Counsel for Petitioner

Transcription

1 No. In the Supreme Court of the United States JOSEPH CONTORINIS, v. Petitioner, SECURITIES AND EXCHANGE COMMISSION, Respondent. ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT PETITION FOR A WRIT OF CERTIORARI ROBERTO FINZI Counsel of Record THEODORE V. WELLS, JR. MARK F. POMERANTZ FARRAH R. BERSE PAUL, WEISS, RIFKIND, WHARTON & GARRISON LLP 1285 Avenue of the Americas New York, NY (212) rfinzi@paulweiss.com Counsel for Petitioner

2 i QUESTION PRESENTED Whether a defendant in a Securities and Exchange Commission ( SEC ) civil enforcement action can be ordered to disgorge profits that he or she never received, possessed, or controlled, but that instead accrued directly to innocent third parties.

3 ii PARTIES TO THE PROCEEDING In addition to the parties named in the caption, Nicos Achilleas Stephanou, Ramesh Chakrapani, Achilleas Stephanou, George Paparrizos a/k/a Georgios Paparrizos, Konstantinos Paparrizos, and Michael G. Koulouroudis were defendants in the district court. The United States was an intervenor in the district court. The charges against Ramesh Chakrapani, Achilleas Stephanou, and Konstantinos Paparrizos were voluntarily dismissed. Consent judgments were entered as to Nicos Achilleas Stephanou, George Paparrizos, and Michael G. Koulouroudis. None of them participated in the Second Circuit proceedings, and therefore none is a party to the proceedings before this Court.

4 iii TABLE OF CONTENTS Page QUESTION PRESENTED... i PARTIES TO THE PROCEEDING... ii TABLE OF AUTHORITIES... v PETITION FOR A WRIT OF CERTIORARI... 1 OPINIONS BELOW... 1 JURISDICTION... 1 STATUTES AND REGULATIONS INVOLVED... 1 STATEMENT OF THE CASE... 2 REASONS FOR GRANTING THE PETITION... 8 I. COURTS OF APPEALS ARE DIVIDED ON WHETHER DISGORGEMENT IS LIMITED TO A DEFENDANT S OWN PROFITS II. THE DECISION BELOW VIOLATES THE LIMITATIONS PLACED BY THIS COURT ON THE EQUITABLE REMEDY OF DISGORGEMENT A. MONETARY EQUITABLE RELIEF MUST BE LIMITED TO FUNDS POSSESSED BY THE DEFENDANT B. STATUTORY DEVELOPMENTS SINCE TEXAS GULF SULPHUR HAVE CONCLUSIVELY

5 iv UNDERMINED THE PANEL MAJORITY S RATIONALE III. THE SECOND CIRCUIT S HOLDING IS OF EXCEPTIONAL IMPORTANCE AS IT THREATENS TO DEPRIVE NUMEROUS DEFENDANTS OF CRITICAL PROCEDURAL PROTECTIONS CONCLUSION APPENDIX A: Denial of Petition for Rehearing of the United States Court of Appeals for the Second Circuit (May 23, 2014)... 1a APPENDIX B: Opinion of the United States Court of Appeals for the Second Circuit (Feb. 18, 2014)... 3a APPENDIX C: Judgment of the United States District Court, Sothern Distirct of New York (Feb. 29, 2012)... 33a APPENDIX D: Memorandum and Order of the United States District Court, Sothern Distirct of New York (Feb. 3, 2012)... 36a APPENDIX E: Relevant Statutes & Regulations 52a

6 v TABLE OF AUTHORITIES Page(s) Cases Albemarle Paper Co. v. Moody, 422 U.S. 405 (1975) Alexander v. Sandoval, 532 U.S. 275 (2001) Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir. 1981) (en banc)... 9 Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) Chauffers, Teamsters & Helpers, Local No. 391 v. Terry, 494 U.S. 558 (1990)... 22, 23 Elkind v. Ligget & Myers, Inc., 635 F.2d 156 (2d Cir. 1980) FTC v. Bronson Partners, LLC, 654 F.3d 359 (2d Cir. 2011) FTC v. Verity Int l, Ltd., 443 F.3d 48 (2d Cir. 2006) Gabelli v. SEC, 133 S. Ct (2013)... 32, 33

7 vi Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204 (2002)... passim Grupo Mexicano de Desarrollo, S.A. v. Alliance Bond Fund, Inc., 527 U.S. 308 (1999)... 10, 23 Hateley v. SEC, 8 F.3d 653 (9th Cir. 1993)... passim J.I. Case Co. v. Borak, 377 U.S. 426 (1964) Kaley v. United States, 134 S. Ct (2014) Meghrig v. KFC Western, Inc., 516 U.S. 479 (1996) Morrison v. Nat l Australia Bank Ltd., 561 U.S. 247 (2010) Riordan v. SEC, 627 F.3d 1230 (D.C. Cir. 2010) SEC v. AbsoluteFuture.com, 393 F.3d 94 (2d Cir. 2004) SEC v. Blatt, 583 F.2d 1325 (5th Cir. 1978)... passim SEC v. Blavin, 760 F.2d 706 (6th Cir. 1985) (per curiam)... 15

8 vii SEC v. Cavanagh, 155 F.3d 129 (2d Cir. 1998) SEC v. Clark, 915 F.2d 439 (9th Cir. 1990) SEC v. Colello, 139 F.3d 674 (9th Cir. 1998) SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90 (2d Cir. 1978) SEC v. ETS Payphones, Inc., 408 F.3d 727 (11th Cir. 2005) (per curiam)... 9, 12, 33 SEC v. First Pacific Bancorp, 142 F.3d 1186 (9th Cir. 1998) SEC v. Great Lakes Equities Co., 775 F. Supp. 211 (E.D. Mich. 1991) SEC v. Gupta, No. 11 Civ. 7566, 2013 WL (S.D.N.Y. July 17, 2013), aff d, 569 F. App x 45 (2d Cir. 2014) SEC v. Halek, 537 F. App x 576 (5th Cir. 2013) SEC v. Huffman, 996 F.2d 800 (5th Cir. 1993) SEC v. MacDonald, 699 F.2d 47 (1st Cir. 1983) (en banc)... 11

