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LITTON IND. v. LEHMAN BROS. KUHN LOEB

April 18, 1990

LITTON INDUSTRIES, INC., PLAINTIFF,
v.
LEHMAN BROTHERS KUHN LOEB INCORPORATED, DENNIS LEVINE, IRA B. SOKOLOW, ROBERT M. WILKIS, BANK LEU INTERNATIONAL, LTD., BANK LEU A.G., BERNHARD MEIER, JOHN R. LADEMANN, BRUNO PLETSCHER, JEAN-PIERRE FRAYSSE, AND CHRISTIAN SCHLATTER, DEFENDANTS.



The opinion of the court was delivered by: Cannella, District Judge:

  MEMORANDUM AND ORDER

Defendants' motion for partial summary judgment is granted in part and denied in part. Fed.R.Civ.P. 56. Plaintiff's motion for leave to file a third amended complaint is granted. Fed.R.Civ.P. 15(a). Plaintiff's motion for reversal or modification of Magistrate Gershon's denial of its motion to compel the deposition testimony of Levine is denied. 28 U.S.C. § 636(b)(1)(A) (1982). Plaintiff's motion to set aside Magistrate Gershon's ruling granting defendants' motion to strike plaintiff's reservation of right to supplement its Rule 26(b)(4) statement is denied. 28 U.S.C. § 636(b)(1)(A) (1982).

BACKGROUND

This action has been before the Court on prior motions and, therefore, complete familiarity with the underlying facts is assumed. Only those facts relevant to the instant motions will be set forth below.

In November 1982, plaintiff, Litton Industries, Inc. ["Litton"], retained defendant Lehman Brothers Kuhn Loeb, Inc. (now known as Shearson Lehman Brothers) ["Lehman Brothers"] to provide services in connection with Litton's tender offer acquisition for all the outstanding securities of Itek Corporation ["Itek"]. Defendant Dennis Levine, an employee in Lehman Brothers' mergers and acquisitions department, allegedly learned of Litton's proposed tender offer from defendant Ira B. Sokolow, another employee of Lehman Brothers. In its second amended complaint [the "Complaint"], Litton alleges that Levine purchased 50,000 shares of Itek in advance of the public disclosure of Litton's tender offer through defendant Bank Leu International Limited (now known as Leu Trust and Banking (Bahamas) Limited) ["BLI"]. The Complaint further alleges that another 10,000 shares were purchased in open market transactions by defendants Jean-Pierre Fraysse (BLI's managing director), Bernhard Meier and Christian Schlatter (BLI employees), and BLI itself. Other defendants who allegedly assisted Levine in his massive trading based on nonpublic information include Bank Leu, A.G. ["BLZ"], John R. Lademann (BLI board member), Bruno Pletscher (BLI general manager), and Robert Wilkis (investment banker with Lazard Freres & Company). The gravamen of Litton's Complaint is that these illegal insider purchasers artificially inflated the market price of Itek stock, causing Litton to pay more than it otherwise would have had to pay in both its open market purchases of Itek stock and in its tender offer for the outstanding Itek securities.

Prior to the commencement of this action, certain defendants disgorged all or part of their profits from trading in Itek securities to the Securities and Exchange Commission [the "SEC"]. Pursuant to paragraph eight of an agreement between defendant BLI and the SEC executed on March 19, 1986, BLI agreed to disgorge on behalf of itself and its employees (other than Meier) all profits realized from the purchase and sale of Itek securities. BLI disgorged a total of $53,747.07 to the SEC as profit realized by BLI and two of its employees (Schlatter and Fraysse) from transactions in Itek securities through accounts maintained at BLI. This disgorgement represents BLI's profit of $14,879.15, Schlatter's profit of $24,038.77, and Fraysse's profit of $14,829.15. See Declaration of Henry A. Hubschman in Support of Motion for Partial Summary Judgment, at ¶¶ 3-5, 86 Civ. 6447 (JMC) (S.D.N.Y. Oct. 26, 1989) ["Hubschman Declaration"]. The other remaining moving defendants — BLZ, Lademann, and Pletscher — did not trade in Itek securities and, therefore, did not disgorge any profits to the SEC.*fn1

Levine realized a profit of $12,651,753.99 from the purchase and sale of securities, including a profit of $805,035.00 from the purchase and sale of 50,000 shares of Itek securities transacted through an account maintained on his behalf at BLI. See Hubschman Declaration, at ¶¶ 6, 8. In connection with a prior insider trading action filed against Levine by the SEC, Levine executed a Consent and Undertaking on June 4, 1986, whereby he agreed to the entry of a "Final Judgment of Permanent Injunction and Other Equitable Relief." See SEC v. Levine, 881 F.2d 1165, 1169 (2d Cir. 1989). Pursuant to the Consent and Undertaking, Levine disgorged assets valued at $11.5 million to a receiver for satisfaction of any claims against Levine "`arising out of the purchase and sale of securities by [Levine and his companies] as alleged in the Complaint'" filed by the SEC. Id. (quoting Consent and Undertaking, at ¶ 8 (July 4, 1986)). The SEC complaint included transactions in securities of Itek.

