UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF FLORIDA Case No. 03-80612-CIV-MARRA/SELTZER ________________________________________________ ) SECURITIES AND EXCHANGE COMMISSION, ) ) Plaintiff, ) v. ) ) MICHAEL LAUER, ) LANCER MANAGEMENT GROUP, LLC, and ) LANCER MANAGEMENT GROUP II, LLC, ) ) Defendants, ) and ) ) LANCER OFFSHORE, INC., ) LANCER PARTNERS, LP, ) OMNIFUND, LTD., ) LSPV, INC., and ) LSPV, LLC, ) Relief Defendants. ) _________________________________________________ ) PLAINTIFF SECURITIES AND EXCHANGE COMMISSION’S NOTICE OF NEWLY ISSUED CASE LAW IN FURTHER SUPPORT OF ITS RESPONSE TO MOTION OF MIZUHO CORPORATE BANK (USA) FOR LEAVE TO INTERVENE AND FOR RELIEF FROM THE ASSET FREEZE ORDER Plaintiff Securities and Exchange Commission files its Notice of Newly Issued Case Law in Further Support of its Response to Motion of Mizuho Corporate Bank (USA) For Leave to Intervene and for Relief from the Asset Freeze Order (“Motion to Intervene”). On March 8, 2006, the SEC filed its seven page Response to the Motion to Intervene, where the SEC, among other things, countered the assertion that the asset freeze should not apply to Lauer’s Greenwich property by citing to the controlling case law in this circuit about the proper standard court should follow in determining the scope of the asset freeze against Lauer. SEC v. ETS Payphones , 408 F.3d 727, 735-36 (11 th Cir. 2005) (proper comparison is to look at the potential 1 of 12 Mar 28 2006 1326/BB
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UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF FLORIDA
Case No. 03-80612-CIV-MARRA/SELTZER
________________________________________________ ) SECURITIES AND EXCHANGE COMMISSION, ) ) Plaintiff, ) v. ) ) MICHAEL LAUER, ) LANCER MANAGEMENT GROUP, LLC, and ) LANCER MANAGEMENT GROUP II, LLC, ) ) Defendants, ) and ) ) LANCER OFFSHORE, INC., ) LANCER PARTNERS, LP, ) OMNIFUND, LTD., ) LSPV, INC., and ) LSPV, LLC, ) Relief Defendants. ) _________________________________________________ )
PLAINTIFF SECURITIES AND EXCHANGE COMMISSION’S NOTICE OF NEWLY ISSUED CASE LAW IN FURTHER SUPPORT OF ITS RESPONSE TO MOTION OF
MIZUHO CORPORATE BANK (USA) FOR LEAVE TO INTERVENE AND FOR RELIEF FROM THE ASSET FREEZE ORDER
Plaintiff Securities and Exchange Commission files its Notice of Newly Issued Case Law
in Further Support of its Response to Motion of Mizuho Corporate Bank (USA) For Leave to
Intervene and for Relief from the Asset Freeze Order (“Motion to Intervene”). On March 8,
2006, the SEC filed its seven page Response to the Motion to Intervene, where the SEC, among
other things, countered the assertion that the asset freeze should not apply to Lauer’s Greenwich
property by citing to the controlling case law in this circuit about the proper standard court
should follow in determining the scope of the asset freeze against Lauer. SEC v. ETS
Payphones, 408 F.3d 727, 735-36 (11th Cir. 2005) (proper comparison is to look at the potential
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Mar 28 2006
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equitable liability of the defendant to the value of the defendant’s assets). [DE 1288].1
Subsequently, on March 10, 2006, the Ninth Circuit filed its decision in SEC v. JT Wallenbrock
& Associates, et al., 2006 WL 572016 (9th Cir. (Cal. 2006)), which gives clear guidance on how
the Court should determine Lauer’s “potential equitable liability” in this matter.2
The Ninth Circuit’s recent decision in Wallenbrock provides further persuasive support
for the SEC’s position that a reasonable approximation of Defendant Michael Lauer’s “potential
equitable liability” is the total amount raised from investors.3 In Wallenbrock, the Ninth Circuit
expressly found that the District Court properly held the defendants jointly and severally liable
for the disgorgement in the amount of $252.2 million, which represented the total amount raised
from investors. [Id., at *5]. The circuit court reasoned that the entire $252.2 million was an “ill-
gotten gain” that “unjustly enriched” a “wrongdoer” because the defendants had “the requisite
close relationship and jointly benefited from the illegal scheme to be found jointly and severally
liable.” [Id., at *5-6]. Notably, the Ninth Circuit did not allow the defendants to offset business
expenses associated with the fraud or “subsequent investment of the illegally obtained investor
funds.” [Id., at *3-6].
