No. 00 Cr. 388 (RPP)
October 18, 2002
For the Government: James B. Comey, U.S. Attorney, Southern District of New York, ATTN: Steven R. Peikin, A.U.S.A., New York, NY.
Counsel for Defendant: Elizabeth M. Fink, Esq., Brooklyn, NY.
OPINION AND ORDER
Defendant, Fred Moldofsky ("Moldofsky"), moves to preclude any sentence of imprisonment despite his conviction on a one-count indictment charging him with violating Section 10(b) of the Securities Exchange Act, Title 15 U.S.C. § 78j(b) and 78ff(a), and Securities and Exchange Commission Rule 10b-5 promulgated thereunder, Title 17 C.F.R. § 240.10b-5.
The Evidence at Trial
The evidence at trial showed that Moldofsky was self-employed as a so-called "on-line day trader," engaging in the daily purchase and sale of securities over the internet; that Moldofsky utilized an internet website maintained by Yahoo! Inc., entitled, "Yahoo! Finance," and, particularly, a message board on that website entitled, "Lucent Message Board"; that "Lucent" referred to Lucent Technologies, a Delaware corporation, whose common stock was traded on the New York Stock Exchange in New York, New York; that Moldofsky posted messages on the Lucent Message Board or "chat room," using a number of different "screen names" or identities, including (a) "kahuna_and_the_brain," and (b) "hot_1ike_wasabe."
Note: "like" starts with the number "1," not the letter "l."
On March 22, 2000, Moldofsky engaged in seven on-line transactions involving 6,000 shares of Lucent common stock and lost money on the trades. Thereafter, on March 22, Moldofsky, using the screen name, "kahuna_and_the brain," posted messages on the Lucent Message Board which expressed doubt that Lucent's earnings for the second quarter of its fiscal year 2000 would meet analysts' estimates. These messages stated, "CNBC JUST REPORTED RUMORS OF EARNINGS. . . SO THAT'S WHY THESE MOTHER FACKERS HAVE BEEN SELLING OFF." (Government Exhibit "GX" 204); "Large hedge fund unloading! . . . Selling off amid rumors that they will miss earnings estimates" (GX 209).
That evening at approximately 6:57 p.m., Moldofsky, using the screen name "hot_1ike_wasabe," posted a message on the Lucent Message Board entitled, "LUCENT RELEASES EARNINGS WARNING! DAMN!" below which was a purported Lucent press release, dated March 22, 2000, in the Lucent format for such releases, which stated that Lucent's second quarter earnings would be lower than analysts' estimates. (GX 214.)
At 7:10 p.m., a third party, using the screen name, "f1oydian_us" posted a message on the Lucent Message Board to "hot_1ike" stating that he had checked and there was no press release from LU (Lucent) and that he would report the posting of the false press release. (GX 216.) At 7:13 p.m., another person's message on the message board stated, "practically word for word fraud." (GX 217.)
At 7:17 p.m., "f1oydian_us" posted a message stating that he was reporting the false posting to Yahoo! and the SEC. (GX 218.) Other users stated the posting constituted a crime or was fraud. (GX 219; GX 220; GX 222; GX 223.)
This screen name was identical to that used by the person who had stated he would report the posting of the false press release, except that "f1oydian" was spelt with the number "1" in place of the letter "l."
Again, around 8:05 p.m., he reposted the same release using the "f1oydian_us" screen name under the headings, "LUCENT WARNS! I'm going to cut my throat" (GX 225), and "PR NEWSWIRE hot off the press! Help me!" (GX 226) and "Lucent warns of earnings shortfall! Ugh." (GX 229.)
At 8:07 p.m., someone, using the screen name "abudeena" posted the message, "SOMEONE TELL ME WAS THE PRESS RELEASE FAKE OR WHAT?" (GX 227.)
