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Saturday, November 08, 2008 2:29:01 PM
11/07/2008 356 MOTION Memorandum in Support of Motion for Disgorgement and Penalties against Defendant Mark Neuhaus re: 355 MOTION Order for Disgorgement and Civil Penalties against Defendant Mark Neuhaus.. Document filed by U.S. Securities and Exchange Commission. (Attachments: # 1 Exhibit Att.1, # 2 Exhibit Att. 2, # 3 Exhibit Att. 3(1), # 4 Exhibit Att. 3(2), # 5 Exhibit Att. 4, # 6 Exhibit Att. 5, # 7 Exhibit Att. 5(a), # 8 Exhibit Att. 6, # 9 Exhibit Att. 7, # 10 Exhibit Att. 8)(Lutz, Julie) (Entered: 11/07/2008)
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Doc 356
Extract
MEMORANDUM OF LAW IN SUPPORT OF PLAINTIFF'S MOTION FOR DISGORGEMENT AND CIVIL PENALTIES AGAINST DEFENDANT MARK S. NEUHAUS
Table of Contents
I. Introduction 1
II. Factual Background of Neuhaus' Illegal Conduct 2
A. Registration Violations 2
B. Fraud Violations 3
1. May 23, 2002 Announcement of $100 million in Funding 3
Commitments
2. Announcement of North American Airline Acquisition 7
III. Argument 9
A. An Order Requiring Disgorgement of Net Trading Proceeds Is Appropriate 9
B. An Order Requiring Payment of Prejudgment Interest is Appropriate 12
C. Neuhaus' Asserted Financial Condition Does Not Preclude Disgorgement 13
D. Third Tier Penalties Are Appropriate Against Neuhaus 14
1. Standards for the Imposition of Civil Penalties in SEC Cases 14
2. Neuhaus' Conduct Warrants Third Tier Penalties 17
a. Neuhaus' conduct involved repeated reckless disregard 17
of a regulatory requirement.
b. Neuhaus' conduct involved risk of harm to investors 18
c. Neuhaus' conduct was egregious 18
d. Neuhaus Acted with Scienter 19
IV. Conclusion 20
TABLE OF AUTHORITIES
[...]
I. Introduction
In this governmental enforcement action, Plaintiff Securities and Exchange Commission ("SEC") charged defendant Mark S. Neuhaus ("Neuhaus") with violations of the registration and antifraud provisions of the federal securities laws in connection with a scheme involving the stock of Universal Express, Inc. ("Universal Express"). Specifically, Neuhaus was charged with violating Sections 5 and 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder during the period 2001 through 2004 by participating in a continuous unregistered distribution of Universal Express stock, and by participating in the creation and dissemination of three false and misleading press releases concerning Universal Express' purported business operations. On February 21, 2007, following the submission of substantial evidence by the parties, the Court granted summary judgment against Neuhaus as to the Section 5 allegations, finding in its Opinion and Order ("Opinion") [Docket No. 172] that between April 2001 and January 2004, Neuhaus sold 259,649,167 shares of stock of Universal Express, Inc. into the public market in numerous unregistered transactions, through which he reaped proceeds of
$9,786,589. [Opinion, pp. 29-34].
In November 2007, Neuhaus consented to a bifurcated settlement of the remaining fraud charges in the complaint, pursuant to which he consented to the imposition of injunctive relief against further violations of the registration and antifraud provisions as well as to the imposition of a bar prohibiting him from participating in any offering of penny stock. On December 4, 2007, pursuant to Neuhaus' consent, the Court issued a permanent injunction and penny stock bar against Neuhaus. [Docket Nos. 260, 261] Under the terms of the bifurcated settlement, the issues of disgorgement and penalties were reserved for later resolution by the Court. Pursuant to the terms of Neuhaus' consent, Neuhaus agreed that he was liable for disgorgement of his ill-gotten gains, plus prejudgment interest on those gains. Neuhaus agreed that (1) he is precluded from arguing that he did not violate the federal securities laws as alleged in the Complaint; (2) he may not challenge the validity of the Court's February 21, 2007 Opinion and Order, his Consent or the Order of Permanent Injunction; (3) solely for the purposes of such motion, the allegations of the Complaint shall be accepted as and deemed true by the Court; and (4) the Court may determine the issues raised in the motion on the basis of affidavits, without regard to the standards for summary judgment contained in Rule 56(c) of the Federal Rules of Civil Procedure. See Neuhaus Consent a pp. 3-4.
Plaintiff SEC files this memorandum of law in support of its claims for disgorgement and penalties against Neuhaus.
II. Factual Background of Neuhaus' Illegal Conduct
A. Registration Violations
Based upon the evidence previously submitted to the Court in support of its summary judgment motion against Neuhaus, the Court has found Neuhaus liable for violations of the securities registration provisions. The salient facts surrounding those violations are summarized in the Court's February 21, 2007 Opinion. As the Court has found, between April 2001 and January 2004, Universal Express, a publicly traded company, issued more than 500 million shares to Neuhaus and three other individuals or entities, purportedly as compensation for consulting services. No registration statements were in effect as to these issuances. Of the more than 500 million shares, 270,698.345 were issued to Neuhaus under the false claim of a purported S-8 registration and 26,233,248 were issued as restricted shares without any claim of registration. Opinion, pp. 4-5. Neuhaus deposited nearly 225 million of the purported "S-8 registration" shares and 5.5 million of the restricted shares into various brokerage accounts he controlled which were held in the in the names of three entities: Coldwater Capital, LLC, H&N LLC, and Perfect Line Investments. Between 2001 and 2004, Neuhaus sold 259,649,167 shares of Universal Express into the public market in unregistered transactions, generating proceeds of $9,786,589. Opinion, pp. 6-7, 29-34.
B. Fraud Violations
The Court denied summary judgment against Neuhaus as to the fraud alleged against him in the Complaint, finding in the Opinion that issues of fact remained as to Neuhaus' state of mind. The Court nevertheless noted that "a conclusion of participation in fraud could be sustained on the basis of the uncontested facts of Neuhaus' conduct, given the repeated nature of this conduct and defendant's undisputedly sizeable, nearly simultaneous sales of Universal Express stock." Opinion, p. 34-36. However, Neuhaus' consent to the bifurcated settlement establishes his violation of the antifraud provisions for purposes of this motion. Moreover, the evidentiary record in the case demonstrates Neuhaus' participation in the fraudulent press releases and his scienter.
1. May 23, 2002 Announcement of $100 million in Funding Commitments
On May 23, 2002, Universal Express issued a press release falsely claiming it had received "Over $100,000,000 in Funding Commitments" from "two International Hedge Funds." Quoting Altomare, the release further stated: "To complete our corporate objectives, Universal obviously needs to jump start revenues, profits and logistical capabilities. Fortunately, that belief is shared by these investors, who have already invested over $5,000,000 with Universal over the past five years. . . . These monies will be invested initially as debt and equity only at prices well above the current market value . . . . [D]eveloping companies like Universal Express with capital can now seize the opportunities that are readily available to it." [Att. 1.]
Prior to the issuance of the release, Richard Altomare ("Altomare") requested Neuhaus to prepare a funding letter concerning a potential transaction involving Universal Express. Neuhaus prepared a letter dated March 22, 2002 which stated that Coldwater Capital had "authorized $5,000,000 in additional seed capital" for Universal Express and that it would "also provide up to $40,000,000 in long-term financing, if necessary." [Att. 2.]
Contrary to the wording of the letter, Neuhaus testified that Coldwater is not a hedge fund and has never been. Neuhaus stated that it may have been Altomare who suggested referring to Coldwater as a hedge fund. [Neuhaus 2 at 65.] [1] Further, in his sworn testimony, Neuhaus admitted that the value of Coldwater's total assets at the time he wrote the letter was far less than $45,000,000. [Neuhaus 1 at 175-177.] Neuhaus valued the investments of Coldwater as definitely below $30 million, and testified that he did not think they ever exceeded $20 million during 2002. [Neuhaus 1 at 177.] Neuhaus also admitted that the statement in the letter that Coldwater Capital had been investing in
Universal Express for the past 10 years was false. [Neuhaus 2 at 50.] Neuhaus testified that he put these and other false statements in the letter because Altomare asked him to. [Neuhaus 2 at 51.]
[1] The cited portions of investigative and deposition testimony are attached as Att. 3.
In his investigative testimony, Neuhaus also admitted that he was unsure of the exact amount that Coldwater had invested in Universal Express as of the date of the letter, though the letter stated that it had invested over $2 million. Neuhaus stated that Altomare asked him to state that he had invested that amount and that he had been investing for 10 years. [Neuhaus 2 at 50.] Neuhaus did nothing to verify the statement that Coldwater Capital had invested over $2 million in Universal Express. [Neuhaus 2 at 51.] Neuhaus also admitted that Coldwater did not have a Board of Directors, even though the letter refers to Coldwater's Board of Directors as having authorized additional funding to Universal Express. He did this also because Altomare asked him to. [Neuhaus 2 at 52.]
