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Securities v. Ehrenkrantz King Nussbaum

March 15, 2012


The opinion of the court was delivered by: Hurley, Senior District Judge:


On September 30, 2005, the Securities Exchange Commission ("SEC") commenced this enforcement action against Ehrenkrantz King Nussbaum, Inc. ("EKN"), Anthony Ottimo ("Ottimo"), and Brendan E. Murray ("Murray") alleging that all three defendants violated Section 17(a) of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b); and Rule 10b-5, 17 C.F.R. § 240.10b-5. (Compl. ¶ 6.) The SEC further alleged that EKN violated, and Ottimo and Murray aided and abetted EKN's violation of: (a) Section 15(c)(1) of the Exchange Act, 15 U.S.C. § 78o(c)(1), and (b) Section 15(b)(7) of the Exchange Act, 15 U.S.C. § 78o(b)(7) as well as Rule 15b7-1, 17 C.F.R. § 240.15b7-1. The crux of the allegations concern defendants' "scheme to defraud at least 9 mutual fund companies . . . for the purpose of enabling defendants' customers to place hundreds of 'market timing' orders in the funds without alerting the [funds] to their activities." (See Compl. ¶ 1.)

On June 6, 2008, the SEC filed a motion seeking the dismissal of all claims against EKN and Ottimo with prejudice.*fn1 By Order dated June 9, 2008, the Court granted the SEC's motion, and EKN and Ottimo were dismissed from the action. Presently before the Court is the SEC's motion for summary judgment against Murray made pursuant to Federal Rule of Civil Procedure 56. For the reasons set forth below, the motion is granted in part and denied in part. BACKGROUND

Murray's Failure to Comply With Local Rule 56.1

The SEC's motion was originally filed on January 11, 2010. The Court deferred ruling on that motion, however, based on its determination that the SEC failed to demonstrate its compliance with Local Rule 56.2 by serving Murray with a "Notice to Pro Se Litigant Opposing Motion for Summary Judgment." (See Aug. 3, 2010 Mem. & Order at 5, 8.) Moreover, Murray's opposition to the SEC's motion did not comply with the requirements of Rule 56 or Local Civil Rule 56.1. Having found that the SEC had not provided Murray with actual notice of the requirements of Rule 56, the Court directed the SEC to re-serve its motion papers with a copy of the Local Civil Rule 56.2 Notice upon Murray, and established a revised briefing schedule to permit Murray "another opportunity to submit an opposition to the SEC's motion for summary judgment that complies with the requirements of Rule 56." (Id. at 9.) Murray was specifically put on notice that his amended opposition papers had to comply with the requirements set forth in Rule 56 and Local Rule 56.1. (Id.) The SEC has demonstrated that it complied with the Court's August 3, 2010 Order by re-serving its moving papers and a proper Local Rule 56.2 Notice upon Murray. (See Aug. 16, 2010 Certif. of Service, Docket No. 70.)

Local Rule 56.1 of the Local Rules of the United States District Courts for the Southern and Eastern Districts of New York requires a party opposing a motion for summary judgment to submit "a correspondingly numbered paragraph responding to each numbered paragraph in the statement of the moving party, and if necessary, additional paragraphs containing a separate, short and concise statement of additional material facts as to which it is contended that there exists a genuine issue to be tried." Local Rule 56.1(b). This Court's Individual Practice Rules contain the additional requirement that "the papers opposing a motion for summary judgment shall reprint the movant's numbered paragraphs before providing a responsive paragraph." See Indiv. Practice Rule 3(k). Despite these requirements, and despite being served with a Local Rule 56.2 Notice, Murray has again failed to file a Local Rule 56.1 Statement. However, "[a] district court has broad discretion to determine whether to overlook a party's failure to comply with local court rules." Holtz v. Rockefeller & Co., Inc., 258 F.3d 62, 73 (2d Cir. 2001). Thus, while the Court could deem each of the SEC's factual statements admitted based upon Murray's failure to comply with this rule, see Local Rule 56.1(c), the Court will, in the exercise of its discretion, consider not only the uncontested facts set forth in the SEC's Local Rule 56.1 Statement, but also the "other facts contained in the record." See Di Rienzo v. Metro. Transp. Auth., 237 Fed. Appx. 642, 646 (2d Cir. June 20, 2007); see also In re Parikh, 2009 WL 2383032, at *2 (E.D.N.Y. July 30, 2009) (collecting cases).

