SEC v. StratoComm Corp.: Assessing Appropriate Relief for Securities Fraud and Registration Violations
In SEC v. StratoComm Corp., 1:11-CV-1188, 2015 BL 62316 (N.D.N.Y. Mar. 09, 2015), the United States District Court for the Northern District of New York held injunctive relief, bars from participation as an officer and director or in a penny stock offering, disgorgement, and civil penalties sought by the Security and Exchange Commission’s (SEC) were warranted. The court had previously found StratoComm Corp., Roger Shearer, and Craig Danzig (“Defendants”) liable for securities fraud and registration violations in connection with the offer and sale of StratoComm stock.
In a prior ruling, the court found that various of the Defendants violated antifraud provisions of the federal securities law, including Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and Sections 10(b) and of the Securities Exchange Act of 1934. The court also held Danzig violated section 15(a) of the Exchange Act, for acting as an unregistered broker, and Shearer under Section 20(a) as a controlling person. The SEC then moved for judgment imposing relief.
The Defendants opposed the SEC’s motion for relief, arguing any violation of the securities law was unintentional and that the costs of the litigation made any large financial payment "an impossibility."
Under the securities laws, the issuance of a permanent injunction required a finding of the risk of future violations. See Section 21(d), 15 USC 78u(d) (Commission may seek injunction "whenever it shall appear to the Commission that any person is engaged or about to be engaged in acts or practices constituting a violation of any provision").
In determining the applicability of an injunction and other relief, courts consider six factors: (1) whether defendant has been found liable for illegal conduct; (2) the degree of scienter involved; (3) whether the infraction is an isolated occurrence; (4) whether the defendant continues to maintain his past conduct is blameless; (5) whether the defendant is in a position that future violations could be anticipated; and (6) the totality of the circumstances.
The court agreed to issue the injunction. The court pointed to Shearer and Danzig's status as “recidivist violators” under the securities laws, the degree of scienter, the non-isolated nature of the offenses, id. (“Contrary to Defendant’s arguments, the instant infractions were not isolated occurrences but rather appeared to be a part of a longstanding and somewhat elaborate scheme to defraud investors”), and what the court described as “protestations of innocence”. See Id. (“Defendants' protestation of innocence is a factor that weighs in favor of the sought-after injunctive relief.”).
The court also found that both disgorgement and prejudgment interest were appropriate. Disgorgement is calculated by a “reasonable approximation of profits causally connected to the violation,” and “any risk of uncertainty should fall on the wrongdoer whose conduct created the uncertainty.” The court determined that Defendants made approximately $4,086,245.00 from the alleged transactions, an amount increased by $882,464.68 for prejudgment interest.
Defendants asserted that the amounts were “excessive” because “(1) a subset of investors submitted affidavits attesting that they were not ‘duped’ by StratoComm and Shearer (and therefore approximately $1.16 million, representing their investments, should not be included in the disgorgement calculation); (2) Shearer did not ‘loot’ the company ‘for his own financial gain’; and (3) StratoComm and Shearer are experiencing extreme financial hardships.” The court rejected the argument, noting in part that “the purpose of disgorgement is not to compensate for losses but to deprive the wrongdoer of ill-gotten gain.” StratoComm and Shearer were therefore found joint and severally liable for the amount. Danzig was not required to disgorge any funds. Id. (“Because StratoComm and Shearer are required to pay disgorgement in the full amount of the investors’ contribution, with interest, disgorgement by Danzig of a portion of that money would result in a double payment for the same conduct.”)..
The court also held that Shearer and Danzig should be barred from the offering of penny stock and that Shearer should be barred from acting as an officer or director of any public company. Finally, the court held each Defendant liable for “third-tier” civil penalties, imposing penalties of $100,000 against StratoComm, $50,000 against Shearer, and $25,000 against Danzig.
The United States District Court for the Northern District of New York granted in part and denied in part Plaintiff’s motion for relief, ordering injunctive relief, disgorgement, a participation bar, and civil penalties against Defendants.
The primary materials for this post can be found on the DU Corporate Governance website.