The opinion of the court was delivered by: Peter Leisure, District Judge
On September 13, 1994, plaintiff, the Securities and Exchange Commission ("SEC") commenced this action, alleging that twelve individual and corporate defendants had violated certain provisions of the federal securities laws in connection with the registration for the initial public offering of Windfall Capital Corp. ("Windfall"), and trading irregularities involving defendant U.S. Environmental, Inc. ("USE") stock. Dispositions have been made for the claims against all defendants save for Michael T. Studer ("Studer") and Castle Securities, Corp. ("Castle").*fn1 Therefore, five claims remain against defendants Castle and Studer, for which the SEC seeks both permanent injunctive relief and disgorgement of illegally obtained profits along with the appropriate pre-judgment interest.
In October 2002, the Court conducted a bench trial on the remaining claims, and the parties have subsequently submitted post-trial briefs, further addressing those issues. Having considered the evidence presented at trial and the parties' post-trial submissions, the Court sets forth herein its findings of fact and conclusions of law pursuant to Rule 52(a) of the Federal Rules of Civil Procedure.
I. Identities and Backgrounds of the Relevant Parties
a. Defendant Castle Securities Corp. ("Castle"),
of Freeport, New York, is a New York corporation,
and is a wholly owned subsidiary of Castle
Holding Corp ("Castle Holding"), a public
corporation.
b. Castle has been a broker-dealer registered
with SEC, pursuant to Section 15(b) of the
Securities Exchange Act of 1934 ("Exchange Act"),
since December 5, 1984, and is a member of the
National Association of Securities Dealers, Inc.
("NASD").
c. Defendant Studer age 50, resides in Rockville
Centre, New York, and has served as president,
treasurer, and a director of Castle since its
inception, and owns part of Castle Holding.
d. From at least January 1, 1988 through the
present, George Hebert ("Hebert") has been the
president and a director of Castle Holding.
e. From January 1, 1988 through the present,
Studer and Hebert have each controlled or owned
between 20% and 33% of Castle Holding.
f. Studer has also been a certified public
accountant since February 5, 1975, and the sole
owner of Michael T. Studer, CPA, P.C., a public
accounting firm ("Studer CPA") since July 1987.
g. From at least April 1988 to at least November
1992, Castle and Studer CPA maintained offices at
the same address, 75 West Merrick Road, Freeport,
New York 11520. During the period from 1988
through 1990, Castle and Studer CPA were very
small operations that shared space and were both
controlled by Studer.
h. Since approximately 1984, defendant Roth, who
is an accountant, has been employed in various
capacities by Studer, initially through Studer's
accounting practices, Fisher & Studer, PC and
Studer CPA, then as an employee of Castle in
1993. In 1989, through correspondence, Roth held
herself out to the SEC as acting on behalf of
Castle. See Plaintiff's Exhibit ("PX") 97
(Letter from Leslie Roth to the SEC, dated August
16, 1989). Roth remains employed by Studer CPA.
i. From 1984 through 1989, Paula Morrelli
("Morrelli"), who is also an accountant, worked
as an employee for Studer in his various
accounting practices, including for Studer CPA in
1988 and 1989.
j. Defendant Romano, age 39, was employed from
March 1989 until August 1992, as a trader and
registered representative at Castle.
k. In March 1989, Studer and Hebert also hired
Louis Calderone ("Calderone") as a trader and
registered representative, who together with
Romano, comprised Castle's trading department in
1989 and 1990.
l. In 1989 and 1990, Studer was responsible for
supervising the registered representatives at
Castle, since he held a Series 24 license from
the NASD, which was required to supervise
registered representatives at a broker-dealer.
m. In the period 1988 through at least 1990,
Studer represented the entirety of Castle's
compliance department, and therefore, he was
responsible for supervising Hebert, Calderone,
and Romano.
n. Throughout the time Romano was a trader and
registered representative at Castle, Studer was
Romano's supervisor.
II. Studer and Castle's Prior Blind Pool Offerings
a. Studer testified that, prior to 1988, through
Castle and his accounting practice, he was
involved in creating "blind pool" companies and
"blind pool" offerings, i.e., forming
corporations with little or no assets and
operations, and then filing Form S-18 filings
with the SEC and seeking to offer the securities
of the blind pool companies to the public. See
Trial Transcript ("Tr.") at 165, 183.
b. On March 28, 1988, pursuant to an
investigative subpoena issued by the SEC's staff,
Studer provided testimony regarding Dynamic
Capital Corp. ("Dynamic"), the first blind pool
offering that Castle underwrote, with Studer's
assistance. The SEC staff questioned Studer
extensively regarding Dynamic. See Tr. at
183-184; PX 88 (Investigative Testimony of
Michael T. Studer in the Matter of Dynamic
Capital Corp., dated March 28, 1988).
c. On May 5, 1989, the SEC issued a public
release stating that the SEC had charged the
president of Dynamic with committing securities
fraud in connection with the Dynamic blind pool
offering, and that the Justice Department had
also brought criminal charges against Dynamic's
president. See PX 87 (SEC Litigation release
regarding Dynamic Capital Corp., dated May 5,
1989).
d. Studer testified that he was not aware that
the president of Dynamic was criminally charged
until his deposition in 2000. See Tr. at 238.
However, based on his knowledge of the SEC's
investigation of Dynamic, Studer was aware that
blind pool companies that undertook a public
distribution of securities could be misused by
securities fraudsters and would be subject to
scrutiny by securities regulators such as the SEC
and NASD.
III. Studer and Castle's Relationship with the D'Onofrio
Group
a. In the Pretrial Order, defendants concede that
D'Onofrio, his father R. D'Onofrio, and Richard
Kirschbaum were partners. (hereafter collectively
referred to as the "D'Onofrio Group"). See
Undiputed Facts, attached as Appendix I to the
Joint Pre Trial Order ("UF"), at mm.
b. Mr. Studer testified that, at the time of the
merger between Windfall and USE, he knew that
Kirschbaum was working together with D'Onofrio.
See Tr. at 265; PX 25 (Deposition of Michael T.
Studer, dated Jan. 12, 2000) at 158. In the
mid-1980s through at least 1990, Kirschbaum and
corporations he controlled, including Kraylink,
Ronart, and Mandrake, were clients of Studer CPA,
and also customers of Castle.
c. Studer was aware that Kirschbaum controlled
Kraylink, Ronart and Mandrake. See Tr. at
205-06, 256-57.
d. The defendants conceded that D'Onofrio and
Kirschbaum sent correspondence to Castle in 1988,
which reference blind pools and indicate the
association between D'Onofrio and Kirschbaum.
See UF at s, t.
e. D'Onofrio testified that, in 1988, the
D'Onofrio Group, through Kirschbaum, entered into
an agreement with Studer and Castle to form blind
pool public corporations for use by the D'Onofrio
Group, i.e., to keep them on the "shelf" for
the D'Onofrio Group. See Tr. 58-59, 61, 69-70.
f. Studer testified that he was aware in 1988 and
1989 that Kirschbaum was always looking for
public companies to serve as "shell" companies.