The letter stated that Coldwater would provide Universal Express with an additional $40 million in financing, if necessary. Neuhaus testified that Coldwater could not have lent or invested as equity $40 million of its own money. Instead, Neuhaus said he believed could have arranged the money through other lenders. [Neuhaus 2 at 57.] When asked about the statements Coldwater authorized $5 million in additional capital for Universal Express, and an additional $40 million, if necessary, Neuhaus testified that he actually meant that he would have invested additional capital if he thought it was a worthwhile investment, and that he would have considered investing $5 million. [Neuhaus 2 at 55.] Neuhaus admits that there was never an event where there was an authorization of the $5 million "other than in his own mind." [Neuhaus 2 at 56.]
Although the March 22, 2002 letter stated that Coldwater and its partners "enthusiastically commit to the funding of Universal Express' strategic acquisition of Trailways Bus Systems," Neuhaus testified that he merely had a "preliminary interest" in funding the acquisition. Neuhaus testified that Altomare asked him to use the stronger, committed language. [Neuhaus 2 at 69-70.]
Neuhaus did not put any restrictions on Altomare's use of the March 22, 2002 letter of intent. [Altomare 1 at 159.] Altomare gave the letter of intent he received from Neuhaus to Trailways as part of merger discussion with that company in 2002. Altomare told Neuhaus that he was providing his letter to Trailways and Neuhaus did not voice any objection. [Altomare 1 at 163.] Neuhaus authorized Altomare to give his name and contact information to Trailways as a part of merger discussions held between the two entities in May 2002. [Altomare 1 at 169.] Neuhaus also confirmed and reiterated the statements in his letters, which he acknowledged to be false or misleading, in a conversation with Gayle Ellsworth from Trailways who called to perform due diligence on the potential merger between Trailways and Universal Express. [Ellsworth at 59-61.]
Altomare also put Neuhaus together with G.E. Capital as one of Universal Express' potential "funders" on another possible business deal. [Altomare 1 at 240-242; Pasqualini at 42-43.] Neuhaus participated in a conference call with personnel from GE Capital who were approached by Altomare to fund a potential transaction between Universal Express and Coach USA. Neuhaus told GE Capital that he would invest equity in connection with the Coach transaction and again falsely stated that Coldwater was a hedge fund. [Neuhaus 1 at 252-254; Pasqualini at 43-47.]
On May 22, 2002, at Altomare's request, Neuhaus provided another letter to Universal Express. [Att. 4.] In this letter, Neuhaus stated that his "hedge fund and partners enthusiastically commit to the funding of Universal Express' strategic acquisition of Trailway's Bus Systems and will do whatever we can to help Universal Express close the transaction with Trailways."
During 2001 and 2002, Neuhaus followed the public announcements of Universal Express on an online data service that would flash when the company issued a public announcement. [Neuhaus 2 at 29-30.] The May 2002 release would have come up as an asterisk on the news tracking service Neuhaus was using. [Neuhaus 2 at 73-74.]
On the first trading day following the issuance of the May 22 press release, Neuhaus, who had been selling approximately 500,000 Universal Express shares per day prior to May 23, 2002, sold at least 1,637,797 shares before the close of trading. [Att. 5, Morgan Neuhaus Aff., ¶ 13]
3. Announcement of North American Airline Acquisition
In the summer of 2003, Neuhaus presented to Altomare a possible acquisition involving North American Airlines ("NAA") [Neuhaus 2 at 86-87.] Neuhaus told Altomare that he, Neuhaus, could probably get most of the financing for the deal. [Neuhaus 2 at 87.] Altomare and the owner of NAA, Dan McKinnon ("McKinnon") engaged in negotiations for an acquisition. Universal Express did not have any funds to complete the merger at the time. [Altomare 2 at 91-92, 104.] To fund a 50% nonrefundable $1 million deposit required by McKinnon as part of an option on the proposed deal, Altomare and Neuhaus agreed that Neuhaus would wire the $1 million on Universal's behalf in exchange for Universal Express. [Neuhaus 1 at 85-88; Att. 6.]
Neuhaus obtained the $1 million deposit from an entity called Orange Investments. Neuhaus transferred Universal Express stock issued to him to an account at Alliance in the name of Black Coomb Ventures ("Black Coomb"). [Neuhaus 1 at 85-87.] Black Coomb was owned by a trust that was solely owned by Neuhaus. [Neuhaus 1 at 35-36; 49.] Orange Investments then loaned Black Coomb the $1 million for 30 days. [Neuhaus 1 at 96-97]. Black Coomb transferred $500,000 directly to McKinnon and $500,000 to an attorney trust account for McKinnon. [Neuhaus 1 at 88.] The loan from Orange Investments was secured by Universal Express stock worth more than $1 million [Neuhaus 1 at 96]. Orange Investments would only lend 50 cents on the dollar. Id.
Neuhaus transferred Universal Express shares issued to him from a Coldwater account to a Black Coomb account at Alliance, which sold them into the public market to pay back the $1 million loan. [Neuhaus 1 at 74-74; 97-98.]
On October 7, Neuhaus sent McKinnon an e-mail falsely stating that SEC rules required Universal to make a public announcement about the transaction. Neuhaus sent the e-mail after discussing a possible announcement with Altomare. [Att. 6, Neuhaus 2 at 94, 102-103.] After receiving Neuhaus' e-mail, the owner agreed to a public release, and on Sunday, October 12, Universal Express issued a press release announcing the option agreement. [Att. 7.] The October 12, 2003 press release, quoting Altomare, stated: "We
have paid a $1,000,000 deposit, 50% of which is which is non-refundable."
The release was materially false and misleading. It failed to disclose that the deposit had been financed through the issuance of unregistered Universal Express shares to Neuhaus. Neuhaus admitted that he and Altomare had discussed disclosing the $1 million deposit and that he had reviewed a draft of the press release that included the statement regarding the deposit. [Neuhaus 1 at 107-109.] The release failed to disclose that Universal Express had no funds to consummate the merger. [Altomare 1 at 146.]
On October 13, 2003, the first trading day after the release was issued, Neuhaus sold 1 million shares of Universal Express stock and thereafter an average of about 1 million shares per day for several weeks. By October 22, 2003 he had received total proceeds from these sales of $1 million. [Att. 5, Morgan Neuhaus Aff., ¶ 11] Neuhaus testified that he was part of the conversations leading up to the October 12, 2003 press release regarding the North American Airline transaction. He commented on the contents before it went out. [Neuhaus 2 at 103-104, 114-15.]
The above facts prove that Neuhaus provided to Universal Express and its two former principals, defendants Altomare and Chris G. Gunderson, two false and misleading letters that were forseeably used as a the basis for drafting certain press releases which the Court has found were "uncontestedly fraudulent " concerning Universal Express' ostensible access to financing. Opinion, p. 35. Neuhaus was involved in the creation of the false North American Airlines release. [2]
[2] As stated above, for purposes of the Court's determination of financial relief in this case, Neuhaus has agreed in his consent filed in the case that the allegations of the complaint as to his participation in false and misleading press releases should be deemed true by the Court. Neuhaus consent, p. 4. [Docket No. 260]
III. Argument
A. An Order Requiring Disgorgement of Net Trading Proceeds Is Appropriate
As stated above, in his consent, Neuhaus has agreed that he is liable for disgorgement of his ill-gotten gains from stock sales, as well as prejudgment interest on those gains. As noted in SEC v. McCaskey, 2002 WL 8500001 (S.D.N.Y. March 26, 2002), the Second Circuit has held that:
The primary purpose of disgorgement as a remedy for violation of the securities laws is to deprive violators of their ill-gotten gains, thereby effectuating the deterrence objectives of those laws. See, e.g., SEC v. Wang, 944 F.2d 80, 85 (2d Cir.1991); SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir. 1978). "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." SEC v. Manor Nursing Centers, Inc.,
458 F.2d [1082,] 1104 [ (2d Cir. 1972) ]; see SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971). McCaskey, 2002 WL at * 3.
