S.E.C. v. Kern
| Decision Date | 27 September 2005 |
| Docket Number | Docket No. 04-0095-CV(CON).,Docket No. 03-6235-CV(L). |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Richard S. KERN, Donald R. Kern, Efi Corp., also known as Electronic Funds, Inc., Barclay Bankcard, Inc., Canyon Vista Corp., Hannah G. Irrevocable Trust, Relief Defendant, Hannah R. Trust, Relief Defendant, Defendants-Appellants, Peter C. Lybrand, Charles Wilkins, Admiral Investments Ltd., Compulink International Corp., Drawnbridge Investment Ltd., Glitter Grove Investment Ltd., Grafton Investments Ltd., Greenford Investment Ltd., McDonalds Ltd., Oasis Enterprises Ltd., Investor Relations, Inc., Tellerstock, Inc., Conversant Enterprises, Inc., Canyon Vista Corp., Salteaux Ltd., also known as First American Security Corp., also known as First American Securities Corp., Defendants. Securities and Exchange Commission, Plaintiff-Appellee, v. Charles Wilkins, Defendant-Appellant, Hannah R Trust, Oasis Enterprises Ltd., Canyon Vista Corp., Salteaux Ltd., also known as First American Security Corp., also known as First American Securities Corp., Hannah G. Irrevocable Trust, Conversant Enterprises, Inc., Efi Corp., also known as Electronic Funds, Inc., Barclay Bankcard, Inc., McDonalds Ltd., Investor Relations, Inc., Tellerstock, Inc., Ford Investments Ltd., Glittergrove Investments Ltd., Grafton Investments Ltd., Greenford Investment Ltd., Admiral Investments, Compulink International Corp., Drawnbridge Investment Ltd., Peter C. Lybrand, formerly known as Peter C. Tosto, Richard S. Kern, Donald R. Kern, Defendants. |
| Court | U.S. Court of Appeals — Second Circuit |
Hope Hall Augustini, Senior Litigation Counsel (Giovanni P. Prezioso, General Counsel, Jacob H. Stillman, Solicitor, Meyer Eisenberg, Deputy General Counsel, on the brief), Securities and Exchange Commission, Washington, D.C., for Plaintiff-Appellee.
Eric W. Berry, New York, N.Y., for Defendants-Appellants.
Before: WALKER, Chief Judge, and POOLER and WESLEY, Circuit Judges.
Defendants-appellants Richard Kern, Donald Kern, Charles Wilkins, and related entities1 appeal from the October 2, 2003, judgment of the United States District Court for the Southern District of New York (Sidney H. Stein, J.), in favor of plaintiff-appellee, the Securities and Exchange Commission ("Commission"), finding defendants in violation of, inter alia, the registration requirements of the Securities Act of 1933, ch. 38, 48 Stat. 74 () ("Act"). This judgment was based on an order filed May 13, 2002, granting partial summary judgment for the Commission, and an order filed September 11, 2003, imposing disgorgement and civil monetary penalties against defendants-appellants. Section 5 of the Act, 15 U.S.C. § 77e, prohibits the offer or sale of securities not registered with the Commission, while other sections of the Act provide exemptions from this requirement. Wilkins and the Kerns engaged in sales orchestrated by defendant Peter Lybrand in unregistered securities. The district court held that these sales did not fall within the exemption provided by Section 4(1) of the Act, 15 U.S.C. § 77d(1), or within the safe harbor of Commission Rule 144, 17 C.F.R. § 230.144, or any other exemption from the requirements of Section 5. The parties then stipulated to disgorgement and injunctions against defendants-appellants prohibiting future violations of the Act. The district court, finding that the violations of Wilkins and the Kerns had involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement and had resulted in substantial losses to another person, further imposed Tier III civil monetary penalties under 15 U.S.C. § 77t(d)(2)(C).
Defendants-appellants argue that their sales are exempt from the registration requirements of Section 5 under Rule 144 or Section 4(1), and that the district court's contrary holdings are the result of misapplications of the law and of the integration doctrine. Defendants-appellants further argue that their violations were not willful or intentional, and that the losses to others have been inflated by improper inclusion of certain sales, so that Tier III civil penalties are inappropriate. We hold that the sales at issue do not qualify for the Rule 144 safe harbor. We further hold that the transactions at issue involved underwriters within the meaning of Section 2(a)(11) of the Act, 15 U.S.C. § 77b(a)(11), and thus cannot qualify for the Section 4(1) exemption. Finally, we hold that the district court did not abuse its discretion in finding that defendants-appellants acted fraudulently and that the determination of penalties should take account of losses caused by all the sales at issue here, and that the penalties imposed were thus within the permissible range of discretion of the district court.
