Court Opinion

ID: 2662666
Source: CourtListenerOpinion
Date Created: 2014-04-03 12:39:15.692075+00
Date Added: 2024-06-11T13:00:16.933929
License: Public Domain

UNITED STATES DISTRICT COURT
                             FOR THE DISTRICT OF COLUMBIA

SECURITIES AND                                      :
EXCHANGE COMMISSION,                                :
                                                    :
                        Plaintiff,                  :           Civil Action No.:       07-0431
                                                    :
                        v.                          :           Re Document Nos.:       53, 59
                                                    :
ONE OR MORE UNKNOWN                                 :
TRADERS IN THE COMMON STOCK                         :
OF CERTAIN ISSUERS et al.                           :
                                                    :
                        Defendants.                 :

                                     MEMORANDUM OPINION

    GRANTING IN PART AND DENYING IN PART THE PLAINTIFF’S MOTION FOR DISGORGEMENT;
    DENYING PAREX’S MOTION FOR SUMMARY JUDGMENT; GRANTING PAREX’S ALTERNATIVE
                          REQUEST TO UNFREEZE $1,164,652.07

                                       I. INTRODUCTION

        This matter comes before the court on both the plaintiff’s motion for disgorgement and

the relief defendant1, JSC Parex Bank, Inc.’s (“Parex”), motion for summary judgment. The

defendants are four individuals who reaped substantial profits by engaging in illegal trading on

the U.S. stock market. They carried out this illegal activity using Parex’s brokerage account and

stored the ill-gotten money at Parex. The court previously ordered Parex to freeze the brokerage

account, which held $3,000,000.00, because it appeared to house the defendants’ illegally

obtained funds. The court also entered default judgment against the defendants and ordered

restitution in the amount of $1,835,347.93.

1
        A relief defendant is a non-party in a case who likely possesses illegally obtained funds. Fed.
        Trade Comm’n v. Cleverlink Trading Ltd., 519 F. Supp. 2d 784, 793 (N.D. Ill. 2007). Typically,
        no wrongdoing is alleged against a relief defendant. Id. A court can order disgorgement of the
        funds if the relief defendant received the funds and if it has no legitimate claim to them. Id.

                                                   1
       The plaintiff, the Securities and Exchange Commission (“SEC”), has filed a motion to

disgorge the frozen funds. In response, Parex moves to unfreeze the frozen funds or, in the

alternative, asks that the court unfreeze the amount in the brokerage account in excess of the

$1,835,347.93 that was ordered in restitution. Because the plaintiff does not sufficiently

establish that the brokerage account funds are causally related to the defendants’ wrongdoing, the

court denies in part the plaintiff’s motion for disgorgement. Further, because a genuine dispute

of material fact exists as to this issue, the court denies in part Parex’s motion for summary

judgment. Because, however, the plaintiff demonstrates that the funds in a particular defendant’s

“current” account were indeed causally related to the wrongdoing, the court grants in part the

plaintiff’s motion. Finally, because the court previously determined that only $1,835,347.93 was

subject to restitution, the court grants Parex’s alternative request to unfreeze the funds in the

frozen brokerage account that exceed the restitution amount.

                     II. FACTUAL & PROCEDURAL BACKGROUND

       In 2002, Parex, a bank located in Latvia, established a brokerage account in the United

States to allow its customers to buy and sell shares of stock on the U.S. stock market. Rel. Def.’s

Statement of Undisputed Material Facts in Supp. of Summ. J. (“Rel. Def.’s Statement”) ¶ 14.

Parex established this brokerage account by contracting with Penson Financial Services, Inc.

(“Penson”), a private financial company. Id. Parex claims that the brokerage account included,

inter alia, a communal “omnibus” account maintained for the benefit of all of its customers who

traded in U.S. securities. Id. Pl.’s Statement of Genuine Issues of Fact in Opp’n to Summ. J.

(“Pl.’s Statement”) ¶ 5. In addition, Parex states, each of its investors had his or her own

separate “current account” that was located in Latvia. Rel. Def.’s Statement ¶ 14.

                                                  2
       Parex claims that an investor would use the brokerage account as a platform to make

trades on the U.S. stock market. Id. at 15. Parex would deposit any resulting proceeds into the

omnibus account within the brokerage account. Id. According to Parex, these funds would then

be sent2 to the investor’s respective “current” account in Latvia. Id.