1 On March 15, 2006, Lauer filed his Opposition to the Motion to Intervene (DE 1301) where he took issue with the propriety of the Court’s Asset Freeze Order. Shortly thereafter, Lauer filed another Motion to Modify the Asset Freeze (DE 1306) where he makes many of the same arguments and cites to several of the same cases as he did in his Opposition to Motion to Intervene. Consequently, for the Court’s convenience, the SEC will address all of Lauer’s arguments in its Response to Lauer’s Motion to Modify the Asset Freeze (currently due by April 5, 2006). The SEC also respectfully requests that the Court defer ruling on the motions relating to modifying the Asset Freeze until it has had an opportunity to consider the SEC’s Response to Lauer’s Motion to Modify the Asset Freeze, so it can consider all relevant briefing before ruling on this important issue. 2 SEC v. Wallenbrock is attached hereto as Exhibit A. 3 E.g. SEC v. Hughes Capital Corp., 124 F.3d 449, 455 (3d Cir. 1997) (holding a defendant jointly and severally liable for disgorgement); SEC v. First Pacific Bancorp, 142 F.3d 1186, 1191-92 (9th Cir. 1998) (holding defendant who was chairman, CEO and majority shareholder jointly and severally liable with corporate defendant); SEC v. Berger, 244 F.Supp. 2d 180 (S.D.N.Y. 2001) (holding defendant jointly and severally liable with corporation because he conceived of the fraud and controlled the corporate defendant).
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The Ninth Circuit’s analysis of when the Court should hold the parties jointly and
severally liable (when they have a close relationship and jointly benefited) fits hand to glove to
the facts of this case. Lauer controlled Corporate Defendants Lancer Management Group, LLC
and Lancer Management Group, II, LLC (collectively “Lancer Management Groups”) and Relief
LLC (collectively “Relief Defendants”) and they all benefited from the scheme (Lauer was by far
the single biggest benefactor). A few examples of Lauer’s extremely close relationship with
Defendants Lancer Management Groups and Relief Defendants and how Lauer benefited from
the scheme, include:
• Lauer is the sole manager and principal owner of Defendants Lancer
Management Groups [See SEC’s Complaint, DE 1, at ¶¶ 4-5].
• Lauer is the founder, sole manager and principal owner of Defendants Lancer
Management Groups and the founder and investment manager of the Relief
Defendants [See Id., at ¶ 3].
• The Private Placement Memorandums of Relief Defendant Lancer Partners state
that Lauer is solely responsible for the operations and activities of that Fund
[See Id., at ¶ 46].
• Lauer had the ultimate decision-making authority and participates in the
day-to-day management of Defendants Lancer Management Groups and Lauer
directly benefited from the manipulative and fraudulent conduct. [See Id., at
¶¶ 47-48].
• The Court preliminary enjoined Lauer under Section 20(a) of the Securities
Exchange Act of 1934 as a control person of Defendants Lancer Management
Groups and as control person the SEC alleged that “Lauer is jointly and
severally liable with and to the same extent as” Defendants Lancer
Management Groups for their violations of the Exchange Act [See Id., at ¶¶ 60-62
and DE 22 at pp. 4-5].
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In fact, with the exception of Lauer, all of the Defendants and Relief Defendants in this matter
are corporate entities. Lauer founded these entities, which can only act through him as their
living breathing control person. Accordingly, Lauer has the prerequisite “close relationship” and
benefited from the scheme by receiving tens of millions of dollars (as further discussed below,
Lauer admits that he received over $36 million of these funds) for the Court to hold him jointly
and severally liable with the Corporate Defendants and Relief Defendants for the total amount
raised from investors.
