The opinion of the court was delivered by: Henry H. Kennedy, Jr. United States District Judge
Defendants Gerald and Marie Levine were found by a jury to have violated the following provisions of federal securities law: § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5; §§ 17(a)(1), (2) and (3) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a); and § 13(b)(5) of the Exchange Act, id. § 78m(b)(5), and Rule 13b2-1 promulgated thereunder, 17 C.F.R. § 240.13b2-1. The second amended complaint filed by the Securities and Exchange Commission ("the Commission") alleged that the Levines had violated securities laws by fraudulently overstating the assets of CEC Industries Corporation ("CEC"), profiting from illicitly selling CEC shares, failing to implement a system of internal accounting controls at CEC, and knowingly falsifying its books, records, accounts, and reports filed with the Commission.
After trial, this court conducted a hearing on remedies, at which the Commission sought (1) an injunction against future violations of federal securities laws; (2) a permanent bar prohibiting the Levines from acting as officers or directors of any issuer that has a class of securities registered pursuant to § 12 of the Exchange Act or that is required to file reports pursuant to § 15(d) of the Exchange Act; (3) civil penalties amounting to $540,000; and (4) disgorgement of ill-gotten gains of approximately $536,289 plus prejudgment interest of $524,582, for a total of $1,060,871.
Based on the evidence presented, the court makes the following:
FINDINGS OF FACT AND CONCLUSIONS OF LAW
I. THE LEVINES MADE NUMEROUS FALSE STATEMENTS REGARDING THE VALUE OF INTERESTS HELD BY CEC
A. The Levines Falsely Overstated the Value of Two CEC Subsidiaries
1. In or about 1993, defendants controlled a company called OTS Holdings ("OTS"), which acquired the two entities that are central to this case: Basia Holdings and Mid-Nevada Art.
G. Levine Test. at 58:9--59:8. OTS's filings with the Commission from that era, which the Levines signed, state that Basia Holdings "owned" 9,000 acres of "valuable" land in Tennessee and Mid-Nevada Art owned paintings by the artist known as Sky Jones. Ex. KKK at 4--5.*fn1
2. Three years later, in 1996, defendants structured a transaction by which OTS exchanged its ownership of Basia and Mid-Nevada for a controlling interest in CEC. Ex. 1 at 20; Ex. 10.4 to Ex. 1 (CEC/OTS Agreement, March 28, 1996); G. Levine Test. at 60:5--25.
3. In 1996 and 1997, defendants signed and filed with the Commission annual and quarterly reports for CEC. Defendants therein falsely claimed that CEC "owned" 9,000 acres of land in Grundy County, Tennessee, that contained valuable deposits of coal and harvestable timber, see, e.g., Ex. 1 at 2, 5; Volume II, Trial Transcript ("Trial Tr.") at 47:21--48:18, and that its inventory of Sky Jones paintings was worth approximately $1.7 million, Ex. 1 at 5; Trial Tr. II at 48:19--24.
1. Ownership of Land in Tennessee
4. Commission witness J. Harvey Cameron, a lawyer who practices in Grundy County, was qualified by the court to offer an opinion on the validity of CEC's claim to ownership of the Tennessee land. He testified that CEC did not own the land, and he explained that other persons maintained residences and businesses on the entirety of this land and had paid real estate taxes on all of it for several years before CEC obtained any interest in it. Trial Tr. II at 134:12--160:25.
5. Defendants did not introduce any evidence at trial or at the remedies hearing that contradicted Cameron's testimony that CEC did not own the Tennessee land. Indeed, Gerald Levine, testifying for the first time in these proceedings at the remedies hearing, stated that "[i]t was never our intention to own the land in Tennessee. It was only our intention to have the mineral rights." G. Levine Test. at 64:6--7.*fn2 CEC's forms 10-K and 10-Q, filed and signed by the Levines in 1996 and 1997, however, state that the CEC subsidiary, Basia Holdings, "owns approximately 9,000 acres of land . . . in Grundy County Tennessee." Ex. 1 at 8; see also id. at 5.
Those documents also refer to the Tennessee land as "fee" land, a reference commonly used to indicate complete ownership. Id. at 2; see also id. at 5.
2. Valuation of the Sky Jones Paintings
6. Commission witness C. Van Northrop is a professional art appraiser who was qualified to offer an opinion on the value of the Sky Jones paintings. Northrop testified that these paintings were worth approximately $10,000, not the $1.7 million that defendants represented to investors that they were worth in CEC's reports to the Commission. Trial Tr. III at 92:5--10; 106:11--115:8.
