S.E.C. v. Pasternak
| Decision Date | 24 June 2008 |
| Docket Number | Civil Action No. 05-3905 (JAP). |
| Citation | 561 F.Supp.2d 459 |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Kenneth D. PASTERNAK and John P. Leighton, Defendants. |
| Court | U.S. District Court — District of New Jersey |
Jane M.E. Peterson, Esq., William H. Kuehnle, Esq., Donald N. Dowie, Esq., Securities and Exchange Commission, Washington, D.C., for Plaintiff, the Securities and Exchange Commission.
Howard Schiffman, Esq., James M. Wines, Esq., Christopher M. McLean, Esq., Dickstein Shapiro LLP, Washington, D.C., for Defendant, Kenneth D. Pasternak.
Joel E. Davidson, Esq., Davidson & Grannum, LLP, Old Tappan, NJ, for Defendant, John P. Leighton.
This matter comes before the Court upon an Amended Complaint brought by Plaintiff Securities and Exchange Commission ("SEC") against Defendants Kenneth D. Pasternak ("Pasternak") and John P. Leighton ("John") (collectively, "Defendants"). The SEC alleges that Defendants, as supervisors and senior executives of Knight Securities, L.P. ("Knight"), a registered broker-dealer firm, violated certain provisions of the Securities Act of 1933 ("the Securities Act") and the Securities Exchange Act of 1934 ("the Exchange Act").
From May 13, 2008 to June 2, 2008, the Court conducted a non-jury trial. After the SEC rested its case, on May 30, 2008, Defendants moved for a judgment on partial findings pursuant to Federal Rule of Civil Procedure 52(c). The SEC opposed the motion. The Court reserved decision on the motions and heard additional arguments on the issue on June 12, 2008. After careful consideration of the extensive record before it, the Court sets forth herein its findings of facts and conclusions of law pursuant to Federal Rule of Civil Procedure 52(a), and finds in favor of Defendants.1
This case inquires into Knight's "market making" business and the actions of one of Knight's institutional sales traders, Joseph Leighton ("Joseph")—John's brother. In particular, the SEC focused its claims on forty-two trades executed by Joseph in 1999 and 2000 on behalf of "buy-side" institutional firms, such as mutual funds and investment advisors. All of the complained-of trades occurred in the NASDAQ Stock Market ("NASDAQ"). During the relevant time period, John, as head of Knight's institutional sales desk, supervised Joseph, while Pasternak held ultimate supervisory responsibilities as Knight's CEO and Chairperson of the Board of Directors.
Based on Defendants' status as supervisors at Knight, and John's familial relationship with Joseph, the SEC, on August 8, 2005, filed a complaint, which they subsequently amended on March 30, 2006. The Amended Complaint asserts five counts against Defendants. In Count I, the SEC alleges that. Defendants aided and abetted "Knight's violation of Section 10(b) of the ... Exchange Act ... and Rule 10b-5 thereunder[.]" (Amended Complaint ("Am. Cmplt.") ¶¶ 72-74 (citing 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5)). In Count II, the SEC asserts that Defendants violated Section 17(a) of the Securities Act. (Am. Cmplt. ¶¶ 75-77 (citing 15 U.S.C. § 77q(a))). In Count III, the SEC alleges that Defendants aided and abetted Knight's violation of Section 15(c)(1)(A) of the Exchange Act. (Am. Cmplt. ¶¶ 78-81 (citing 15 U.S.C. § 78o(c)(1)(A))). In Count IV, the SEC claims that Defendants aided and abetted Knight's violations of Section 17(a) of the Exchange Act and Rule 17a-3 thereunder. (Am. Cmplt. ¶¶ 82-85 (citing 15 U.S.C. § 78q(a); 17 C.F.R. § 240.17a-3)). Finally, the SEC alleges in Count V that Pasternak is jointly and severally liable, pursuant to the "control person liability" set forth in Section 20(a) of the Exchange Act, for Knight's violations of Sections 15(c)(1)(A) and 17(a) of the Exchange Act, as well as Rule 17a-3. (Am. Cmplt. ¶¶ 86-87 (citing 15 U.S.C. §§ 78o(c)(1), 78q(a), 78t(a); 17 C.F.R. § 240.17a-3)).
Throughout the trial, the SEC offered varying theories of liability. In the Amended Complaint, the SEC alleges:
Joseph Leighton, Knight's most prolific sales trader, engaged in a pattern of fraud by trading for Knight's institutional customers using a method that concealed from the customer the manner in which not held orders were worked, including the use of a delayed execution scheme and the improper use of ACT [ (Automated Confirmation Transaction Service) ("ACT") ] modifiers, which obscured the quality of the execution price, resulting in profits above the industry norm at effectively no risk to Knight.
(Am. Cmplt. ¶ 18). As a result, the SEC submits that "Joseph Leighton failed to make full and appropriate disclosures and failed to provide best execution for orders placed by the institutional customers." (Am. Cmplt. ¶ 18). During the trial, the SEC expressed that this pattern of fraud amounted to improper front-running; that is, Joseph, upon receipt of an institutional order, would take a position in the ordered security and delay the execution of the order to take advantage of fluctuating market conditions, thereby generating profits that the SEC deems improper. (Trial Transcript ("Tr.") 487:15-493:3).
The SEC further alleges that Defendants knew of, or were reckless in not knowing of, Joseph's fraud. (Am. Cmplt. ¶ 46). The Commission claims Defendants participated in the perpetration of this fraud by misstating to Knight's customers and the public that Knight provided "best execution" and failing to disclose "the manner in which [Joseph] priced executions to customers." (Am. Cmplt. ¶ 47). During the trial, the SEC explained that John and Pasternak owed an independent fiduciary obligation to disclose to Knight's institutional customers Joseph's profits, and the failure to so inform the customers breached their fiduciary duties. The SEC further argued that Pasternak made a false and misleading statement by signing Knight's 1999 and 2000 Form 10-Ks, which stated that Knight provided its customers with best execution. Finally, the SEC alleges that institutional sales traders at Knight, including Joseph, misused ACT modifiers, causing inaccurate and untimely reporting of trades to NASDAQ, and that Defendants knew of this systematic misuse. (Am. Cmplt. ¶¶ 66-70).
Based on those allegations, the SEC seeks injunctive relief, as well as statutory damages and disgorgement. Specifically, in the form of injunctive relief, the SEC requests that the Court permanently enjoin Defendants from future violations of the Securities Act and the Exchange Act, from aiding and abetting any future violations of the Exchange Act, and "from controlling any person that is in a position to violate Exchange Act Sections 15(c)(1)(A) and 17(a) and Exchange Act Rule 17a-3[.]" (Am. Cmplt. ¶¶ (I)-(III)).
During a fifteen-day bench trial, the Court provided both' parties with the opportunity to present evidence. The SEC proffered the following witnesses from Knight: Gregory Cavallo, Carmine Curra, Thomas Fedele, David Miller, ...
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...708, 714 (D.N.J.2005) ("Lucent I"). The elements of a Section 17(a) claim mirror a claim under Section 10(b), S.E.C. v. Pasternak, 561 F.Supp.2d 459, 498 (D.N.J.2008) (citing SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996)), except that Section 17(a)(2) and (3) do not req......
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