Securities and Exchange Commission v. Locke Capital Management, Inc. et al

Filing 69

OPINION AND ORDER granting 41 Motion for Default Judgment against Locke Capital Management, Inc. in the amount of $7,569,904.00; Further, Locke Capital Management, Inc. is enjoined from future securities law violations; Judgment will enter at the conclusion of this case, once the SEC's claims against non-defaulting Defendant Jenkins have been resolved. So Ordered by Judge William E. Smith on 7/21/10. (Jackson, Ryan)

Securities and Exchange Commission v. Locke Capital Management, Inc. et al

Doc. 69

UNITED STATES DISTRICT COURT DISTRICT OF RHODE ISLAND ____________________________________ ) SECURITIES AND EXCHANGE COMMISSION, ) Plaintiff, ) ) vs. ) ) LOCKE CAPITAL MANAGEMENT, INC. and ) LEILA C. JENKINS, ) Defendants. ) ____________________________________)

C.A. No. 09-100 S

OPINION AND ORDER WILLIAM E. SMITH, United States District Judge. Defendant Locke Capital Management, Inc. ("Locke")

defaulted in this matter on March 15, 2010. Securities and Exchange Commission (the

The United States or the

"Commission"

"SEC") now seeks the entry of a default judgment against Locke imposing injunctive relief and damages. The Commission's Motion

is granted, and the Court will enter judgment against Locke according to the terms set forth below. I. Standard for default and allegations "When a court enters a default judgment against a

defendant, all allegations in the complaint must be taken as true." McKinnon v. Kwong Wah Rest., 83 F.3d 498, 506 n.5 (1st In this

Cir. 1996) (quotation marks and citation omitted).

case, the Commission alleges that Locke, an investment advisory

Dockets.Justia.com

firm, committed multiple violations of federal securities laws in furtherance of a fraudulent scheme. Specifically, Locke

fabricated a massive Swiss banking client to drum up business among potential investors. Locke's apparent assets This had the effect of inflating management far beyond reality.

under

(See generally Compl. ¶¶ 11-25, C.A. No. 09-100 S, Doc. No. 1, Mar. 9, 2009). In marketing materials, Locke touted how much Locke

money the fictitious client had placed in Locke's care.

also falsified numerous records and SEC filings to document the sham customer. Then, when asked to back up its claims about the (See id. ¶¶ 26-29.)

phony bank, Locke lied to investigators. II.

Conclusions of law as to Locke's liability After default, favor the on Court may grant a judgment by in the

plaintiff's

all

claims

supported

"well-pleaded

allegations in [the] . . . complaint." F.2d 148, 153 (1st Cir. 1976). The Commission requests a

Eisler v. Stritzler, 535

finding

that

Locke

violated

numerous provisions of the Investment Advisers Act of 1940 (the "Advisers Act"), as well as the anti-fraud provisions of the Securities Exchange Act of 1934 (the "Exchange Act") and the Securities Act of 1933 (the "Securities Act"). that the well-pleaded allegations in the The Court finds Complaint easily

establish the alleged breaches of the anti-fraud, bookkeeping,

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reporting, and advertising regulation provisions of the Advisers Act, and of rules promulgated thereunder. See 15 U.S.C. §§ 80b-

3, 80b-4, 80b-4A, 80b-6, 80b-7 (2010); 17 C.F.R. §§ 275.2042(a), 275.204A-1, 275.206(4)1-3 (2010). At first blush, the Exchange Act claims appear to be a closer call. Section 10(b) of the Exchange Act, and Rule 10b-5

promulgated thereunder, only prohibit fraud "in connection with" the purchase or sale of securities. 77q(a); 17 C.F.R. § 240.10b-5. "touch" or "coincide with" a See 15 U.S.C. § 78j(b), §

This means that the fraud must securities transaction. See

Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 85 (2006); Superintendent of Ins. of N.Y. v. Bankers Life & Cas. Co., 404 U.S. 6, 12-13 (1971). The bulk of Locke's alleged

lies related to hawking investment advice, not securities or trades; thus, unlike in cases involving issuers or broker-

dealers, here there is an extra step between the fraud and the trading.1 In fact, in the cases cited by the Commission, as well as other cases involving Exchange Act violations by investment advisors and financial consultants, the fraud related to either specific trading practices or specific securities. See S.E.C. v. K.W. Brown & Co., 555 F. Supp. 2d 1275, 1304-06 (S.D. Fla. 2007) (finding a § 10(b) violation where investment advisers stated they would "not utilize client[s'] funds" to trade on behalf of themselves, but did in fact use client funds to "place[] numerous buy and sell orders for securities" for their own benefit); S.E.C. v. Rana Research, Inc., 8 F.3d 1358, 1362
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Nevertheless, the Complaint here also reveals a sufficient link to purported and intended securities trades to satisfy the "in connection with" requirement. allegedly falsified "trade As part of the charade, Locke data." (Compl. ¶ 21.)

