Summary
refusing to allow deduction from disgorgement for illicit profits defendant shared with his trader under a prior arrangement because the arrangement "was more a method of compensating [defendant's] employees, than it was a brokerage commission"
Summary of this case from Sec. & Exch. Comm'n v. NadelOpinion
94 Civ. 6608 (PKL)(AJP).
July 21, 2003.
Alexander M. Vasilescu, Esq., Cynthia A. Matthews, Esq., Burk Burnett, Esq. Securities and Exchange Commission, New York, NY, Attorneys for Plaintiff Securities and Exchange Commission.
John E. Lawlor, Esq., Attorney for Defendants Castle Securities Corp. and Michael T. Studer.
OPINION AND ORDER
On September 13, 1994, plaintiff, the Securities and Exchange Commission ("SEC") commenced this action, alleging that twelve individual and corporate defendants had violated certain provisions of the federal securities laws in connection with the registration for the initial public offering of Windfall Capital Corp. ("Windfall"), and trading irregularities involving defendant U.S. Environmental, Inc. ("USE") stock. Dispositions have been made for the claims against all defendants save for Michael T. Studer ("Studer") and Castle Securities, Corp. ("Castle"). Therefore, five claims remain against defendants Castle and Studer, for which the SEC seeks both permanent injunctive relief and disgorgement of illegally obtained profits along with the appropriate pre-judgment interest.
The only claim against defendant Mark Geller, a charge of conspiracy to violate certain federal securities laws, was dismissed by the Court on August 24, 1995. The Court also issued an order dismissing the case against defendant Louis Sepe, who is deceased, and his widow Maria Sepe. Various defendants consented to final judgments and permanent injunctions, including defendants Mark D'Onofrio ("D'Onofrio"), his father Ramon N. D'Onofrio ("R. D'Onofrio"), Leslie Roth ("Roth"), John Romano ("Romano"), USE, Ernest Miccicche ("Miccicche"), and Dudley Mihran Freeland ("Freeland"). Moreover, the D'Onofrios were criminally prosecuted for their violations.
In October 2002, the Court conducted a bench trial on the remaining claims, and the parties have subsequently submitted post-trial briefs, further addressing those issues. Having considered the evidence presented at trial and the parties' post-trial submissions, the Court sets forth herein its findings of fact and conclusions of law pursuant to Rule 52(a) of the Federal Rules of Civil Procedure.
A. FINDINGS OF FACT
I. Identities and Backgrounds of the Relevant Parties
a. Defendant Castle Securities Corp. ("Castle"), of Freeport, New York, is a New York corporation, and is a wholly owned subsidiary of Castle Holding Corp ("Castle Holding"), a public corporation.
b. Castle has been a broker-dealer registered with SEC, pursuant to Section 15(b) of the Securities Exchange Act of 1934 ("Exchange Act"), since December 5, 1984, and is a member of the National Association of Securities Dealers, Inc. ("NASD").
c. Defendant Studer age 50, resides in Rockville Centre, New York, and has served as president, treasurer, and a director of Castle since its inception, and owns part of Castle Holding.
d. From at least January 1, 1988 through the present, George Hebert ("Hebert") has been the president and a director of Castle Holding.
e. From January 1, 1988 through the present, Studer and Hebert have each controlled or owned between 20% and 33% of Castle Holding.
f. Studer has also been a certified public accountant since February 5, 1975, and the sole owner of Michael T. Studer, CPA, P.C., a public accounting firm ("Studer CPA") since July 1987.
g. From at least April 1988 to at least November 1992, Castle and Studer CPA maintained offices at the same address, 75 West Merrick Road, Freeport, New York 11520. During the period from 1988 through 1990, Castle and Studer CPA were very small operations that shared space and were both controlled by Studer.
h. Since approximately 1984, defendant Roth, who is an accountant, has been employed in various capacities by Studer, initially through Studer's accounting practices, Fisher Studer, PC and Studer CPA, then as an employee of Castle in 1993. In 1989, through correspondence, Roth held herself out to the SEC as acting on behalf of Castle. See Plaintiff's Exhibit ("PX") 97 (Letter from Leslie Roth to the SEC, dated August 16, 1989). Roth remains employed by Studer CPA.
i. From 1984 through 1989, Paula Morrelli ("Morrelli"), who is also an accountant, worked as an employee for Studer in his various accounting practices, including for Studer CPA in 1988 and 1989.
j. Defendant Romano, age 39, was employed from March 1989 until August 1992, as a trader and registered representative at Castle.
k. In March 1989, Studer and Hebert also hired Louis Calderone ("Calderone") as a trader and registered representative, who together with Romano, comprised Castle's trading department in 1989 and 1990.
l. In 1989 and 1990, Studer was responsible for supervising the registered representatives at Castle, since he held a Series 24 license from the NASD, which was required to supervise registered representatives at a broker-dealer.
m. In the period 1988 through at least 1990, Studer represented the entirety of Castle's compliance department, and therefore, he was responsible for supervising Hebert, Calderone, and Romano.
n. Throughout the time Romano was a trader and registered representative at Castle, Studer was Romano's supervisor.
II. Studer and Castle's Prior Blind Pool Offerings
a. Studer testified that, prior to 1988, through Castle and his accounting practice, he was involved in creating "blind pool" companies and "blind pool" offerings, i.e., forming corporations with little or no assets and operations, and then filing Form S-18 filings with the SEC and seeking to offer the securities of the blind pool companies to the public. See Trial Transcript ("Tr.") at 165, 183.
b. On March 28, 1988, pursuant to an investigative subpoena issued by the SEC's staff, Studer provided testimony regarding Dynamic Capital Corp. ("Dynamic"), the first blind pool offering that Castle underwrote, with Studer's assistance. The SEC staff questioned Studer extensively regarding Dynamic. See Tr. at 183-184; PX 88 (Investigative Testimony of Michael T. Studer in the Matter of Dynamic Capital Corp., dated March 28, 1988).
c. On May 5, 1989, the SEC issued a public release stating that the SEC had charged the president of Dynamic with committing securities fraud in connection with the Dynamic blind pool offering, and that the Justice Department had also brought criminal charges against Dynamic's president. See PX 87 (SEC Litigation release regarding Dynamic Capital Corp., dated May 5, 1989).
d. Studer testified that he was not aware that the president of Dynamic was criminally charged until his deposition in 2000. See Tr. at 238. However, based on his knowledge of the SEC's investigation of Dynamic, Studer was aware that blind pool companies that undertook a public distribution of securities could be misused by securities fraudsters and would be subject to scrutiny by securities regulators such as the SEC and NASD.
III. Studer and Castle's Relationship with the D'Onofrio Group
a. In the Pretrial Order, defendants concede that D'Onofrio, his father R. D'Onofrio, and Richard Kirschbaum were partners. (hereafter collectively referred to as the "D'Onofrio Group"). See Undiputed Facts, attached as Appendix I to the Joint Pre Trial Order ("UF"), at mm.
b. Mr. Studer testified that, at the time of the merger between Windfall and USE, he knew that Kirschbaum was working together with D'Onofrio. See Tr. at 265; PX 25 (Deposition of Michael T. Studer, dated Jan. 12, 2000) at 158. In the mid-1980s through at least 1990, Kirschbaum and corporations he controlled, including Kraylink, Ronart, and Mandrake, were clients of Studer CPA, and also customers of Castle.
c. Studer was aware that Kirschbaum controlled Kraylink, Ronart and Mandrake. See Tr. at 205-06, 256-57.
d. The defendants conceded that D'Onofrio and Kirschbaum sent correspondence to Castle in 1988, which reference blind pools and indicate the association between D'Onofrio and Kirschbaum. See UF at s, t.
e. D'Onofrio testified that, in 1988, the D'Onofrio Group, through Kirschbaum, entered into an agreement with Studer and Castle to form blind pool public corporations for use by the D'Onofrio Group, i.e., to keep them on the "shelf" for the D'Onofrio Group. See Tr. 58-59, 61, 69-70.
f. Studer testified that he was aware in 1988 and 1989 that Kirschbaum was always looking for public companies to serve as "shell" companies. See Tr. at 226-27. At trial, Studer defined a "shell company" as a public company that does not have an operating business. See id.
g. On or about January 20, 1988, Kirschbaum sent a letter to Castle, addressed to Hebert, requesting that Hebert "get all the work taken care of as quickly as possible, per our discussion," and enclosed four subscription checks, each in the amount of $2,500. The letter identifies D'Onofrio as one of the subscribers for Castle's blind pool companies. See PX 153.
h. On or about May 31, 1988, D'Onofrio sent a letter to Castle, which attached Kraylink's subscription agreement bearing Kirschbaum's signature, and discusses D'Onofrio and Castle "initiating" the blind pool companies of Windfall and Emerging Enterprises. See PX 27.
i. Studer and Hebert provide no explanation for the letters from either D'Onofrio or Kirschbaum and deny their association with the D'Onofrios and Kirschbaum, and their involvement with Windfall and Emerging Enterprises.
j. Studer's and Castle's involvement with Kirschbaum is significant. Various published court decisions prior to 1988 identify Kirschbaum as a partner of R. D'Onofrio in the commission of D'Onofrio's securities violations. See PX 250 (SEC v. D'Onofrio, [1975-76 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,201, at 98,011-12 (S.D.N.Y. June 3, 1975); Competitive Assoc., Inc. v. Laventhol Krekstein, 478 F. Supp. 1328, 1332 (S.D.N.Y. 1979)).
k. The defendants concede that the D'Onofrio Group purchased the majority of shares in the Windfall offering, which later traded under the name USE, and then manipulated the price from $0.05 to $5 per share of those securities. See UF at www.
1. D'Onofrio and R. D'Onofrio consented to final judgments enjoining them from further violating the antifraud provisions of the securities laws and directing them to disgorge ill-gotten gains. See PX 139 (Final Judgment of Permanent Injunction and Other Relief as to Defendant Mark J. D'Onofrio, dated September 19, 1994). Kirschbaum died before this litigation commenced.
IV. The Formation of Windfall
a. Windfall was incorporated in Delaware on February 18, 1988. The Certificate of Incorporation indicates that George Hebert was Windfall's sole initial director.
b. Windfall was a shell corporation that had no business or revenue. See Tr. at 227-28.
c. From at least January 1, 1988 through the present, Hebert has been the President and a Director of Castle's parent company. Hebert decided on the name "Windfall" for the company.
d. At its incorporation, Windfall's address was listed as 30 Bedell Street, Freeport, New York, the same address as Castle.
e. In 1988, Roth became president and chairman of the board of directors of Windfall, and Morelli became secretary-treasurer and a director of Windfall.
f. Roth and Morelli became officers of Windfall after Studer had approached them and asked them if they would be interested in incorporating a company and undertaking a public offering of securities for that company. See Tr. at 655.
g. Prior to Windfall, Roth and Morrelli had never been officers of any corporations, let alone any public corporations.
h. Roth and Morrelli became initial shareholders in Windfall, pursuant to subscription agreements both dated April 21, 1988.
l. Studer compensated Roth for her work as an officer of Windfall by approving timesheets that Roth submitted to Studer CPA, which included time she had pent working on matters pertaining to the Windfall blind pool. Roth's timesheets show that she worked on both Windfall and Emerging Enterprises while she was working for Studer CPA in 1988 and 1989.
m. In 1988, Windfall hired Alan Berkun, Esq. ("Berkun"). Berkun was also an initial investor in Windfall.
n. Prior to being hired by Windfall, Berkun provided legal services to Castle.
o. In July 1988, Richard J. Dasch, CPA ("Dasch") was employed by Studer and Castle as a registered representative.
p. After he began working for Castle as a registered representative, Studer hired Dasch to prepare Windfall's audited and unaudited financial statements.
q. Dasch also worked for Studer on a per diem basis as an accountant, prior to undertaking the Windfall audit.
r. Studer also hired Dasch to perform the audit for Emerging Enterprises, the other blind-pool company listed on D'Onofrio's letter to Castle dated May 31, 1988.
s. Dasch testified that he did not speak to Roth or Morelli in preparing the audit of Windfall, and received the materials and documents necessary to prepare the audit from Studer. Dasch testified that he believed that Studer was the "inside" accountant for Windfall. See Tr. at 780, 783.
t. After Windfall was incorporated and before Windfall became a public company, Windfall had eleven initial investors, who each received restricted stock. See UF at q.
u. Studer was responsible for getting most of Windfall's initial investors. See Tr. at 707. In addition to Roth, Morrelli, and Berkun, the other initial Windfall shareholders consisted of the following employees, relatives, and close friends of Studer and Hebert, as well as one corporation, Kraylink, which was controlled by Kirschbaum:
1. John Lawless ("Lawless"), who is Studer's brother-in-law.
2. Marie Butsky ("Butsky"), who is Hebert's mother-in-law.
3. Marvin Rostolder ("Rostolder"), a friend of Hebert whom he met while in the brokerage business during the mid-1980's. See PX 199 (Investigative Testimony of Marvin Rostolder, dated August 15, 1990) at 42. Hebert introduced Rostolder to Studer sometime prior to Studer Fisher's 1987 Christmas party. Id. Rostolder first met Roth and Morrelli at the 1987 Christmas party. See id. at 3132. Rostolder was a registered representative at Castle from July 1988 through December 1988. See id. at 60. Roth asked Rostolder to invest in Windfall at the Christmas party or shortly thereafter; and Roth later asked Rostolder if he would sell 90% of his Windfall securities back to the company. See id. at 55-56, 85-88. Rostolder was told by either Roth or Studer that other private investors were selling their securities back to the company to help with a potential merger. See id. at 88; PX 198 (Deposition of Marvin Rostolder, dated October 14, 1999) at 38-42.
