S.E.C. v. Wang

• Citation: 944 F.2d 80
• Decision Date: 06 September 1991
• Docket Number: D,No. 1308,1308
• Parties: Fed. Sec. L. Rep. P 96,240 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Stephen Sui-Kuan WANG; Fred C. Lee, also known as Chwan Hong Lee, Defendants-Appellees, Susquehanna Investment Group, objector to the Revised Plan for Distribution of Disgorged Assets, Appellant. ocket 90-6327.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Page 80

944 F.2d 80

Fed. Sec. L. Rep. P 96,240

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Stephen Sui-Kuan WANG; Fred C. Lee, also known as Chwan Hong Lee, Defendants-Appellees Susquehanna Investment Group, objector to the Revised Plan for Distribution of Disgorged Assets, Appellant.

No. 1308, Docket 90-6327.

United States Court of Appeals Second Circuit.

Argued April 8, 1991.

Decided Sept. 6, 1991.

Barry E. Ungar, Philadelphia, Pa. (Janet Stern Holcombe, Mann, Ungar & Spector, of counsel), for appellant Susquehanna Inv. Group.

Richard A. Kirby, Washington, D.C. (Paul Gonson, James R. Doty, Jacob H. Stillman, and Michael G. Lenett, S.E.C., of counsel), for appellee S.E.C.

Before CARDAMONE and MAHONEY, Circuit Judges, and PARKER, District Judge. ^*

CARDAMONE, Circuit Judge:

This appeal concerns objections to a proposed plan drafted by the Securities and Exchange Commission (SEC) to distribute to injured investors funds disgorged by defendants in a securities fraud civil enforcement action brought by the SEC. Susquehanna Investment Group, a partnership composed of seven corporations, claims to be damaged as a result of defendants' insider trading activities. It objects to certain aspects of the SEC's proposed plan to distribute $19,213,136.50 in disgorged profits.

Because the SEC is charged with enforcing the securities laws, it acts as a law enforcement agency when it seeks to enjoin their violation. When it succeeds, as it has in the case at hand, in obtaining both an injunction against continuing violations and an order compelling disgorgement, that order is not focused on those who have been duped out of their money. Rather, the primary purpose of the equitable remedy of disgorgement in these circumstances is to ensure that those guilty of securities fraud do not profit from their ill-gotten gains. When a plan for distribution, incorporating the disgorgement order, is later presented to the district court it is reviewed under that court's general equitable powers to ensure that it is fair and reasonable. Here the United States District Court for the Southern District of New York (Owen, J.) rejected Susquehanna's objections and approved the Revised Plan. We affirm.

FACTS

In June 1988 the SEC filed a civil enforcement action in the Southern District of New York against Stephen Sui-Kuan Wang, Jr. (Wang) and Fred C. Lee, a/k/a Chwan Hong Lee, (Lee) alleging that they, through an insider trading scheme, violated the antifraud provisions of the Securities Exchange Act of 1934, §§ 10(b) and 14(e) and Rules 10b-5 and 14e-3. The complaint alleged that from at least July 1987, Wang, an analyst in the mergers and acquisitions department of Morgan Stanley & Co., Inc., provided Lee with material, nonpublic information about actual or contemplated tender offers, mergers or other extraordinary business transactions acquired in confidence during Wang's employment.

Lee, it is alleged, used this information to purchase securities (stock and options) in at least 25 different publicly held companies producing profits of at least $19 million when the market price of these securities rose in response to public disclosure of the information. The SEC asserted that Wang was paid $200,000 by Lee for giving him the confidential information, and it sought an injunction and, pursuant to the Insider Trading Sanctions Act of 1984 (15 U.S.C. § 78u(d)), the payment of triple the illegal trading profits made by defendants.

After the SEC had obtained a default judgment against Lee and caused defendants' assets to be frozen and more than $19 million in disgorged profits to be paid into the court, defendants Wang and Lee consented to the entry of final judgments against them, and are no longer part of this litigation. Without admitting or denying the allegations of the complaint, each defendant consented to the entry of a permanent injunction and other equitable relief. More specifically, Wang agreed that funds held by the trial court totaling $127,585.50 Lee agreed similarly that of the $25,150,000 in assets to be transferred to the receiver, after payments to the Internal Revenue Service and a civil penalty to the United States Treasury, the balance of $19,085,551 "shall be available for the satisfaction of claims under the federal securities laws arising out of the securities transactions alleged in the complaint, pursuant to a plan to be submitted by the Commission and approved by the Court." Susquehanna had no role in the determination of the provisions of the consent judgments.

