Opinion
21-CV-01381 (PGG)(SN)
01-30-2023
SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. COINSEED, INC., et al., Defendants.
REPORT AND RECCOMENDATION
SARAH NETBURN, United States Magistrate Judge
TO THE HONORABLE PAUL G. GARDEPHE:
The Honorable Paul G. Gardephe referred this matter to my docket for an inquest on damages following an entry and order of default against defendants Coinseed, Inc. (“Coinseed”) and Delgerdalai Davaasambuu (“Davaasambuu”). Plaintiff Securities and Exchange Cormnission (“SEC”) submitted a Proposed Findings of Fact and Conclusions of Law (“Proposed Findings”). Defendants failed to respond.
The SEC requests that the Corut order Coinseed and Davaasambuu to pay disgorgement, respectively, in the amounts of $28,282 and $113,128, plus pre-judgment interest. The SEC further requests that each defendant pay a civil money penalty in the amount of $141,410. Because the SEC has provided the Court with a sufficient basis on which to award damages, the Court recommends an award of the relief requested, as modified by this report and recommendation.
BACKGROUND
I. Factual Background
In light of Defendants' default, the SEC's properly-pleaded allegations are accepted as true, except those relating to damages. See Cotton v. Slone, 4 F.3d 176, 181 (2d. Cir. 1993). The following findings of fact are based on the complaint's allegations regarding liability.
Coinseed is a Delaware corporation incorporated in November 2017. Davaasambuu is Coinseed's founder and CEO, possesses an 80% ownership interest in the company, and wrote the code underlying its website and application.
Coinseed's principal product was a mobile application that allows users-after linking the app to a payment card or bank account-to invest money by “rounding up” purchases to the nearest whole dollar amount and then depositing the difference in an investment portfolio, whose assets the user could select. Coinseed also allowed users to view each other's portfolios and corresponding returns, and encouraged users to convert their portfolios to match those with the highest rate of return. When a user opted to convert their portfolio to replicate another, Coinseed assessed a fee of 1% of the user's portfolio's value.
To raise capital, Coinseed offered and sold digital tokens (that it named “CSD”) in two rounds from December 2017 to January 2018, and March 2018 to May 2018. Davaasambuu wrote the code underlying CSD and prepared whitepapers describing Coinseed's business plan, including the sale of CSD to fund Coinseed's marketing and growth. The whitepaper also promised prospective CSD purchasers a regular distribution of profits, specifically stating that around the close of the second round of sales in May 2018, and on a monthly basis thereafter, CSD holders would be entitled to a pro-rata share of 50% of the revenue generated by Coinseed's 1% portfolio conversion fees. According to Defendants' public filings, they raised at least $141,410 from hundreds of individual investors through the sale of CSD. See ECF No. 5414 at 35. Coinseed never registered CSD as a security with the SEC.
II. Procedural Background
On February 17, 2021, the SEC brought this action against Coinseed and Davaasambuu alleging violations of Sections 5(a) and (c) of the Securities Act of 1933 (“Securities Act”). See 15 U.S.C. §§ 77e(a) and (c). The complaint was served on Coinseed on February 26, 2021, and Davaasambuu waived service on March 29, 2021. Counsel entered an appearance on behalf of Defendants on April 5, 2021, but moved to withdraw on April 22. On May 7, 2021, the Court held a conference to discuss the motion. Despite being directed to attend, neither defendant appeared at the conference, and later that day the Court granted the motion. The Court's order also directed Defendants to answer or otherwise move against the complaint by June 4, 2021, and Defendant Coinseed to retain counsel by June 11. On June 18, 2021, neither Defendant had made any filing, and the Court directed the SEC to move for default judgment.
On June 23, 2021, the Clerk of Court issued certificates of default as to both Defendants, and on July 6 the Court issued an order to show cause, with a hearing date of August 19. Defendants did not respond to the order or attend the hearing, and on August 23, 2021, the Court entered default judgment against them and enjoined them from further violations of the Securities Act.
That same day Judge Gardephe referred this matter to me for an inquest on damages. On August 24, 2021, I directed the SEC to file submissions supporting its request for a final judgment against defendants. The Order notified the parties that, absent a request from either side that the Court hold a hearing, the Court would conduct its inquest regarding damages based solely upon the parties' written submissions. The SEC submitted the Proposed Findings and an affidavit seeking to recover a combined total disgorgement of $141,410 plus pre-judgment interest, along with a civil monetary penalty of $141,410 per defendant. The Court gave Defendants until October 23, 2021, to respond, but they did not. Neither party has requested a hearing on the issue of damages.
