Summary
describing factors commonly considered in making S.E.C. penalty determinations
Summary of this case from Securities Exchange Commission v. Worldcom, Inc.Opinion
Case No. 97 Civ. 2931 (CBM)
March 31, 2003
Plaintiff: U.S. Securities and Exchange Commission, Wayne M. Carlin, Director, Northeast Regional Office, By: Elizabeth L. Goot and Craig S. Warkol
Defendant: Martin J. Auerbach, Esq., New York, N.Y.
MEMORANDUM OPINION ORDER
The Securities and Exchange Commission ("SEC" or "Commission") brought this action on April 24, 1997, charging Joseph C. Kane, Jr. (the "defendant") with defrauding multiple brokerage houses, misappropriating their funds, fraudulently misappropriating a total of approximately $595,000 of his customers' funds and securities, and forging signatures and fabricating documents to perpetuate and conceal this fraud, in violation of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5.
Without admitting or denying the Commission's allegations against him, Kane consented to the entry of a Partial Final Consent Judgment ("Consent Judgment"), enjoining him from future violations of those statutes. The Consent Judgment required defendant to "disgorge his ill-gotten gains from the conduct alleged in the Complaint, plus prejudgment interest . . . in an amount to be determined by the parties or, failing that, by the Court" and to "pay civil penalties as a result of the conduct alleged in the Complaint in an amount to be determined by the parties or, failing that, by the Court."
Whereas the Commission subsequently determined that Kane had fully repaid his victims, with interest, and that Kane had no other ill-gotten gains related to acts alleged in the Complaint, only the amount of the civil judgment remained to be determined by the parties pursuant to the Consent Judgment. The parties having failed to agree on an amount for a civil penalty, the matter has now been submitted to the court for resolution, by means of a motion to set the amount of defendant's civil penalty, brought by the SEC.
BACKGROUND
The facts related to liability are essentially undisputed inasmuch as the defendant's agreements with the SEC prohibit him from denying the allegations in the Complaint. In cursory summary, Kane was a broker at Dean Witter Reynolds, Inc. ("Dean Witter") from 1983 through August 1995 and at Laidlaw Equities, Inc. ("Laidlaw") from 1995 through 1996. From January 1989 through April 1996, defendant defrauded four brokerage customers. During this period, defendant misappropriated approximately $595,000 of customer funds by misrepresenting investment opportunities, forging customer signatures, diverting money from one customer to repay another previously defrauded customer, and fabricating brokerage documents to conceal his activities.
Mr. Kane went to great lengths to perpetuate his fraudulent activities. As an example, Kane forged the signatures of a client pursuant to a plan to pledge $400,000 worth of the client's bonds as collateral for a $900,000 line of credit to Software Affiliates of America, Inc., a privately-held company based in California. When the client discovered that his bonds were pledged as collateral and demanded an explanation from his broker, Kane lied to him, telling his client that the bonds had been returned to his account. Mr. Kane presented his client with a fabricated, computer-generated document which purported to reflect that the bonds had been returned to his account. Mr. Kane went so far as to have a friend represent that he was Kane's supervisor at Dean Witter and to assure the client that his bonds would be returned.
The record, which the defendant does not dispute, indicates that the foregoing example is reflective and representative of a pattern of outrageous conduct by the defendant. Mr. Kane abused the trust his clients placed in their relationship with him and the firms for which he worked. He intentionally and willfully stole from his clients. He lied, forged, and falsified documents in furtherance of his fraudulent activities. He lied, forged, and falsified documents pursuant to his attempts to conceal his reprehensible conduct. His attempts were unsuccessful: Mr. Kane got caught.
On September 29, 1997, defendant was indicted in U.S. District Court for the Southern District of New York on charges mirroring the claims in the Commission's Complaint with respect to one of the four investors Kane defrauded. On July 15, 1998, defendant pled guilty to the criminal charges. On October 16, 1998, the criminal court fined Kane $4,000 and sentenced him to four years probation and 600 hours of community service. The court did not impose an order of restitution, as Kane had previously repaid his victims.
DISCUSSION
I. The Applicable Law
The SEC now seeks an order requiring Kane to pay a "substantial civil penalty" pursuant to Section 20(d)(2)(C) of the Securities Act, 15 U.S.C. § 77t(d)(2)(C) and Section 21(d)(3)(B)(iii) of the Exchange Act, 15 U.S.C. § 78u(d)(3)(B)(iii). Congress promulgated these sections pursuant to the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the "Penalty Act"). "By enacting the Penalty Act, Congress sought to achieve the dual goals of punishment of the individual violator and deterrence of future violations." SEC v. Moran, 944 F. Supp. 286, 296 (S.D.N.Y. 1996); SEC v. Coates, 137 F. Supp.2d 413, 428 (S.D.N.Y. 2001); SEC v. Credit Bancorp. Ltd., 2002 WL 31422602 at *1 (S.D.N.Y. Oct 29, 2002) (quoting Moran). Where a securities law violation has been established, the court is authorized to impose civil monetary penalties, with the amount of any penalty to be "determined by the court in light of the facts and circumstances" of the particular case. 15 U.S.C. § 77t(d)(2)(A), 78u(d)(3)(B)(i).