9 viii SEC v. Quinlan, 373 F. App x 581 (6th Cir. 2010) SEC v. Rajaratnam, 822 F. Supp. 2d 432 (S.D.N.Y. 2011) SEC v. Randolph, 736 F.2d 525 (9th Cir. 1985) SEC v. Seghers, No. 04 Civ. 1320, Dkt. No. 268 (N.D. Tex. Aug. 18, 2009), aff d, 404 F. App x 863 (5th Cir. 2010) (per curiam) SEC v. Sierra Brokerage Servs., Inc., 608 F. Supp. 2d 923 (S.D. Ohio 2009) SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc) SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77 (S.D.N.Y. 1970) SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971)... passim SEC v. UNIOIL, 951 F.2d 1304 (D.C. Cir. 1991) (Edwards, J., concurring) SEC v. United Energy Partners, Inc., 88 F. App x 744 (5th Cir. 2004) (per curiam)... 13

10 ix SEC v. Wash. Cnty. Util. Dist., 676 F.2d 218 (6th Cir. 1982)... 9, 14, 15 SEC v. Wyly, 860 F. Supp. 2d 275 (S.D.N.Y. 2012) Sereboff v. Mid Atl. Med. Servs., Inc., 547 US 356 (2006) Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148 (2008) United States v. Chiarella, 450 F. Supp. 95 (S.D.N.Y. 1978), aff d, 588 F.2d 1358 (2d Cir. 1978), rev d sub nom. Chiarella v. United States, 445 U.S. 222 (1980) United States v. Contorinis, 692 F.3d 136 (2d Cir. 2012)... 4, 5, 26 United States v. Elliott, 714 F. Supp. 380 (N.D. Ill. 1989) United States v. EME Homer City Generation, L.P., 727 F.3d 274 (3d Cir. 2013) United States v. Gupta, 925 F. Supp. 2d 581 (S.D.N.Y. 2013) United States v. Nacchio, 573 F.3d 1062 (10th Cir. 2009)... 26

11 x United States v. O Hagan, 521 U.S. 642 (1997) United States v. Razmilovic, 419 F.3d 134 (2d Cir. 2005) United States v. Skowron, 839 F. Supp. 2d 740 (S.D.N.Y. 2012) Statutes and Regulations 17 C.F.R b U.S.C U.S.C Insider Trading and Securities Fraud Enforcement Act of 1988 ( ITSFEA ), Pub. L. No , 102 Stat Insider Trading Sanctions Act of 1984 ( ITSA ), Pub. L. No , 98 Stat Securities Exchange Act of passim Section 10, 15 U.S.C. 78j... 1 Section 15, 15 U.S.C. 78o Section 21, 15 U.S.C. 78u... passim Section 21A, 15 U.S.C. 78u Section 32, 15 U.S.C. 78ff... 26

12 xi Other Authorities Brief for the SEC in Opposition to Certiorari, Pentagon Capital Mgmt. PLC v. SEC, No , 2014 WL In the Matter of Joseph Contorinis, File No , 2014 WL (SEC Apr. 25, 2014) ITSA House Report, H.R. Rep. No , 1984 U.S.C.C.A.N (Sept. 15, 1983) Jacobs, Arnold S., 5E Disclosure & Remedies Under the Securities Laws 20:109 (2004) Memorandum of the Securities and Exchange Commission in Support of the Insider Trading Sanctions Act of 1982, 128 Cong. Rec. 29,531 (Dec. 8, 1982) Office of Chief Counsel, Division of Enforcement, SEC, Enforcement Manual (Oct. 9, 2013) Robinson, John K., A Reconsideration of the Disgorgement Remedy in Tipper-Tippee Insider Trading Cases, 62 GEO. WASH. L. REV. 432 (1994)... 27, 28

13 xii Ryan, Russell G., The Equity Façade of SEC Disgorgement, 4 HARV. BUS. L. REV. ONLINE 1 (2013), available at 22

14 1 PETITION FOR A WRIT OF CERTIORARI Petitioner Joseph Contorinis respectfully submits this petition for a writ of certiorari to review the judgment of the United States Court of Appeals for the Second Circuit. OPINIONS BELOW The Second Circuit s majority and dissenting opinions are reported at 743 F.3d 296. Pet. App. 3a. The Second Circuit s order denying rehearing and rehearing en banc is unreported. Id. at 1a. The opinion of the district court is unreported but is available at 2012 WL Id. at 36a. The Second Circuit s opinion in Mr. Contorinis s closelyrelated criminal case is reported at 692 F.3d 136. JURISDICTION The Second Circuit entered its judgment on February 18, 2014, and denied a timely petition for rehearing and rehearing en banc on May 23, On August 15, 2014, Justice Ginsburg extended Mr. Contorinis s time to file a petition for a writ of certiorari until October 20, App. No. 14A178. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). STATUTES AND REGULATIONS INVOLVED Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act ), 15 U.S.C. 78j(b), Rule 10b-5 promulgated thereunder, 17 C.F.R b- 5, and Section 21(d)(1), (5) of the Exchange Act, 15

15 U.S.C. 78u(d)(1), (5), are reproduced in the appendix to this petition. Pet. App. 52a-55a. 2 STATEMENT OF THE CASE Introduction. This case involves an important, recurring question under the federal securities laws: whether a defendant in an SEC civil enforcement action can be ordered to disgorge profits that he or she never received, possessed, or controlled, but that instead accrued directly to innocent third parties. A divided panel of the United States Court of Appeals for the Second Circuit answered that question in the affirmative creating a split with at least three other Circuits when it affirmed an order requiring Mr. Contorinis to disgorge more than $7 million in profits (plus nearly $2.5 million in prejudgment interest) that Mr. Contorinis never received, possessed, or controlled, but which instead accrued directly to innocent third parties. In so ruling, the majority, recognizing that its ruling highlighted an ambiguity in the concept of disgorgement and that the decisions of other courts of appeals are mixed on the point, dramatically and improperly expanded the permissible scope of equitable disgorgement to include all property causally related to the wrongdoing, including gains that accrue to innocent third parties and are never possessed and never controlled by the defendant. Pet. App. 10a, 16a-17a, 18a n.5, 22a (internal quotation marks omitted). This novel expansion of disgorgement conflicts with the holdings of at least three other courts of appeals (and with the Second Circuit s own ruling

