The opinion of the court was delivered by: HAIGHT
MEMORANDUM OPINION AND ORDER
The Securities and Exchange Commission ("Commission") seeks a preliminary injunction against defendants James and Daniel Covello barring the Covellos from future violations of sections 10(b) and 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78(n)(e), and Rules 10b-5 and 143-3 promulgated thereunder, 17 C.F.R. §§ 240.10b-5 and 240.14e-3. The Commission also seeks to freeze certain identified profits from allegedly illegal trades made by the Covellos, as well as all profits realized by the Covellos on trades in any of the stocks at issue in this proceeding.
In a Memorandum Opinion and Order dated November 22, 1983, familiarity with which is assumed, this Court denied the Commission's request for a temporary restraining order against the defendants Covello and a third defendant, James Stivaletti. The matter was set down for an evidentiary hearing on December 8, 1983. Prior to that hearing, Stivaletti joined certain other defendants in this action in consenting to a full preliminary injunction and an asset freeze pending the entry of final judgment. Accordingly, the motion presently before me seeks relief only with respect to the Covellos.
In addition to evidence presented in connection with the December 8, 1983 hearing, this Court will also be considering newly discovered evidence presented by the Commission in two supplemental memoranda dated January 12 and 16, 1984. To expedite a decision in this matter, defendants have agreed that the facts set forth in these memoranda may be admitted into evidence for the limited purpose of this motion without additional testimony or affidavits. Before turning to a consideration of plaintiff's motion for injunctive relief, I will first address two preliminary issues raised at the December 8 hearing.
In a Memorandum Opinion and Order of December 9, 1983, familiarity with which is assumed, this Court admitted into evidence certain disputed material, to wit, the admissions underlying summaries of the Musella group's trading activities (Px 3) and the affidavit of Yiu Wung Kai (Px 5). The parties were invited, however, to address the question of whether a record composed, at least in part, of hearsay declarations would be sufficient to justify preliminary injunctive relief. The evidence having been admitted, the present issue is its weight, absent the benefits to be derived from live testimony and cross-examination.
After evaluating the nature of the disputed materials, I conclude that their reliability is such as to warrant their full consideration. The Second Circuit's opinion in SEC v. Frank, 388 F.2d 486 (2d Cir. 1968), is illuminating in this regard. In Frank, the Court addressed the necessity of holding an evidentiary hearing in the context of a preliminary injunction motion. While such a hearing is clearly appropriate in "cases where everything turns on what happened and that is in sharp dispute," id. at 491, the Court endorsed a far more flexible view in instances where, as here, "there is little dispute as to the raw facts but much as to the inferences to be drawn from them, as well, perhaps, as to the meaning and applicability of the governing statute or common law rule." Id. at 490. In such cases, although "an evidentiary hearing would be of . . . value and should be held whenever practicable," the need for a "trial-type hearing" is not as compelling. Id. at 490. With respect to the documents at issue here, this is not an instance where defendants have proffered conflicting evidence to contest the "raw facts," but rather one in which they strenuously dispute the inferences to be drawn from those facts.If under the distinctions drawn in Frank an evidentiary hearing may be entirely dispensed with, given the exigent nature of an application for preliminary relief, then a fortiori the Court may give full weight to particular evidence it deems reliable, even if such evidence is not presented by way of live testimony or subject to cross-examination.
Turning to the particular exhibits in question, each is in some sense inherently trustworthy. The Musella group trading summaries were served on the individual defendants involved in the form of requests to admit, and they have been admitted after presumably thorough consultation with counsel. (Tr. at 8-9). Defendants' objection on hearsay grounds that these are not admissions of the Covellos but rather of other party defendants, and that the documents are therefore inadmissible at this proceeding, was addressed and rejected in this Court's prior ruling. But the fact that these individuals are defendants with an equally strong interest in the outcome of the litigation does serve as an indicia of the evidence's trustworthiness. Little purpose would be served, and much time consumed, by requiring each of the Musella group defendants to testify individually as to the accuracy of the extensive data compilations received in connection with the testimony of the Commission's financial analyst.
I also find the affidavit of Yiu Wung Wai, the chief accountant at the Hotel Singapore, worthy of this Court's full consideration. While Mr. Yiu's oral testimony would of course be preferable, the nature of the averments made by Mr. Yiu and the nature of defense counsel's objection to that document render this a proper case in which to rely, at least at this preliminary stage, on a written submission. In directing that a party present live testimony rather than affidavits, a court's primary concern is to afford opposing counsel an opportunity to cross-examine the witness. The benefit of such a dialogue is that it permits the Court to evaluate the witnesses's demeanor and credibility, an important factor in instances where the facts presented are sharply contested or where a particular witness's credibility is in dispute. See SEC v. Vesco, 358 F. Supp. 1186, 1189 (S.D.N.Y. 1973).