A district court has broad discretion not only in determining whether or not to order disgorgement but also in calculating the amount to be disgorged. See, e.g., SEC v. Lorin, 76 F.3d 458, 462 (2d. Cir. 1996). The amount of disgorgement ordered "need only be a reasonable approximation of profits causally connected to the violation." SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995) (internal quotation marks omitted). Further, "any risk of uncertainty [in calculating disgorgement] should fall on the wrongdoer whose illegal conduct created that uncertainty." Id. (internal quotation marks omitted). See also, SEC v. Materia, 745 F.2d 197, 200-201 (2d Cir. 1984), cert. denied, 471 U.S. 1053
(1985); SEC v. First City Financial Corp., Ltd., 890 F.2d 1215, 1230 (D.C. Cir. 1989). Since it is difficult in many cases to separate "legal from illegal profit. . . it is proper to assume that all profits gained while defendants were in violation of the law constituted ill-gotten gains." SEC v. Bilzerian, 814 F. Supp. 116, 118 (D.D.C. 1993), aff'd, 29 F.3d 689 (D.C. Cir. 1994) (citations omitted).
The SEC seeks an order requiring Neuhaus to disgorge his illicit trading proceeds, as found by the Court, of $9,786,589. The SEC has calculated Neuhaus' disgorgement figure based upon the Court's findings as to his trading proceeds between 2001 and 2004. This amount includes $5,861,488 which Neuhaus paid to Universal Express. Many courts have held that a securities law violator may not offset his disgorgement liability by the sums that he paid to effect the fraudulent transactions. See, e.g., SEC v. Kenton Capital Ltd., 69 F. Supp. 2d 1 (D.D.C. 1998) ("overwhelming weight of authority hold[s] that securities law violators may not offset their disgorgement liability with business expenses"); SEC v. Hughes Capital Corp., 917 F. Supp. 1080 (D.N.J. 1996) (same), aff'd, 124 F.3d 449 (3d Cir. 1997); SEC v. Great Lakes Equities Co., 775 F. Supp. 211 (E.D. Mich. 1991); SEC v. United Monetary Services, Inc., 1990 U.S. Dist. LEXIS 11334 (S.D. Fla. May 13 1990)
("Defendants are not entitled to any offset or reduction in the amount of disgorgement for the expenses of conducting the fraud"); SEC v. Great Lakes Equities Co., 775 F. Supp. at 214-215 & n.22 ("The deductions for overhead, commissions and other expenses are not warranted. The manner in which defendants ... chose to spend their misappropriation is irrelevant as to their objection to disgorgement"); SEC v. Dimensional Entertainment Corp., 493 F. Supp. 1270, 1283 (S.D.N.Y. 1980) (defendant's "`expenses in carrying out his scheme and in defending himself are hardly appropriate or legitimate deductions from the amount he received for his own benefit'").
Further, Neuhaus should be held jointly and severally liable with Universal Express for the disgorgement his trading proceeds resulting from the fraudulent scheme which were sent to Universal Express. Where two or more individuals or entities collaborate or have a close relationship in engaging in the violations of the securities laws, they have been held jointly and severally liable for disgorgement of illegally obtained proceeds. SEC v. First Jersey Sec., 101 F.3d at 1475; SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987); SEC v. Graystone Nash, Inc., 820 F. Supp. 863 (D. N.J. 1993), rev'd on other grounds, 25 F.3d 187 (3d Cir. 1994); SEC v. Micro-Therapeutics, Inc., [1982-1983 Transfer Binder] Fed.
Sec. L. Rep. (CCH) ¶ 99,086 (S.D.N.Y. 1983); SEC v. Hughes Capital Corp., 124 F.3d 449, 455 (3d Cir. 1997).
An order requiring disgorgement of Neuhaus' trading proceeds is appropriate based upon the Court's prior findings of Section 5 violations, irrespective of the fact that the Court has not issued its conclusions as to the fraud violations alleged against Neuhaus. See e.g., SEC v. Platforms Wireless, 2007 U.S. Dist. LEXIS 31911 (S.D. Cal. April 30, 2007), (disgorgement ordered after partial summary judgment on Section 5 violations); SEC v. Alpha Telcom, Inc., 187 F.Supp.2d 1250, 1262-63(D. Or. 2002), aff'd SEC v. Rubera, 350 F.3d 1084 (9th Cir. 2003) (disgorgement for Section 5 violations ordered after denial of fraud charges); SEC v. Friendly Power Co., LLC, 49 F. Supp. 2d 1363, 1372-73 (S.D. Fla. 1999)(disgorgement ordered on the basis of Section 5 violations).
B. An Order Requiring Payment of Prejudgment Interest is Appropriate
In his consent filed in this action, Neuhaus has agreed that an award of prejudgment interest on his ill-gotten gains is appropriate. Neuhaus consent, p. 3 [Docket 260] Courts ordering disgorgement of illegal profits routinely also order payment of prejudgment interest on those profits. See e.g., SEC v. Stephenson, 732 F. Supp. 438,439 (S.D.N.Y. 1990); SEC v. Tome, 638 F. Supp. 638, 639 (S.D.N.Y. 1986), aff'd, 833 F.2d 1086 (2d Cir. 1987), cert. denied, 486 U.S. 1014 (1988). See also SEC v. Cross Fin. Servs., Inc., 908 F. Supp. 718, 734 (C.D. Cal. 1995), aff'd sub nom. SEC v. Colello, 139 F.3d 674 (9th Cir. 1998). An order of prejudgment interest "ensure(s) that the wrongdoer does not profit from the illegal activity." Id.
The SEC has calculated prejudgment interest using the standard rates of IRS underpayment of taxes, which calculates the benefit received from the date of the violation (or underpayment of taxes). Courts have endorsed the use of those rates as an appropriate method of calculating prejudgment interest. See, e.g., SEC v. Drexel Burnham Lambert, Inc., 837 F. Supp. 587, 612 n.8 (S.D.N.Y. 1983); SEC v. Bilzerian, 814 F. Supp. 116 (D.D.C. 1993) (final judgment ordering $29.2 million in prejudgment interest), aff'd, 29 F.3d 689 (D.C. Cir. 1994). The IRS rates are not punitive, but rather are set at the level needed to prevent unjust enrichment. See 26 U.S.C.§6621(a)(2). In his consent, Neuhaus agreed that the commencement date for the imposition of such prejudgment interest should be February 1, 2004. Using those rates, the SEC has calculated prejudgment interest of $3,434,919, for a total disgorgement figure as to Neuhaus of $13,221,508. Att. 8.
C. Neuhaus' Asserted Financial Condition Does Not Preclude Disgorgement
Neuhaus has submitted financial information to the SEC and the SEC believes he would contend that he does not have the present ability to pay disgorgement and prejudgment interest of $13,221,508. The SEC nevertheless seeks an order imposing that amount, as to which collection efforts can be made indefinitely. As a threshold matter, financial hardship is not grounds for denying disgorgement. The Court may order disgorgement "without giving consideration to whether or not the defendant may have squandered and/or hidden the ill-gotten profits." McCaskey, 2002 WL at * 5 (citing Rosenfeld, 97 Civ. 1467, 2001 WL 118612 at *2 (S.D.N.Y. Jan. 9, 2001); accord, e.g., CFTC v. Avco Financial Corp., 97 Civ. 3119, 1998 WL 524901 at *1 (S.D.N.Y. Aug.21, 1998) (" declin[ing] to take into consideration Defendant's ... claim of an inability to pay" disgorgement under Commodities Exchange Act), aff'd in part & rev'd in part on other grounds sub nom. CFTC v. Vartuli, 228 F.3d 94 (2d Cir.2000); SEC v. Grossman, 87 Civ. 1031, 1997 WL 231167 at *10 (S.D.N.Y. May 6, 1997) (Kram, D.J.) ("there is no legal support for [defendant's] assertion that his financial hardship precludes the imposition of an order of disgorgement" ), aff'd in part, vacated in part on other grounds sub nom. SEC v. Hirshberg, No. 97-6171, 97-6259, 173 F.3d 846 (table), 1999 WL 163992 (2d Cir. Mar.18, 1999); SEC v. Thomas James Assoc., Inc., 738 F. Supp. 88, 95 (W.D.N.Y.1990) (" Nor may a securities law violator avoid or diminish his responsibility to return his ill gotten gains by establishing that he is no longer in possession of such funds due to subsequent, unsuccessful investments or other forms of discretionary spending.")
Neuhaus' unregistered sales were of significant scope and extended duration. Waiver of any portions of the SEC's requested disgorgement would be inappropriate under the factual circumstances of this case.
D. Third Tier Penalties Are Appropriate Against Neuhaus [3]
1. Standards for the Imposition of Civil Penalties in SEC Cases
Section 21(d)(3)(B)(iii) of the Exchange Act and Section 20(d)(2)(C) of the Securities Act were promulgated by Congress pursuant to the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 ("Remedies Act"). "By enacting the Remedies Act, Congress sought to achieve the dual goals of punishment of the individual
violator and deterrence of future violations." SEC v. Moran, 944 F. Supp. 286, 296 (S.D.N.Y. 1996). The statutes provide that any civil penalty is to be determined by the Court "in light of the facts and circumstances" of the particular case. Exchange Act
Section 21(d)(3).