See Tr. at 226-27. At trial, Studer defined a
"shell company" as a public company that does not
have an operating business. See id.
g. On or about January 20, 1988, Kirschbaum sent
a letter to Castle, addressed to Hebert,
requesting that Hebert "get all the work taken
care of as quickly as possible, per our
discussion," and enclosed four subscription
checks, each in the amount of $2,500. The letter
identifies D'Onofrio as one of the subscribers
for Castle's blind pool companies. See PX 153.
h. On or about May 31, 1988, D'Onofrio sent a
letter to Castle, which attached Kraylink's
subscription agreement bearing Kirschbaum's
signature, and discusses D'Onofrio and Castle
"initiating" the blind pool companies of Windfall
and Emerging Enterprises. See PX 27.
i. Studer and Hebert provide no explanation for
the letters from either D'Onofrio or Kirschbaum
and deny their association with the D'Onofrios
and Kirschbaum, and their involvement with
Windfall and Emerging Enterprises.
j. Studer's and Castle's involvement with
Kirschbaum is significant. Various published
court decisions prior to 1988 identify Kirschbaum
as a partner of R. D'Onofrio in the commission of
D'Onofrio's securities violations. See PX 250
(SEC v. D'Onofrio, [1975-76 Transfer Binder]
Fed. Sec. L. Rep. (CCH) ¶ 95,201, at 98,011-12
(S.D.N.Y. June 3, 1975); Competitive Assoc.,
Inc. v. Laventhol Krekstein, 478 F. Supp. 1328,
1332 (S.D.N.Y. 1979)).
k. The defendants concede that the D'Onofrio
Group purchased the majority of shares in the
Windfall offering, which later traded under the
name USE, and then manipulated the price from
$0.05 to $5 per share of those securities. See
UF at www.
1. D'Onofrio and R. D'Onofrio consented to final
judgments enjoining them from further violating
the antifraud provisions of the securities laws
and directing them to disgorge ill-gotten gains.
See PX 139 (Final Judgment of Permanent
Injunction and Other Relief as to Defendant Mark
J. D'Onofrio, dated September 19, 1994).
Kirschbaum died before this litigation commenced.
IV. The Formation of Windfall
a. Windfall was incorporated in Delaware on
February 18, 1988. The Certificate of
Incorporation indicates that George Hebert was
Windfall's sole initial director.
b. Windfall was a shell corporation that had no
business or revenue. See Tr. at 227-28.
c. From at least January 1, 1988 through the
present, Hebert has been the President and a
Director of Castle's parent company. Hebert
decided on the name "Windfall" for the company.
d. At its incorporation, Windfall's address was
listed as 30 Bedell Street, Freeport, New York,
the same address as Castle.
e. In 1988, Roth became president and chairman of
the board of directors of Windfall, and Morelli
became secretary-treasurer and a director of
Windfall.
f. Roth and Morelli became officers of Windfall
after Studer had approached them and asked them
if they would be interested in incorporating a
company and undertaking a public offering of
securities for that company. See Tr. at 655.
g. Prior to Windfall, Roth and Morrelli had never
been officers of any corporations, let alone any
public corporations.
h. Roth and Morrelli became initial shareholders
in Windfall, pursuant to subscription agreements
both dated April 21, 1988.
l. Studer compensated Roth for her work as an
officer of Windfall by approving timesheets that
Roth submitted to Studer CPA, which included time
she had pent working on matters pertaining to the
Windfall blind pool. Roth's timesheets show that
she worked on both Windfall and Emerging
Enterprises while she was working for Studer CPA
in 1988 and 1989.
m. In 1988, Windfall hired Alan Berkun, Esq.
("Berkun"). Berkun was also an initial investor
in Windfall.
n. Prior to being hired by Windfall, Berkun
provided legal services to Castle.
o. In July 1988, Richard J. Dasch, CPA ("Dasch")
was employed by Studer and Castle as a registered
representative.
p. After he began working for Castle as a
registered representative, Studer hired Dasch to
prepare Windfall's audited and unaudited
financial statements.
q. Dasch also worked for Studer on a per diem
basis as an accountant, prior to undertaking the
Windfall audit.
r. Studer also hired Dasch to perform the audit
for Emerging Enterprises, the other blind-pool
company listed on D'Onofrio's letter to Castle
dated May 31, 1988.
s. Dasch testified that he did not speak to Roth
or Morelli in preparing the audit of Windfall,
and received the materials and documents
necessary to prepare the audit from Studer. Dasch
testified that he believed that Studer was the
"inside" accountant for Windfall. See Tr. at
780, 783.
t. After Windfall was incorporated and before
Windfall became a public company, Windfall had
eleven initial investors, who each received
restricted stock. See UF at q.
u. Studer was responsible for getting most of
Windfall's initial investors. See Tr. at 707.
In addition to Roth, Morrelli, and Berkun, the
other initial Windfall shareholders consisted of
the following employees, relatives, and close
friends of Studer and Hebert, as well as one
corporation, Kraylink, which was controlled by
Kirschbaum:
1. John Lawless ("Lawless"), who is Studer's
brother-in-law.
2. Marie Butsky ("Butsky"), who is Hebert's
mother-in-law.
3. Marvin Rostolder ("Rostolder"), a friend of
Hebert whom he met while in the brokerage
business during the mid-1980's. See PX 199
(Investigative Testimony of Marvin Rostolder,
dated August 15, 1990) at 42. Hebert introduced
Rostolder to Studer sometime prior to Studer &
Fisher's 1987 Christmas party. Id. Rostolder
first met Roth and Morrelli at the 1987 Christmas
party. See id. at 3132. Rostolder was a
registered representative at Castle from July
1988 through December 1988. See id. at 60.
Roth asked Rostolder to invest in Windfall at the
Christmas party or shortly thereafter; and Roth
later asked Rostolder if he would sell 90% of his
Windfall securities back to the company. See
id. at 55-56, 85-88. Rostolder was told by
either Roth or Studer that other private
investors were selling their securities back to
the company to help with a potential merger.
See id. at 88; PX 198 (Deposition of Marvin
Rostolder, dated October 14, 1999) at 38-42.
4. John Hill, who had known Studer and Hebert
since approximately 1986. See PX 213
(Investigative Testimony of John Hill, dated
Sept. 25, 1990) at 59. Hill first became aware of
Windfall through either Roth or Morrelli at the
1987 Christmas party. Id. at 11-12. Hill spoke
with both Studer and Hebert about Windfall before
he invested, inquired of either Studer or Hebert
to whom he should write the check in order to
invest in Windfall, and ultimately gave the check
to Studer. Id. at 12, 21-22. Studer told Hill
that a company raised some money and wanted to
buy all of Windfall's stock, and that he could
make a profit by selling his stock at that time.
Id. at 26. Studer handled Hill's sale of his
Windfall stock at Castle's offices. Id. at
24-25. Hill never had any substantive discussions
about Windfall or the sale of his stock with
either Roth or Morrelli. Id. at 28, 40.
5. Joseph Fisher ("Fisher"), who was Studer's
former accounting partner. Studer's partnership
with Fisher began in 1982. See Tr. at 161. In
1988, Fisher owned the building that leased
office space to Castle. Id. at 209.
6. Ronald Winge ("Winge"), who had been Studer's
longtime friend. Winge is a letter carrier for
the U.S. Postal Service. See PX 217 (Deposition
of Ronald Winge, sworn to on Feb. 16, 2000) at
12. Studer and Winge were childhood friends who
met in either grade school or high school and had
been close ever since. See PX 218
(Investigative Testimony of Ronald Winge, dated
August 15, 1990) at 62; PX 217 at 10. Studer is
Winge's stockbroker. Winge admitted that he does
not know much about stocks and has depended on
Studer for advice when it comes to the purchase
and sale of securities. See PX 218 at 43-44.
Winge first became aware of Windfall through
either Roth or Studer at the 1987 Christmas
party. Id. at 31, 44. Studer advised Winge to
invest in Windfall because it was a good
investment and he could make some money. Id. at
8; PX 217 at 21. Studer solicited Winge to sell
his Windfall securities. See PX 218 at 40.
Winge trusted Studer's judgment and told him to
do whatever he wanted as long as he made a
profit. Id. at 41; PX 217 at 21.
7. Noel Meeks ("Meeks"), who had been a friend of
Hebert for over 30 years, and had known Studer
since approximately the mid-1980's. See Tr. at
1035; PX 225 (Deposition of Noel Meeks, dated
Apr. 19, 2000) at 22-24. Meeks was also friends
with Roth and Morelli. See Tr. at 1038. Meeks
had been performing odd jobs at Castle since
approximately 1989 and had been employed in an
official capacity by Castle since 1993. Id. at
1033-42. Meeks spoke with Roth and Morelli about
investing in Windfall's private placement and may
have spoken with Studer. Id. at 1051-52. Meeks
sold his private placement shares because he was
satisfied with the price. Id. at 1068-69.