This is not such a situation. Mr. Yiu is, to all appearances, a disinterested witness whose testimony has been elicited to authenticate registration, restaurant, and telephone records from the Hotel Singapore. Defense counsel's specific objection at the December 8, 1983, hearing focused on the legibility of a telephone number said to reflect a long-distance collect call from James Stivaletti to Alan Ihne on February 9, 1982. (Px 5, Ex. G). Counsel professed an interest in examining the affiant to ascertain how Mr. Yiu could determine from this document that the "number is what he says it is." (Tr. at 72).
After examining the original of the disputed document, I concur with defense counsel's view that the eighth digit of the recorded telephone number is severely smudged. The Commission's assertion that this number is "clearly legible as a "2" reflects either wishful thinking or counsel's superior eyesight. But the fact finder's vision, failing though it may be, controls; and my examination of the telephone slip, under a bright light and aided by a magnifying glass, reveals only an indecipherable smudge in place of this digit. The hotel's accounting stamp is superimposed upon it. If this were the only evidence proffered with respect to the alleged February 9 Stivaletti-Ihne phone call, defense counsel's argument as to the necessity of cross-examining Mr. Yiu would be far more compelling. However, in his deposition testimony of December 2, 1983, Stivaletti responded to the question, "Did you place any calls to the U.S.?" with the following: "I called Albert Ihne. I thanked him for driving me to the airport." (Stivaletti Dep. at 65). While no date was specified, New York Telephone Company records indicate that, on February 9, 1982, a collect call was made from the Hotel Singapore to Alan Ihne's home telephone number. (Gutowski Dep. at 8; Px 7). The evidence indicates, therefore, that Stivaletti called Ihne's home phone number -- 212-763-2213 -- at some point during his stay in Hong Kong; that Ihne received a collect call from the Hotel Singapore on February 9, 1982; and that the Hotel Singapore put through a call from Mr. Stivaletti on February 9, 1982, to the number 212-763-2 13.
The inference to be drawn therefrom -- that Stivaletti called Ihne on February 9 -- is at least reasonable, if not compelling. But in any case defense counsel will have an opportunity to challenge Mr. Yiu's testimony prior to or at trial. Mr. Spears has represented to the Court that the Commission "intends to undertake a procedure whereby the courts of this country make a request of the courts of Hong Kong for judicial assistance in obtaining the testimony" of Mr. Yiu, thereby enabling counsel to "observe this witness and to cross-examine him." (Tr. at 74). For the purpose of the motion presently before me, however, I find no reason to question Mr. Yiu's credibility, the reliability of the affidavit offered in evidence, or the inference it supports, i.e., that Mr. Stivaletti called Mr. Ihne from Hong Kong on February 9, 1982.
The Fifth Amendment Privilege in a Civil Proceeding
Both Daniel and James Covello, asserting their Fifth Amendment privilege against self-incrimination, have refused to respond to questions posed by the Commission during their respective depositions. (Px 8 and 9). They have, for example, refused to testify about the existence of other brokerage accounts here or abroad, or about trading in any of the other stocks at issue in this proceeding. Similarly, they have declined to produce certain trading records sought by the Commission. Plaintiff urges the Court to draw an adverse inference from the assertion of the privilege.Defendants argue generally that the nature of an SEC enforcement proceeding, coupled with the fact that defendants are targets of a parallel criminal investigation, is sufficient to implicate the same policy considerations that make it impermissible to draw such an inference against a derfendant in a criminal proceeding.
I appreciate and am sensitive to the competing policy rationales that have arisen in connection with a party's assertion of the Fifth Amendment privilege in a civil context. Certainly the issue becomes far more complex where, as here, conduct giving rise to civil liability also constitutes an element of a crime. On the other hand, given the extreme difficulty in successfully challenging an individual's reliance on the privilege, see, e.g., Hoffman v. United States, 341 U.S. 479, 95 L. Ed. 1118, 71 S. Ct. 814 (1951); Malloy v. Hogan, 378 U.S. 1, 11-12, 12 L. Ed. 2d 653, 84 S. Ct. 1489 (1964); Emspak v. United States, 349 U.S. 190, 198 n.18, 99 L. Ed. 997, 75 S. Ct. 687 (1955), it would seem proper to afford a civil litigant stymied by his adversary's silence some means of moderating the potentially overwhelming disadvantage he faces in establishing his case. In instances of insider trading, where the nature of the violation makes the proof inherently difficult to obtain, assertion of the privilege may lead to a complete failure of proof.
