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Securites and Exchange Comm'n v. Grotto

October 24, 2006


The opinion of the court was delivered by: Gerard E. Lynch, District Judge


In this action for enforcement of federal antifraud securities laws, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the Securities and Exchange Commission ("SEC") moves for summary judgment against defendants Patrick A. Grotto and Mark B. Leffers. The SEC contends that no issue exists for trial, as all material facts were resolved in a prior state civil action and defendants should be collaterally estopped from relitigating them. Defendants, who appear pro se, oppose this motion primarily on the ground that it would be unfair to apply collateral estoppel to this case. They further protest that the action is untimely.

For the reasons below, the SEC's motion is granted, and judgment in the form of injunctive relief, disgorgement, and monetary penalties will be awarded as sought.


On June 24, 2005, the SEC filed a complaint charging Grotto and Leffers with fraudulent conduct in connection with the June 2000 initial public offering ("IPO") of, Inc. ("Busybox"), a now defunct corporation that was then headquartered in California.*fn1 The complaint charges that defendants violated Section 17(a) by employing fraud in the offer or sale of securities and Section 10(b) and related Rule 10b-5 by engaging in deceptive practices or schemes in connection with the sale of securities. Defendants are accused of acting with the scienter necessarily associated with certain of these allegations, namely intent to deceive, manipulate, or defraud, or recklessness. See Aaron v. SEC, 446 U.S. 680, 696-97 (1980), Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), and Edward J. Mawod & Co. v. SEC, 591 F.2d 588, 595-97 (10th Cir. 1979).

The complaint alleges a course of conduct identical to that alleged and proved in a California civil action previously brought by a private investor, Bernard J. Carl. Carl had charged Grotto and Leffers, among others, with making numerous material misrepresentations and omissions in prospectuses and SEC filings ("Offering Documents") relating to the Busybox IPO, along with other illegal acts. Following a bench trial, the Honorable Richard L. Fruin of the Superior Court for the State of California, County of Los Angeles, found that from approximately early 1999 through fall 2000 Grotto had served as Busybox's chairman and chief executive officer, while Leffers had served as chief financial officer, treasurer, and controller. In those positions, the court found, Grotto and Leffers had prepared, signed, and disseminated to potential investors Offering Documents that they knew to be fraudulent in the following ways:

The documents falsely stated that an outside underwriter had purchased all of Busybox's IPO securities, when actually defendants and other insiders schemed to purchase 20 percent, or some $2.5 million, in unsold Busybox securities using proceeds from the IPO itself; they falsely reported an estimated $375,000 in legal fees payable from proceeds of the IPO, when an existing retainer agreement then known to defendants entitled counsel to at least $960,000; they falsely overstated, given defendants' purchasing scheme, net IPO proceeds by some $2.5 million; and, they failed to disclose that a substantial portion of IPO proceeds would be given to Busybox executives, including Grotto and Leffers. The Offering Documents were created between June 1999 and June 26, 2000; on June 30, 2000, Grotto and Leffers signed a Certificate of Officers and Directors certifying that the Offering Documents did not contain any material misrepresentations or omissions and that there was no known "material adverse effect" from those documents. (Carl Decision at 12.)

The Carl Court also found that Grotto and Leffers, as part of the scheme to make up for the deficient underwriting, had received IPO stock worth $307,500 and $215,250, respectively. Also from the IPO proceeds, Leffers paid himself $94,757.70 and Grotto $132,383.44. Defendants left Busybox four months after the close of the IPO, but before then they additionally took unauthorized payments of tens of thousands of dollars each, substantially from the IPO proceeds.

Upon finding these facts and others, Judge Fruin determined that Grotto and Leffers were liable for statutory fraud, common law fraud, fraudulent concealment, and violations of Section 11 of the federal Securities Act in connection with the Busybox IPO. He ordered Grotto to pay damages, attorneys' fees, costs, and interest, including punitive damages of $1 million, for a total judgment of $2,486,809.34. Leffers was similarly ordered to pay, including punitive damages of $500,000, a total judgment of $1,986,809.34.

Defendants received notice of the trial, but did not appear.*fn2 Despite defendants' apparent default, the court based its judgment on a detailed, explicit consideration of the substantial evidentiary record, which defendants were able to and did participate in establishing via pretrial litigation. Both Grotto and Leffers failed to appeal within 60 days of being served with a filed, stamped copy of the Carl Judgment, rendering that judgment final. See Rule 2, California Rules of Court; see, e.g., In re Harmon, 250 F.3d 1240, 1246 (deeming final for the purposes of collateral estoppel a prior California trial court's judgment, because defendant in that case had failed to file a timely appeal); (see also P. Exs. E, M).


Summary judgment shall be granted "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits . . . show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c). A "genuine issue of material fact" exists if the evidence is such that a reasonable jury could find in favor of the non-moving party. Holtz v. Rockefeller & Co., 258 F.3d 62, 69 (2d Cir. 2001). The moving party bears the burden of establishing the absence of any genuine issue of material fact. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 256 (1986). In deciding a summary judgment motion, the court must "resolve all ambiguities and draw all reasonable references in the light most favorable to the party opposing the motion."

Cifarelli v. Vill. Of Babylon, 93 F.3d 47, 51 (2d Cir. 1996). Moreover, the court is not to make any credibility assessments or weigh the evidence at this stage. Weyant v. Okst, 101 F.3d 845, 854 (2d Cir. 1996). Further, the supporting papers of a pro se litigant should be liberally interpreted "to raise the strongest arguments that they suggest." Burgos v. Hopkins, 14 F.3d 787, 790 (2d Cir.1994).

The nonmoving party, however, may not rely on "conclusory allegations or unsubstantiated speculation." Scotto v. Almenas, 143 F.3d 105, 114 (2d Cir. 1998). The non-moving party "must do more than simply show that there is some metaphysical doubt as to the material facts," Matsushita Elec. Indus. Co., Ltd., v. Zenith Radio Corp., 475 U.S. 574, 586 (1986), and rather show that there is "significant, ...

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