At 8:10 p.m., Moldofsky, using the screen name "f1oydian_us" sent out the false press release again, under the heading, "abudeena: the press release is REAL" (GX 228) and made more postings of the press release, indicating that the press release was official. (GX 230; 232; 234.)
At 8:35 p.m., Moldofsky, using the screen name "kahuna_and_the_brain" posted a message entitled, "There's nothing illegal about news post [by f1oydian us]." (GX 236.) Several other messages were thereafter published by others, stating that the posting of the press release was fraudulent and a crime. (GX 238; GX 243; GX 244.)
The next morning, at 10:09 a.m, 10:10 a.m., and 10:11 a.m, Moldofsky, under the headings, "Lucent just released earnings warning!" "Lucent just warned of lower earnings," and "Lucent official press release! Damn," again published the false press release using his "f1oydian_us" screen name, but altering the posting to contain, in small print, towards the end of the press release, "this is a joke you idiots" (GX 246; GX 247; GX 248). He continued to post similar messages and the false press release with the inserted phrase (GX 253; GX 254; GX 255; GX 259; GX 260; GX 261) until Lucent disclaimed the press release. (Tr. at 46).
Lucent's stock traded significantly down during the morning of March 23, 2000 and rose upon Lucent's announcement that Moldofsky's press release was false.
Defendant's motion is based on Section 78ff(a) of Title 15, United States Code, the penalty provision applicable to the Section 10(b) securities fraud offense charged in the indictment. It provides:
Any person who willfully violates any provision of this chapter (other than section 78dd-1 of this title), or any rule or regulation thereunder the violation of which is made unlawful or the observance of which is required under the terms of this chapter, or any person who willfully and knowingly makes, or causes to be made, any statement in any application, report, or document required to be filed under this chapter or any rule or regulation thereunder or any undertaking contained in a registration statement as provided in subsection (d) of section 78o of this title, or by any self-regulatory organization in connection with an application for membership or participation therein or to become associated with a member thereof, which statement was false or misleading with respect to any material fact, shall upon conviction be fined not more than $5,000,000, or imprisoned not more than 20 years, or both, . . .; but no person shall be subject to imprisonment under this section for the violation of any rule or regulation if he proves that he had no knowledge of such rule or regulation.15 U.S.C. § 78ff(a) (emphasis added).
During the trial and prior to the close of evidence, the defendant sought a jury instruction based on the final sentence of Title 15 U.S.C. § 78ff(a), which would have required the jury to find "beyond a reasonable doubt that the defendant did not know of Rule 10b-5 in order to convict the defendant of the charged offense." The Court denied the requested charge, holding that the final sentence of Section 78ff(a) did not make defendant's knowledge of Rule 10b-5 an element of the crime charged in the indictment. Instead, the Court determined that defendant's knowledge of the Rule was relevant to the issue of whether Moldofsky could be sentenced to a term of imprisonment. Accordingly, the Court gave the jury instruction with respect to the element of willfulness as:
See Defendant's Request to Charge No. 10 and Defendant's Letter of March 4, 2001.
Willfully meaas to act knowingly and purposely with an intent to do something the law prohibits, that is to say, with bad purpose either to disobey or to disregard the law. The defendant need not have known that he was breaking any particular law or rule. He need only have been aware of the generally unlawful nature of his acts.
(Trial Tr. at 1018) (emphasis added).
The jury, in reaching its guilty verdict, found that Moldofsky:
(1) had made an untrue statement of a material fact or omitted to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading;
(2) had acted willfully, knowingly and with intent to defraud.
The Motion Papers and Hearing
In support of his motion for a finding that his conviction cannot result in a sentence of imprisonment, the defendant has submitted an affidavit stating in essence:
— At the time of his offense, he "had no idea that it was a crime under the Security [sic] Exchange Act or under any other state or federal law to provide false information over the Internet"; and
— He "had no idea that it was against the law to knowingly transmit false information in public chat rooms over the Internet, including but not limited to finance chat rooms and sites maintained by Yahoo. . . . In fact, [he] believed the Opposite — that people provided false information over the Internet all the time and that it was the established norm to do so.
