Sec. And Exch. v. Tzolov

Decision Date28 January 2011
Docket NumberCase:No 08 Civ. 7699 (SAS)
CourtU.S. District Court — Southern District of New York


Plaintiff, the Securities and Exchange Commission (the "SEC" or "Commission''), brings this civil enforcement action against defendant Eric S. Butler ("Butler") alleging violations of Section 17(a) of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b); and Rule 10b-5 of the Exchange Act, 17 C.F.R. § 240.1 Qb-5.1 The Commission now seeks summary judgment under Rule 56 of the Federal Rules of Civil Procedure based on collateral estoppel arising from a jury verdict in a parallel criminal case, United States v. Julian Tzolov and Eric Butler, 08 CR 370 (JBW) (the "EDNY Case"), which was prosecuted in the Eastern District of New York ("EDNY").2 In addition, the Commission seeks to permanently restrain and enjoin Butler from committing future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.3 Butler opposes both summary judgment and the proposed injunction on the following grounds: (1) the issues in the instant civil action were not necessarily decided in the EDNY Case (identity of issues); (2) Butler did not have a full and fair opportunity to litigate the criminal charges against him; and (3) the Commission is not entitled to the injunction it seeks. For the following reasons, the Commission's motion is granted and Butler is permanently restrained and enjoined from future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 of the Exchange Act.


"The doctrine of offensive collateral estoppel permits a plaintiff to bar a defendant from relitigating an issue that was decided in a prior case against the defendant."4 Collateral estoppel applies when:

"(1) the issues in both proceedings are identical, (2) the issue in the prior proceeding was actually litigated and actually decided; (3) there was full and fair opportunity to litigate in the prior proceeding, and (4) the issue previously litigated was necessary to support a valid and final judgement on the merits."5

Furthermore, "[t]he moving party has the burden of demonstrating the identity of the issues and the opposing party has the burden of showing lack of a full and fair opportunity to litigate the issue in the prior action."6

"'It is well-settled that a criminal conviction, whether by jury verdict or guilty plea, constitutes estoppel in favor of the United States in a subsequent civil proceeding as to those matters determined by the judgment in the criminalcase.'"7 The rationale behind this rule is as follows:

"The Government bears a higher burden of proof in the criminal than in the civil context and consequently may rely on the collateral estoppel effect of a criminal conviction in a subsequent civil case. Because mutuality of estoppel is no longer an absolute requirement under federal law, a party other than the Government may assert collateral estoppel based on a criminal conviction. The criminal defendant is barred from relitigating any issue determined adversely to him in the criminal proceeding, provided that he had a full and fair opportunity to litigate the issue."8

B. Section 10b and Rule 10b-5

The well-established elements of a violation of Section 10(b) and/or Rule 10b-5 are as follows: (1) there was an untrue statement of fact or an omission of fact;9 (2) the misrepresentation or omission is material;10 (3) the exclusion or misrepresentation is made with scienter;11 (4) the exclusion or misrepresentation ismade in relation to the purchase or sale of securities;12 and (5) the exclusion or misrepresentation is made in connection with interstate commerce or through the mail system.13

C. Section 17(a)

"Section 17(a) of the Securities Act is a general prohibition against fraud in the offer or sale of securities, using the mails or the instruments of interstate commerce."14 "Courts have applied collateral estoppel in the securities fraud context because the elements necessary to establish civil liability under Section 17(a) and 10(b) are identical to those necessary to establish criminal liability under Section 10(b)."15

A. Identity of the Issues

Butler argues that "while there is a factual overlap between the Complaint and Indictment, an accurate analysis of each shows that the issues in the two cases are not identical, that the SEC cannot establish that the allegations in its Complaint were 'actually decided' in the EDNY Case, or that the issues that the SEC seeks to establish by collateral estoppel were 'necessary to support a valid and final judgment' in the EDNY Case."16 More specifically, according to Butler,

the allegations in the Indictment and the Complaint are not the same, rendering collateral estoppel inapplicable. The Indictment alleged conduct in violation of securities laws directed against two entities-GlaxoSmithKline pic. ("Glaxo") and Randgold Resources, Ltd. ("Randgold")-that was not alleged in the Complaint. The jury in the EDNY Case rendered a general verdict, such that the SEC cannot establish that the jury in the EDNY Case found that defendant, Eric Butler, engaged in any conduct alleged in the Complaint. This precludes a finding of collateral estoppel.17

