Proves
U.S. Told Restitution Bid in Investor Fraud Case Remains Flawed
Giving federal prosecutors a fourth and final chance to win restitution from a man who pleaded guilty last year to defrauding investors, Eastern District Judge Nicholas G. Garaufis said the government has failed to prove its claim that the scheme caused investors to lose $9 million.
In United States v. Gushlak, 1:03-cr-00833, Judge Garaufis ordered prosecutors to submit additional evidence by Aug. 22 to support their request for restitution in the case of Myron Gushlak. The judge set a Sept. 6 hearing on the issue.
"If the Government again fails to prove loss causation and the amounts of each victim's loss, the court will be forced to deny the Government's request to order Gushlak to make restitution," the judge said. "This would be unfortunate. Gushlak has admitted to stealing from a large number of people what likely amounted to a significant portion of their personal wealth."
Mr. Gushlak, who was a director of GlobalNet Inc., pleaded guilty to securities fraud in 2003. He admitted that in 1999 and 2000 he worked to inflate the value of GlobalNet stock, partly by paying kickbacks to brokers who bought the stock for their clients.
When the fraud came to an end in 2000, GlobalNet's stock lost value and investors suffered losses. But the scheme did not come to light until after the company stopped trading publicly in 2002, soon after GlobalNet was acquired by The Titan Corp. (Titan was in turn acquired by L-3 Communications Corp. in 2005.)
In November 2010, Mr. Gushlak was ordered to pay a $25 million fine and sentenced to six years in prison. He is now serving the prison term while he appeals the sentence.
Prosecutors from the Eastern District U.S. Attorney's office asked for restitution in December, seeking $20 million. They did not provide the trading records the government relied on, the methodology used to calculate the figure or a list of victims and their losses.
Because of these omissions, Judge Garaufis said the government had not proven the investors were entitled to restitution and he ordered that the missing information be provided.
In their second request for restitution, submitted in January, prosecutors explained that they looked at trading records for GlobalNet stock between March 1 and Nov. 1, 2000, to calculate losses. They said they ignored investors who received positive return from the stock and they valued GlobalNet stock that was not sold at the end of the trading period at $0.
Judge Garaufis was again not convinced. He said the government had not explained how it decided on the trading period or why it valued unsold stock at $0, effectively assuming "that GlobalNet had literally no intrinsic value."
The judge pointed to the 2007 decision in United States v. Rutkoske, 506 F.3d 170, 178, where the U.S. Court of Appeals for the Second Circuit held that in seeking restitution for a stock price manipulation scheme, the government must prove what the stock would have been worth without the manipulation.
Furthermore, the judge said, the government had not shown that all the decline in GlobalNet's stock resulted from Mr. Gushlak's fraud.
Prosecutors submitted a third request for restitution in April. In order to account for factors other than Mr. Gushlak's fraud that influenced the stock price, they looked at various stock price indices. The indices declined 20 percent during the relevant trading period, while GlobalNet stock declined 72 percent, prosecutors said. Taking into account the effect of the market, the government lowered its request for restitution to $9 million.
Judge Garaufis said Tuesday that the problems with the earlier restitution requests had not been resolved.
"The Government has failed to prove that any of the people who purchased GlobalNet stock lost money because of Gushlak's securities fraud conspiracy," he said.
"Even though Gushlak has admitted that the price of GlobalNet shares was inflated, the Government has offered no basis for inferring that the decline in GlobalNet's share price—and the resulting loss suffered by GlobalNet shareholders—was caused by the fraud. Gushlak's guilty plea establishes only transaction causation—the causal link between the fraud and the GlobalNet stock purchasers' decisions to purchase GlobalNet stock," Judge Garaufis said. "The plea does not establish loss causation—a causal link between the fraud and the decline in GlobalNet's share price."
The judge dismissed the government's comparison of GlobalNet stock to indices as "irrelevant." Such a comparison could be helpful in a more traditional case where shareholders lost money after a fraud was revealed to the public, he said.
"But where the market remains entirely unaware of fraud that is inflating a stock's price, a comparison of the decline in the stock price and the decline of the price of comparable companies and relevant market indices does not say anything about what portion of the decline in the stock's price was caused by the fraud," he said.
Judge Garaufis made a number of suggestions for what additional information the government could provide, going so far as to explain how it could organize data to establish "what percentage of the daily market for GlobalNet shares during the relevant trading period was comprised of trading activity attributable to the GlobalNet conspiracy."
He added, "The Government could do this by creating a spreadsheet listing the trading volume of GlobalNet shares for each day during the relevant trading period in one column, in a second column listing the percentage of the trading volume each day that was comprised of trades attributable to the GlobalNet conspiracy, and in a third column listing the daily closing price for GlobalNet shares."
The judge also asked the government to explain exactly when and how the scheme unraveled, saying that information was largely missing from the record.
Brian Rosner of Rosner Napierala and Alan S. Futerfas, attorneys for Mr. Gushlak, both said in a joint interview that they were pleased with the decision. They said it supported their view that the government could not prove loss causation and that Mr. Gushlak should not pay restitution.
Robert Nardoza, a spokesman for the Eastern District U.S. Attorney's Office, said the government is reviewing the decision and declined to comment further.
(Published by New York Law Journal - July 28, 2011)