       Between December 2005 and December 2006, the defendants used the brokerage account

to purchase and sell shares of common stock on the U.S. stock market. Id. ¶¶ 2, 15, 18.

Utilizing “a modern-day, technological version of the traditional ‘pump-and-dump’ market

manipulation scheme,” the defendants illegally inflated stock prices for their personal gain. Id. ¶

3. To carry out this scheme, the defendants first purchased stocks in thinly traded3 companies at

very low prices. Id. The defendants then hacked into the accounts of third-party investors and

bought shares in these thinly traded companies in order to increase the appearance of trading

activity and thereby artificially inflate their stock prices. Id. Once the stock prices were

significantly inflated, the defendants sold all of their personal shares in the companies for

substantial monetary gains. Id.

       According to Parex, the illegally obtained assets were “credited” to the defendants’

respective “current” accounts in Latvia. Rel. Def.’s Mot., Ex. B, Mem. of P. & A. in Supp. of

Opp’n to Pl.’s Mot. and Rel. Def.’s Cross-Mot. for Summ. J.4 (“Rel. Def.’s Mem.”) at 6. Parex

2
       Parex has not clarified who was responsible for allegedly transferring the illegal funds to the
       defendants’ respective current accounts.
3
       “Thinly traded” stocks are shares of small, relatively unknown publically traded companies.
       United States v. Hughes, 505 F.3d 578, 583 (6th Cir. 2007). Such stocks often have a limited
       number of interested buyers and sellers. Id. Prices of thinly traded securities thus tend to be
       more volatile than those traded more actively because just a few trades can affect the market price
       substantially. Id.
4
       Parex has labeled this memorandum as part of its motion. For clarity, the court has relabeled this
       document as “ Exhibit B.”

                                                    3
claims that it closed those current accounts due to the defendants’ suspicious activities well

before the plaintiff filed this action. Id. at 7-8.

        In March 2007, the plaintiff brought this suit against the defendants, alleging that their

actions violated § 17(a) of the Securities Act, § 10(b) of the Exchange Act and SEC Rule 10b-5,

codified at 17 C.F.R. § 240.10b-5. See generally Compl. The plaintiff then filed a preliminary

injunction to enjoin the illegal activity and Parex was named as a relief defendant because it

allegedly held the ill-gotten funds.5 See generally Pl’s Mot. for Prelim. Inj. The court granted

the injunction and entered a consent order for Parex to freeze $3,000,000.00 held in the omnibus

account. Order (Mar. 6, 2007) at 3. The defendants did not respond to any of the allegations and

neglected to engage in the proceedings. See generally Mem. Op. (Aug. 31, 2010). Eventually,

the court entered default judgment against each of the defendants and ordered them to

collectively pay $1,835,347.93 in restitution. Id.

        Because the defendants have yet to pay any of the judgment ordered against them, the

plaintiff has now filed a motion requesting that the relief defendant turn the frozen funds over to

the SEC to satisfy the restitution order. See Pl.’s Mot. for Order Directing Rel. Def. JSC Parex

Bank to Turnover Frozen Funds (“Pl.’s Mot.”). In response, Parex has filed a motion for

summary judgment, contending that the funds in the brokerage account are not subject to

disgorgement. Rel. Def.’s Mem. at 6. The court now turns to the parties’ arguments and the

relevant legal standard.

5
        Parex has not been accused of any wrongdoing, including any participation in or knowledge of
        the illegal activity. See generally Compl.

                                                      4
                                          III. ANALYSIS

                          A. Legal Standard for Summary Judgment

       Summary judgment is appropriate when the pleadings and evidence show “that there is

no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of

law.” FED. R. CIV. P. 56(a); see also Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986);

Diamond v. Atwood, 43 F.3d 1538, 1540 (D.C. Cir. 1995). To determine which facts are

“material,” a court must look to the substantive law on which each claim rests. Anderson v.

Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). A “genuine dispute” is one whose resolution

could establish an element of a claim or defense and, therefore, affect the outcome of the action.

Celotex, 477 U.S. at 322; Anderson, 477 U.S. at 248.

