Securities and Exchange Commission v. Lek Securities Corporation

Background

The Securities and Exchange Commission sued Lek Securities Corporation, Samuel Lek, Vali Management Partners doing business as Avalon FA Ltd., Nathan Fayyer, and Sergey Pustelnik. The Lek defendants later settled. The court was deciding the remedies against Avalon, Fayyer, and Pustelnik after a jury verdict in the Securities and Exchange Commission’s favor on November 12, 2019.

The jury found that the three defendants violated provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933. Each violated Section 10(b) of the Exchange Act and Rules 10b-5(a) and (c). Each also violated Sections 17(a)(1) and 17(a)(3) of the Securities Act. The jury additionally found Avalon and Fayyer directly liable under Section 9(a)(2) of the Exchange Act, found Fayyer and Pustelnik liable for knowingly or recklessly providing substantial assistance, and found Avalon, Fayyer, and Pustelnik liable as control persons.

The violations arose from two schemes. In the layering scheme, traders placed multiple orders on one side of the market to create the appearance of demand or supply, placed smaller orders on the other side, and then canceled the first group after the price moved. In the Cross-Market Strategy, traders used stock trades to influence the price of a corresponding option, established an options position that benefited from the artificial price, and then reversed the stock position.

The opinion states that the schemes operated from 2012 through 2016 and involved more than 675,000 instances of layering and 668 instances of Cross-Market trading. The schemes generated more than $21 million in layering revenue and $8.1 million in Cross-Market revenue, with almost $4.5 million retained by the three defendants.

Disgorgement

Disgorgement requires a defendant to give up profits obtained through unlawful conduct. The Securities and Exchange Commission sought $4,495,564 in disgorgement plus $131,750 in prejudgment interest. The court held that the requested amount reasonably approximated the defendants’ profits from the unlawful schemes: $2,457,073 from layering and $2,038,491 from the Cross-Market Strategy.

The defendants argued that disgorgement was unavailable after the Supreme Court’s decision in Kokesh v. SEC and that the Securities and Exchange Commission had not identified the specific transactions producing the profits. Judge Cote rejected both arguments. She explained that Kokesh addressed the statute of limitations and did not decide whether courts had authority to order disgorgement. She also relied on the jury’s findings and the Securities and Exchange Commission experts’ identification of the trading patterns. The court found that the experts used conservative methods and that the defendants had not shown that the identified profits were unrelated to the violations.

The court also ordered prejudgment interest to prevent the defendants from receiving the equivalent of an interest-free benefit from their unlawful activity. The disgorgement and interest were imposed jointly and severally against Avalon, Fayyer, and Pustelnik, meaning each was responsible for the full combined amount, subject to the court’s order.

Civil penalties

The Securities and Exchange Commission sought third-tier civil penalties of $13.8 million against each defendant. The defendants proposed penalties of $300,000 for Fayyer and Pustelnik and $1.45 million for Avalon. The court determined that the violations qualified for third-tier penalties because they involved fraud and created a significant risk of substantial losses to other people.

Judge Cote considered the seriousness and duration of the conduct, the defendants’ intentional actions, the losses or risks imposed on other market participants, the repeated nature of the violations, and the defendants’ financial circumstances. The court found that the defendants coordinated large-scale, years-long manipulation, recruited traders, improved technology to carry it out, and took steps to conceal the conduct. The court also found that the defendants continued or increased the manipulation after regulatory scrutiny began.

For calculating the penalties, the court rejected both the defendants’ proposal to treat each scheme as one violation and the Securities and Exchange Commission’s request to impose the maximum penalty for each month, which would have produced $13.8 million per defendant. The court treated the monthly approach as a reasonable intermediate measure given the millions of transactions and numerous instances of manipulation.

Disposition

The court stated that the Securities and Exchange Commission’s motion for remedies was granted in part. It entered judgment requiring Avalon, Fayyer, and Pustelnik to pay $4,495,564 in disgorgement plus $131,750 in prejudgment interest, jointly and severally. It assessed a $5 million civil penalty against each defendant. It also permanently enjoined each defendant from violating Sections 9(a)(2) and 10(b) of the Exchange Act, Rule 10b-5, and Section 17(a) of the Securities Act.

The order provides that if the disgorgement order cannot be enforced, the civil penalty against each defendant will increase to $7.5 million. The opinion also notes that the defendants had largely consented to applying $5.5 million seized by the Securities and Exchange Commission toward the disgorgement obligation.