(Affidavit of Fred Moldofsky, dated April 19, 2002, at ¶¶ 2-3).
After reviewing the defendant's affidavit and the letter motion of defendant's counsel dated April 21, 2002, as well as the letter from the Government in response thereto dated May 1, 2002, the Court, on August 15, 2002, denied a request dated August 15, 2002, for a further adjournment of the sentence by defense counsel, and stated that it would hear testimony of the defendant's lack of knowledge of "any applicable rule" regarding the alleged violation of SEC Rule 10b-5, citing United States v. Dixon, 536 F.2d 1388 (1976). The hearing was held on August 21, 2002.
At the hearing, defense counsel took the position that the defendant's case should be distinguished from the other cases cited in the motion papers because, in the other cases, the defendants made or attempted to make money as a result of their violation of an SEC rule, while, in this case, there is no evidence the defendant was trying to make money by his violation of SEC Rule 10b-S. (Tr. at 3.)
Transcript of hearing held August 21, 2002.
Thereafter, the defendant took the stand and testified that he had spent fourteen to eighteen hours a day trading securities from 1996 to the date of his arrest. (Tr. at 5.) He stated that he used his home computer and the internet for securities trading and news gathering; that in later years he subscribed to TheStreet.com, and, of course, checked out the chat boards, subject to verification of anything that was said on the chat boards. (Tr. at 6.) He described the Yahoo! message chat board as follows: "It is a place where people come and discuss what's happening in the stock market and usually each message board is peculiar to a specific stock. . . . You choose Lucent or choose Ford or you choose General Motors. You choose the chat board upon which you wish to discuss things with other people." (Tr. at 6.)
Defendant stated that he did not believe the SEC rules applied to the Yahoo! message board chat room (Tr. at 10) and that he posted the false press release on March 22, 2002 as a joke. (Tr. at 14.)
He stated that, in sending GX-236, titled, "There's nothing illegal about news post," he was relying on the Terms of Service at the top of the Yahoo! message board. (Tr. at 17.) Those terms stated, "These messages are only the opinion of the poster, are no substitute for your own research and should not be relied on for trading or any other purpose." He also testified that he reviewed postings on the message board on the morning of March 23, 2000, saw that people did not realize the false news release was a joke and, at 10:09 a.m. on March 23, 2000, posted the false press release, including the words, "this is a joke" in one of the bylines near the bottom of the false press release. (Tr. at 21.) Lastly, he stated that he did not believe that he had committed a violation of the SEC rules until he was arrested. (Tr. at 22-23.)
On cross examination, the defendant admitted that, prior to posting the false press release in March 2000, he knew that the SEC regulated securities trading after a company went public (Tr. at 30); that he knew the SEC promulgated rules that govern securities markets in the United States; and that the SEC had the responsibility for enforcing those rules (Tr. at 32). He also admitted that he knew that the SEC had a rule that prohibited people from committing fraud in connection with the purchase or sale of securities (Tr. at 32-33); that he knew that the SEC has rules prohibiting fraud in connection with the purchase or sale of securities (Tr. at 33) and had heard about people being sued by the SEC for committing fraud in connection with the purchase and sale of securities. (Id.) He admitted that he had known the SEC had rules about fraud applicable to companies, corporate executives and stockbrokers and that the SEC had rules that prevented people from manipulating the price of a stock (Tr. at 68-69).
He admitted, on learning that the SEC was actively pursuing the case, he had reformatted the hardware on his computer (Tr. at 48) and admitted that, at the time of his arrest, he had denied being the person who posted the fake press release (Tr. at 54), and had made the false claim that someone had hacked into his computer. (Tr. at 54.)
The Defendant maintained, however, that he did not believe he was participating in the purchase and sale of stocks when he was on the Yahoo message board and that he did not believe that the Yahoo message board was subject to any rule of the Government or the Securities Exchange Commission. (Tr. at 65.)
