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Securities and Exchange Commission v. Zafar

January 20, 2009

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
FAISAL ZAFAR AND SAMEER THAWANI, DEFENDANTS.



The opinion of the court was delivered by: John Gleeson, United States District Judge

MEMORANDUM AND ORDER

On April 6, 2006, the Securities and Exchange Commission ("SEC" or "the Commission") brought this civil action against Faisal Zafar and Sameer Thawani, alleging a conspiracy to fraudulently manipulate the prices of 24 thinly traded "microcap" stocks. On the same day, Safar and Thawani were arrested in connection with parallel criminal charges in this district. United States v. Zafar, 06-CR-289 (JG). Zafar was found guilty after a jury trial before me of fifteen counts of securities fraud and one count of conspiracy to commit securities fraud. He was subsequently sentenced to principally a 57-month term of imprisonment.

In this civil action, the SEC now seeks partial summary judgment. Specifically, it seeks (1) an order permanently enjoining Zafar from violating Section 17(a) of the Securities Act of 1933 ("Securities Act"), Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and SEC Rule 10b-5; (2) an order requiring Zafar to disgorge his gains from the allegedly fraudulent scheme, plus prejudgment interest; and (3) an appropriate civil monetary penalty. Zafar contends that there is still a genuine issue of material fact regarding the amount of profit he realized through his unlawful conduct. For the following reasons, I grant the government's request for injunctive relief, order disgorgement in the amount of $290,193.14, and impose a civil penalty of the same amount.

On November 26, 2007, Zafar moved for a modification of an earlier order freezing certain of his assets. Because the amount of financial relief awarded to the SEC exceeds the amount of assets frozen, his motion is denied.

BACKGROUND*fn1

On the day the SEC filed its complaint, I entered a Temporary Restraining Order ("TRO") freezing Zafar's and Thawani's assets and enjoining them from continuing the violations alleged in the complaint. On April 28, 2006, the federal grand jury indicted Zafar*fn2 on a single count of conspiracy to commit securities fraud and 15 counts of securities fraud arising from transactions involving 15 of the 24 stocks mentioned in the civil complaint. On May 5, 2006, I ordered, with defendants' consent, that the asset freeze and other injunctive relief set forth in the TRO remain in place, as a preliminary injunction, during the pendency of the criminal case.

At trial, the government presented evidence that, between November 2004 and April 2006, Zafar knowingly and unlawfully manipulated the stock prices of the 15 companies identified in the indictment. Pursuant to Federal Rule of Evidence 404(b), it also presented evidence of Zafar's manipulation of two additional stocks. The trial evidence demonstrated that, with regard to each of the 17 companies, Zafar engaged in a "pump and dump" scheme, purchasing shares of stock at the prevailing market price, knowingly making or causing to be made material false statements about the value of the stock, and then selling his shares at the higher prices after the false statements were made. On June 12, 2007, a jury found Zafar guilty of all sixteen counts.

On September 28, 2007, Zafar was sentenced. The parties disputed the magnitude of the loss caused by Zafar's crimes. The government argued that under United States Sentencing Guidelines ("U.S.S.G.") § 2B1.1(b)(1), Zafar's offense level should be increased by 14 based on a loss of more than $400,000 but less than $1,000,000. Gov't Letter 1-2, United States v. Zafar, 06-CR-289 (E.D.N.Y. Sept. 11, 2007). Relying on Application Note 3(B) of Section 2B1.1, the government contended that the gain from the offense was a proper measure of loss because the actual amount of loss could not be reasonably ascertained. Id. The government contended that Zafar's "illegal trading profits from his manipulation of the fifteen stocks expressly named in the indictment total $621,031," and that his "illegal trading profits from his manipulation of the additional two stocks as to which the government presented evidence at trial . . . total $34,775." SEC Stmt. ¶ 28. The Presentence Report (PSR) stated that Zafar's trading profits from the manipulation of the 24 stocks referenced in the civil complaint total $762, 159. Id. at ¶ 31. The PSR also stated that Thawani made $153,811 by illegally manipulating the stocks referenced in the civil complaint, bringing the total of Zafar and Thawani's profits to $915,970. Id.