As posited by Butler, the distinction between the two cases is that in the EDNY Case, the jury heard evidence regarding six Customers: the four customers referenced in the Complaint as Customers A, B, C and D, and later identified as Potash Corporation of Saskatchewan Inc. ("Potash"), ST Microelectronics Ltd. ("STMicro"), Roche International Ltd. ("Roche"), and Compania Panamena De Aviacion SA ("Copa"), plus two additional Customers, Glaxo and Randgold. Butler then speculates that the jury's verdict could have been based on conduct solely directly against Glaxo and/or Randgold to the complete exclusion of the four other Customers.18 Arguably, under this scenario, the criminal conviction would not support the application of collateral estoppel.19

There are two problems with Butler's argument. The first is that the term "Customers" as used in the Complaint is not restricted to Customers A, B, C, and D. Rather, the Complaint defines the term "Customers" as those "corporate customers that had authorized Tzolov and Butler to purchase only auction ratesecurities collateralized by federally guaranteed student loans."20 Similar to the Indictment's use of the generic term "Companies, "21 the four Customers cited in the Complaint were offered to illustrate Butler's fraudulent conduct and were not offered as an exhaustive list of every victim of the fraud. As a factual matter, therefore, the Complaint encompasses Glaxo and Randgold in its definition of Customers.

Second, Butler was indicted, tried and convicted for making material misrepresentations and omissions in the sale of auction rate securities collateralized by debt obligations other than student loans. These same misrepresentations and omissions are the basis for the SEC's Complaint. A comparison of the Indictment and the Complaint reveals that the same conduct is alleged in both instruments. Specifically, "The Fraudulent Scheme" section of the Indictment alleges the following:

10. Beginning in or about November 2004, without the knowledge or consent of the Companies, the defendants ERIC BUTLER and JULIAN TZOLOV engaged in a fraudulent scheme which included using the Companies' funds to purchase other types of ARSs [auction rate securities] on behalf of the Companies, including mortgage-backed CDO-ARSs [collateralized debt obligations-auction ratesecurities] (the "Subject CDO-ARSs"), instead of the SL-ARSs [student loan-auction rate securities] which the Companies requested.

11. As part of their fraudulent scheme, and to conceal the true nature of their conduct, the defendants ERIC BUTLER and JULIAN TZOLOV, among other things, sent to the Companies and directed others to send to the Companies emails in which TZOLOV and BUTLER, or others working at their direction, falsified the names of the products held by the Companies to make it appear that those products were SL-ARSs when they were, in fact, other types of ARSs, including the Subject CDO-ARSs. The defendants engaged in this fraudulent scheme to enrich themselves.

12. In approximately August 2007, the market for mortgage-backed CDOs, including the Subject CDO-ARSs, collapsed, and the various auctions for the Subject CDO-ARSs began to fail. As a result of those auction failures, the defendants ERIC BUTLER and JULIAN TZOLOV were unable to sell the investments of the Companies and return their money.22

Included in the SEC's Complaint are the following nearly identical allegations:

1. Defendants Julian Tzolov and Eric Butler, while registered representatives associated with Credit Suisse Securities (USA) LLC ("Credit Suisse"), made over [one] billion dollars of unauthorized purchases of auction rate securities for the accounts of corporate customers. Tzolov and Butler concealed these unauthorized purchases by making false and misleading statements to their customersabout the nature of the securities Tzolov and Butler had purchased for the customers and the assets collateralizing them. These customers authorized Tzolov and Butler to purchase only auction rate securities backed by federally guaranteed student loans, which Tzolov and Butler had promoted as low risk, highly liquid alternatives to investments like bank deposits, money market funds, and commercial paper. Instead, from at least February 2005 through August 2007, Tzolov and Butler purchased for these customers without authorization over $1 billion in auction rate securities collateralized by subprime mortgages,...

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