DISGORGEMENT AND THE FIFTH AMENDMENT IN SEC ACTIONS
Disgorgement and the impact of the Fifth Amendment are issues which reoccur in SEC enforcement actions. Circuit Judge Loken, in an opinion concurring in part and dissenting in part, from an order affirming a grant of summary judgment in a Commission enforcement action provides a thoughtful discussion specific of aspects of each issue. SEC v. Brown, Case no. 10-2479 (8th Cir. Oct. 13, 2011).
The case centers on an investment fund fraud. Defendant Sherwin Brown is the president and controlling shareholder of Jamerica Financial, Inc. The firm is a registered investment adviser which had under management $1.62 million from 53 clients. The funds were invested in Brawta Ventures, LLC, a private investment fund organized by defendant Brown.
The SEC’s complaint against Sherwin Brown and both entities alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 204 and 206(1) and (2). It claims misrepresentations were made and that investor funds were pocketed by defendant Brown. An emergency freeze order was entered followed by a preliminary injunction.
Subsequently, a Chapter 7 proceeding was initiated by Mr. Brown. A receiver was appointed to represent Brawta and its investors. That receiver filed an adversary proceeding for the benefit of the investors. The bankruptcy court granted summary judgment in favor of the receiver and the investors.
The district court granted summary judgment in favor of the SEC in its action. In granting summary judgment the court disregarded the interrogatory answers of defendant Brown offered in opposition because Mr. Brown had invoked the Fifth Amendment precluding the SEC from taking his deposition. The court also entered a permanent injunction against Sherwin Brown and directed the payment of $869,633 as disgorgement along with prejudgment interest as requested by the SEC.
The Eight Circuit affirmed in a per curiam opinion. The court found that the district court’s adoption of the magistrate’s report on disgorgement was appropriate and that the grant of summary judgment was supported by the record.
Circuit Judge Loken concurred in affirming the grant of summary judgment but dissented from the decision to affirm the disgorgement order. First, there is no doubt that the court has broad jurisdiction under the securities laws to order the disgorgement of any ill-gotten profits. Its “purposes are to provide a remedy for fraud victims and to deprive the defendant of unjust enrichment, not to punish . . .” the Judge noted.
In this case defendant Brown diverted the amount of investor funds claimed by the SEC. The question is what remedy is proper. Equitable remedies should only issue “upon a concrete showing of need and should impose the least drastic remedy necessary to achieve the desired goals.” Here the district court did not consider the fact that a freeze order was entered, amounts recovered by the receiver or if amounts attributable to legitimate investment activities should offset the amount disgorged. The court also failed to consider if the remedy would interfere with the efforts of the victims’ to recover their losses. Rather, the district court simply accepted the SEC’s request. “On this record, the only apparent rationale for the SEC’s disgorgement request was punitive, not remedial.” Accordingly, it was an abuse of discretion to grant the Commission’s request.
Judge Loken also concluded that disregarding defendant Brown’s interrogatory answers was error although on the record here it was harmless. Here the U.S. Attorney notified defense counsel that Brown was a target of a criminal investigation after the SEC case was filed and after the interrogatory answers had been served. The district court denied a defense motion to stay the civil case and then later disregarded the interrogatory answers. It was error to do both according to Judge Loken.
Precluding evidence is an extreme remedy. While an adverse inference can be drawn from invoking the Fifth Amendment in a civil case, since “the privilege . . . is constitutionally based, the detriment to the party asserting it should be no more than is necessary to prevent unfair and unnecessary prejudice to the other side” the Judge noted, quoting SEC v. Graystone Nash, Inc., 25 F. 3d 187, 192 93rd Cir. 1994). In situations such as this case where both civil and criminal actions can be brought, courts must give “special consideration . . . to the plight of the party . .. “ asserting it. The district court has an array of remedies which include a preclusion order, barring the use of the defendant’s testimony from the civil case in the criminal proceeding or staying the civil case. Here the district court failed to consider the options.
Finally, an analysis of the record shows little if any prejudice to the SEC in this case. The interrogatory responses were submitted prior to any assertion of the Fifth Amendment. There was no unfair surprise from them and little if any prejudice. This is not a case where the privilege was asserted to block the SEC from obtaining the evidence it required to prevail. Preclusion was thus an error but, on the record here, harmless.
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