DISCUSSION
The Court of Appeals for the Second Circuit succinctly set forth the procedural rules applicable to the entry of a default judgment in City of New York v. Mickalis Pawn Shop, LLC:
“Federal Rule of Civil Procedure 55 is the basic procedure to be followed when there is a default in the course of litigation.” Vt. Teddy Bear Co. v. 1-800 Beargram Co., 373 F.3d 241, 246 (2d Cir. 2004). Rule 55 provides a “two-step process” for the entry ofjudgment against a party who fails to defend: first, the entry of a default, and second, the entry of a default judgment. New York v. Green, 420 F.3d 99, 104 (2d Cir. 2005). The first step, entry of a default, formalizes a judicial recognition that a defendant has, through its failure to defend the action, admitted liability to the plaintiff.... The second step, entry of a default judgment, converts the defendant's admission of liability into a final judgment that terminates the litigation and awards the plaintiff any relief to which the court decides it is entitled, to the extent permitted by Rule 54(c).645 F.3d 114, 128 (2d Cir. 2011). The Court of Appeals has noted that, while the “typical Rule 55 case [is one] in which a default has entered because a defendant failed to file a timely answer,” Brock v. Unique Racquetball & Health Clubs, Inc., 786 F.2d 61, 64 (2d Cir. 1986), “a district court is also empowered to enter a default against a ‘defendant [that] has failed to . . . otherwise defend.'” Mickalis Pawn Shop, 645 F.3d at 129 (quoting Brock, 786 F.2d at 64). Here, Defendants failed to file an answer or respond at all to the SEC's complaint, and Coinseed failed to defend by not obtaining new counsel once its former counsel withdrew. See Jones v. Niagara Frontier Transp. Auth., 722 F.2d 20, 22 (2d Cir. 1983) (noting that a corporation cannot proceed pro se). See also Mickalis Pawn Shop, 645 F.3d at 130 (holding that entry of default was proper where a limited liability company failed to obtain counsel despite the court's warning that such failure would result in default).
I. Liability
Courts evaluating damages in a default context first look to the complaint to determine whether the plaintiff has established aprimafacie case for recovery. See Lenard v. Design Studio, 889 F.Supp.2d 518, 528 (S.D.N.Y. 2012) (the court must first determine whether the allegations in the complaint were sufficiently pleaded to establish liability); Eurosteel Corp. v. M/V Koggegracht, No. 01-cv-7731 (DLC), 2003 WL 1872652, at *1 (S.D.N.Y Apr. 11, 2003) (finding that a report and recommendation correctly concluded that plaintiff had established a prima facie case for recovery).
The SEC asserts claims for sale of an unregistered security in violation of 15 U.S.C. § 77e(a) and failure to register a security in violation of 15 U.S.C. § 77e(c). The Securities Act defines a security as, inter alia, an “investment contract.” 15 U.S.C. § 77b(a)(a). An “investment contract” is a “contract, transaction or scheme whereby a person invests [their] money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). “The three-prong Howey test for determining whether a particular scheme is an investment contract is whether the scheme involves (1) an investment of money; (2) in a common enterprise; and (3) with the expectation of profits to be derived from the efforts of a third-party.” Rocky Aspen Mgmt. 204 LLC v. Hanford Holdings LLC, 230 F.Supp.3d 159, 163 (S.D.N.Y. 2017) (internal quotation marks omitted). 15 U.S.C. § 77e(c) makes it unlawful to sell any security without first filing a registration statement with the SEC.
The complaint alleges that Defendants, without filing a registration statement, advertised and sold a token which entitled its purchasers, with no further action required, to a portion of Coinseed's future earnings; Defendants also explicitly told consumers that the proceeds from the token sales would fund Coinseed's development. Accordingly, the complaint contains sufficient facts to plead that Defendants sold an unregistered security. Indeed, Judge Gardephe has already granted the SEC an injunction against Coinseed on this claim. And because Defendants never registered CSD with the SEC, the allegations in the complaint also establish a valid claim of failure to register a security.
II. Inquest on Damages
Once liability is established, the sole remaining issue before the court is whether the plaintiff has provided adequate support for the relief it seeks. Transatlantic Marine Claims Agency, Inc. v. Ace Shipping Corp., Div. of Ace Young Inc., 109 F.3d 105, 111 (2d Cir. 1997); see also Greyhound Exhibitgroup, Inc. v. E.L.U.L. Realty Corp., 973 F.2d 155, 158 (2d Cir. 1992) (“While a party's default is deemed to constitute a concession of all well pleaded allegations of liability, it is not considered an admission of damages.”).