       In ruling on a motion for summary judgment, the court must draw all justifiable

inferences in the nonmoving party’s favor and accept the nonmoving party’s evidence as true.

Anderson, 477 U.S. at 255. A nonmoving party, however, must establish more than “the mere

existence of a scintilla of evidence” in support of its position. Id. at 252. To prevail on a motion

for summary judgment, the moving party must show that the nonmoving party “fail[ed] to make

a showing sufficient to establish the existence of an element essential to that party’s case, and on

which that party will bear the burden of proof at trial.” Celotex, 477 U.S. at 322. By pointing to

the absence of evidence proffered by the nonmoving party, a moving party may succeed on

summary judgment. Id.

       The nonmoving party may defeat summary judgment through factual representations

made in a sworn affidavit if he “support[s] his allegations . . . with facts in the record,” Greene v.

Dalton, 164 F.3d 671, 675 (D.C. Cir. 1999) (quoting Harding v. Gray, 9 F.3d 150, 154 (D.C. Cir.

1993)), or provides “direct testimonial evidence,” Arrington v. United States, 473 F.3d 329, 338

                                                  5
(D.C. Cir. 2006). Indeed, for the court to accept anything less “would defeat the central purpose

of the summary judgment device, which is to weed out those cases insufficiently meritorious to

warrant the expense of a jury trial.” Greene, 164 F.3d at 675.

                  B. Legal Standard for Disgorgement of Ill-Gotten Funds

       Disgorgement is appropriate under the court’s equitable powers to deprive wrongdoers of

unjust enrichment and to deter others from violating securities laws. Sec. and Exch. Comm’n v.

Banner Fund Int’l, 211 F.3d 602, 617 (D.C. Cir. 2000); Sec. and Exch. Comm’n v. First City Fin.

Corp., Ltd., 890 F.2d 1215, 1231 (D.C. Cir. 1989). A disgorgement order is not a punitive

measure but is instead “intended to prevent unjust enrichment. Banner, 211 F.3d at 617; First

City, 890 F.2d at 1230.

       A court may order disgorgement only as to “property causally related to the

wrongdoing.” First City, 890 F.2d at 1231. The plaintiff bears the burden of showing the causal

relationship between the wrongdoing and the illegally obtained funds. Id. Disgorgement,

however, need only be a reasonable approximation of profits causally connected to the violation.

Id. A defendant may legitimately avoid an order of disgorgement by establishing a clear break

or considerable attenuation in the causal connection between the wrongdoing and the illegally

obtained funds. Id. at 1232.

       If the illegal funds are causally related to the wrongdoing, the court may order a relief

defendant to disgorge assets if it has received ill-gotten funds and does not have a legitimate

claim to such funds. Sec. and Exch. Comm’n v. Cavanagh, 155 F.3d 129, 136 (2d Cir. 1998);

Sec. and Exch. Comm’n v. Whittemore, 659 F.3d 1, 9-10 (D.C. Cir. 2011) (affirming the district

court’s determination that disgorgement was proper in cases that met the two factors of the

                                                 6
Cavanagh test). When ill-gotten gains are comingled with legitimately obtained assets, the

entire pool of money is subject to disgorgement. Banner, 211 F.3d at 617; Sec. and Exch.

Comm’n v. Rosenthal, 426 F. App’x 1, 1-2 (2d Cir. 2011).

      C. The Court Grants in Part and Denies in Part the Parties’ Respective Motions

       The plaintiff argues that Parex should disgorge all of the frozen funds in its omnibus

account, which total $3,000,000.00, because these funds are causally related to the defendants’

illegal activity. Pl.’s Mot. at 3. More specifically, the plaintiff asserts that the omnibus account

facilitated the defendants’ pump-and-dump scheme. Pl.’s Opp’n at 8. According to the plaintiff,

the defendants’ illegal trading proceeds were placed in Parex’s omnibus account and have

remained there since the court ordered the account frozen. Id. Disgorgement is therefore proper,

the plaintiff asserts, because Parex received the illegal funds and has no legitimate claim to them.

Id. In addition, the plaintiff avers that even if the ill-gotten funds were comingled with

legitimately obtained monies in the omnibus account, the entire pool of funds is subject to

disgorgement because it would deter future defendants from dispersing illegally obtained profits

to avoid disgorgement. Id.

