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United States Securities and Exchange Commission v. Zwick

March 16, 2007


The opinion of the court was delivered by: John G. Koeltl, District Judge


In this action, the Securities and Exchange Commission (the "SEC") sued David Zwick and Terrence J. O'Donnell for violations of the federal securities laws in connection with a scheme to defraud New York Life Insurance Company ("New York Life"). At all times relevant to this case, both Zwick and O'Donnell were securities professionals associated with the Ft. Lauderdale broker-dealer Suncoast Capital Group ("Suncoast"). From January 1998 through May 1999, Anthony Dong-Yin Shen, a bond trader at New York Life, defrauded his employer by directing bond trades to Suncoast, frequently at prices materially unfavorable to New York Life, in return for cash and other gifts. Deborah Breckenridge, a sales representative at Suncoast, provided items of value to Shen and received sales commissions from Suncoast's trades with New York Life in return. Shen and Breckenridge were criminally convicted of securities fraud for their roles in the scheme.

At the time of the relevant events, Zwick was a one-third owner of the general partner of Suncoast, a principal of the firm, Breckenridge's supervisor, and the Chief Compliance Officer for the firm. O'Donnell, a Suncoast mortgage-backed bond trader, executed the Suncoast--New York Life trades starting in 1997 until in or around May 1999.

The complaint alleged three claims against the defendants: (1) direct violations of Section 17(a) ("Section 17(a)") of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a) (First Claim);*fn1 (2) direct violations of Section 10(b) ("Section 10(b)") of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder ("Rule 10b-5"), 17 C.F.R. § 240.10b-5 (Second Claim);*fn2 and (3) aiding and abetting Breckenridge's and Shen's violations of Section 10(b) and Rule 10b-5, in violation of Section 20(e) ("Section 20(e)") of the Exchange Act, 15 U.S.C. § 78t(e) (Third Claim).*fn3

After a three week trial, the jury returned a special verdict in which it was asked not only whether each defendant violated the specific provisions of the federal securities laws as charged in the complaint, but also, if they found a violation, to identify which of two schemes constituted the violation. The first scheme was a scheme to provide bribes, kickbacks, and items of value to Anthony Shen in exchange for Shen's directing trades from New York Life to Suncoast. The second scheme involved the failure to disclose to New York Life excessive markups charged by Suncoast on its trades with New York Life. The jury's responses to the special verdict form found that Zwick had violated each of the three provisions of the securities laws at issue by participating in and aiding and abetting both schemes. The jury found that O'Donnell did not directly violate either Section 17(a) or Section 10(b) and Rule 10b-5, and violated Section 20(e) only by aiding and abetting Breckenridge and Shen in the excessive-markup scheme.

At the close of the trial, after the jury returned its verdict, the defendants orally moved for judgment as a matter of law pursuant to Federal Rule of Civil Procedure 50(b) and, in the alternative, for a new trial pursuant to Federal Rule of Civil Procedure 59. The Court reserved decision on those motions and the parties proceeded to brief them. Meanwhile, the SEC has requested the relief that it contends should be included in the judgment to be entered by the Court. The SEC seeks a permanent injunction against each defendant prohibiting him from violating Section 17(a) and Section 10(b) and Rule 10b-5; an order of disgorgement in the amount of $181,625.18 for Zwick and $53,567.44 for O'Donnell, together with pre-judgment interest; and civil penalties in the amount of $330,000 for Zwick and $110,000 for O'Donnell. The defendants have resisted each of the claims for relief, contending that no injunction should be issued and that the amounts of disgorgement and civil penalties, if any, should be substantially less than those sought by the SEC.

For the reasons explained below, the defendants' motions pursuant to Rules 50(b) and 59 are denied. The Court will enter a judgment that includes some-but not all-of the relief sought by the SEC.


It is well-established that a district court should deny a Rule 50 motion unless "viewed in the light most favorable to the nonmoving party, 'the evidence is such that, without weighing the credibility of the witnesses or otherwise considering the weight of the evidence, there can be but one conclusion as to the verdict that reasonable [persons] could have reached.'" Cruz v. Local Union No. 3 of the Int'l Bhd. of Elec. Workers, 34 F.3d 1148, 1154-55 (2d Cir. 1994) (quoting Simblest v. Maynard, 427 F.2d 1, 4 (2d Cir. 1970)) (alteration in original); see also Fowler v. N.Y. Transit Auth., No. 96 Civ. 6796 (JGK), 2001 WL 83228, at *1 (S.D.N.Y. Jan. 31, 2001); Dailey v. Société Générale, 915 F. Supp. 1315, 1321 (S.D.N.Y. 1996), aff'd in relevant part, 108 F.3d 451, 457-58 (2d Cir. 1997).