The SEC has already presented evidence of a reasonable approximation of the amount
raised from investors during the fraudulent time period. The Receiver, Marty Steinberg, testified
during the October 28, 2003 evidentiary hearing (held before Chief Judge Zloch for the purpose
of determining Lauer’s Initial Motion to Modify the Asset Freeze) that Lauer raised over $600
million dollars from 2000 to the filing of this action.4 [See DE 85 at pp. 109-112 and DE 93 at
p. 6 and Exhibit 12].
Accordingly, the Ninth Circuit’s timely decision in SEC v. Wallenbrock provides further
support for the SEC’s position that a reasonable approximation of Lauer’s ill-gotten gains that
the Court should use in determining his potential equitable liability arising from this matter is
$600 million, which is the total amount raised from investors during the fraudulent time period.
Respectfully submitted,
Dated: March 28, 2006 By: s/ Christopher E. Martin Christopher E. Martin Senior Trial Counsel SD Fla. Bar. No. A5500747 Direct Dial No.: (305) 982-6386 Attorney for Plaintiff
4 The receiver also testified that from 2000 through 2002 Defendants Lancer Management Groups received from the Relief Defendants approximately $72 million in fees. [Id.]. Of this $72 million, Lauer admitted that he personally received over $36 million. [See DE 85 at p. 171 and Lauer’s Affidavit, DE 44, Exhibit 6].
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SECURITIES AND EXCHANGE COMMISSION 801 Brickell Avenue, Suite 1800 Miami, Florida 33131 Facsimile: (305) 536-4154
CERTIFICATE OF SERVICE
I HEREBY CERTIFY that a true and correct copy of the foregoing was served by
FedEx this 28th day of March 2006, on the following:
Marty Steinberg, Receiver Craig V. Rasile, Esq. Hunton & Williams LLP 1111 Brickell Avenue, Suite 2500 Miami, Florida 33131-1802 Carl Schoeppl, Esq. Schoeppl & Burke, P.A. 4651 North Federal Highway Boca Raton, FL 33431 Mary Apostolakos Hervey, Esq. U.S. Department of Justice 555 4th St., NW, Room 6217 Washington, D.C. 20001 Thomas Messana, Esq, Katie Lane, Esq. Ruden McClosky Smith Schuster & Russell PA 200 East Broward Blvd., Suite 1500 Fort Lauderdale, FL 33301 Local Counsel for Mizuho Corporate Bank (USA) s/ Christopher E. Martin Christopher E. Martin
SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee,
v. JT WALLENBROCK & ASSOCIATES; Citadel
Capital Management Group, Inc ., Defendants,
and Larry Toshio Osaki; Van Y. Ichinotsubo,
Defendants-Appellants. NO. 04-55100.
Argued and Submitted Oct. 17,2005. Filed March 10,2006.
Huey P. Cotton and Christine E. Field, Cozen O'Connor, Los Angeles, CA, for the defendants- appellants.
Mark Pennington, Assistant General Counsel, Securities and Exchange Commission, Washington, D.C., for the plaintiff-appellee.
Appeal from the United States District Court for the Central District of California; Edward Rafeedie, District Judge, Presiding. D.C. No. CV-02- 00808- ER.
Before ANDREW J. KLEINFELD, A. WALLACE TASHIMA and RAYMOND C. FISHER, Circuit Judges.
OPINION
FISHER, Circuit Judge.
*1 At issue is an order entered against parties to a securities pyramid or Ponzi scheme, requiring the principal and his two companies, jointly and severally, to disgorge millions of dollars that the district court found to be ill-gotten gains from their having defrauded numerous investors. The defendants are J.T. Wallenbrock & Associates ("Wallenbrock") and Citadel Capital Management Group, Inc. ("Citadel"), business entities that were organized and controlled by appellant-defendant
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Larry Osaki, the managing general partner of Wallenbrock and a 99.5 percent owner of Citadel (collectively "the defendants"). rFNl] Another appellant-defendant is Van Ichinotsubo, an employee of both companies who solicited investors on their behalf and invested $1.2 million in Wallenbrock.
We affirm the district court's disgorgement order.
FlVI. Although Citadel was a named defendant in the SEC's complaint, the SEC requests that we dismiss Citadel's appeal because the notice of appeal does not name Citadel in either the caption or the body of the notice as required by Fed. R.App. P. 3(c)(l)(A). In their reply brief, the defendants concede that the appellants include only Wallenbrock, Osaki and Ichinotsubo. Our disposition of the case ultimately renders this issue moot. Because Citadel was a named defendant in the complaint, we include Citadel as a "defendant" in this opinion.