8. Kraylink, the only corporation that was an
initial shareholder of Windfall, was controlled
by Kirschbaum through his ex-wife and daughter.
Romano testified that Kraylink had been a client
of Castle. See Tr. at 825-30. Roth testified
that she met Kirschbaum through Studer. See
id. at 676.
v. Windfall's Form S-18, filed with the SEC on or
about December 5, 1988, reveals that Kraylink
provided nearly half of the $5,000 of Windfall's
initial funds. See PX 1 (Windfall Form S-18,
received by SEC on Dec. 5, 1988) at 35. The
Kraylink subscription bears the signature of
Richard Kirschbaum.
w. D'Onofrio sent a letter to Castle, dated May
31, 1988, addressed to Hebert, which enclosed
subscription agreements and checks to invest in
the blind pool offerings of Windfall and Emerging
Enterprises. Included in the subscription
agreements was the subscription for Kraylink.
D'Onofrio wrote, "We sincerely apologize for the
delay. I hope we can move forward on all pools we
have initiated."
x. The initial Windfall investors acquired
2,025,000 restricted shares by July 1988.
V. Windfall's Form S-18 and Amendments and, the Public
Offering of Securities during the Offering Period of
February 10, 1989 Through August 17, 1989
a. On or about December 5, 1988, Windfall filed a
registration statement on Form S-18 with the SEC
("Windfall Form S-18"), seeking to register one
million units, each to be sold at $0.05 (the
"Windfall Offering"). See PX 1.
b. On February 3, 1989, the 1st Amendment to the
Windfall Form S-18 ("1st Amendment") was filed
with the SEC. See PX 2 (Windfall Form S-18 1st
Amendment, SEC stamp dated February 3, 1989).
c. The Form S-18 and amendments represented that:
1. Each unit of the Windfall Offering consisted
of one share of common stock and five warrants.
See PX 2 at 2.
2. For a twenty-four month period following the
effective date of the Windfall Form S-18, each
warrant could be exchanged for one share of
common stock at a price of $0.10. Id.
3. The Windfall Form S-18 and amendments stated
that Roth was Windfall's president and a
director, and that Morrelli served as
secretary-treasurer and a director. Roth and
Morrelli signed the Windfall Form S-18 as
officers and directors of Windfall.
4. The Windfall Form S-18 and amendments
described Roth and Morrelli as self-employed
public accountants, and stated that neither Roth
nor Morrelli had received, or would receive for a
period of one year after the Windfall Offering
closed, remuneration for their services or
reimbursement of expenses relating to Windfall.
See PX 1 at 24.
5. The Windfall Form S-18 and amendments stated
that "[t]he [Windfall Offering] is a `blind
pool' in that neither [Windfall's] business nor
its use of proceeds of this offering has been
specified." See PX 1 at 8.
6. The Windfall Form S-18 and amendments
further stated that Windfall "[h]ad not
identified any specific business or assets
which it intend[ed] to acquire," had "received
no commitments . . . regarding the purchase or
availability of any subsidiary business or for
any of its proposed operations," and had not
identified the individuals who ultimately would
manage Windfall. See PX 1 at 11.
7. The Windfall Form S-18 and amendments also
stated that the units to be registered would be
offered and sold to the public by Windfall
rather than by a broker-dealer acting as
underwriter, thereby describing a
"self-underwriting." See PX 2 at 5.
d. The SEC declared Windfall's registration
effective on or about February 10, 1989, and the
Windfall Offering closed on or about August 17,
1989.
e. The Windfall Form S-18 and 1st Amendment were
the only offering documents filed with the SEC on
behalf of Windfall for the offering period of
February 10, 1989 through August 17, 1989.
f. Castle and Studer oversaw the creation and
initial investment in Windfall and supervised its
Form S-18 filings.
g. Roth testified that Studer approached her and
Morelli, and inquired whether they would be
interested in forming a company and doing a
public offering. As both Roth and Morelli were
studying for the Certified Public Accountant
("CPA") exam at the time, they took the
opportunity, suggested by Studer, to form
Windfall, because they thought it would be a
"good learning experience." In addition to
providing advice to Roth regarding the formation
of Windfall, Studer reviewed Windfall's Form S-18
before Roth submitted it to the SEC. See Tr. at
655-56, 707-08, 768 (Roth); Tr. at 175, 190-91
(Studer).
h. Studer was aware that the timesheets that Roth
filled out in the course of her employment at
Studer CPA had numerous Windfall entries, as well
as Emerging Enterprise entries, in 1988 and 1989.
See Tr. at 685-700.
i. In March 1989, during the course of the
Windfall Offering, Hebert told Romano that
Windfall was a blind pool company that was being
underwritten by Castle. See Tr. at 820-21.
VI. False Statements and Facts Omitted From the Windfall
Form S-18 and 1st Amendment
a. A Form S-18 is a registration statement used
by a company to register its securities with the
SEC. An S-18 discloses the company's officers,
directors, principal shareholders, and control
persons of the company. An S-18 describes how a
company's securities will be distributed to the
public. The purpose of a registration statement
is to provide full and complete disclosures of
material information that an investor would deem
important in deciding whether to invest in the
company's securities. See Tr. at 519-20.
b. The Windfall Form S-18 and amendments did not
disclose Studer's or Castle's participation in
the formation of Windfall or the Windfall
Offering. See PX 1; PX 2. Rather, the Windfall
Form S-18 represented that it was a
self-underwriting, where units would be offered
and sold to the public by Windfall, rather than
by a broker-dealer acting as an underwriter.
See PX 2 at 5. Since Studer and Castle did
provide the services of an underwriter in
participating in the distribution of Windfall
shares to the public, Windfall's offering of
securities could not be deemed a
self-underwriting.
c. The Windfall Form S-18 and amendments did not
disclose that Kirschbaum and the D'Onofrios were
promoters for Windfall. See PX 1; PX 2.
d. The Windfall Form S-18 and amendments did not
disclose that Studer reviewed Windfall's Form
S-18 and provided advice to Roth regarding the
Form S-18. See Tr. at 175.
e. The Windfall Form S-18 and amendments did not
disclose the compensation paid to Roth for the
time she spent on Windfall. See PX 1; PX 2;
see also Tr. at 718-19.
f. When Windfall was incorporated and before
Windfall became a public company, Windfall's
initial shares were issued to individuals and a
corporation with pre-existing personal and
business relationships with Studer, Castle, and
the D'Onofrio Group. See UF at u.
VII. Windfall's Merger With USE
a. D'Onofrio testified that, prior to the closing
of the Windfall Offering on August 17, 1989,
Studer and Castle had a secret agreement with the
D'Onofrio Group to supply the Windfall blind pool
company to the D'Onofrio Group for a merger with
another company. See Tr. at 74-75.
b. In March 1989, Studer and Hebert told Romano
that Kirschbaum was a promoter and was
responsible for finding a merger partner for
Windfall, since Roth and Morrelli had no
experience with corporations and corporate
acquisitions. See Tr. at 836-40, 945.
c. During the Windfall Offering, Roth mailed
Windfall material to Studer and to Kirschbaum at
his address at United Atlantic Investments. See
Tr. at 728-30; see also PX 86 (Federal Express
receipts for Windfall Capital Corp.).
d. In or about July 1989, before the Windfall
Offering was completed, defendant Mark A. Geller
("Geller") arranged and attended a meeting (the
"Geller Meeting") at the D'Onofrio Group's
offices with D'Onofrio, R. D'Onofrio, Kirschbaum,
and defendant Sepe, a director of defendant USE,
then a privately held company with no operating
revenue. See Tr. at 44-46.
e. At the Geller Meeting, the attendees discussed
the prospect of merging USE with a public blind
pool company. During the meeting, D'Onofrio
offered to arrange a merger between USE and
Windfall in the form of a "90-10" deal, which
would result in the USE shareholders controlling
90% of the combined company and the original
Windfall shareholders controlling 10%. See Tr.
at 52-53. Therefore, through a "backdoor" merger,
USE would become a public company, since the one
million registered Windfall units offered in the
Windfall initial public offering ("IPO") would be
part of the capitalization of USE after the
merger with Windfall. Sepe expressed a desire
that the stock of the merged company trade at a
price in excess of one dollar. See Tr. at
53-54.
f. Within several days of the Geller Meeting,
Sepe agreed to the merger with Windfall. See
Tr. at 56. By letters dated July 24, 1989 and
July 26, 1989, the D'Onofrio Group confirmed with
Sepe that USE would merge with a public company.