4. John Hill, who had known Studer and Hebert since approximately 1986. See PX 213 (Investigative Testimony of John Hill, dated Sept. 25, 1990) at 59. Hill first became aware of Windfall through either Roth or Morrelli at the 1987 Christmas party. Id. at 11-12. Hill spoke with both Studer and Hebert about Windfall before he invested, inquired of either Studer or Hebert to whom he should write the check in order to invest in Windfall, and ultimately gave the check to Studer. Id. at 12, 21-22. Studer told Hill that a company raised some money and wanted to buy all of Windfall's stock, and that he could make a profit by selling his stock at that time. Id. at 26. Studer handled Hill's sale of his Windfall stock at Castle's offices. Id. at 24-25. Hill never had any substantive discussions about Windfall or the sale of his stock with either Roth or Morrelli. Id. at 28, 40.
5. Joseph Fisher ("Fisher"), who was Studer's former accounting partner. Studer's partnership with Fisher began in 1982. See Tr. at 161. In 1988, Fisher owned the building that leased office space to Castle. Id. at 209.
6. Ronald Winge ("Winge"), who had been Studer's longtime friend. Winge is a letter carrier for the U.S. Postal Service. See PX 217 (Deposition of Ronald Winge, sworn to on Feb. 16, 2000) at 12. Studer and Winge were childhood friends who met in either grade school or high school and had been close ever since. See PX 218 (Investigative Testimony of Ronald Winge, dated August 15, 1990) at 62; PX 217 at 10. Studer is Winge's stockbroker. Winge admitted that he does not know much about stocks and has depended on Studer for advice when it comes to the purchase and sale of securities. See PX 218 at 43-44. Winge first became aware of Windfall through either Roth or Studer at the 1987 Christmas party. Id. at 31, 44. Studer advised Winge to invest in Windfall because it was a good investment and he could make some money. Id. at 8; PX 217 at 21. Studer solicited Winge to sell his Windfall securities. See PX 218 at 40. Winge trusted Studer's judgment and told him to do whatever he wanted as long as he made a profit. Id. at 41; PX 217 at 21.
7. Noel Meeks ("Meeks"), who had been a friend of Hebert for over 30 years, and had known Studer since approximately the mid-1980's. See Tr. at 1035; PX 225 (Deposition of Noel Meeks, dated Apr. 19, 2000) at 22-24. Meeks was also friends with Roth and Morelli. See Tr. at 1038. Meeks had been performing odd jobs at Castle since approximately 1989 and had been employed in an official capacity by Castle since 1993. Id. at 1033-42. Meeks spoke with Roth and Morelli about investing in Windfall's private placement and may have spoken with Studer. Id. at 1051-52. Meeks sold his private placement shares because he was satisfied with the price. Id. at 1068-69.
8. Kraylink, the only corporation that was an initial shareholder of Windfall, was controlled by Kirschbaum through his ex-wife and daughter. Romano testified that Kraylink had been a client of Castle. See Tr. at 825-30. Roth testified that she met Kirschbaum through Studer. See id. at 676.
v. Windfall's Form S-18, filed with the SEC on or about December 5, 1988, reveals that Kraylink provided nearly half of the $5,000 of Windfall's initial funds. See PX 1 (Windfall Form S-18, received by SEC on Dec. 5, 1988) at 35. The Kraylink subscription bears the signature of Richard Kirschbaum.
w. D'Onofrio sent a letter to Castle, dated May 31, 1988, addressed to Hebert, which enclosed subscription agreements and checks to invest in the blind pool offerings of Windfall and Emerging Enterprises. Included in the subscription agreements was the subscription for Kraylink. D'Onofrio wrote, "We sincerely apologize for the delay. I hope we can move forward on all pools we have initiated."
x. The initial Windfall investors acquired 2,025,000 restricted shares by July 1988.
V. Windfall's Form S-18 and Amendments and, the Public Offering of Securities during the Offering Period of February 10, 1989 Through August 17, 1989
a. On or about December 5, 1988, Windfall filed a registration statement on Form S-18 with the SEC ("Windfall Form S-18"), seeking to register one million units, each to be sold at $0.05 (the "Windfall Offering"). See PX 1.
b. On February 3, 1989, the 1st Amendment to the Windfall Form S-18 ("1st Amendment") was filed with the SEC. See PX 2 (Windfall Form S-18 1st Amendment, SEC stamp dated February 3, 1989).
c. The Form S-18 and amendments represented that:
1. Each unit of the Windfall Offering consisted of one share of common stock and five warrants. See PX 2 at 2.
2. For a twenty-four month period following the effective date of the Windfall Form S-18, each warrant could be exchanged for one share of common stock at a price of $0.10. Id.
3. The Windfall Form S-18 and amendments stated that Roth was Windfall's president and a director, and that Morrelli served as secretary-treasurer and a director. Roth and Morrelli signed the Windfall Form S-18 as officers and directors of Windfall.
4. The Windfall Form S-18 and amendments described Roth and Morrelli as self-employed public accountants, and stated that neither Roth nor Morrelli had received, or would receive for a period of one year after the Windfall Offering closed, remuneration for their services or reimbursement of expenses relating to Windfall. See PX 1 at 24.
5. The Windfall Form S-18 and amendments stated that "[t]he [Windfall Offering] is a `blind pool' in that neither [Windfall's] business nor its use of proceeds of this offering has been specified." See PX 1 at 8.
6. The Windfall Form S-18 and amendments further stated that Windfall "[h]ad not identified any specific business or assets which it intend[ed] to acquire," had "received no commitments . . . regarding the purchase or availability of any subsidiary business or for any of its proposed operations," and had not identified the individuals who ultimately would manage Windfall. See PX 1 at 11.
7. The Windfall Form S-18 and amendments also stated that the units to be registered would be offered and sold to the public by Windfall rather than by a broker-dealer acting as underwriter, thereby describing a "self-underwriting." See PX 2 at 5.
d. The SEC declared Windfall's registration effective on or about February 10, 1989, and the Windfall Offering closed on or about August 17, 1989.
e. The Windfall Form S-18 and 1st Amendment were the only offering documents filed with the SEC on behalf of Windfall for the offering period of February 10, 1989 through August 17, 1989.
f. Castle and Studer oversaw the creation and initial investment in Windfall and supervised its Form S-18 filings.
g. Roth testified that Studer approached her and Morelli, and inquired whether they would be interested in forming a company and doing a public offering. As both Roth and Morelli were studying for the Certified Public Accountant ("CPA") exam at the time, they took the opportunity, suggested by Studer, to form Windfall, because they thought it would be a "good learning experience." In addition to providing advice to Roth regarding the formation of Windfall, Studer reviewed Windfall's Form S-18 before Roth submitted it to the SEC. See Tr. at 655-56, 707-08, 768 (Roth); Tr. at 175, 190-91 (Studer).
h. Studer was aware that the timesheets that Roth filled out in the course of her employment at Studer CPA had numerous Windfall entries, as well as Emerging Enterprise entries, in 1988 and 1989. See Tr. at 685-700.
i. In March 1989, during the course of the Windfall Offering, Hebert told Romano that Windfall was a blind pool company that was being underwritten by Castle. See Tr. at 820-21.
VI. False Statements and Facts Omitted From the Windfall Form S-18 and 1st Amendment
a. A Form S-18 is a registration statement used by a company to register its securities with the SEC. An S-18 discloses the company's officers, directors, principal shareholders, and control persons of the company. An S-18 describes how a company's securities will be distributed to the public. The purpose of a registration statement is to provide full and complete disclosures of material information that an investor would deem important in deciding whether to invest in the company's securities. See Tr. at 519-20.
b. The Windfall Form S-18 and amendments did not disclose Studer's or Castle's participation in the formation of Windfall or the Windfall Offering. See PX 1; PX 2. Rather, the Windfall Form S-18 represented that it was a self-underwriting, where units would be offered and sold to the public by Windfall, rather than by a broker-dealer acting as an underwriter. See PX 2 at 5. Since Studer and Castle did provide the services of an underwriter in participating in the distribution of Windfall shares to the public, Windfall's offering of securities could not be deemed a self-underwriting.
c. The Windfall Form S-18 and amendments did not disclose that Kirschbaum and the D'Onofrios were promoters for Windfall. See PX 1; PX 2.
d. The Windfall Form S-18 and amendments did not disclose that Studer reviewed Windfall's Form S-18 and provided advice to Roth regarding the Form S-18. See Tr. at 175.
e. The Windfall Form S-18 and amendments did not disclose the compensation paid to Roth for the time she spent on Windfall. See PX 1; PX 2; see also Tr. at 718-19.
f. When Windfall was incorporated and before Windfall became a public company, Windfall's initial shares were issued to individuals and a corporation with pre-existing personal and business relationships with Studer, Castle, and the D'Onofrio Group. See UF at u.