[3] Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u(d)(3)] authorizes the Court to order civil penalties against any person who has violated the Exchange Act, and contains three tiers of penalties "for each violation," depending upon the nature of the violation.
The relevant House Report states:
The Committee believes that the money penalties proposed in this
legislation are needed to provide financial disincentives to securities law violations other than insider trading.... Disgorgement merely requires the return of wrongfully obtained profits; it does not result in any actual economic penalty or act as a financial disincentive to engage in securities fraud. A violator who avoids detection is able to keep the profits resulting
from illicit activities. Currently, even a violator who is caught is required merely to give back his gains with interest, leaving him no worse off financially than if he had not violated the law. The Committee therefore concluded that authority to seek or impose substantial money penalties, in addition to the disgorgement of profits, is necessary for the deterrence of securities law violations that otherwise may provide great financial returns
to the violator.
H.R. Rep. No. 101-616 (1990), 101st Cong., 2d Sess., reprinted in 1990 U.S.C.C.A.N. 1379, 1384-86.
The dual purpose of a civil penalty is to punish the individual violator and to deter future violations of the securities laws. SEC v. Coates, 137 F. Supp. 413, 428 (S.D.N.Y. 2001); SEC v. Downe, 969 F. Supp. 149, 158 (S.D.N.Y. 1997); SEC v. Palmisano, 135 F.
3d 860, 866 (2d. Cir. 1998). In deciding whether to impose a civil penalty, and the appropriate amount of such penalty, courts have articulated the following relevant factors:
(1) the egregiousness of the violations at issue, (2) defendants' scienter, (3) the repeated nature of the violations, (4) defendants' failure to admit to their wrongdoing; (5) whether defendants' conduct created substantial losses or the risk of substantial losses to other persons; (6) defendants' lack of
cooperation and honesty with authorities, if any; and (7) whether the penalty that would otherwise be appropriate should be reduced due to defendants' demonstrated current and future financial condition.
SEC v. Lybrand, 281 F. Supp. 2d 726, 730 (S.D.N.Y 2003). See also, 16
The amount of any civil penalty should be determined "'in light of the facts and circumstances of the particular case. SEC v. Berger, 244 F. Supp. 2d 180 (S.D.N.Y.2001). The statute establishes three tiers of penalties for a violation of securities laws, with the third tier being the most severe.[4] Third-tier penalties are appropriate when the violation (1) "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement," and (2) "resulted in substantial losses or created a significant risk of substantial losses to other persons." See 15 U.S.C. 78u(d)(3)(B)(iii); SEC v. Phoenix Telecom, LLC, 231 F. Supp. 2d at 1223, 1225 (N.D. Ga. 2001); SEC v. Kenton Capital, Ltd., 69 F. Supp. 2d 1, 17 (D.D.C. 1998). While there are maximum amounts associated with each of the three tiers of civil penalties set forth in the statue, the statute also provides for a greater penalty not to exceed the "gross amount of pecuniary gain to such defendant as a result of the violation."
[4] Third tier penalties at the time of Neuhaus' unregistered sales were $120,000 per violation under Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u(d)(3)]. )]. See also 17 CFR § 201.1002 (2001)(increasing penalty amounts).
While the Court has not made findings as to the issue of Neuhaus' fraud liability, the Court's Opinion finding Section 5 liability is a sufficient predicate for imposition of penalties as to Neuhaus. Further, Neuhaus has agreed that the Court should deem the SEC's
allegations as to his participation in the preparation of three false and misleading press releases issued by Universal Express to be true for the purposes of assessing the appropriateness of penalties in this case.
2. Neuhaus' Conduct Warrants Third Tier Penalties
Analysis of relevant criteria identified above for the imposition of penalties demonstrates that a significant third tier penalty against Neuhaus is appropriate. The Commission moves the Court to impose third tier civil penalties against Neuhaus in the
amount of his pecuniary gain.
a. Neuhaus' conduct involved repeated reckless disregard of a regulatory requirement.
Third tier civil penalties are appropriate if Neuhaus' conduct involved reckless disregard of a regulatory requirement. Section 21(d)(3) of the Exchange Act. In its Opinion, the Court noted that in selling unregistered stock in a volume constituting at times over 40 percent of the outstanding stock of Universal Express, Neuhaus acted in the face of red flags indicating the impropriety of his conduct, including questions by a brokerage firm as to the registration of the stock Neuhaus was selling. Opinion, pp. 6, 34.
Neuhaus admittedly failed to take even rudimentary steps to confirm the legitimacy of his trading, among other things never checking to see whether a registration statement had been filed with the SEC as to the shares he was selling. He further never consulted with any independent attorney to obtain an opinion as to the legitimacy of his massive stock sales. Opinion, pp. 6, 30. As demonstrated by the evidence submitted by the SEC on summary judgment, Neuhaus conducted voluminous trading through fourteen different brokerage accounts held in nominee names on a continuous basis for nearly four years. Neuhaus typically liquidated the stock he obtained from Universal Express within days of receiving it. Neuhaus' conduct involved "numerous and inexcusable instances of circumstances, the Court has previously imposed on other defendants in the case third tier penalties in the amount of their pecuniary gain. securities laws violations" which generated "substantial monies" to Neuhaus. In similar circumstances, the Court has previously imposed on other defendants in the case third tier penalties in the amount of their pecuniary gain.
b. Neuhaus' conduct involved risk of harm to investors
Neuhaus participated in the preparation and dissemination of several press releases which fraudulently depicted Universal Express' access to capital and its business operations. These false press releases inflated the market for Universal Express stock, into which Neuhaus sold stock to public investors. Opinion, pp. 35-36. This type of "pump and dump" merits strong sanctions from the Court. A pump and dump scheme is by definition designed to artificially pump up the price and volume of a stock "only to dump it on unsuspecting investors in order to reap . . . illicit gains." SEC v. Calvo, 387 F. 3d 1211 (11th Cir. 2004). See also, SEC v. McCaskey, 2002 U.S. Dist. LEXIS 4915 *47 n. 19 (S.D.N.Y. 2002), citing SEC v. Friendly Power Co., 49 F. Supp. 2d 1363, 1373 (S.D. Fla.) (ordering civil monetary penalty of $100,000 because defendants' "Failure to register their securities with the SEC created a substantial risk that the investors would lose their investments"); SEC v. Softpoint Inc., 958 F. Supp. 846, 868 (S.D.N.Y. 1997) (assessing third tier $100,000 civil monetary penalty because defendant's "conduct created a significant risk of substantial losses to others" by selling unregistered common stock), aff'd, 159 F. 3d 1348 (2d Cir. 1998).
c. Neuhaus' conduct was egregious
Neuhaus sold over 250 million unregistered Universal Express shares into the public market, generating millions in illicit proceeds. Neuhaus achieved enhanced profits on these sales by participating in the dissemination of three false and misleading press releases which inflated the market price for Universal Express stock. Several courts have interpreted the "each violation" language in Section 20(d)(2) of the Securities Act to allow imposition of a separate penalty for each transaction that violates the federal
securities laws. SEC v. Coates, 137 F. Supp. 2d 413, 428-30 (S.D.N.Y. 2001) (imposing separate penalty for each of defendant's four misrepresentations); SEC v. Kenton Capital, Ltd., 69 F. Supp. 2d 1, 17 n.15 (D.D.C. 1998) (imposing separate penalty for each of the 12 investors whom the defendant defrauded).[5] If viewed separately, Neuhaus' numerous violations would warrant penalties in excess of his pecuniary gain.
[5] Even were the Court to conclude that only a second tier penalty is warranted here, the amount of such penalty should be significant. See McCaskey, 2002 WL 850001 at n.21 (alternative justification for $100,000 civil penalty was second tier penalty applied to each violation); SEC v. Todt, 2000 WL 223836 at *12 (S.D.N.Y. 2000) (rejecting third tier penalty, but granting second-tier penalty of $200,000 based on four violations).
d. Neuhaus Acted with Scienter
The evidence considered by the Court in reaching summary judgment on the issue of registration violations, as well as the evidence submitted here as to Neuhaus' participation in the fraud, clearly demonstrate scienter warranting significant penalties. Neuhaus engaged in a massive unregistered distribution over a several year period and can point to no reasonable steps to attempt even basic due diligence. At a minimum, his own testimony demonstrates that he provided false information to Altomare and Gunderson with the knowledge that it was their practice to continuously issue press
releases concerning Universal Express' ostensible business activities. He profited significantly when the false statements hew provided were used to inflate the market price of Universal Express stock.
