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
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
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
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.
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
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.
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
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
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,
To obtain an injunction proscribing future violations of federal
securities laws, the SEC must demonstrate that there
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
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 ...