7. Defendants did not offer any evidence at trial that contradicted Northrop's opinion that the Sky Jones paintings had only nominal value. Gerald Levine did state that defendants had relied on Generally Accepted Accounting Principals ("GAAP") to value the paintings and the land. G. Levine Test. at 86:8--87:2. Defendants, however, did not show at trial or at the remedies hearing that the assets were correctly valued according to GAAP, or that GAAP was even relevant to the question of the value of the purported interest in the Tennessee land or the Sky Jones paintings.
B. The Levines Made the False Statements With Reckless Disregard for Their Veracity
8. By determining that the Levines violated § 10(b) and Rule 10b-5, the jury found that the Levine's fraudulent statements were made at least recklessly as to their falsity, if not knowingly. See Jury Verdict Form [#169]; see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976) (holding that no "private cause of action for damages will lie under § 10(b) and Rule 10b-5 in the absence of any allegation of 'scienter'- intent to deceive, manipulate, or defraud").
II. THE COMMISSION HAS PARTIALLY MET ITS BURDEN TO REASONABLY APPROXIMATE THE AMOUNT BY WHICH THE LEVINES UNJUSTLY ENRICHED THEMSELVES VIA THE SALE OF ARTIFICIALLY INFLATED CEC STOCK
9. The court now turns to the Commission's request for disgorgement. The court possesses power to order the defendants to disgorge fully the ill-gotten gains of their fraudulent activities. See, e.g., SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1475 (2d Cir. 1996); SEC v. Hasho, 784 F. Supp. 1059, 1111 (S.D.N.Y. 1992).
10. "Disgorgement is an equitable remedy designed to deprive a wrongdoer of his unjust enrichment and to deter others from violating [federal] securities laws." SEC v. First City Fin. Corp., Ltd., 890 F.2d 1215, 1230 (D.C. Cir. 1989). The Commission need establish only "a reasonable approximation of profits causally connected to the violation" to establish the amount of disgorgement that it may claim. First Jersey Sec., 101 F.3d at 1475 (citation and internal quotations omitted). The burden then shifts to defendants "clearly to demonstrate that the disgorgement figure [is] not a reasonable approximation." First City Fin., 890 F.2d at 1232. "Any risk of uncertainty in calculating disgorgement should fall on the wrongdoer[s] whose illegal conduct created that uncertainty." First Jersey Sec., 101 F.3d at 1475 (citation and internal quotations omitted); see also First City Fin. at 1232.
11. The gravamen of the Commission's request for disgorgement is that the Levines profited from the sale of fraudulently inflated CEC stock. The Commission contends that the Levines directed a private company they controlled, Wire to Wire Inc. ("Wire to Wire"), to sell CEC stock and then funneled the proceeds of these sales to themselves through Wire to Wire's accounts. The Commission also contends that the Levines similarly enriched themselves with stock proceeds held by their lawyer, Alvin Green, and their daughter, Lisa Levine. In assessing the Commission's disgorgement request, the court will first address the relationships among the Levines, Wire to Wire, and CEC, and then will address the Commission's approximation of alleged profits from the Levines' fraudulent activities.
12. As noted, Wire to Wire is a private company. Since late March, 1996, Gerald Levine has been its president and Marie Levine its secretary-treasurer. G. Levine Test. at 31:22--31:24, 42:11--13; M. Levine Dep., November 20, 2002 ("M. Levine Dep. II") at 352:10--19. According to Gerald Levine, Wire to Wire focuses on helping troubled companies.
G. Levine Dep., Nov. 7, 2006 ("G. Levine Dep.") at 42:6--43:8. Mr. Levine began helping troubled companies early in his career. G. Levine Test. at 57:25--58:9.
1. Wire to Wire's relationship with CEC
13. On April 1, 1996, immediately after gaining control of CEC and Wire to Wire, the Levines caused CEC to sign an agreement with Wire to Wire under which Wire to Wire would provide CEC with management personnel and other qualified technical support. Ex. BBBBB (CEC 1997 10-K) at 19.
14. On May 30, 1996, the Levines filed a Form S-8 Registration Statement on behalf of CEC, registering the issuance of 762,136 shares of its common stock to "Employees, or Consultants of the Company, whether individual or corporate." Ex. HHHHH (Form S-8, May 30, 1996) at 16. Pursuant to the Form S-8 Registration Statement, Wire to Wire was issued shares of CEC common stock, some of which the Levines caused to be sold in calendar year 1996. G. Levine Test. at 48:4--25; Ex. BBBBB at 20.
15. On October 8, 1996, the Levines filed another Form S-8 Registration Statement on behalf of CEC, registering the issuance of 755,000 shares of its common stock to "compensate officers, directors, consultants and certain other persons providing bona fide services to the Company, through the award of C.E.C.'s common stock." Ex. IIIII (Form S-8, October 8, 1996) at 14. Wire to Wire may have received CEC shares pursuant to this Registration Statement. G. Levine Test. at 48:4--25.
