Opinion ID: 700615
Heading Depth: 2
Heading Rank: 1

Heading: Computation of Avoided Losses

Text: 8 Although Patel agrees that he should disgorge his ill-gotten gains on the basis of the losses he avoided by selling his shares before the public announcement of the negative information known to him, he takes the position that the formula suggested by the SEC and applied by the district court is unreasonable under the circumstances. The district court computed the loss by multiplying the $1,576,358 that Patel received from the sale of his stock by 28.75%, the percentage of the decline of Par stock between the closing price on July 21, the last trading day preceding the announcement on July 24 that Par was recalling its generic Maxzide, and the closing price on July 25. On appeal, Patel argues that this method of computation arbitrarily limits the time period for measuring the effect of the inside information on the stock price and fails to consider the effect on the price of various events that preceded the post-announcement decline. 9 In the exercise of its equity powers, a district court may order the disgorgement of profits acquired through securities fraud. SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1104 (2d Cir.1972). [D]isgorgement need only be a reasonable approximation of profits causally connected to the violation. SEC v. First City Fin. Corp., 890 F.2d 1215, 1231 (D.C.Cir.1989); see also SEC v. Bilzerian, 29 F.3d 689, 697 (D.C.Cir.1994). We have held that, where stock is purchased on the basis of inside information, the proper measure of damages is the difference between the price paid for shares at the time of purchase and the price of the shares shortly after the disclosure of the inside information. SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir.), cert. denied, 404 U.S. 1005, 92 S.Ct. 562, 30 L.Ed.2d 558 (1971). In that case, we recognized that disgorgement of profits merely deprives the [wrongdoers] of the gains of their wrongful conduct. Id. 10 It therefore seems necessary to examine the movement of a stock's price after the relevant information is made public in order to determine the proper measure of the illicit profit (or loss avoided) to be charged to one who traded illegally while in possession of the material, non-public information. See SEC v. MacDonald, 699 F.2d 47, 55 (1st Cir.1983) (en banc); SEC v. Shapiro, 494 F.2d 1301, 1305-07 (2d Cir.1974). It has been said that the market itself may be the best indicator of how long it took for the investing public to learn of, and react to, the disclosed facts. MacDonald, 699 F.2d at 55. Here, Patel avoided losses when he sold his stock in advance of the July 24 recall announcement at a time when he had material, non-public information regarding the fraudulent generic Maxzide Application and its likely consequences. 11 Patel argues that the drop in price of Par stock was not entirely due to the recall announcement and therefore that not all the losses he avoided when he sold his shares are chargeable to him. Specifically, Patel notes that the stock was on a downward spiral or, as he puts it, in freefall during the period beginning November 1987 through July 24, 1989. Patel asserts that the Par stock fell 17.26% from March 1988 to July 1988 in the absence of specific negative information; that the stock fell 8.63% following reports of the subpoena for Par's records in July of 1988; that the stock quietly declined 22.83% between the negative news reports in July and October of 1988; and that the October disclosure of the grand jury investigation resulted in a decline of 17.35%. Accordingly, Patel contends that the drop of 28.75% in the stock price that occurred between July 21, 1989 and July 25, the date following the recall disclosure, was not solely attributable to the disclosure. He also contends that the disgorgement calculation arbitrarily failed to consider the higher closing price of Par stock on July 26, the third day after disclosure, when the stock rallied from $7.125 to $7.625. If the latter figure were used in the computation, the decline in price would have been 23.75% rather than 28.75%, resulting in avoided losses of $374,385 rather than $453,203. Patel asserts that the SEC's method produces an unrealistic result that exaggerates the effect of the disclosure of the 'inside information' on which appellant acted. In so doing, the SEC's disgorgement figure is not a realistic, reasonable approximation of appellant's 'avoided losses' and must be reduced. We disagree. 12 We think that the district court's calculation of avoided losses was appropriate and reasonable in all respects and not an abuse of discretion. See SEC v. Posner, 16 F.3d 520, 522 (2d Cir.1994), cert. denied, --- U.S. ----, 115 S.Ct. 724, 130 L.Ed.2d 629 (1995). While calculations of this nature are not capable of exactitude, we agree with the District of Columbia Circuit that any risk of uncertainty [in calculating disgorgement] should fall on the wrongdoer whose illegal conduct created that uncertainty. First City Fin. Corp., 890 F.2d at 1232. Applying this principle, we find that the district court was eminently reasonable in its approach to the issue of avoided losses in this case. There certainly was a rational basis for the court to conclude that the earlier negative announcements had been fully taken into account by the market and that the July 24, 1989 disclosure alone accounted for the 28.75% decline identified as of July 25. Likewise, it was reasonable to use July 25, the day following the announcement, rather than July 26, in making the calculation. District courts must be given wide latitude in these matters, and we have no difficulty in finding that the district court reasonably approximated the losses avoided by Patel that were causally connected to the securities fraud violations in this case. 13