FN2. We also include Ichinotsubo in our reference to "the defendants."
I. Factual and Procedural Background TFN31
FN3. The undisputed facts are based on the allegations in the SEC's complaint and the district court's disgorgement order. In accordance with a February 28, 2003 order of permanent injunction, the defendants are precluded from denying or arguing that they did not violate federal securities law in the manner set out in the SEC's complaint.
From at least 1997 to October 2003, the defendants raised nearly $253.2 million fiom thousands of investors through the fraudulent sale of unregistered promissory notes. TFN41 The defendants misrepresented to investors that they were using the proceeds of the notes, matched by Wallenbrock, to purchase accounts receivable of Malaysian latex glove manufacturing companies and that the investments would yield returns of 15-20 percent every 90 days. The defendants told investors that there was little or no risk in the Wallenbrock investments and emphasized the safety of profits. In fact, the defendants did not purchase such receivables
but instead used the investors' funds to engage in a high-stakes Ponzi scheme and invest in speculative business ventures. TFN.51
FN4. According to the "Accounting of Investor Funds" prepared by a forensic certified public accountant ("CPA") on behalf of the court-appointed receiver, this amount included $229.2 million received from individuals and companies and $24.0 million from investors' IRA and other retirement accounts. The Accounting of Investor Funds summarizes the findings of the CPA's comprehensive accounting of Wallenbrock and Citadel based on records provided by the defendants.
FN5. As the SEC's complaint explains, the defendants have "no evidence confirming that [investor] funds were being invested as represented or confirrning the source of funds returned as profit or repayment of principal to investors." For example, the defendants have "no documentation showing any ownership interest in accounts receivable" and "no documentation confirming the use of investor funds, such as schedules reflecting the purchase of receivables, dates payments were expected or received on receivables and information on defaults."
Wallenbrock first deposited the investors' $253.2 million in Osaki's Wallenbrock checking account. The defendants then used $1 13 .8 million of these funds to pay investors their "returns," maintaining the illusion that the defendants were actually making the investments as represented. Of the remaining $139.4 million, the defendants spent $1 1.1 million to cover operating expenses for both Citadel and Wallenbrock, including expenses such as office space and payroll for over 60 employees of both companies, and $25.5 million to pay for various Wallenbrock operating expenses and Osaki's personal expenses. TFN61 Wallenbrock also spent $99.8 million to fund over 175 start-up companies on Citadel's behalf, of which Citadel was obligated to repay Wallenbrock $71.2 million plus 10 percent annual interest. TFN71 The remaining $3.0 million was still in Osaki's Wallenbrock checking account as of December 2001.
FNG. Because of the large volume of transactions, the commingled use of funds and the inadequacies in Wallenbrock's accounting, the forensic CPA was unable to
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ascertain what amount of the $25.5 million in payments were for personal or for business expenses. For example, included in these payments were items that could be personal expenses of Osaki such as over $1.5 million in payments to at least 10 credit card companies and approximately $1 .5 million in cash withdrawals.
EN7. The defendants assert that Wallenbrock loaned $13 1.0 million to Citadel for its investment business, rather than $99.8 million. They support this assertion by relying on an unverified one- page accounting they provided to the district court in February 2002 and numerous one- paragraph promissory notes dated between October 1, 1996 and December 3 1, 2001 that obligate Citadel to pay Wallenbrock several million dollars "for value received." However, it is unclear how the defendants arrive at their $13 1.0 million figure, and the record shows that Citadel was obligated to repay Wallenbrock only $71.2 million "for value received." In addition, the CPA's detailed accounting shows that Wallenbrock spent only $1 10.8 million related to Citadel, $99.8 million of which went directly to start- up companies on Citadel's behalf. In any event, the defendants' argument that the district court should have deducted the loan to Citadel--whatever its amount--from the disgorgeable gain lacks merit. See Section III.A.2, infra.
