The opinion of the court was delivered by: Dora L. Irizarry, United States District Judge:
The Securities and Exchange Commission ("SEC") initiated the instant enforcement action on May 5, 2010 against defendants Spongetech Delivery Systems, Inc. ("Spongetech"), RM Enterprises International, Inc. ("RM Enterprises"), Steven Y. Moskowitz, Michael E. Metter, George Speranza, Joel Pensley, and Jack Halperin, alleging violations of several securities laws and rules, including Sections 5 and 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5.*fn1 The SEC alleges that defendants "pumped" the value of Spongetech‟s shares and "dumped" the shares into the public market in unregistered transactions. Presently before the court is the SEC‟s Motion for preliminary injunctive relief. For the reasons set forth below, the SEC‟s motion is granted in part, stayed in part, and denied in part without prejudice.
Spongetech is a publicly-traded company that sells soap-filled sponges. On July 9, 2010, while the parties were briefing the current motion, Spongetech petitioned for bankruptcy. On July 19, 2010, the Bankruptcy Court directed the appointment of a trustee over Spongetech, and on July 20, 2010, the trustee was approved.
RM Enterprises is the majority shareholder of Spongetech. Metter was Spongetech‟s President and Chief Executive Officer ("CEO"), but he resigned as CEO subsequent to the filing of the instant motion. (Spongetech Memorandum in Opposition, Docket Entry 39 ("Spongetech Opp."), at 4.) Metter also served as President of RM Enterprises until his resignation in September 2007.*fn2 (Metter Memorandum in Opposition, Docket Entry 40, "Metter Opp."), at 3.) Moskowitz is Spongetech‟s Chief Operating Officer ("COO"), Chief Financial Officer ("CFO"), Chief Accounting Officer ("CAO"), and Secretary, and he served as a member of Spongetech‟s Board of Directors.*fn3 Moskowitz also served as an officer and director of RM Enterprises, although his current status is unclear. Speranza is a self-employed consultant associated with Spongetech.
Pensley and Halperin are attorneys licensed to practice in the state of New York. Pensley has a history of securities violations. In 1998, Pensley was enjoined from future violations of the general antifraud and registration provisions of the federal securities laws and suspended pursuant to Rule 102(e) of the SEC‟s Rules of Practice.
B.SEC ALLEGATIONS AND FACTUAL BACKGROUND
1. Spongetech, Metter and Moskowitz Issue False Statements in Press Releases and Public Filings
To create the appearance of prosperity, Spongetech, Metter, and Moskowitz allegedly made materially false or misleading statements in press releases and public SEC filings with respect to Spongetech‟s reduction in the number of its outstanding shares, business with five customers, and Spongetech‟s revenue. Moskowitz and Metter reviewed and authorized the press releases and signed and certified the public filings before they were issued. (See Declaration of Christine E. Neal, dated May 13, 2010 ("Neal Decl.") ¶ 8 & Ex. B.)
In a February 2, 2009 press release, Metter announced that Spongetech had decreased its issued and outstanding shares "by approximately 29%," leaving 700,000,000 shares issued and outstanding. (Declaration of Charles C. Davis, dated May 13, 2010 ("Davis Decl. I") ¶ 26 & Ex. R.) However, the actual number of shares as of that date was 1,240,355,602. (Id. ¶ 26 & Ex. Q.) Similarly, Spongetech‟s quarterly report for the quarter ended February 28, 2009 states that Spongetech had 722,866,061 shares of common stock issued and outstanding as of April 16, 2009. (Id. ¶ 26 & Ex. G.) However, the actual number of shares as of that date was 1,621,866,461. (Id. ¶ 26 & Ex. Q.)