Among the various types of relief sought in the instant action, Litton seeks disgorgement of all profit, fees, and commissions earned from the sale and purchase of Itek securities by defendants Levine, Sokolow, Wilkis, Fraysse, Schlatter, Meier, BLI, and any third party acting on information supplied by any of the defendants. See Complaint, Relief ¶ 2.

There are four motions presently before the Court. First, defendants BLZ, BLI, Lademann, Pletscher, Schlatter, Fraysse, and Levine [collectively the "Bank Leu defendants"] seek partial summary judgment on Litton's claim for disgorgement of all profit, fees, and commissions earned on the purchase and sale of Itek securities. Second, Litton moves for leave to file a third amended complaint. Third, Litton moves for reversal or modification of Magistrate Gershon's denial of its motion to compel the deposition testimony of Levine. Lastly, Litton moves to set aside Magistrate Gershon's ruling granting defendants' motion to strike plaintiff's reservation of right to supplement its Rule 26(b)(4) statement.

DISCUSSION

I. Summary Judgment

A. Disgorgement of Profits

The Bank Leu defendants seek partial summary judgment on Litton's claim for disgorgement of all profits earned from the sale and purchase of Itek securities on the ground that such profits previously have been disgorged to the SEC.*fn2 Litton contends that disgorgement is an appropriate measure of damages in a private action under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982) [the "1934 Act"] and Rule 10b-5 promulgated thereunder despite any prior disgorgement to the SEC. Alternatively, Litton argues that the Bank Leu defendants did not disgorge the full extent of their profits to the SEC, thereby preserving the availability of disgorgement as a measure of damages in this action.

The traditional measure of damages for a violation of Section 10(b) and Rule 10b-5 is the out-of-pocket rule as developed in the tort action of deceit. See, e.g., Huddleston. v. Herman & MacLean, 640 F.2d 534, 555 (5th Cir. 1981), aff'd in part, rev'd in part on other grounds, 459 U.S. 375, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983); Blackie v. Barrack, 524 F.2d 891, 909 (9th Cir. 1975), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976); Levine v. Seilson, Inc., 439 F.2d 328, 334 (2d Cir. 1971). With respect to defrauded sellers under Rule 10b-5, the Supreme Court has recognized that the proper measure of out-of-pocket loss is the difference between the value of what the seller received and the value of what the seller would have received had there been no fraudulent conduct. Affiliated Ute Citizens v. United States, 406 U.S. 128, 155, 92 S.Ct. 1456, 1473, 31 L.Ed.2d 741 (1972); see also Alley v. Miramon, 614 F.2d 1372, 1387 (5th Cir. 1980) ("As a general rule, the correct measure of a seller's damages in a 10b-5 action is the difference between the price received and the value of the securities at the time of the fraudulent transaction."). However, the Supreme Court recognized one major exception to this customary measure of damages. Where the defrauding purchaser receives more than the seller's actual loss, the proper measure of damages shall be the amount of the purchaser's profits. Affiliated Ute Citizens, 406 U.S. at 155, 92 S.Ct. at 1473.

The origin of the disgorgement measure of damages for defrauded sellers of securities endorsed by the Supreme Court in Affiliated Ute Citizens is Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert. denied, 382 U.S. 879, 86 S.Ct. 163, 15 L.Ed.2d 120 (1965). In Janigan, the First Circuit recognized that the profit made by a purchaser who acquired property by fraud should be deemed the proximate consequence of the fraud since the profit would not have accrued absent the fraudulently induced sale. 344 F.2d at 786. Although the Janigan disgorgement measure of damages has been applied primarily in the context of a defrauded seller, the Second Circuit has expressly rejected any such limitation. See Zeller v. Bogue Elec. Mfg. Corp., 476 F.2d 795, 802 (2d Cir. 1973). Other circuits have similarly recognized that disgorgement principles apply equally to an innocent party induced to purchase securities. See, e.g., Pidcock v. Sunnyland America, Inc., 854 F.2d 443, 447 n. 7 (11th Cir. 1988); Hackbart v. Holmes, 675 F.2d 1114, 1122 (10th Cir. 1982); Ohio Drill & Tool Co. v. Johnson, 498 F.2d 186, 191 (6th Cir. 1974); Occidental Life Ins. Co. v. Pat Ryan & Assocs., Inc., 496 F.2d 1255, 1265 (4th Cir.), cert. denied, 419 U.S. 1023, 95 S.Ct. 499, 42 L.Ed.2d 297 (1974).