16 3 on the permissible scope of forfeiture in the parallel criminal case), disregards the limitations that this Court and others have placed on the equitable remedy of disgorgement, and threatens to impose massive financial penalties on numerous defendants while depriving them of critical procedural protections. This Court should grant review. The Parallel Criminal Action. During the relevant time period, Mr. Contorinis was a Managing Director of Jefferies & Co., Inc. and a coportfolio manager of the Jefferies Paragon Fund (the Fund ). Id. at 5a-6a. Between September 2005 and January 2006, Mr. Contorinis traded for the Fund in the common stock of the supermarket chain Albertson s, Inc. ( Albertson s ). Id. In November 2009, in a parallel criminal action, a grand jury sitting in the Southern District of New York returned an indictment charging Mr. Contorinis with one count of conspiracy to commit securities fraud and nine substantive counts of securities fraud relating to the Fund s purchases and sales of Albertson s stock. C.A. J.A The government alleged that Mr. Contorinis placed the trades on the Fund s behalf on the basis of material, non-public information that he allegedly received from Nicos Stephanou, an investment banker advising a consortium that acquired Albertson s in January Mr. Stephanou pled guilty and testified against Mr. Contorinis. Pet. App. 38a.

17 4 In October 2010, a jury acquitted Mr. Contorinis of two of the substantive counts of securities fraud and convicted Mr. Contorinis of the remaining counts. Id. at The district judge determined that the Fund realized profits of $7,304,738 and avoided losses of $5,345,700 in connection with the counts on which Mr. Contorinis was convicted. Pet. App. 6a. Mr. Contorinis was sentenced to six years of imprisonment and ordered to forfeit $12,650,438 (the sum of the Fund s realized profits and avoided losses). Id. Although Mr. Contorinis made investment decisions for the Fund, the Fund s assets were not Mr. Contorinis s personal assets. Id. at 6a. Mr. Contorinis never personally controlled the [Fund s] profits, did not personally enjoy the proceeds of the resulting gain, and did not pocket the profits from his trades. Id. at 10a-11a. Rather, these profits were received by the Fund s investors who, though unjustly enriched, may have been unaware of any wrongdoing. Id. at 16a n.4. On appeal in the criminal case, the Second Circuit affirmed Mr. Contorinis s conviction but vacated the order of forfeiture, holding that Mr. Contorinis could not be required to forfeit funds that were never possessed or controlled by himself or others acting in concert with him. United States v. Contorinis, 692 F.3d 136, 148 (2d Cir. 2012). Instead, the Court determined that the profits went directly to an innocent third party the Fund over which Mr. Contorinis lack[ed] control. Id. at The Second Circuit declined to extend a rule permitting co-conspirators to be ordered to

18 5 jointly and severally forfeit the proceeds of a crime jointly committed, to a situation where proceeds go directly to an innocent third party and are never possessed by the defendant. Id. at 147. The Second Circuit remanded to the district court for the calculation of an appropriate forfeiture amount made up of any salaries, bonuses, dividends, or enhanced value of equity in the Fund acquired by Mr. Contorinis as a result of the trades at issue. Id. at 148 n.4. On remand, the government stipulated that that amount was $427,875. Pet. App. 7a. The SEC Action. The SEC brought this parallel civil action against Mr. Contorinis based on the same conduct alleged in the criminal case. Id. Following the verdict in the criminal case, the district court granted summary judgment for the SEC, and entered an order enjoining Mr. Contorinis from violations of the securities laws and ordering him to disgorge $7,260,604, plus prejudgment interest of $2,485,205, and to pay a civil monetary penalty of $1,000,000. Id. at 7a-8a, 33a-35a. 2 The disgorgement amount represented the total profits realized by the Fund in its [Albertson s] trades between December 30, 2005 and January 23, 2006, less $45,074 in commission costs. Id. at 45a. A divided panel of the Second Circuit affirmed. The majority held that the equitable remedy of disgorgement may extend to all property casually related to the wrongdoing, even amounts that 2 Mr. Contorinis did not seek review of the civil monetary penalty in the Second Circuit and is not seeking review of it, or of the injunction, in this Court.

19 6 accrue to innocent third parties and that are never possessed and never controlled by the defendant. Id. at 16a, 17a, 22a (internal quotation marks omitted). The majority further held that culpable concert between the defendant and the unjustly enriched third party is unnecessary in order for the defendant to be ordered to disgorge the third party s profits. Id. at 12a n.2. The majority concluded that a district court has broad discretion to decide whether a defendant should disgorge only his or her own ill-gotten gains, or also the ill-gotten gains of third parties. Id. at 17a. The majority acknowledged that this issue highlights an ambiguity in the concept of disgorgement and that the decisions of other courts of appeals are mixed on the point. Id. at 10a, 18a n.5. The majority relied primarily on a line of cases articulating what had previously been a narrow exception to the ordinary rule that disgorgement is limited to a defendant s own unjust enrichment. Those cases hold that a tipper i.e. one who communicates material, non-public information to a tippee who trades on that information can be required to disgorge both his or her own profits and those realized by the tippee. Id. at 5a, 11a-14a & n.2 (citing SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971); Elkind v. Ligget & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); SEC v. Warde, 151 F.3d 42 (2d Cir. 1998)). Although the Court did not find that Mr. Contorinis was a tipper he was not, and was never alleged to be, a tipper it extended the underlying principle to this case.

