SEC - Opposition to Stoker summary judgment motion

UNITED STATES DISTRICT COURTSOUTHERN DISTRICT OF NEW YORK________________________________________________

:SECURITIES AND EXCHANGE COMMISSION, :

:Plaintiff, :

: 11 Civ. 07388 (JSR)v. :

: ECF CaseBRIAN H. STOKER, :

:Defendant. :

________________________________________________:

PLAINTIFF’S MEMORANDUM OF LAW IN OPPOSITION TO DEFENDANT BRIAN H. STOKER’S MOTION FOR SUMMARY JUDGMENT

Jeffery T. InfeliseAssistant Chief Litigation CounselJane M. E. PetersonAssistant Chief Litigation CounselAndrew FellerSenior AttorneyU.S. Securities and ExchangeCommission – Enforcement Division100 F Street, N.E.Washington, D.C. 20549(202) 551-4904(202) 772-9282 (fax)

May 23, 2012 Attorneys for PlaintiffU.S. Securities and Exchange Commission

Case 1:11-cv-07388-JSR Document 48 Filed 05/23/12 of 35

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TABLE OF CONTENTS

TABLE OF AUTHORITIES ............................................................................................. iii

PRELIMINARY STATEMENT .........................................................................................1

STATEMENT OF FACTS ..................................................................................................2

I. Structuring The Class V III CDO .........................................................................2

II. Marketing of Class V III .....................................................................................7

III. Closing of Class V III CDO...............................................................................9

ARGUMENT.....................................................................................................................11

I. Standard For Consideration Of Motion For Summary Judgment ......................11

II. The Evidence Is Legally Sufficient To Prove That Stoker Violated Section 17(a)(2) ............................................................................................................12

A. Janus Does Not Apply To Section 17(a)(2) ..........................................12

B. Stoker Obtained Money Or Property By Means Of A False Statement14

1. Stoker Participated In The Preparation Of Marketing Materials14

2. Stoker “Used” Misleading Statements To Obtain Money or Property .....................................................................................16

C. The Class V III Marketing Materials Contained Material Omissions ..16

D. Stoker Obtained Money Or Property As Required By Section 17(a)(2)19

1. Stoker Deprived Victims Of Money Or Property ......................19

2. Stoker Obtained Money or Property..........................................20

III. Stoker Participated in a Scheme Under Section 17(a)(3) ................................23

A. A Violation Of Section 17(a)(3) May Be Based On Misrepresentations Or Omissions.........................................................................................23

B. Class V III Was Intended As A Means For Citigroup To Profit From The Poor Performance of Class V III’s Assets......................................24


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C. Stoker Was A Key Participant In A Transaction He Knew OrReasonably Should Have Known Was Intended As A Proprietary Trade......................................................................................................26

CONCLUSION..................................................................................................................27


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TABLE OF AUTHORITIES

FEDERAL CASES

Aaron v. SEC, 446 U.S. 680 (1980) ..................................................................................24

Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972).............................24

Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247 (1986).............................................11

Bank of China, New York Branch v. NBM LLC, 359 F.3d 171 (2d Cir. 2004) ............................................................................................................................22

Burt Rigid Box, Inc. v. Travelers Property Cas. Corp., 302 F.3d 83 (2d Cir. 2002) .....................................................................................................................11

Donald T. Sheldon., 51 S.E.C. 59 (1992), aff’d, 45 F.3d 1515 (11th Cir. 1995). ...........................................................................................................................15

Dolphin and Bradbury, Inc. v. SEC., 512 F.3d 634 (D.C. Cir. 2008)................................19

Finkel v. Stratton Corp., 962 F.2d 169 (2d Cir. 1992).......................................................12

Halperin v. eBanker USA.Com, Inc., 295 F.3d 352 (2d Cir. 2002) ..................................19

Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011)...............................................................................................................12, 13, 14

Joseph v. Wiles, 223 F.3d 1155 (10th Cir. 2000) ..............................................................24