See PX 146.
g. The entire one million units of the Windfall
Offering were subscribed to, either directly or
indirectly through nominees, by members of the
D'Onofrio Group, Sepe, Geller and individuals or
entities connected to Studer and Castle. 47.4%
was controlled by the D'Onofrio Group, 4.6% by
individuals or entities connected to Studer and
Castle, and the balance by Geller and nominees of
Sepe.
h. Members of the D'Onofrio Group, Sepe and
Geller reached an understanding regarding the
amount each party would invest in the Windfall
offering. See Tr. 57-58. D'Onofrio testified
that Kirschbaum conveyed to Studer the details of
this agreement, and the amount of stock that was
allocated to the individuals whom Studer and
Castle were to find to invest in the Windfall
offering. See Tr. at 61, 64.*fn2
i. The only Windfall investors who subscribed
during the first four months of the offering were
Martin and Judith Hausman, a married couple who
were D'Onofrio's nominees. They invested $200 and
purchased 4,000 of the 1 million units offered by
Windfall. See Tr. at 65.
j. Although the Windfall Offering period was
between February 10, 1989 and August 17, 1989,
996,000 of the 1 million units offered were
subscribed to between July 28, 1989 and August 9,
1989, just days after the deal was struck at the
Geller Meeting, all by individuals or entities
associated with the D'Onofrio Group, Studer and
Castle, or USE insiders. See PX 56-PX 69
(various Windfall subscriptions agreements,
completed between July 29, 1989 and August 9,
1989).
k. The D'Onofrio Group subscribed to or directly
controlled 474,000 units or 47.4% of the
Offering, 20.4% of which were purchased through
two subscription agreements in the name of Ronart
and Mandrake, two companies controlled by
Kirschbaum, which were clients of Castle. See
PX 60; PX 66. Studer filled out the Ronart and
Mandrake subscriptions because Kirschbaum
suffered from arthritis. See Tr. at 256-57.
Kirschbaum then signed the Ronart and Mandrake
subscriptions. Therefore, Studer was aware that
Kirschbaum subscribed to 20.4% of the Windfall
public securities. Furthermore, the D'Onofrio
Group did not hide their control of other
companies that subscribed to large portions of
the Windfall offering. That is, the Cable
Partners' subscription (62,000 Units) bears
D'Onofrio's and his wife's signature and, and the
Raven Industries' subscription (102,000 Units)
bears Ramon D'Onofrio's signature. D'Onofrio
Group Nominees include: Illford Pharmacueuticals;
Cable Partners, Inc.; Raven Industries; Ronart,
Inc.; Mandrake Capital; and Martin and Judith
Hausman. See Tr. 64-67.
l. Geller and Sepe nominees subscribed to 48% of
the Offering (48,000 units). See Tr. at 67-68.
m. Castle's and Studer's employees, relatives,
friends, and customers subscribed to the
remaining 46,000 units or 4.6% of the Offering.
The D'Onofrio Group, through Kirschbaum,
instructed Studer and Hebert to arrange for
approximately 30 nominees to purchase the 4.6% of
the Windfall Offering to make the offering appear
to have a large investor base, concealing from
the regulators that the Windfall Offering was a
highly concentrated distribution. See Tr. at
59. Castle and Studer managed to arrange for four
individuals and one corporation to purchase
Windfall securities.
n. These four individuals and one corporation
included: Lester Buckman, Raymond DeSalvo,
Barbara Parker, Raymond Snediker, and Regluc
Limited. The four individuals and the corporation
Regluc were all closely associated with Castle
and Studer, and none of them were experienced in
securities investments. Furthermore, the
subscription agreements for all five of them bore
the same execution date of August 9, 1989.
Moreover, all five Castle-related owners of USE
sold their securities to Castle in the immediate
after-market trading. Each of the transactions in
which these customers sold their USE shares back
to Castle were solicited by Castle, and the
assigned registered representative was either
Studer or Hebert. See Tr. 891-896.
o. On August 28, 1999, Windfall and USE merged,
allowing USE to be a publicly tradable security
without going through an IPO. See UF at pp; Tr.
at 52-53.
p. The merger took place at Castle's offices at
75 West Merrick Road, Freeport, New York.
q. Studer reviewed the merger contract a few days
before the merger. See Tr. at 262.
r. On August 28, 1989, all of the 11 initial
Windfall shareholders sold 90% of their
unregistered Windfall securities for nominal
profits to entities controlled by the D'Onofrio
Group. See UF at tt.
s. Sepe and Geller agreed to withhold from the
market the 48% of the shares to which they had
subscribed, and to make their shares available to
the D'Onofrio Group whenever the D'Onofrio Group
"called" or asked for those shares. See PX 135
(Deposition of Mark D'Onofrio, dated Dec. 15,
1999) at 199-201.
t. Through conversations with Kirschbaum, Castle
and Studer agreed to make the 4.6% of the shares
subscribed to by their nominees available to the
D'Onofrio Group shortly after "after-market"
trading commenced. See PX 135 at 243-44.
u. Therefore, the D'Onofrio Group had an
unwritten, undisclosed call option on the shares
of USE which it did not control directly, which
gave the D'Onofrio Group indirect control over
these shares and enabled them to dominate and
control trading in the USE stock in the
after-market. See PX 135 at 242-44.
v. Pursuant to the terms of the merger, Windfall
acquired all of the outstanding stock of
privately held USE, which became a wholly owned
subsidiary of Windfall and Windfall changed its
name to USE. See UF at ss. Both D'Onofrio and
Studer were present at Castle's offices at the
time of the merger. See Tr. at 271-72.
w. On September 8, 1989, Studer opened an account
at Castle in D'Onofrio's name. See PX 74; PX
122. D'Onofrio immediately attempted to sell USE
securities before the securities were delivered
to his account. See Tr. at 983-86.
x. Calderone refused to undertake D'Onofrio's
sell transaction until the securities were
delivered into the account. D'Onofrio spoke with
Studer who directed Calderone to effect
D'Onofrio's trade. Id.
VIII. Castle Made the Market for USE Securities and
Oversaw the Manipulations of the Stock Price From $0.05
to $5.50
a. Commencing on September 8, 1989, Castle, under
Studer's supervision, was the initial, and then
principal, market maker of USE securities
(formerly the Windfall securities registered with
the SEC pursuant to the Form S-18). See UF at
xx; yy; zz.
b. In the days before September 8, 1989, Castle,
through Studer, filed forms with the NASD that
listed Castle as the first market maker for USE
securities. See UF at yy; see also Tr. at
974.
c. USE securities were listed to be quoted on the
"pink sheets" of the NASD's over-the-counter
market (the "Pink Sheets" and "OTC"). Castle, as
a market maker, would submit the daily quote of
the bid and ask to the NASD, which would publish
the quotes for USE securities on a daily basis in
the Pink Sheets. See Tr. at 277-78; Tr. at
862-63. The Pink Sheets provided broker-dealers,
investors and other market participants with the
trading price of USE securities as posted by the
registered market makers for the securities.