VII. Windfall's Merger With USE
a. D'Onofrio testified that, prior to the closing of the Windfall Offering on August 17, 1989, Studer and Castle had a secret agreement with the D'Onofrio Group to supply the Windfall blind pool company to the D'Onofrio Group for a merger with another company. See Tr. at 74-75.
b. In March 1989, Studer and Hebert told Romano that Kirschbaum was a promoter and was responsible for finding a merger partner for Windfall, since Roth and Morrelli had no experience with corporations and corporate acquisitions. See Tr. at 836-40, 945.
c. During the Windfall Offering, Roth mailed Windfall material to Studer and to Kirschbaum at his address at United Atlantic Investments. See Tr. at 728-30; see also PX 86 (Federal Express receipts for Windfall Capital Corp.).
d. In or about July 1989, before the Windfall Offering was completed, defendant Mark A. Geller ("Geller") arranged and attended a meeting (the "Geller Meeting") at the D'Onofrio Group's offices with D'Onofrio, R. D'Onofrio, Kirschbaum, and defendant Sepe, a director of defendant USE, then a privately held company with no operating revenue. See Tr. at 44-46.
e. At the Geller Meeting, the attendees discussed the prospect of merging USE with a public blind pool company. During the meeting, D'Onofrio offered to arrange a merger between USE and Windfall in the form of a "90-10" deal, which would result in the USE shareholders controlling 90% of the combined company and the original Windfall shareholders controlling 10%. See Tr. at 52-53. Therefore, through a "backdoor" merger, USE would become a public company, since the one million registered Windfall units offered in the Windfall initial public offering ("IPO") would be part of the capitalization of USE after the merger with Windfall. Sepe expressed a desire that the stock of the merged company trade at a price in excess of one dollar. See Tr. at 53-54.
f. Within several days of the Geller Meeting, Sepe agreed to the merger with Windfall. See Tr. at 56. By letters dated July 24, 1989 and July 26, 1989, the D'Onofrio Group confirmed with Sepe that USE would merge with a public company. See PX 146.
g. The entire one million units of the Windfall Offering were subscribed to, either directly or indirectly through nominees, by members of the D'Onofrio Group, Sepe, Geller and individuals or entities connected to Studer and Castle. 47.4% was controlled by the D'Onofrio Group, 4.6% by individuals or entities connected to Studer and Castle, and the balance by Geller and nominees of Sepe.
h. Members of the D'Onofrio Group, Sepe and Geller reached an understanding regarding the amount each party would invest in the Windfall offering. See Tr. 57-58. D'Onofrio testified that Kirschbaum conveyed to Studer the details of this agreement, and the amount of stock that was allocated to the individuals whom Studer and Castle were to find to invest in the Windfall offering. See Tr. at 61, 64.
i. The only Windfall investors who subscribed during the first four months of the offering were Martin and Judith Hausman, a married couple who were D'Onofrio's nominees. They invested $200 and purchased 4,000 of the 1 million units offered by Windfall. See Tr. at 65.
j. Although the Windfall Offering period was between February 10, 1989 and August 17, 1989, 996,000 of the 1 million units offered were subscribed to between July 28, 1989 and August 9, 1989, just days after the deal was struck at the Geller Meeting, all by individuals or entities associated with the D'Onofrio Group, Studer and Castle, or USE insiders. See PX 56-PX 69 (various Windfall subscriptions agreements, completed between July 29, 1989 and August 9, 1989).
k. The D'Onofrio Group subscribed to or directly controlled 474,000 units or 47.4% of the Offering, 20.4% of which were purchased through two subscription agreements in the name of Ronart and Mandrake, two companies controlled by Kirschbaum, which were clients of Castle. See PX 60; PX 66. Studer filled out the Ronart and Mandrake subscriptions because Kirschbaum suffered from arthritis. See Tr. at 256-57. Kirschbaum then signed the Ronart and Mandrake subscriptions. Therefore, Studer was aware that Kirschbaum subscribed to 20.4% of the Windfall public securities. Furthermore, the D'Onofrio Group did not hide their control of other companies that subscribed to large portions of the Windfall offering. That is, the Cable Partners' subscription (62,000 Units) bears D'Onofrio's and his wife's signature and, and the Raven Industries' subscription (102,000 Units) bears Ramon D'Onofrio's signature. D'Onofrio Group Nominees include: Illford Pharmacueuticals; Cable Partners, Inc.; Raven Industries; Ronart, Inc.; Mandrake Capital; and Martin and Judith Hausman. See Tr. 64-67.
l. Geller and Sepe nominees subscribed to 48% of the Offering (48,000 units). See Tr. at 67-68.
m. Castle's and Studer's employees, relatives, friends, and customers subscribed to the remaining 46,000 units or 4.6% of the Offering. The D'Onofrio Group, through Kirschbaum, instructed Studer and Hebert to arrange for approximately 30 nominees to purchase the 4.6% of the Windfall Offering to make the offering appear to have a large investor base, concealing from the regulators that the Windfall Offering was a highly concentrated distribution. See Tr. at 59. Castle and Studer managed to arrange for four individuals and one corporation to purchase Windfall securities.
n. These four individuals and one corporation included: Lester Buckman, Raymond DeSalvo, Barbara Parker, Raymond Snediker, and Regluc Limited. The four individuals and the corporation Regluc were all closely associated with Castle and Studer, and none of them were experienced in securities investments. Furthermore, the subscription agreements for all five of them bore the same execution date of August 9, 1989. Moreover, all five Castle-related owners of USE sold their securities to Castle in the immediate after-market trading. Each of the transactions in which these customers sold their USE shares back to Castle were solicited by Castle, and the assigned registered representative was either Studer or Hebert. See Tr. 891-896.
o. On August 28, 1999, Windfall and USE merged, allowing USE to be a publicly tradable security without going through an IPO. See UF at pp; Tr. at 52-53.
p. The merger took place at Castle's offices at 75 West Merrick Road, Freeport, New York.
q. Studer reviewed the merger contract a few days before the merger. See Tr. at 262.
r. On August 28, 1989, all of the 11 initial Windfall shareholders sold 90% of their unregistered Windfall securities for nominal profits to entities controlled by the D'Onofrio Group. See UF at tt.
s. Sepe and Geller agreed to withhold from the market the 48% of the shares to which they had subscribed, and to make their shares available to the D'Onofrio Group whenever the D'Onofrio Group "called" or asked for those shares. See PX 135 (Deposition of Mark D'Onofrio, dated Dec. 15, 1999) at 199-201.
t. Through conversations with Kirschbaum, Castle and Studer agreed to make the 4.6% of the shares subscribed to by their nominees available to the D'Onofrio Group shortly after "after-market" trading commenced. See PX 135 at 243-44.
u. Therefore, the D'Onofrio Group had an unwritten, undisclosed call option on the shares of USE which it did not control directly, which gave the D'Onofrio Group indirect control over these shares and enabled them to dominate and control trading in the USE stock in the after-market. See PX 135 at 242-44.
v. Pursuant to the terms of the merger, Windfall acquired all of the outstanding stock of privately held USE, which became a wholly owned subsidiary of Windfall and Windfall changed its name to USE. See UF at ss. Both D'Onofrio and Studer were present at Castle's offices at the time of the merger. See Tr. at 271-72.
w. On September 8, 1989, Studer opened an account at Castle in D'Onofrio's name. See PX 74; PX 122. D'Onofrio immediately attempted to sell USE securities before the securities were delivered to his account. See Tr. at 983-86.
x. Calderone refused to undertake D'Onofrio's sell transaction until the securities were delivered into the account. D'Onofrio spoke with Studer who directed Calderone to effect D'Onofrio's trade. Id.
VIII. Castle Made the Market for USE Securities and Oversaw the Manipulations of the Stock Price From $0.05 to $5.50
a. Commencing on September 8, 1989, Castle, under Studer's supervision, was the initial, and then principal, market maker of USE securities (formerly the Windfall securities registered with the SEC pursuant to the Form S-18). See UF at xx; yy; zz.
b. In the days before September 8, 1989, Castle, through Studer, filed forms with the NASD that listed Castle as the first market maker for USE securities. See UF at yy; see also Tr. at 974.
c. USE securities were listed to be quoted on the "pink sheets" of the NASD's over-the-counter market (the "Pink Sheets" and "OTC"). Castle, as a market maker, would submit the daily quote of the bid and ask to the NASD, which would publish the quotes for USE securities on a daily basis in the Pink Sheets. See Tr. at 277-78; Tr. at 862-63. The Pink Sheets provided broker-dealers, investors and other market participants with the trading price of USE securities as posted by the registered market makers for the securities. See Tr. at 285.
d. As a NASD registered market maker, Castle had a duty to make a fair and orderly market in USE securities. See Tr. at 287, 336-37 (Studer); Tr. at 483-84 (Robert W. Lowry, plaintiff's expert).
e. A broker-dealer has a duty to supervise trading and to implement a reasonable supervisory system that detects indications that there may not be a fair and orderly market in the trading of a certain security, otherwise known as "red flags." See Tr. at 504. A broker-dealer's supervisory system must have procedures in place to investigate these red flags. See Tr. at 504. The principal of the broker-dealer has a duty to enforce the supervisory procedures. see id.
f. Through Castle's OTC trading as a market maker in USE securities, under the supervision of Studer, the D'Onofrio Group was able to raise artificially the price of USE securities from five cents per share to more than five dollars per share by employing manipulative and deceptive devices. See Tr. at 485-87. Below are summaries of four categories of manipulative and deceptive acts employed:
1. First Manipulative Category: The D'Onofrio Group Guaranteed Castle's Market Making Profits For USE Securities
i. At or about the time the Windfall Offering closed, the D'Onofrio Group, Studer, and other defendants, agreed that Castle would act as a market maker in USE securities. See Tr. at 296-98 (Studer); Tr. at 99-101 (D'Onofrio).
ii. Castle had a small capital base in 1989. Studer and Hebert were concerned about Castle's net capital restrictions. See UF at ttt; see also Tr. at 289-91 (Studer); Tr. at 997-98 (Calderone).
iii. Studer instructed Romano and Calderone to make a market in USE securities, even though investments in such securities are known to be extremely risky, where, as was the case with USE, the company has no operating history and practically no assets. See Tr. at 956-57.
iv. Studer instructed Romano and Calderone that Castle was going to be making a market in USE securities. Romano and Calderone began making a market in USE securities on the first day of trading, September 8, 1989, without conducting any due diligence. See Tr. 845-50.
v. In return for Castle's acting as a market maker, D'Onofrio agreed to protect Castle from market risk by buying out any "long" position and covering any "short" position, both at a profit to Castle. See Tr. at 103-04.
vi. This arrangement enabled Castle to generate trading profits without running the risks normally assumed by a market maker. See Tr. at 484-85.
vii. In the period between September 8, 1989, and February 1, 1990, Castle achieved a zero balance inventory of USE stock on fifty-three different occasions by either buying its short position from or selling its long position to an account controlled by the D'Onofrio Group. Castle's trading department made a profit on each of these fifty-three occasions. See UF at uuu; Tr. at 497-500.
viii. The vast majority of the fifty-three trading sequences involved transactions with D'Onofrio's account at Castle or accounts controlled by D'Onofrio at other broker-dealers. See UF at uuu; Tr. at 497-500.
ix. Studer closely monitored Castle's market making activity and the firm's exposure in various securities. See Tr. at 296-98 (Studer); Tr. at 867 (Romano); Tr. at 997-98 (Calderone).
x. As the supervisor of Castle's trading department, Studer testified that he had reviewed and initialed most of the USE trading tickets, approving the transactions encompassing the fifty-three consecutive profitable trading sequences in USE securities. See Tr. at 302-05.
2. Second Manipulative Category: Castle and Studer Arranged for Castle's Customers to Flip Back Their Windfall Securities.
i. In the immediate after-market of trading in USE securities, Studer and Castle arranged for the individuals and entities who had subscribed to the 46,000 units in the Windfall offering to sell those securities back to Castle. See PX 135 at 242-44.
ii. D'Onofrio called Castle in the early after-market and complained that Castle customers were not selling their USE securities, indicating that he was aware of their positions in the stock. See UF at kkk; Tr. at 327-29 (Studer); Tr. at 118-19 (D'Onofrio); Tr. at 494-96 (Lowry). D'Onofrio wanted to acquire the shares owned by the Castle customers, who purchased them during the Windfall Offering, to eliminate any potential sellers of the stock before its price significantly increased. See Tr. at 118-19 (D'Onofrio); Tr. at 495 (Lowry).
iii. D'Onofrio testified that he warned Hebert that he would no longer conduct his trading through Castle, unless the Castle nominees sold their USE securities. See Tr. at 118-19.
iv. Shortly after D'Onofrio's warning, all of Studer's and Castle's nominees sold their USE securities. See UF at ppp. Each order ticket for these sales indicate that the transactions were solicited by Castle, and Studer or Hebert was the assigned registered representative. See PX 89; Tr. at 891-95.
iv. D'Onofrio's complaint about other shareholders not selling their stock when he was selling is inconsistent with market participants trading in a competitive market. See Tr. at 495-96.