       Parex asserts that the omnibus account is not subject to disgorgement because the

omnibus account did not contain the ill-gotten funds at the time of the court-ordered freeze. Rel.

Def.’s Mem. at 16. According to Parex, all of the illegal trading profits were sent to the

defendants’ respective “current” accounts in Latvia. Id. Parex claims that the defendants

withdrew almost all of these illegal monies before Parex closed the accounts for suspicious

activity and the plaintiff brought this action. Id. In the alternative, Parex argues that even if the

court determines that disgorgement is proper, only the $1,835,347.93 that the court ordered in

                                                  7
restitution should be disgorged, and the court should unfreeze the remaining $1,164,652.07 in the

omnibus account. Id. at 19.

       In its reply, the plaintiff maintains that Parex remained in possession of the illegal funds

at the time of the court-ordered freeze. Pl.’s Mot. at 11. The plaintiff observes that Parex’s

agreement with its U.S. counterpart, Penson, indicated that the brokerage account would be the

only account used for all trading-related activities. Pl.’s Opp’n at 6. Additionally, the plaintiff

argues that Parex has provided no proof that the illegal money ever actually left the omnibus

account. Id. at 9. Similarly, the plaintiff contends that even if the illegal profits were transferred

from the omnibus account to the defendants’ respective “current” accounts, Parex offers no

evidence that the defendants withdrew the monies from those accounts. Id. at 9.

       As mentioned previously, a court may order disgorgement only as to property that is

causally related to the wrongdoing. First City, 890 F.2d at 1231. If the plaintiff cannot establish

that this causal relationship exists, disgorgement is improper. Id. As a threshold matter, the

court already determined that the proceeds from the defendants’ activities are causally related to

their wrongdoing when it entered an order of restitution. Order (Mar. 14, 2007) at 4. The

parties’ dispute, however, lies in whether the frozen funds in Parex’s omnibus account are indeed

those illegal funds, or in other words, whether the funds in the omnibus account are causally

related to the defendants’ wrongdoing. See Pl.’s Mot. at 8-10; Rel. Def.’s Mot. at 15-18.

       Parex maintains that disgorgement is inappropriate because the ill-gotten funds were not

present in Parex’s accounts at the time of the court-ordered freeze. Rel. Def.’s Mot. at 15.

According to Parex, the illegal proceeds were sent from the omnibus account to the defendants’

respective “current” accounts, at which point the defendants successfully withdrew the majority

of the illegal funds. Id. at 16. Parex claims that it was only after this that it became suspicious

                                                  8
and closed the “current” accounts altogether. Id. Parex offers financial records and affidavits

from bank personnel to support these claims. See generally Rel. Def.’s Reply, Exs. B, C, D.

Specifically, Parex puts forward affidavits from bank personnel that state that the illegal

proceeds were sent to the “current” accounts. Rel. Def.’s Reply, Ex. B at 11; Ex. C at 5. In

addition, the affidavits indicate that Parex closed these accounts prior to the court-ordered freeze.

Rel. Def.’s Reply, Ex. B at 12; Ex. C at 6. Further, Parex provides statements of the defendants’

respective “current” accounts before they were closed, two of which reflect a near-zero balance.6

Rel. Def.’s Reply, Ex. D at 11, 19, 25. A reasonable juror could therefore conclude from such

evidence that Parex did not possess all of the ill-gotten funds at the time of the court-ordered

freeze.

          Some of Parex’s financial records and the plaintiff’s affidavits, however, raise doubt as to

whether the illegal funds ever left the omnibus account. The SEC’s fraud personnel affirm that

there are no documents reflecting that any funds were sent to the “current” accounts, or that any

funds ever left the omnibus account at all. Pl.’s Mot., Ex. A at 1-2; Ex. B at 3. Indeed, the

plaintiffs note, the financial statements for the “current” accounts indicate that there were

transfers made to the brokerage account, instead of from it. See generally Rel. Def.’s Reply, Ex.