Between April 2007 and May 2010, Spongetech issued several press releases, often quoting Metter or Moskowitz, describing business with five customers that do not exist. On April 30, 2007, Spongetech issued a press release claiming that it had "signed a Letter of Intent (LOI) to sell 1,500,000 Car Wash and Car Wax sponges to exporter, SA Trading Group Corp. . . . an exporter of automotive products to South America." (Id. ¶ 7 & Ex. C.) The press release quoted Moskowitz as stating that they were finalizing their agreement with SA Trading Group Corp. (Id.) In 2008, Spongetech issued press releases claiming product sales to three large foreign customers: SA Trading, US Asia Distribution ("US Asia"), and Dubai Export Import Company ("Dubai"). (Id. ¶ 8 & Ex. D.) On September 1, 2009, Spongetech issued a press release, which described the financial success of the company and quoted both Metter and Moskowitz describing the success of the company and the large amount of orders the company had received. (Id. ¶ 10 & Ex. F.)
In Spongetech‟s 10-Q for the period ended February 28, 2009, Spongetech reported revenue in excess of $30 million and stated that 99.4% of its sales were attributable to six customers: SA Trading, Dubai, US Asia, Fesco Sales Corp., New Century Media and Walgreens. (Neal Decl. ¶ 8 & Ex. B.) Several other filings contained similar misrepresentations about customers and revenue. In Spongetech‟s Form 10-KSB for the fiscal year ended May 31, 2008, Spongetech represented that 70.5% of its reported shares for the period were derived from orders received from customers identified as SA Trading, US Asia and Dubai. (Id. ¶ 5 & Ex. B.) In Spongetech‟s Form 10-Q, filed with the SEC on October 15, 2008, Spongetech represented that, for the three-month period that ended August 31, 2008, 67.7% of its reported sales were derived from SA Trading, US Asia and Dubai. (Id. ¶ 6 & Ex. B.) In Spongetech‟s Form 10-Q, filed with the SEC on January 14, 2009, Spongetech represented that, for the period that ended November 30, 2008, 82.9% of its reported sales were derived from SA Trading, Dubai and New Century Media. (Id. ¶ 7 & Ex. B.)
Many of the statements in the press releases and public filings were allegedly false. The SEC was unable to contact five of the customers or verify any information provided by Spongetech regarding the companies‟ existences, and consequently determined that SA Trading, Dubai, US Asia, Fesco Sales Corp., and New Century Media do not exist, and only Walgreens is an existing company. (See SEC Memorandum in Support of Preliminary Injunction, Docket Entry 2 ("SEC Mem."), at 5-7; see also Neal Decl. ¶¶ 4-53.) Moreover, Spongetech‟s bank records demonstrate that it never received payments for the alleged business with these customers. (SEC Mem. 5-6; Davis Decl. I ¶ 14.) Spongetech identified a single corporate bank account in response to an SEC subpoena, the records for which demonstrate that transfers from RM Enterprises, and not customer orders, were the source of the majority of the funds flowing into Spongetech. (Davis Dec. I ¶¶ 14-21.)
2. Speranza Creates False Websites
In September 2009, in response to public and SEC inquiries about Spongetech‟s customers, Speranza created websites and virtual office space for the fictitious customers. (Neal Decl. ¶¶ 26-34, 39-43, 47 & Exs. U, SS.) Speranza maintained the websites and forwarded all emails sent to the websites to his own email account. (Id. ¶ 47.) Speranza testified before the SEC that he made up the names of the contact people for the alleged customers that were listed on the websites. (Id. Ex. SS, Speranza Testimony, at 102-04.) On September 10, 2009, Speranza registered the domain names of each website with a private registration service that prevents access to the personal identifying information of the registrant. (Id. ¶ 42, Ex. GG.) Speranza also arranged for physical space for the fictitious customers. (Id. ¶ 47 & Ex. SS, Speranza Testimony, at 94, 102-04.)
3. Spongetech, Metter and Moskowitz Distributed Restricted Shares through RM Enterprises
After inflating the value of its shares, Spongetech distributed the shares in unregistered transactions to RM Enterprises and other affiliated entities that acted as conduits to further distribute the shares. (Davis Decl. I ¶¶ 27, 35.) Spongetech claimed an exemption and safe harbor under Section 4(2) of the Securities Act and Rule 506 of Regulation D. Both require the issuer to exercise reasonable care to assure that the securities are purchased for investment and not with a view to public distribution. The SEC contends that the shares were issued for the purpose of publicly distributing them.