"constitute disgorgement by Wang and shall be available for satisfaction of claims arising out of Wang's activities in connection with the purchase and sale of securities, and options to purchase and sell securities, by ... Lee," and to the transfer of the funds to a court-appointed receiver "who shall distribute such funds pursuant to a plan to be proposed by the Commission and approved by the Court."

Prior to the entry of these consent judgments, Susquehanna had commenced a civil action against Lee in the Eastern District of Pennsylvania, captioned as Susquehanna Investment Group vs. Fred C. Lee, a/k/a Chwan Hong Lee, Civil Action No. 88-7999, seeking to recover losses of $1.6 million incurred on the sale of options contemporaneous with Lee's activity, and in some instances directly with Lee. Susquehanna's still pending civil action alleges claims under § 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(e), Rule 14e-3, and civil RICO.

On June 29, 1990 the SEC submitted to the trial court its first Proposed Plan for Distribution of Disgorged Assets which, after comments and objections by potential claimants including Susquehanna was revised. The SEC characterized the Revised Plan as representing "a compromise that treats all potential claimants equitably without requiring the Receiver to engage in extensive and costly analysis of each claim." It described the Revised Plan as limiting compensation in the first round of distribution to options traders who suffered out-of-pocket losses, stating

In general, options traders often employ strategies to minimize losses from sales of a particular option series by contemporaneously establishing related positions in other options of the same issuer. Any trader who established other positions avoided suffering the full paper loss they would have experienced if they had merely sold options. Rather than permitting such traders to reap a disproportionate share of the limited fund, the Court, in the Commission's view, should allow such traders to obtain compensation only for losses based on the value of their overall stock and option positions ...

Those same equities support limiting, at least for the first round of distributions, the claims of options traders to their out-of-pocket losses so as to ensure that sufficient funds exist to pay all eligible claimants. Then, in the event funds remain, the Court will have the opportunity to evaluate whether any inequities actually resulted from the implementation of the Revised Plan.

The out-of-pocket loss restriction limits recovery to those options traders who issued call options of a series that were being purchased contemporaneously by Lee and which remained outstanding throughout the trading period. The SEC's Plan designates such sales as "short." "Short" for options traders for purposes of the Plan meant short in the series of call options sold by such trader, not necessarily short in the underlying stock. So an options trader need not be a "naked" short to be entitled to participate under the Plan because he could be a "covered" short if he happened to own the underlying stock. As a consequence, a short in the relevant sense under the Plan is defined as above, that is, short in the series of call options (no call options in inventory) when the option was sold. Although the SEC's proposed plan was limited to covering compensation in the "first round" of distribution, it has conceded that the potential total losses of contemporaneous traders exceed the profits made by the defendants on the securities they purchased, making the first round most likely the last round of distribution.

Under the Revised Plan, the determination of eligible investor claims is different for traders in common stock than it is for options traders. The plan creates separate pools of funds for each separate security traded by Lee. The money in each fund is to be distributed to investors injured in their trades in that security. The allocation of money among the funds is based on the amount of trading profits the defendant made on each particular security. Where Lee traded in both common stock and options on the same underlying issue, separate allocations are made for profits derived from each, and the claims of contemporaneous traders are paid from the allocation corresponding to the type of security sold by each claimant.

Susquehanna submitted its objections to the proposed Revised Plan by a letter to the district court dated September 11, 1990. These objections were limited to challenging the plan's disparate treatment of similarly situated stock and option traders, and of similarly affected option traders. On September 14, 1990 a hearing was held on these objections and those of other potential claimants. By a memorandum dated October 9, 1990 the district court rejected the objections, and finding the Revised Plan to be both reasonable and fair, approved it. It entered judgment accordingly on December 6, 1990. This appeal followed.

DISCUSSION

There are two issues to be decided: the appropriate standard of review a district court should accord to the Commission's distribution of disgorged insider trading profits under a settlement; and, under that standard, whether the district court properly approved the SEC's Revised Plan in this case.

Before turning to the first issue, we observe that, though this opinion is not intended as a primer on all one...