3. Third Manipulative Category: Castle, Under Studer's Oversight, Allowed the D'Onofrio Group to Employ Castle's Market Making Services for Purposes of Executing D'Onofrio's Matching Orders and Wash Trades.
i. At or shortly after Romano was introduced to D'Onofrio, Romano executed trades in USE securities, at D'Onofrio's direction, on nearly a daily basis; Romano also agreed to move or adjust the price Castle quoted for USE shares at D'Onofrio's direction. See Tr. at 108-09 (D'Onofrio); Tr. at 878-80, 885-86 (Romano); PX 99 (Notes of FBI interview with John Romano, dated Jan. 16, 1991).
ii. D'Onofrio would inquire of Romano how much trading there had been in USE shares each day, and what orders Castle had received for USE shares. D'Onofrio would then dictate the prices and direct Romano to buy or sell shares from specific accounts controlled by the D'Onofrio Group or nominees of the D'Onofrio Group, or to deal with other market makers. See Tr. at 108-09 (D'Onofrio); Tr. at 878-80, 884-88 (Romano).
iii. In many instances, Romano completed transactions directed by D'Onofrio by obtaining stock from, or selling stock to, D'Onofrio's retail accounts at Castle. However, Romano sometimes obtained stock to fill Castle's positions from buy or sell orders received from other broker-dealers that D'Onofrio directed to Romano, and where the D'Onofrio Group, or nominees of the D'Onofrio Group, maintained brokerage accounts. See Tr. at 529-30 (Lowry); Tr. at 878-80, 884-88 (Romano).
iv. D'Onofrio called Romano and Calderone to alert them that Castle would be receiving incoming buy and sell orders from other broker-dealers. See Tr. at 878-80, 884-88 (Romano); Tr. at 1001 (Calderone); PX 99. Customers do not normally have a role in how market makers buy or sell stock with other broker-dealers. See Tr. 501. The call from D'Onofrio should have been a red flag to the trader that D'Onofrio had information about other broker-dealer accounts that is inconsistent with the information customers normally possess. Id.
v. Romano believed that D'Onofrio was on both sides of the trading in USE stock. See Tr. at 887; PX 99.
vi. While Romano does not specifically remember recounting this information or this belief to Studer, he was not in the practice of keeping secrets from Studer, had a good relationship with Studer and normally spoke with Studer several times during the trading day. See Tr. at 879-80. In describing Studer's presence in the Castle trading department, Calderone testified that, "[Studer] would come in, check tickets, check positions to see if we're [the traders, Romano and Calderone] spending too much money, too short, too long with reference to the market at that time." See Tr. at 970.
vii. On a significant number of trading days from in or about September 1989 through December 1989, the D'Onofrio Group engaged in manipulative practices that had the effect of transferring shares from one D'Onofrio Group controlled account to another D'Onofrio Group controlled account at successively higher prices, as well as giving the false appearance of demand for USE shares, without any change in beneficial ownership. See Tr. at 480-83; PX 239 (USE trading report, from Sept. 8, 1989 through Jan. 30, 1991).
viii. These manipulative devices, which included prearranged simultaneous "buy" and "sell" orders, are referred to as "wash sales" and "matched orders." See Tr. at 481.
ix. In order to effect the "wash sales" and "matched orders," the D'Onofrio Group utilized approximately 43 brokerage accounts it controlled, in several brokerage firms, located primarily in Canada, as well as approximately three accounts maintained at Castle. Most of these accounts were in the names of nominees. See UF at ww; Tr. at 481-83; PX 239.
x. Castle frequently received orders in USE stock at the end of day from other broker-dealers in the amount needed to cover Castle's position. See Tr. at 875-76 (Romano); Tr. 529-32 (Lowry); PX 236 (Ex. A to Lowry Report). The timing of these trades and the precision in the number of shares traded to cover Castle's position should have raised a red flag to the trader and the supervisor reviewing the order tickets. See Tr. at 531-32.
xi. Between in or about September and December 1989, the D'Onofrio Group accounted for the overwhelming majority of trading in USE. See UF. at vv; PX 239.
xii. Retail interest in USE stock was modest during the month of October 1989, consisting of purchases of approximately 5,000 shares and sales of approximately 7,000 shares. In contrast, the D'Onofrio Group purchased approximately 38,000 shares and sold approximately 36,000 shares during that month. See PX 239.
xiii. As a result of the manipulative devices employed by the D'Onofrio Group, made possible by the over-the-market trading service of Castle as the market maker, an active, competitive market for USE stock did not exist during the trading period from September 1989 through February 1990. See Tr. at 479.
4. Fourth Manipulative Category: Castle Set Artificial Bid and Ask Prices for USE Securities that Raised the Price of USE Stock from Five Cents to More than Five Dollars Per Share.
i. Castle's bid and ask prices from September 8, 1989 through January 1990, raised the price of USE securities from five cents per share to more than five dollars per share. See PX 239 at 1-15; Tr. at 485-86.
ii. On the first day of trading, the price of USE stock increased from $0.05 to an intraday high of $0.75. The only sellers that day were the Castle nominees and D'Onofrio. By the third day of trading, the price of USE stock reached $1.50 and closed at $1.313. See UF at sss; PX 239 at 1.
iii. During that three-day period, there were only 34 trades, largely by accounts controlled by D'Onofrio and the Castle nominees. See PX 239 at 1.
iv. By the end of September 1989, there had been only 95 transactions pertaining to USE securities, yet Castle raised the bid and ask prices to as high as $3.50 per share. See PX 239 at 1-3.
v. There was no information that justified the price increase for USE stock. USE's filings with the SEC reveal that the company had practically no assets or operations. See PX 55 (USE Form 10, filed Sept. 5, 1989); Tr. at 338-40 (Studer); Tr. at 861, 902-04 (Romano); Tr. at 493-94 (Lowry).
vi. In September 1989, USE was based in a 1,000 square foot office with no revenues and only $11,550 in assets. See PX 55 at 10.
vii. USE's market capitalization was more than $100 million when its securities were priced at $5 per share. Studer was aware that USE had 1 million public shares outstanding and more than 20 million restricted shares; therefore Studer understood that USE had a market capitalization of $100 million by November 1989. See Tr. at 338-40 (Studer); Tr. at 902-04 (Romano).
viii. Romano did not review USE's Form 10 until several weeks after Castle had created a market in that security. See Tr. at 974-77.
ix. On several occasions, Castle increased or decreased the bid and ask prices in large increments that bore no relations to supply or demand, or any other type of market information. See PX 236; Tr. at 486-87.
x. Market makers trade within a pricing range of the bid and the ask prices, which is determined by competition. See Tr. at 487. However, on several occasions, Castle sold USE stock to D'Onofrio at prices below what were the current market conditions. See Tr. at 487; PX 236.
xi. These sales of USE stock to D'Onofrio below the market prices should have served as red flags, which would have alerted the supervisor reviewing the trades to the fact that a fair and orderly market did not exist in the trading of USE securities. See Tr. at 488. An inquiry should have been made into why the USE stock was being sold below the current market price. See Tr. at 487.
IX. The D'Onofrio Group and Castle, under Studer's Control and Oversight Sold the USE Stock to Public Investors at Manipulated Prices and Made Ill-Gotten Gains of $178,000
a. Beginning in January 1990, the D'Onofrio Group enlisted Castle and at least two other brokerage firms to liquidate its holdings and reap profits from the manipulation, which would total $940,374 by November 1990. See PX 139 (Final Judgment against Mark D'Onofrio).
b. Between June 8, 1990 and July 3, 1990, approximately 130 Castle customer accounts bought almost 15,000 shares of USE stock at prices as high as $6 per share. See PX 239 at 68-83.
c. The D'Onofrio Group sold stock to Castle during this period at prices ranging from $4 per share to $5.25 per share to supply this demand. Id.
d. Retail customers at Castle were buying USE stock at prices not determined by a competitive market. See Tr. at 525. When the price of USE stock declined, many of those customers lost most or all of their money. See Tr. at 526.
e. From September 1989 through August 1990, Castle's trading account bought and sold at least 1,123,000 shares of USE stock at a profit of approximately $178,000. See UF at www; PX 239 at 1-108.
f. In the Pretrial Order, defendants concede they made trading profits of at least $170,000. See UF at www.
g. Pursuant to his consent to a final judgment, defendant Romano previously disgorged one quarter of those ill-gotten gains, totaling $43,776, leaving an undisgorged balance of $134,224.
h. At trial, the SEC introduced a publication from the Internal Revenue Service ("IRS") which lists the various statutory interest rates for the period from September 1, 1990 through October 31, 2002 for a tax-payer's underpaymet of taxes. Such rates are reasonable interest rates for purposes of calculating prejudgment interest. See Tr. 1148-51; PX 264 (Internal Revenue Bulletin, dated September 23, 2002).
X. Likelihood that Securities Violations Could Reoccur Based on Castle's and Studer's Conduct Subsequent to the Windfall and USE Frauds
To this end, the Court did consider D'Onofrio's testimony as to the statements Kirschbaum made to him, in which Kirschbaum relayed conversations and agreements that Kirschbaum, on behalf of the D'Onofrio Group, had discussed with Studer, Castle and Hebert. The Court agrees with the plaintiff that these statements of Kirschbaum's should not be considered hearsay as they are statements made by a co-conspirator in furtherance of a conspiracy. See Fed.R.Evid. 801(d)(2)(E). Kirschbaum's statements are admissible because plaintiff has shown, by a preponderance of the evidence, that: (1) a conspiracy existed between Kirschbaum, D'Onofrio, Studer and Castle, among others, (2) Kirshbaum, Studer and Castle were members of this conspiracy, and (3) the statements were made in furtherance of the conspiracy. See United States v. Gigante, 166 F.3d 75, 83 (2d Cir. 1999).
While circumstantial evidence may be used to determine whether a conspiracy existed between the declarant and the parties against whom the statement is offered, see United States v. DeSena, 260 F.3d 150, 155 (2d Cir. 2001), and the statements themselves may be considered, there must also be some corroborating evidence of defendants' participation in the conspiracy in order for the statements to be admissible. See Gigante, 166 F.3d at 83; United States v. Tellier, 83 F.3d 578, 580-81 (2d Cir. 1996). In this case, there is corroborating evidence, outside of Kirschbaum's statements themselves, of Studer and Castle's participation in a conspiracy with Kirschbaum to form Windfall as a blindpool for use by the D'Onofrio Group. Such evidence consists of Romano's testimony that Studer and Herbert told him that Kirschbaum was responsible for finding a company for Windfall to acquire or with which Windfall would merge. See Tr. at 836. Moreover, there is evidence of Studer's knowledge that Kirschbaum was associated with D'Onofrio, in the form of the letter dated May 31, 1988, sent from D'Onofrio to Castle attaching the $5,000 Windfall subscription agreement of Kraylink, a corporation controlled by Kirschbaum, with a subscription agreement signed by Kirschbaum, and discussing the blind pool companies, Windfall and Emerging Enterprises, being initiated. Finally, the statements made by Kirschbaum to D'Onofrio, which include, among other things, Kirschbaum's instruction to Studer and Castle to have Castle customers subscribe to 4.6% of the Windfall offering, either directly or indirectly through nominees, are clearly in furtherance of the conspiracy, as Kirshbaum made these statements on behalf of the D'Onofrio Group, and in furtherance of their interests in setting up the Windfall blindpool.