20 7 In so doing, the majority rejected Mr. Contorinis s argument, among others, that the same limitation that the Court had placed on the scope of criminal forfeiture which is designed to punish, id. at 20a (quoting United States v. Bajakajian, 524 U.S. 321, 332 (1998)) must also apply to the equitable remedy of disgorgement, which cannot properly be used to inflict punishment. Id. at 20a- 23a. The majority reasoned that because forfeiture is a creature of statute, whereas disgorgement is not confined by precise contours of statutory language, it would be unrealistic to expect the same outcomes. Id. at 22a-23a. In his dissent, Judge Denny Chin (who was on the panel that issued the conflicting decision in the criminal appeal) argued, among other things, that the order of disgorgement and prejudgment interest went beyond the permissible scope of the district court s equitable authority. Id. at 28a (Chin, J., dissenting). The panel s decision, he explained, was inconsistent with both the nature and purpose of disgorgement, because disgorgement should do no more than return[] a defendant to his status quo prior to the wrongdoing. Id. at 27a. Judge Chin also argued that the majority s decision was inconsistent with the decision in the related criminal case. Id. The Second Circuit denied rehearing and rehearing en banc. Id. at 1a.

21 8 REASONS FOR GRANTING THE PETITION This case raises important questions that are critical to the proper administration of the federal securities laws. The scope of disgorgement endorsed by the majority s decision conflicts with the wellsettled law of at least three other Circuits, violates the limitations this Court and others have placed on the scope of disgorgement, and exposes defendants in SEC civil enforcement actions to de facto penalties that are not limited in any way to the profits the defendants received. Importantly, it does so without granting defendants the important Constitutional and statutory protections that would be available if the disgorgement, when imposed in this manner, were labeled as the penalty that it clearly represents. As an initial matter, the Second Circuit s significant expansion of the equitable remedy of disgorgement conflicts with the holdings of at least three other courts of appeals. While the Second Circuit now permits the disgorgement from a defendant not only of his or her own ill-gotten gains, but also of amounts accruing directly to innocent third parties, at least the Fifth, Sixth, and Ninth Circuits limit disgorgement to those ill-gotten gains possessed by the defendant alone, or, in cases involving co-defendants and findings of joint and several liability, the gains of joint violators. See SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978) ( Disgorgement is remedial and not punitive. The court s power to order disgorgement extends only to the amount with interest by which the defendant profited from his wrongdoing. Any further sum

22 9 would constitute a penalty assessment. ); 3 SEC v. Wash. Cnty. Util. Dist., 676 F.2d 218, (6th Cir. 1982) (holding that a defendant who received kickbacks for aiding and abetting a co-defendant s profitable violation should disgorge the value of the kickbacks); Hateley v. SEC, 8 F.3d 653, (9th Cir. 1993) (holding that a brokerage firm and its principals could only be required to disgorge 10% of the commissions generated by an unregistered broker because they paid that broker the other 90%). Here, the profits ordered disgorged were possessed only by third-party recipients, who, though unjustly enriched, may have been unaware of any wrongdoing. Pet. App. 16a n.4. Because the Fund was not charged, and because the SEC never alleged or sought to prove the Fund s culpability, at least the Fifth, Sixth, and Ninth Circuits as well as the Second Circuit in the context of criminal forfeiture would have ordered Mr. Contorinis to disgorge no more than his own profits, which were already ordered forfeited in connection with his criminal case. Instead, the Second Circuit ordered him to disgorge a sum 23 times that amount (including prejudgment interest). This Court should resolve this Circuit split. 3 Because it was decided prior to September 30, 1981, Blatt is also binding precedent in the Eleventh Circuit. Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir. 1981) (en banc); see SEC v. ETS Payphones, Inc., 408 F.3d 727, 735 (11th Cir. 2005) (per curiam).

23 10 Moreover, the majority s holding disregards the limitations placed by this Court and others on the permissible scope of the equitable remedy of disgorgement. This Court has explained that statutes, like the Securities Exchange Act of 1934, which provide for equitable relief, authorize only restitution in equity, not restitution at law. Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204, 213 (2002) (emphasis in original). Restitution in equity, unlike restitution at law, requires the plaintiff to identify particular funds or property in the defendant s possession. Id. As a result, an equitable order requiring a defendant to pay money must be limited to funds currently or formerly in the defendant s possession. Id. at & n.2. The Second Circuit s holding conflicts with this fundamental limitation, as well as this Court s traditionally cautious approach to equitable powers, which leaves any substantial expansion of past practice to Congress. Grupo Mexicano de Desarrollo, S.A. v. Alliance Bond Fund, Inc., 527 U.S. 308, 329 (1999). In the Second Circuit, where many SEC civil enforcement actions are filed, the SEC can now use the threat of massive disgorgement awards no longer bounded by this Court s limitations on the scope of equitable relief to extract unfair and burdensome settlements. Finally, the question of whether a district court has the authority to order disgorgement of funds that went to innocent third parties is of exceptional importance to the defendants in the hundreds of SEC civil enforcement actions brought each year. The broad disgorgement orders allowed by the Second Circuit amount to enormous de facto

24 11 equitable penalties that can now be imposed without critical procedural protections. These protections include: (i) a five-year statute of limitations; (ii) the right to a trial by jury; and (iii) the right to be free from a pre-trial asset freeze. Individually and cumulatively, the loss of these rights may deprive defendants and the public of fair adjudications. I. COURTS OF APPEALS ARE DIVIDED ON WHETHER DISGORGEMENT IS LIMITED TO A DEFENDANT S OWN PROFITS. The Second Circuit ordered Mr. Contorinis to disgorge over $7 million in profits that he does not possess and indisputably never possessed. Pet. App. 22a. This holding exceeds the scope of permissible disgorgement in at least the Fifth, Sixth, and Ninth Circuits, which do not permit the disgorgement of third-party profits outside of the narrow circumstances allowing for disgorgement of a co-conspirator s profits of a violation committed jointly. This Court s review is needed to resolve this split of authority. As the Fifth Circuit long ago held: Disgorgement is remedial and not punitive. The court s power to order disgorgement extends only to the amount with interest by which the defendant profited from his wrongdoing. Any further sum would constitute a penalty assessment. SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978). This definition of disgorgement has been endorsed repeatedly by other courts. See, e.g., SEC v. MacDonald, 699 F.2d 47, 54 (1st Cir. 1983) (en

