Securities and Exchange Commission v. Rosenthal

10-1204-cv (L)
Securities and Exchange Commission v. Rosenthal
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
SUMMARY ORDER
RULINGS BY SUMMARY ORDER DO NOT HAVE PRECEDENTIAL EFFECT. CITATION TO A
SUMMARY ORDER FILED ON OR AFTER JANUARY 1, 2007, IS PERMITTED AND IS GOVERNED BY
FEDERAL RULE OF APPELLATE PROCEDURE 32.1 AND THIS COURT’S LOCAL RULE 32.1.1. WHEN
CITING A SUMMARY ORDER IN A DOCUMENT FILED WITH THIS COURT, A PARTY MUST CITE
EITHER THE FEDERAL APPENDIX OR AN ELECTRONIC DATABASE (WITH THE NOTATION
“SUMMARY ORDER”). A PARTY CITING A SUMMARY ORDER MUST SERVE A COPY OF IT ON ANY
PARTY NOT REPRESENTED BY COUNSEL.
At a stated Term of the United States Court of Appeals for the Second Circuit, held at the
Daniel Patrick Moynihan United States Courthouse, at 500 Pearl Street, in the City of New York,
on the 9th day of June, two thousand eleven.
Present: ROBERT D. SACK,
ROBERT A. KATZMANN,
DENNY CHIN,
Circuit Judges.
____________________________________________________________
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff-Appellee,
-v- Nos. 10-1204-cv (L); 10-1253 (con)
ZVI ROSENTHAL, AMIR ROSENTHAL, AYAL ROSENTHAL, OREN ROSENTHAL,
EFRAT ROSENTHAL, RIVKA ROSENTHAL,
Defendants-Appellants,
ARAGON CAPITAL MANAGEMENT, LLC, ARAGON PARTNERS, LP, NOGA DELSHAD,
Defendants.
____________________________________________________________
For Plaintiff-Appellee: TRACEY A. HARDIN, Senior Counsel (David M. Becker,
General Counsel; Mark D. Cahn, Deputy General
Counsel; Jacob H. Stillman, Solicitor; Randall W.
Quinn, Assistant General Counsel, on the brief),
Securities & Exchange Commission, Washington, D.C.
For Defendants-Appellants Zvi, AMIR ROSENTHAL, pro se (Zvi Rosenthal, Otisville,
Amir, and Ayal Rosenthal: N.Y., Ayal Rosenthal, Tel Aviv-Yafo, Israel, on the
brief), New York, N.Y.
For Defendants-Appellants Oren, ROBERT KNUTS, Park & Jensen LLP, New York, N.Y.
Efrat, and Rivka Rosenthal:
Appeal from the United States District Court for the Southern District of New York
(Maas, Mag. J.).
ON CONSIDERATION WHEREOF, IT IS HEREBY ORDERED, ADJUDGED,
AND DECREED that the judgment of the district court is AFFIRMED in part and VACATED
in part.
Defendants-Appellants appeal from the judgment of the United States District Court for
the Southern District of New York (Maas, Mag. J.), entered on February 1, 2010, granting partial
summary judgment to Plaintiff-Appellee Securities and Exchange Commission (“SEC”),
ordering disgorgement, granting injunctive relief against Defendants-Appellants Zvi and Amir
Rosenthal, and imposing penalties on Defendants-Appellants Zvi, Amir, and Ayal Rosenthal.
On appeal, Defendants-Appellants Oren, Efrat, and Rivka Rosenthal (collectively, “relief
defendants”) challenge the district court’s order of disgorgement against them and use of the
Internal Revenue Service’s (“IRS”) underpayment rate to calculate prejudgment interest.1 Zvi
and Amir Rosenthal challenge the district court’s imposition of penalties under section 21A of
the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78u-1.2 We assume the
1
Ayal Rosenthal joins in the arguments of the relief defendants with respect to the
disgorgement that was ordered against him due to the Aragon disbursement, in connection with
which he was not alleged to have committed any wrongdoing.
2
In an accompanying opinion, we address the argument of Amir and Ayal Rosenthal that
the district court erred in imposing penalties pursuant to section 21(d)(3) of the Exchange Act,
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parties’ familiarity with the facts and procedural history of the case.
“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,” and we accordingly review a
disgorgement order for abuse of discretion. SEC v. First Jersey Sec., Inc., 101 F.3d 1450,
1474-75 (2d Cir. 1996). Disgorgement may be ordered “against a person who is not accused of
wrongdoing in a securities enforcement action where that person: (1) has received ill-gotten
funds; and (2) does not have a legitimate claim to those funds.” SEC v. Cavanagh, 155 F.3d 129,
136 (2d Cir. 1998).
With respect to the first prong of the Cavanagh test, the relief defendants contend that
although their limited partnership, Aragon Partners LP (“Aragon”), admittedly received
$962,905.58 in illicit insider trading profits in 2004, these profits cannot be traced to the
distributions that they received in May 2006. They emphasize that Aragon held more than $1.5
million in legitimately obtained assets prior to the illicit trades in 2004, and that it continued to
make legitimate trades, both profitably and unprofitably, after that period of illicit trading.