Most of the facts in this case are not disputed or are definitively established by documentary evidence. Because the case was decided under Federal Rule of Civil Procedure 56, where the facts are subject to dispute, we accept the version most favorable to the non-movant defendants-appellants. Furthermore, the factual background is extensive and complex, and was well summarized by the district court below. See SEC v. Lybrand, 200 F.Supp.2d 384, 387-91 (S.D.N.Y.2002). Many of the facts specified or even emphasized by the parties relate only to the illegality of 1998 sales or other issues not in dispute on appeal. We therefore summarize here only those facts relevant to the limited issues argued on appeal.
This case involved three similar schemes, negotiated between Richard Kern and Lybrand, to sell to Lybrand three corporations: Polus, Inc., Citron, Inc., and Electronic Transfer Associates, Inc. ("Polus," "Citron," and "ETA," respectively, and "Issuers" collectively). The Issuers were controlled variously by Richard Kern, Donald Kern, or Wilkins ("Sellers"). Id. at 388. Each Issuer had been purchased or incorporated by one of the Sellers, and stock of each corporation had been distributed to friends and family of the purchase or incorporator ("Owners"). The Owners, several of whom nominally served as corporate officers of an Issuer, were not involved with any decision-making and were unaware of the nature of the company's business, all of which was instead handled by the Sellers. The Issuers were intended to be "shell corporations"—corporations that would qualify for public trading on the over-the-counter bulletin board of the National Association of Securities Dealers, and could then be sold to owners of non-publicly-traded companies. By merging their non-public company into the publicly-traded shell, such a purchaser could cheaply take their company public.
The Sellers were approached by Lybrand at various times in 1998 with plans to purchase 90% or more of the stock of each Issuer for $150,000. Under these plans, Sellers acquired shares from the Owners. These shares were purchased with cash, no records were kept, and neither Donald Kern nor Charles Wilkins could remember even approximately how much they paid for these shares. Donald Kern testified that he set the price of these purchases, but could not remember the prices. Richard Kern testified to one purchase of a ten to fifteen percent interest in Citron for $500. After effecting ten-for-one stock splits, the reacquired shares of each Issuer were sold, via a broker, in the public market, while entities at the direction of Lybrand purchased shares at identical prices and quantities (the "Matched-Order Sales"). Officers and directors of each Issuer were also replaced by Lybrand's team on beginning the Matched-Order Sales. Lybrand used the Matched-Order Sales to illegally manipulate market prices and perceptions. Once enough of these sales had been made so that Sellers had obtained the full purchase price, the remaining shares were transferred to entities controlled by Lybrand (the "Transfers"). The Sellers retained the small number of shares that were not part of the deal (around 5% of the shares). By January 1999, Lybrand's manipulations had seen great success, and the market value of the Issuers had increased dramatically. The Sellers then sold some of their remaining shares in over-the-counter market transactions (the "Market Sales"), netting at least $6 million in profits.
Specifically, Wilkins purchased Polus in 1996. Shares of Polus were distributed to the Polus Owners. Matched-Order Sales of Polus stock occurred between June 22 and July 14, 1998. Lybrand had an 88% interest by July 14, 1998. Transfers of Polus Stock continued up through January 1999. Citron was incorporated by Richard Kern in 1993, and shares were issued to some thirty Owners. Matched-Order Sales of Citron took place from July 13 to August 18, 1998. By August 18, 1998, Lybrand controlled 94% of the Citron stock. Transfers of Citron stock continued through January 1999. Richard Kern signed a merger agreement on behalf of Citron in January 1999. The ETA sale was slightly different. ETA was incorporated by Donald Kern in 1996. Seventy-five percent, or 1.5 million shares, of the ETA stock were issued to Richard Kern and his wife, and 25% (500,000 shares) was issued to the Owners. Matched-Order Sales started on November 4, and Transfers continued through January 1999. By January 1, 1999, at least 75% of ETA had been transferred to Lybrand.
On January 29, 1999, the Commission ordered a suspension of trading in the securities of the Issuers. On February 24, 2000, the Commission sued defendants-appellants, Lybrand, and Lybrand's related entities for securities fraud and selling unregistered securities. After discovery, the Commission moved for partial summary judgment on liability. The district court granted the motion for all claims, holding in relevant part that the Matched-Order Sales, Transfers,...
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