25 12 banc); SEC v. UNIOIL, 951 F.2d 1304, 1306 (D.C. Cir. 1991) (Edwards, J., concurring); SEC v. ETS Payphones, Inc., 408 F.3d 727, 735 (11th Cir. 2005) (per curiam). Leading treatises agree. 4 Like this case, Blatt involved a defendant found liable for using material, non-public information to execute securities trades for the benefit of a thirdparty. Gerson Blatt was an attorney intimately involved in a target corporation s negotiations with its acquirer. 583 F.2d at Blatt relayed his knowledge to a long-time client, John Pullman, arranged Pullman s purchase of shares from the target s shareholders, and negotiated Pullman s sale to the acquiring corporation for a profit in excess of $300,000. Id. at The trial court ordered Pullman to disgorge his actual profits of $313, and ordered Blatt and Pullman to share in paying the trustee s expenses in collecting and distributing the disgorged funds. Id. at 1335 & n.30. The Fifth Circuit 4 See, e.g., Arnold S. Jacobs, 5E Disclosure & Remedies Under the Securities Laws 20:109 (2004) ( The most difficult issue concerning disgorgement is the amount the defendant must pay. In short, the defendant must disgorge the amount by which he was unjustly enriched.... [T]he amount disgorged cannot equal a penalty. Accordingly, one defendant cannot be required to disgorge more than the amount by which he actually profited. (footnotes omitted)). 5 Blatt and his law partner also committed a separate violation, involving their own shares, but that violation proved unprofitable and was not relevant to the disgorgement analysis. Blatt, 583 F.2d at 1328 & n.4.

26 13 vacated, holding that this limited expansion of the remedy of disgorgement as to Blatt depart[ed] from the accepted practice and would be a penalty assessment. Id. at The Fifth Circuit held that a district court s equitable power extends only to the profit realized by each defendant for his assistance in executing the fraud, and defendants thus cannot be ordered to pay more than what each received for their role in the fraud. Id. at The Court thus held that Blatt could not be required to pay more than $3,500, the amount of legal fees that he received. Id. at In the Fifth Circuit, the only exception to this general rule is that co-conspirators may, under certain circumstances, be held jointly and severally liable for the profits of a violation jointly committed. 6 But, as the decision below acknowledged, the Fifth Circuit does not accept the premise that all knowing participants in an illegal securities scheme can be required to disgorge the scheme s total profits. Pet. App. 18a n.5. This general rule is so well-established in the Fifth Circuit that the SEC has effectively agreed to 6 See, e.g., SEC v. Halek, 537 F. App x 576, 581 (5th Cir. 2013) (affirming order holding Halek jointly and severally liable for disgorgement with two companies he owned and operated because Halek had authority to receive and disburse funds from all the relevant accounts ); SEC v. United Energy Partners, Inc., 88 F. App x 744 (5th Cir. 2004) (per curiam) (affirming order holding United Energy, and two of its executive who together owned 100% of its shares, jointly and severally liable for the corporation s profits).

27 14 it when it brings cases there. For example, in SEC v. Seghers, No. 04 Civ (N.D. Tex.), the SEC alleged that Conrad Seghers fraudulently induced investors to invest $70 million into three hedge funds he operated, from which he personally withdrew $952,896 in the form of management and performance fees. 7 After Seghers was found liable, the SEC sought from Seghers only the disgorgement of his personal profits. 8 The SEC never argued that Seghers should or even could be ordered to disgorge the funds profits, even after the district court declined to order any disgorgement at all, citing a lack of proof that the funds Seghers personally withdrew were connected to the fraud. See SEC v. Seghers, No. 04 Civ. 1320, Dkt. No. 268 (N.D. Tex. Aug. 18, 2009), aff d, 404 F. App x 863 (5th Cir. 2010) (per curiam). The Sixth Circuit also has held that a defendant s own unjust enrichment is the proper measure of disgorgement. In SEC v. Washington County Utility District, the Sixth Circuit determined that Wade Patrick, the manager of a municipal garbage service, violated the securities 7 Dkt. No. 57 (Am. Compl.) 3 ( [D]efendants raised over $71.6 million from approximately 30 investors. ); id. 4 ( Seghers controlled the Funds.... Seghers made the investment decision on behalf of the Funds. ); id. 56 ( Seghers received $952,895 in investor funds. ). 8 Dkt. No. 171 (SEC Mem. In Support of Disgorgement) at 7-8 ( Seghers should be required to disgorge all illicit profits he unjustly received as a result of his fraudulent activities, plus prejudgment interest.... Accordingly, Seghers should be required to disgorge ill-gotten gains of $952,896. ).

28 15 laws by failing to disclose kickbacks that he received from Thomas Alnock, an underwriter that Patrick hired to issue $3,675,000 in revenue bonds for the municipality at exorbitant rates. 676 F.2d 218, & nn.6, 15 (6th Cir. 1982). The municipality compensated Alnock both with the spread on the bonds and with a fiscal agent fee of 5% of their face value. Id. at 221. Alnock secretly paid half of the fiscal agent fee to Patrick. Id. at 222. The Sixth Circuit held that the district court should order Patrick to disgorge a sum of money equal to the total value of all the payments he received from Alnock. Id. at 227 (emphasis added). Further, the Sixth Circuit remanded to allow the submission of further evidence by Patrick indicating that he received less than one-half of the fee. Id. at 227 n.20. Despite the fact that Patrick aided and abetted Alnock s violation, id. at 224, the Sixth Circuit did not hold, or even suggest, that the district court had the discretion to order Patrick to disgorge Alnock s profits. 9 9 The panel majority below cited other cases from the Sixth Circuit and its district courts SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985) (per curiam), SEC v. Sierra Brokerage Servs., Inc., 608 F. Supp. 2d 923 (S.D. Ohio 2009), and SEC v. Great Lakes Equities Co., 775 F. Supp. 211, 212 (E.D. Mich. 1991) as supporting its view of disgorgement. Pet. App. 18a n.5. They do not. Blavin involved a single defendant the sole owner of an unincorporated (and unlawfully unregistered) investment advisory newsletter who was ordered to disgorge the subscription fees of that newsletter and his personal trading profits in three stocks promoted by the newsletter. Id. at , 713. As the unincorporated association was

