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Media Alerts - SEC v. ALFRED TEO - Third Circuit
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February 14, 2014
  SEC v. ALFRED TEO - Third Circuit
Headline: Third Circuit Addresses Analytical Framework for Determining Remedy in SEC Disgorgement Motion

Area of Law: Securities

Issues Presented: Whether direct causation between illegal profit and wrongdoing is necessary in determining a disgorgement remedy?

Brief Summary: An investor, Alfred Teo, and his trust failed to disclose their holdings and future plans in a corporation under the Securities Exchange Act. The effect of this was to insulate Teo from the corporation and its poison pill. During this time, as their holdings grew, Teo attempted to privatize the corporation and be placed on its Board of Directors. When Best Buy Co. announced a tender offer and acquired the corporation's shares, Teo sold his shares at great profit. The SEC subsequently filed a civil law enforcement suit against Teo for violations of the Securities Exchange Act. A jury found him liable and the District Court ordered Teo and the Trust to disgorge $17 million, plus prejudgment interest amounting to over $14 million. Teo and the Trust appealed, arguing chiefly that the District Court erred in allowing the disgorgement when the SEC had not proven that the violations were a direct cause of the share profits. The Third Circuit, citing a DC Circuit opinion, policy goals underlying SEC enforcement actions, and the Restatement (Third) of Restitution, found that the SEC need only show but-for causation. The Third Circuit further held that the burden then shifts to the defendant to prove the disgorgement figure is not a reasonable approximation. The Court found that Teo and the Trust failed to prove that the figure was not reasonable because they only offered a plausible alternate explanation for their profit, instead of specific evidence.

Extended Summary: This case centers around the actions of Alfred Teo, a businessman and investor, and his trust, MAAA Trust. In 1997, Teo's brokerage accounts held approximately 5.25 percent of stock in Musicland, a retailer of music, video, books, computer software and video games. Importantly, Musicland's "shareholder rights plan," also known as a poison pill, could be activated when individual ownership reached 17.5 percent ownership of the company's stock. The poison pill allowed shareholders to purchase stock at a lower price to dilute a hostile buyer's holdings to a lower percentage. Up until 1998, Teo properly disclosed his Musicland holdings to the SEC and they were always below the poison pill threshold. The SEC requires disclosure of an individual's holdings, specifically any plans or proposals to change the Board of Directors or to cause an extraordinary corporate transaction. From 1998 to 2000, Teo and his Trust filed numerous false SEC Schedule 13D disclosure statements, failing to report holdings in Musicland even though their holdings continued to exceed the reporting threshold. The District Court found that Teo and the Trust controlled 17.79 percent of Musicland shares in 1998 and 35.97 percent in 2000. During this time, Teo repeatedly tried to get himself or associates placed on Musicland's Board of Directors. Teo also made plans several times to privatize Musicland. Teo's admitted intent was to create an opportunity for him to cash out his holdings. He never filed a Schedule 13D on any of the above activities. In December 2000, Best Buy Co. announced a tender offer of all Musicland shares and acquired them in January 2001, causing stock prices to rise. Teo sold all of his shares (some publicly and some to Best Buy). The District Court found that Teo's profit from the Musicland stock, beginning at the first SEC violation, was $21 million.

In April 2004, the SEC filed a civil law enforcement action against Teo asserting violations of the Securities Exchange Act Sections 13(d) and 10(b) and numerous SEC rules and regulations. A jury found Teo and his trust, MAAA Trust, liable for violating the above sections of the Securities Exchange Act. The District Court denied Defendants' motions for judgment as a matter of law and for a new trial. It ordered Defendants to disgorge over $17 million, plus prejudgment interest amounting to $14 million. Defendants appealed, alleging errors arising from admission of certain evidence and the use of a general verdict form, and challenging the court's disgorgement and prejudgment interest award.