C. In addition, the SEC fraud personnel testify that Parex has failed to provide any financial

records pertaining to the omnibus account, save the sole 2011 record indicating that the omnibus

account currently contains the frozen $3,000,000.00. Pl.’s Mot., Ex. A at 2. The absence of such

evidence may cause a reasonable juror to question whether the illegal funds ever left the omnibus

account. Westfall v. Erwin, 484 U.S. 292, 292-93 (1988) (determining that if there is an absence

6
          One of the “current” accounts contained $6.99 at the time that it was closed. Rel. Def.’s Reply,
          Ex. D at 11. Another contained $13.58 at that time. Id. at 19.

                                                      9
of evidence from the moving party, there is a genuine issue of material fact and summary

judgment is denied).

       In reviewing the aforementioned evidence, the court concludes that reasonable jurors

could disagree as to whether the illegal proceeds were found in the omnibus account at the time

of the court-ordered freeze. Therefore, reasonable jurors could disagree as to whether the frozen

funds in the account were causally connected to the defendants’ wrongdoing. Because the

plaintiff has not established that the funds in the omnibus account are causally connected to the

defendants’ wrongdoing, the court denies in part the plaintiff’s motion for disgorgement. Sec.

and Exch. Comm’n v. Pallais, 2010 WL 2772329, at *7 (S.D.N.Y. July 9, 2010) (denying the

plaintiff’s motion for disgorgement because of its failure to establish a causal connection to the

wrongdoing); Sec. and Exch. Comm’n v. Conaway, 2009 WL 902063, at *19 (E.D. Mich. Mar.

31, 2009) (determining that uncertainty as to whether the disputed funds are causally connected

to the wrongdoing precludes disgorgement). Similarly, because a genuine dispute of material

fact exists as to whether the funds in the account are causally connected to the defendants’

wrongdoing, the court denies in part Parex’s motion for summary judgment. Conaway, 2009

WL 902063, at *19 (determining that uncertainty about whether the disputed funds are subject to

disgorgement creates a genuine issue of material fact as to their causal connection to the

wrongdoing); Sec. and Exch. Comm’n v. Vassallo, 2009 WL 4895323, at *1 (E.D. Cal. Dec. 11,

2009) (holding that because there was a disputed issue of fact concerning disgorgement,

summary judgment was denied and the disgorgement determination would only be made after an

evidentiary hearing).

       The court grants summary judgment to the plaintiff, however, with respect to the

$159,169.55 that remains in one defendant’s “current” account. See Rel. Def.’s Mot. at 19.

                                                10
Parex concedes that these funds consist of proceeds from the illegal activity and are thus subject

to disgorgement. Id. Because Parex admits that it received such funds and that it has no

legitimate claims to them, the court grants in part the plaintiff’s motion for disgorgement as to

these funds. See e.g., Sec. and Exch. Comm’n v. Colello, 139 F.3d 674, 676 (9th Cir. 1998)

(determining that when an entity possesses ill-gotten funds but does not have a legitimate claim

to them, disgorgement is proper in order to facilitate recovery).

       Finally, the court considers Parex’s request, in the alternative, to unfreeze the amount in

the brokerage account in excess of the ordered restitution. The court previously determined that

$1,835,347.93 was causally related to the defendants’ wrongdoing and is therefore subject to

disgorgement. Mem. Op. (Aug. 31, 2010) at 5. As noted earlier, however, the frozen funds in

the omnibus account total $3,000,000.00. See Order (Mar. 6, 2007) at 3. Because the plaintiff

has not attempted to show that the excess $1,164,652.07 in the brokerage account is causally

related to the wrongdoing, Parex’s motion for summary judgment is granted in part and the court

orders that this excess amount be unfrozen. First City, 890 F.2d at 1232 (holding that profits

derived outside of the illegal activity are not subject to disgorgement if the defendant shows a

clear break or a considerable attenuation between the illegal activity and the funds in question);

Rosenthal, 426 F. App’x at 1-2 (“The district court has broad discretion not only in determining

whether or not to order disgorgement but also in calculating the amount to be disgorged.”)

(internal citations omitted).

                                       IV. CONCLUSION

       For the foregoing reasons, the court grants in part and denies in part the plaintiff’s motion

for disgorgement and grants in part and denies in part Parex’s motion for summary judgment.

                                                11
An Order consistent with this Memorandum Opinion is separately and contemporaneously issued

this 28th day of March, 2012.

                                                       RICARDO M. URBINA
                                                      United States District Judge

                                            12