execution

Although those "trades" were of course not real, the alleged purpose of the scheme was attracting actual money to be invested by Locke in securities. (See id. ¶ 19.) Together, these

allegations demonstrate that the fraud "touched" upon securities transactions. See Bankers Life, 404 U.S. at 12-13. The fact

that the "in connection with" requirement "should be construed flexibly" reinforces this conclusion. U.S. 813, 813-14 (2002). Accordingly, the Commission has also demonstrated S.E.C. v. Zandford, 535

violations of the anti-fraud provisions of the Exchange Act, as well as § 17(b) of the Securities Act.2

(9th Cir. 1993) (finding § 10(b) liability based on fraud about a specific transaction); S.E.C. v. Pirate Investor LLC, 580 F.3d 233, 237-38 (4th Cir. 2009) (finding a § 10(b) violation based on fraud about a particular stock). Section 17(b) only applies to fraud "in the offer or sale of any securities." 15 U.S.C. § 77q(a). However, courts treat this language even more flexibly than the terms of § 10(b). See Pinter v. Dahl, 486 U.S. 622, 643 (1988) (explaining that the terms "offer" and "sell" are "expansive enough to encompass the entire selling process"). The Commission has thus carried its burden on this claim as well.
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III. Remedy A. Damages

In assessing damages pursuant to a default, if the claim is not for a "sum certain or a sum that can be made certain by computation," Rule 55(b) provides that a court can "conduct

hearings" to "determine the amount of damages" payable pursuant to a default judgment. Fed. R. Civ. P. 55(b)(2). Even in cases

not involving a "sum certain," the First Circuit allows district courts discretion to forego damages hearings in some

circumstances.

See KPS & Assocs., Inc. v. Designs By FMC, Inc.,

318 F.3d 1, 21 (1st Cir. 2003) (observing that hearings may not be necessary when a court is "intimately familiar" with the facts and may calculate damages from "documents of record," or when "inundated by with opposing In this affidavits, counsel") case, the evidence, (quotation and marks oral and

presentations citation

omitted).

Commission's

proposed

judgment was unopposed, but the Court did hold a hearing to question the Commission about the appropriateness of the

requested damages.

The Commission's presentation, together with

the evidence submitted as part of its Motion, provide the Court with sufficient information to assess a penalty. The Court has discretion to order disgorgement of fees

earned in connection with securities fraud.

See S.E.C. v. Happ,

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392 F.3d 12 (1st Cir. 2004).

"The amount of disgorgement need

only be a reasonable approximation of profits causally connected to the violation." citation omitted). Id. at 31 (internal quotation marks and The Commission seeks disgorgement of

$1,781,520 in fees that it claims Locke collected as a result of the hoax, plus prejudgment interest. it provides at an the affidavit Commission, calculated from In support of the request, C. Huntington, he has senior

Frank

counsel Locke's

explaining the

that

reviewed since it

books

and

company's

profits

perpetrated the fraud.

(See Declaration of Frank C. Huntington, The Commission also interest at the tax

Apr. 6, 2010 ("Huntington Decl.") ¶ 4.) submits a chart tabulating prejudgment

underpayment rate, which amounts to $110,956. Ex. A.)

(See id. ¶ 5 &

These materials are adequate to demonstrate that Locke

should pay $1,892,476 as a "reasonable approximation" of what it owes in disgorgement. The Court also has discretion to impose civil penalties under each of the securities laws Locke violated. Infractions

that involve "fraud, deceit, [or] manipulation" trigger "second tier" sanctions. See, e.g., Section 209(e) of the Advisers Act, For each such violation, corporations

15 U.S.C. § 80b-9(e).

face penalties of no more than the greater of $325,000 or "the gross amount of pecuniary gain." See id.; 17 C.F.R. Pt. 201,

6

Subpt. E, Tbl. III (providing tax-adjusted penalties).