The following material facts, which are drawn from the Complaint and the parties' submissions, are undisputed unless otherwise noted.

Market Timing

The practice of market timing involves frequent, short-term buying, selling, and exchanging of mutual fund shares in order to take advantage of inefficiencies in mutual fund pricing. (See Compl. ¶ 2; Pl.'s 56.1 ¶ 4; Murray Dep. at 17.) The SEC acknowledges that market timing is not illegal, but asserts that such practice could "dilute the value of mutual fund shares and increase transaction costs" for a particular fund. (Compl. ¶ 2.) Additionally, the SEC asserts that "[s]ubstantial redemptions by a market timer may force a portfolio manager to liquidate certain fund holdings under unfavorable circumstances." (Id.)

The Relationship Between EKN, Ottimo, and Murray

EKN is a securities brokerage firm headquartered in Garden City, New York. (Id. ¶ 1; Pl.'s 56.1 ¶ 4.) Ottimo is EKN's Chief Executive Officer and a registered representative of the firm. (Compl. ¶ 1.) Between 2002 and 2004, Murray was the chief executive, sole owner, and only employee of White Star Capital ("White Star"), a corporation Murray formed for the purpose of "becom[ing] involved in the mutual fund industry." (Pl.'s 56.1 ¶ 2; Murray Dep. at 6; Murray's Opp'n ¶ 8.) Murray intended that White Star would serve as a "conduit for investment advisors engaged in market timing, to find venues for the execution and clearance of their mutual fund trades." (Murray Dep. at 7.)

At the end of 2002, Murray was introduced to Ottimo by an individual named Charles Sanacore. (Id. at 15.) During his deposition, Murray described Sanacore as someone who was "associated with [White Star] for a brief period of time in 2002," and "would facilitate the introduction of broker-dealers who would be willing to take on market timing business." (Id. at 6, 13.) As best the Court can determine from the record, at some point in early 2003, Sanacore became an employee of EKN. (Id. at 108.) Sanacore departed from EKN in July 2003. (Id. at 110.)

As a result of Sanacore's introduction, Murray and Ottimo entered into an agreement pursuant to which White Star provided "consulting services" to EKN, (Pl.'s 56.1 ¶¶ 4, 6; Murray's Opp'n ¶ 8; Pl.'s Ex. 118), which included locating professional investors and money managers who engaged in market timing, recruiting those investors to become clients of EKN, and then facilitating those investors' market timing once they became EKN clients. (Murray's Opp'n ¶ 8; Pl.'s 56.1 ¶ 4.) As compensation for these services, White Star received one-third of the "revenue streams" generated from the White Star-recruited investors-turned EKN clients. (Pl.'s Ex. 118.)*fn2 The relationship between White Star and EKN began in January 2003 and lasted through the end of that year. (Pl.'s 56.1 ¶ 6.)*fn3

White Star provided EKN "back office support for the processing of mutual fund transactions," which Murray defined as including: (1) "[a] knowledge of how mutual funds were processed in the industry," (2) facilitation of communication with EKN clients who were market timing, and (3) entering orders for those clients through EKN. (Pl.'s 56.1 ¶ 7; Murray Dep. at 14-15.) In 2003, Murray considered himself to be "an independent contractor" of EKN. (Murray Dep. at 108; Murray's Opp'n ¶ 8.) Murray was assigned a desk on EKN's trading floor of its Garden City office, an EKN telephone extension, and an email address within EKN's email system. (Pl.'s 56.1 ¶ 7; Murray's Opp'n ¶¶ 11, 12.)

