SECURITIES EXCHANGE COMMISSION v. HOUSE ASSET MGMT

ORDER

DAVID BERNTHAL, Magistrate Judge

In June 2002, Plaintiff, United States Securities and Exchange Commission, filed a Complaint for Injunctive and Other Equitable Relief (#1) against Defendants House Asset Management, L.L.C., House Edge, L.P., Paul House, and Brandon Moore. The Court has jurisdiction over this case based on federal question ( 28 U.S.C. § 1331).

In June 2002, the Court filed an Order of Permanent Injunction and Other Relief Against Defendants House Asset Management, L.L.C. (hereinafter "Adviser"), House Edge, L.P., Paul J. House, and Brandon R. Moore (#6), ordering Defendants to disgorge all ill-gotten gains received by them as a result of the conduct alleged in the complaint. The order also stated that the Court would set the specific amount of disgorgement, determine whether Defendant Moore shall be held jointly and severally liable with Defendant House for disgorgement amounts, and determine whether civil penalties should be imposed on Defendants, and the amount of any such penalties. (#6, p. 8.) Following an evidentiary hearing regarding these issues on April 14, 2004, the Court issued an Order (#103) ruling on some of the issues and requesting more information which the SEC has now provided. (Plaintiff Securities and Exchange Commission's Response to the Court's Request for Additional Information, #106.) Plaintiff also filed a Motion To Reconsider Portions of the June 18, 2004 Order (#104.)

I. Discussion A. Disgorgement

The Court previously concluded that Defendant Moore's disgorgement should be limited to the amount by which he was unjustly enriched. The SEC has notified the Court that Moore received $35,687.21 in compensation from the Adviser. Accordingly, the Court assesses Moore's disgorgement in the amount of $35,687.21. In addition, the Court determined that Defendant Moore would be individually liable for disgorging $117,979 that he "borrowed" from the Hedge Fund to purchase his house, and jointly and severally liable, with Defendant House, for $249,343, which Moore and House borrowed from the Hedge Fund to purchase the Adviser's office building. (Order #103, p. 8.)

B. Joint and Several Liability

The next issue is whether Defendant Moore should be jointly and severally liable with Defendant House for the total amount of investor claims. The Court's previous Order (#103) thoroughly discussed the issue of joint and several liability. In its motion to reconsider, the SEC stated that the Court erred by (1) applying a legal standard that required participants to be "knowing participants" before imposing joint and several liability; and (2) incorrectly relying on the Private Securities Litigation Reform Act of 1995 in support of the "knowing participant" standard.

The SEC first argues that "knowledge" of fraud is not a hard and fast requirement for joint and several liability. It observed that the Third Circuit decision in SEC v. Hughes Capital Corp. did not use the language "knowing participants." Hughes Capital, 124 F.3d 449, 455 (3rd Cir. 1997). The Court agrees; that language was taken from the district court's decision in Hughes, which the Third Circuit affirmed. Hughes v. Capital Corp., 917 F.Supp. 1080, 1089 (D.N.J. 1996) (citing Hateley v. SEC, 8 F.3d 653, 656 (9th Cir. 1993)). In affirming Hughes, the Third Circuit stated that "Courts have held that joint-and-several liability is appropriate in securities cases when two or more individuals or entities collaborate or have close relationships in engaging in the illegal conduct." Hughes, 124 F.3d at 455 (citing S.E.C. v. First Jersey Sec., Inc., 101 F.3d 1450, 1475 (2d Cir. 1996)). The Third Circuit court also stated that "[g]enerally, apportionment is difficult or even practically impossible because defendants have engaged in complex and heavily disguised transactions." Id. (citing CFTC v. American Bd., 803 F.2d 1242, 1252 (2d Cir. 1986)). Nevertheless, the Hughes decision indicated that if it is possible to apportion liability among the parties, joint and several liability may not be appropriate.

Here, unlike Hughes, liability can be apportioned. The SEC does not argue that Defendant Moore was enriched beyond the amount of compensation that he received from the Adviser. As many courts have pointed out, disgorgement should not operate as a fine. See Hateley, 8 F.3d at 656; SEC v. World Gambling Corp., 555 F.Supp. 930, 931 (S.D.N.Y. 1983) ("To the extent that joint liability requires payment of a sum greater than the profits unlawfully gained by the fraudulent transactions, it is a penalty and therefore improper."). It would clearly be punitive to hold Moore jointly and severally liable for the total amount of investor losses, which exceeds $2,750,000, when Moore received only $35,687.21 in ill-gotten gains. Accordingly, the Court adheres to its previous conclusion that Defendant Moore cannot be held jointly and severally liable for the entire amount of investor claims. Consistent with that decision, the Court denies Plaintiff's Motion To Reconsider Portions of the June 18, 2004 Order (#104).