IV. Conclusion
For the reasons stated above, Plaintiff requests that the Court enter an order: (1) requiring Neuhaus to pay disgorgement of $9,786,589; (2) requiring Neuhaus to pay prejudgment interest of $3,434,919; and (3) requiring Neuhaus to pay third tier penalties
in the amount of his pecuniary gain.
DATED: November 7, 2008
Respectfully submitted:
s/ Julie K. Lutz
Julie K. Lutz
Leslie J. Hughes
Attorneys for Plaintiff
U.S. Securities and Exchange Commission
---------------
Doc 356
Extract
MEMORANDUM OF LAW IN SUPPORT OF PLAINTIFF'S MOTION FOR DISGORGEMENT AND CIVIL PENALTIES AGAINST DEFENDANT MARK S. NEUHAUS
Table of Contents
I. Introduction 1
II. Factual Background of Neuhaus' Illegal Conduct 2
A. Registration Violations 2
B. Fraud Violations 3
1. May 23, 2002 Announcement of $100 million in Funding 3
Commitments
2. Announcement of North American Airline Acquisition 7
III. Argument 9
A. An Order Requiring Disgorgement of Net Trading Proceeds Is Appropriate 9
B. An Order Requiring Payment of Prejudgment Interest is Appropriate 12
C. Neuhaus' Asserted Financial Condition Does Not Preclude Disgorgement 13
D. Third Tier Penalties Are Appropriate Against Neuhaus 14
1. Standards for the Imposition of Civil Penalties in SEC Cases 14
2. Neuhaus' Conduct Warrants Third Tier Penalties 17
a. Neuhaus' conduct involved repeated reckless disregard 17
of a regulatory requirement.
b. Neuhaus' conduct involved risk of harm to investors 18
c. Neuhaus' conduct was egregious 18
d. Neuhaus Acted with Scienter 19
IV. Conclusion 20
TABLE OF AUTHORITIES
[...]
I. Introduction
In this governmental enforcement action, Plaintiff Securities and Exchange Commission ("SEC") charged defendant Mark S. Neuhaus ("Neuhaus") with violations of the registration and antifraud provisions of the federal securities laws in connection with a scheme involving the stock of Universal Express, Inc. ("Universal Express"). Specifically, Neuhaus was charged with violating Sections 5 and 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder during the period 2001 through 2004 by participating in a continuous unregistered distribution of Universal Express stock, and by participating in the creation and dissemination of three false and misleading press releases concerning Universal Express' purported business operations. On February 21, 2007, following the submission of substantial evidence by the parties, the Court granted summary judgment against Neuhaus as to the Section 5 allegations, finding in its Opinion and Order ("Opinion") [Docket No. 172] that between April 2001 and January 2004, Neuhaus sold 259,649,167 shares of stock of Universal Express, Inc. into the public market in numerous unregistered transactions, through which he reaped proceeds of
$9,786,589. [Opinion, pp. 29-34].
In November 2007, Neuhaus consented to a bifurcated settlement of the remaining fraud charges in the complaint, pursuant to which he consented to the imposition of injunctive relief against further violations of the registration and antifraud provisions as well as to the imposition of a bar prohibiting him from participating in any offering of penny stock. On December 4, 2007, pursuant to Neuhaus' consent, the Court issued a permanent injunction and penny stock bar against Neuhaus. [Docket Nos. 260, 261] Under the terms of the bifurcated settlement, the issues of disgorgement and penalties were reserved for later resolution by the Court. Pursuant to the terms of Neuhaus' consent, Neuhaus agreed that he was liable for disgorgement of his ill-gotten gains, plus prejudgment interest on those gains. Neuhaus agreed that (1) he is precluded from arguing that he did not violate the federal securities laws as alleged in the Complaint; (2) he may not challenge the validity of the Court's February 21, 2007 Opinion and Order, his Consent or the Order of Permanent Injunction; (3) solely for the purposes of such motion, the allegations of the Complaint shall be accepted as and deemed true by the Court; and (4) the Court may determine the issues raised in the motion on the basis of affidavits, without regard to the standards for summary judgment contained in Rule 56(c) of the Federal Rules of Civil Procedure. See Neuhaus Consent a pp. 3-4.
Plaintiff SEC files this memorandum of law in support of its claims for disgorgement and penalties against Neuhaus.
II. Factual Background of Neuhaus' Illegal Conduct
A. Registration Violations
Based upon the evidence previously submitted to the Court in support of its summary judgment motion against Neuhaus, the Court has found Neuhaus liable for violations of the securities registration provisions. The salient facts surrounding those violations are summarized in the Court's February 21, 2007 Opinion. As the Court has found, between April 2001 and January 2004, Universal Express, a publicly traded company, issued more than 500 million shares to Neuhaus and three other individuals or entities, purportedly as compensation for consulting services. No registration statements were in effect as to these issuances. Of the more than 500 million shares, 270,698.345 were issued to Neuhaus under the false claim of a purported S-8 registration and 26,233,248 were issued as restricted shares without any claim of registration. Opinion, pp. 4-5. Neuhaus deposited nearly 225 million of the purported "S-8 registration" shares and 5.5 million of the restricted shares into various brokerage accounts he controlled which were held in the in the names of three entities: Coldwater Capital, LLC, H&N LLC, and Perfect Line Investments. Between 2001 and 2004, Neuhaus sold 259,649,167 shares of Universal Express into the public market in unregistered transactions, generating proceeds of $9,786,589. Opinion, pp. 6-7, 29-34.
B. Fraud Violations
The Court denied summary judgment against Neuhaus as to the fraud alleged against him in the Complaint, finding in the Opinion that issues of fact remained as to Neuhaus' state of mind. The Court nevertheless noted that "a conclusion of participation in fraud could be sustained on the basis of the uncontested facts of Neuhaus' conduct, given the repeated nature of this conduct and defendant's undisputedly sizeable, nearly simultaneous sales of Universal Express stock." Opinion, p. 34-36. However, Neuhaus' consent to the bifurcated settlement establishes his violation of the antifraud provisions for purposes of this motion. Moreover, the evidentiary record in the case demonstrates Neuhaus' participation in the fraudulent press releases and his scienter.
1. May 23, 2002 Announcement of $100 million in Funding Commitments
On May 23, 2002, Universal Express issued a press release falsely claiming it had received "Over $100,000,000 in Funding Commitments" from "two International Hedge Funds." Quoting Altomare, the release further stated: "To complete our corporate objectives, Universal obviously needs to jump start revenues, profits and logistical capabilities. Fortunately, that belief is shared by these investors, who have already invested over $5,000,000 with Universal over the past five years. . . . These monies will be invested initially as debt and equity only at prices well above the current market value . . . . [D]eveloping companies like Universal Express with capital can now seize the opportunities that are readily available to it." [Att. 1.]
Prior to the issuance of the release, Richard Altomare ("Altomare") requested Neuhaus to prepare a funding letter concerning a potential transaction involving Universal Express. Neuhaus prepared a letter dated March 22, 2002 which stated that Coldwater Capital had "authorized $5,000,000 in additional seed capital" for Universal Express and that it would "also provide up to $40,000,000 in long-term financing, if necessary." [Att. 2.]
Contrary to the wording of the letter, Neuhaus testified that Coldwater is not a hedge fund and has never been. Neuhaus stated that it may have been Altomare who suggested referring to Coldwater as a hedge fund. [Neuhaus 2 at 65.] [1] Further, in his sworn testimony, Neuhaus admitted that the value of Coldwater's total assets at the time he wrote the letter was far less than $45,000,000. [Neuhaus 1 at 175-177.] Neuhaus valued the investments of Coldwater as definitely below $30 million, and testified that he did not think they ever exceeded $20 million during 2002. [Neuhaus 1 at 177.] Neuhaus also admitted that the statement in the letter that Coldwater Capital had been investing in
Universal Express for the past 10 years was false. [Neuhaus 2 at 50.] Neuhaus testified that he put these and other false statements in the letter because Altomare asked him to. [Neuhaus 2 at 51.]
[1] The cited portions of investigative and deposition testimony are attached as Att. 3.
In his investigative testimony, Neuhaus also admitted that he was unsure of the exact amount that Coldwater had invested in Universal Express as of the date of the letter, though the letter stated that it had invested over $2 million. Neuhaus stated that Altomare asked him to state that he had invested that amount and that he had been investing for 10 years. [Neuhaus 2 at 50.] Neuhaus did nothing to verify the statement that Coldwater Capital had invested over $2 million in Universal Express. [Neuhaus 2 at 51.] Neuhaus also admitted that Coldwater did not have a Board of Directors, even though the letter refers to Coldwater's Board of Directors as having authorized additional funding to Universal Express. He did this also because Altomare asked him to. [Neuhaus 2 at 52.]