4. Halperin and Pensley Rendered Baseless Opinion Letters
Between July 2007 and May 2009, numerous opinion letters written on Pensley letterhead were sent to Spongetech‟s transfer agent. (SEC Reply Brief as to Pensley, Docket Entry 106 ("Pensley Reply"), at 2 n.2.) The SEC contends that, although 216 of the letters allegedly were forged, at least four of the letters can be attributed to Pensley. (Id.; SEC Mem. 10.) The SEC argues that the four letters do not have the font and formatting inconsistencies that appear in many of the allegedly forged letters. (SEC Pensley Reply 2 n.2.) The transfer agent used these four opinion letters to remove restrictive legends from approximately twelve million restricted shares. (SEC Mem. 10.) RM Enterprises then distributed the shares in unregistered transactions. In each of the four opinion letters, Pensley contended that all of the requirements of Staff Legal Bulletin No. 4 were met, including that RM Enterprises, as the parent of Spongetech, was "spinning-off" shares of Spongetech to RM Enterprises‟ shareholders, and that RM Enterprises was not doing so for value. (Davis Decl. I ¶ 31 & Ex. V.) The SEC argues that these requirements were not in fact met.
Between June 2009 and September 2009, Halperin issued ninety-two opinion letters, which were sent to Spongetech‟s new transfer agent, who improperly removed restrictive legends from over 922 million Spongetech shares held by RM Enterprises so that the shares could be publicly distributed. In the opinion letters, Halperin relied on Rule 144 and stated that the restrictive legends on Spongetech shares issued to RM Enterprises could be removed because RM Enterprises had held the securities for six months or longer. However, on several occasions, Moskowitz used Halperin‟s letters to remove the restrictive legends from shares only a few days after Spongetech issued the shares to RM Enterprise or other affiliates.
A.Preliminary Injunction Standards
1. Restraint Against Future Securities Law Violations
To obtain a preliminary injunction enjoining future violations of securities laws, the SEC must make a "clear showing" of both (1) the likelihood of success by establishing a prima facie case of a past violation of the securities laws, and (2) a "reasonable likelihood" of future violations absent the injunction. SEC v. Unifund SAL, 910 F.2d 1028, 1037 (2d Cir. 1990); see also SEC v. Cavanagh, 155 F.3d 129, 132 (2d Cir. 1998) (requiring "a substantial showing"). There is no requirement that the SEC demonstrate irreparable injury or lack of any adequate remedy at law. See SEC v. Mgmt. Dynamics, Inc., 515 F.2d 801, 808 (2d Cir. 1975).
"Although the Court may enter an injunction upon a proper showing of a violation of securities laws, "there is no per se rule requiring the issuance of an injunction upon the showing of a past violation.‟" SEC v. Gonzalez de Castilla, 145 F. Supp. 2d 402 (S.D.N.Y. 2001) (quoting SEC v. Bausch & Lomb, Inc., 565 F.2d 8, 18 (2d Cir. 1977)). To determine whether an injunction should be granted, courts consider such factors as: (1) the degree of scienter exhibited; (2) whether the violation was an isolated incident; (3) the sincerity of the defendant‟s assurances against future violations; (4) the defendant‟s recognition of the wrongful nature of his conduct; and (5) whether, by reason of his professional occupation, defendant might be in a position that may provide the opportunity for future violations. SEC v. Suman, 684 F.Supp.2d 378, 391-92 (S.D.N.Y.2010); SEC v. Prater, 296 F. Supp. 2d 210, 216 (D. Conn. 2003); see also SEC v. Universal Major Indus., 546 F.2d 1044, 1048 (2d Cir. 1976).