A trial court considering a motion under Rule 50(b) "must view the evidence in a light most favorable to the non-movant and grant that party every reasonable inference that the jury might have drawn in its favor." Samuels v. Air Transp. Local 504, 992 F.2d 12, 16 (2d Cir. 1993). A jury verdict should be set aside only when "there is such a complete absence of evidence supporting the verdict that the jury's findings could only have been the result of sheer surmise and conjecture, or [where there is] such an overwhelming amount of evidence in favor of the movant that reasonable and fair minded [jurors] could not arrive at a verdict against [the movant]." Logan v. Bennington Coll. Corp., 72 F.3d 1017, 1022 (2d Cir. 1996) (alteration in original) (internal quotation marks and citations omitted); see also Dailey, 915 F. Supp. at 1321.

In the alternative, the defendants move for a new trial pursuant to Rule 59. See Fed. R. Civ. P. 59(a).*fn4 In determining whether a new trial is appropriate under Rule 59(a), a court makes the same type of inquiry as on a motion for judgment as a matter of law, but it imposes a less stringent standard. See Katara v. D.E. Jones Commodities, Inc., 835 F.2d 966, 970 (2d Cir. 1987). A Rule 59(a) motion "ordinarily should not be granted unless the trial court is convinced that the jury has reached a seriously erroneous result or that the verdict is a miscarriage of justice." Patrolmen's Benevolent Ass'n v. City of New York, 310 F.3d 43, 54 (2d Cir. 2002) (internal quotation marks omitted); Katara, 835 F.2d at 970; Newmont Mines Ltd. v. Hanover Ins. Co., 784 F.2d 127, 132 (2d Cir. 1986); Fowler, 2001 WL 83228, at *2.


There was sufficient evidence introduced at trial from which the jury could reasonably have found as follows.

Zwick co-founded Suncoast in 1993. (Trial Tr. ("Tr.") 1457.) In or around August 1993, Zwick hired Breckenridge to be an administrative assistant at Suncoast. (Tr. 661--62.) She was eventually promoted to a sales position and began to receive 40 percent to 50 percent of Suncoast's gross commissions on her sales to institutional customers. (Tr. 670, 1038.)

In late 1997, Breckenridge began to arrange securities trades with New York Life through Shen, a trader at New York Life. (Tr. 687--88.) The securities trades with New York Life were "riskless." As the SEC's expert Perrin Arturi explained, a "riskless" transaction is one in which the trader incurs little or no risk because the trader purchases and sells the security simultaneously, essentially acting as an agent of the buyer or seller. (Tr. 1152--56.) Suncoast would purchase the security from New York Life and simultaneously sell it to another customer, usually a primary broker-dealer, or buy the security from another customer and simultaneously sell it to New York Life. (Tr. 552, 694, 1162--63, 1914--15, 1921.) All the trades with New York Life beginning in 1997 were "riskless" trades. (Tr. 564, 694, 1152, 1155--56.)

The securities transactions that Breckenridge arranged with New York Life were primarily the purchase from or the sale to New York Life of mortgage-backed securities issued by federal agencies. The mortgages underlying those securities were either "to be announced" ("TBA") or "specified pools." (Tr. 1162-64.) The transactions also involved some Treasury bonds. (Tr. 1165.) According to Arturi, the prevailing rate charged by a broker to effect the purchase or sale of a TBA on a riskless principal or agency basis was the difference between the buy and sell price of the security, which in 1998 and 1999 was 1/32 of one percent of the value of the TBA bond or Treasury bond and 4/32 of one percent of the value of a specified pool. (Tr. 1164--65.)

A "tick" is the commonly used term for 1/32 of one percent of the value of the bond, or $312.50 per million dollars on a bond. (Tr. 1145-46.) Arturi testified that the purchases or sales of TBAs or Treasury securities to New York Life that included a markup of 2 ticks or more included an unreasonable or excessive markup, and that the purchases or sales of specified pools to New York that included a markup in excess of 8 ticks included an unreasonable or excessive markup.*fn5 (Tr. 1164-66.) Arturi concluded that, during 1998 and 1999, Breckenridge arranged twenty-seven transactions with New York Life that included excessive markups. (Tr. 1165.) These twenty-seven transactions, out of a total of forty-nine transactions with New York Life (Tr. 1165), included excessive markups and the total commissions earned on those transactions was about $1.3 million out of total commissions on all transactions with New York Life in excess of $1.6 million (Pl.'s Ex. 154-A, 154-B).