Kenneth R. Ward, Exchange Act Release No. 3-9327, 2003 WL 1447865 (Mar. 19, 2003) aff’d 75 Fed. Appx. 320 (5th Cir. 2003)............................................15

Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574 (1986) ........................11

Mount Vernon Fire Ins. Co. v. Belize NY, Inc., 277 F.3d 232, 236 (2d Cir. 2002) ............................................................................................................................11

Piesco v. Koch, 12 F.3d 332 (2d Cir. 1993) ......................................................................12

Porcelli v. United States, 404 F.3d 157 (2d Cir. 2005)......................................................20

Rombach v. Chang, 355 F.3d 164 (2d Cir. 2010)..............................................................18

SEC v. KPMG, LLP, 412 F. Supp. 2d 349 (S.D.N.Y. 2006) ............................................14


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SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008) reh’g granted en banc,opinion withdrawn, 573 F.3d 54 (2009), reinstated in relevant part(597 F.3d 436 (2010) .......................................................................................13, 14, 21

SEC v. Wolfson, 539 F.3d 1249 (10th Cir. 2008) .............................................................14

Slayton v. Am. Express Co., 604 F.3d 758 (2d Cir. 2010) ................................................18

Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87 (2d Cir. 2001) .....................................................................................................................22

TSC Indus., Inc. v. Northway, Inc.,, 426 U.S. 438 (1976) ................................................16

United States v. Beech-Nut Nutrition Corp., 871 F.2d 1181 (2d Cir. 1989) .....................15

United States v. Bilotti, 380 F.2d 649 (2d Cir. 1967)........................................................24

United States v. Crispo, 306 F.3d 71 (2d Cir. 2002) .........................................................20

United States v. Gayle., 342 F.3d 89 (2d Cir. 2003)..........................................................12

United States v. Males, 459 F.3d 154 (2d Cir. 2006) ........................................................20

United States v. Naftalin, 441 U.S. 768 (1979) .................................................................24

United States v. Shellef, 507 F.3d 82 (2d Cir. 2007).........................................................20

Williamson v. united States, 207 U.S. 425 (1908).............................................................15

Varold, LLC v. Cerami., 545 F.3d 114, 121 (2d Cir. 2008) ..............................................11

DOCKETED CASES

De Jesus v. City of New York, No. 10 Civ. 9400, 2012 WL 569176 (S.D.N.Y. Feb 21, 2012) ..............................................................................................11

Redd v. New York Div. of Parole, No. 10-41410-cv, 2012 WL 1560403(May 4, 2012)...............................................................................................................17

SEC v. Daifotis, No. C 11-00137 WHA, 2011 WL 3295139 (N.D. Cal. Aug. 1, 2011) ...............................................................................................................13

SEC v. Delphi Corp., No. 06-14891, 2008 WL 4539519 (E.D. Mich. Oct. 8, 2008) ..................................................................................................................21, 22

SEC v. Geswein, No. 5:10CV1235, 2011 WL 4565861 (N.D. Ohio Sept.


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29, 2011) ......................................................................................................................13

SEC v. Kelly, No. 08 Civ. 4612 (CM), 2011 WL 4431161 (S.D.N.Y. Sept. 22, 2011) ......................................................................................................................13

SEC v. Mercury Interactive, LLC, No. 5:07-cv-02822-WHA, 2011 WL 5871020 (N.D. Cal. Nov. 22, 2011).............................................................................13

SEC v. Pentagon Capital Mgmt. PLC, No. 08 Civ. 3324, 2012 WL 479576 (S.D.N.Y. Feb. 14 2012) .................................................................................13

SEC v. Radius Capital Corp., No. 2:11-cv-116-ftM-29DNF, 2012 WL 695668 (M.D. Fla. Mar. 1, 2012).................................................................................13

SEC v. Sentinel Mgmt. Grp., Inc., No. 07 C 4684, 2012 WL 1079961 (N.D. Ill. Mar. 30, 2012)..............................................................................................13