In the instant action, plaintiff seeks a damage award from the Bank Leu defendants measured by the value of their illegal profits. While disgorgement is clearly permitted as a proper measure of damages in a 10b-5 action, it is essential to bear in mind that disgorgement is a mechanism by which the equitable remedy of restitution is effectuated. See Tull v. United States, 481 U.S. 412, 424, 107 S.Ct. 1831, 1839, 95 L.Ed.2d 365 (1987); 5 J. Moore, J. Lucas & J. Wicker, Moore's Federal Practice ¶ 38.24[2], at 38-206 (2d ed. 1988). In fact, the Janigan court — which pioneered the disgorgement measure of damages — concluded that disgorgement is a proper alternative measure of damages because "it is simple equity that a wrongdoer should disgorge his fraudulent enrichment." Janigan, 344 F.2d at 786. The Supreme Court has recently recognized that the disgorgement measure of damages in a 10b-5 action is a remedy designed to prevent unjust enrichment.

  This alternative standard aims at preventing the
  unjust enrichment of a fraudulent buyer, and it
  clearly does more than simply make the plaintiff
  whole for the economic loss proximately caused by
  the buyer's fraud. Indeed, the accepted rationale
  underlying this alternative is

  simply that "[i]t is more appropriate to give the
  defrauded party the benefit even of windfalls
  than to let the fraudulent party keep them."

Randall v. Loftsgaarden, 478 U.S. 647, 663, 106 S.Ct. 3143, 3152, 92 L.Ed.2d 525 (1986) (quoting Janigan, 344 F.2d at 786).

It is clear that the underlying purpose of allowing disgorgement as an exception to the traditional out-of-pocket measure of damages is to prevent unjust enrichment. Thus, the Court finds that once ill-gotten gains have been disgorged to the SEC, there remains no unjust enrichment and, therefore, no basis for further disgorgement in a private action. Any other result would conflict with the well settled principle in the Second Circuit that a private party may not recover punitive damages for a violation of Section 10(b) and Rule 10b-5. See, e.g., Manufacturers Hanover Trust Co. v. Drysdale Sec. Corp., 801 F.2d 13, 29 (2d Cir. 1986), cert. denied sub nom., Arthur Anderson & Co. v. Manufacturers Hanover Trust Co., 479 U.S. 1066, 107 S.Ct. 952, 93 L.Ed.2d 1001 (1987); Globus v. Law Research Serv., Inc., 418 F.2d 1276, 1283 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970); Green v. Wolf Corp., 406 F.2d 291, 302-03 (2d Cir. 1968), cert. denied, 395 U.S. 977, 89 S.Ct. 2131, 23 L.Ed.2d 766 (1969). Once ill-gotten profits have been disgorged to the SEC, further disgorgement as damages in a private action is clearly punitive in its effect and would constitute an impermissible penalty assessment.

Decisional law touching on related issues supports this limitation on the availability of the disgorgement measure of damages in a private action under Section 10(b) and Rule 10b-5. For example, in National Westminster Bancorp NJ v. Leone, 702 F. Supp. 1132 (D.N.J. 1988), the court considered whether a corporation could recover its statutory remedy under Section 16(b) of the 1934 Act for disgorgement of profits realized in short-swing trading by insiders when the SEC had already settled a separate suit for disgorgement under Rule 10b-5. Plaintiff asserted that the profits disgorged to the SEC in the 10b-5 action were substantially lower than the proper calculation of profits under Section 16(b). Id. at 1134. Defendants, on the other hand, argued that no profits remained to be disgorged since it paid all profits to the SEC pursuant to its settlement. Id. at 1135. The court held that "plaintiff may not recover from defendants any profits already disgorged to SEC in the prior action, but plaintiff may attempt to prove the insufficiency of the SEC settlement and recover any difference between actual profits and the amount disgorged to the SEC." Id. at 1140. The Court finds no meaningful legal distinction between Leone, which involved a private action under Section 16(b), and the instant action, which involves a private action under Section 10(b). Under both sections, disgorgement is a proper measure ...


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