In late 1997, when Breckenridge began arranging securities trades with Shen, Breckenridge's riskless trades with New York Life carried markups that ranged from approximately 0.13 ticks to 1.75 ticks and earned Suncoast gross commissions of between approximately $1,400 and $11,000 per trade. (Pl.'s Ex. 152, 154-B.) She worked on three more trades with New York Life and Shen in early January 1998, on which the markups Suncoast charged New York Life ranged from 0.5 ticks to 1.5 ticks. Defendant O'Donnell was the trader for each of these trades.*fn6

In 1998 and 1999, all of Suncoast's trades with New York Life were riskless, and all involved either mortgage-backed securities or Treasury bonds. However, the markups Suncoast charged, the gross commissions it obtained, and the manner of trading itself changed significantly in late January 1998, when, shortly after Breckenridge took Shen to dinner in New York, Shen purchased a $25 million Fannie Mae 6.5% TBA bond through Suncoast, giving Suncoast a 3.25 tick markup and a gross commission of $25,390.63 on the trade. The markup was nearly twice the largest markup on any previous riskless New York Life trade, and the gross commission-which was more than twice the largest commission Suncoast had received on any previous trade with New York life-exceeded the gross commissions on all of the 1997 riskless New York Life trades. No one questioned the trade; Zwick and O'Donnell (the trader on the trade) instead congratulated Breckenridge for a "good trade." (Pl.'s Ex. 1-B, 154-B; Tr. 702--10.)

When Breckenridge asked Shen for a trade the following day, Shen refused, e-mailing Breckenridge "hahaha, sure for two [NBA] all-star tix." (Pl.'s Ex. 2-C; Tr. 268--70.) Breckenridge discussed the e-mail with Zwick, her supervisor. Zwick told her that even though it would be a violation of the National Association of Securities Dealers ("NASD") gift rules if Breckenridge did not accompany Shen to the game, Zwick would see if he could get the tickets for Shen. (Tr. 711.) Zwick initially thought he might be able to obtain the tickets at no cost from a broker's broker. (Id.) Fifteen minutes after Shen had first asked for the tickets, Breckenridge e-mailed Shen that Suncoast was working on getting him the tickets. Thereafter, Shen announced that "now we can reverse [the previous day's] trade" and gave a firm offer to sell a $25 million Freddie Mae 6.5% TBA to Suncoast at a price below the market price. (Pl.'s Ex. 2-C; Tr. 271.) Suncoast then completed the transaction by buying the bond from New York Life and selling it to Lehman Brothers at a markup of 7 ticks for a gross commission of $54,687.50. (Pl.'s Ex. 154-B.)

Unable to obtain the tickets at no cost, Zwick obtained the All-Star tickets from a Ft. Lauderdale ticket broker for $6,400, arranged for the delivery of the tickets to Shen, and personally rerouted the tickets from Shen's home to his office address at Shen's request. (Pl.'s Ex. 3-C, 43; Tr. 713--715, 1562--65.) On the day the All-Star tickets were delivered, Shen gave Suncoast a third off-market TBA trade, giving Suncoast a 5.5 tick markup and a gross commission of $60,156.25 on a bond Suncoast bought from Salomon Smith Barney and sold to New York Life. (Pl.'s Ex. 3-A, 3-B, 3-C.)

Thus, on three off-market trades within two weeks, Suncoast made more than $140,000 in gross commissions compared to under $50,000 in gross commissions for all its previous trades with New York Life. O'Donnell was the trader on all of these trades. (Pl.'s Ex. 1-A, 1-B, 2-A, 2-B, 3-A, 3-B.)

Zwick did not fill out a gift form for the tickets, nor were the tickets reported to New York Life. Aware that giving tickets to unattended sporting events for trades was considered bribery, Zwick nonetheless personally obtained the tickets, ensured that Shen was satisfied with the seats, and ensured that Shen received them. (Tr. 1627.) Breckenridge's compensation was reduced by 40 percent of the cost of the tickets, just as she would receive 40 percent of any commissions she generated. (Tr. 1629--30.) Shen understood that the All-Star tickets were a sign that Suncoast was prepared to swap trades for incentives. (Tr. 208.)

Thereafter, Breckenridge engaged in a series of "one-way" bets with Shen, on the outcome of events such as the Academy Awards or sporting events such as the Masters Golf Tournament.