FEDERAL STATUTES

Securities Act of 1933Section 17(a)…….[15 U.S.C. § 77q(a)] .................................................................... passim

Securities Exchange Act 1934Rule 10(b)……….[17 CFR § 240.1b] .........................................................................12, 20

18 U.S.C. § 1341................................................................................................................20

LOCAL RULES

S.D.N.Y. R. 7.1 ....................................................................................................................1

MISCELLANEOUS

Robert A. Prentice, Scheme Liability: Does It Have a Future After Stoneridge?, 2009 Wisc. L. Rev. 351 (2009)...............................................................20


3UNITED STATES DISTRICT COURTSOUTHERN DISTRICT OF NEW YORK________________________________________________

:SECURITIES AND EXCHANGE COMMISSION, :

:Plaintiff, :

: 11 Civ. 07388 (JSR)v. :

: ECF CaseBRIAN H. STOKER, :

:Defendant. :

________________________________________________:

PLAINTIFF’S MEMORANDUM OF LAW IN OPPOSITION TO DEFENDANT BRIAN H. STOKER’S MOTION FOR SUMMARY JUDGMENT

Pursuant to Local Civil Rule 7.1 and the Court’s Case Management Plan, dated

November 15, 2011, Plaintiff, the Securities and Exchange Commission (“Commission”),

respectfully submits its Memorandum of Law in Opposition to Defendant Brian H. Stoker’s

Motion for Summary Judgment.

PRELIMINARY STATEMENT

The evidence demonstrates that the defendant, Brian H. Stoker (“Stoker”) violated

Sections 17(a)(2) and (3) of the Securities Act of 1933 (“Securities Act”) because of his role in

the structuring and marketing of a largely synthetic collateralized debt obligation (“CDO”)

named Class V Funding III (“Class V III”). As a director of the CDO structuring desk at

Citigroup Global Markets, Inc. (“Citigroup”) and the lead structurer for Class V III, Stoker was

responsible for ensuring the accuracy of the disclosure documents used to market the deal.

Nevertheless, the offering circular (which Stoker personally edited) and the pitch book (which

Stoker personally distributed) failed to disclose that Citigroup played a substantial role in the

selection of the collateral for Class V III. Instead, those documents stated only that the collateral


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manager, Credit Suisse Alternative Capital (“CSAC), had selected the assets for the Class V III

portfolio without disclosing that, in fact, Citigroup had selected a substantial portion of the

assets. Further, although Stoker knew or reasonably should have known that Class V III was

intended as a proprietary trade to position Citigroup to profit from the poor performance of the

assets it selected, neither the pitch book nor the offering circular contained any disclosure that

Citigroup had taken an approximately $500 million naked short position on the assets it selected.

This information clearly would have been viewed by a reasonable investor as having

significantly altered the “total mix” of information available about Class V III.

In addition, the evidence demonstrates that Stoker played an active role in the Class V III

transaction that acted as a fraud upon investors. Stoker not only failed to ensure the

completeness and accuracy of disclosures concerning Class V III, he also structured the CDO

knowing it would be used by Citigroup to execute a proprietary trade, created models to

determine what profit Citigroup would make by taking short positions on the collateral in the

CDO, suggested what assets should be included and admonished his supervisor not to tell the

purported asset manager for Class V III that it was intended by Citigroup as a proprietary trade.

This evidence is more than sufficient for a reasonable juror could conclude that Stoker violated

both Section 17(a)(2) and (3).