2. Wire to Wire's relationship with the Levines
16. The sole shareholder of Wire to Wire is Yonus Development ("Yonus"), a company organized and incorporated under the law of the British Virgin Islands. Id. at 31:22--32:3.
17. Defendants claim not to know who owns Yonus. Id. at 32:24--25. Moreover, Gerald Levine testified that he does not know today who is the managing director of Yonus or where it is located. Id. at 91:23--92:3. The Levines continue to operate Wire to Wire today. Id. at 31:22--24. While Yonus may be Wire to Wire's sole shareholder, Yonus exerts no visible control over Wire to Wire's operations. Since approximately 1999, defendants have not had any contact with a Yonus representative. M. Levine Dep. II at 452:4--16; G. Levine Dep. at 36:10--37:17. Gerald Levine claimed at the remedies hearing that Alvin Green was the U.S. agent for Yonus, and that the two men spoke frequently during 1996 and 1997, though not necessarily regarding Yonus or its interests in Wire to Wire. G. Levine Test. at 34:7--24; 36:7--37:2.
18. In her second deposition, Marie Levine testified that she and her husband have not been in contact with any Yonus representative since about 1999. M. Levine Dep. II at 451:19--452:19; 453:21--454:25.
19. In her third deposition, however, she testified that Michael Barth, the former Switzerland-based managing director of Yonus, had repaid them "about half" of a $500,000 loan between 1996 and 2002 or 2003. M. Levine Dep., September 22, 2003 ("M. Levine Dep. III") at 600:25--604:11. Ms. Levine admitted that when she prepared the Levines' joint personal tax returns, she did not treat these loan repayments as "taxable income." See M. Levine Dep. III 671:13--674:20; 588:11--600:1 (discussing tax year 2000 "reimbursements"), 602:4--605:6 (discussing tax year 1999 "reimbursements"), 607:25--610:13 (discussing 1998 "reimbursements"), 610:21--614:2 (discussing 1997 return), 614:8--616:16 (discussing the 1996 return). She alleged that she no longer possessed the records of this loan transaction or any details of its repayment and that she had previously given them to Green, who had lost them. See M. Levine Dep. III at 601:25--604:14, 599:12--600:2.
20. Ms. Levine elsewhere testified, however, that Wire to Wire was the borrower and Yonus the lender of $500,000. M. Levine Dep. II at 447:17--451:8.
21. This inconsistent testimony casts doubt on Marie Levine's credibility and raises serious questions as to whether the claimed loan took place between the Levines and Yonus.
22. Gerald Levine testified at the remedies hearing that Green was functional even after he had a stroke in 1998, including signing papers to release a lien on the house owned by Wire to Wire in which the Levines lived. G. Levine Test. at 37:16--38:8, 53:14--54:3. Marie Levine testified in her April 2002 deposition, however, that Green could not remember anything about Wire to Wire records given to him for safekeeping, and was incapable of even remembering his own address. M. Levine Dep., Apr. 24, 2002 ("M. Levine Dep. I") at 25:2--21. She further testified in November 2002 that Green "was unable to function as a businessperson," and had been in that state since 1998 or 1999. M. Levine Dep. II at 451:19--452:3. These inconsistencies cast further doubt upon the Levines' credibility.
23. As Wire to Wire's only officers and directors, the Levines possessed and continue to possess authority to act on behalf of Wire to Wire, as Nevada's corporation law provides. Thus, they have the power to enter contracts, open brokerage and bank accounts, and direct the disposition of assets in those accounts. G. Levine Test. at 71:17--72:2, 72:14--19 (Levines control Wire to Wire's bank accounts), 72:20--73:4 (Levines control Wire to Wire brokerage accounts). No person other than the Levines possesses that authority over Wire to Wire's accounts. G. Levine Test. at 72:7--73:8; G. Levine Dep. at 32:21--34:1.
3. The Levines' finances and use of Wire to Wire accounts
24. The Levines' federal income tax returns for 1996 and 1997 raise substantial doubt as to whether their reported taxable income could cover their living expenses for those years. See Exs. 280--84.