In January 2002, the SEC brought a civil enforcement action against the defendants alleging violations of the anti-fraud, broker-dealer registration and securities registration provisions of the federal securities laws. TFN81 The district court granted the SEC's request for an asset freeze and temporary restraining order enjoining future violations, and appointed a receiver on February 21, 2002. In May 2002, the defendants consented to a preliminary injunction. After we affirmed the district court's denial of the defendants' motion to dismiss in SEC v. Wallenbrock. 313 F.3d 532 (9th Cir.20022, the defendants, in February 2003, settled with the SEC by consenting to entry of a permanent injunction against future violations. The injunction order authorized the district court to determine the amounts of disgorgement, plus prejudgment interest and civil penalties to be imposed on the defendants "as a result of the conduct alleged in the Commission's complaint." The injunction order also precluded the
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defendants from "denying or arguing that they did not violate the federal securities laws in the manner set out in the Commission's complaint," but did not preclude defendants from "presenting evidence as to whether and what amount of disgorgement, prejudgment interest and civil penalties are appropriate."
*2 In December 2003, the district court granted the SEC's motion for disgorgement. The court found that Osaki and Ichinotsubo operated a Ponzi scheme through Wallenbrock and Citadel, repaying to investors $113.8 million of the $253.2 million raised and spending $136.4 million of the investor funds "for their own benefit." TFN91 In its order, the court imposed (1) disgorgement against Wallenbrock, Osaki and Citadel, jointly and severally, of $139.4 million (the entire proceeds from the scheme less amounts paid to investors) plus prejudgment interest of $24.3 million, minus any disgorgement payments made by Ichlnotsubo; (2) disgorgement against Ichinotsubo of $409,798 (the amount he received from the proceeds of the scheme) plus prejudgment interest of $85,435; and (3) a civil penalty of $100,000 each against Osaki and Ichinotsubo pursuant to 15 U.S.C. 6 78t(d)(2)(c) and 15 U.S.C. $ 78u(d)(3)(B)(iii). [FN 101 The defendants have appealed only the district court's calculation of disgorgement assessed against each of them.
FN9. The amount "spent" by the defendants included the $36.6 million in Wallenbrock and Citadel operating expenses and the $99.8 million paid to start-up companies. The remaining $3.0 million in Osaki's Wallenbrock checking account had been frozen and transferred to a receivership shortly after the SEC filed its complaint.
FN 10. On March 22,2005, Osaki pled guilty to conspiracy to commit securities fraud, two counts of securities fraud, obstruction of justice and one count of money laundering in relation to the pyramid scheme. See U.S. Department of Justice Press Release, March 22, 2005, available at http:// www.usdoj.govlusaolcaclpr2005/05 1 .html. Osalu acknowledged that he relocated operations to Canada, Belize and elsewhere after consenting to the permanent injunction. Id. On December 16, 2005, Osaki was
sentenced to 20 years in federal prison and ordered to pay more than $145 million in restitution to his victims. Ici.
11. Jurisdiction and Standard of Review
The district court had jurisdiction pursuant to 28 U.S.C. F 6 133 1 and 1345, and we have jurisdiction pursuant to 28 U.S.C. 8 1291. We review the district court's order of disgorgement for abuse of discretion. SEC v. First Pac. Bancorp, 142. F.3d 1 186, 1190 (9th Cir. 1998).
111. Discussion
The defendants argue that the district court abused its discretion in refusing to deduct $36.6 million in Wallenbrock and Citadel business and operating expenses from the disgorgement amount. They also contend that Wallenbrock loaned $13 1.0 million to Citadel for "business operations-capital investment," which the district court improperly included as disgorgeable gain. Finally, the defendants claim that Wallenbrock received $23.0 million from business operations unrelated to income from defrauded investors, that the district court should not have ordered disgorged. Each of these arguments lacks merit.
A. Determining "ill-gotten gains" and "unjust enrichment"
As we made clear in First Pacific Bancorp, the district court has broad equity powers to order the disgorgement of "ill-gotten gains" obtained through the violation of federal securities laws. 142 F.3d at 1 19 1 ; see also SEC v. Colello. 139 F.3d 674. 679 (9th Cir. 1998) ("To order disgorgement, the district court .... need find only that [the defendant] has no right to retain the funds illegally taken from the victims."). "Disgorgement is designed to deprive a wrongdoer of unjust enrichment, and to deter others from violating securities laws by making violations unprofitable." First Pac. Bancorp, 142 F.3d at 1191 (citing Hatelev v. SEC. 8 F.3d 653. 655 (9th Cir.1993)). The district court also has broad discretion in calculating the amount to be disgorged. See, e.g., SEC v. First Jersey Sec.. Inc., 101 F.3d 1450. 1474- 75 (2d Cir.1996). A disgorgement calculation requires only a "reasonable approximation of profits causally connected to the violation," First Pac. Bancorp, 142 F.3d at 1192 n. 6 (internal citation omitted), and the amount of disgorgement should include "all gains flowing from the illegal activities." SEC v. Cross Fin. Selvs., 908 F.Supp. 718.734 (C.D.Cal.1995).