See Tr. at 285.
d. As a NASD registered market maker, Castle had
a duty to make a fair and orderly market in USE
securities. See Tr. at 287, 336-37 (Studer);
Tr. at 483-84 (Robert W. Lowry, plaintiff's
expert).*fn3
e. A broker-dealer has a duty to supervise
trading and to implement a reasonable supervisory
system that detects indications that there may
not be a fair and orderly market in the trading
of a certain security, otherwise known as "red
flags." See Tr. at 504. A broker-dealer's
supervisory system must have procedures in place
to investigate these red flags. See Tr. at 504.
The principal of the broker-dealer has a duty to
enforce the supervisory procedures. see id.
f. Through Castle's OTC trading as a market maker
in USE securities, under the supervision of
Studer, the D'Onofrio Group was able to raise
artificially the price of USE securities from
five cents per share to more than five dollars
per share by employing manipulative and deceptive
devices. See Tr. at 485-87. Below are summaries
of four categories of manipulative and deceptive
acts employed:
1. First Manipulative Category: The D'Onofrio
Group Guaranteed Castle's Market Making Profits
For USE Securities
i. At or about the time the Windfall
Offering closed, the D'Onofrio Group,
Studer, and other defendants, agreed that
Castle would act as a market maker in USE
securities. See Tr. at 296-98 (Studer);
Tr. at 99-101 (D'Onofrio).
ii. Castle had a small capital base in
1989. Studer and Hebert were concerned
about Castle's net capital restrictions.
See UF at ttt; see also Tr. at
289-91 (Studer); Tr. at 997-98
(Calderone).
iii. Studer instructed Romano and
Calderone to make a market in USE
securities, even though investments in
such securities are known to be extremely
risky, where, as was the case with USE,
the company has no operating history and
practically no assets. See Tr. at
956-57.
iv. Studer instructed Romano and Calderone
that Castle was going to be making a
market in USE securities. Romano and
Calderone began making a market in USE
securities on the first day of trading,
September 8, 1989, without conducting any
due diligence. See Tr. 845-50.
v. In return for Castle's acting as a
market maker, D'Onofrio agreed to protect
Castle from market risk by buying out any
"long" position and covering any "short"
position, both at a profit to Castle.
See Tr. at 103-04.
vi. This arrangement enabled Castle to
generate trading profits without running
the risks normally assumed by a market
maker. See Tr. at 484-85.
vii. In the period between September 8,
1989, and February 1, 1990, Castle
achieved a zero balance inventory of USE
stock on fifty-three different occasions
by either buying its short position from
or selling its long position to an account
controlled by the D'Onofrio Group.
Castle's trading department made a profit
on each of these fifty-three occasions.
See UF at uuu; Tr. at 497-500.
viii. The vast majority of the fifty-three
trading sequences involved transactions
with D'Onofrio's account at Castle or
accounts controlled by D'Onofrio at other
broker-dealers. See UF at uuu; Tr. at
497-500.
ix. Studer closely monitored Castle's
market making activity and the firm's
exposure in various securities. See Tr.
at 296-98 (Studer); Tr. at 867 (Romano);
Tr. at 997-98 (Calderone).
x. As the supervisor of Castle's trading
department, Studer testified that he had
reviewed and initialed most of the USE
trading tickets, approving the
transactions encompassing the fifty-three
consecutive profitable trading sequences
in USE securities. See Tr. at 302-05.
2. Second Manipulative Category: Castle and
Studer Arranged for Castle's Customers to Flip
Back Their Windfall Securities.
i. In the immediate after-market of
trading in USE securities, Studer and
Castle arranged for the individuals and
entities who had subscribed to the 46,000
units in the Windfall offering to sell
those securities back to Castle. See PX
135 at 242-44.
ii. D'Onofrio called Castle in the early
after-market and complained that Castle
customers were not selling their USE
securities, indicating that he was aware
of their positions in the stock. See UF
at kkk; Tr. at 327-29 (Studer); Tr. at
118-19 (D'Onofrio); Tr. at 494-96 (Lowry).
D'Onofrio wanted to acquire the shares
owned by the Castle customers, who
purchased them during the Windfall
Offering, to eliminate any potential
sellers of the stock before its price
significantly increased. See Tr. at
118-19 (D'Onofrio); Tr. at 495 (Lowry).
iii. D'Onofrio testified that he warned
Hebert that he would no longer conduct his
trading through Castle, unless the Castle
nominees sold their USE securities. See
Tr. at 118-19.
iv. Shortly after D'Onofrio's warning, all
of Studer's and Castle's nominees sold
their USE securities. See UF at ppp.
Each order ticket for these sales indicate
that the transactions were solicited by
Castle, and Studer or Hebert was the
assigned registered representative. See
PX 89; Tr. at 891-95.
iv. D'Onofrio's complaint about other
shareholders not selling their stock when
he was selling is inconsistent with market
participants trading in a competitive
market. See Tr. at 495-96.
3. Third Manipulative Category: Castle, Under
Studer's Oversight, Allowed the D'Onofrio Group
to Employ Castle's Market Making Services for
Purposes of Executing D'Onofrio's Matching
Orders and Wash Trades.
i. At or shortly after Romano was
introduced to D'Onofrio, Romano executed
trades in USE securities, at D'Onofrio's
direction, on nearly a daily basis; Romano
also agreed to move or adjust the price
Castle quoted for USE shares at
D'Onofrio's direction. See Tr. at 108-09
(D'Onofrio); Tr. at 878-80, 885-86
(Romano); PX 99 (Notes of FBI interview
with John Romano, dated Jan. 16, 1991).
ii. D'Onofrio would inquire of Romano how
much trading there had been in USE shares
each day, and what orders Castle had
received for USE shares. D'Onofrio would
then dictate the prices and direct Romano
to buy or sell shares from specific
accounts controlled by the D'Onofrio Group
or nominees of the D'Onofrio Group, or to
deal with other market makers. See Tr.
at 108-09 (D'Onofrio); Tr. at 878-80,
884-88 (Romano).
iii. In many instances, Romano completed
transactions directed by D'Onofrio by
obtaining stock from, or selling stock to,
D'Onofrio's retail accounts at Castle.
However, Romano sometimes obtained stock
to fill Castle's positions from buy or
sell orders received from other
broker-dealers that D'Onofrio directed to
Romano, and where the D'Onofrio Group, or
nominees of the D'Onofrio Group,
maintained brokerage accounts. See Tr.
at 529-30 (Lowry); Tr. at 878-80, 884-88
(Romano).
iv. D'Onofrio called Romano and Calderone
to alert them that Castle would be
receiving incoming buy and sell orders
from other broker-dealers. See Tr. at
878-80, 884-88 (Romano); Tr. at 1001
(Calderone); PX 99. Customers do not
normally have a role in how market makers
buy or sell stock with other
broker-dealers. See Tr. 501. The call
from D'Onofrio should have been a red flag
to the trader that D'Onofrio had
information about other broker-dealer
accounts that is inconsistent with the
information customers normally possess.
Id.
v. Romano believed that D'Onofrio was on
both sides of the trading in USE stock.