Defendants have requested that the Court re-evaluate its decision on the in limine motion admitting the testimony of Robert W. Lowry, the plaintiff's expert, on the grounds that the testimony of Lowry at trial was "demonstrably unreliable as based on unexplored and unidentified legal criteria," and should be deemed "inadmissible as a usurpation of the trial judge's role as it, in part, simply told the trier of fact what result to reach." Post Trial Memorandum of Defendants Castle Securities Corp. and Michael T. Studer ("Def. Mem.") at 20; SEC v. U.S. Environmental, Inc., No. 94 Civ. 6608, 2002 WL 31323832 (S.D.N.Y. Oct. 16, 2002) (Leisure, J.). While the Court did reserve the right to alter its decision admitting Lowry's testimony based on how that testimony developed at trial, having heard Lowry's testimony, the Court stands by its finding that the reliability of Lowry's trial testimony could be sufficiently evaluated by looking to "Mr. Lowry's thirty years of experience as a regulator, compliance director and securities consultant, as well as his experience in testifying as an expert in approximately 30 securities actions." Id. at *3 ("Lowry arrives at such conclusions based on his knowledge of typical trading activity and the types of trading patterns that an experienced trader would recognize as irregular, and as such, are supported by his 30 years of experience in the securities industry."). Moreover, the Court finds that in his testimony, Lowry paid heed to the advice of the Court, imparted in its in limine decision, to be cautious of the distinction between imparting factual conclusions that embrace an ultimate issue of fact and giving legal conclusion. Id. at *6. Lowry testified regarding his findings and observations from his review of the USE trading records, assisting the Court with helpful factual conclusions based on that review, but not giving legal conclusions, which would have "encroach[ed] upon the Court's duty to instruct on the law." United States v. Bilzerian, 926 F.2d 1285, 1294 (2d Cir. 1991). Therefore, the Court sees no reason to change its decision regarding the admissibility of Lowry's testimony.
a. The Investigation of USE
B. CONCLUSIONS OF LAW
1. During its investigation of the trading of USE securities in the summer of 1990, the SEC's staff issued subpoenas to Studer, Hebert, Romano, Roth, Meeks and various other individuals. Studer, Hebert, Romano, Roth and Meeks each appeared and provided testimony in 1990.
2. In their testimony, both Studer and Hebert denied any involvement with the D'Onofrio Group or the formation of Windfall. See PX 38 (Investigative Testimony of Michael T. Studer, dated Aug. 8, 1990); PX 18 (Investigative Testimony of George R. Hebert, dated July 31, 1990).
3. Roth and Meeks refused to answer most of the SEC staffs questions based on the assertion of their Fifth Amendment privilege against self-incrimination. See PX 10 (Investigative Testimony of Leslie Roth, dated Aug. 2, 1990); PX 226 (Investigative Testimony of Noel Meeks, dated Nov. 30, 1990).
b. The Manipulation of Reshone International Investment Group, Ltd.
1. In the face of the investigations of USE securities by the U.S. Attorney's office and the SEC's staff, Castle, under Studer's supervision, manipulated the securities of another issuer, Reshone International Investment Group, Ltd. ("Reshone") from approximately November 1991 through April 1992. See PX 103 (SEC Release No. 34-39523, 1998 WL 3456, dated Jan. 7, 1998).
2. In May 1991, Castle acted as the sole underwriter of an IPO of securities of Reshone, a newly formed blind pool company with no operating history. Id. at 2. Studer personally negotiated the offering price of Reshone securities at $6 per unit. Id.
3. Studer listed Castle as the initial market maker for Reshone securities, and Castle was the exclusive market maker for those securities from November 7, 1991 through May 31, 1992. Id.
4. There was insufficient demand for Reshone securities at $6 to close the offering; however, Castle began selling Reshone securities to retail customers at $9 per share in December 1991 and increased the price per share to $11 by May 31, 1992. Id.
5. As the sole underwriter, Castle knew the identity of the customers who purchased Reshone's IPO securities; Castle was the only dealer in the after market of Reshone securities; Castle conducted almost all of the secondary market transactions in Reshone securities; Castle continued to sell Reshone securities at inflated, arbitrary prices to its customers, despite a lack of investor interest. See id. at 3.
6. Castle and Studer never denied that the manipulation and markup violations of Reshone securities occurred, but instead, claimed that a Castle employee was responsible. See id. at 3.
7. The NASD found that Castle, under Studer's supervision, manipulated the market in the common stock of Reshone in violation of Article III, Sections 1, 4 and 18 of the NASD's Rules of Fair Practice ("NASD Rules") and Section 10(b) of the Exchange Act and Rule 10b-5. See id.
8. The NASD determined that there were "serious deficiencies in both [Castle's] written supervisory procedures and supervisory system that failed to prevent or detect the manipulation and mark-up violations." Id. at 4. The NASD concluded that Studer, as the president of Castle, was responsible for the establishment of supervisory procedures, and that Studer had failed to satisfy this responsibility. Therefore, NASD found that Castle and Studer violated Article III, Sections 1 and 27 of the NASD Rules. See id. at 1-2.
c. The Ardian Finance Fraudulent Offering and Studer's Assertion of the Fifth Amendment Privilege
1. Recently, Castle conducted an alleged fraudulent securities scheme through Michael Yeninas ("Yeninas"), a registered representative in its New York City branch. See PX 254 (SEC Complaint dated Aug. 8, 2002 in SEC v. Ardian Finance Group, et al, 02 Civ. 4366 (E.D.N.Y.)); PX 255 (Declaration of James Gange, dated Aug. 6, 2002).
2. On August 8, 2002, the SEC charged Yeninas and others with committing securities fraud from approximately October 2001 through August 2002, by soliciting and making material misrepresentations to investors to induce them to purchase securities in private offerings.
3. From July 2001 through March 2002, during most of the period that he committed his alleged fraud, Yeninas worked as a registered representative at Castle.
4. On or about August 23, 2002, Yeninas consented to the Court's issuance of a preliminary injunction against him in the Ardian litigation. See PX 257 (Preliminary Injunction Order, dated Aug. 23, 2002).
5. On August 13, 2002, Studer was subpoenaed by the SEC to appear for deposition testimony in the Ardian litigation. In response to nearly all questions posed by the SEC's staff, including questions regarding Studer's and Castle's involvement in the Ardian offering and knowledge of Yeninas' activities, Studer refused to testify, invoking his Fifth Amendment privilege against self-incrimination. See PX 258 at 12-20 (Transcript of Studer deposition on Aug. 26, 2002).
d. The Fraudulent Solicitation of a North Carolina Investor in Connection with "CastleOnline" Securities
1. On May 23, 2002, during the investigation of the Ardian offering of securities, the SEC's examination staff interviewed Studer at Castle's office. In that interview, Studer admitted that in 2001, Castle Holding had undertaken an offering of unregistered securities to raise funds for Castle's New York City office and to raise capital for Castle's operations. See PX 259 (Notes of Janowsky's interview of Studer, dated May 23, 2002).
2. Studer told the SEC staff that Castle Holding's private placement offering of securities did not involve Castle and was conducted by Castle Holding's officers. Studer further stated that "Castle had not received any complaints regarding private placements, but that he did receive inquiries." See id. at 2
3. Studer's representation to the examination staff on May 23, 2002 was false, as Justin Alcott ("Alcott"), an investor residing in North Carolina, sent Studer a letter of complaint, dated March 27, 2002. See PX 262 (Letter from Justin Alcott to Michael Studer, dated Mar. 27, 2002); Tr. at 592.
4. In his letter, Alcott states that Yeninas had solicited him in or about August 2001 to invest in the securities of an entity called CastleOnline for $1 per share, and that Yeninas had represented that CastleOnline's securities would be publicly distributed in an IPO and would soon trade at $5 per share. See PX 262.
5. Alcott and his father invested $40,000 in the securities of CastleOnline, but instead, received preferred common stock of Castle Holding which were only worth approximately 10 cents per share. There was no IPO for CastleOnline. See Tr. at 591-95.
6. Studer responded to Alcott's complaint by sending a letter containing the boilerplate language from the subscription agreement that Yeninas had sent Alcott for Castle Holding preferred common stock. Studer provided Alcott with no explanation for Yeninas' conduct. See id.
7. After receving Alcott's letter, Studer sent Yeninas a letter asking him to address the allegations lodged by Alcott regarding the representations made by Yeninas. Upon Yeninas' denial of Alcott's allegations, Studer conducted no further investigation. Significantly, Castle's website states that it is not licensed to do business in various states, including North Carolina, yet Studer undertook no investigation to determine how Yeninas came to solicit Alcott in North Carolina or how a registered representative of Castle was involved in selling the securities of Castle Holding. See Tr. at 417-21.
1. The Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act, 15 U.S.C. § 77v(a), and Sections 21(e) and 27 of the Exchange Act, 15 U.S.C. § 78u(e), 78aa.
2. The means and instrumentalities of interstate commerce and the mails or the facilities of a national securities exchange were used in connection with the conduct described in the proposed findings of fact involving defendants Castle and Studer.
3. Through the conduct described below in relation to the Windfall Offering and merger, Castle and Studer violated 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 thereunder, 17 C.F.R. § 240.10b-5.
a. Defendants Castle and Studer, directly or indirectly, singly or in concert, in the offer or sale, and in connection with the purchase or sale, of securities, knowingly or recklessly: (1) have employed devices, schemes, and artifices to defraud; (2) have obtained money or property by means of, or have otherwise made, untrue statements of material fact or omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (3) have engaged in transactions, acts, practices, and courses of business which have operated as a fraud or deceit upon purchasers of securities and other persons.
b. The Windfall Form S-18 failed to disclose the actual terms of the Windfall Offering, and defendants D'Onofrio, R. D'Onofrio, Castle, Studer, Sepe, and Roth, in offering and selling Windfall securities, made material misrepresentations of fact and omitted to disclose material facts, including the following:
i. D'Onofrio acted as an undisclosed promoter and, directly or indirectly, controlled the issuer;
ii. D'Onofrio selected USE as the company with which Windfall would merge, and the terms of the merger were arranged before the Windfall Offering closed;
iii. Studer acted as an undisclosed promoter, and Castle acted as an undisclosed underwriter;
iv. Roth and Morrelli undertook the creation of Windfall at Studer's direction;
v. Roth received compensation for her services, and reimbursement for expenses, relating to Windfall, from Studer CPA;
vi. By prearrangement among the D'Onofrio group, Sepe, Geller, Studer, and Castle, the Windfall Offering was acquired entirely by the D'Onofrio group, Sepe, Geller, Studer, and Castle, or by their nominees;
vii. The Windfall Offering was controlled by the D'Onofrio group, which had a prearranged undisclosed call option to purchase the entire portion of the Windfall Offering that nominees of the D'Onofrio group had not acquired directly.
viii. The D'Onofrio Group would commence a public offering through resales after the Windfall Offering purportedly closed, and after the stock price had been manipulated upwards to several dollars per USE share.
4. Through the conduct described below relating to the manipulation of the market for USE securities, Castle and Studer violated Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), Section 10(b) and 15(c)(1) of the Exchange Act, 15 U.S.C. § 78j(b), 78o(c)(1), and Rules lOb-5, 10b-3, and 15c1-2 thereunder, 17 C.F.R. § 240.10b-5, 240.10b-3, 240.15c1-2.
a. Defendants Castle and Studer, directly or indirectly, singly or in concert, in the offer or sale, and in connection with the purchase or sale, of securities, knowingly or recklessly: (1) have employed devices, schemes, and artifices to defraud; (2) have obtained money or property by means of, or have otherwise made, untrue statements of material fact or omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (3) have engaged in transactions, acts, practices, and courses of business which have operated as a fraud or deceit upon purchasers of securities and other persons.
b. Defendant Castle, and defendant Studer, as a controlling person of Castle, directly or indirectly, singly or in concert, and knowingly or recklessly effected transactions in, or induced or attempted to induce the purchase or sale of a security (other than commercial paper, bankers' acceptances, or commercial bills), otherwise than on a national securities exchange of which Castle was a member, by means of manipulative, deceptive, or other fraudulent devices or contrivances, as defined by rules and regulations of the SEC, including, without limitation, by means of: (1) acts, practices, or courses of business which operated as a fraud or deceit upon any person; or (2) untrue statements of a material fact and omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, which statement or omission was made with knowledge or reasonable grounds to believe that it was untrue or misleading.
c. As part and in furtherance of these violations, defendants Castle and Studer, directly, and through Romano, knowingly or recklessly participated in and furthered a market manipulation by:
i. effecting offers, purchases, and sales of USE securities in return for promises of risk-free profit for engaging in such trades;
ii. effecting directed and controlled trades of USE securities;
iii. effecting "wash sales" and "matched orders"; and
iv. effecting trades involving undisclosed nominees.