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*3 The essence of the defendants' scheme was to obtain investors' money under false pretenses in order to fund the defendants' speculative business ventures. Rather than put their own money at risk, the defendants benefitted from the use of investors' money to spend at the defendants' discretion-- whether to cover operating expenses, invest in start- up companies, pay personal expenses or to pay fake returns to investors to perpetuate the fraud. Cf: E C v. Great Lakes Eguities Co.. 775 F.Supv. 21 1, 2 15 [E,D.Mich.l9911 (reasoning that where a defendant's use of fraudulently obtained funds is "to defray obligations of the wrongdoer, the wrongdoer is benefitted by those expenditures"). Given these circumstances, all $253.2 million obtained from investors was an ill-gotten gain that unjustly enriched the defendants.
1. Business and Operating Expenses
It follows that it would be unjust to permit the defendants to offset against the investor dollars they received the expenses of running the very business they created to defraud those investors into giving the defendants the money in the fust place. Cf: SEC v. TLC Invs. & Trade Co.. 179 F.Supp.2d 1149, 1157 (C.D.Ca1.2001) (concluding that "expenses in carrying out a fraudulent scheme ... are hardly appropriate or legitimate deductions") (internal citation and quotation omitted).
This is not the case of a partially legitimate company misdirecting or misappropriating revenues. For example, if an investor buys stock through a licensed broker who then skims off some or all of the profits generated by the stock, either through dividends or upon resale, the broker is enriched by the amount skimmed. Under some circumstances, the broker might be entitled to offset expenses customarily incurred in the purchase and sale of such stock if the investor would have had to pay for such expenses in any legitimate transaction. For example, in SEC v. Thomas James Assocs., Inc., 738 F.Suvp. 88, 89-90 (W.D.N.Y. 19901 the district court ordered the defendants (including a brokerage f m ) to disgorge the illegal profits reaped by their manipulation of the market to "charge excessive markups in the initial aftermarket" of four initial public offerings. [FN 1 11 In assessing disgorgement, the court deducted certain business expenses, such as commissions, telephone charges and underwriting expenses. Id. at 92, 94-95. The court explained that "markups are a function of the way a securities firm does business, and thus have corresponding costs and expenses related to them."
Id. at 95. Given that the customers would have had to factor these expenses into their returns regardless of the defendants' scheme, the court concluded that a reduction was appropriate "to reflect a fair setoff for necessary business expenses." Id. at 92 (emphasis added); see also Litton Indus.. Inc. v. Lehman Bros., 734 F. SUPP 1071. 1077 (S.D.N.Y.1990) (allowing deductions for various transaction costs, including brokerage commissions paid to third party brokers as part of an agreement for services customarily rendered in connection with the transactions at issue).
FN11. The defendants' scheme in Thomas James was implemented by dominating and controlling the supply and demand of the stocks, causing their price to rise upon the opening of the aftermarket. 738 F.Supv. at 89-91. At these "artificially inflated prices," the defendants filled the waiting purchase orders of its customers from their own private reserve of securities units. Id. at 91. In the fust three days of trading the IPOs, the scheme generated several million dollars in excessive markups. Id.
"4 Applying Thomas James ' analysis does not help the defendants here. Their entire business enterprise and related expenses were not legitimate at all, and no aspect of the defendants' conduct can be fairly characterized as a "function of the way a securities fm does business." 738 F.Supp. at 95; see also Cross Fin. Servs., 908 F.Suvp. at 732 (explaining that a defendant's "receipt of investor monies for an alleged purpose that was never disclosed to the investors" demonstrates in part "the absence of any legitimate call on the funds"). Unlike the brokerage firm in Thomas Jqmes, Wallenbrock and Citadel existed simply to obtain investors' money under false pretenses, money the defendants spent at their sole discretion, unrelated to the investors' expectations of the purposes, risks and rewards of entrusting the defendants with their investment dollars. rFNl2l In short, the defendants here seek an offset for entirely illegitimate expenses incurred to perpetuate an entirely fraudulent operation.