As Shen explained to Breckenridge over the telephone, betting with him was a "win-win" proposition. If Breckenridge lost, she would pay off the bet, and Shen would provide a favorable trade to Suncoast. If Shen lost, he would provide a favorable trade to Suncoast. (Tr. 720-724, 739-41.) Shen continued to provide trades to New York Life with excessive markups. Breckenridge testified credibly that Zwick was aware of the continuing arrangement, and indeed instructed her on how to make the payments. (Id.; Tr. 728-32, 738.) Zwick also instructed Breckenridge to keep her trades with New York Life quiet after a co-worker complained about the trades with Shen, but also instructed her to continue trading with Shen, and to keep Shen happy. (Tr. 752-54.)

When Shen asked for tickets to a Knicks game on May 10, 1998, Breckenridge discussed Shen's request with Zwick. Zwick told her that the firm had already spent too much on Shen, but he advised her that she could use the same ticket broker who sold him the NBA All-Star tickets he obtained for Shen in February, and gave Breckenridge the business card for the broker. He also said, if anyone asked about the conversation, he would deny that it had occurred. Breckenridge followed Zwick's advice, purchasing the tickets for $2,600 on May 6, 1998. In return, Shen sent New York Life trades to Suncoast in May to "compensate [Suncoast] for the price they had to pay for the tickets." Breckenridge told Zwick that she had purchased the tickets, and he told her to keep up the good work. (Pl.'s Ex. 110; Tr. 359--60, 759--66.)

In 1999, in response to Shen's request for some travel and entertainment from Suncoast, Zwick agreed to pay for Shen's expenses for a trip in April to Paradise Island, a gambling casino in the Bahamas, where he would be accompanied by Breckenridge and her husband. After the trip, Zwick asked Breckenridge about the trip and whether she had paid for Shen's gambling. Breckenridge said that she had paid her debts, that she paid off her bets. Breckenrdige paid Shen $14,000 in cashier's checks and $6,000 in cash to compensate him for the New York Life trades with Suncoast. (Pl.'s Ex. 111; Tr. 788-- 93.)*fn7

Breckenridge testified that defendant O'Donnell executed the mortgage-backed securities trades with New York Life in 1998 and 1999, as well as the riskless TBA trades with New York Life in 1997. (Tr. 754.) O'Donnell executed twenty of the twenty-seven trades with excessive markups. The remaining seven trades involved Treasury securities.*fn8 O'Donnell received a commission on the New York Life trades he executed for Breckenridge. (Tr. 1900--04.) The jury could reasonably find that he was aware that the trades he executed with New York Life contained excessive markups. His position as a trader provided him with the information to see that the markups to New York Life were in fact excessive, and O'Donnell testified that he reviewed the prices in the market for the New York Life trades he executed and reviewed the markups to determine if they were excessive. (Tr. 1911-12.) Despite this review, he executed a trade on January 13, 1999 on a specified pool which Suncoast sold to New York Life at a markup of 42.5 ticks, substantially in excess of 1 percent or 32 ticks, for a gross commission of $125,590.11. (Pl.'s Ex. 154-B; Tr. 1905-06.) He also executed a sale of another specified pool to New York Life on January 25, 1999 with a markup of 43 ticks, again substantially in excess of 1 percent or 32 ticks, for a gross commission of $148,157.56. (See Pl.'s Ex. 154-B.)

Moreover, there was evidence from which the jury could reasonably have inferred that O'Donnell took steps to disguise the excessive markups to New York Life. For example, he tried to locate higher coupon (9% to 10%) mortgage pools to trade with New York Life as a means to conceal the red flag raised by the progressively higher spreads on the New York Life trades. (Tr. 1032--34.) When Breckenridge informed O'Donnell that someone at New York Life had questioned the $150 million dollar roll trade he did on April 7, 1999 as excessively marked up, he did not challenge or investigate that statement, but proceeded to alter the trade tickets to make it appear that, consistent with Shen's excuse for the trade, all the individuals involved in the trade-- including Breckenridge, O'Donnell, and Shen--had coincidentally all made the same mistake on the price. (Tr. 794--96, 801--03.) This resulted in reducing the original 2 1/4 tick markup to a 1/4 tick markup and reduced the commission from $90,000 to $11,000. (Id.) Finally, O'Donnell also executed the last trade between Suncoast and New York Life on May 13, 1999, a trade conducted at no profit to Suncoast, designed to make it appear that there had been some "legitimate" business between Suncoast and New York Life. (Pl.'s Ex. 185; Tr. 806--07.)