5. Castle and Studer violated Sections 5(a) and (c) of the Securities Act, 15 U.S.C. § 77e(a), (c), relating to the sale of unregistered securities.
a. As a result of the conduct described above, defendants Castle and Studer, directly or indirectly, singly or in concert: (1) made use of the means or instruments of transportation or communication in interstate commerce or of the mails to sell securities through the use or medium of any prospectus or otherwise, when no registration statement was in effect as to such securities and when no exemption from registration was available; (2) carried such securities or caused them to be carried through the mails or in interstate commerce, by the means or instruments of transportation, for the purpose of sale or for delivery after sale, when no registration statement was in effect as to such securities; and (3) made use of the means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any securities, when no registration statement was filed as to such securities, or while the registration statement was the subject of a refusal order or stop order or (prior to the effective date of the registration statement) a public proceeding or examination under Section 8 of the Securities Act, 15 U.S.C. § 77h, in violation of Sections 5(a) and (c) of the Securities Act, 15 U.S.C. § 77e(a), (c).
b. As a part and in furtherance of these violations:
i. Defendants D'Onofrio and R. D'Onofrio dominated and controlled USE, and acquired and controlled shares from the Offering with the intent to distribute the shares to the public after the manipulation was accomplished;
ii. Defendants Castle, Studer, and Romano took stock from the D'Onofrio group with a view to distributing the stock to the public, rendering them statutory underwriters pursuant to Section 2(11) of the Securities Act, 15 U.S.C. § 77b(1); and
iii. No registration statement was in effect respecting the plan of distribution engaged in by the D'Onofrio group, Castle, Studer, and Romano.
c. As a result of the foregoing, defendants Castle and Studer violated and, unless enjoined, will continue to violate Sections 5(a) and (c) of the Securities Act, 15 U.S.C. § 77e(a), (c).
6. Through the conduct described below relating to the distribution of the Windfall Offering, Castle and Studer violated Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-6 thereunder, 17 C.F.R. § 240.10b-6.
a. Defendants Castle and Studer, while they were (1) an underwriter or prospective underwriter in a particular distribution of securities; (2) an issuer or other person on whose behalf such distribution was being made; (3) a broker, dealer, or other person who agreed to participate or was participating in such distribution; or (4) an "affiliated purchaser" as defined in Rule 10b-6(c)(6), 17 C.F.R. § 240.10b-6(c)(6), directly or indirectly, singly or in concert, in connection with the purchase or sale of any security, knowingly or recklessly: (A) bid for or purchased for any account in which he or it had a beneficial interest, any security which was the subject of a distribution, any security of the same class and series, or any right to purchase any such security; or (B) attempted to induce any person to purchase any such security or right, before he or it completed his or its participation in such distribution.
b. The distribution of the Windfall Offering did not come to rest until the shares were retailed to the public by, among others, Castle and two other broker-dealers.
c. While the distribution continued, the D'Onofrio group, Castle, Studer, Romano, and Freeland were all bidding for or purchasing USE stock, or inducing other persons to purchase USE stock, or both. Between in or about July 1989, when the distribution of the USE shares began, and in or about August 1990, when the distribution came to rest, the D'Onofrio group, and Castle, Studer, and Romano were all bidding for and purchasing USE stock. As set forth more fully above, from in or about September 1989 through in or about August 1990, Castle and Studer, directly and through Romano, bid for and purchased USE securities. During the distribution, the D'Onofrio group bid for and purchased USE stock, and induced other persons to purchase USE stock.
Defendants argue that Castle and Studer were at most "secondary actors" in D'Onofrio's alleged scheme, and as such cannot be held primarily liable under Section 10(b) for mere knowledge and assistance in the fraud. Def. Mem. at 14 (citingWright v. Ernst Young, LLP, 152 F.3d 169 (2d Cir. 1998);see also Central Bank of Denver v. First Interstate Bank, 511 U.S. 164, 177 (1994) (holding that private civil liability under Section 10(b) applies only to those who engage in manipulative or deceptive practice, but not to those "who aid and abet a § 10(b) violation"); Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997) ("Allegations of `assisting,' `participating in,' `complicity in' and similar synonyms . . . all fall within the prohibitive bar of Central Bank" (citations omitted)). However, there is no merit to defendants' argument that they cannot be held primarily liable under Section 10(b) because Castle's and Studer's conduct did constitute primary violations of the antifraud provisions. See SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1471 (2d Cir. 1996) (Kearse, J.) ("Primary liability can be imposed `not only on persons who made fraudulent misrepresentations but also on those who had knowledge of the fraud and assisted in its perpetration'" (quoting Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2d Cir. 1994))). Furthermore, Studer and Castle's scienter is not relevant to this issue; rather, whether a defendant is considered a primary violator, "turns on the nature of his acts, not on his state of mind when he performed them." SEC v. U.S. Environmental, Inc., 155 F.3d 107, 111 (2d Cir. 1998) (vacating and remanding this Court's grant of Romano's motion to dismiss on the grounds that the SEC failed to allege that Romano was a "primary violator" because the Second Circuit found that Romano's actions, as alleged in the complaint, "fell well within the boundaries of primary liability"); see also Plaintiff Securities and Exchange's Post Trial Reply Memorandum ("Pl. Rep.") at 20. The evidence presented at trial demonstrates that Studer and Castle were intricately involved in D'Onofrio's fraudulent scheme, beginning with the creation of Windfall and carrying through to the manipulation of trading in USE securities, and therefore they did engage in conduct which subjects them to liability as primary violators under Section 10(b). See First Jersey Sec., 101 F.3d at 1471-72.
7. Establishing Scienter
To establish a violation of Section 10(b) or 15(c)(1) of the Exchange Act, and Section 17(a)(1) of the Securities Act, plaintiff must prove that the defendants acted with scienter, "a mental state embracing intent to deceive, manipulate or defraud." See Ernst Ernst v. Hochfelder 425 U.S. 185 (1976). Reckless conduct may be sufficient to meet the scienter requirement of a 10(b) action, Rolf v. Blyth, Eastman, Dillon Co., 570 F.2d 38, 44-45 (2d Cir. 1978), however, recklessness has been defined "as a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, which presents a danger of misleading buyers and sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.'" Sundstrand v. Sun Chem. Corp., 553 F.2d 1033, 1045-1046 (7th Cir. 1976) (citing Franke v. Midwestern Oklahoma Dev. Auth., 428 F. Supp. 719 (W.D. Okla. 1976)).
In the case at bar, as is often the case, proof of defendants' scienter in violating these provisions must be inferred largely from circumstantial evidence. See Herman MacLean v. Huddleston, 459 U.S. 375, 390-91 n. 30 (1983) ("The Court of Appeals also noted that the proof of scienter required in fraud cases is often a matter of inference from circumstantial evidence. If anything, the difficulty of proving the defendant's state of mind supports a lower standard of proof. In any event, we have noted elsewhere that circumstantial evidence can be more than sufficient." (citing Michalic v. Cleveland Tankers, Inc., 364 U.S. 325, 330 (1960))).
Even if the Court were to accept Studer's insistence that he was not aware of D'Onofrio's plan to manipulate the market in USE securities, it is clearly established that, in performing his role as supervisor of the trading desk, and reviewing the trading tickets for each day at the end of the day and initialing them, Studer would have and certainly should have been alerted by a series of indicators that, in fact, a fair and orderly market did not exist for USE securities. Defendants argue that Studer can not be found to have violated Section 15(b)(4)(E) of the Exchange Act, which provides that a person has not failed to supervise another if (1) a system of procedures is in place and is being applied which reasonably would be expected to prevent and detect, insofar as practicable, the violations, and (2) the person reasonably discharged his obligations and had no reasonable cause to believe that these procedures were not being complied with. See Defendants' Post-Trial Reply Memorandum ("Def. Rep.") at 16. Defendants argue that Studer did reasonably discharge these duties, and the fact that "he did not pick up on what in hindsight may appear to be a pattern of `red flags' is at best evidence of negligence and does not prove recklessness or intentional conduct." Id. However, even accepting Studer's assertion that he was unaware of D'Onofrio's plan, the Court does not find that Studer reasonably discharged his supervisory duties since the pattern of red flags, apparent from a review of the trading record of USE securities, would have alerted a supervisor who was reasonably discharging his duties and using the system of procedures in place to detect violations, like the ones at issue here.
Furthermore, to ask the Court to believe that Studer and Castle chose to make the market in USE, a stock with very few visible assets and no apparent operating function, without conducting any due diligence regarding the value of the company bends credulity. The Court finds it difficult to believe that, assuming Studer was unaware of the agreements testified to by D'Onofrio regarding D'Onofrio's assurance to Studer that he would cover any long or short positions Castle maintained in USE securities at the end of each day, Studer would not have been alarmed by the sheer volume of trading that Castle was conducting in a company with so few assets and no apparent operating function, particularly in light of Romano's and Studer's own testimony that Studer had an ongoing concern regarding Castle's net capital requirements. If Studer had been unaware of D'Onofrio's manipulative devices, then a reasonable supervisor would have been prompted by a natural concern regarding the volume of trading in any one security by the relatively small firm to conduct further investigation into the trading activity for that particular security, and if necessary, cease making a market in that security until the supervisor could ensure that a fair and orderly market did exist. See Tr. at 530.
While it may have been normal for the price of a new stock to rise in its first few days of trading, perhaps as a result of new interest, even Romano acknowledged that the rise in the price of USE stock from $0.05 at the start of a trading to a high of $1.50 on only the third day of trading could be characterized as "fantastic trading activity" unlike any other underwriting Castle had been involved in prior to that. See Tr. at 901. Reviewing the order tickets each day, Studer would of course have been aware of this "fantastic" price rise. Furthermore, with the continued rise in price over the first four months of trading, Studer was aware that the market capitalization of USE, a company with no visible operating functions and very few assets, was approaching $500 million.See Tr. at 338-340. However, this price rise is just one in a series of red flags which would have been apparent to anyone in Studer's unique vantage — that of a supervisor who reviews all of the trading tickets at the end of the day.
Other indicators that would have alerted Studer to the fact that there was not a fair and orderly market for USE securities include, among other things:
a. The occurrence of orders to buy or sell USE stock, which came in towards the end of the trading day on multiple occasions throughout the Fall of 1989, for the precise amount needed to cover Castle's position, so that Castle could close trading in USE on those days with a zero balance. During the period between September 8, 1989 and February 1, 1990, Castle achieved a zero balance inventory on USE stock on fifty-three different occasions by either buying their short positions from or selling their long position to an entity controlled by D'Onofrio. On each of these occasions, Castle made a profit. Even if the Court were to reject D'Onofrio's testimony that he had an agreement with Studer to protect Castle from market risk by buying out any long position and covering any short position, thereby guaranteeing Castle's profit, and accept the premise that these risk-free trades occurred without an agreement between D'Onofrio and Studer, the patterns of trades coming in towards the close of the day in the precise amount needed to cover Castle's position in USE, and secure Castle's continued profit on the trading of USE securities, would have alerted the supervisor reviewing the daily and monthly trading report that a fair and orderly market did not exist for USE securities.
b. A pattern of trades where the same number of shares in USE would be bought and sold on the same day, indicating a potential wash trade or a matching order trade. Upon review of the daily and monthly trading report, which Studer did examine in addition to reviewing each trading ticket on a daily basis, a pattern of such trades would be evident, and would certainly have been a strong indication that a fair and orderly market did not exist in the trading of USE securities.
c. Telephone calls from D'Onofrio, including one to Studer in the immediate after-market, complaining that not enough Castle customers were selling their USE securities, and several calls from D'Onofrio throughout the Fall of 1989, alerting Romano that Castle would be receiving incoming buy and sell orders from other broker-dealers, indicate that D'Onofrio had knowledge inconsistent with that of customers in a fair and orderly market.
As in SEC v. Cooper, trading in the aftermarket demonstrated conclusively that forces other than the natural market supply and demand were at work. See SEC v. Cooper, 402 F. Supp. 516, 519 (S.D.N.Y. 1975). The rise in the price from .05 to $5 a share was clearly not the result of normal market activity since it bore no logical relationship to the development of USE's business operations, but rather was the result of the manipulative tactics and devices employed by the D'Onofrio Group. However the D'Onofrio Group could not have conducted this manipulative scheme alone; the success of this scheme was dependent upon the trading services of Castle, under the supervision of Studer.