The SEC does not quantify what it means by "substantial."
Section 20(d)(2) of the Securities Act and Section 21(d)(3) of the Exchange Act provide for three tiers of maximum penalties for specified degrees of culpability. The third tier allows for a penalty for each violation of the Act of up to $100,000 for a natural person or the gross amount of pecuniary gain to a defendant as a result of the violation if the violation (1) involved "fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement" and (2) such violation directly or indirectly "resulted in . . . or created a significant risk of substantial losses" to other persons. See Credit Bacorp., Ltd., 2002 WL 31422602 at *2 (S.D.N.Y. Oct. 29, 2002) (citing Section 20(d)(2)(C) of the Securities Act, 15 U.S.C. § 77t(d)(2)(C), and Section 21(d)(3)(B)(iii) of the Exchange Act, 15 U.S.C. § 78u(d)(3)(B)(iii)) (emphasis added).
II. The Law Applied
The conduct of the defendant in this case involved fraud, deceit, manipulation, and a deliberate disregard of a regulatory requirement. In his criminal plea allocution, Kane admitted that he defrauded one investor by making untrue statements in connection with the purchase and sales of securities. According to his memorandum in response to the Commission's motion, Kane does not challenge the Commission's factual recitation regarding his conduct with respect to any of his alleged victims. Kane's undisputed fraudulent conduct consists of numerous deliberate violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, as alleged in the Commission's Complaint.
A violation of these anti-fraud provisions occurs when (1) there is a misstatement or omission of material fact; (2) made in the offer or sale, or in connection with the purchase or sale, of securities; and (3) the defendant acted with scienter. Basic, Inc. v. Levinson, 485 U.S. 224, 235 n. 13 (1988). Scienter is a "mental state embracing intent to deceive, manipulate or defraud," Ernst Ernst v. Hochfelder, 425 U.S. 185, 194 n. 12 (1976), and requires proof of knowing or reckless conduct. IIT v. Cornfield, 619 F.2d 909, 923 (2d Cir. 1980). In order for a misrepresentation to be material, the false statement or omitted fact must have been viewed by a reasonable investor as having significantly altered the total mix of information available. Basic, 485 U.S. at 232.;TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976). The record reflects that each of these elements is present in this case.
The case before the court also satisfies the second prong, thus qualifying the defendant for a third tier penalty. Kane misappropriating approximately $595,000 of his clients' money from 1989 to 1996. Notwithstanding his disgorgement of pecuniary gain, it is evident that Kane's actions "created a significant risk of substantial losses to other persons." 15 U.S.C. § 77t(d)(2)(C), 78u(d)(3)(B)(iii) (emphasis added). That the defendant may not have ultimately realized a net gain (inasmuch as he disgorged all profits from his illegal activities) is irrelevant to consideration of whether he created a significant "risk" of loss on others. See SEC v. McCaskey, 2002 WL 850001 at *13 (S.D.N.Y. March 26, 2002) (Peck, M.J.) (whether the defendant "incurred a net loss or gain over the manipulation period is entirely irrelevant to the infliction of losses, or the `risk' of loss, on others").
Again, civil penalties were enacted by Congress both to punish and to deter securities law violations. See,e.g., SEC v. Palmisanto, 135 F.3d 860, 866 (2d Cir.), cert. denied, 525 U.S. 1023 (1998); SEC v. Coates, 137 F. Supp.2d 413, 428 (S.D.N.Y. 2001); SEC v. Rosenfeld, 2001 WL 118612 at *4 (S.D.N.Y. Jan. 9, 2001). The relevant House Report stated:
The Committee believes that the money penalties proposed in this legislation are needed to provide financial disincentives to securities law violations other than insider trading. . . . Disgorgement merely requires the return of wrongfully obtained profits; it does not result in any actual economic penalty or act as a financial disincentive to engage in securities fraud. A violator who avoids detection is able to keep the profits resulting from illicit activities. Currently, even a violator who is caught is required merely to give back his gains with interest, leaving him no worse off financially than if he had not violated the law. The Committee therefore concluded that authority to seek or impose substantial money penalties, in addition to the disgorgement of profits, is necessary for the deterrence of securities law violations that otherwise may provide great financial returns to the violator.SEC v. Coates, 137 F. Supp.2d at 428-29 (quoting H.R. Rep. No. 101-616 (1990)); accord, e.g., SEC v. Moran, 944 F. Supp. 286, 296 (S.D.N.Y. 1996) (quoting the same House Report). See also Inorganic Recycling Corp., 2002 WL 1968341 at *4 ("[d]isgorgement alone is an insufficient remedy, since there is little deterrent in a rule that allows a violator to keep the profits if she is not detected, and requires only a return of ill-gotten gains if she is caught").
