Securities & Exchange Commission v. Colonial Investment Management LLC

09-3503-cv
SEC v. Colonial Inv. Mgmt., et al.

UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

SUMMARY ORDER

RULINGS BY SUM M ARY ORDER DO NOT HAVE PRECEDENTIAL EFFECT. CITATION TO A SUMMARY ORDER
FILED ON OR AFTER JANUARY 1, 2007, IS PERMITTED AND IS GOVERNED BY FEDERAL RULE OF
APPELLATE PROCEDURE 32.1 AND THIS COURT’S LOCAL RULE 32.1.1. WHEN CITING A SUM M ARY ORDER
IN A DOCUM ENT FILED W ITH THIS COURT, A PARTY M UST CITE EITHER THE FEDERAL APPENDIX OR AN
ELECTRONIC DATABASE (W ITH THE NOTATION “SUM M ARY ORDER”). A PARTY CITING A SUM M ARY
ORDER M UST SERVE A COPY OF IT ON ANY PARTY NOT REPRESENTED BY COUNSEL.

1 At a stated term of the United States Court of Appeals for the Second Circuit, held at the
2 Daniel Patrick Moynihan United States Courthouse, 500 Pearl Street, in the City of New York,
3 on the 17th day of June, two thousand and ten.
4
5 PRESENT:
6 BARRINGTON D. PARKER,
7 DEBRA ANN LIVINGSTON,
8 GERARD E. LYNCH,
9 Circuit Judges.
10 _________________________________________
11
12 SECURITIES AND EXCHANGE COMMISSION,
13
14 Plaintiff-Appellee,
15
16 v. (09-3503-cv)
17
18 COLONIAL INVESTMENT MANAGEMENT LLC,
19 COLONIAL FUND LLC, and CARY G. BRODY,
20
21 Defendants-Appellants.
22 _________________________________________
23
24 FOR DEFENDANTS-APPELLANTS: IRA LEE SORKIN (Bradley M. Brown, Ketevan
25 Kulidzhanova, on the brief), Dickstein Shapiro LLP,
26 New York, NY.
27

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 1 FOR PLAINTIFF-APPELLEE: DAVID LISITZA , Senior Counsel, (David M. Becker,
2 Gen. Counsel; Mark D. Cahn, Deputy Gen. Counsel;
3 Jacob H. Stillman, Solicitor; Randall W. Quinn, Asst.
4 Gen. Counsel, on the brief), Securities and Exchange
5 Commission, Washington, D.C.
6
7 Appeal from a judgment of the United States District Court for the Southern District of New

8 York (Castel, J.).

9 UPON DUE CONSIDERATION, it is hereby ORDERED, ADJUDGED, AND DECREED

10 that the judgment of the district court be AFFIRMED.

11 The Securities and Exchange Commission (“SEC”) brought this action against Defendants-

12 Appellants Colonial Investment Management LLC, Colonial Fund LLC, and Cary G. Brody

13 (collectively “Colonial” or “defendants”) for engaging in transactions that the SEC alleged violated

14 Rule 105 of Regulation M, 17 C.F.R. § 242.105 (1997) (“Rule 105”), promulgated under the

15 Securities Exchange Act of 1934. Following a six-day bench trial in May 2009, the United States

16 District Court for the Southern District of New York (Castel, J.) entered judgment against

17 defendants on July 17, 2009, concluding in a thorough set of findings that defendants had violated

18 Rule 105 in eighteen transactions between 2001 and 2004. The court permanently enjoined

19 defendants from violating Rule 105 in the future and ordered disgorgement of the defendants’ profits

20 from the transactions, along with prejudgment interest. Finally, the court imposed a $450,000 civil

21 penalty on Defendant-Appellant Brody individually. Defendants appeal, challenging the judgment

22 of liability as to thirteen of the eighteen transactions at issue. Defendants also challenge the

23 injunctive relief ordered by the district court and the award of prejudgment interest; defendant Brody

24 challenges the imposition of the individual penalty. We assume the parties’ familiarity with the

25 remaining facts and procedural history of the case and with the issues presented for review.

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 1 1. Liability

2 Initially, we reject defendants’ contention that the version of Rule 105 promulgated after

3 2007 was retroactively applied to their conduct. The SEC’s complaint charged violations of the

4 version of Rule 105 in place at the time of the challenged transactions, and the district court clearly

5 applied that version of the Rule in its findings. The only question in this appeal with respect to

6 liability is whether there was sufficient evidence to support the district court’s conclusion that the

7 defendants violated the version of the Rule in place at the time of their conduct.