STATEMENT OF FACTS

I. Structuring The Class V III CDO

During the fall of 2006, Citigroup learned of a large market demand to purchase

protection on CDOs, many of them synthetic, whose assets consisted primarily of BBB-rated

subprime, residential mortgage backed securities (“RMBS”), Facts ¶ 40,1

1 “Facts ¶ __,” refers to Plaintiff’s Counter-Statement of Undisputed Facts.

particularly for


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mezzanine CDOs named after constellations (the “Constellation” deals) and for CDOs known as

“President” deals. Facts ¶ 41. A synthetic CDO does not hold actual assets, but merely

references other assets. This is accomplished by having the CDO sell insurance against the risk

of loss facing investors in the referenced RMBS. If the mortgage borrowers default on the loans

in the RMBS, the investors in a synthetic CDO face the same loss as the investors in the RMBS.

Facts ¶ 42. The insurance contract issued by a synthetic CDO is called a credit default swap

(“CDS”). The investor in a CDS purchases “protection” from the CDO on a specific asset such

as an RMBS or a tranche from another CDO. Facts ¶ 43.

The demand for protection was particularly strong from James Prusko of Magnetar

Capital. Facts ¶ 41. Magnetar was a hedge fund that engaged in a strategy on Constellation and

President CDOs, of betting against the performance of those deals by purchasing protection on

the mezzanine tranches (taking a “short” position). Facts ¶ 44. As a result of this increased

demand, Citigroup’s CDO Group (“CDO Group”) had internal discussions about structuring and

marketing a CDO squared. Facts ¶ 45. In a CDO squared, the underlying assets are themselves

tranches of existing CDOs. Facts ¶ 48. As early as September 2006, Citigroup was aware that

the default rate of a CDO squared could double, if as little as five or ten percent of the CDO

assets included in it were “weak.” Facts ¶ 104.

On October 19, 2006, Citigroup initiated discussions with CSAC about CSAC acting as

collateral manager for the proposed CDO squared. Facts ¶ 47. Citigroup knew that representing

to investors that an experienced, third-party collateral manager had selected the investment

portfolio would facilitate the placement of the CDO squared’s liabilities. Facts ¶ 49. During this

same time, there were discussions between Donald Quintin (“Quintin”) a Managing Director and

head of the CDO Group’s secondary trading desk and other members of the CDO group,


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including Stoker, about buying protection (taking a short position) on certain assets, including

Constellation and President deals. Facts ¶ 50. A “naked short position” is a position that has not

been hedged or covered. Facts ¶ 51. During this period, Stoker was a director on the CDO

Group’s structuring desk. Facts ¶ 52. In October 2006, Quintin asked Stoker to begin

structuring a CDO to be used by Quintin to execute a proprietary trade, Facts ¶ 53, which is a

trade executed by a trading desk that is not part of a dealer’s market-making role. Facts ¶ 54.

On October 23, 2006, Quintin sent Stoker a list of 21 assets on which he wished to purchase

protection from a CDO. Facts ¶ 14(a). Twelve of the assets on this list were Constellation deals

and three were President deals. Facts ¶ 55. On October 26, 2006, Stoker informed Quintin,

Darius Grant (“Grant”), a Managing Director and head of the CDO Group’s structuring desk, and

Shalabh Merish (“Merish”), a Managing Director and head of the CDO Group’s syndicate desk,

he had prepared models for two structures for a CDO squared that included consideration of the

profit Citigroup could make by taking short positions on the collateral. Facts ¶ 56.

On November 1, 2006, Stoker forwarded the list of assets he received from Quintin, to

Sohail Khan (“Khan”) the sales person at Citigroup who covered CSAC. Facts ¶ 14(b). This list

was not in the typical format used to propose a “dummy portfolio” for a CDO. Facts ¶ 14(c).

Stoker did not normally send a list of potential assets for inclusion in a deal to a sales person at

Citigroup and he did not normally suggest specific assets for inclusion in a CDO he was

structuring. Facts ¶ 14(d). Stoker learned that Khan forwarded this list along with the names of

four other assets to Samir Bhatt (“Bhatt”) at CSAC. Facts ¶ 14(e)-(f). In Stoker’s experience, it

was unusual for a sales person at Citigroup to send a proposed portfolio to a manager in advance

of doing a deal. Facts ¶ 57.