The Third Circuit first addressed the admission of Teo's 2006 allocution when he pleaded guilty to five counts of insider trading. The Third Circuit found that the allocution was probative of Teo's willfulness and knowledge in evading SEC regulations as they applied to Musicland holdings, and its prejudicial effect did not outweigh its probative value, especially since his convictions were a part of the record. Further, the Third Circuit dismissed Defendants' argument that the limiting instruction was inadequate.

The Third Circuit also addressed the challenge by the Defendants to the District Court's order to disgorge $17 million in profit from transactions tainted by the SEC violations. They did not appeal the calculation, but rather the fact that the District Court had granted the SEC's motion for this remedy. The Third Circuit began its analysis by noting the differences between private and SEC civil enforcement actions. Private enforcement actions often draw analogies to cases at common law, like civil fraud claims. There, courts will often require proximate cause to establish injury. The Third Circuit stated that common law torts, in contrast, are not part of the jurisprudence or the statutory developments relating to SEC enforcement actions. SEC suits are described as "promoting economic and social policies" and are not "collection agenc[ies] for defrauded investors" as private civil enforcement litigation often is.

The Court found that it needed to separately analyze what type of causation standard should apply to SEC motions for disgorgement. The Third Circuit first addressed the importance of the policies driving SEC-initiated civil enforcement suits. The main policy goals are constructed around two objectives: (1) to deprive a wrongdoer of unjust enrichment, and (2) to deter others from violating securities law. The Court held that in light of this, the analytical framework for determining the remedy differs from that of a private enforcement action. Citing SEC v. First City Fin. Corp., 890 F.2d 1215 (D.C. Cir. 1989), the Court explained a burden-shifting approach to causation. Under this approach, the SEC is required to produce evidence supporting a reasonable approximation of "actual profits on the tainted transactions" (essentially satisfying but-for causation). This creates a presumption of illegal profits, which the defendant can rebut by demonstrating that the "disgorgement figure is not a reasonable approximation." According to First City, the risk of uncertainty should fall on the wrongdoer who created the uncertainty. The Third Circuit drew two points from this case: (1) that intervening causation is not an element of the SEC's evidentiary burden in setting out an amount to be disgorged, and (2) if the issue of intervening cause is going to be raised, it will normally be the defendant's burden to do so. The Court also observed that First City appeared to be based on the Restatement (Third) of Restitution, which acknowledges that the court has broad discretion in deciding the amount disgorged. The Restatement affirms that the court may apply tests of causation as reason and fairness dictate and cautions the court not to give inordinate weight to the attenuation between wrongdoing and money damages. The Court then dismissed Defendants' argument that the SEC needed to prove more than but-for causation. The Third Circuit held that the policies underlying disgorgement - deterrence and prevention of unjust enrichment - must weigh heavily in the court's consideration of whether the profits are legally attributable to the wrongdoing.

Applying the above framework, the Third Circuit agreed with the District Court that the SEC introduced evidence that demonstrated a reasonable approximation of profits from transactions tainted by SEC violations. The Court stated that Defendants needed to adduce specific evidence and not just put forth a plausible alternate explanation for the profit. The Third Circuit further explained how Teo's misreporting and fraud insulated him from the poison pill and Musicland awareness, which enabled him to acquire and hold a large amount of stock that netted huge profits when sold to Best Buy. For all of the above reasons, the Court found the District Court did not abuse its discretion in determining the disgorgement amount.
To read the full opinion, please visit

Panel (if known): Sloviter, Jordan, and Nygaard, Circuit Judges

Argument Date: April 23, 2013

Date of Issued Opinion: February 10, 2014

Docket Number: No. 12-1168

Decided: Affirmed

Case Alert Author: Shannon Zabel

Counsel: Eric O. Corngold, Esq., Mary E. Mulligan, Esq., Cheryl A. Krause, Esq. for Defendants Alfred S. Teo, Sr. and MAAA Trust; David Lisitza, Esq. for Appellee, Securities & Exchange Commission

Author of Opinion: Judge Nygaard

Circuit: Third Circuit

Case Alert Supervisor: Professor Mary E. Levy

    Posted By: Susan DeJarnatt @ 02/14/2014 01:53 PM     3rd Circuit  

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