Plaintiff next argues that the Court erred by relying on the Private Securities Litigation Reform Act of 1995 to support its "knowing participant" standard. However, the Court reached its conclusion that a defendant's reckless conduct fails to satisfy the "knowing" requirement for joint and several liability for reasons unrelated to that statute. Instead, the Court referred to the particular provisions of the Securities Exchange Act of 1934 Act ( 15 U.S.C. §§ 78u-4(f)(2)(A) and 78u-4(f)(10)(b)) to demonstrate that its provisions are consistent with the Court's conclusion. The Court is aware that Section 78u-4 of the Securities Act of 1934 applies to private class actions. Otherwise the statutory provisions cited would have been dispositive of the particular issue for which they were simply cited as additional support.

The Court specifically referred to 15 U.S.C. § 78u-4(f)(2)(A) which states as follows: "Any covered person against whom a final judgment is entered in a private action shall be liable for damages jointly and severally only if the trier of fact specifically determines that such covered person knowingly committed a violation of the securities laws" and 15 U.S.C. § 78u-4(f)(10)(b) which states as follows: "reckless conduct by a covered person shall not be construed to constitute a knowing commission of a violation of the securities laws by that covered person." Those provisions were formerly found in subsection (g), which has now been redesignated (f).

C. Prejudgment Interest

The SEC also seeks prejudgment interest on the money subject to disgorgement. In an enforcement action brought by the SEC, the disgorgement order should include all gains flowing from the illegal conduct, including prejudgment interest, to ensure that the wrongdoer does not benefit from what amounts to an interest-free loan obtained as a result of illegal activity. SEC v. Jakubowski, 94 C 4539, 1997 WL 598108, at *2 (N.D. Ill. Sept. 19, 1997). In deciding whether an award of prejudgment interest is warranted, a court should consider (1) the need to fully compensate the wronged party for actual damages suffered, (2) considerations of fairness and the relative equities of the award, (3) the remedial purpose of the statute involved, and/or (4) such other general principles that the court deems relevant. Id.

Having considered the circumstances surrounding this case, the Court finds Defendant Moore liable for prejudgment interest on his ill-gotten gains. The Court orders that Defendant Moore be assessed prejudgment interest in the amount of $10,981.34 on the amount he borrowed to purchase his home and $4,690.23 on the amount of his compensation. In addition, he shall be jointly and severally liable with Defendant House for prejudgment interest of $24,571.24 on the amount that he and House borrowed to purchase real estate.

D. Civil Penalty

In addition to disgorgement and prejudgment interest, the SEC asks the Court to impose a third-tier civil penalty of $120,000 on Defendant Moore. A third-tier civil penalty may be imposed when an individual's conduct "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement" and it "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other person." 15 U.S.C. § 77t(d)(2)(C); 15 U.S.C. § 78u(d)(3)(B)(iii).

The Court has determined that Defendant Moore recklessly disregarded his duty to investigate Defendant House's misrepresentations of the Hedge Fund returns. His involvement in House's fraudulent scheme has contributed to substantial losses for investors. Thus, his conduct clearly involved the elements required for a third-tier civil penalty.

The relevant provisions of the Securities Act, the Securities Exchange Act, and the Investment Advisers Act provide that the amount of any such penalty "shall be determined by the court in light of the facts and circumstances" of the particular case. 15 U.S.C. § 77t(d)(2)(A); 15 U.S.C. § 78u(d)(3)(B)(I); 15 U.S.C. § 80(b)-9(e). The Court considered the following circumstances in this case: Moore's conduct in blaming others, including the SEC, for some of the investor losses; the intentional nature of Moore's real estate self-dealing; Moore's position as an officer, at least nominally; his recklessness in failing to investigate the Hedge Fund's returns; his lack of ownership; his remorse; his cooperation with the SEC and the receiver; and his financial condition.

The SEC seeks $120,000, the maximum third-tier penalty for a violation of securities laws. In light of the circumstances, especially Defendant's financial condition, this amount seems too severe. The Court concludes that an amount of $65,000 will sufficiently punish Moore for his intentional and reckless conduct and serve as an adequate deterrent to others. Accordingly, the Court orders Defendant Moore to pay a civil penalty in the amount of $65,000.

II. Summary

The Court orders that Defendant Moore shall be held individually liable for the following amounts: Disgorgement in the amounts of (1) $35,687.21 for the amount he received as compensation, plus prejudgment interest of $4,690.23 on that amount, and (2) $117,979.00 for the amount he borrowed from The Hedge Fund to purchase his residence, plus prejudgment interest of $10,981.34. The Court further finds that Defendant Moore shall be held jointly and severally liable, with Defendant House, for the disgorgement amount of $249,343.00 for the amount that Moore and House borrowed from the Hedge Fund to purchase the Adviser's office building, plus prejudgment interest of $24,571.24. In addition, the Court orders Moore to pay a civil penalty in the amount of $65,000.

This Order MOOTS Plaintiff's Motion Seeking Joint and Several Liability for the Full Disgorgement Amount and the Imposition of a Third Tier Civil Penalty Against Brandon R. Moore (#94). In addition, the Court DENIES Plaintiff's Motion To Reconsider Portions of the June 18, 2004 Order (#104). This case is terminated.