US v. Regan

• Decision Date: 18 May 1989
• Docket Number: No. S 88 Cr. 517 (RLC).,S 88 Cr. 517 (RLC).
• Citation: 713 F. Supp. 629
• Parties: UNITED STATES of America v. James Sutton REGAN, Charles M. Zarzecki, Jack Z. Rabinowitz, Paul Berkman, Steven Barry Smotrich, Bruce Lee Newberg, Defendants.
• Court: U.S. District Court — Southern District of New York

713 F. Supp. 629

UNITED STATES of America v. James Sutton REGAN, Charles M. Zarzecki, Jack Z. Rabinowitz, Paul Berkman, Steven Barry Smotrich, Bruce Lee Newberg, Defendants.

No. S 88 Cr. 517 (RLC).

United States District Court, S.D. New York.

May 4, 1989.

As Amended May 18, 1989.

Benito Romano, U.S. Atty., S.D.N.Y., New York City (Mark C. Hansen, Neil Cartusciello and Peter G.A. Safirstein, Asst. U.S. Attys., of counsel), for U.S.

Lowenstein Sandler Kohl Fisher & Boylan, Roseland, N.J. (Theodore V. Wells, of counsel), for defendant Regan.

Grand & Ostrow, New York City (Paul Grand, of counsel), for defendant Zarzecki.

Robert Hill Schwartz, P.C., New York City (Robert Hill Schwartz, of counsel), for defendant Rabinowitz.

Robinson Wayne & LaSala, Newark, N.J. (John D. Arseneault, of counsel), for defendant Berkman.

Hayden, Perle and Silber, New York City (Alan Silber, of counsel), for defendant Smotrich.

Gerald B. Lefcourt, P.C., New York City (Gerald B. Lefcourt, of counsel), for defendant Newberg.

Goldman & Hafetz, New York City (Frederick P. Hafetz, of counsel), for defendant Newberg.

AMENDED OPINION

ROBERT L. CARTER, District Judge.

Defendants have been charged in a sixty-eight count indictment with conspiracy,¹ racketeering conspiracy and participation in a racketeering enterprise (the "RICO" charges),² mail and wire fraud,³ securities fraud,⁴ and subscribing to and aiding and assisting in the preparation and presentation of false and fraudulent tax returns.⁵ In connection with the RICO charges, forfeiture is sought of all interests of the defendants in the alleged criminal enterprise and all proceeds of the defendants' alleged racketeering activity.⁶

Defendants have moved for dismissal of most of these charges on both statutory and constitutional grounds. First, they claim they had no statutory duty to keep the records they are charged with conspiring to falsify. Second, they claim that the government's factual allegations fail to state all of the necessary elements of mail and wire fraud. Finally, they claim that their constitutional right to fair notice that their conduct under the due process clause has been violated. Defendant Steven Smotrich has additionally moved for severance of his trial from that of his co-defendants.

Background

All of the defendants except Bruce Newberg are general partners or executives in Princeton/Newport Partners, L.P. ("PNP"), an investment firm with offices in Princeton, New Jersey and Newport Beach, California. At all times relevant to the indictment, Defendant Newberg was a trader in the High Yield and Convertible Bond Department of Drexel Burnham Lambert, Inc. ("Drexel") in Beverly Hills, California.

The charges are based on alleged criminal conduct beginning in or about June, 1984, in connection with three types of securities transactions. The first are so-called "tax trades" in which defendants allegedly engaged in a pattern of sham purchases and sales of securities in order to permit PNP to claim false short term capital loss deductions for federal income tax purposes.

Specifically, it is alleged that defendants arranged for PNP to sell securities subject to secret repurchase agreements which set the repurchase price for the securities without regard to the market value of the securities at the time the repurchase was effected. The alleged purpose of this scheme was to permit PNP to retain effective economic ownership of the securities while appearing to sell them for tax purposes. The tax advantage to PNP was that the short-term capital losses, seemingly incurred as a result of the sale of the securities, could be used to offset short-term capital gains that would otherwise be taxable as ordinary income. The government alleges that defendants' goal was to defraud the United States of income tax revenue and to defraud the limited partners of PNP of truthful information about the amount and legality of the partnership's capital gains and losses. In connection with these alleged illegal acts, each of the defendants is charged with mail and wire fraud and with subscribing to and/or aiding in the preparation of false tax returns.