In short, based on Moldofsky's own testimony, the defendant acknowledged that on March 22, 2000, he was well aware that the SEC had rules against acts of fraud in connection with the purchase or sale of stock, and rules against manipulating the price of stocks, but that he didn't believe that those rules applied to his messages on Yahoo's Lucent message board.
The record is clear that persons using the Lucent Message Board had an interest in the price of Lucent securities.
In United States v. O'Hagan, 521 U.S. 642(1997), the Supreme Court held that O'Hagan, a partner in a law firm representing the offering company who, without disclosure to his firm or the firm's client, purchased stock in the target company prior to the tender offer, had violated Section 10b-5 under the misappropriation theory because he engaged in deceptive conduct in connection with securities transactions.
The Supreme Court, in reversing and remanding the case to the Eighth Circuit, stated, "To establish a criminal violation of Rule 10b-5, the government must prove that a person "willfully" violated the provision. Furthermore, a defendant may not be imprisoned for violating Rule 10b-5 if he proves he had no knowledge of the Rule." O'Hagan, 521 U.S. at 665-666.
On remand, O'Hagan argued that his convictions for securities fraud in violation of Rule 10b-5 must be reversed because the Government failed to prove that he "willfully" violated Rule 10b-5 because it failed to establish that he knew what acts Rule 10b-5 prohibited and that he intentionally committed acts in violation of the Rule. The Eighth Circuit held that, although a defendant must act willfully, as opposed to acting negligently or recklessly, in order to violate the securities laws, the Supreme Court's language in O'Hagan did not create a requirement that the defendant know that his acts were in violation of Rule 10b-5. The court approved his sentence to imprisonment in view of his willful violation of the securities laws and O'Hagan's failure to prove that he did not know of the existence of the Rule. United States v. O'Hagan, 139 F.3d 641 at 646-647 (8th Cir. 1998).
The Eighth Circuit's decision in O'Hagan, supra, comports with the Second Circuit's ruling in United States v. Dixon, 536 F.2d 1388(2d Cir. 1976). Dixon, a corporate officer, did not deny he knew that there were SEC rules requiring him to report the corporation's loans to officers, but stated he was incorrectly informed of their content and, thus, did not have knowledge of the rules in question. The court stated in footnote 10, "We read the provisions of § 32(a) as requiring proof that the defendant did not know there was any applicable rule; we would not regard it as satisfied by proof that he did not have accurate information of the content of the rule" Id. at 1398 fn. 10 (citing United States v. Lilley, 291 F. Supp. 989(S.D. Texas 1968); United States v. Sloan, 399 F. Supp. 982 (S.D.N.Y. 1975)).
Moldofsky's claim is most similar to the defendant Copp's argument inUnited States v. D'Honau, 459 F.2d 73(9th Cir. 1972), a 10(b) action. There Copp, who was experienced in the securities business, posted a false advertisement in the Wall Street Journal that Great American Holding Company, a non-existent company, intended to purchase the stock of another company, causing the price of the target company's stock to rise. Defendant Copp's claim of ineffective assistance of counsel, for the failure to raise his lack of knowledge of Rule 10b-5 at sentencing, was rejected by the court which found that for counsel to raise such a claim would have been frivolous.
Here, defendant Moldofsky was an experienced trader in the stock market, knew that the SEC had rules against fraud and manipulation of the price of stock, and was found by the jury to have acted willfully, with knowledge of the general unlawful nature of his acts when he posted his false press releases which, the expert evidence showed, had an adverse effect on the price of Lucent stock. Based on United States v. Dixon,supra, and the decisions of the Eighth and Ninth Circuits, his motion to preclude a sentence of imprisonment is denied since he knew that the SEC had rules against fraud and manipulating the price of a stock at the time he posted the false press release.
Sentencing of defendant is set for October 31, 2002 at 4:00 p.m.