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On November 2, 2006, Quintin told Stoker that CSAC was “amenable to the portfolio”

that Citigroup proposed. Facts ¶ 58. That same day, Stoker distributed a draft engagement letter

for a CDO squared with CSAC. Id. On November 3, 2006, in response to an inquiry from Grant

concerning whether Citigroup was going forward with the proposed “CSAC CDO squared,”

Stoker replied: “I hope so. This is DQ’s [Donald Quintin’s] prop trade (don’t tell CSAC).

CSAC agreed to terms even though they don’t get to pick the assets.” Facts ¶ 59. On November

14, 2006, Stoker personally forwarded the list of 25 assets to Bhatt’s supervisor, Michael

Shackelford. Facts ¶ 14(i). On November 22, 2006, Stoker distributed “the latest structure” of

Class V III to the CDO Group, in which he recommended President and Constellation deals be

included in a “CSAC CDO squared.” Facts ¶ 60. Stoker understood Magnetar purchased

protection on mezzanine tranches of the Constellation deals because these CDOs were structured

so that if the equity in the CDO lost value, it was because all the underlying assets performed

poorly and, thus, the mezzanine tranche would also perform poorly so the protection purchaser

would profit. Facts ¶ 61.

On December 21, 2006, Bhatt sent a list of approximately 128 CDOs as potential

candidates for inclusion in the proposed CDO to Khan, who, in turn, forwarded it to Stoker,

Quintin and Mehrish. Facts ¶ 14(j). Citigroup had never previously received a list of potential

candidates for inclusion in a CDO portfolio of this length. Facts ¶ 14(k). CSAC’s list included

20 of the 25 assets Khan sent to CSAC on November 1, 2006, including 15 Constellation deals

and 3 President deals. Facts ¶ 62. On the morning of January 8, 2007, Citigroup selected 25

CDOs on which Citigroup wanted to purchase protection from CSAC’s list and provided those

names to CSAC. Facts ¶¶ 14(l)-(m). Twelve of these 25 assets were Constellation deals and 3

were President deals. Facts ¶ 63. Within an hour, CSAC agreed to include all 25 assets in the


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CDO that became Class V III. Facts ¶ 14(m). The amount of protection Citigroup purchased on

these 25 reference assets was $250 million. Facts ¶ 64. Stoker learned CSAC agreed to sell

Citigroup $250 million of protection on 25 assets on that same day. Facts ¶ 65. In Stoker’s

experience, there was a lot of give and take between an asset manager and an arranging bank at

the beginning of a deal, but that give and take did not generally include discussions of specific

assets. Facts ¶ 16. During the time Citigroup was structuring Class V III, it was aware the

performance of sub-prime mortgages and CDOs containing sub-prime mortgages was

deteriorating—especially those originated in 2006. Facts ¶ 103. All but one of the 25 assets

Citigroup selected for Class V III was a CDO that closed in 2006. Facts ¶ 105.

On January 12, 2007, Citigroup and CSAC agreed Citigroup would double the amount of

protection on each of the original 25 assets that Citigroup selected for the investment portfolio.

Facts ¶ 66. Ultimately, the size of the Class V III transaction was approximately $1 billion,

Facts ¶ 67, and contained a total of 58 individual names,2

Stoker understood that if someone selects synthetic assets for inclusion in a synthetic

CDO for the purpose of purchasing protection on those assets, it is likely the person would want

those assets to perform poorly. Facts ¶ 69. The 25 reference assets on which Citigroup

purchased protection were of a lower quality than the other candidate reference assets proposed

49 of which were synthetic. Id.

Citigroup intermediated the trades of 23 the other 24 synthetic assets. Facts ¶ 68. With one

exception, Citigroup sold its position on these 23 synthetic assets before Class V III closed—the

vast majority of these sales occurring on the same day Citigroup intermediated the purchase of

protection from Class V III—for a fee of three basis points (.03%). Id.