The second type of securities transaction the government charges was illegal involved Drexel's alleged "parking" of preferred stock of Mattel, Inc. ("Mattel") with PNP. It is alleged that defendants arranged for Drexel to sell Mattel stock to PNP subject to secret repurchase agreements which set the repurchase price for the stock irrespective of changes in its price. It is further alleged that defendants arranged for PNP to purchase additional shares of Mattel stock subject to a secret agreement that any gain or loss on the position would belong to Drexel. The alleged purpose of this scheme was to enable Drexel to retain effective economic ownership of the Mattel stock in violation of a recapitalization agreement that Drexel had entered with Mattel and a group of investors organized by Warburg, Pincus, L.P. that included Drexel (the "Warburg investors group"). The government claims that defendants thereby defrauded Mattel, other members of the Warburg investors group, and other purchasers of Mattel securities. The government also claims that the United States was a contingent victim of the criminal activity. Each of the defendants is charged with mail and wire fraud in connection with these transactions.

The third type of securities transaction cited in the indictment involves an alleged effort to manipulate the market price of C.O.M.B. Co. ("COMB") common stock. It is alleged that defendants arranged to have PNP sell blocks of COMB stock in an effort to drive its price down temporarily without informing either COMB or purchasers of the stock of the attempted manipulation. The alleged goal of this plan was to mislead COMB regarding the value of its securities in order to affect the outcome of a meeting at which key terms were to be set for an issue of COMB convertible bonds that Drexel was underwriting. The government claims that defendants' objective was to defraud both COMB and purchasers of COMB securities. Three of the defendants are charged with wire fraud and securities fraud in connection with this alleged scheme.

The Records Charge

Defendants contend that the parts of Count One that allege a conspiracy to "cause a registered broker-dealer to make and keep false books and records, in violation of Title 15, United States Code, §§ 78q(a) and 78ff, and Title 17, Code of Federal Regulations, §§ 240.17(a)(3) and 240.17(a)(4) must be stricken, because the relevant financial records accurately and truthfully record all the transactions that occurred." Moreover, defendants add, federal law did not require the financial recordkeeping of repurchase agreements at the time defendants executed their repurchase agreements.

Defendants' arguments are not persuasive. To be sure, the financial records of Drexel may accurately reflect both the actual sale and repurchase of defendants' securities, but these records fail to reveal the alleged agreement to repurchase the securities made at the time of sale. The crime for which the government charges the defendants does not concern the inaccurate recordkeeping of the actual sale and repurchase transactions, but rather, the omission of the repurchase agreements from Drexel's bookeeping and records.

Moreover, federal law did require registered broker-dealers to keep records of repurchase agreements at the relevant times covered by the indictment, notwithstanding defendants' emphasis on the SEC release of July 25, 1987. Rules and Regulations of Securities and Exchange Commission, Rel. No. 34—24553, 52 FR 2229501 (July 25, 1987). Defendants contend that the July 25, 1987 SEC release established for the first time the requirement for registered broker-dealers to keep records of repurchase agreements and that, therefore, federal law did not require the recordkeeping of repurchase agreements before that date.

A careful reading of the SEC release, however, undermines defendants' argument. The SEC release does not establish a new requirement of general recordkeeping for repurchase agreements; instead, it establishes special recordkeeping requirements for repurchase agreements in addition to the prior recordkeeping requirements already in place. The SEC release states that the proposed amendments to Rule 17a-3 will "specifically require a broker-dealer to: (i) maintain a separate ledger reflecting the assets and liabilities resulting from repo reverse repo transactions ...; (ii) record securities subject to repos and reverse repos on the securities record; and (iii) maintain copies of confirmations that it sends out with regard to repurchase transactions." Rules and Regulations of Securities and Exchange Commission, Rel. No. 34—24553, supra.

Before the July 25, 1987 SEC release, the Code of Federal Regulations required registered broker-dealers to keep, inter alia, the following records:

(1) Blotters (or other records of original entry) containing an itemized daily record of all purchases and sales of securities....

(3) Ledger accounts (or other records) itemizing separately as to each cash and margin account of every customer and of such member ... all purchases and sales ... of securities....

(8) Copies of confirmations of all purchases and sales of securities and copies of notices of all other debts and credits for securities....

17 C.F.R. § 240.17a-3(a)(1), (3), (8). The term "purchase" included any contract to purchase securities, see 15 U.S.C. § 78c(13) ("The terms `buy' and `purchase' each include any contract to buy, purchase, or otherwise acquire."), and the term "sale" included any contract to sell securities. See 15 U.S.C. § 78c(14) ("The terms `sale' and `sell' each include any contract to sell or otherwise dispose of.").⁷ Thus, defendants cannot contend that federal law did not require Drexel to keep records of their repurchase agreements at the time defendants made these...