I am not concerned with the motives of defense counsel in advising their clients to assert the privileges. But such a defense strategy clearly cripples plaintiff's efforts to conduct meaningful discovery and to marshal proof in an expeditious fashion, if at all. The delay thereby generated is, in my view, an especially significant factor with respect to the application presently before the Court. The Commission seeks, at a relatively early stage in the proceedings, to preliminarily enjoin defendants from future violations of the securities laws and to freeze certain of their assets prior to entry of final judgment. The objective, of course, is to ensure that defendants' assets will remain available to satisfy any future court order to disgorge illegal profits. In short, the nature of the relief sought is such as to require the Commission to put forth proof well in advance of trial, and before the completion of pretrial discovery, to ensure that a future disposition of the case in its favor will be meaningful.
In light of these various factors, I am inclined to conclude that, in determining the sufficiency of plaintiff's showing on an application for preliminary relief, the Court should draw an adverse inference from defendants' assertion of the privilege. I am well aware that this decision may tip the balance in cases where, as here, the evidence is largely circumstantial and demands a certain degree of mental agility on the part of the Court to draw the proper inferences from the disparate facts presented. The law of this Circuit, however, supports the view that the assertion of the privilege in a civil proceeding is materially different from its invocation in a criminal proceeding, and may be treated as such.
The Second Circuit's most recent discussion of the privilege in a civil context arose out of Judge Weinfeld's ruling that witnesses in a civil trial could be questioned about their knowledge of, and participation in, certain thefts of parking meter revenues, and that their refusal to answer was competent and admissible evidence against their employer, Brink's Inc.In its summation, the City relied on the witness's refusal to testify as circumstantial evidence in support of its claim against Brink's. The district court mentioned this reliance in its charge to the jury and instructed them as follows: "You may, but need not, infer by such refusal that the answers would have been adverse to the witness' interest."
The Court of Appeals, after noting that its "[p]revious decisions . . . lend logical support to different treatment of claims of privilege in criminal and civil cases," Brink's Inc. v. City of New York, 717 F.2d 700, 709 (2d Cir. 1983), observed that "earlier decisions limiting the inferential use of such claims were rooted in factors unique to the criminal context. . . ." Id. While the court recognized that in a jury trial the probation value of such evidence might, in certain instances, be outweighed by its inflammatory effect and the consequent danger of undue prejudice, factors not pertinent here, it concluded that claims of privilege were admissible and competent evidence "given the fact that there is no constitutional mandate against their admission." Id. at 710.
In Baxter v. Palmigiano, 425 U.S. 308, 47 L. Ed. 2d 810, 96 S. Ct. 1551 (1976), a case involving a prison disciplinary proceeding with sanctions arguably akin to a criminal proceeding, the Supreme Court upheld a disciplinary board's decision to place an inmate in punitive segregation for thirty days and to downgrade his status classification, despite the fact that the board's decision was based in part on the adverse inference drawn from the inmate's invocation of his privilege not to testify. The Court states as follows:
"Our conclusion is consistent with the prevailing rule that the First Amendment does not forbid adverse inferences against parties to civil actions when they refuse to testify in respnse to probative evidence offered against then: the Amendment "does not preclude the inference where the privilege is claimed by a party to a civil cause. " 8 J. Wigmore, Evidence 439 (McNaughton rev. 1961)." Id. at 307 (emphasis in original).
Subsequently, in Lefkowitz v. Cunningham, 431 U.S. 801, 53 L. Ed. 2d 1, 97 S. Ct. 2132 (1977), the Court made clear that although a sanction cannot be automatically imposed on an individual merely because he or she chooses to invoke the privilege, an adverse inference can "be drawn in a civil case from a party's refusal to testify," provided this is "only one of a number of factors to be considered by the finder of fact in assessing a penalty. . . ." Id. at 808 n.5. See also SEC v. Scott, 565 F. Supp. 1513, 1533 (S.D.N.Y. 1983) ("an adverse inference may be drawn against parties to civil actions when they refuse to testify in response to probative evidence offered against them").
Having carefully considered the arguments of counsel and the relevant case law, I conclude that defendants' refusal to testify and to produce pertinent records is a factor that may be considered by the Court. Certainly the relief sought here -- an injunction against future § 10(b) and § 14(e) violations and maintenance of the status quo with respect to certain assets pending a trial on the merits -- is less oppresssive than the penalties upheld by the Supreme Court in Baxter, supra. Further, while I would be loathe to impose a penalty for invocation of the privilege on a civil litigant who is currently a defendant in a parallel criminal prosecution -- given the invitation to prosecutorial abuse this might entail -- the situation is somewhat different where the invoker is not facing trial but rather is a target of a grand jury investigation. The distinction may come as cold comfort to the target, but I regard it as meaningful in law. To bar the inferential value of a party's refusal to testify in an ongoing civil proceeding based only on the possibility, however real or remote, of future prosecution would disregard the explicit distinction between civil and criminal proceedings endorsed by the courts in both Baxter and Brinks, supra. See also Scott, supra, 565 F. Supp. at 1533-34, n.33 (defendant's contention "that it would be unreasonable to expect him to waive his privilege in light of the grand jury investigation into the John Muir firm . . . does nothing to persuade the Court against [drawing an adverse] inference" from his failure to testify).