FN12. Thomas James itself recognized that "securities law violations may exist in which disgorgement is properly ordered in the amount of the total gross profits." 738 F.Supp. at 95 (citing SEC v. R.J. Allen and Associates, Inc.. 386 F.Suuu. 866 /S.D.Fla.1974), in which the court ordered disgorgement of all proceeds received in a fraudulent scheme aimed at deceiving and
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defrauding investors). For example, the court noted that when a securities law violator earns profits "in furtherance of arguably more egregious forms of securities fraud," such as insider trading, the wrongdoer may not insulate those profits from disgorgement. Id.
Neither the deterrent purpose of disgorgement nor the goal of depriving a wrongdoer of unjust enrichment would be served were we to allow these defendants--who defrauded investors of $253.2 million--to "escape disgorgement by asserting that expenses associated with this fraud were legitimate." SEC. v. Kenton Capital. Ltd., 69 F.Supv.2d 1. 16 (D.D.C.1998); see also SEC v. Hughes Couital Coru., 917 F.Supp. 1080. 1087 (D.N.J.1996) (stating that the "overwhelming weight of authority holds that securities law violators may not offset their disgorgement liability with business expenses"). The district court did not abuse its discretion in refusing to deduct $36.6 million in Wallenbrock and Citadel business and operating expenses from the disgorgement amount. See also SEC v. Blavin. 760 F.2d 706. 713 (6th Cir.1985) (holding that the court possesses the equitable power to grant disgorgement of "a sum of money equal to all the illegal payments [ ] received").
2. Loan to Citadel
The defendants contend that Wallenbrock loaned $13 1.0 million to Citadel as a capital investment. However, the forensic CPA's comprehensive accounting of the defendants' scheme reveals that Wallenbrock loaned only $99.8 million to Citadel, an amount Wallenbrock paid directly to start-up businesses on Citadel's behalf. The district court properly ordered this amount disgorgeable, because it was a subsequent investment of the illegally obtained investor funds. TFN131 See, e.g., Thomas James. 738 F.Supp, at 95 ("[A] securities law violator [may not] avoid or diminish his responsibility to return his ill- gotten gains by establishing that he is no longer in possession of such funds due to subsequent, unsuccessful investments or other forms of discretionary spending.").
FN13. The defendants' records indicate that Citadel was obligated to repay Wallenbrock only $71.2 million of the $99.8 million loaned. For disgorgement purposes, however, we construe the entire $99.8 million as a subsequent investment of the illegally obtained funds, regardless of its
loan status.
To challenge this finding, the defendants rely on Hatelev v. SEC, 8 F.3d 653 (9th Cir. 19931, to suggest that the $99.8 million paid to start-up companies should not be disgorged because the defendants dissipated and did not retain these funds. Hateley provides no support for this argument. The three petitioners in Hateley were a broker-dealer securities firm that was a registered member of the National Association of Securities Dealers, Inc. ("NASD") and two of its officers. Id. at 654. They had entered into a "finder's fee agreement" with a third party (who--in violation of NASD rules--' was not a registered representative of the fm) giving him 90 percent of the commissions generated by all securities transactions he solicited on behalf of the firm. Id. These commissions totaled roughly $55,000, of which the petitioners retained only $5,062.50, according to the agreement's terms. Id. The NASD, affirmed by the SEC, held the three petitioners jointly and severally responsible for disgorging the entire $55,000 in commissions, although also holding the third party liable for disgorging his $50,000 share. Id. at 655- 56.
*5 We upheld the joint and several aspect of the disgorgement award because the petitioners "acted collectively" to enter into the "improper arrangement" with the unregistered third party. Id. at 656. But we held that the petitioners' "unjust enrichment" was limited to the $5,062.50 in fees they actually retained under the terms of the preexisting illicit agreement. Moreover, to hold them also liable for the third party's $50,000 share would have been duplicative of his disgorgement liability and over 10 times their own illicit fee. Id.