In light of all of the indicators pointing to the clear absence of a fair and orderly market in the trading of USE securities, including but not limited to the sky-rocketing price and the pattern of trading activity, Studer's insistence that he was unaware of D'Onofrio's scheme of manipulation, and his assertion that these objective factors did not and would not have raised any red flags during his supervision of Castle's trading department "flies in the face of reality." Cooper, 402 F. Supp. at 523-24.
8. Injunctive Relief
In an action involving "remedial statutes," such as the federal securities laws, a district court has broad discretion to enjoin future violations of law where past violations have been shown. SEC v. Everest Management Corp., No. 73 Civ. 4932, 1982 U.S.Dist.LEXIS 14346, *41 (S.D.N.Y. July 30, 1982) (citingSEC v. Culpepper, 270 F.2d 241, 249-50 (2d Cir. 1959)). Under the federal securities laws charged in this action, the Court is empowered to issue injunctive relief upon a proper showing that there is a reasonable likelihood of future violations. See SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 99 (2d Cir. 1978); SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1100 (2d Cir. 1972) ("[A] district court has broad discretion to enjoin possible future violations of law where past violations have been shown."). In addition to the existence of past violations, from which the Court can make the inference that future violations may occur, the Court can also consider "the degree of scienter involved, the isolated or recurrent nature of the infraction, the nature of the infraction, the nature of the violations involved, and a defendant's recognition of his wrongful conduct." Everest Management Corp., 1982 U.S. Dist. LEXIS 14346, at *42.
In this case, plaintiff points to several of these factors, in particular the recurrent nature of the violations, to establish that there is a reasonable likelihood that future violations will occur. The plaintiff has shown that the fraudulent Windfall offering and the manipulation of USE securities was not an isolated event, as Castle, through Studer, has been associated with three other alleged securities frauds, specifically: (1) their involvement with the Dynamic blind pool offering, which should have alerted Studer to the potential for fraudulent misuse of blind pool offerings; (2) Castle's manipulation, under Studer's supervision, of the common stock of Reshone, not more than two years after the USE manipulation, occurring while the SEC's investigation of the USE matter was ongoing; and most recently, (3) Castle, under Studer's supervision, became involved in another alleged fraudulent securities scheme in the Ardian offering. In both of the subsequent violations — Reshone and Ardian — Castle, though Studer, has alleged that the violations were the result of the actions of a rogue Castle registered representative. Even accepting that as true, Castle, and Studer as the responsible supervisor there, have clearly abdicated their responsibilities to supervise the actions of their employees, responsibilities of which Castle and Studer should have been well aware after the SEC's investigation into the fraudulent Windfall offering and the manipulation of USE securities. However, in the midst of that investigation, two years after the Windfall offering, the NASD found that Castle, under Studer's supervision, manipulated the market in the common stock of Reshone, and the NASD identified "serious deficiencies in both the Firm's written supervisory procedures and supervisory system that failed to prevent or detect the manipulation or mark-up violations." See PX 103 at *4.
Furthermore, in light of the fact that Studer continues to operate Castle as a registered broker-dealer, and the fact that Castle's website claims that Castle will continue to underwrite public offerings of securities, it is clear that Castle and Studer will have several opportunities to commit future securities violations. See PX 242, (printout of the website for Castle Holding Corp., dated Oct. 17, 2002). In addition, Studer and Hebert operate Citadel Securities, another broker-dealer which makes markets on OTC and Pink Sheet securities, from the same location as Castle. See id; Tr. at 465. Furthermore, Castle and Studer have refused to acknowledge that any of their conduct in relation to the Windfall Offering and the trading of USE securities was improper. In none of the fraudulent securities transactions with which Castle has been linked — the USE manipulation, the Reshone offering or the Ardian fraud — has Castle or Studer acknowledged any wrongdoing, or even taken responsibility for the lack of supervision of the Castle employees on whom they placed the blame for these frauds. Therefore, it is necessary to enjoin Studer and Castle from committing these securities violations in the future. Their violations are egregious and repeated, and neither Studer nor Castle have acknowledged any wrongdoing or accepted any responsibility for the frauds perpetrated upon the public. Under the circumstances involved in the this case, the Court finds that there exists a reasonable likelihood that Studer and Castle, unless enjoined, will in the future continue to engage in conduct violative of the federal securities laws.
9. Disgorgement of Illegally Obtained Profits
When the SEC has established that a defendant has violated the securities laws, a district court has the authority to order the disgorgement of illegally obtained profits realized from the fraudulent conduct, as well as prejudgment interest on those profits. See, e.g., SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987); Manor Nursing Centers, Inc., 458 F.2d at 1104. Disgorgement is not a penalty assessment, but merely a means of divesting a wrongdoer of ill-gotten gains, a way "to make sure that wrongdoers will not profit from their wrongdoing." Tome, 833 F.2d at 1096. "The effective enforcement of the federal securities laws requires that the SEC be able to make violations unprofitable. The deterrent effect of an SEC enforcement action would be greatly undermined if securities law violators were not required to disgorge illicit profits." Manor Nursing Centers, Inc., 458 F.2d at 1104.
In the Pretrial Order, defendants stipulated to the fact that Castle's profit from the trading in USE securities from September 1989 to August 1990 totaled approximately $170,000.See UF at www. Previously, pursuant to a final judgment on consent, Romano disgorged approximately one-quarter of Castle's trading profits, $43,776. Therefore, plaintiff requests that the Court order defendants to disgorge the remaining three-quarters of the ill-gotten gains, in the amount of $134,224, along with prejudgment interest pursuant to the IRS statutory rate for the period September 1990 through the present. See PX 264.
Furthermore, plaintiff argues that Castle and Studer should be jointly liable for Castle's trading profits, since Castle was a very small broker-dealer during the USE manipulation, and Studer, as a Series 24 supervisor and part owner of Castle Holding, was Castle's controlling person. A principal of a firm who is "intimately involved" in the fraud and is liable as a controlling person is properly held jointly and severally liable for disgorgement of the total amount of the firm's illegally obtained profits. See First Jersey Sec., 101 F.3d at 1475-76. In First Jersey, the Second Circuit stated that, "under the terms of § 20(a), a controlling person who has failed to establish a good faith defense is to be held `liable jointly and severally with and to the same extent as' the controlled person." Id; see also 15 U.S.C. § 78t. The SEC maintains that Studer did play an intimate role in the USE fraud, while defendants argue that Studer should not be held liable since Studer was not "`intimately involved' in the perpetration of the securities violations, and did not personally profit from the transaction." Def. Rep. at 17-18 (quoting First Jersey Sec., 101 F.3d 1450, 1475-76 (2d Cir. 1996)). The Court finds that, from the formation of Windfall to his oversight of Castle's role in the manipulation of USE securities, Studer did play an intimate role in the fraudulent transactions, and as such should be held jointly and severally liable for the disgorgement of the total amount of Castle's illegally obtained profits. As the supervisor of a very small broker-dealer, with only two traders to supervise, Studer would have been aware of the status and any developments with regard to Castle's trading of USE securities.See Tr. at 970 (in describing Studer's presence in the Castle trading department, Calderone testified that, "[Studer] would come in, check tickets, check positions to see if we're [the traders, Romano and Calderone] spending too much money, too short, too long with reference to the market at that time.")
"Thus, once the Commission shows the existence of a fraudulent scheme in violation of federal securities laws, the burden shifts to the defendant to `demonstrate that he received less than the full amount allegedly misappropriated and sought to be disgorged.'" SEC v. Rosenfeld, No. 97 Civ. 1467, 2001 WL 118612 at *2 (S.D.N.Y. Jan. 9, 2001) (quoting SEC v. Benson, 657 F. Supp. 1122, 1133 (S.D.N.Y. 1987)). However, defendants in this case have failed to demonstrate that Studer did not personally benefit from the fraudulent transactions. Defendants merely argue that Studer did not maintain the type of ownership over Castle that Mr. Brennan, the defendant in First Jersey, hid over his company since Studer had only a 15% ownership in Castle Holding. 101 F.3d at 1475. However, defendants do not demonstrate that Studer received any less than the full amount misappropriated. Therefore, since the Court does find that Studer was "intimately involved" in the fraud and is liable for that fraud as a controlling person of Castle, the Court holds Studer and Castle jointly and severally liable for the amount to be disgorged. Id.
In addition to the Court's broad discretion in determining whether or not disgorgement is applicable, this Court has a similar breadth of discretion when it comes to determining the amount to be disgorged. See SEC v. Lorin, 76 F.3d 458, 462 (2d Cir. 1996) ("The decision to order disgorgement of ill-gotten gains, and the calculation of those gains, lie within the discretion of the trial court, which `must be given wide latitude in these matters.'" (citing SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995))); First Jersey Sec., 101 F.3d at 1474-75. Defendants argue that disgorgement, if any, should be limited to no more than Castle's net profits after write-offs for trading losses and the payment of half of the trading profits to Romano and Calderone. Def. Mem. at 66-68. Defendants contend that the arrangement by which half of Castle's trading profits were paid to the two traders, Romano and Calderone, should be considered as commissions paid to the traders, and therefore can be deemed "transaction costs," and as such, should be deducted from defendant's gross profits. Rosenfeld, 2001 WL 118612 at *2 (S.D.N.Y. Jan. 9, 2001) ("A court may in its discretion, deduct from the defendant's gross profits certain expenses incurred while garnering illegal profits, including correspondence and related expenses and transaction costs, such as brokerage commissions." (citing Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb, Inc., 734 F. Supp. 1071, 1077 (S.D.N.Y. 1990), rev'd on other grounds, 967 F.2d 742 (2d Cir. 1992))). Indeed, courts in this Circuit have held that a court may, within its discretion, deduct from the amount of illegal profits to be disgorged any direct transaction costs, such as brokerage commissions, which "plainly reduce the wrongdoer's actual profit." SEC v. McCaskey, No. 98 Civ. 6153, 2002 WL 850001, *4 (S.D.N.Y. Mar. 26, 2002); see also Rosenfeld, 2001 WL 118612 at *2; SEC v. Shah, No. 92 Civ. 1952, 1993 WL 288285, *5 (S.D.N.Y. July 28, 1993) ("Allowing a deduction for reasonable brokers' commissions incurred in making insider trades is consistent with the view in the Second Circuit that disgorgement is not a penalty assessment, but merely a means of divesting a wrongdoer of ill-gotten gains.").
