The D.C. Circuit rejected challenges to a disgorgement order which used a zero basis for stock rather than a market quote for the share price and which imposed joint and several liability for the full amount on a defendant who claimed to have transferred a portion of the funds to others. SEC v. Whittemore, No. 10-5321 (D.C. Cir. Oct. 28, 2011).

The underlying enforcement action was brought against Peter Cahill and another group identified as the Whittemore defendants. The complaint centered on an alleged pump and dump scheme involving a thinly traded penny stock quoted in the Pink Sheets. Mr. Cahill and other defendants consented to the entry of permanent injunctions but reserved the resolution of questions regarding disgorgement to the court. The district court entered an order which concluded that Mr. Cahill was liable for disgorgement in an amount based on valuing the stock from the scheme at zero, effectively finding that the entire sale price was the proper measure of the remedy. The court also concluded that Mr. Cahill could be held responsible for the entire amount of the disgorgement despite his claim that he had transferred a portion of the proceeds to others and that he is jointly and severally liable with the other defendants.

The Circuit Court affirmed. First, the Court concluded that using a zero basis for the value of the stock was appropriate. Separating legal from the illegal profits exactly may at times be virtually impossible the court held. Thus the SEC is only required to make a reasonable approximation of profits causally connected to the violation. Here the agency argued that the stock should have a zero basis while the Appellant claimed that the proper value is $0.32 per share. The value offered by Mr. Cahill however was from one market quote in an otherwise illiquid market. In fact the evidence demonstrates that the stock was rarely quoted. In addition, there is no evidence that Mr. Cahill could have sold the block of stock he obtained in the scheme. Under these circumstances it was appropriate for the SEC to use a zero basis to meet its initial burden. At that point the burden shifted to Mr. Cahill to demonstrate the value of the shares prior to the fraud. Since he failed to offer any evidence on this point, the district court’s calculation was appropriate.

Second, the district court correctly concluded that Mr. Cahill was liable for the entire amount of the disgorgement. A disgorgement order, the court held, pertains to “’a sum equal to the amount wrongfully obtained, rather than a requirement to replevy a specific asset’ and ‘establishes a personal liability, which the defendant must satisfy regardless [of] whether he retains the selfsame proceeds of his wrongdoing,’” quoting SEC v. Banner Fund International, 211 F. 3d 602 (D.C. Cir. 2000). Thus a person who controls the distribution of funds such as Mr. Cahill is responsible for those he retains and those he distributes.

Finally, the Court found it appropriate under the circumstances here to hold Mr. Cahill jointly and severally liable with the other defendants. Mr. Cahill argued that to impose such liability the court had to find that two or more individuals or entities collaborate and have a close relationship in engaging in the illegal conduct. While these tests are appropriate the Court noted, they should be stated in the disjunctive. Accordingly, once the Commission established the close collaboration between Mr. Cahill and the Whittemore defendants in the scheme, the burned shifted to Appellant to establish that apportionment was appropriate. Since Mr. Cahill wrongfully obtained the proceeds from the sale of the stock and controlled the distribution, if any, it was appropriate for the district court to impose joint and several liability.

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