See Tr. at 887; PX 99.
vi. While Romano does not specifically
remember recounting this information or
this belief to Studer, he was not in the
practice of keeping secrets from Studer,
had a good relationship with Studer and
normally spoke with Studer several times
during the trading day. See Tr. at
879-80. In describing Studer's presence in
the Castle trading department, Calderone
testified that, "[Studer] would come in,
check tickets, check positions to see if
we're [the traders, Romano and Calderone]
spending too much money, too short, too
long with reference to the market at that
time." See Tr. at 970.
vii. On a significant number of trading
days from in or about September 1989
through December 1989, the D'Onofrio Group
engaged in manipulative practices that had
the effect of transferring shares from one
D'Onofrio Group controlled account to
another D'Onofrio Group controlled account
at successively higher prices, as well as
giving the false appearance of demand for
USE shares, without any change in
beneficial ownership. See Tr. at 480-83;
PX 239 (USE trading report, from Sept. 8,
1989 through Jan. 30, 1991).
viii. These manipulative devices, which
included prearranged simultaneous "buy"
and "sell" orders, are referred to as
"wash sales" and "matched orders." See
Tr. at 481.
ix. In order to effect the "wash sales"
and "matched orders," the D'Onofrio Group
utilized approximately 43 brokerage
accounts it controlled, in several
brokerage firms, located primarily in
Canada, as well as approximately three
accounts maintained at Castle. Most of
these accounts were in the names of
nominees. See UF at ww; Tr. at 481-83;
PX 239.
x. Castle frequently received orders in
USE stock at the end of day from other
broker-dealers in the amount needed to
cover Castle's position. See Tr. at
875-76 (Romano); Tr. 529-32 (Lowry); PX
236 (Ex. A to Lowry Report). The timing of
these trades and the precision in the
number of shares traded to cover Castle's
position should have raised a red flag to
the trader and the supervisor reviewing
the order tickets. See Tr. at 531-32.
xi. Between in or about September and
December 1989, the D'Onofrio Group
accounted for the overwhelming majority of
trading in USE. See UF. at vv; PX 239.
xii. Retail interest in USE stock was
modest during the month of October 1989,
consisting of purchases of approximately
5,000 shares and sales of approximately
7,000 shares. In contrast, the D'Onofrio
Group purchased approximately 38,000
shares and sold approximately 36,000
shares during that month. See PX 239.
xiii. As a result of the manipulative
devices employed by the D'Onofrio Group,
made possible by the over-the-market
trading service of Castle as the market
maker, an active, competitive market for
USE stock did not exist during the trading
period from September 1989 through
February 1990. See Tr. at 479.
4. Fourth Manipulative Category: Castle Set
Artificial Bid and Ask Prices for USE
Securities that Raised the Price of USE Stock
from Five Cents to More than Five Dollars Per
Share.
i. Castle's bid and ask prices from
September 8, 1989 through January 1990,
raised the price of USE securities from
five cents per share to more than five
dollars per share. See PX 239 at 1-15;
Tr. at 485-86.
ii. On the first day of trading, the price
of USE stock increased from $0.05 to an
intraday high of $0.75. The only sellers
that day were the Castle nominees and
D'Onofrio. By the third day of trading,
the price of USE stock reached $1.50 and
closed at $1.313. See UF at sss; PX 239
at 1.
iii. During that three-day period, there
were only 34 trades, largely by accounts
controlled by D'Onofrio and the Castle
nominees. See PX 239 at 1.
iv. By the end of September 1989, there
had been only 95 transactions pertaining
to USE securities, yet Castle raised the
bid and ask prices to as high as $3.50 per
share. See PX 239 at 1-3.
v. There was no information that justified
the price increase for USE stock. USE's
filings with the SEC reveal that the
company had practically no assets or
operations. See PX 55 (USE Form 10,
filed Sept. 5, 1989); Tr. at 338-40
(Studer); Tr. at 861, 902-04 (Romano); Tr.
at 493-94 (Lowry).
vi. In September 1989, USE was based in a
1,000 square foot office with no revenues
and only $11,550 in assets. See PX 55 at
10.
vii. USE's market capitalization was more
than $100 million when its securities were
priced at $5 per share. Studer was aware
that USE had 1 million public shares
outstanding and more than 20 million
restricted shares; therefore Studer
understood that USE had a market
capitalization of $100 million by November
1989. See Tr. at 338-40 (Studer); Tr. at
902-04 (Romano).
viii. Romano did not review USE's Form 10
until several weeks after Castle had
created a market in that security. See
Tr. at 974-77.
ix. On several occasions, Castle increased
or decreased the bid and ask prices in
large increments that bore no relations to
supply or demand, or any other type of
market information. See PX 236; Tr. at
486-87.
x. Market makers trade within a pricing
range of the bid and the ask prices, which
is determined by competition. See Tr. at
487. However, on several occasions, Castle
sold USE stock to D'Onofrio at prices
below what were the current market
conditions. See Tr. at 487; PX 236.
xi. These sales of USE stock to D'Onofrio
below the market prices should have served
as red flags, which would have alerted the
supervisor reviewing the trades to the
fact that a fair and orderly market did
not exist in the trading of USE
securities. See Tr. at 488. An inquiry
should have been made into why the USE
stock was being sold below the current
market price. See Tr. at 487.
IX. The D'Onofrio Group and Castle, under Studer's Control
and Oversight Sold the USE Stock to Public Investors at
Manipulated Prices and Made Ill-Gotten Gains of $178,000
a. Beginning in January 1990, the D'Onofrio Group
enlisted Castle and at least two other brokerage
firms to liquidate its holdings and reap profits
from the manipulation, which would total $940,374
by November 1990. See PX 139 (Final Judgment
against Mark D'Onofrio).
b. Between June 8, 1990 and July 3, 1990,
approximately 130 Castle customer accounts bought
almost 15,000 shares of USE stock at prices as high
as $6 per share. See PX 239 at 68-83.
c. The D'Onofrio Group sold stock to Castle during
this period at prices ranging from $4 per share to
$5.25 per share to supply this demand. Id.
d. Retail customers at Castle were buying USE stock
at prices not determined by a competitive market.
See Tr. at 525. When the price of USE stock
declined, many of those customers lost most or all
of their money. See Tr. at 526.
e. From September 1989 through August 1990,
Castle's trading account bought and sold at least
1,123,000 shares of USE stock at a profit of
approximately $178,000. See UF at www; PX 239 at
1-108.
f. In the Pretrial Order, defendants concede they
made trading profits of at least $170,000. See UF
at www.
g. Pursuant to his consent to a final judgment,
defendant Romano previously disgorged one quarter
of those ill-gotten gains, totaling $43,776,
leaving an undisgorged balance of $134,224.
h. At trial, the SEC introduced a publication from
the Internal Revenue Service ("IRS") which lists
the various statutory interest rates for the period
from September 1, 1990 through October 31, 2002 for
a tax-payer's underpaymet of taxes. Such rates are
reasonable interest rates for purposes of
calculating prejudgment interest. See Tr.
1148-51; PX 264 (Internal Revenue Bulletin, dated
September 23, 2002).
X. Likelihood that Securities Violations Could Reoccur
Based on Castle's and Studer's Conduct Subsequent to the
Windfall and USE Frauds
a. The Investigation of USE
1. During its investigation of the trading
of USE securities in the summer of 1990, the
SEC's staff issued subpoenas to Studer, Hebert,
Romano, Roth, Meeks and various other
individuals. Studer, Hebert, Romano, Roth and
Meeks each appeared and provided testimony in
1990.
2. In their testimony, both Studer and
Hebert denied any involvement with the D'Onofrio
Group or the formation of Windfall. See PX 38
(Investigative Testimony of Michael T. Studer,
dated Aug. 8, 1990); PX 18 (Investigative
Testimony of George R. Hebert, dated July 31,
1990).
3. Roth and Meeks refused to answer most of
the SEC staffs questions based on the assertion
of their Fifth Amendment privilege against
self-incrimination. See PX 10 (Investigative
Testimony of Leslie Roth, dated Aug. 2, 1990); PX
226 (Investigative Testimony of Noel Meeks, dated
Nov. 30, 1990).
b. The Manipulation of Reshone International Investment
Group, Ltd.
1. In the face of the investigations of USE
securities by the U.S. Attorney's office and the
SEC's staff, Castle, under Studer's supervision,
manipulated the securities of another issuer,
Reshone International Investment Group, Ltd.
("Reshone") from approximately November 1991
through April 1992. See PX 103 (SEC Release No.
34-39523, 1998 WL 3456, dated Jan. 7, 1998).
2. In May 1991, Castle acted as the sole
underwriter of an IPO of securities of Reshone, a
newly formed blind pool company with no operating
history. Id. at 2. Studer personally negotiated
the offering price of Reshone securities at $6
per unit. Id.