The letter stated that Coldwater would provide Universal Express with an additional $40 million in financing, if necessary. Neuhaus testified that Coldwater could not have lent or invested as equity $40 million of its own money. Instead, Neuhaus said he believed could have arranged the money through other lenders. [Neuhaus 2 at 57.] When asked about the statements Coldwater authorized $5 million in additional capital for Universal Express, and an additional $40 million, if necessary, Neuhaus testified that he actually meant that he would have invested additional capital if he thought it was a worthwhile investment, and that he would have considered investing $5 million. [Neuhaus 2 at 55.] Neuhaus admits that there was never an event where there was an authorization of the $5 million "other than in his own mind." [Neuhaus 2 at 56.]
Although the March 22, 2002 letter stated that Coldwater and its partners "enthusiastically commit to the funding of Universal Express' strategic acquisition of Trailways Bus Systems," Neuhaus testified that he merely had a "preliminary interest" in funding the acquisition. Neuhaus testified that Altomare asked him to use the stronger, committed language. [Neuhaus 2 at 69-70.]
Neuhaus did not put any restrictions on Altomare's use of the March 22, 2002 letter of intent. [Altomare 1 at 159.] Altomare gave the letter of intent he received from Neuhaus to Trailways as part of merger discussion with that company in 2002. Altomare told Neuhaus that he was providing his letter to Trailways and Neuhaus did not voice any objection. [Altomare 1 at 163.] Neuhaus authorized Altomare to give his name and contact information to Trailways as a part of merger discussions held between the two entities in May 2002. [Altomare 1 at 169.] Neuhaus also confirmed and reiterated the statements in his letters, which he acknowledged to be false or misleading, in a conversation with Gayle Ellsworth from Trailways who called to perform due diligence on the potential merger between Trailways and Universal Express. [Ellsworth at 59-61.]
Altomare also put Neuhaus together with G.E. Capital as one of Universal Express' potential "funders" on another possible business deal. [Altomare 1 at 240-242; Pasqualini at 42-43.] Neuhaus participated in a conference call with personnel from GE Capital who were approached by Altomare to fund a potential transaction between Universal Express and Coach USA. Neuhaus told GE Capital that he would invest equity in connection with the Coach transaction and again falsely stated that Coldwater was a hedge fund. [Neuhaus 1 at 252-254; Pasqualini at 43-47.]
On May 22, 2002, at Altomare's request, Neuhaus provided another letter to Universal Express. [Att. 4.] In this letter, Neuhaus stated that his "hedge fund and partners enthusiastically commit to the funding of Universal Express' strategic acquisition of Trailway's Bus Systems and will do whatever we can to help Universal Express close the transaction with Trailways."
During 2001 and 2002, Neuhaus followed the public announcements of Universal Express on an online data service that would flash when the company issued a public announcement. [Neuhaus 2 at 29-30.] The May 2002 release would have come up as an asterisk on the news tracking service Neuhaus was using. [Neuhaus 2 at 73-74.]
On the first trading day following the issuance of the May 22 press release, Neuhaus, who had been selling approximately 500,000 Universal Express shares per day prior to May 23, 2002, sold at least 1,637,797 shares before the close of trading. [Att. 5, Morgan Neuhaus Aff., ¶ 13]
3. Announcement of North American Airline Acquisition
In the summer of 2003, Neuhaus presented to Altomare a possible acquisition involving North American Airlines ("NAA") [Neuhaus 2 at 86-87.] Neuhaus told Altomare that he, Neuhaus, could probably get most of the financing for the deal. [Neuhaus 2 at 87.] Altomare and the owner of NAA, Dan McKinnon ("McKinnon") engaged in negotiations for an acquisition. Universal Express did not have any funds to complete the merger at the time. [Altomare 2 at 91-92, 104.] To fund a 50% nonrefundable $1 million deposit required by McKinnon as part of an option on the proposed deal, Altomare and Neuhaus agreed that Neuhaus would wire the $1 million on Universal's behalf in exchange for Universal Express. [Neuhaus 1 at 85-88; Att. 6.]
Neuhaus obtained the $1 million deposit from an entity called Orange Investments. Neuhaus transferred Universal Express stock issued to him to an account at Alliance in the name of Black Coomb Ventures ("Black Coomb"). [Neuhaus 1 at 85-87.] Black Coomb was owned by a trust that was solely owned by Neuhaus. [Neuhaus 1 at 35-36; 49.] Orange Investments then loaned Black Coomb the $1 million for 30 days. [Neuhaus 1 at 96-97]. Black Coomb transferred $500,000 directly to McKinnon and $500,000 to an attorney trust account for McKinnon. [Neuhaus 1 at 88.] The loan from Orange Investments was secured by Universal Express stock worth more than $1 million [Neuhaus 1 at 96]. Orange Investments would only lend 50 cents on the dollar. Id.
Neuhaus transferred Universal Express shares issued to him from a Coldwater account to a Black Coomb account at Alliance, which sold them into the public market to pay back the $1 million loan. [Neuhaus 1 at 74-74; 97-98.]
On October 7, Neuhaus sent McKinnon an e-mail falsely stating that SEC rules required Universal to make a public announcement about the transaction. Neuhaus sent the e-mail after discussing a possible announcement with Altomare. [Att. 6, Neuhaus 2 at 94, 102-103.] After receiving Neuhaus' e-mail, the owner agreed to a public release, and on Sunday, October 12, Universal Express issued a press release announcing the option agreement. [Att. 7.] The October 12, 2003 press release, quoting Altomare, stated: "We
have paid a $1,000,000 deposit, 50% of which is which is non-refundable."
The release was materially false and misleading. It failed to disclose that the deposit had been financed through the issuance of unregistered Universal Express shares to Neuhaus. Neuhaus admitted that he and Altomare had discussed disclosing the $1 million deposit and that he had reviewed a draft of the press release that included the statement regarding the deposit. [Neuhaus 1 at 107-109.] The release failed to disclose that Universal Express had no funds to consummate the merger. [Altomare 1 at 146.]
On October 13, 2003, the first trading day after the release was issued, Neuhaus sold 1 million shares of Universal Express stock and thereafter an average of about 1 million shares per day for several weeks. By October 22, 2003 he had received total proceeds from these sales of $1 million. [Att. 5, Morgan Neuhaus Aff., ¶ 11] Neuhaus testified that he was part of the conversations leading up to the October 12, 2003 press release regarding the North American Airline transaction. He commented on the contents before it went out. [Neuhaus 2 at 103-104, 114-15.]
The above facts prove that Neuhaus provided to Universal Express and its two former principals, defendants Altomare and Chris G. Gunderson, two false and misleading letters that were forseeably used as a the basis for drafting certain press releases which the Court has found were "uncontestedly fraudulent " concerning Universal Express' ostensible access to financing. Opinion, p. 35. Neuhaus was involved in the creation of the false North American Airlines release. [2]
[2] As stated above, for purposes of the Court's determination of financial relief in this case, Neuhaus has agreed in his consent filed in the case that the allegations of the complaint as to his participation in false and misleading press releases should be deemed true by the Court. Neuhaus consent, p. 4. [Docket No. 260]
III. Argument
A. An Order Requiring Disgorgement of Net Trading Proceeds Is Appropriate
As stated above, in his consent, Neuhaus has agreed that he is liable for disgorgement of his ill-gotten gains from stock sales, as well as prejudgment interest on those gains. As noted in SEC v. McCaskey, 2002 WL 8500001 (S.D.N.Y. March 26, 2002), the Second Circuit has held that:
The primary purpose of disgorgement as a remedy for violation of the securities laws is to deprive violators of their ill-gotten gains, thereby effectuating the deterrence objectives of those laws. See, e.g., SEC v. Wang, 944 F.2d 80, 85 (2d Cir.1991); SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir. 1978). "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." SEC v. Manor Nursing Centers, Inc.,
458 F.2d [1082,] 1104 [ (2d Cir. 1972) ]; see SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971). McCaskey, 2002 WL at * 3.
A district court has broad discretion not only in determining whether or not to order disgorgement but also in calculating the amount to be disgorged. See, e.g., SEC v. Lorin, 76 F.3d 458, 462 (2d. Cir. 1996). The amount of disgorgement ordered "need only be a reasonable approximation of profits causally connected to the violation." SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995) (internal quotation marks omitted). Further, "any risk of uncertainty [in calculating disgorgement] should fall on the wrongdoer whose illegal conduct created that uncertainty." Id. (internal quotation marks omitted). See also, SEC v. Materia, 745 F.2d 197, 200-201 (2d Cir. 1984), cert. denied, 471 U.S. 1053
(1985); SEC v. First City Financial Corp., Ltd., 890 F.2d 1215, 1230 (D.C. Cir. 1989). Since it is difficult in many cases to separate "legal from illegal profit. . . it is proper to assume that all profits gained while defendants were in violation of the law constituted ill-gotten gains." SEC v. Bilzerian, 814 F. Supp. 116, 118 (D.D.C. 1993), aff'd, 29 F.3d 689 (D.C. Cir. 1994) (citations omitted).