25. At trial, the Commission played a videotape of excerpts from two of Marie Levine's three depositions. Ex. 248. Ms. Levine there explained that she and Mr. Levine supported themselves from gambling winnings. Id. at 4 (M. Levine Dep. I at 66:7--69:3). At the remedies hearing, Mr. Levine also testified on this point. G. Levine Test. at 88:22--89:4. In her September 22, 2003 deposition, the Commission asked Ms. Levine about the personal tax returns that she and Gerald Levine filed for 1996 through 2001. M. Levine Dep. III at 583:22--619:23 and Exs. 280--84. Ms. Levine admitted that she had prepared and filed the tax returns for those years. See M. Levine Dep. III at 585:6--22; 591:12--592:18; 600:3--602:6; 606:11--607:20; 610:21--611:15; 614:7--615:4. On each return, defendants' gambling losses essentially set off their gambling winnings:
YearGambling WinningsGambling LossesTaxable Income
See Ex. 280 (1996 Form 1040 and Other Income Schedule (reporting gambling income from Form W-2G) and Schedule A, Miscellaneous Itemized Deductions Statement, line 17 (reporting gambling losses); Ex. 281 (1997 Form 1040); M. Levine Dep. III at 610:22--612:7 (identifying $127,821 as income from gaming), 613:5--8 (confirming that gambling income was precisely set off by gambling losses); Ex. 282 (1998 Form 1040, Line 21 reporting income from Form W-2G); Ex. 283 (1999 Form 1040 Other Income Statement and Schedule A); Ex. 284 (2000 Form 1040, line 21 reporting gambling winnings (Form W-2G), and Schedule A, reporting gambling losses).
26. Ms. Levine testified that, from time to time, she and her husband paid $2,000 as monthly rent to Wire to Wire, the owner of their home. Ex. 248 at 1 (M. Levine Dep. I at 8:18--9:3). For each year from 1996 to 2001, defendants failed to report sufficient taxable income to pay Wire to Wire that rent.
27. Ms. Levine admitted that she might have used funds from Wire to Wire's account to pay defendants' individual income tax, the utilities for their house, business meals and travel, and some medical expenses. M. Levine Dep. III at 667:23--668:25; 670:1--674:4; see also
M. Levine Dep. I at 65:20--70:3. She admitted that she did not report the referenced payments on their federal income tax returns for 1996 and 1997. M. Levine Dep. III at 671:13--674:20. Wire to Wire also supplied an automobile to Ms. Levine. Id. at 613:9--614:2.
28. Ms. Levine also testified that the Levines paid personal expenses from Wire to Wire's bank account in 1996. Ex 248 at 3--4 (M. Levine Dep. I at 65:20--66:6); M. Levine Dep. III at 671:13--674:20. For example, she admitted intermingling of personal and Wire to Wire funds. See M. Levine Dep. II at 345:17--346:23. She also admitted that she frequently deposited her gambling winnings in Wire to Wire's checking account. In her words, "It happened a lot." Ex. 248 at 4--5 (M. Levine Dep. I at 67:9--19).
29. In light of the evidence that the Levines' gambling losses offset their gambling winnings, Marie Levine's testimony that she reimbursed Wire to Wire for payments of personal expenses from gambling winnings is not credible. See M. Levine Dep. I at 69:1--8. The self-serving and often false testimony about reimbursements supports an inference that defendants used Wire to Wire accounts in 1996 to provide for their personal living expenses.
30. In early 2003, the Levines requested that the Internal Revenue Service (IRS) provide them with copies of Wire to Wire's 1996 and 1997 corporate income tax returns. By letter dated April 11, 2003, the IRS stated that it had no record of Wire to Wire filing corporate tax returns for those years. See M. Levine Dep. III at 620:19--621:21, Ex. 7; Ex. 285. In explanation of the IRS's letter, Marie Levine insisted that she filed Wire to Wire's returns for those years and gave her only copies to Green, who lost them. See M. Levine Dep. III at 622:18--625:6.
31. The evidence that Wire to Wire's corporate tax returns are nonexistent casts further serious doubt upon the Levines' credibility and supports an inference that defendants used Wire to Wire to sustain their lifestyle.
32. Finally, the evidence that Wire to Wire paid the Levines no salary, G. Levine Test. at 41:8--42:9, but that the Levines frequently wrote themselves checks from Wire to Wire's accounts, see Part II.C.2.a(ii), infra, further supports a finding that defendants used Wire to Wire to sustain their lifestyle.
4. Conclusions regarding the Levines and Wire to Wire
33. For purposes of this proceeding, the court concludes the owner of Yonus exercised little, if any, influence or control over defendants' management of Wire to Wire. Thus, only the Levines control it, and at all times relevant to this suit, they did so without respecting corporate formalities.
34. The evidence shows that Wire to Wire was the vehicle through which defendants perpetrated and profited from their fraud. The court determines that the Levines made extensive use of Wire to Wire for personal purposes. Accordingly, the fact that some proceeds from CEC stock sales flowed into Wire to Wire accounts, rather than to accounts held in the Levines' names, does not give rise to an inference that the Levines did not obtain, use, or profit from those proceeds. To the contrary, the inference arises that, in light of the Levines' control over Wire to Wire and use thereof ...