3. Studer listed Castle as the initial market
maker for Reshone securities, and Castle was the
exclusive market maker for those securities from
November 7, 1991 through May 31, 1992. Id.
4. There was insufficient demand for Reshone
securities at $6 to close the offering; however,
Castle began selling Reshone securities to retail
customers at $9 per share in December 1991 and
increased the price per share to $11 by May 31,
1992. Id.
5. As the sole underwriter, Castle knew the
identity of the customers who purchased Reshone's
IPO securities; Castle was the only dealer in the
after market of Reshone securities; Castle
conducted almost all of the secondary market
transactions in Reshone securities; Castle
continued to sell Reshone securities at inflated,
arbitrary prices to its customers, despite a lack
of investor interest. See id. at 3.
6. Castle and Studer never denied that the
manipulation and markup violations of Reshone
securities occurred, but instead, claimed that a
Castle employee was responsible. See id. at
3.
7. The NASD found that Castle, under Studer's
supervision, manipulated the market in the common
stock of Reshone in violation of Article III,
Sections 1, 4 and 18 of the NASD's Rules of Fair
Practice ("NASD Rules") and Section 10(b) of the
Exchange Act and Rule 10b-5. See id.
8. The NASD determined that there were "serious
deficiencies in both [Castle's] written
supervisory procedures and supervisory system
that failed to prevent or detect the manipulation
and mark-up violations." Id. at 4. The NASD
concluded that Studer, as the president of
Castle, was responsible for the establishment of
supervisory procedures, and that Studer had
failed to satisfy this responsibility. Therefore,
NASD found that Castle and Studer violated
Article III, Sections 1 and 27 of the NASD Rules.
See id. at 1-2.
c. The Ardian Finance Fraudulent Offering and Studer's
Assertion of the Fifth Amendment Privilege
1. Recently, Castle conducted an alleged
fraudulent securities scheme through Michael
Yeninas ("Yeninas"), a registered
representative in its New York City branch.
See PX 254 (SEC Complaint dated Aug. 8, 2002
in SEC v. Ardian Finance Group, et al, 02
Civ. 4366 (E.D.N.Y.)); PX 255 (Declaration of
James Gange, dated Aug. 6, 2002).
2. On August 8, 2002, the SEC charged Yeninas
and others with committing securities fraud
from approximately October 2001 through August
2002, by soliciting and making material
misrepresentations to investors to induce them
to purchase securities in private offerings.
3. From July 2001 through March 2002, during
most of the period that he committed his
alleged fraud, Yeninas worked as a registered
representative at Castle.
4. On or about August 23, 2002, Yeninas
consented to the Court's issuance of a
preliminary injunction against him in the
Ardian litigation. See PX 257 (Preliminary
Injunction Order, dated Aug. 23, 2002).
5. On August 13, 2002, Studer was subpoenaed by
the SEC to appear for deposition testimony in
the Ardian litigation. In response to nearly
all questions posed by the SEC's staff,
including questions regarding Studer's and
Castle's involvement in the Ardian offering and
knowledge of Yeninas' activities, Studer
refused to testify, invoking his Fifth
Amendment privilege against self-incrimination.
See PX 258 at 12-20 (Transcript of Studer
deposition on Aug. 26, 2002).
d. The Fraudulent Solicitation of a North Carolina
Investor in Connection with "CastleOnline" Securities
1. On May 23, 2002, during the investigation of
the Ardian offering of securities, the SEC's
examination staff interviewed Studer at Castle's
office. In that interview, Studer admitted that
in 2001, Castle Holding had undertaken an
offering of unregistered securities to raise
funds for Castle's New York City office and to
raise capital for Castle's operations. See PX
259 (Notes of Janowsky's interview of Studer,
dated May 23, 2002).
2. Studer told the SEC staff that Castle
Holding's private placement offering of
securities did not involve Castle and was
conducted by Castle Holding's officers. Studer
further stated that "Castle had not received any
complaints regarding private placements, but that
he did receive inquiries." See id. at 2
3. Studer's representation to the examination
staff on May 23, 2002 was false, as Justin Alcott
("Alcott"), an investor residing in North
Carolina, sent Studer a letter of complaint,
dated March 27, 2002. See PX 262 (Letter from
Justin Alcott to Michael Studer, dated Mar. 27,
2002); Tr. at 592.
4. In his letter, Alcott states that Yeninas had
solicited him in or about August 2001 to invest
in the securities of an entity called
CastleOnline for $1 per share, and that Yeninas
had represented that CastleOnline's securities
would be publicly distributed in an IPO and would
soon trade at $5 per share. See PX 262.
5. Alcott and his father invested $40,000 in the
securities of CastleOnline, but instead, received
preferred common stock of Castle Holding which
were only worth approximately 10 cents per share.
There was no IPO for CastleOnline. See Tr. at
591-95.
6. Studer responded to Alcott's complaint by
sending a letter containing the boilerplate
language from the subscription agreement that
Yeninas had sent Alcott for Castle Holding
preferred common stock. Studer provided Alcott
with no explanation for Yeninas' conduct. See
id.
7. After receving Alcott's letter, Studer sent
Yeninas a letter asking him to address the
allegations lodged by Alcott regarding the
representations made by Yeninas. Upon Yeninas'
denial of Alcott's allegations, Studer conducted
no further investigation. Significantly, Castle's
website states that it is not licensed to do
business in various states, including North
Carolina, yet Studer undertook no investigation
to determine how Yeninas came to solicit Alcott
in North Carolina or how a registered
representative of Castle was involved in selling
the securities of Castle Holding. See Tr. at
417-21.
B. CONCLUSIONS OF LAW
1. The Court has jurisdiction over this action
pursuant to Section 22(a) of the Securities Act,
15 U.S.C. § 77v(a), and Sections 21(e) and 27 of the
Exchange Act, 15 U.S.C. § 78u(e), 78aa.
2. The means and instrumentalities of interstate
commerce and the mails or the facilities of a
national securities exchange were used in connection
with the conduct described in the proposed findings
of fact involving defendants Castle and Studer.
3. Through the conduct described below in relation to
the Windfall Offering and merger, Castle and Studer
violated Section 17(a) of the Securities Act,
15 U.S.C. § 77q(a), Section 10(b) of the Exchange Act,
15 U.S.C. § 78j(b), and Rule 10b-5 thereunder,
17 C.F.R. § 240.10b-5.
a. Defendants Castle and Studer, directly or
indirectly, singly or in concert, in the offer or
sale, and in connection with the purchase or sale,
of securities, knowingly or recklessly: (1) have
employed devices, schemes, and artifices to
defraud; (2) have obtained money or property by
means of, or have otherwise made, untrue statements
of material fact or omissions to state material
facts necessary in order to make the statements
made, in the light of the circumstances under which
they were made, not misleading; and (3) have
engaged in transactions, acts, practices, and
courses of business which have operated as a fraud
or deceit upon purchasers of securities and other
persons.
b. The Windfall Form S-18 failed to disclose the
actual terms of the Windfall Offering, and
defendants D'Onofrio, R. D'Onofrio, Castle, Studer,
Sepe, and Roth, in offering and selling Windfall
securities, made material misrepresentations of
fact and omitted to disclose material facts,
including the following:
i. D'Onofrio acted as an undisclosed
promoter and, directly or indirectly,
controlled the issuer;
ii. D'Onofrio selected USE as the company
with which Windfall would merge, and the
terms of the merger were arranged before the
Windfall Offering closed;
iii. Studer acted as an undisclosed
promoter, and Castle acted as an undisclosed
underwriter;
iv. Roth and Morrelli undertook the creation
of Windfall at Studer's direction;
v. Roth received compensation for her
services, and reimbursement for expenses,
relating to Windfall, from Studer CPA;
vi. By prearrangement among the D'Onofrio
group, Sepe, Geller, Studer, and Castle, the
Windfall Offering was acquired entirely by
the D'Onofrio group, Sepe, Geller, Studer,
and Castle, or by their nominees;
vii. The Windfall Offering was controlled by
the D'Onofrio group, which had a prearranged
undisclosed call option to purchase the
entire portion of the Windfall Offering that
nominees of the D'Onofrio group had not
acquired directly.
viii. The D'Onofrio Group would commence a
public offering through resales after the
Windfall Offering purportedly closed, and
after the stock price had been manipulated
upwards to several dollars per USE share.