8 A. General Standards

9 In a civil enforcement proceeding, the SEC must prove a violation of the relevant statute or

10 rule by a preponderance of the evidence, see, e.g., SEC v. Posner, 16 F.3d 520, 521 (2d Cir. 1994);

11 SEC v. Enters. Solutions, Inc., 142 F. Supp. 2d 561, 573 (S.D.N.Y. 2001), meaning that the SEC in

12 this case had the burden to show that it was “more likely than not” that defendants violated Rule

13 105, see United States v. Basciano, 599 F.3d 184, 202 (2d Cir. 2010). Because the district court’s

14 conclusion that the defendants violated Rule 105 is “predominantly . . . factual,” we review the

15 court’s findings only for clear error. In re Am. Express Merchants’ Litig., 554 F.3d 300, 316 n.11

16 (2d Cir. 2009), vacated and remanded on other grounds sub nom. Am. Express Co. v. Italian Colors

17 Rest., No. 08-1473, 2010 WL 1740528 (U.S. May 3, 2010); see also SEC v. Cayman Islands Reins.

18 Corp., 734 F.2d 118, 119 (2d Cir. 1984) (per curiam). Under this standard, we only review whether

19 the district court’s “account of the evidence is plausible in light of the record viewed in its entirety,”

20 and we will only reverse a factual determination when we have a “definite and firm conviction that

21 a mistake has been committed,” Doe v. Menefee, 391 F.3d 147, 164 (2d Cir. 2004) (internal

22 quotation marks omitted); this will only take place when a finding is “without adequate support in

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 1 the record” or is “against the clear weight of the evidence.” Ezekwo v. N.Y. City Health & Hosps.

2 Corp., 940 F.2d 775, 780 (2d Cir. 1991).

3 Until it was amended in 2007, Rule 105 provided that:

4 In connection with an offering of securities for cash pursuant to a registration
5 statement or a notification on Form 1-A . . . filed under the Securities Act, it shall be
6 unlawful for any person to cover a short sale with offered securities purchased from
7 an underwriter or broker or dealer participating in the offering, if such short sale
8 occurred during . . . [t]he period beginning five business days before the pricing of
9 the offered securities and ending with such pricing . . . .
10
11 17 C.F.R. § 242.105 (1997). To “cover a short sale” means to purchase the security that the seller

12 has sold short and return it to the lender of the security. See ATSI Commc’ns, Inc. v. Shaar Fund,

13 Ltd., 493 F.3d 87, 96 n.1 (2d Cir. 2007); see also Levitin v. PaineWebber, Inc., 159 F.3d 698, 700

14 (2d Cir. 1998) (“[T]he [seller] ‘covers’ the short by buying identical stock and restoring it to the

15 broker-lender.”). Thus the SEC had the burden to show that the securities that defendants were

16 allocated in secondary offerings — rather than those the defendants purchased in the open market

17 later in the same day as the offerings — were used to cover the defendants’ short position in the

18 stock.

19 B. Trades Involving Banc of America Securities (BAS)

20 We conclude that the district court did not clearly err in concluding that the two of

21 defendants’ trades facilitated by BAS as defendants’ prime broker violated Rule 105. The district

22 court was entitled to credit the testimony of Claudia Lewis, a former prime brokerage compliance

23 manager at BAS who reviewed data concerning defendants’ trades. Lewis concluded that defendant

24 Colonial Fund LLC instructed BAS to use the shares allocated to defendants in secondary offerings

25 to cover Colonial’s short positions in the relevant stock. It was BAS’s policy not to cover a short

26 position unless specifically instructed by the customer to do so. The district court was entitled to

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 1 disbelieve the testimony of Colonial’s “back office personnel” that Colonial gave no such

2 instructions because such orders had to have come from BAS’s customers and because these

3 “personnel” could not explain how they knew allocated shares were not used to cover short positions

4 and admitted that they did nothing to prevent it. Lewis also noted that the prices of the securities

5 Colonial used to cover its short positions were identical to the prices at which Colonial purchased

6 allocated shares. Finally, BAS’s data confirmed that Colonial used a “first in first out” (“FIFO”)

7 liquidation method; the district court did not clearly err in considering the purported evidence to the

8 contrary, on which defendants also rely on appeal, of low probative value. It was also undisputed

9 that Colonial acquired shares from secondary offerings before engaging in open-market transactions

10 in the same stock. Thus the evidence supported the conclusion that defendants “cover[ed] . . . short

11 sale[s] with offered securities” prior to acquiring new securities on the open market. 17 C.F.R.

12 § 242.105 (1997).

