, Fayyer’s, and
Pustelnik’s violations of § 10(b) and Rule 10b-5.

The complaint

alleges primary violations of § 10(b) and Rule 10b-5 by Avalon,
Fayyer, and Pustelnik with particularity.

It describes at

length and in detail two manipulation schemes, either one of
which if proven at trial would violate § 10(b).

The complaint

is also replete with allegations of scienter by Avalon, Fayyer,
and Pustelnik.
The SEC also adequately pleads the Lek Defendants’
knowledge of Avalon’s manipulative activity and substantial
assistance.

The Lek Defendants received multiple warnings

concerning Avalon’s layering and cross-market manipulation
18

activity.

The activity at issue was conducted in large part

through the Avalon Account.

In addition, the Lek Defendants

actively facilitated Avalon’s layering and cross-market
manipulation activity by relaxing Q6 Control for Avalon and
upgrading Lek’s options trading technology in response to
Fayyer’s request.
IV.

Claim under § 15(b) of the Securities Act for Aiding
and Abetting Avalon’s, Fayyer’s, and Pustelnik’s
Violations of § 17(a)(1) and § 17(a)(3)

Section 15(b) of the Securities Act likewise establishes
aiding and abetting liability.

15 U.S.C. § 77o(b).

It

provides:
For purposes of any action brought by the Commission
under subparagraph (b) or (d) of section 77t of this
title, any person that knowingly or recklessly
provides substantial assistance to another person in
violation of a provision of this subchapter, or of any
rule or regulation issued under this subchapter, shall
be deemed to be in violation of such provision to the
same extent as the person to whom such assistance is
provided.
15 U.S.C. § 77o(b) (emphasis supplied).

Because the operative

language in § 15(b) is nearly identical to that in § 20(e), the
standard for aiding and abetting liability is the same under
both statutes.

See, e.g., SEC v. Wey, 15cv7116 (PKC), 2017 WL

1157140, at *21 (S.D.N.Y. Mar. 27, 2017).
Section 17(a) of the Securities Act prohibits fraud in the
offer or sale of a security, and provides in pertinent part:

19

(a) Use of interstate commerce for purpose of fraud or
deceit
It shall be unlawful for any person in the offer or
sale of any securities . . . by the use of any means
or instruments of transportation or communication in
interstate commerce or by use of the mails, directly
or indirectly
(1) to employ any device, scheme, or artifice to
defraud, or
. . .
(3) to engage in any transaction, practice, or course
of business which operates or would operate as a fraud
or deceit upon the purchaser.
15 U.S.C. § 77q(a) (emphasis supplied).
To plead a violation of § 17(a), the SEC must allege that
the defendant engaged in manipulative acts in connection with
the offer or sale of securities.

See SEC v. Pentagon Capital

Mgmt. PLC, 725 F.3d 279, 285 (2d Cir. 2013).

Scienter is a

required element for a violation of § 17(a)(1).
446 U.S. 680, 697 (1980).
however, under § 17(a)(3).

Aaron v. SEC,

No showing of scienter is required,
Id.; Pentagon Capital, 725 F.3d 279

at 285.
For the reasons stated above, the SEC adequately alleges
that the Lek Defendants violated § 15(b) of the Securities Act
by aiding and abetting Avalon’s, Fayyer’s, and Pustelnik’s
violations of §§ 17(a)(1) and 17(a)(3) of the Securities Act.
The Lek Defendants’ motion to dismiss this claim is also denied.

20

V.

Claim under § 20(e) of the Exchange Act for Aiding and
Abetting Avalon’s Violations of § 9(a)(2)

The governing standard regarding § 20(e) is recited above.
Section 9(a)(2) prohibits a series of securities transactions
that create active trading in a security, or raise or depress
the price of a security, for the purpose of inducing others to
purchase or sell the security.

