Searching over 5,500,000 cases.


searching
Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.

SECURITIES & EXCHANGE COMMISSION v. U.S. ENVTL.

July 21, 2003

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
U.S. ENVIRONMENTAL, INC., CASTLE SECURITIES CORP., MARK D'ONOFRIO, RAMON N. D'ONOFRIO, LOUIS J. SEPE, ERNEST MICCICHE, MARK A. GELLER, MICHAEL T. STUDER, JOHN ROMANO, LESLIE S. ROTH, AND DUDLEY MIHRAN FREELAND, DEFENDANTS, AND MARIA SEPE, RELIEF DEFENDANT.



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

OPINION AND ORDER

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.

A. FINDINGS OF FACT

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 ...


Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.