BREAKING STORY!!! FULL-TEXT 2 Cir Opinion in USA v. Mandell. Analysis by Bill Singer

May 17, 2014

This odyssey of a criminal prosecution began back on July 8, 2009, when the United States Attorney for the Southern District of New York issued a press release announcing SIX CHARGED IN $140 MILLION INVESTMENT FRAUD AND STOCK MANIPULATION SCHEME. In that initial Indictment, Defendants Ross H. Mandell, Stephen Shea, Adam Harrington, a/k/a "Adam Rukdeschel," Arn Wilson, Robert Grabowski, and Michael Passaro were charged in two-counts with conspiracy to commit securities, wire and mail fraud; and with securities fraud. As alleged by federal prosecutors:

From 1998 through 2006, the defendants participated in a scheme to defraud investors via two successive securities broker-dealers: The Thornwater Company, L.P., ("Thornwater"); and Sky Capital LLC and associated entities, including Sky Capital Enterprises Inc., and Sky Capital Holdings Ltd. (collectively "Sky Capital"). Until late 2006, shares of Sky Capital Holdings ("SKH") and Sky Capital Enterprises ("SKE") were traded publicly on the Alternative Investment Market of the London Stock Exchange. Through material misrepresentations and omissions, the defendants induced victims to invest in purported investment opportunities promising large returns, such as private placements, offers to purchase restricted stock, and offers to purchase Sky Capital securities. In fact, investor funds were substantially used to enrich the defendants and others; to pay excessive undisclosed commissions to brokers; and to pay off victims who had lost money through prior purported investment opportunities. In connection with the scheme, the defendants, acting primarily from Thornwater and Sky Capital's offices in New York, New York, raised a total of approximately $140 million from investors . . .

SDNY Jury Trial

Following the filing of an expanded  Superseding Indictment on December 14, 2010, and after five weeks of trial in the United States District Court for the Southern District of New York ("SDNY"), on May 7, 2012, a jury found Defendants Mandell and Harrington guilty of:
  • conspiracy to commit securities fraud, wire fraud, and mail fraud, in violation of 18 U.S.C. § 371; 
  • securities fraud, in violation of 15 U.S.C. §§ 78j(b) & 78ff, 17 C.F.R. § 240.10b-5, and 18 U.S.C. § ; 
  • wire fraud, in violation of 18 U.S.C. § 1001; and 
  • mail fraud, in violation of 18 U.S.C. §§ 1343 & 2. 
SDNY  imposed upon:

Mandell: 144 months in prison, $50 million forfeiture, $10,000 fine, and a $400 assessment; 
Harrington: 50 months in prison, $20 million forfeiture; $400 assessment.

Pleas

On January 25, and 28, 2011, respectively, Defendant Grabowski,  and thereafter, Defendants Wilson and Passaro pled guilty to four counts charging them with conspiracy and substantive securities, wire, and mail fraud crimes. They each face a maximum term of 65 years in prison, a fine of $5 million or twice the gross pecuniary gain or loss on each count, and a maximum of three years of supervised release. READ FBI Release

On February 11, 2011, Defendant Shea pled guilty to conspiracy and securities fraud charges. Shea faces a maximum sentence of five years in prison on the conspiracy count; up to 20 years in prison on the fraud count; a maximum fine of $250,000, or twice the gross gain or loss from the offense on the conspiracy count; and a maximum fine of $5 million on the securities fraud count. He also faces mandatory restitution to the victims.  

Morrison and Vilar

In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (United States Supreme Court 2010), the Supreme Court reversed 2Cir in an Opinion in which Chief Justice Roberts, Kennedy, Thomas, and Alito, Joined; Beyer, Stevens, and Ginsburg Concurred; Sotomayor took no part. The Supreme Court's Opinion held that:

Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an Amterican stock exchange, and the purchase or sale of any other security in the United States. This case involves no securities listed on a domestic exchange, and all aspects of the purchases complained of by those petitioners who still have live claims occurred outside the United States. Petitioners have therefore failed to state a claim on which relief can be granted. We affirm the dismissal of petitioners' complaint on this ground.

Subsequent to the pleas and convictions in Mandell, 2Cir held in United States v. Vilar, 729 F.3d 62 (2d Cir. 2013) that pursuant to Morrison that a:

[D]efendant may be convicted of securities fraud under Section 10(b) [of the Securities Exchange Act of 1934] and Rule 10b-5 only if he has engaged in fraud in connection with (1) a security listed on a U.S. exchange, or (2) a security purchased or sold in the United States." Vilar, 729 F.3d at 67. Thus, we held that Section 10(b) does not "apply extraterritorially in criminal cases.