15 U.S.C. § 78i(a)(2).

It

provides:
(a) Transactions relating to purchase or sale of
security
It shall be unlawful for any person, directly or
indirectly, by the use of the mails or any means or
instrumentality of interstate commerce, or of any
facility of any national securities exchange, or for
any member of a national securities exchange -. . .
(2) To effect, alone or with 1 or more other persons,
a series of transactions in any security registered on
a national securities exchange, any security not so
registered, or in connection with any security-based
swap or security-based swap agreement with respect to
such security creating actual or apparent active
trading in such security, or raising or depressing the
price of such security, for the purpose of inducing
the purchase or sale of such security by others.
Id. (emphasis supplied).

Section 9(a)(2), of course, does not

proscribe all market transactions that raise or lower the price
of a security.

Chris-Craft Indus., Inc. v. Piper Aircraft

Corp., 480 F.2d 341, 383 (2d Cir. 1973).

Rather, its purpose is

to “outlaw every device used to persuade the public that
21

activity in a security is the reflection of a genuine demand
instead of a mirage.”

Crane Co. v. Westinghouse Air Brake Co.,

419 F.2d 787, 794 (2d Cir. 1969) (citation omitted).
Courts have held that a “series of transactions” includes
not only completed purchases or sales but also bids and orders
to purchase or sell securities.

See SEC v. Malenfant, 784 F.

Supp. 141, 145 (S.D.N.Y. 1992); Spicer v. Chicago Bd. Options
Exch., Inc., No. 88 C 2139, 1990 WL 172712, at *2 (N.D. Ill.
Oct. 30, 1990), aff’d sub nom. Spicer v. Chicago Bd. of Options
Exch., Inc., 977 F.2d 255 (7th Cir. 1992).

In considering the

legislative history of § 9(a)(2), the SEC has concluded that
Congress “clearly intended its prohibition against manipulation
to extend beyond the actual consummation of purchases or sales.”
In the Matter of Kidder Peabody & Co., et al., SEC Release No.
3673, 18 S.E.C. 559, 1945 WL 332559, at *8 (Apr. 2, 1945); see
In the Matter of Biremis, 105 S.E.C. 862, 2012 WL 6587520, at *2
(Dec. 18, 2012); Lewis D. Lowenfels, Sections 9(a)(1) and
9(a)(2) of the Securities Exchange Act of 1934: An Analysis of
Two Important Anti-Manipulative Provisions Under the Federal
Securities Laws, 85 NW. U. L. Rev. 698, 707–08 (1991).

Proof of

a violation of § 9(a)(2) requires evidence of “manipulative
motive and willfulness,” which are normally inferred from the
circumstances of the case.

Crane Co., 419 F.2d at 794.

22

The SEC adequately alleges that the Lek Defendants violated
§ 20(e) by aiding and abetting Avalon’s violations of § 9(a)(2).
The SEC alleges a primary violation by Avalon through the series
of securities transactions in which it conducted both its
layering and cross-market trading schemes.

Each of these

schemes was designed to create a false impression of supply or
demand for securities and to induce other market participants to
purchase or sell securities.

As previously described, the SEC

also adequately alleges that the Lek Defendants had knowledge of
Avalon’s layering and cross-market activities and provided
Avalon substantial assistance.
In a claim-specific objection, the Lek Defendants argue
that the complaint fails to allege a primary violation of §
9(a)(2) in connection with the layering scheme because cancelled
bids and offers are not “transactions.”

As previously

described, courts and regulators have found that a “series of
transactions” that create “actual or apparent” active trading
encompasses not only executed trades but also bids and orders to
purchase or sell securities.

The Lek Defendants’ motion to

dismiss this claim is denied.
VI.

Claim under § 17(a)(3) of the Securities Act

The complaint also alleges that the Lek Defendants
themselves violated § 17(a)(3) of the Securities Act.

23

Section

17(a)(3) and the relevant standards for applying that law have
already been described.
The SEC has adequately alleged that the Lek Defendants
themselves engaged in a course of business that operated as a
fraud.