29 16 The Ninth Circuit also has held it improper to order disgorgement that includes the unjust enrichment of a party with whom the defendant could not be held jointly and severally liable. In Hateley v. SEC, 8 F.3d 653 (9th Cir. 1993), the Court reviewed the SEC s affirmance of a disgorgement award by the National Association of Securities Dealers, Inc. ( NASD ). The agency had ordered The Cambridge Group, Inc., a broker-dealer firm, and its two principles (husband and wife), to disgorge $55,000 in commissions that the firm received as a result of a finder s fee agreement with an unregistered broker. Id. at 654. Although the Ninth Circuit approved joint and several liability as between the firm and its two principals, id. at 656, it reduced the disgorgement order to the $5, that the firm retained after passing $49, on to the unregistered broker under the agreement. Id. at The Court held that the agency s order was unreasonable, excessive, and punitive rather than remedial in nature because it amounted to more than ten times the amount of their unjust enrichment. Id. held to be Blavin s alter-ego, Blavin did not order the disgorgement of any third-party profits. Id. at 709. In Great Lakes Equities, the founder, sole shareholder, president, and only director of a corporation was held to be its alter-ego, and thus ordered to disgorge the corporation s profits. 608 F. Supp. 2d at And in Sierra Brokerage, a case involving twelve defendants, the only joint and several liability ordered by the court (which was unopposed) was between three individual defendants and the companies that they respectively controlled. 775 F. Supp. at 968 n.49, 974.

30 Citing the Sixth Circuit s decision in Washington County, the Ninth Circuit held that a disgorgement order must be equal to the unjust enrichment. Id. at 656 (emphasis added). The majority in this case attempted to distinguish Hateley on the ground that [o]utcomes in the Ninth Circuit... depend[] upon the defendant s level of responsibility for the unjust enrichment. Pet. App. 18a n.5. The panel claimed that the defendants in Hateley were unaware of the illicit conduct. Id. This ignores Hateley s finding that the defendants there were aware that [the unregistered broker] was not registered with Cambridge. 8 F.3d at 654 (emphasis added). 10 The Second Circuit has now departed from the Fifth, Sixth, and Ninth Circuits. Under the Second Circuit s minority rule, a defendant s liability to 10 The panel majority also cited SEC v. First Pacific Bancorp, 142 F.3d 1186 (9th Cir. 1998), as conflicting with Hateley. But First Pacific Bancorp merely stands for the uncontroversial proposition that joint and several liability between co-defendants is appropriate where two or more individuals or entities collaborate or have a close relationship in engaging in the violations of the securities laws. 142 F.3d at 1191; see also Brief for the SEC in Opp n to Certiorari at 13, Pentagon Capital Mgmt. PLC v. SEC, No , 2014 WL ( Every court of appeals to consider the issue has held that defendants who collaborate or have close relationships in engaging in the illegal conduct may be held jointly and severally liable for disgorgement of resulting profits. ). As demonstrated by Blatt, Washington County, and Hateley, not every jointly committed violation falls within this exception. Nor does this widely accepted rule extend to profits accruing to uncharged, innocent third parties.

31 18 disgorge profits that accrue to innocent third parties is unlimited, even if the defendant never possessed and never controlled those profits. Id. at 16a, 22a. Nor is it necessary that the defendant have acted in culpable concert with the person unjustly enriched. Id. at 12a n.2. The Second Circuit so held despite acknowledging mixed results in other circuits, including Blatt and Hateley. Id. at 18a n.5. Until the decision below, it might have been argued that the Second Circuit diverged from its sister circuits only with respect to a narrow exception for tipping cases. See id. at 5a, 11a-14a & n.2 (citing SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971); Elkind v. Ligget & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); SEC v. Warde, 151 F.3d 42 (2d Cir. 1998)). But this case goes beyond the tipping cases. The panel majority did not disagree with the dissenting judge that Mr. Contorinis was not a tipper, see id. at 31a (Chin, J., dissenting); indeed, he was never alleged to be a tipper. Rather, the panel majority decided to extend this previously narrow exception to those responsible for the illegal acts, including to those with investment power over third-party accounts used to make illegal investments as well as to tippers. Id. at 15a (emphasis added). By approving disgorgement from any defendant responsible for illegal acts, the Second Circuit has eliminated the necessary link between disgorgement and possession of ill-gotten gains. The Fifth, Sixth, and Ninth Circuits would have ordered Mr. Contorinis to disgorge no more than his

32 19 personal profits of $427,875. Only the Second Circuit deems it equitable to require Mr. Contorinis to disgorge more than $7 million that he never received, possessed, controlled, or enjoyed. This profound disagreement over whose unjust enrichment a defendant must pay back is a purely legal question which will routinely create discrepancies even in cases like this one that involve no battle of economic experts and, indeed, no relevant factual disputes at all. A disagreement as profound as this one which creates exponential differences in disgorgement awards based on the fortuity of venue should be resolved, and this Court should grant the petition to clarify the ambiguity in the concept of disgorgement (id. at 10a) identified by the court below. II. THE DECISION BELOW VIOLATES THE LIMITATIONS PLACED BY THIS COURT ON THE EQUITABLE REMEDY OF DISGORGEMENT. The Second Circuit s expansion of the remedy of disgorgement disregards the limitations that this Court and others have placed on the monetary remedies that can be ordered pursuant to a federal court s equitable powers. Although this Court has not yet decided an SEC disgorgement case, this Court s precedents concerning monetary equitable remedies are consistent with the limits that the Fifth, Sixth, and Ninth Circuits place on SEC disgorgement and inconsistent with the Second Circuit s practice of ordering defendants to disgorge the profits of innocent third parties that those defendants never possessed.