4. Through the conduct described below relating to
the manipulation of the market for USE securities,
Castle and Studer violated Section 17(a) of the
Securities Act, 15 U.S.C. § 77q(a), Section 10(b) and
15(c)(1) of the Exchange Act, 15 U.S.C. § 78j(b),
78o(c)(1), and Rules lOb-5, 10b-3, and 15c1-2
thereunder, 17 C.F.R. § 240.10b-5, 240.10b-3,
240.15c1-2.
a. Defendants Castle and Studer, directly or
indirectly, singly or in concert, in the offer or
sale, and in connection with the purchase or sale,
of securities, knowingly or recklessly: (1) have
employed devices, schemes, and artifices to
defraud; (2) have obtained money or property by
means of, or have otherwise made, untrue statements
of material fact or omissions to state material
facts necessary in order to make the statements
made, in the light of the circumstances under which
they were made, not misleading; and (3) have
engaged in transactions, acts, practices, and
courses of business which have operated as a fraud
or deceit upon purchasers of securities and other
persons.
b. Defendant Castle, and defendant Studer, as a
controlling person of Castle, directly or
indirectly, singly or in concert, and knowingly or
recklessly effected transactions in, or induced or
attempted to induce the purchase or sale of a
security (other than commercial paper, bankers'
acceptances, or commercial bills), otherwise than
on a national securities exchange of which Castle
was a member, by means of manipulative, deceptive,
or other fraudulent devices or contrivances, as
defined by rules and regulations of the SEC,
including, without limitation, by means of: (1)
acts, practices, or courses of business which
operated as a fraud or deceit upon any person; or
(2) untrue statements of a material fact and
omissions to state material facts necessary in
order to make the statements made, in the light of
the circumstances under which they were made, not
misleading, which statement or omission was made
with knowledge or reasonable grounds to believe
that it was untrue or misleading.
c. As part and in furtherance of these violations,
defendants Castle and Studer, directly, and through
Romano, knowingly or recklessly participated in and
furthered a market manipulation by:
i. effecting offers, purchases, and sales of
USE securities in return for promises of
risk-free profit for engaging in such trades;
ii. effecting directed and controlled trades
of USE securities;
iii. effecting "wash sales" and "matched
orders"; and
iv. effecting trades involving undisclosed
nominees.
5. Castle and Studer violated Sections 5(a) and (c)
of the Securities Act, 15 U.S.C. § 77e(a), (c),
relating to the sale of unregistered securities.
a. As a result of the conduct described above,
defendants Castle and Studer, directly or
indirectly, singly or in concert: (1) made use of
the means or instruments of transportation or
communication in interstate commerce or of the
mails to sell securities through the use or medium
of any prospectus or otherwise, when no
registration statement was in effect as to such
securities and when no exemption from registration
was available; (2) carried such securities or
caused them to be carried through the mails or in
interstate commerce, by the means or instruments of
transportation, for the purpose of sale or for
delivery after sale, when no registration statement
was in effect as to such securities; and (3) made
use of the means or instruments of transportation
or communication in interstate commerce or of the
mails to offer to sell or offer to buy through the
use or medium of any prospectus or otherwise any
securities, when no registration statement was
filed as to such securities, or while the
registration statement was the subject of a refusal
order or stop order or (prior to the effective date
of the registration statement) a public proceeding
or examination under Section 8 of the Securities
Act, 15 U.S.C. § 77h, in violation of Sections 5(a)
and (c) of the Securities Act, 15 U.S.C. § 77e(a),
(c).
b. As a part and in furtherance of these
violations:
i. Defendants D'Onofrio and R. D'Onofrio
dominated and controlled USE, and acquired
and controlled shares from the Offering with
the intent to distribute the shares to the
public after the manipulation was
accomplished;
ii. Defendants Castle, Studer, and Romano
took stock from the D'Onofrio group with a
view to distributing the stock to the public,
rendering them statutory underwriters
pursuant to Section 2(11) of the Securities
Act, 15 U.S.C. § 77b(1); and
iii. No registration statement was in effect
respecting the plan of distribution engaged
in by the D'Onofrio group, Castle, Studer,
and Romano.
c. As a result of the foregoing, defendants Castle
and Studer violated and, unless enjoined, will
continue to violate Sections 5(a) and (c) of the
Securities Act, 15 U.S.C. § 77e(a), (c).
6. Through the conduct described below relating to
the distribution of the Windfall Offering, Castle and
Studer violated Section 10(b) of the Exchange Act,
15 U.S.C. § 78j(b), and Rule 10b-6 thereunder,
17 C.F.R. § 240.10b-6.*fn4
a. Defendants Castle and Studer, while they were
(1) an underwriter or prospective underwriter in a
particular distribution of securities; (2) an
issuer or other person on whose behalf such
distribution was being made; (3) a broker, dealer,
or other person who agreed to participate or was
participating in such distribution; or (4) an
"affiliated purchaser" as defined in Rule
10b-6(c)(6), 17 C.F.R. § 240.10b-6(c)(6), directly
or indirectly, singly or in concert, in connection
with the purchase or sale of any security,
knowingly or recklessly: (A) bid for or purchased
for any account in which he or it had a beneficial
interest, any security which was the subject of a
distribution, any security of the same class and
series, or any right to purchase any such security;
or (B) attempted to induce any person to purchase
any such security or right, before he or it
completed his or its participation in such
distribution.
b. The distribution of the Windfall Offering did
not come to rest until the shares were retailed to
the public by, among others, Castle and two other
broker-dealers.
c. While the distribution continued, the D'Onofrio
group, Castle, Studer, Romano, and Freeland were
all bidding for or purchasing USE stock, or
inducing other persons to purchase USE stock, or
both. Between in or about July 1989, when the
distribution of the USE shares began, and in or
about August 1990, when the distribution came to
rest, the D'Onofrio group, and Castle, Studer, and
Romano were all bidding for and purchasing USE
stock. As set forth more fully above, from in or
about September 1989 through in or about August
1990, Castle and Studer, directly and through
Romano, bid for and purchased USE securities.
During the distribution, the D'Onofrio group bid
for and purchased USE stock, and induced other
persons to purchase USE stock.
7. Establishing Scienter
To establish a violation of Section 10(b) or 15(c)(1) of the Exchange Act, and Section 17(a)(1) of the Securities Act, plaintiff must prove that the defendants acted with scienter, "a mental state embracing intent to deceive, manipulate or defraud." See Ernst & Ernst v. Hochfelder 425 U.S. 185 (1976). Reckless conduct may be sufficient to meet the scienter requirement of a 10(b) action, Rolf v. Blyth, Eastman, Dillon & Co., 570 F.2d 38, 44-45 (2d Cir. 1978), however, recklessness has been defined "as a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, which presents a danger of misleading buyers and sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.'" Sundstrand v. Sun Chem. Corp., 553 F.2d 1033, 1045-1046 (7th Cir. 1976) (citing Franke v. Midwestern Oklahoma Dev. Auth., 428 F. Supp. 719 (W.D. Okla. 1976)).
In the case at bar, as is often the case, proof of defendants' scienter in violating these provisions must be inferred largely from circumstantial evidence. See Herman & MacLean v. Huddleston, 459 U.S. 375, 390-91 n. 30 (1983) ("The Court of Appeals also noted that the proof of scienter required in fraud cases is often a matter of inference from circumstantial evidence. If anything, the difficulty of proving the defendant's state of mind supports a lower standard of proof. In any event, we have noted elsewhere ...