The court also must consider the nature of the preliminary relief the SEC is seeking. The SEC should make a "more persuasive showing of its entitlement to a preliminary injunction the more onerous are the burdens of the injunction it seeks." SEC v. Unifund SAL, 910 F.2d 1028, 1039 (2d Cir. 1990); see also SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1102 (2d Cir. 1972) ("the adverse effect of an injunction upon defendants is a factor to be considered by the district court in exercising its discretion")."In some cases a preliminary injunction can have very serious consequences, yet in other cases may be fairly described as only a mild prophylactic." Unifund, 910 F.2d at 1039(internal quotation marks and citations omitted).
More rigorous scrutiny of the SEC‟s evidence in support of restraining future action is warranted where a legal professional is alleged to have violated the securities laws, because "[t]he allegation of such a violation . . . is serious enough to eviscerate an honest lawyer‟s career if endorsed by a court based upon mere suspicion and innuendo." Gonzalez de Castilla, 145 F. Supp. 2d at 415. In SEC v. Cavanagh, 1 F. Supp. 2d 337 (S.D.N.Y. 1998), the court noted: "The reputational and economic harm of suffering a preliminary injunction, especially on charges of fraud, is . . . severe for individuals who make their living in the securities industry . . . . These individuals stand to lose considerable business and respect in their communities if even a preliminary injunction is entered." 1 F. Supp. 2d at 360; see also Gonzalez de Castilla, 145 F. Supp. 2d at 415.
A freeze of assets is an ancillary remedy that merely "assures that any funds that become due can be collected." SEC v. Unifund SAL, 910 F.2d 1028, 1037 (2d Cir. 1990). To obtain an asset freeze, the SEC must demonstrate prima facie evidence that a violation of the securities laws has occurred, but it does not need to show a likelihood of future violations. See id. Courts can also consider whether the "asset freeze is needed in order to prevent [the defendant] from secreting or dissipating his assets." SEC v. Margolin, 1992 WL 279735, at *6 (S.D.N.Y. Sept. 30, 1992); see also SEC v. Montle, 65 Fed. Appx. 749 (2d Cir. 2003); Gonzalez de Castilla, 145 F. Supp. 2d at 420. "A freeze is particularly warranted where the defendant‟s alleged conduct involves fraud." SEC v. Credit Bancorp Ltd., 2010 WL 768944, at *3 (S.D.N.Y. Mar. 8, 2010) (citing Manor Nursing Ctrs., 458 F.2d at 1106).
The SEC‟s burden of proof rises in relation to the hardship the asset freeze would create for the defendants. See Unifund SAL, 910 F.2d at 1037. The court must weigh the importance of ensuring that assets will be available to compensate investors or provide disgorgement against the possibility that the freeze will cause such a disruption of defendants‟ legitimate business affairs that the assets would be destroyed and the investors would be placed in greater danger of losing their funds. See Manor Nursing, 458 F.2d at 1106.
3. Accounting and Preservation Of Documents "[T]he SEC may seek [relief] other than injunctive relief to effectuate the purposes of the federal securities laws." Manor Nursing, 458 F.2d at 1104 (citing SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971)); see also SEC v. Lybrand, 2000 WL 913894, at *12 (S.D.N.Y. July 6, 2000). For example, an accounting is appropriate where it is necessary to determine the amount of profits reaped from the allegedly illicit sales, the present location of such proceeds, or the defendants‟ ability to repay. See Lybrand, 2000 WL 913894, at *12; SEC v. Margolin, 1992 WL 279735, at *7 (S.D.N.Y. Sept. 30, 1992). "Such relief is minimally intrusive." SEC v. Bremont, 954 F. Supp. 726, 733 (S.D.N.Y. 1997). Moreover, an order barring the alteration or destruction of documents is also appropriate where there is a need to preserve the status quo until a final resolution of the merits. See Unifund, 910 F.2d at 1040 n.11.