33 20 Nor does the Exchange Act compel a departure from these clearly established equitable principles. Rather, the comprehensive set of criminal, civil, and administrative remedies and penalties that the Exchange Act provides for insider trading further undermines the Second Circuit s rationale. A. MONETARY EQUITABLE RELIEF MUST BE LIMITED TO FUNDS POSSESSED BY THE DEFENDANT. Congress has authorized courts in SEC civil enforcement actions to award the SEC any equitable relief that may be appropriate or necessary for the benefit of investors. 15 U.S.C. 78u(d)(5) (emphasis added). 11 The appropriate or necessary clause may further restrict the relief available, see Sereboff v. Mid Atl. Med. Servs., Inc., 547 US 356, 368 n.2 (2006), but the threshold question presented in this case is whether the relief was equitable. Congress felt comfortable 11 SEC disgorgement originally was justified under former 15 U.S.C. 78u(e), currently codified at 15 U.S.C. 78u(d)(1), which authorizes a federal court to enjoin such acts or practices as violate the securities laws. That provision was interpreted to also authorize ancillary equitable relief so long as such relief is remedial relief and is not a penalty assessment. Texas Gulf Sulphur, 446 F.2d at & n.8. In light of the 2003 enactment of 78u(d)(5), the validity of disgorgement under 78u(d)(1) is now academic. As with the 10(b) private right of action, SEC disgorgement began as a judicial construct, which Congress now has ratified. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, (2008). But that ratification is not an invitation for lower courts to expand the remedy. Id.

34 21 referring to equitable relief in this statute as it has in many others precisely because the basic contours of the term are well known. Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204, 217 (2002) (footnote omitted). 12 Under these well-known contours, an order requiring the defendant to pay money is generally not an equitable remedy. [F]or restitution to lie in equity, the action generally must seek not to impose personal liability on the defendant, but to restore to the plaintiff particular funds or property in the defendant s possession. Id. at 214 (emphasis added). This general rule is subject to a limited exception, for certain profits derived from property formerly held by the defendant. Id. at 214 n.2 (emphasis added). In other words, it may be equitable to require a defendant to pay back what the defendant currently possesses (or formerly possessed), but not to impose personal liability on a defendant for ill-gotten gains that the defendant never possessed. The latter is the province of money damages in actions at law, not equity See also Albemarle Paper Co. v. Moody, 422 U.S. 405, 417 (1975) ( [W]hen Congress invokes the Chancellors conscience to further transcendent legislative purposes, what is required is the principled application of standards consistent with those purposes and not equity [which] varies like the Chancellor s foot. ). 13 Indeed, the Second Circuit itself correctly follows Knudson in FTC disgorgement cases. See FTC v. Bronson Partners, LLC, 654 F.3d 359, 369 (2d Cir. 2011) ( As our decision in Verity made clear, funds... never received by a defendant are not unjust gains. ); FTC v. Verity Int l, Ltd., 443 F.3d 48, (2d Cir. 2006) (holding that, under Knudson, only

35 22 As noted in Knudson, Congress has relied upon this established meaning of equity in many different statutes. Id. at 217 & n.3. Uniform application of the historically-grounded set of remedies is thus necessary to preserv[e] a stable background against which Congress can legislate with predictable effects. Morrison v. Nat l Australia Bank Ltd., 561 U.S. 247, 261 (2010). If Knudson s definition of equity does not apply to 78u(d)(5), a statute enacted shortly after Knudson, 14 then a wide variety of potential defendants are now exposed to an uncertain and ever-shifting set of novel remedies. The basic principle that the possession of illgotten gains, and not culpability, is the touchstone of monetary equitable remedies is further confirmed by Chauffers, Teamsters & Helpers, Local No. 391 v. Terry, 494 U.S. 558 (1990). In that case, this Court considered whether an order requiring a defendant labor union to pay backpay to employees as a result of its breach of its duty of fair representation was an equitable remedy, for which the union would not have a Seventh Amendment right to a jury trial. 15 This Court held that the remedy could not be the sum in fact received by a defendant may be the basis for the disgorgement remedy ). 14 See Russell G. Ryan, The Equity Façade of SEC Disgorgement, 4 HARV. BUS. L. REV. ONLINE 1, 4 & n.22, 9 n.57 (2013), available at 15 As with the misappropriation theory of insider trading applicable to this case, see United States v. O Hagan, 521 U.S. 642, 650 (1997), the employees claim against the union was essentially one for breach of fiduciary duty. Terry, 494 U.S. at

36 23 characterized as one for disgorgement of improper profits, id. at 570 (quoting Tull v. United States, 481 U.S. 412, 424 (1987)), because [t]he backpay sought by [the employees] is not money wrongfully held by the Union, but wages and benefits [the employees] would have received from [the employer] had the Union processed the employees grievances properly. Such relief is not restitutionary. Id. at This Court s traditionally cautious approach to equitable powers... leaves any substantial expansion of past practice to Congress. Grupo Mexicano, 527 U.S. at 329. As Knudson and Terry confirm, an order that the defendant pay money that he or she never possessed is not equitable. In fact, it is a clear depart[ure] from the accepted practice. Blatt, 583 F.2d at The Exchange Act, 15 U.S.C. 78u(d)(1), (5), therefore, does not authorize such an order. B. STATUTORY DEVELOPMENTS SINCE TEXAS GULF SULPHUR HAVE CONCLUSIVELY UNDERMINED THE PANEL MAJORITY S RATIONALE. The enhanced disgorgement remedy devised by the Second Circuit, however unauthorized, may have seemed necessary in 1971 to punish and deter 16 Terry s careful distinction of the different equitable relief available against an employer (the enriched third-party), as opposed to a union (the wrongdoer), see 494 U.S. at , disposes of the Second Circuit s reasoning below that, because disgorgement from the Fund would be equitable, disgorgement from Mr. Contorinis must also be equitable. See Pet. App. 16a n.4, 21a-23a.