Here, there was no preexisting agreement limiting the defendants to only a share of the ill-gotten gain or requiring them to pay a portion of the proceeds to third parties. The defendants funneled all of the proceeds from the scheme to the Wallenbrock checking account, which Osaki then distributed to himself, to Wallenbrock, to Citadel or to start-up investment companies. The manner in which Osaki chose to spend the illegally obtained funds has no relevance to the disgorgement calculation because, as we have explained, the defendants had the full benefit of the entire $253.2 million fraudulently raised from investors. Cf: SEC v. Benson, 657 F.Supp. 1122. 1134 (S.D.N.Y.1987) (stating that the "manner in which [the defendant] chose to spend his misappropriations is irrelevant" to the disgorgement calculation). As with the defendants' other uses of their ill-gotten
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gains, using the investors' $99.8 million to invest in start-up companies (rather than purchase accounts receivable) was part of the defendants' unjust enrichment. The district court did not abuse its discretion when it included this amount as part of the disgorgeable gain.
3. Unrelated Income
Finally, we see no merit to the defendants' assertion that $23 million of the funds raised came from its business operations unrelated to income from investors. The forensic CPA's accounting (which is based on the defendants' own records) shows that investor funds comprised the entire $253.2 million, including $229.2 million received from individuals and companies and $24.0 million from investors' IRA and other retirement accounts. The defendants have not offered evidence to challenge the CPA's accounting. Thus, the district court did not abuse its discretion when it included this amount as ill-gotten gain.
B. Joint and Several Liability
The district court properly held Wallenbrock, Osaki and Citadel jointly and severally liable for the disgorgement of their fraudulently obtained investor funds. "[Wlhere two or more individuals or entities collaborate or have a close relationship in engaging in the violations of the securities laws, they [may be] held jointly and severally liable for the disgorgement of illegally obtained proceeds." See First Pac. Bancorp, 142 F.3d at 1191; see also Hatelev, 8 F.3d at 656. Based on the undisputed allegations in the complaint and the forensic CPA's accounting, the district court found that Osaki, Wallenbrock and Citadel raised the almost $253.2 million fiom investors by fraudulently offering high return investments in accounts receivable financing. LFN141 Rather than invest the money as they represented, the defendants used all of the investors' funds to operate their pyramid scheme and invest in speculative business ventures, all to the defendants' benefit. Given these undisputed allegations, the district court did not abuse its discretion in concluding that Wallenbrock, Osaki and Citadel evinced the requisite close relationship and jointly benefitted fiom the illegal scheme to be found jointly and severally liable. TFNI51
FN14. Citadel also acted as an unregistered securities broker-dealer in connection with the scheme.
FN15. The defendants' argument that joint and several liability cannot be imposed on Citadel, a nominal defendant, is without merit. Even if Citadel is a nominal defendant, the district court has the authority to require disgorgement of ill-gotten gains from such defendants. See SEC v. Colello, 139 F.3d 674, 676-77 (9th Cir.1998) (holding that the SEC may sue a nominal defendant "to effect full relief in the marshaling of assets that are the h i t of the underlying fraud").
C. Disgorgement against Ichinotsubo
*6 The district court did not abuse its discretion in ordering disgorgement of $409,798 against Ichinotsubo despite his loss on the $1.2 million he invested in the pyramid scheme. As we noted in First Pacific Bancorp, "the fact that [a defendant's] scheme ultimately failed and he lost $1,000,000 of his own funds [does not] release him from his[disgorgement] obligations." 142 F.3d at 1192 n. 6. The district court found that Ichinotsubo made false representations to investors and that he was unjustly enriched by $409,798 as a result of his conduct. TFN161
FN16. This amount includes $232,704 in payroll payments, $36,503 in unpaid loans from Citadel, a $50,000 unpaid loan to Ichinotsubo's company, a $60,591 credit card payment made by Osaki with investor funds on Ichinotsubo's behalf, and a $30,000 direct payment of investor funds from Osaki to Ichinotsubo.
IV. Conclusion
The entire $253.2 million the defendants received was an "ill-gotten gain" that "unjustly enriched" a "wrongdoer." First Pac. Bancorp, 142 F.3d at 1191- 93. Because the district court did not abuse its discretion in assessing the amount of disgorgement against the defendants or in imposing joint and several liability against Wallenbrock, Osaki and Citadel, the judgment of the district court is AFFIRMED.
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