SEC v. Cole: Failure to Cooperate with Court Orders

In SEC v. Cole, No. 12-cv-8167 (RJS), 2014 BL 263123 (S.D.N.Y. Sept. 22, 2014), the United States District Court for the Southern District of New York granted the Securities and Exchange Commission’s (“SEC”) motion for relief against Defendants Lee Cole and Linden Boyne (“Defendants”).

The SEC alleged that Defendants, among other things, “lied to the investing public” and “secretly funnel[ed] millions of shares” to certain entities they controlled. Their actions were alleged to have violated several Sections of the Securities Act of 1933 and the Securities Exchange Act of 1934. 

The court entered default judgment against Defendants for failure to comply with five court orders. Notably, Defendants failed to: appear for a deposition, respond to sanctions, or make an appearance during the motion for default judgment. Hence, on November 8, 2013, the court entered default judgment against Defendants.

Unless vacated, a default judgment is deemed “final.” The factual allegations in the complaint are treated as true “except those relating to damages.” Following the determination, the SEC filed a motion seeking (1)  disgorgement, (2) civil penalties, (3) permanent injunctions, (4) a bar from serving as officers or directors of any public company, and (5) a bar from participating in any activities involving the offer of penny stocks.

First, the SEC requested Defendants to disgorge their “ill-gotten gains” and pay prejudgment interest on any monies they had illegally obtained. The court applied a two-part burden-shifting framework to determine the amount of disgorgement. First, the SEC had to show that its calculations were reasonably calculated to the amount of Defendants’ unjust gains. The burden of proof then shifted to the Defendants to show that the SEC’s estimates were “inaccurate, or that some of the gains were not the result of wrongdoing.” Defendants were unable to refute the SEC’s proposed disgorgement figures. Thus, the court found Defendants jointly and severally liable for a total of $14,670,750.99.

Second, the SEC argued that each Defendant should pay civil penalties. Courts may impose civil fines on Defendants for violations of 15 U.S.C. §§ 77t(d)(2) (the Securities Act) and 78u(d)(3)(B) (the Exchange Act). These statutes impose a tiered system of penalties. As the court noted:  “The egregiousness of their conduct and lack of cooperation with the Court warrant a severe third-tier civil penalty.” Thus, the court imposed $7,500,000 in civil penalties for each Defendant.

Third, the SEC sought to permanently enjoin Defendants from (1) violating the securities laws, (2) serving as officers or directors of any public company, and (3) participating in any activities involving the offer of penny stocks.

To enjoin Defendants from violating the securities laws, a court considers whether the defendant has violated the securities laws and there is a “reasonable likelihood that the wrong will be repeated.” Given the lack of care Defendants used, even after the SEC brought its allegations, the court found a permanent injunction was appropriate. 

Fourth, the SEC sought an officer and director bar. To prohibit Defendants from serving as officers or directors of any public company, the court must consider: “(1) the egregiousness of the underlying securities law violation; (2) the defendant’s repeat offender status; (3) the defendant’s role or position when he engaged in the fraud; (4) the defendant’s degree of scienter; (5) the defendant’s economic stake in the violation; and (6) the likelihood that misconduct will recur.” Here, the court determined Defendants' actions required a complete bar.

Fifth, the SEC sought a penny stock bar. The court’s analysis to merit a penny stock bar “essentially mirrors that for imposing an officer-or-director bar.” Therefore, the court also enjoined Defendants from participating in any activities involving penny stocks.

Accordingly, the United States District Court for the Southern District of New York granted the SEC’s motion for penalties and remedies in its entirety.

The primary materials for this case may be found on the DU Corporate Governance website.