37 24 insider trading. Today, given the comprehensive set of criminal, civil, and administrative remedies and penalties applicable to insider trading, it is as unnecessary as it is unauthorized. 1. Texas Gulf Sulphur. The panel majority below called SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301 (2d Cir. 1971), the foundational case for insider trading liability. Pet. App. 12a. In that case, several insiders of Texas Gulf Sulphur with knowledge of a large mineral discovery in Canada acquired shares of the company in advance of the public announcement. The portion of the remedies opinion relied upon by the panel majority below, which dealt with issues of restitution, not disgorgement, 17 concerned only a single defendant, geologist Kenneth Darke. 18 In addition to purchasing for himself, Darke had tipped other purchasers of the company s stock, and was ordered to pay the profits of three of his tippees (including his brother) to the company. 446 F.2d at As to the other defendants, who were ordered to disgorge only their own profits, the Court quickly disposed of the argument that such disgorgement was a penalty assessment. Id. at As the Court explained, [r]estitution of the profits on these 17 Elkind, also relied on by the majority below, similarly was not a case about the proper scope of disgorgement. 18 The Second Circuit s better-known, en banc opinion, among other things, reversed the district court s dismissal as to Darke. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, (2d Cir. 1968) (en banc). Darke s appeal after remand was not heard en banc.

38 25 transactions merely deprives the appellants of the gains of their wrongful conduct. Id. The same could not be said of Darke: As to the requirement that Darke make restitution for the profits derived by his tippees, admittedly more of a hardship is imposed. However, without such a remedy, insiders could easily evade their duty to refrain from trading on the basis of inside information. Either the transactions so traded could be concluded by a relative or an acquaintance of the insider, or implied understandings could arise under which reciprocal tips between insiders in different corporations could be given. Id.; see also SEC v. Texas Gulf Sulphur Co., 312 F. Supp. 77, & n.23 (S.D.N.Y. 1970). Texas Gulf Sulphur s rationale clearly is premised on achieving deterrence through punishment, not on preventing unjust enrichment. Some measure of punishment might have seemed necessary in 1971, when Texas Gulf Sulphur was decided. Just five years earlier, this Court had instructed the lower courts that it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose. J.I. Case Co. v. Borak, 377 U.S. 426, 433 (1964). But what followed demonstrates why this

39 26 Court has since sworn off the habit. Alexander v. Sandoval, 532 U.S. 275, 287 (2001) Other Punishments and Remedies for Insider Trading. Today, a wide variety of criminal, civil, and administrative punishments are available for insider trading. Upon conviction, a defendant may be sentenced to 20 years of imprisonment and criminally fined $5,000,000 per count. 15 U.S.C. 78ff(a). Criminal forfeiture may also be ordered of the defendant s own profits, 20 as well as criminal restitution, which may include the attorney s fees incurred by third parties during the SEC s investigation as well as, for defendants employed in the securities industry, past paid compensation. 21 In SEC civil enforcement actions, in addition to injunctions and disgorgement, a defendant may be 19 This tipper/tippee rule has also been applied by courts outside the Second Circuit. SEC v. Clark, 915 F.2d 439 (9th Cir. 1990), also addresses this rule, but in that case, the defendant conceded that a tipper may be liable for the profits realized by his tippees, and sought only to argue that the other party (his wife) was not a tippee because the jury had found her not liable. Id. at Cf. SEC v. Randolph, 736 F.2d 525, 530 (9th Cir. 1985) (noting that a consent order requiring a tipper to disgorge the profits of his tippee, without interest, and without an additional civil monetary penalty, surely is a substantial penalty ). 20 See United States v. Contorinis, 692 F.3d at 145 & nn.2-3; United States v. Nacchio, 573 F.3d 1062, (10th Cir. 2009). 21 See United States v. Skowron, 839 F. Supp. 2d 740 (S.D.N.Y. 2012), aff d, 529 F. App x 71 (2d Cir. 2013) ($6,420, in past compensation and $3,827, in legal fees and costs); United States v. Gupta, 925 F. Supp. 2d 581 (S.D.N.Y. 2013) ($6,218, in legal fees).

40 27 ordered to pay a civil monetary penalty of up to three times the profit gained or loss avoided as a result of the offense. 15 U.S.C. 78u-1(a)(2). The SEC argues, and courts have held, that this treble penalty may be based on third-party profits. 22 And, the SEC may bar violators from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, from participating in an offering of penny stock, and from serving as an officer or director of a public company. 15 U.S.C. 78o(b)(6), 78u(d)(1), (2), (6). The available menu of remedies and punishments was less comprehensive in 1971, when Texas Gulf Sulphur was decided. See John K. Robinson, A Reconsideration of the Disgorgement Remedy in Tipper-Tippee Insider Trading Cases, 62 GEO. WASH. L. REV. 432, (1994). Criminal prosecution may have been a hypothetical possibility, but the first indictment was still years away. 23 No civil monetary penalty for insider 22 See SEC v. Gupta, No. 11 Civ. 7566, 2013 WL , at *2 n.4 (S.D.N.Y. July 17, 2013), aff d, 569 F. App x 45, (2d Cir. 2014); SEC v. Rajaratnam, 822 F. Supp. 2d 432, 435 (S.D.N.Y. 2011). 23 The first criminal prosecution for insider trading was United States v. Chiarella, 450 F. Supp. 95 (S.D.N.Y. 1978), aff d, 588 F.2d 1358 (2d Cir. 1978), rev d sub nom. Chiarella v. United States, 445 U.S. 222 (1980). See Arnold H. Lubasch, Printer Is Indicted on Charges of Using Inside Data, N.Y. Times, Jan. 5, The indictment in that case came six years after the Texas Gulf Sulphur remedy opinion.