On an inquest for damages, the plaintiff bears the burden of proof and must introduce sufficient evidence to establish the amount of damages with reasonable certainty. Transatlantic Marine, 109 F.3d at 111. See also Lenard, 889 F.Supp.2d at 538 (awarding no damages because plaintiff failed to demonstrate the amount of fines incurred that were attributable to defendant); Griffiths v. Francillon, No. 10-cv-3101 (JFB)(GRB), 2012 WL 1341077, at *2 (Jan. 30, 2012) (recommending that no damages be awarded because motion papers alone were insufficient to support an award of damages), adopted, 2012 WL 1354481 (E.D.N.Y. Apr. 13, 2012). A court may determine the appropriate damages on the basis of affidavits and other documentary evidence “as long as [the court has] ensured that there [is] a basis for the damages specified in the default judgment.” Transatlantic Marine, 109 F.3d at 111 (quoting Fustok v. ContiCommodity Servs., Inc., 873 F.2d 38, 40 (2d. Cir. 1989)). See Action S.A. v. Marc Rich & Co., 951 F.2d 504, 508 (2d Cir. 1991) (leaving the decision of whether a hearing is necessary for determining damages to the discretion of the district court). See also Fed.R.Civ.P. 55(b)(2).
A. Disgorgement
The Securities Act provides that “[i]n any action or proceeding brought by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may order, disgorgement.” 15 U.S.C. §§ 78u(d)(7). “Once the district court has found federal securities law violations, it has broad equitable power to fashion appropriate remedies, including ordering that culpable defendants disgorge their profits.” S.E.C. v. First Jersey Sec., Inc., 101 F.3d 1450, 1474 (2d Cir. 1996). “Disgorgement is a method of forcing a defendant to give up the amount by which he was unjustly enriched....The amount of disgorgement ordered need only be a reasonable approximation of profits causally connected to the violation.” S.E.C. v. Razmilovic, 738 F.3d 14, 31 (2d Cir. 2013) (internal quotation marks omitted). Where a firm and its owner and CEO collaborated in and profited from unlawful conduct, “it is within the discretion of the court to determine that the owner-officer too should be subject, on a joint and several basis, to the disgorgement order.” First Jersey Sec., Inc., 101 F.3d at 1475-76 (gathering cases); see also S.E.C. v. AbsoluteFuture.com, 393 F.3d 94, 97 (2d Cir. 2004).
Defendants' publicly filed Form C states that they received approximately $141,410 in exchange for CSD tokens sold between December 2017 through May 2018. See ECF No. 54-14 at 35. This amount was directly derived from Defendants' unlawful conduct, and therefore disgorgement is an appropriate remedy here. Citing Defendant Davaasambuu's 80% interest in Coinseed, the SEC seeks disgorgement of $113,128 from him, and the remaining $28,282 from Coinseed. However, because Davaasambuu is Coinseed's founder, CEO, and majority stakeholder, I recommend the Court hold both Defendants jointly and severally liable for the full amount of $141,410.
Form C is an “offering statement” filed with the SEC in connection with a crowdfunding campaign the filer believes is exempt from registration. Defendants' Form C was filed December 3, 2018.
B. Prejudgment Interest
The SEC seeks pre-judgment interest from June 1, 2018 (the conclusion of the second round of token sales) at the IRS underpayment rate. “The decision whether to grant prejudgment interest and the rate used if such interest is granted are matters confided to the district court's broad discretion, and will not be overturned on appeal absent an abuse of that discretion.” Endico Potatoes, Inc. v. CIT Grp./Factoring, Inc., 67 F.3d 1063, 1071-72 (2d Cir. 1995) (internal quotation marks omitted).
The goal of crafting an appropriate prejudgment interest calculation is to address adequately the “circumstances of the individual case” by considering the “remedial purpose” of the judgment, the “fairness and the relative equities of the award,” and “the same considerations that inform the court's decision whether or not to award interest at all.” Jones v. UNUM Life Ins. Co. of Am., 223 F.3d 130, 139 (2d Cir. 2000). In addition, in measuring the benefit to defendants of the free use of the money, a court may consider the likely rate of return that defendants could have achieved by investing the funds. Id. “When the SEC itself orders disgorgement . . . the interest rate it imposes is generally the IRS underpayment rate ....Accordingly, courts have approved the use of the IRS underpayment rate in connection with disgorgement.” First Jersey Sec., Inc., 101 F.3d at 1476.
The SEC filed this action nearly three years after Defendants' violations, and another two years have passed since. This extended delay, largely attributable to the SEC and the Court itself, calls into question the fairness of awarding pre-judgment interest at the IRS underpayment rate, which skews high. Accordingly, I recommend pre-judgment interest be calculated from June 1, 2018, at the lower of the average LIBOR or IRS underpayment rates for each year. See S.E.C. v. Wyly, 56 F.Supp.3d 394, 433 (S.D.N.Y. 2014) (reaching the same conclusion for similar reasons).