The SEC asserts that "Murray dealt with primarily just Ottimo on all Murray's customer accounts." (Pl.'s 56.1 ¶ 8.) Murray contends that between January and July 2003 he reported directly to Sanacore, but then began reporting directly to Ottimo following Sanacore's departure in July 2003. (Murray's Opp'n ¶ 8.) In any event, Murray testified during his deposition that, at all times in 2003, either he or Sanacore "would update Mr. Ottimo as far as what was happening with the accounts." (Murray Dep. at 108.)

Mutual Fund Restrictions on Market Timing

In 2002 and 2003, various mutual funds issued statements via their respective prospectuses indicating that "frequent trading might be disruptive to funds" and was, therefore, "frowned upon." (Pl.'s 56.1 ¶ 9.) Specifically, several mutual fund families limited the number of "exchanges" that a customer could make. (Id. ¶ 10.) An "exchange" is defined as a transaction moving money out of one fund and into another fund within a given mutual fund family. (Id.) For example, the AIM mutual fund family limited exchanges to ten per customer per year. (Id. ¶¶ 11-15; Pl.'s Ex. 234.) AIM's exchange policy was intended to limit each customer to ten exchanges; it did not condone the practice of a customer opening multiple accounts to do ten exchanges per account. (Pl.'s 56.1 ¶ 14.) By promulgating this exchange limit policy, the AIM mutual fund family was attempting to prevent market timing and its attendant negative potential impact on shareholders, including higher administrative costs and lower returns. (Id. ¶ 13.)

Other mutual fund families espoused similar policies. The Invesco fund family had an exchange policy in place during 2003 that limited customers to four exchanges out of each fund per twelve-month period. (Id. ¶ 16; Pl.'s Ex. 207.) The Fidelity Investments fund family limited investors to four exchanges out of each fund per calendar year. (Pl.'s 56.1 ¶ 23; Pl.'s Ex. 267.) The Scudder Funds' prospectuses similarly reserved the right to limit any exchange where the shares had been held by the investor for less than fifteen days. (Pl.'s 56.1 ¶ 33.) Each of these policies was aimed at limiting and/or preventing investors from engaging in market timing. (Pl.'s 56.1 ¶¶ 25, 33-34.) When a mutual fund family detected a pattern of market timing, it would generally reject the trades and/or put a stop on the offending account so that no further trades could be made through that account. (Id. ¶¶ 15, 30, 38.)

Each of the above-mentioned mutual fund families dedicated some number of employees to the task of reviewing accounts and trading information in order to detect market timing activity. (Id. ¶¶ 17, 20, 27, 35.) For example, AIM had a market timing group comprised of two or three employees in 2003. (Id. ¶ 17.) Each day, this market timing group would receive a list of all exchanges involving $100,000 or more; this list usually had between 175 and 200 transactions per day. (Gunnar Dep. at 60-61.) The group would divvy up the list and review the trading history of each particular account to see if other exchanges had taken place on that account, and to determine whether the account had exceeded AIM's ten-exchange limit. (Id. at 61-62.) During 2003, AIM "kicked out" approximately $700 million in business when accounts were determined to have engaged in market timing. (Id. at 72.)

Each mutual fund family had difficulty detecting market timing when an investor opened more than one account and engaged in multiple exchanges per account. The mutual fund families generally had no method of linking account activity together, particularly when each account had separate account numbers, representative codes, or branch identifiers. (Pl.'s 56.1 ¶¶ 18, 20, 28, 29, 36-37.) For example, the "vast majority" of accounts within the Scudder family of funds were classified as "Level 3" accounts, for which Scudder did not have an individual account owner's name. (Id. ¶ 36.) Thus, an account held by an EKN customer would have shown up on Scudder's system only as an account of the entity that served as a clearing broker for EKN. (Id.) Scudder could see the representative code for each account, and did use that information in an attempt to identify patterns of market timing. (Id. ¶ 37.) A Scudder representative testified that it would have been more difficult for Scudder to identify a pattern of market timing in multiple accounts that were under common control of a single investor if different representative codes were used on each account. (Id.)