The SEC seeks an order requiring Neuhaus to disgorge his illicit trading proceeds, as found by the Court, of $9,786,589. The SEC has calculated Neuhaus' disgorgement figure based upon the Court's findings as to his trading proceeds between 2001 and 2004. This amount includes $5,861,488 which Neuhaus paid to Universal Express. Many courts have held that a securities law violator may not offset his disgorgement liability by the sums that he paid to effect the fraudulent transactions. See, e.g., SEC v. Kenton Capital Ltd., 69 F. Supp. 2d 1 (D.D.C. 1998) ("overwhelming weight of authority hold[s] that securities law violators may not offset their disgorgement liability with business expenses"); SEC v. Hughes Capital Corp., 917 F. Supp. 1080 (D.N.J. 1996) (same), aff'd, 124 F.3d 449 (3d Cir. 1997); SEC v. Great Lakes Equities Co., 775 F. Supp. 211 (E.D. Mich. 1991); SEC v. United Monetary Services, Inc., 1990 U.S. Dist. LEXIS 11334 (S.D. Fla. May 13 1990)
("Defendants are not entitled to any offset or reduction in the amount of disgorgement for the expenses of conducting the fraud"); SEC v. Great Lakes Equities Co., 775 F. Supp. at 214-215 & n.22 ("The deductions for overhead, commissions and other expenses are not warranted. The manner in which defendants ... chose to spend their misappropriation is irrelevant as to their objection to disgorgement"); SEC v. Dimensional Entertainment Corp., 493 F. Supp. 1270, 1283 (S.D.N.Y. 1980) (defendant's "`expenses in carrying out his scheme and in defending himself are hardly appropriate or legitimate deductions from the amount he received for his own benefit'").
Further, Neuhaus should be held jointly and severally liable with Universal Express for the disgorgement his trading proceeds resulting from the fraudulent scheme which were sent to Universal Express. Where two or more individuals or entities collaborate or have a close relationship in engaging in the violations of the securities laws, they have been held jointly and severally liable for disgorgement of illegally obtained proceeds. SEC v. First Jersey Sec., 101 F.3d at 1475; SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987); SEC v. Graystone Nash, Inc., 820 F. Supp. 863 (D. N.J. 1993), rev'd on other grounds, 25 F.3d 187 (3d Cir. 1994); SEC v. Micro-Therapeutics, Inc., [1982-1983 Transfer Binder] Fed.
Sec. L. Rep. (CCH) ¶ 99,086 (S.D.N.Y. 1983); SEC v. Hughes Capital Corp., 124 F.3d 449, 455 (3d Cir. 1997).
An order requiring disgorgement of Neuhaus' trading proceeds is appropriate based upon the Court's prior findings of Section 5 violations, irrespective of the fact that the Court has not issued its conclusions as to the fraud violations alleged against Neuhaus. See e.g., SEC v. Platforms Wireless, 2007 U.S. Dist. LEXIS 31911 (S.D. Cal. April 30, 2007), (disgorgement ordered after partial summary judgment on Section 5 violations); SEC v. Alpha Telcom, Inc., 187 F.Supp.2d 1250, 1262-63(D. Or. 2002), aff'd SEC v. Rubera, 350 F.3d 1084 (9th Cir. 2003) (disgorgement for Section 5 violations ordered after denial of fraud charges); SEC v. Friendly Power Co., LLC, 49 F. Supp. 2d 1363, 1372-73 (S.D. Fla. 1999)(disgorgement ordered on the basis of Section 5 violations).
B. An Order Requiring Payment of Prejudgment Interest is Appropriate
In his consent filed in this action, Neuhaus has agreed that an award of prejudgment interest on his ill-gotten gains is appropriate. Neuhaus consent, p. 3 [Docket 260] Courts ordering disgorgement of illegal profits routinely also order payment of prejudgment interest on those profits. See e.g., SEC v. Stephenson, 732 F. Supp. 438,439 (S.D.N.Y. 1990); SEC v. Tome, 638 F. Supp. 638, 639 (S.D.N.Y. 1986), aff'd, 833 F.2d 1086 (2d Cir. 1987), cert. denied, 486 U.S. 1014 (1988). See also SEC v. Cross Fin. Servs., Inc., 908 F. Supp. 718, 734 (C.D. Cal. 1995), aff'd sub nom. SEC v. Colello, 139 F.3d 674 (9th Cir. 1998). An order of prejudgment interest "ensure(s) that the wrongdoer does not profit from the illegal activity." Id.
The SEC has calculated prejudgment interest using the standard rates of IRS underpayment of taxes, which calculates the benefit received from the date of the violation (or underpayment of taxes). Courts have endorsed the use of those rates as an appropriate method of calculating prejudgment interest. See, e.g., SEC v. Drexel Burnham Lambert, Inc., 837 F. Supp. 587, 612 n.8 (S.D.N.Y. 1983); SEC v. Bilzerian, 814 F. Supp. 116 (D.D.C. 1993) (final judgment ordering $29.2 million in prejudgment interest), aff'd, 29 F.3d 689 (D.C. Cir. 1994). The IRS rates are not punitive, but rather are set at the level needed to prevent unjust enrichment. See 26 U.S.C.§6621(a)(2). In his consent, Neuhaus agreed that the commencement date for the imposition of such prejudgment interest should be February 1, 2004. Using those rates, the SEC has calculated prejudgment interest of $3,434,919, for a total disgorgement figure as to Neuhaus of $13,221,508. Att. 8.
C. Neuhaus' Asserted Financial Condition Does Not Preclude Disgorgement
Neuhaus has submitted financial information to the SEC and the SEC believes he would contend that he does not have the present ability to pay disgorgement and prejudgment interest of $13,221,508. The SEC nevertheless seeks an order imposing that amount, as to which collection efforts can be made indefinitely. As a threshold matter, financial hardship is not grounds for denying disgorgement. The Court may order disgorgement "without giving consideration to whether or not the defendant may have squandered and/or hidden the ill-gotten profits." McCaskey, 2002 WL at * 5 (citing Rosenfeld, 97 Civ. 1467, 2001 WL 118612 at *2 (S.D.N.Y. Jan. 9, 2001); accord, e.g., CFTC v. Avco Financial Corp., 97 Civ. 3119, 1998 WL 524901 at *1 (S.D.N.Y. Aug.21, 1998) (" declin[ing] to take into consideration Defendant's ... claim of an inability to pay" disgorgement under Commodities Exchange Act), aff'd in part & rev'd in part on other grounds sub nom. CFTC v. Vartuli, 228 F.3d 94 (2d Cir.2000); SEC v. Grossman, 87 Civ. 1031, 1997 WL 231167 at *10 (S.D.N.Y. May 6, 1997) (Kram, D.J.) ("there is no legal support for [defendant's] assertion that his financial hardship precludes the imposition of an order of disgorgement" ), aff'd in part, vacated in part on other grounds sub nom. SEC v. Hirshberg, No. 97-6171, 97-6259, 173 F.3d 846 (table), 1999 WL 163992 (2d Cir. Mar.18, 1999); SEC v. Thomas James Assoc., Inc., 738 F. Supp. 88, 95 (W.D.N.Y.1990) (" Nor may a securities law violator avoid or diminish his responsibility to return his ill gotten gains by establishing that he is no longer in possession of such funds due to subsequent, unsuccessful investments or other forms of discretionary spending.")
Neuhaus' unregistered sales were of significant scope and extended duration. Waiver of any portions of the SEC's requested disgorgement would be inappropriate under the factual circumstances of this case.
D. Third Tier Penalties Are Appropriate Against Neuhaus [3]
1. Standards for the Imposition of Civil Penalties in SEC Cases
Section 21(d)(3)(B)(iii) of the Exchange Act and Section 20(d)(2)(C) of the Securities Act were promulgated by Congress pursuant to the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 ("Remedies Act"). "By enacting the Remedies Act, Congress sought to achieve the dual goals of punishment of the individual
violator and deterrence of future violations." SEC v. Moran, 944 F. Supp. 286, 296 (S.D.N.Y. 1996). The statutes provide that any civil penalty is to be determined by the Court "in light of the facts and circumstances" of the particular case. Exchange Act
Section 21(d)(3).
[3] Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u(d)(3)] authorizes the Court to order civil penalties against any person who has violated the Exchange Act, and contains three tiers of penalties "for each violation," depending upon the nature of the violation.