However, the Court does not agree with the defendants that the payment to Romano and Calderone of half of the profits from the trading of USE should be considered as a direct transaction cost of the trading in USE securities. Romano testified that he and Calderone agreed to join Castle and start up their trading department upon reaching an arrangement after several conversations with Studer and Hebert, whereby they would not receive a salary but rather they would receive a weekly draw of $200, and fifty percent of all the trading profits. See Tr. at 810, 819 (Romano); 968 (Calderone). Therefore, Castle's payment to Romano and Calderone of fifty percent of the all the trading profits, including those made in the trading of USE securities, was more a method of compensating its employees, than it was a brokerage commission, or some other type of incidental transaction expense incurred in the purchasing or selling of USE securities. In fact, in cases where courts have deducted direct transactional costs, such as brokerage commissions, from the amount to be disgorged, those courts have been careful to distinguish between the expenses and costs associated with the transactions, and "general business expenses, such as overhead expenses, which should not reduce the disgorgement amount."McCaskey, 2002 WL 850001, at * 4 n. 6; see also Rosenfeld, 2001 WL 118612 at *2 ("This, however, does not mean that a defendant can group his expenses under a broad category of business costs and accordingly expect deductions from the disgorgement amount without supporting evidence." (citingBenson, 657 F. Supp at 1133-34 (S.D.N.Y. 1987))). The arrangement arrived at between Castle and its traders Romano and Calderone, whereby Romano and Calderone received fifty percent of all trading profits, would have been instrumental in Romano and Calderone's decision to join Castle and build a trading department there, where there had been none earlier. Castle's agreement with Romano and Calderone that they would receive fifty percent of the trading profits can be reasonably understood as Castle's method of compensating them, since Romano and Calderone had agreed to come work at Castle and build a trading department there without receiving any sort of salary. Such compensation is more appropriately considered as a general business expense, than an indirect transactional expense incurred in connection with the trading of USE securities. See Rosenfeld, 2001 WL 118612 at *2; Benson, 657 F. Supp at 1133-34 (rejecting defendant's argument that the amount to be disgorged should be reduced by a certain amount which was spent "supplementing salaries" of certain employees, and finding that "[t]he manner in which Benson chose to spend his misappropriations is irrelevant as to his objection to disgorge"). By guaranteeing Romano and Calderone fifty percent of the trading profits, Studer and Castle were able to entice them to join Castle and build a trading department there. Without that trading department, Castle would not have been able to play the integral role it did in the manipulation of USE securities. Therefore, the Court agrees with the SEC that, "[a]llowing the defendants to deduct half the ill-gotten gains for the mere fact that Studer chose to compensate Castle employees from Castle's trading profits is unjust and would allow Castle and Studer to reap the benefits of their fraud." Pl. Rep. at 29.
Furthermore, contrary to defendants' assertion, requiring defendants to disgorge $132,224 would not be penalizing them by effectively compelling them to pay the commissions twice, see Def. Mem. at 67 (citing Shah, 1993 WL 288285, at *5). The SEC's request for the amount to be disgorged by the defendants, $132,224, has already been reduced by the $43,776 previously paid by Romano, presumably from his portion of the profits from the trading of USE. Furthermore, defendants have produced no evidence that the percentage of profits paid to Calderone should be considered as a direct transaction cost for the making of a market in USE securities. In fact, Calderone testified that that Romano handled a larger percentage of D'Onofrio's trades in USE securities because Calderone and D'Onofrio did not "see eye to eye after the first day of trading," when Calderone refused to trade D'Onofrio's USE securities until those securities were in the customers' accounts. See Tr. at 983.
Defendants also seek to deduct $24,655 for certain write-offs and ticket charges. See Defendants' Exhibit ("DX") B (described by defense counsel as "some handwritten notations by Mr. Studer along with an end-of-month firm trading report to June 29, 1990"); DX E (described by defense counsel as "Studer's handwritten computations of Castle's profit in USE trading");see also Tr. at 1141-42. In the submissions of these exhibits, defendants purport to offer supporting evidence for their calculations of these ticket charges and write-offs. However, in seeking to deduct $9,455 in ticket charges from the amount to be disgorged, defendants offer only an incomplete, hand-written sheet, ostensibly a balance sheet, which appears to indicate $9,455 in supposed ticket charges. Neither at trial, nor in defendants' post-trial submissions, did defendants explain how or when this document was created and never introduced any supporting documents that he may have used in accounting for these deductions. In seeking to deduct $15,200 from the amount to be disgorged, defendants rely upon an end-of-month firm trading report, covering only May 29, 1990 through June 29, 1990, with a cover sheet that includes Studer's handwritten notations, dated April 5, 2001. See DX B. Therefore, it would appear that this cover sheet was created after the discovery period in this case had been completed. See Pl. Rep. at 29. Again, defendants did not explain the nature of these write-offs in their post-trial submissions, and it is not clear to the Court, from the face of the documents, how the defendants arrived at the amount they now seek to deduct. The Court agrees with plaintiff SEC that, without additional testimony or documentary evidence supporting defendants' claimed deductions, the write-offs and ticket charges that defendants seek to deduct are no more than bald assertions that this money was used for legitimate business purposes and should not be deducted from any amount of disgorgement." Id.; Rosenfeld, 2001 WL 118612 at *2 (holding that a defendant cannot, "group his expenses under a broad category of business costs and accordingly expect deductions from the disgorgement amount without supporting evidence" (citing Benson, 657 F. Supp. at 1133-34)).
Defendants merely include a footnote in their Post Trial Memorandum indicating that DX B and E disclose write-offs of $15,200 and ticket charges of $9,455. See Def. Mem. at 67 n. 5. Defendants further state that "these calculations were not contested by the SEC at trial." Id. However, a review of the trial transcript indicates that the parties stipulated to the admission of these exhibits into evidence with the understanding that they may be addressed in the parties' post-trial briefs.See Tr. at 1140-43.
10. Prejudgment Interest
In deciding whether an award of prejudgment interest is warranted, a court should consider "(i) the need to fully compensate the wronged party for actual damages suffered, (ii) considerations of fairness and the relative equities of the award, (iii) the remedial purpose of the statute involved, and/or (iv) such other principles as are deemed relevant by the Court." Wickham Contracting Co., Inc. v. Local Union No. 3, 955 F.2d 831, 833-34 (2d Cir. 1992). The Court has the same breadth of discretion in determining whether to grant prejudgment interest and the rate used if such interest is granted, as it does in determining the amount to be disgorged.See Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 67 F.3d 1063, 1071-72 (2d Cir. 1995). "In an enforcement action brought by a regulatory agency, the remedial purpose of the statute takes on special importance." First Jersey Sec., 101 F.3d at 1476; accord, e.g., McCaskey, 2002 WL 850001 at *12 n. 17.
The district court generally calculates prejudgment interest by using the IRS rates for underpayment of taxes under 26 U.S.C. § 6621(a)(2). See., e.g., First Jersey Sec., 101 F.3d at 1476; Rosenfeld, 2001 WL 118612, at *3. Generally, courts use the IRS underpayment rate to determine the amount of prejudgment interest because "[t]hat rate reflects what it would have cost to borrow the money from the government and therefore reasonably approximates one of the benefits the defendant derived from its fraud." First Jersey Sec., 101 F.3d at 1476. At trial, the SEC submitted a publication from the IRS that establishes the statutory interest rates for underpayment of taxes from September 1, 1990 through October 31, 2002. See PX 264. Defendants have not submitted any materials objecting to the use of these rates for the calculation of the prejudgment interest. Therefore, the Court deems it apppropriate to order Castle and Studer to pay prejudgment interest pursuant to the IRS statutory rate for the period from September 1990 through the present.
C. CASTLE AND STUDER ARE ENJOINED AND ORDERED TO DISGORGE ILL-GOTTEN GAINS.
SO ORDERED.
a. IT IS HEREBY ORDERED, ADJUDGED AND DECREED that defendants Castle and Studer are each permanently enjoined and restrained from, directly or indirectly, singly or in concert, by use of the mails, or any means or instruments of transportation or communication in interstate commerce, in the offer or sale of any security:
1. employing any device, scheme or artifice to defraud;
2. obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and
3. engaging in any transaction, practice or course of business which operates or would operate as a fraud or deceit upon the purchaser, in violation of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a).
b. IT IS FURTHER ORDERED, ADJUDGED AND DECREED that defendants Castle and Studer be and hereby are permanently enjoined and restrained from, directly or indirectly, singly or in concert, by use of any means or instrumentalities of interstate commerce, or of the mails, or of any facility of any national securities exchange, in connection with the purchase or sale of any security:
1. employing any device, scheme, or artifice to defraud
2. making any untrue statement of a material fact or omitting to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and
3. engaging in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person, in violation of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule lOb-5 thereunder, 17 C.F.R. § 240.10b-5.
c. IT IS FURTHER ORDERED, ADJUDGED AND DECREED that defendants Castle and Studer, as a controlling person of Castle, be and hereby are permanently enjoined and restrained from, directly or indirectly, singly or in concert, making use of the mails or any means or instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any security (other than commercial paper, bankers' acceptances, or commercial bills) otherwise than on a national securities exchange of which it is a member, by means of any manipulative, deceptive, or other fraudulent device or contrivance, as defined by rules and regulations of the SEC, including, without limitation, by means of:
1. any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person; or
2. any untrue statement of a material fact and any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, which statement or omission is made with knowledge or reasonable grounds to believe that it is untrue or misleading, in violation of Sections 10(b) and 15(c)(1) of the Exchange Act, 15 U.S.C. § 78j(b), 78o(c)(1), and Rules 10b-3 and 15c1-2 thereunder, 17 C.F.R. § 240.10B-3, 240.15C1-2.
d. IT IS FURTHER ORDERED, ADJUDGED AND DECREED that defendants Castle and Studer be and hereby are permanently restrained and enjoined from violating Section 10(b) of the Exchange Act [ 15 U.S.C. § 78j(b)], and Section 101 of Regulation M [ 17 C.F.R. § 242.101], by, in connection with a distribution of securities, directly or indirectly, bidding for, purchasing, or attempting to induce any person to bid for or purchase, the security that is the subject of the distribution, or any reference security, during the applicable restricted period, which is defined as:
1. For any security with an average daily trading volume value of $100,000 or more of an issuer whose common equity securities have a public float value of $25 million or more, the period beginning on the later of one business day prior to the determination of the offering price or such time that a person becomes a distribution participant, and ending upon such person's completion of participation in the distribution;
2. For all other securities, the period beginning on the later of five business days prior to the determination of the offering price or such time that a person becomes a distribution participant, and ending upon such person's completion of participation in the distribution; and
3. In the case of a distribution involving a merger, acquisition, or exchange offer, the period beginning on the day proxy solicitation or offering materials are first disseminated to security holders, and ending upon the completion of the distribution, while acting as an underwriter, prospective underwriter, broker, dealer, or other person who has agreed to participate or is participating in the distribution, or as an affiliated purchaser of such distribution participant, in the absence of an applicable exception or exemption under Sections 101(b) or 101(c) of Regulation M [ 17 C.F.R. § 242.101(b) or 101(c)].
e. IT IS FURTHER ORDERED, ADJUDGED AND DECREED that defendants Castle and Studer be and hereby are permanently enjoined and restrained from violating Section 5(a) and 5(c) of the Securities Act ( 15 U.S.C. § 77e(a) and (c)) by, directly or indirectly and in the absence of any applicable exemption, (1) unless a registration statement is in effect as to a security, making use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise, (2) unless a registration statement is in effect as to a security, carrying or causing to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale, and (3) making use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under Section 8 of the Securities Act ( 15 U.S.C. § 77h).
f. IT IS FURTHER ORDERED, ADJUDGED AND DECREED that defendants Castle and Studer pay within sixty days of this Final Judgment disgorgement in the amount of $134,224 representing joint profits gained as a result of the conduct alleged in the Complaint, together with prejudgment interest from September 30, 1990 to the present in the amount calculated pursuant to the IRS statutory rates as listed in exhibit PX 264. Payment of the full amount of $134,224 of the disgorgement plus pre-judgment interest shall be joint and severally owed by defendants Castle and Studer. Any payment that defendants Castle and Studer make to satisfy their disgorgement obligation, in whole or in part, shall be made payable by defendant Castle and/or defendant Studer or may be made on their behalf, in the following manner: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Alexandria, VA 22132-0003; and (D) submitted under or with a cover letter that identifies Castle and Studer as defendants in this action, the case number of this action, the Commission case number "NY-5883," a copy of which cover letter and money order or check shall be sent to Alexander M. Vasilescu, Senior Trial Counsel, Northeast Regional Office, Securities and Exchange Commission, 233 Broadway, 13th Floor, New York, New York 10279, and to this Court.
And there being no just reason for delay, the Clerk of this Court is hereby directed to enter this judgment pursuant to Rule 58 of the Federal Rules of Civil Procedure.
On December 18, 1996, the SEC adopted a revision of Rule 10b-6, which became effective on March 4, 1997. Securities Exchange Act Release No. 38067 (December 20, 1996), 62 FR 520. Among other things, this amendment deemed Rules 101 and 102 of Regulation M as successor rules to Rule 10b-6. Accordingly, defendants Castle and Studer are permanently enjoined and restrained from violating Rule 101 of Regulation M.