13 C. Trades Involving Goldman Sachs Execution and Clearing (GSEC)

14 The district court similarly did not clearly err in concluding that defendants violated Rule

15 105 on eleven occasions in transactions executed by GSEC. The co-manager of Client Services for

16 GSEC’s prime brokerage business David Miller stated in his declaration that

17 [a]ll buys and sells of the same security in the same base account would be netted
18 against each other and any existing position throughout the day such that the account
19 would have one position . . . in the particular security at the end of the trading
20 day. . . . GSEC’s practice was that if a customer had a short position in a particular
21 security in a particular base account and the customer purchased or otherwise
22 acquired shares of that security, those purchases and receipts would be netted against
23 the short position unless the customer gave specific instructions otherwise.
24
25 Miller Decl. ¶ 20 (emphasis added). It was undisputed that defendants gave no such “specific

26 instructions,” although they could have (but did not) use a specific type of account that would have

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 1 prevented GSEC from covering short positions with allocated shares. Finally, Colonial’s purchases

2 of the allocated shares were the first purchases of the day, and GSEC used the FIFO method to

3 liquidate Colonial’s short positions. This, we conclude, was sufficient evidence taken together to

4 support the district court’s findings. The court was entitled to disbelieve defendants’ internal

5 records, which, defendants contend, demonstrate that Colonial’s short positions were covered by

6 shares purchased in the open market, because these records were inconsistent and sloppy and

7 because there was no evidence that defendants told their brokers that allocated shares should not be

8 used to cover short positions.

9 2. Remedies

10 Defendants raise challenges to three of the remedies ordered by the district court: the

11 permanent injunction against future violations of Rule 105, the award of prejudgment interest, and

12 the civil penalty imposed on Brody individually. We review the remedies ordered by the district

13 court for abuse of discretion. See SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1100 (2d Cir.

14 1972) (injunctive relief); see also Advance Pharm., Inc. v. United States, 391 F.3d 377, 398 (2d Cir.

15 2004) (monetary penalties and injunctive relief).

16 A. Permanent Injunction

17 A permanent injunction against future violations of the securities laws is warranted where

18 “the defendant’s past conduct indicates that there is a reasonable likelihood of further violation in

19 the future.” SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 99 (2d Cir. 1978) (alteration and

20 internal quotation marks omitted). A district court may take into account the following factors,

21 among others, in determining whether to issue a permanent injunction:

22 the fact that defendant has been found liable for illegal conduct; the degree of
23 scienter involved; whether the infraction is an “isolated occurrence;” whether

6
 1 defendant continues to maintain that his past conduct was blameless; and whether,
2 because of his professional occupation, the defendant might be in a position where
3 future violations could be anticipated.
4
5 Id. at 100 (quoting SEC v. Commonwealth Chem. Sec., Inc., 410 F. Supp. 1002, 1020 (S.D.N.Y.

6 1976)); see also SEC v. Cavanagh, 155 F.3d 129, 135 (2d Cir. 1998). Applying these factors, it is

7 clear the district court did not abuse its discretion in permanently enjoining defendants from future

8 violations of Rule 105. The violations at issue here were in no way “isolated”; indeed, defendants

9 admitted to seven violations of the Rule and were found liable for eighteen. The pattern of

10 defendants’ transactions, which, the district concluded, was intended to mask the defendants’

11 violations of the Rule, supported the court’s conclusion that defendants acted with a high degree of

12 scienter. Finally, defendants make no argument here that convinces us the district court clearly erred

13 in concluding that Colonial’s internal compliance mechanisms, put in place in 2004, are inadequate

14 to prevent future violations.

15 B. Award of Prejudgment Interest

16 Defendants contend that it was an abuse of discretion for the district court to award

17 prejudgment interest on the amounts it ordered defendants to disgorge because the SEC delayed in

18 bringing the case against them. We rejected an identical argument in SEC v. First Jersey Securities,

19 Inc., 101 F.3d 1450 (2d Cir. 1996). See First Jersey, 101 F.3d at 1476-77.

20 C. Monetary Penalty on Brody

21 The district court imposed a “Second tier” monetary penalty on Brody in the amount of

22 $450,000, $25,000 per violation. See 15 U.S.C. § 78u(d)(3)(B)(ii) (defining “Second tier”

23 penalties). The Exchange Act provides that the district courts may impose such penalties in amounts

24 determined “in light of the facts and circumstances.” Id. § 78u(d)(3)(B)(i); see also SEC v.

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 1 Opulentica, LLC, 479 F. Supp. 2d 319, 331 (S.D.N.Y. 2007) (detailing a non-exclusive list of factors

2 district courts may consider in determining whether to impose monetary penalties but emphasizing

3 that “particular facts and circumstances” in each case will bear on the propriety of such penalties).

4 The “facts and circumstances” found by the district court here, including that Brody was Colonial’s

5 head trader at the relevant times and was “responsible for all of Colonial’s trading and investment

6 decisions,” Spec. App’x at 11, demonstrate that there was no abuse of discretion in the district

7 court’s award. Moreover, the district court did not abuse its discretion in awarding a “Second tier”

8 penalty as opposed to a lesser one, as the evidence clearly established that Brody engaged in conduct

9 that was, at the very least, in “reckless disregard of [the] regulatory requirement.” 15 U.S.C. §

10 78u(d)(3)(B)(ii).

11 3. Conclusion

12 We have considered defendants’ remaining arguments on appeal and conclude that they are

13 without merit. For the foregoing reasons, the judgment of the district court is AFFIRMED.

14

15 FOR THE COURT:

16 Catherine O’Hagan Wolfe, Clerk

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