The relevant House Report states:
The Committee believes that the money penalties proposed in this
legislation are needed to provide financial disincentives to securities law violations other than insider trading.... Disgorgement merely requires the return of wrongfully obtained profits; it does not result in any actual economic penalty or act as a financial disincentive to engage in securities fraud. A violator who avoids detection is able to keep the profits resulting
from illicit activities. Currently, even a violator who is caught is required merely to give back his gains with interest, leaving him no worse off financially than if he had not violated the law. The Committee therefore concluded that authority to seek or impose substantial money penalties, in addition to the disgorgement of profits, is necessary for the deterrence of securities law violations that otherwise may provide great financial returns
to the violator.
H.R. Rep. No. 101-616 (1990), 101st Cong., 2d Sess., reprinted in 1990 U.S.C.C.A.N. 1379, 1384-86.
The dual purpose of a civil penalty is to punish the individual violator and to deter future violations of the securities laws. SEC v. Coates, 137 F. Supp. 413, 428 (S.D.N.Y. 2001); SEC v. Downe, 969 F. Supp. 149, 158 (S.D.N.Y. 1997); SEC v. Palmisano, 135 F.
3d 860, 866 (2d. Cir. 1998). In deciding whether to impose a civil penalty, and the appropriate amount of such penalty, courts have articulated the following relevant factors:
(1) the egregiousness of the violations at issue, (2) defendants' scienter, (3) the repeated nature of the violations, (4) defendants' failure to admit to their wrongdoing; (5) whether defendants' conduct created substantial losses or the risk of substantial losses to other persons; (6) defendants' lack of
cooperation and honesty with authorities, if any; and (7) whether the penalty that would otherwise be appropriate should be reduced due to defendants' demonstrated current and future financial condition.
SEC v. Lybrand, 281 F. Supp. 2d 726, 730 (S.D.N.Y 2003). See also, 16
The amount of any civil penalty should be determined "'in light of the facts and circumstances of the particular case. SEC v. Berger, 244 F. Supp. 2d 180 (S.D.N.Y.2001). The statute establishes three tiers of penalties for a violation of securities laws, with the third tier being the most severe.[4] Third-tier penalties are appropriate when the violation (1) "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement," and (2) "resulted in substantial losses or created a significant risk of substantial losses to other persons." See 15 U.S.C. 78u(d)(3)(B)(iii); SEC v. Phoenix Telecom, LLC, 231 F. Supp. 2d at 1223, 1225 (N.D. Ga. 2001); SEC v. Kenton Capital, Ltd., 69 F. Supp. 2d 1, 17 (D.D.C. 1998). While there are maximum amounts associated with each of the three tiers of civil penalties set forth in the statue, the statute also provides for a greater penalty not to exceed the "gross amount of pecuniary gain to such defendant as a result of the violation."
[4] Third tier penalties at the time of Neuhaus' unregistered sales were $120,000 per violation under Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u(d)(3)]. )]. See also 17 CFR § 201.1002 (2001)(increasing penalty amounts).
While the Court has not made findings as to the issue of Neuhaus' fraud liability, the Court's Opinion finding Section 5 liability is a sufficient predicate for imposition of penalties as to Neuhaus. Further, Neuhaus has agreed that the Court should deem the SEC's
allegations as to his participation in the preparation of three false and misleading press releases issued by Universal Express to be true for the purposes of assessing the appropriateness of penalties in this case.
2. Neuhaus' Conduct Warrants Third Tier Penalties
Analysis of relevant criteria identified above for the imposition of penalties demonstrates that a significant third tier penalty against Neuhaus is appropriate. The Commission moves the Court to impose third tier civil penalties against Neuhaus in the
amount of his pecuniary gain.
a. Neuhaus' conduct involved repeated reckless disregard of a regulatory requirement.
Third tier civil penalties are appropriate if Neuhaus' conduct involved reckless disregard of a regulatory requirement. Section 21(d)(3) of the Exchange Act. In its Opinion, the Court noted that in selling unregistered stock in a volume constituting at times over 40 percent of the outstanding stock of Universal Express, Neuhaus acted in the face of red flags indicating the impropriety of his conduct, including questions by a brokerage firm as to the registration of the stock Neuhaus was selling. Opinion, pp. 6, 34.
Neuhaus admittedly failed to take even rudimentary steps to confirm the legitimacy of his trading, among other things never checking to see whether a registration statement had been filed with the SEC as to the shares he was selling. He further never consulted with any independent attorney to obtain an opinion as to the legitimacy of his massive stock sales. Opinion, pp. 6, 30. As demonstrated by the evidence submitted by the SEC on summary judgment, Neuhaus conducted voluminous trading through fourteen different brokerage accounts held in nominee names on a continuous basis for nearly four years. Neuhaus typically liquidated the stock he obtained from Universal Express within days of receiving it. Neuhaus' conduct involved "numerous and inexcusable instances of circumstances, the Court has previously imposed on other defendants in the case third tier penalties in the amount of their pecuniary gain. securities laws violations" which generated "substantial monies" to Neuhaus. In similar circumstances, the Court has previously imposed on other defendants in the case third tier penalties in the amount of their pecuniary gain.
b. Neuhaus' conduct involved risk of harm to investors
Neuhaus participated in the preparation and dissemination of several press releases which fraudulently depicted Universal Express' access to capital and its business operations. These false press releases inflated the market for Universal Express stock, into which Neuhaus sold stock to public investors. Opinion, pp. 35-36. This type of "pump and dump" merits strong sanctions from the Court. A pump and dump scheme is by definition designed to artificially pump up the price and volume of a stock "only to dump it on unsuspecting investors in order to reap . . . illicit gains." SEC v. Calvo, 387 F. 3d 1211 (11th Cir. 2004). See also, SEC v. McCaskey, 2002 U.S. Dist. LEXIS 4915 *47 n. 19 (S.D.N.Y. 2002), citing SEC v. Friendly Power Co., 49 F. Supp. 2d 1363, 1373 (S.D. Fla.) (ordering civil monetary penalty of $100,000 because defendants' "Failure to register their securities with the SEC created a substantial risk that the investors would lose their investments"); SEC v. Softpoint Inc., 958 F. Supp. 846, 868 (S.D.N.Y. 1997) (assessing third tier $100,000 civil monetary penalty because defendant's "conduct created a significant risk of substantial losses to others" by selling unregistered common stock), aff'd, 159 F. 3d 1348 (2d Cir. 1998).
c. Neuhaus' conduct was egregious
Neuhaus sold over 250 million unregistered Universal Express shares into the public market, generating millions in illicit proceeds. Neuhaus achieved enhanced profits on these sales by participating in the dissemination of three false and misleading press releases which inflated the market price for Universal Express stock. Several courts have interpreted the "each violation" language in Section 20(d)(2) of the Securities Act to allow imposition of a separate penalty for each transaction that violates the federal
securities laws. SEC v. Coates, 137 F. Supp. 2d 413, 428-30 (S.D.N.Y. 2001) (imposing separate penalty for each of defendant's four misrepresentations); SEC v. Kenton Capital, Ltd., 69 F. Supp. 2d 1, 17 n.15 (D.D.C. 1998) (imposing separate penalty for each of the 12 investors whom the defendant defrauded).[5] If viewed separately, Neuhaus' numerous violations would warrant penalties in excess of his pecuniary gain.
[5] Even were the Court to conclude that only a second tier penalty is warranted here, the amount of such penalty should be significant. See McCaskey, 2002 WL 850001 at n.21 (alternative justification for $100,000 civil penalty was second tier penalty applied to each violation); SEC v. Todt, 2000 WL 223836 at *12 (S.D.N.Y. 2000) (rejecting third tier penalty, but granting second-tier penalty of $200,000 based on four violations).
d. Neuhaus Acted with Scienter
The evidence considered by the Court in reaching summary judgment on the issue of registration violations, as well as the evidence submitted here as to Neuhaus' participation in the fraud, clearly demonstrate scienter warranting significant penalties. Neuhaus engaged in a massive unregistered distribution over a several year period and can point to no reasonable steps to attempt even basic due diligence. At a minimum, his own testimony demonstrates that he provided false information to Altomare and Gunderson with the knowledge that it was their practice to continuously issue press
releases concerning Universal Express' ostensible business activities. He profited significantly when the false statements hew provided were used to inflate the market price of Universal Express stock.
IV. Conclusion
For the reasons stated above, Plaintiff requests that the Court enter an order: (1) requiring Neuhaus to pay disgorgement of $9,786,589; (2) requiring Neuhaus to pay prejudgment interest of $3,434,919; and (3) requiring Neuhaus to pay third tier penalties
in the amount of his pecuniary gain.
DATED: November 7, 2008
Respectfully submitted:
s/ Julie K. Lutz
Julie K. Lutz
Leslie J. Hughes
Attorneys for Plaintiff
U.S. Securities and Exchange Commission
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