An Appealing Case

Morrison had been decided after the filing of the initial Indictment and, in part, prompted the Superseding Indictment. The SDNY trial had commenced after that Supreme Court decision. Appellants likely hoped that the 2Cir's holdings in Vilar (announced after the verdict in their SDNY trial) might offer a basis for reversal. 

Asserting that their SDNY convictions for securities fraud should be reversed for a lack of sufficient evidence of domestic securities transactions, Defendant/Appellants Mandell and Harrington appealed to the United States Court of Appeals for the Second Circuit ("2Cir")United States of America, Appellee, v, Ross H. Mandell, Adam Harrington, Defendants-Appellants, - and - Stephen Shea, Arn Wilson, Robert Grabowski, Michael Passaro, Defendants (2Cir, Docket No. 12-1967, 12-2090).

2Cir Affirms and Vacates

On May 16, 2014, 2Cir affirmed the SDNY convictions; however, as to Defendant Mandell's contention that the SDNY forfeiture order should have made the defendants jointly and severally liable, 2Cir vacates and remands for amendment. 

Mo' or Less Morrison?

In addressing Appellant's core argument that the conduct at issue was essentially extraterritorial in nature and, as such, Morrison precluded the application of Section 10(b) and Rule 10b-5, 2Cir offered this test:

[a] securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States." Id., citing Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 69 (2d Cir. 2012). We went on to explain that a "domestic transaction has occurred when the purchaser [has] incurred irrevocable liability within the United States to take and pay for a security, or . . . the seller [has] incurred irrevocable liability within the United States to deliver a security."  . . .

Finding sufficient evidence of domestic transactions, 2Cir noted that:

The jury considered evidence of five private placement offerings relating to three entities--Global Secure, Sky Capital Enterprises, and Sky Capital Holdings. Investors in the Global Secure private placement were required to submit purchase applications and payments to the company in the United States; the company had discretion to accept or reject those applications on receipt. Under Vilar, these were "domestic transactions." Vilar, 729 F.3d at 76. Investors also made domestic purchases of private placement shares of Sky Capital Enterprises. In light of this evidence of domestic transactions, and viewing the evidence "in the light most favorable to the government," a "rational jury" could have found the "essential elements" of Mandell and Harrington's convictions beyond a reasonable doubt. Abdulle, 564 F.3d at 125. . .

A Lottery Ticket

In addressing Appellant Mandell's argument that there had been insufficient evidence of material misrepresentations or  a duty to disclose commission payments, 2Cir noted that:

[T]here was evidence that Mandell falsely told victims that there "were absolutely no risks involved" in making certain securities purchases, even while he was telling his associates that making money on such purchases was "almost equivalent to buying a lottery ticket." There was also evidence that brokers had been instructed by Mandell on how to "pitch" private placements deceptively to potential investors. As to the duty to disclose, our cases make clear that brokers have a duty to disclose in this context. See, e.g., United States v. Santoro, 302 F.3d 76, 80-81 (2d Cir. 2002) (holding that a "broker has an affirmative duty to disclose all relevant information, including the receipt of excessive commissions," and stating that a "customer relying on a broker's recommendation would want to know information about the broker's receipt of extraordinary commissions in exchange for his recommendation of the stock because . . . it would raise a 'red flag' that the broker had reason to misrepresent the quality of the investment"); see also United States v. Szur, 289 F.3d 200, 211-12 (2d Cir. 2002).

Pulling Out

An interesting bit of commentary by the 2Cir involved the consideration of Appellant Harrington's assertion that he had effectively withdrawn from the alleged conspiracy. Noting that he had failed to satisfy his burden of proof, 2Cir explained that the mere cessation of conspiratorial activity is insufficient to prove withdrawal and proof of some affirmative action consistent with disavowing or defeating the conspiracy's purpose is required.  Pointedly, in addressing Harrington's appeal, 2Cir admonished that:

Far from taking affirmative steps to "disavow or defeat" the conspiracy, Harrington went on to seek payment of Sky shares from Mandell, even though those shares would have been worthless had the conspiracy not been ongoing. Moreover, each of the conversations at issue included discussion of the progress of the conspiracy sufficient to render them admissible. . .

Bill Singer's Comment

This case is likely far from over and Appellants may well appeal to the Supreme Court, which previously reversed the very same 2Cir in Morrison.  Moreover, the Supreme Court has shown hostility to expanding our nation's jurisdiction to include matters that are taking on an increasingly international tone and may well use the Mandell appeal to either expand or clarify the extraterritorial concerns. 

In this expanding age of the internationalization of securities transactions on increasingly global stock markets accompanied by the ever-expanding role of the Internet, Mandell may well pose problems for courts trying to decide just where to draw the line between "our" problem and "theirs." This tension is already being seen around the LIBOR and Forex disputes that have resulted in indictments or may well head in that direction.