B.Standards for Demonstrating Securities Violations
1. Sections 10(b) and 17(a) of the Exchange Act
To state a violation of section 10(b) or Rule 10b-5, the SEC must allege that a defendant "(1) made a material misrepresentation or a material omission as to which he had a duty to speak, or used a fraudulent device; (2) with scienter; (3) in connection with the purchase or sale of securities." SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999). "Essentially the same elements are required under Section 17(a)(l)-(3) in connection with the offer or sale of a security, though no showing of scienter is required for the SEC to obtain an injunction under subsections (a)(2) or (a)(3)." Id.
Violative statements are not limited to those made in issuing documents, and defendants have been held liable for misrepresentations in press releases and other corporate documents. In re Ames Dep't Stores Inc. Stock Litig., 991 F.2d 953, 963 (2d Cir. 1993) (citing Fischman v. Raytheon, 188 F.2d 783 (2d Cir. 1951)). A fact is material if "there is a substantial likelihood that a reasonable investor would consider it important in deciding [whether to purchase a security]." Cavanagh, 1998 WL 186847, at *39 (citations omitted). Scienter has been defined as a the "intent to deceive, manipulate or defraud, . . . or at least knowing misconduct." SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1467 (2d Cir. 1996) (internal citations omitted). The "in connection with" requirement is construed broadly and flexibly, and is satisfied when the misrepresentation or omission would be the sort on which a reasonable investor would rely when purchasing or selling securities. In re Carter-Wallace, Inc. Sec. Litig., 150 F.3d 153, 156 (2d Cir. 1998).
To establish an aiding and abetting securities violation, the SEC must show a securities law violation by a primary party, scienter on the part of the aider and abettor, and "substantial assistance" by the aider and abettor in the achievement of the primary violation. Nat'l Union Fire Ins. Co. of Pittsburgh, Pa. v. Turtur, 892 F.2d 199, 206 (2d Cir. 1989); see also SEC v. U.S. Environmental, Inc., 155 F.3d 107, 113 (2d Cir. 1998) (noting that the SEC now has authority to assert aiding and abetting claims under Section 10(b)).
2. Section 5 of the Securities Act
To establish a violation of Securities Act Section 5, the SEC must show that (1) no registration statement was filed or in effect at the time of the sale; (2) the defendant, directly or indirectly, sold or offered to sell the securities; and (3) interstate means were used in connection with the offer or sale. See SEC v. Universal Exp., Inc., 475 F. Supp. 2d 412, 422 (S.D.N.Y. 2007); SEC v. Lybrand, 2000 WL 913894, at *10 (S.D.N.Y. July 6, 2000). Liability under Section 5 "extends beyond those who sell stock to all necessary participants in a sale of unregistered stock." SEC v. Cavanaugh, 1 F. Supp. 2d 337, 372 (S.D.N.Y.), aff'd, 155 F.3d 129 (2d. Cir. 1998).
3. Section 13 of the Exchange Act
Section 13(a) states that issuers of securities must file "such information and documents as the Commission shall require." 15 U.S.C. § 78m(a)(1). Under Rules 13a-1 and 13a-13, issuers consequently must file quarterly and annual reports. 17 C.F.R. §§ 240.13a-1, 13a-13. Section 13(b)(2)(A) requires that issuers who are subject to the reporting provisions of the Exchange Act "make and keep books, records, and accounts, which . . . accurately and fairly reflect the[ir] transactions and dispositions of the[ir] assets." 15 U.S.C. § 78m(b)(2)(A). Section 13(b)(2)(B) requires that issuers who are subject to the reporting provisions of the Exchange Act "devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that" transactions are appropriately executed and assets are adequately protected. 15 U.S.C. § 78m(b)(2)(B). Section 13(b)(5) states that "No person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record, or account described in paragraph (2)." An aiding-and-abetting claim must allege a primary violation, actual knowledge of the violation, and substantial assistance in the violation. SEC v. Espuelas, 698 F. Supp. 2d 415, 434 (S.D.N.Y. 2010).