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United States District Court, S.D. New York

February 25, 2004.


The opinion of the court was delivered by: MICHAEL MUKASEY, Chief Judge, District


The Securities and Exchange Commission ("SEC") sues defendants James J. McDermott, Jr., Kathryn B. Gannon (a.k.a. "Marylin Star"), and Anthony P. Pomponio pursuant to Sections 21(d)(1), 21(e), and 21A of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78u(d)(1), 78u(e), 78u-1 (2000). The SEC seeks a judgment permanently enjoining defendants from violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, as well as other relief. In response, McDermott moves to dismiss the complaint pursuant to Fed.R.Civ.P. 12(b)(6) to the extent that it seeks injunctive relief against him. For the reasons set forth below, McDermott's Rule 12(b)(6) motion is denied.


  The following facts, which are accepted as true for the purposes of this motion, are alleged in the SEC's complaint.

  Defendant James J. McDermott, Jr., first joined Keefe, Bruyette & Woods, Inc., ("KBW") as a research analyst in 1977. (Compl. ¶ 7) Over the next 20 years, he held different positions at the firm, including Director of Research, Executive Vice President, and President. (Id. ¶ 7) McDermott was a member of KBW's Board of Directors from 1988 to June 30, 1999, and he served as the Chairman and CEO of KBW from January 1, 1998, to Page 2 June 30, 1999. (Id. ¶ 7) McDermott had access to information concerning all merger and acquisition transactions in which KBW was involved. (Id. ¶ 12) According to KBW's Employment Manual, all KBW employees were strictly prohibited from disclosing any confidential or proprietary information obtained in the course of employment. (Id.)

  From June 1997 through September 1998, McDermott had a personal relationship with Kathryn B. Gannon, an escort, exotic dancer, and actress in what are known as adult movies, who uses the stage name "Marylin Star." (Id. ¶ 1) McDermott transferred approximately $37,000 to Gannon between September 3, 1997, and September 23, 1998, and he also provided Gannon with material nonpublic information about six upcoming merger transactions involving companies on KBW's Watch List. (Id. ¶¶ 13-15) The Watch List included the names of companies that had formally retained KBW and given KBW confidential, material, nonpublic information. (Id. ¶ 20) KBW employees were prohibited from either trading in the securities of Watch List companies or recommending the purchase of such securities to others. (Id.)

  Gannon, who had minimal investment experience, opened a brokerage account on June 13, 1997, with an initial deposit of $25,800. (Id. ¶ 16) Between June 1997 and March 1998, Gannon purchased stock in six regional banks that were listed on KBW's Watch List. (See id. ¶¶ 21-22, 24-27, 31-32, 37-38, 43-44) With Page 3 respect to two of these companies, Gannon bought their securities shortly after McDermott was personally informed that a corporate merger or acquisition was imminent. (See id. ¶¶ 19, 26) Five of the six companies in which Gannon invested completed a corporate merger or acquisition within two weeks after Gannon bought their stock.*fn1 (See id. 22-23, 27-29, 32-34, 38-40, 44-46) Gannon sold each company's stock shortly after its merger or acquisition (Id. ¶¶ 23, 30, 35, 41, 47), and netted at least $88,135 as a result of her trading. (Id. ¶ 2) Anthony P. Pomponio, a friend of Gannon's, also bought and sold the stock of four of these companies around the time of their mergers and acquisitions (Id. ¶¶ 28, 33, 39, 45), and he made profits of at least $86,378. (Id. ¶ 3)

  Based on the above facts, the SEC alleges that McDermott violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and is likely to commit such violations in the future unless enjoined from doing so. (Id. ¶¶ 49, 54)