The Alleged Account Cloning and "Mirror" Account Scheme

Murray, through White Star, introduced four clients to EKN and serviced their trading during 2003: Richard Lund, Dr. German Shapiro, Spectrum LLC, and Huntrise Capital Partners. (Pl.'s 56.1 ¶¶ 40, 94.) The SEC asserts that Murray engaged in a similar account cloning scheme with respect to each of these clients in an attempt to deceive various mutual fund families and allow his clients to engage in market timing that would have been rejected had it been detected by the mutual fund families.

1. Richard Lund

In 2002, Murray contacted Richard Lund, an individual who controlled a hedge fund by the name of International Equity Advisers d/b/a International Timing Fund, in an attempt to establish a business relationship between White Star and Lund. (Pl.'s 56.1 ¶¶ 41, 43; Pl.'s Ex. 50.) In a solicitation letter to Lund dated April 19, 2002, Murray noted the "tremendous bias" against market timing "within the mutual fund community," and pledged that White Star would "use [its] contacts to secure relationships with Investment Companies friendly to market timing investments." (Pl.'s Ex. 50.) Lund subsequently became a client of EKN, and Murray serviced Lund's accounts. (Pl.'s 56.1 ¶ 43.) At the beginning of their relationship, Murray explained to Lund that "by having White Star act on behalf of the market timer, we provide an additional level of shielding with respect to the name of a Market Timing Advisor being 'known' to a clearing broker and hassled about their trading activities." (Pl.'s Ex. 51.) During his deposition, Murray testified that he envisioned White Star serving as a "conduit" for Lund with the purpose of concealing Lund's identity so that he could engage in market timing. (Murray Dep. at 25.) This arrangement was acceptable to Lund, who had indicated to Murray that mutual fund families had previously stopped his market timing activity and that he "wanted the availability to trade as he saw fit." (Id. at 27.)

Lund and EKN entered into a formal agreement on January 7, 2003. (Pl.'s Ex. 54.) Subsequently, EKN set up at least three (and as many as nine) accounts for Lund and his hedge fund, International Equity Advisors ("IEA") under the names HabCo, First Cinco, and CoCinco. During his deposition, Murray described these account names as "three different operating entities" of Lund's business, and conceded that he "always believed them to be" simply nominee names. (Murray Dep. at 38-39.)

Murray's daily responsibilities in connection with servicing Lund's investments through EKN involved preparing a "recap of the prior day's trading activities," which he would then fax to Lund. (Murray's Opp'n ¶ 20.) Murray would wait to receive any trading instructions from Lund and then facilitated the requested transactions. (Id.) Specifically, Lund directed trades in each of his accounts by faxing orders to Murray or Ottimo who, in turn, provided those orders to one of the four traders who worked at the EKN trading desk. (Pl.'s 56.1 ¶ 57.) Murray was also responsible for "reviewing the prospectus of each fund to note what the fund's stated policy was on market timing." (Murray's Opp'n ¶ 20; see also Pl.'s Ex. 54.)

During 2003, EKN processed its trades through a clearing broker, Correspondent Services Corp. ("CSC"). (Pl.'s 56.1 ¶ 58.) CSC used a "Level 3" system to process some of its mutual fund trades, including certain of the trades ordered by Lund. (Id.; Murray Dep. at 43.) A Level 3 system electronically links the records of a broker-dealer (such as EKN) to the records of a particular fund's transfer agent. (Pl.'s 56.1 ¶ 59.) On the fund's end, the account number of a particular investor would identify only information about the broker-dealer, such as branch office location and representative code, and not information about the individual investor who actually controlled the account. (Id. ¶¶ 56, 59.) During his deposition, Murray testified that during 2003 he understood that if an EKN investor traded in a fund using two different accounts ...

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