2 Because Citigroup and others purchased protection on the some assets twice, Class V III actually contained 92 assets.


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by CSAC, exhibited riskier structures and were more likely to default in the event of a downturn

in housing prices than the other candidate assets proposed by CSAC for Class V III. Facts ¶ 70.

II. Marketing of Class V III

Citigroup’s primary materials for marketing Class V III included a pitch book and an

offering circular. Facts ¶ 71. The pitch book was based on the pitch book for a CDO named

Adams Square II, for which Stoker was the lead structurer. Facts ¶ 3. The pitch book for Class

V III represented in its “Transaction Overview” that CSAC was the “collateral manager” and that

CSAC had selected the collateral for Class V III. Facts ¶ 72. The twenty-page “Manager”

section prepared by CSAC contained a section purporting to describe how CSAC selected each

asset it included in the investment portfolio of its CDOs. Facts ¶ 73. Citigroup prepared the

Risk Factors section of the pitch book that also stated CSAC had “selected” the collateral for

Class V III. Facts ¶ 74. The pitch book did not disclose Citigroup had specifically requested 25

assets be included in Class V III and that Citigroup had taken a $500 million naked short position

on those assets. Facts ¶ 75.

Stoker was the lead structurer or “deal manager” on Class V III. Facts ¶ 1. Stoker and

another individual, Keith Pinniger (“Pinniger”), worked on the marketing documents for the

CDO, including the offering circular. Id. As lead structurer on Class V III, Stoker was

responsible for reviewing the pitch book to make sure it was accurate and for approving it before

it could be finalized. Id. Citigroup’s structuring desk reviewed the Manager section to ensure its

accuracy and provided comments to the Manager about anything that needed to be corrected.

Facts ¶ 2. When preparing an offering circular for a new CDO, it was standard practice at

Citigroup to use the offering circular from a previous deal as a template for the new one. Id.

Stoker spent a lot of time modifying deal documents used by the structuring desk so they could


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be used for any type of CDO, id., and his goal was to have his deal documents used in all new

CDOs at Citigroup. Id. The offering circular for Class V III was also based upon the offering

circular for Adams Square II. Facts ¶ 8.

Beginning in late January 2007, Citigroup broadly marketed Class V III, providing the

pitch book and offering circular to prospective investors. Facts ¶ 82. Stoker personally sent a

copy of the Class V III pitch book to a prospective investor along with a representation that Class

V III was a “top-of-the-line CDO squared.” Facts ¶ 83. The largest investor in Class V III was

Ambac Financial Group (“Ambac”), which received multiple drafts of the offering circular, one

of which was provided by Stoker. Facts ¶ 84. The participation of CSAC as the collateral

manager for Class V III was an important consideration for Ambac. Facts ¶ 85. Ambac was

unaware of Citigroup’s approximately $500 million naked short position in Class V III or the

extent of Citigroup’s influence on the asset selection process. Facts ¶ 86.

Rating agencies required Citigroup to act as the initial swap counterparty for any

synthetic collateral in a CDO and, therefore, Citigroup was the intermediary for all protection

purchased on the synthetic collateral in a CDO. Facts ¶ 23. Stoker viewed Citigroup’s normal

role as initial swap counterparty as an “intermediary,” “just an administrator moving money

around.” Facts ¶ 76. However, for the 25 assets in Class V III on which Citigroup purchased

protection, Citigroup’s role was different. Facts ¶ 23.

In February 2007, Stoker reviewed the preliminary offering circular for Class V III and

made substantial edits to portions of it, including the Risk Factors, but, he made no changes or

edits to the sections stating CSAC selected the assets or to the section describing Citigroup’s

position as initial swap counterparty. Facts ¶ 8. Stoker made no attempt to obtain information

about whether the secondary trading desk had taken a naked short position on any of the assets in


9

Class V III and the size of its short position or otherwise take action to ensure the disclosures

concerning Citigroup’s interest in Class V III were accurate. Facts ¶ 77. As deal manager for

Class V III, Stoker was responsible for providing information to outside counsel for inclusion in

the offering memorandum and for providing counsel with information regarding differences

between Class V III and other CDOs. Facts ¶ 8. Stoker believed he should tell the attorneys

reviewing a CDO if he knew something in the offering circular was inaccurate or if he was aware

of “something interesting” about the CDO. Facts ¶ 78.