However, it is undisputed that the ill-gotten gains of the insider trading were commingled in the
Aragon account. The SEC is not required to trace specific funds to their ultimate recipients in
such a situation. Cf. SEC v. Banner Fund Int’l, 211 F.3d 602, 617 (D.C. Cir. 2000) (reasoning
that “disgorgement is an equitable obligation to return a sum equal to the amount wrongfully
obtained, rather than a requirement to replevy a specific asset”). Imposing such a tracing
requirement would allow an insider trading defendant to escape disgorgement by spending down
illicit gains while protecting legitimately obtained assets or, as was the case here, by
15 U.S.C. § 78u(d)(3).
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commingling and transferring such profits. Because the balance in the account after the
distributions was less than the amount of illicit profits, the distributions must necessarily have
contained funds subject to disgorgement. Denying disgorgement in such a situation because of
the SEC’s inability to trace the funds would be inconsistent with disgorgement’s purpose “to
prevent unjust enrichment.” Id.
We therefore turn to the second Cavanagh prong. While the Second Circuit “ha[s] not
developed explicit guidelines for what qualifies as a ‘legitimate claim,’ we have held that the
receipt of property as a gift, without the payment of consideration, does not create a ‘legitimate
claim’ sufficient to immunize the property from disgorgement.” Commodity Futures Trading
Comm’n v. Walsh, 618 F.3d 218, 226 (2d Cir. 2010). The relief defendants contend that they
have a legitimate claim to the funds that were disbursed to them by virtue of their status as
limited partners in Aragon. However, we note first that, for the reasons previously discussed,
this status cannot give the limited partners a legitimate claim to ill-gotten profits that were
commingled in the partnership’s account. Moreover, the relief defendants lack a legitimate
claim to the distributions under the law of Delaware, the state in which Aragon was formed.
Because the post-distribution balance in Aragon’s account was less than the amount of the illicit
profits that are subject to disgorgement, the distributions violated Delaware law’s prohibition on
such a payout where, “after giving effect to the distribution, all liabilities of the limited
partnership . . . exceed the fair value of the [remaining] assets of the limited partnership.” Del.
Code Ann. tit. 6, § 17-607(a). Accordingly, the district court did not err in ordering
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disgorgement from them.3
The relief defendants next challenge the use of the IRS underpayment rate, instead of the
lower short-term interest rates published by the Federal Reserve, to calculate prejudgment
interest on the money that they were ordered to disgorge. We review an award of prejudgment
interest for abuse of discretion. First Jersey, 101 F.3d at 1476. We note first that the relief
defendants did not raise this objection until after the district court made its initial ruling, and
accordingly the district court correctly found that this argument had been waived. Nonetheless,
this argument also fails on the merits. We have previously approved as within the district court’s
discretion the use of the IRS underpayment rate to calculate prejudgment interest on
disgorgement, see id. at 1476-77, and we accordingly find no abuse of discretion in its use here.
We therefore turn to Zvi and Amir’s contention that the district court erred in imposing
civil penalties on them under section 21A of the Exchange Act. The district court’s imposition
of civil penalties is also reviewed for abuse of discretion. SEC v. DiBella, 587 F.3d 553, 572 (2d
Cir. 2009). Here, the district court properly considered factors including “(1) the egregiousness
of the defendant’s conduct; (2) the degree of the defendant’s scienter; (3) whether the
defendant’s conduct created substantial losses or the risk of substantial losses to other persons;
(4) whether the defendant’s conduct was isolated or recurrent; and (5) whether the penalty
should be reduced due to the defendant’s demonstrated current and future financial condition.”
SEC v. Aragon Capital Mgmt., LLC, 672 F. Supp. 2d 421, 447 (S.D.N.Y. 2009) (quoting SEC v.
Haligiannis, 470 F. Supp. 2d 373, 386 (S.D.N.Y. 2007)) (internal quotation mark omitted). We
3
We note that the district court relied on New York and New Jersey law in this respect
rather than Delaware law. The result, however, is the same.
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conclude that, notwithstanding Zvi and Amir’s claims of financial hardship, the district court did
not abuse its discretion in finding that the defendants’ repeated and knowing violations of the
securities laws warranted a civil penalty equal to two times the illegal profits generated from
their violations — a penalty that we note is less than the statutory maximum sought by the SEC.
See 15 U.S.C. § 78u-1(a)(2).
Zvi and Amir also contend that these penalties violate the Eighth Amendment’s
prohibition on excessive fines, a challenge that we review de novo. United States v. Bajakajian,
524 U.S. 321, 336-37 & n.10 (1998). Because they raise this challenge for the first time on
appeal, it has been waived. In re Nortel Networks Corp. Sec. Litig., 539 F.3d 129, 132 (2d Cir.
2008) (per curiam). In any event, because the factors for “proportionality” under the Eighth
Amendment are substantially similar to those that the district court considered when it properly
imposed the penalties, we find no constitutional violation. See United States v. Sabhnani, 599
F.3d 215, 262 (2d Cir. 2010) (citing von Hofe v. United States, 492 F.3d 175, 186 (2d Cir.
2007)).
We have considered the defendants-appellants’ remaining arguments and find them to be
without merit. Accordingly, for the foregoing reasons and the reasons stated in the
accompanying opinion, the judgment of the district court is AFFIRMED in part and
VACATED in part.
FOR THE COURT:
CATHERINE O’HAGAN WOLFE, CLERK
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