Schemes

that also "created a significant risk of substantial losses to other persons" lift offenders to the "third tier" for fines. U.S.C. § 80b-9(e). but still This caps raises the the default at assessment the amount 15 to of

$650,000,

maximum

disgorgement if that is greater. C.F.R. Pt. 201, Subpt. E, Tbl. III. For amount of either a secondor

See 15 U.S.C. § 80b-9(e); 17

third-tier exceed the

violation, default to

Locke's

disgorgement Therefore, it

would is

recommended whether risk of

penalty. Locke's

not

necessary to a

decide

scheme

exposed

others

"significant

substantial losses" to ascertain the maximum fine. 80b-9(e).

15 U.S.C. §

Since the Complaint adequately sets forth six counts

for relief, each detailing a separate violation (and in some cases, multiple violations each), at a minimum Locke's exposure exceeds $10 million. Whether Locke created a substantial risk of loss to others, however, is still one of the factors to consider in setting a fine. 421, See S.E.C. v. Aragon Capital Mgmt., LLC, 672 F. Supp. 2d 447 (S.D.N.Y. of the 2009). defendant's Other factors and include the degree the of

egregiousness

conduct

scienter the conduct suggested. not only lied to investors

See id. how

In this matter, Locke much business it was

about

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getting, but conjured a phantom client out of forged records. Worse, it then misled investigators to cover its tracks. In

light of those facts, the absence of allegations showing Locke actually endangered clients' investments (for instance, by

giving faulty trading tips, or inflating the value of a security based on false information) carries little mitigating effect. Accordingly, a severe penalty is in order, although not the maximum amount. In most decisions dealing with circumstances like these, in which the defendant committed multiple violations warranting

second- or third-tier penalties, courts do not exact the maximum fee. to Instead, they select an intermediate punishment sufficient the remedial purposes of securities laws. See

fulfill

Aragon, 672 F. Supp. 2d at 449 ("The Commission seeks . . . three times the illegal profits that [the defendants] obtained. In my judgment, a civil penalty equal to two times the illegal profits . . . is more than sufficient to accomplish the

statute's purpose."); S.E.C. v. Colonial Inv. Mgmt. LLC, 659 F. Supp. 2d 467, 503 (S.D.N.Y. 2009) (finding that the defendant "should be subject to a severe penalty, but not the maximum one," and thus imposing penalties "in the amount of $25,000 per violation" out of a maximum of $60,000, "totaling $450,000"); S.E.C. v. Abellan, 674 F. Supp. 2d 1213, 1222 (W.D. Wash. 2009)

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(imposing

a

$480,000

civil

penalty

and

disgorgement

of

$15,403,703); S.E.C. v. Aimsi Techs., Inc., 650 F. Supp. 2d 296, 308 (S.D.N.Y. 2009) ("Since [t]he exact number of violations committed by the Defendants is nearly impossible to determine . . . the Court imposes . . . third-tier civil penalt[ies] against [the defendants] equal to [their] pecuniary gain.") (internal quotation marks and citations omitted). The Court here adopts the same approach. It therefore

finds that Locke should pay $5,677,428 in civil damages, an amount equal to three times the disgorgement it owes. B. Injunctive relief

Each of the laws that Locke flouted authorizes permanent injunctions in cases where there is a "reasonable likelihood of recidivism." 2003). S.E.C. v. Sargent, 329 F.3d 34, 39 (1st Cir.

As the Commission points out, Locke lied to clients for

years, and then to the Commission itself when confronted with questions (which, about its must assets be under as the management. true for These facts of is the a

again,

taken

purposes there

Commission's

motion)

convince

Court

that

reasonable likelihood Locke could attempt to evade securities laws and regulations in the future if it sought to continue doing business. The Court therefore grants the Commission's

9

request

for

an

order

enjoining

Locke

from

committing

future

violations. IV. Conclusion For the reasons motion ordered set for to forth a pay above, the Court GRANTS Locke the will and

Commission's therefore be

default

judgment. in

$1,892,476

disgorgement

$5,677,428 in civil penalties, for a total of $7,569,904, and enjoined from future securities law violations, by a separate Final Judgment. case, once the Judgment will enter at the conclusion of this Commission's claims against non-defaulting

Defendant Jenkins have been resolved.3 IT IS SO ORDERED.

/s/ William E. Smith
William E. Smith United States District Judge Date: July 21, 2010

Cross-motions for summary judgment by the Commission and Jenkins are currently pending before the Court.
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