On or about February 14, 2007, Quintin communicated to Citigroup’s Risk Management

Group that the secondary trading desk intended to retain the short positions in Class V III even if

Citigroup sold all the tranches of Class V III. Facts ¶ 28. Due to the excess risk this position

created, a three-month exception to risk limitations was granted by the Independent Risk Group

for this short position. Id. On or about February 26, 2007, Citigroup finalized the offering

circular for Class V III. Facts ¶ 79. The finalized version of the Class V III offering circular

stated CSAC “will act as the manager for the portfolio of assets,” and the body of the offering

circular contained repeated references that the investment portfolio was “selected” by CSAC.

Facts ¶ 80. Both the pitch book and the offering circular contained a disclosure concerning

Citigroup’s role as “Initial CDS Asset Counterparty.” Facts ¶ 81. But, neither of these

documents disclosed that Citigroup had any role in selecting 25 of the assets in Class V III or

that it actually had taken a naked short positions on those 25 assets. Id.

III. Closing of Class V III CDO

The Class V III transaction closed on February 28, 2007. Facts ¶ 87. Effective March

16, 2007, Ambac finalized its $500 million investment in Class V III’s super senior tranche by

agreeing to assume the credit risk associated with that portion of the capital structure. Facts ¶ 88.


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Had Ambac been informed Citigroup had taken a $500 million naked short position on the 25

assets it asked Citigroup to include in Class V III, but only intermediated the protection on the

other assets, it would have considered “walk[ing] away from the transaction.” Facts ¶ 89.

Citigroup also provided the pitch book and offering circular to Subordinate Investors. Facts ¶

90. Ultimately, approximately 15 different investors purchased or sold protection on tranches of

Class V III with a face value of approximately $893 million. Facts ¶ 91.

By late July 2007, 14 of the 58 names in the Class V III portfolio had been placed on

negative watch by Moody’s and/or Standard & Poor’s. Facts ¶ 92. Eleven of the 14 names

placed on negative watch were names Citigroup selected. Facts ¶ 93. On November 19, 2007,

Class V III was declared to be in an Event of Default, id., and, as a result, Ambac ultimately

suffered losses of about $305 million. Facts ¶ 98.

The 25 names Citigroup selected for Class V III performed significantly worse than other

names in Class V III and significantly worse than the other names on the list that CSAC provided

to Citigroup. Facts ¶ 94. On the date Class V III was declared to be in default, 6 of the 25 assets

selected by Citigroup also were declared in default, while only 2 of the 102 other assets proposed

by CSAC on December 21, 2006, were declared in default. Facts ¶ 95. This difference in

default rates is statistically significant at the one percent level. Id. Also, while 6 of the 25 assets

Citigroup selected were declared in default by November 19, 2007, none of the other 20 assets in

Class V III from the list of names CSAC provided were declared in default. Facts ¶ 96. Finally,

the credit ratings of the 25 assets Citigroup selected were downgraded at a much higher rate than

the other 102 assets that CSAC proposed. Facts ¶ 97.

Typically, when Citigroup acted as the arranging bank for a CDO, it was compensated by

receiving structuring fees from the investors. Facts ¶ 99. Citigroup received approximately $34


11

million from investors as fees for structuring Class V III. Facts ¶ 100. In addition, as a result of

the short position it took on the 25 assets in Class V III, Citigroup made a profit of at least $250

million. Facts ¶ 101. Stoker was paid a salary and a bonus for his work as a structurer on CDOs,

including Class V III. Facts ¶ 31. His compensation was based on both qualitative and

quantitative considerations, including the revenue he generated. Id. In 2006, Stoker was paid a

salary of $150,000 and a guaranteed bonus of $1.05 million, and in February 2007, Stoker

negotiated a salary of $150,000 and a guaranteed bonus of $2.25 million for 2007. Facts ¶ 102.