As the court in Moran observed, "[c]onsidering the discretionary nature of the civil penalty framework, prior decisions and consent decrees are of little value for any individual matter. Each case, of course, has its own particular facts and circumstances which determine the appropriate penalty to be imposed." 944 F. Supp. 286, 296-97 (S.D.N.Y. 1996). The court may consider a number of factors in determining the appropriate amount for a civil penalty, including (1) the egregiousness of the defendant's conduct; (2) the degree of the defendant's scienter; (3) whether the conduct created substantial losses or the risk of substantial losses to other persons; (4) whether the conduct was isolated or recurrent; and (5) whether the penalty should be reduced in light of the defendant's demonstrated current and future financial condition. See Credit Bancorp. Ltd., 2002 WL 31422602 at *3 (citing Coates, 137 F. Supp.2d at 428 (listing factors)).
While Kane acknowledges that, pursuant to the Consent Judgment, he has agreed to pay a civil penalty, he asks the court, in light of the particular facts of this case, to impose "as modest a civil penalty as possible." See Def. Mem. at 2. In support of this request, the defendant raises at least four principal points which believes ought to be viewed as mitigating factors in this case. In furtherance of his request for a modest civil penalty, Kane urges the court to consider that he has not gained financially from the fraudulent activities alleged in this matter; that he is impoverished and, as a result, may not be able to pay if a severe penalty is imposed; that he has taken responsibility for his actions and cooperated in this proceeding; and that there has been a criminal proceeding addressing matters related to this case and, as a result, he has received severe punishment. The court shall address each of these proffered mitigating circumstances in turn.
Kane does not directly address the issue of whether a third-tier penalty is appropriate. Rather, he generally provides factors which might mitigate the substantial penalty which the SEC seeks.
First, as the court observed above, Congress promulgated the civil monetary provisions of the relevant sections because it felt that disgorgement alone does not serve the important goal of deterrence. That the defendant did not gain financially from his illegal activities, in and of itself, does not exert mitigating force in the court's crafting of a civil penalty.
Second, and in light of the goal of deterrence, a defendant's claims of poverty cannot defeat the imposition of a civil penalty by a court. If the defendant is indeed impecunious, the SEC will ultimately not be able to collect on the judgment. As Judge Lynch observed in SEC v. Inorganic Recycling Corp., to withhold a civil penalty simply because a defendant cannot pay "would not serve the purposes of the securities laws." 2002 WL 1968341 at *4 (S.D.N.Y. Aug. 23, 2002). See also SEC v. Palmisano, 135 F.3d 860, 866 (2d Cir. 1998), cert. denied, 525 U.S. 1023 (1998) (Congress enacted civil penalty provisions to deter securities law violations). While the court may take the defendant's current financial difficulties into account, these circumstances alone cannot negate the need for a severe civil penalty. Even if Kane's proffered representations concerning his bleak financial condition are complete and accurate, his financial problems, including his inability to work again as a stock broker, are the natural consequences of his fraudulent conduct. Kane's predicament is shared by many defendants in similar cases, and if given the weight that Kane urges, a defendant's impecuniosity could preclude the imposition of a meaningful penalty in even those cases involving the most egregious fraud. In addition, the court agrees with the Commission that it should not ignore the possibility that a defendant's fortunes will improve, and that one day the SEC will be able to collect on even a severe judgment.
The Commission's motion papers suggest that they are not. The court takes no position on this issue.
Third, although the court has no reason to doubt the extent of the defendant's contrition, the extent of his cooperation in this is not significant enough to warrant substantial mitigation. Unlike the defendant who did not receive a civil penalty in Inorganic Recycling, Mr. Kane did not immediately and actively cooperate with law enforcement authorities and assist in the prosecution of other, more culpable individuals. See Inorganic Recycling, 2002 WL 1968341 at *5 (Defendant demonstrated "substantial and meaningful contrition by his prompt and significant cooperation in the criminal investigation. . . . Such cooperation is important to the investigation, prosecution and punishment of frauds of this kind, and should be rewarded").
Fourth, although Kane has been punished in a criminal proceeding, the criminal charges addressed only one of the four separate frauds which Kane committed. Moreover, his guilty plea itself does not conclusively establish his appreciation of the full extent of his past wrongdoing. The court acknowledges, however, that Kane's criminal punishments may "lessen the responsibility of the fine to provide a retributive and deterrent effect." Credit Bancorp. Ltd., 2002 WL 31422602 at *4.
The seriousness of the fraud and the exclusive role played by Kane make appropriate a fine approximating the maximum. This was not an isolated incident. Kane's fraudulent activities spanned over six years. He lied to his customers in order to steal their money and lied to try to get away with it. In light of the unlikelihood of any recovery, and taking into account all of the facts and circumstances of the case, a penalty of only $200,000 is imposed.
CONCLUSION
Judgment will enter against Kane for a civil penalty in the amount of $200,000.