C. Civil Monetary Penalty
In addition to disgorgement, the Securities Act provides that a court may impose a civil penalty upon violators of the Act. 15 U.S.C. § 78u(d)(3)(A)(i). Congress authorized civil penalties “to further the dual goals of punishment of the individual violator and deterrence of future violations.” Off, Comm. of Unsecured Creditors of WorldCom, Inc. v. S.E.C., 467 F.3d 73, 81 (2d Cir. 2006) (internal quotation marks omitted). First-tier penalties, sought here, require no specific culpability and are to be determined “in light of the facts and circumstances” but for each violation may not exceed the greater of “$5,000 for a natural person or $50,000 for any other person” or “the gross amount of pecuniary gain to such defendant as a result of the violation.” Id. “It is within the Court's discretion to determine the number of violations for the purpose of assessing the amount of a penalty.” United States Sec. & Exch. Comm'n v. Gould, No. 11-cv-0404 (PKC), 2012 WL 13042034, at *13 (S.D.N.Y. Sept. 18, 2012).
“Violation” is not defined by the Securities Act, and the Court of Appeals has yet to definitively address the question of whether Defendants' conduct constitutes two violations (the sale of an unregistered security and failure to register) or several hundred (counting every sale to a distinct consumer as one violation). We are not entirely without guidance, however. “In instances where the ‘per-trade penalty would be so substantial that [the defendant] would not be reasonably capable of paying it,' fashioning a remedy to count the number of violations other than by the number of trades to ‘best effectuate[] the purposes of the statute' is not an abuse of discretion.” United States Sec. & Exch. Comm'n v. Vali Mgmt. Partners, No. 21-453, 2022 WL 2155094, at *3 (2d Cir. June 15, 2022) (quoting Sec. & Exch. Comm'n v. Fowler, 6 F.4th 255, 264-65 (2d Cir. 2021)). In Fowler, the Court of Appeals did not answer the question of “whether each defrauded customer can be counted as a separate ‘violation' under the statute.” 6 F.4th at 265. However, it ultimately decided that the District Court did not abuse its “wide discretion” in “treating each defrauded customer as a separate unit of violation.” Id. at 266.
Here, the SEC seeks a civil penalty of $141,410 per Defendant. Considering Davaasambuu's 80% ownership interest, his “gross amount of pecuniary gain” would equal $113,128. The most conservative definition of violation would yield two here, and a corresponding maximum first-tier penalty of $226,236.
Following the SEC's rationale, Coinseed's “gross amount of pecuniary gain” would equal $28,282, less than the default first-tier penalty of $50,000 per violation. Thus, assuming only two violations, Coinseed's maximum first-tier penalty would be $100,000.
Given the blatant nature of Defendants' Securities Act violations, and their knowing failure to defend against the SEC's allegations, the SEC's requested penalties-a significant downward departure from the maximum fine available for Davaasambuu, and a more modest upwards departure for Coinseed-are reasonable.
CONCLUSION
Based on the evidence presented and the applicable law, the Court recommends that Defendants be held jointly and severally liable for disgorgement of $141,410, plus pre-judgment interest, and that each Defendant be ordered to pay a civil monetary penalty of $141,410.
NOTICE OF PROCEDURE FOR FILING OBJECTIONS TO THIS REPORT AND RECOMMENDATION
The parties shall have fourteen days from the service of this Report and Recommendation to file written objections pursuant to 28 U.S.C. § 636(b)(1) and Rule 72(b) of the Federal Rules of Civil Procedure. See also Fed.R.Civ.P. 6(a), (d) (adding three additional days when service is made under Fed.R.Civ.P. 5(b)(2)(C), (D), (E), or (F)). A party may respond to another party's objections within fourteen days after being served with a copy. Fed.R.Civ.P. 72(b)(2). Such objections shall be filed with the Clerk of the Court, with courtesy copies delivered to the chambers of the Honorable Paul G. Gardephe at the United States Courthouse, 40 Foley Square, New York, New York 10007, and to any opposing parties. See 28 U.S.C. § 636(b)(1); Fed.R.Civ.P. 6(a), 6(d), 72(b). Any requests for an extension of time for filing objections must be addressed to Judge Gardephe. The failure to file these timely objections will result in a waiver of those objections for purposes of appeal. See 28 U.S.C. § 636(b)(1); Fed.R.Civ.P. 6(a), 6(b), 72(b); Thomas v. Arn, 474 U.S. 140 (1985).