They provided Avalon with access to U.S. securities

markets, thereby enabling Avalon to conduct its layering and
cross-market trading schemes.

The Lek Defendants’ motion to

dismiss this claim is denied.
VII. Claim under § 20(a) of the Exchange Act
The final claim at issue here is the claim that Lek
controlled Pustelnik and is liable for his violations of § 10(b)
and Rule 10b-5.

Section 20(a) of the Exchange Act imposes

derivative liability on entities that control individuals who
violate the Exchange Act.

In re Vivendi, S.A. Sec. Litig., 838

F.3d 223, 238 n.6 (2d Cir. 2016).

It provides:

(a) Joint and several liability; good faith defense
Every person who, directly or indirectly, controls any
person liable under any provision of this chapter or
of any rule or regulation thereunder shall also be
liable jointly and severally with and to the same
extent as such controlled person to any person to whom
such controlled person is liable (including to the
Commission in any action brought under paragraph (1)
or (3) of section 78u(d) of this title), unless the
controlling person acted in good faith and did not
directly or indirectly induce the act or acts
constituting the violation or cause of action.
15 U.S.C. § 78t(a) (emphasis supplied).

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The statutory language identifies two components to a
control person claim: (1) a primary violation by a controlled
person and (2) direct or indirect control of the primary
violator by the defendant.
defense of good faith.

It also provides for an affirmative

The concept of “culpable participation,”

which is a regular fixture of the Second Circuit’s
jurisprudence, describes that degree of control which is
sufficient to render a person liable under § 20(a).

In re

WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 392, 415 (S.D.N.Y.
2003); cf. Fed. Hous. Fin. Agency v. Nomura Holding Am., Inc.,
104 F. Supp. 3d 441, 575-78 (S.D.N.Y. 2015) (analyzing trial
evidence of the nature of the controlled entity, the status of
the alleged controlling entity, and the actions taken by the
controlling entity on behalf of the controlled entity) (Section
15 of the Securities Act).

“[T]here is no required state of

mind for a defendant’s culpable participation in a Section 20(a)
offense.”

In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d at

415; see In re WorldCom, Inc. Sec. Litig., 02cv3288 (DLC), 2005
WL 638268, at *13 (S.D.N.Y. Mar. 21, 2005).
Control over a primary violator may be established by
showing that the defendant possessed “the power to direct or
cause the direction of the management and policies of the
primary violators, whether through the ownership of voting
securities, by contract, or otherwise.”
25

In re Lehman Bros.

Mortg.-Backed Sec. Litig., 650 F.3d 167, 185 (2d Cir. 2011)
(citation omitted).

Once the plaintiff makes out a prima facie

case of liability under § 20(a), the burden shifts to the
defendant “to show that he acted in good faith, and that he did
not directly or indirectly induce the act or acts constituting
the violation.”

SEC v. First Jersey Sec., Inc., 101 F.3d 1450,

1473 (2d Cir. 1996) (citation omitted).
The SEC adequately pleads its claim under § 20(a).

The SEC

has alleged primary violations of § 10(b) and Rule 10b-5 by
Pustelnik.

The SEC also adequately alleges that Lek exercised

control over Pustelnik.

The complaint alleges that Pustelnik

became a registered representative at Lek, that Samuel Lek
supervised Pustelnik, and that Pustelnik received commissions
and other payments from Lek on the trades that Avalon placed
through Lek.
In response, Lek principally contends that the SEC fails to
allege it controlled Pustelnik because Pustelnik acted outside
the scope of his employment, operated as a secret owner of
Avalon, and lied to Lek about Avalon’s layering activity.

This

argument does not suggest that the pleading of control person
liability is inadequate.

Instead, it describes a defense of

good faith that Lek will have the opportunity to present at
trial.

Lek’s motion to dismiss this claim is denied.

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VIII. The Lek Defendants’ General Arguments
In their motion to dismiss, the Lek Defendants principally
present arguments addressed to the SEC’s overarching theory of
liability.