  This court may not grant a Rule 12(b)(6) motion unless "it appears beyond doubt that the plaintiff can prove no set of Page 4 facts in support of his claim which would entitle him to relief." Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir. 2001). For the purposes of this motion, all factual allegations in the complaint are accepted as true, and all reasonable inferences are drawn in the plaintiff's favor. Id. at 137-38. In evaluating a Rule 12(b)(6) motion, this court may not consider matters outside the pleadings without converting the motion into a summary judgment motion. Courtenay Communications Corp. v. Hall. 334 F.3d 210, 213 (2d Cir. 2003). As a result, a court has two options when confronted with material outside the pleadings on a Rule 12(b)(6) motion: (1) exclude the additional material and decide the motion only on the complaint, or (2) convert the motion into a summary judgment motion and give both parties the opportunity to present supporting material. Friedl v. City of New York, 210 F.3d 79, 83 (2d Cir. 2000). In this case, both parties urge this court to treat McDermott's motion as a Rule 12(b)(6) motion, and they do" not seek to convert it into a motion for summary judgment. (See Pl. Memo, at 9-10; Def. Reply Memo. at 11 n.4) Therefore, instead of converting this motion to a summary judgment motion, this court will decide McDermott's Rule 12(b)(6) motion on the pleadings and exclude all additional matters.

  For the purposes of Rule 12(b)(6), the complaint is deemed to include its exhibits, any statement or document it incorporates by reference, and any document upon which it relies Page 5 heavily. Chambers v. Time Warner, Inc., 282 F.3d 147, 152-53 (2d Cir. 2002). In support of his motion, McDermott offers also an information and belief affidavit from his attorney, Robert J. Anello, which includes factual claims about McDermott's background and current employment. (See Notice of Motion, Affidavit of Robert J. Anello) Because a court may not consider affidavits or exhibits submitted by a defendant in ruling on a Rule 12(b)(6) motion, Friedl, 210 F.3d at 83-84, Anello's affidavit is excluded for the purposes of deciding McDermott's motion. The SEC also urges this court to consider a matter outside the pleadings — McDermott's criminal conviction by guilty plea in the parallel criminal case. (See Pl. Memo. at 3 n.2) However, there is no need for this court to take judicial notice of McDermott's conviction because the complaint contains factual allegations, accepted as true for the purposes of this motion, which indicate that McDermott has committed several violations of the federal securities laws.*fn2 (See, e.g., Compl. ¶¶ 1-2, 12-15, 19-23)


  To obtain an injunction proscribing future violations of federal securities laws, the SEC must demonstrate that there Page 6 is a substantial likelihood that such violations will occur. S.E.C. v. Cavanagh, 155 F.3d 129, 135 (2d Cir. 1998). When determining whether such an injunction should issue, the Second Circuit has noted that "the commission of past illegal conduct is highly suggestive of the likelihood of future violations." S.E.C. v. Management Dynamics, Inc., 515 F.2d 801, 807 (2d Cir. 1975). At the same time,*[w]hether the inference that the defendant is likely to repeat the wrong is properly drawn . . . depends on the totality of circumstances. . . ." Id. Accordingly, a court will ultimately examine a number of factors in deciding whether to issue this kind of injunctive relief. See Cavanagh, 155 F.3d at 135.

  The complaint in this case adequately states a claim for the requested injunction against McDermott. Because "past illegal conduct is highly suggestive of the likelihood of future violations," Management Dynamics, 515 F.2d at 807, the SEC properly pleaded its prayer for injunctive relief by alleging that McDermott has violated federal securities laws in the past. See S.E.C. v. Alexander, 160 F. Supp.2d 642, 655 (S.D.N.Y. 2001) ("In alleging [defendant] violated the securities laws, the SEC has pled adequately a claim for injunctive relief."); S.E.C. v. Drescher, 99 Civ. 1419 (SAS), 1999 WL 946864, at *5 (S.D.N.Y. Oct. 19, 1999) (same); S.E.C. v. Naegeli, 92 Civ. 4583 (RPP), 1993 WL 15126, at *3 (S.D.N.Y. Jan. 12, 1993) (same). It remains Page 7 to be seen whether the SEC ultimately can prevail on its claim for injunctive relief; McDermott raises a number of arguments to suggest that he is not substantially likely to violate federal securities laws in the future. However, it would be premature at this stage to engage in this kind of scrutiny of the totality of circumstances because "[t]he task of the court in ruling on a 12(b)(6) motion is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof." Cooper v. Parsky, 140 F.3d 433, 440 (2d Cir. 1998) (internal quotation marks omitted).

  For the reasons stated above, McDermott's Rule 12(b)(6) motion is denied.


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