Eighth Circuit Affirms Disgorgement of Misappropriated Investor Funds to Deter Future Violations of Securities Laws
Sima Saran Ahuja | Bloomberg Law
With one judge dissenting in part, the U.S. Court of Appeals for the Eighth Circuit affirmed the district court’s grant of summary judgment to the Securities and Exchange Commission (SEC) in a civil enforcement action alleging that an investment adviser’s President induced clients to invest with him through fraudulent misrepresentations. The Eighth Circuit also affirmed an order for disgorgement of funds together with injunctive relief.
Defendants Diverted Funds
Sherwin P. Brown was the President of Jemerica Financial, Inc. (Jemerica), a registered investment adviser, whose clients invested in Brawta Ventures, LLC (Brawta), a private investment fund organized by Brown (collectively, Defendants). The SEC alleged that, between May 2004 and January 2006, 53 of Jemerica’s clients invested $1.62 million in Brawta based on Defendants’ fraudulent misrepresentations. Defendants then diverted from Brawta a portion of those funds for personal expenses. The SEC charged Defendants with violating Sections 17(a)(1)-(3) of the Securities Act of 1933, Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 204 and 206(1)-(2) of the Investment Advisers Act of 1940 and moved for summary judgment.
District Court Orders Disgorgement
The district court granted the SEC’s motion for summary judgment and permanently enjoined Brown and Jemerica from future violations of the securities laws. Moreover, the district court ordered Defendants to disgorge $869,633 in misappropriated investor funds. The district court concluded that disgorgement was “appropriate to discourage future violations of securities laws and to make the investors whole.” According to the district court, the record did not support Brown’s contention that the SEC’s damages calculations were inconsistent. In fact, the district court ultimately assessed additional “Tier III” civil penalties of $80,000 against Brown and $400,000 against Jermerica.
Interrogatory Response Not Sufficient to Resist Summary Judgment
In resolving the summary judgment motion, the district court did not allow Brown to rely on an interrogatory response in which he explained that transfers from Brawta funds to Brown and Jermerica were related to compensation, expense reimbursements, and consideration for assets transferred into the Brawta funds. Because Brown invoked his right against self-incrimination after submitting the interrogatory response, the district court explained, the SEC would be unable to explore the interrogatory answers in a deposition. Moreover, the district court held that “allowing Brown to rely on the interrogatory response . . . ‘would allow him to manipulate the discovery process so that his unquestioned, conclusory assertions are the only version of his testimony in the record.’”
Eighth Circuit Affirms Disgorgement Order
On appeal, representing himself pro se, Brown argued that (1) he was a victim of “selective prosecution,” (2) the SEC refused to turn over exculpatory documents, (3) the Brawta venture was not a Ponzi scheme, and (4) there was no accounting proof of the alleged fraud. Brown asked the Eighth Circuit to overturn all judgments, fines, and decisions against him and to reimburse him for his defense costs. Not persuaded by Brown, the Eighth Circuit affirmed the grant of summary judgment to the SEC finding that the district court’s reasoning was appropriate. Moreover, according to the Eighth Circuit, Brown’s challenges on appeal were “without merit.”
The dissent did not agree with the Eighth Circuit’s affirmance of the disgorgement order. In the dissent’s view, disgorgement’s purpose is to “provide a remedy for fraud victims” and “not to punish.” Moreover, the dissent found that violations of federal securities laws could be appropriately remedied through restitution and the equitable remedy of unjust enrichment. However, the dissent continued, “even when the remedy is intended to deter misconduct . . . it must be remedial, not punitive.”
In this case, the dissent found that disgorgement of $869,633 that was fraudulently diverted from 53 identifiable victims was the appropriate equitable remedy. However, the dissent asserted, the SEC’s request for disgorgement of “all wrongfully diverted funds” after this remedy was in place was inappropriate because the SEC did not explain the remedial purpose of its request. The dissent concluded that “on this record, the only apparent rationale for the SEC’s disgorgement request was punitive, not remedial” and it was thus an abuse of discretion to grant the request.
Addressing the dissent, the Eighth Circuit found that “ample” authority supported the disgorgement order and relied on decisions in other SEC civil actions. For example, the Eighth Circuit found persuasive the argument that “Congress added civil penalties . . . because disgorgement merely requires the return of wrongfully obtained profits; it does not result in any actual economic penalty or act as a financial disincentive to engage in securities fraud.” In affirming, the Eighth Circuit also relied on the theory that “securities laws violators may not offset their disgorgement liability with business expenses.”
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