In his objections to the PSR, Zafar argued that the probation office's profit calculations (1) involved stocks not contained in the indictment; (2) included profits made by Thawani, who was not convicted of any crimes; (3) did not include any losses sustained by Zafar; (4) ignored the fact that some of Zafar's profits came from increases in stock prices that were not caused by his false statements; and (5) ignored the possibility that some of Zafar's profits resulted from the legitimate use of stock-trading software. Based on these contentions, Zafar submitted "that a more appropriate enhancement would be 12 levels based on a profit of more than two hundred thousand but less than four hundred thousand." Request for Adjournment and Pre-Sentence Response 2, United States v. Zafar, No. 06-CR-289 (JG) (E.D.N.Y. Aug. 17, 2007).

I determined that a 14-level enhancement was appropriate. I found that the profit calculation contained in the PSR was a "reasonable estimate as to the amount of loss," and I noted that even if Zafar's actual profit was only half of the government's estimate, the 14-level enhancement would still apply. Sept. 28, 2007 Tr. 23, United States v. Zafar, No. 06-CR-289 (E.D.N.Y. Sept. 28, 2007). Based on those findings, Zafar's advisory guidelines sentence range was 46 to 57 months, and I sentenced him to 57 months in the custody of the Attorney General, five years of supervised release, $1,600 in special assessments, and restitution in the amount of $85,082.09. Id. at 33. On September 4, 2008, the court of appeals affirmed Zafar's conviction and sentence by summary order. United States v. Zafar, No. 07-4345-cr, 2008 WL 4138219 (2d Cir. 2008).

On November 11, 2008, the SEC filed the instant motion for partial summary judgment. It argues that it is entitled to the relief it seeks as a matter of law following Zafar's conviction and my findings during sentencing. Zafar did not file a formal response to the motion. On November 17, 2008, I received a letter by fax from Mishal Zafar, the defendant's wife, indicating that he had recently been transferred to MDC Brooklyn and requesting a four-week enlargement of time to file a response. I denied the motion without prejudice to renewal at oral argument and directed that Zafar be produced in court for the argument on December 12, 2008. Zafar argued that the government's calculations overstated the profits he realized through his fraud. He asserted that the profits he made by trading the named stocks at the time he made false statements about those stocks amounted to only $290,000, and that any other profits he made by trading those stocks are not relevant for calculating disgorgement or civil penalties.

While Zafar's appeal was pending, he sought access to some of the funds covered by the May 2006 preliminary injunction and asset freeze. In a letter motion filed on November 26, 2007, he sought approximately $2,400 in living expenses, $12,000 per month in legal expenses relating to the civil case, and $5,000 to pay for an expert witness in the civil action. On November 30, 2007, I referred this motion to Magistrate Judge Marilyn D. Go for a report and recommendation. During a December 5, 2007 hearing on this motion, Judge Go directed Zafar to submit an accounting statement addressing the amount of profits he realized by trading the 15 stocks mentioned in the indictment. In a letter dated December 28, 2007, Zafar submitted a letter stating that the total profit made on these stocks was $290,193.14. The government responded that the true calculation of Zafar's ill-gotten gains should include all profits from trades made during the period of the fraudulent scheme alleged in the indictment, from November 2004 through April 2006.

On November 24, 2008, Judge Go issued a Report and Recommendation ("R&R") recommending that I deny Zafar's motion. Judge Go concluded that "the Commission has provided sufficient evidence, based on evidence presented in the criminal trial of defendant, that his ill-gotten gains from his fraudulent scheme involving the same 15 stocks that are at issue in this civil case totaled $621,032." R&R 8. Because the SEC was seeking disgorgement in this amount, and the total value of the frozen assets was $502,408, Judge Go concluded that "the asset freeze should remain unchanged in order to preserve the already limited funds that may be used to satisfy any future disgorgement order." Id. at 9. Judge Go also noted that, even if Zafar's profit calculation was correct, the SEC could seek, in addition to disgorgement, a civil penalty equal to the amount of profit. Accordingly, assuming $290,000 of gain and an identical amount in civil penalty, "the amount frozen is still insufficient to satisfy any award that the Commission could recover in this case." Id.

On December 5, 2008, Mishal Zafar faxed me a letter requesting that, despite Judge Go's recommendation, I carve out some amount of assets for living expenses for her and her two young children. At the December 12 oral argument on the summary judgment motion, Zafar requested additional time to file a formal objection to the report and recommendation. He indicated that his objection would be based on his calculation of his "ill-gotten" profits. Dec. 12 Tr. 15 ("As far as that motion goes, . . . I'm basing it on the same principle that I just discussed as far as the 290,000, because I was given a differentiation of several hundred thousand, which would basically leave some money that's not considered ...


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