They argue that Avalon’s layering and cross-market

trading activity do not constitute market manipulation.

With

respect to Avalon’s layering activity, they argue that even
Avalon’s non-bona fide orders were “live, real, and actionable”
orders that were subject to market risk and therefore could not
create a false impression of supply and demand or send a false
pricing signal.

They contend that the “logical inference” from

the alleged facts is that Avalon wanted its bids and offers
executed.

Likewise, the Lek Defendants argue that Avalon’s

cross-market trading activity did not inject false information
into the market because the trading involved “real buyers” and
was “reactive” to bids and offers for stock and options placed
by others in the market.

They argue as well that Avalon’s stock

trades were undertaken to hedge its risk from its options
trading.
These arguments largely present factual assertions which
are inappropriate for a motion to dismiss.

This is particularly

true when it comes to the intentions of either the Avalon
defendants or the Lek Defendants.

The complaint contains

sufficiently detailed allegations to support its assertions as
to each defendant’s mens rea.

Whether the SEC will present
27

sufficiently compelling evidence of scienter and whether any
defendant offers a credible defense on this ground must await
trial.
To the extent that the Lek Defendants argue that the entry
of an order in the open market may never constitute manipulative
conduct, they are wrong.
the mark.

Moreover, this argument largely misses

It ignores the thrust of the SEC’s claim, which

concerns coordinated patterns of trading, indeed voluminous
trading, designed to mislead the market.
The Lek Defendants’ argument regarding the legality of
Avalon’s trading also overlooks the SEC’s substantial
allegations of manipulative intent.

As the Second Circuit has

recognized, manipulative conduct may appear perfectly legal on
its face.

“[I]n some cases scienter is the only factor that

distinguishes legitimate trading from improper manipulation.”
ATSI, 493 F.3d at 102.

Here, the complaint is replete with

allegations of scienter.2
The Lek Defendants next argue that the SEC fails to allege
their scienter in connection with the aiding and abetting
claims.

They emphasize that Lek implemented Q6 Control and deny

The Lek Defendants do not argue that the complaint fails to
plead scienter with respect to Avalon, Fayyer, and Pustelnik.
They briefly argue, however, that it fails to plead the scienter
of Avalon’s day traders. The SEC claims that Avalon, Fayyer,
and Pustelnik are the principals who have violated § 10(b). It
is facts supporting their liability under the securities laws
that must be pleaded, and the complaint meets that burden.
2

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that it was mere window-dressing, despite the complaint’s
factual allegations that support its characterization that it
was only that.

They also point out that they were assured by

Pustelnik that Avalon was not engaged in manipulative conduct.
They assert as well that the receipt of regulatory inquiries is
insufficient to show scienter.

Again, these factual arguments

may be raised at trial; they do not suggest that the pleading is
deficient.

The SEC will have the burden of proving that the Lek

Defendants acted with the requisite scienter, and the defendants
may contest that evidence.

All that matters at this stage is

whether the complaint meets the requirements imposed by Rule
9(b), and it does.
Finally, the Lek Defendants argue that the SEC fails to
plead that they provided substantial assistance to Avalon.

They

represent that the brokerage services that they provided to
Avalon were “routine services” that broker-dealers regularly
provide to all customers.

Providing brokerage services -- and

with those services entrée to U.S. securities markets -constitutes substantial assistance to a market manipulator.
See, e.g., Graham v. SEC, 222 F.3d 994, 1004 (D.C. Cir. 2000).
If done with the requisite knowledge, it is a violation of §§
20(e) and 15(b).

In any event, the complaint also describes

other acts taken specifically by the Lek Defendants to
substantially assist Avalon’s schemes.
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CONCLUSION
Lek and Samuel Lek’s June 2, 2017 motion to dismiss the
complaint is denied.
Dated:

New York, New York
August 25, 2017
________________________________
DENISE COTE
United States District Judge

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