I turn now to a review of the evidence presently before the Court.
Both Daniel and James Covello have been involved in the securities business for well over a decade. Daniel Covello is a vice-president and corporate bond trader at Dean Witter Reynolds, Inc., in New York City. His brother James Covello is a corporate bond trader with Gintel & Co. in New York City.
Alan Robert Ihne, until he was named as a defendant in this action, was the manager of the office services department at Sullivan & Cromwell ("Sullivan"), a New York City law firm.(Tr. at 52). He is presently on a leave of absence from the firm.Also named as defendants in this action are eight individuals -- Dominick Musella, Albert DeAngelis, Thomas Dispigno, Richard Rosenkranz,
John Musella, Anthony Brunetti, Edward O'Neill, and Richard Martin -- known collectively for the purposes of this proceeding as the "Musella group."
The Commission does not presently suggest any direct connection between the Musella group and the Covellos. The activities of the Musella group are probative, however, with respect to the assertion that Alan Ihne was the individual at Sullivan & Cromwell, who, on at least four occasions, simultaneously disclosed non-public material market information to one or both of the Covellos and to the Musella group. Summaries of the Musella (group's trading activities (Px 3), which were served on those defendants as requests to admit and have been admitted, reveal that the Musella group purchased Marathon Oil, Steiger Tractor, Tesoro Petroleum, and MAPCO, Inc. securities on the same days as, or shortly after, one or both Covellos traded in those securities.
I will consider each of these transactions, and Sullivan's connection to them, in turn.
On October 29 and 30, 1981, Daniel and James Covello purchased a total of 70 Marathon call options at a price of $41,636 (Px 1 and 2); the Musella group purchased a total of 445 Marathon call options at a price of $152,022.48 on October 29, 1981. (Tr. at 18, Px 3). On the morning of October 30,, 1981, shortly after each of the Covellos bought additional Marathon options, trading was halted in Marathon pending the announcement later that day of the Mobil Oil Corporation's tender offer for Marathon Oil. Sullivan & Cromwell was retained on October 27, 1981, by Merrill Lynch, Pierce, Fenner & Smith ("Merrill Lynch"), Mobil's dealer/manager in the tender offer, to provide legal services in connection with the Mobil-Marathon takeover. (Tr. at 45-46).
On February 11, 1982, Sullivan was retained by Morgan Stanley & Co., Inc., to provide legal services in connection with a proposed reorganization of Tesoro Petroleum Corporation. At that time, Morgan Stanley was acting as financial advisor to a special advisory committee of Tesoro's board of directors. In mid-May 1982, Sullivan was specifically involved in reviewing a proposed leveraged buy-out of Tesoro's assets, a proposal that was never carried through. (Tr. at 48-49). On May 19, 1982, Daniel Covello bought 2000 shares of Tesoro for a price of $42,862,
and James Covello bought 2,000 shares of Tesoro and 60 Tesoro call options for a total price of $59,551. (Px 1 and 2). Over a four-day period commencing May 18, 1982, members of the Musella group purchased 515 Tesoro call options and 57,000 Tesoro shares for a total price of $1,434,221.14. (Tr. at 19-20; Px 3).
Sullivan was also retained on July 29, 1982, by Klockner, Humboldt & Deutz, A.G., to render legal services in connection with a proposed acquisition by that company of all the outstanding stock of Steiger Tractor, Inc. (Tr. at 50-51). On August 26, 1982, Daniel Covello purchased 1,500 Steiger shares for $12,232. (Px 1). On that same day, James Covello purchased 3000 shares of Steiger through his account at Paine Webber Jackson & Curtis for $22,603.35. (Pl. Supp. Mem. of Jan. 16, 1984). Commencing on August 26, 1982, and continuing through the next day, Dominick Musella purchased a total of 15,000 Steiger shares for $119,612. (Tr. at 20, Px 3). According to the testimony of Edward Harrington, a financial analyst for the Securities and Exchange Commission, a review of the trading in Steiger common stock during the period July 1, 1982 through September 30, 1982, indicates that the stock was "thinly ...