Both Zwick and O'Donnell argue that they are entitled to judgment as a matter of law or a new trial on the grounds that, as a matter of law, the jury could not have found, or at least was seriously erroneous in concluding, that there was a scheme to defraud based on charging New York Life excessive markups. Each of the defendants argues that the markups in this case were not excessive under the current law, that the defendants were not on notice that the markups in this case could be deemed excessive, and indeed, that it would be a violation of due process to uphold a jury verdict that concluded that the markups were excessive.

The Court of Appeals for the Second Circuit has long recognized that broker-dealers must disclose excessive markups to their customers. See Press v. Chem. Inv. Serv. Corp., 166 F.3d 529, 534 (2d Cir. 1999) (stating that a broker "has a duty to disclose the specifics of a markup... when there is either a fiduciary relationship with the complaining party or when the markup is 'excessive.'" (citing Grandon v. Merrill Lynch & Co., 147 F.3d 184, 190 (2d Cir. 1998))); Charles Hughes & Co. v. SEC, 139 F.2d 434, 437 (2d Cir. 1943) ("[T]he [SEC] has consistently held that a dealer cannot charge prices not reasonably related to the prevailing market price without disclosing that fact."); see also SEC v. Feminella, 947 F. Supp. 722, 728--29 (S.D.N.Y. 1999). The duty is grounded in the "implied representation that broker-dealers charge their customers securities prices that are reasonably related to the prices charged in an open and competitive market." Grandon, 147 F.3d at 189; see also SEC v. First Jersey Secs., Inc., 101 F.3d 1450, 1469 (2d Cir. 1996).

It is also well-established that a "failure to disclose an excessive markup constitutes a violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder." Feminella, 947 F. Supp. at 731 (emphasis omitted); see also Grandon, 147 F.3d at 190 ("a broker-dealer commits fraud... by charging customers excessive markups without proper disclosure"); First Jersey, 101 F.3d at 1469 ("a broker-dealer who charges customers retail prices that include an undisclosed, excessive markup violates § 17(a) and § 10(b) of the securities laws"). Markups are measured as the difference between the price charged to the customer and the prevailing market price. Absent other evidence, the market price is the dealer's cost of acquiring a security or the price the dealer received on the sale of that security. See Grandon, 147 F.3d at 189. Markups are excessive when they bear "no reasonable relation to the prevailing market price." Id. at 190.

The determination of whether a markup is excessive involves a factual analysis to be done on a case-by-case basis; the reasonableness of the markups charged differs depending on the circumstances, including, specifically, the type of securities involved in the trades. See Feminella, 947 F. Supp. at 729 ("there is no single, fixed definition of what constitutes an excessive markup for all transactions"). Among the factors relevant to the determination of whether a markup is excessive are the expense associated with effectuating the transaction, the reasonable profit fairly earned by the broker or dealer, the expertise provided by the broker or dealer, the total dollar amount of the transaction, the availability of the financial product in the market, the price or yield of the instrument, the resulting yield after the subtraction of the markup compared to the yield on other securities of comparable quality, maturity, availability, and risk, and the role played by the broker or dealer.

Press, 166 F.3d at 535; see Grandon, 147 F.3d at 190 (discussing relevant considerations in assessing excessiveness of markups on municipal securities). The finder of fact must assess various factors including "industry practice regarding the range of appropriate markups on a particular security or similar type of security in comparable transactions... and the nature of the services that the brokerage firm or its associated persons have provided to the customer." Feminella, 947 F. Supp. at 729 (citations omitted); see In the Matter of Lehman Bros. Inc., S.E.C. Exchange Act Release No. 34-37673, 1996 WL 519914, at *5 (Sept. 12, 1996).

Both defendants argue that the alleged excessive markups on the trades involved in this case, which ranged from 2.5 ticks to 43 ticks, were simply too low as a matter of law to be excessive. However, based on the particular facts and circumstances of this case, and viewing those facts in the light most favorable to the SEC, a rational jury could conclude that Suncoast's charges to New York Life in this case included excessive markups.

During the trial, the SEC presented substantial evidence to show that the prices charged by Suncoast to New York Life included excessive markups. First, the SEC presented expert testimony from Perrin Arturi, the only expert presented at the trial, who identified twenty-seven trades occurring between January 1998 and April 1999 in which, in his opinion, Suncoast charged excessive markups to New York Life. (Tr. 1169--70, 1177-- 78, 1182--85; see also Pl.'s Ex. 154-A.) Arturi, a senior managing director of Bear Stearns & Company, had extensive experience in the trading of mortgage-backed securities and Treasury securities, including experience trading the types of securities that were traded between Suncoast and New York Life from 1997 to 1999. (Tr. ...

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