ARGUMENT

I. Standard For Consideration Of Motion For Summary Judgment

To prevail on a motion for summary judgment, the moving party bears the burden of

demonstrating the absence of a genuine dispute of material fact. Anderson v. Liberty Lobby,

Inc., 477 U.S. 242, 247 (1986); Varold, LLC v. Cerami, 545 F.3d 114, 121 (2d Cir. 2008). “A

dispute regarding a material fact is genuine if the evidence is such that a reasonable jury could

return a verdict for the nonmoving party.” Mount Vernon Fire Ins. Co. v. Belize NY, Inc., 277

F. 3d 232, 236 (2d Cir. 2002) (citation omitted).

When the moving party has discharged its burden, the non-moving party must come

forward with “specific facts showing there is a genuine issue for trial.” Matsushita Elec. Indus.

Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986); Burt Rigid Box, Inc. v. Travelers Property

Cas. Corp., 302 F.3d 83, 91 (2d Cir. 2002). The court evaluates the evidence presented in the

light most favorable to the non-moving party and “is required to resolve all ambiguities and draw

all inferences in favor of the non-moving party.” De Jesus v. City of New York, No. 10 Civ.

9400, 2012 WL 569176, at *4 (S.D.N.Y. Feb. 21, 2012). A court may grant summary judgment

“only if it can conclude that, with credibility assessments made against the moving party and all


12

inferences drawn against the moving party, a reasonable juror would have been compelled to

accept the view of the moving party.” Piesco v. Koch, 12 F.3d 332, 343 (2d. Cir. 1993).

II. The Evidence Is Legally Sufficient To Prove That Stoker Violated Section 17(a)(2)

A. Janus Does Not Apply To Section 17(a)(2)

Stoker’s claim that the Commission must prove he had “ultimate authority” over

misleading statements or omissions about Class V III to establish a violation of Section 17(a)(2),

Def. Mem. at 6,3

In Janus, the Supreme Court addressed only what constitutes “mak[ing]” a false

statement in violation of Section 10(b) and Rule 10b-5(b) thereunder. See Janus at 2302. The

Court based its interpretation of that term on two primary considerations. First, the Court relied

on the dictionary definition of the word “make” as used in the Rule 10b-5(b). Id. Second, the

Court reasoned that applying a broader definition of the term “make” would expand the scope of

liability in implied private rights of action under Rule 10b-5. Id. at 2302-03. Neither of these

considerations is applicable to the interpretation of Section 17(a). Liability under Section

17(a)(2) is not based on “making” a false statement. Rather, Section 17(a)(2) makes it unlawful

to obtain money or property “by means of” any untrue statement or omission of material fact.

See 15 U.S.C. § 77q(a)(2). Because the operative language of Section 17(a) does not contain the

phrase “to make,” Janus is inapplicable to Section 17(a) claims. See United States v. Gayle, 342

F.3d 89, 92 (2d Cir. 2003) (“Statutory construction begins with the plain text and, if that text is

unambiguous, it usually ends there as well.”). In addition, the policy concerns underlying Janus

are absent here, as there is no implied private right of action under Section 17(a). Finkel v.

is based on a misapplication of the Supreme Court’s holding in Janus Captial

Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011) to Section 17(a)(2).

3 “Def. Mem. at ___,” refers to Memorandum of Points and Authorities in support of Defendant Brian H. stoker’s Motion for Summary Judgment.


13

Stratton Corp., 962 F.2d 169, 174 (2d Cir. 1992). Accordingly, “Janus does not apply to claims

brought pursuant to Section 17(a) of the Securities Act.” SEC v. Pentagon Capital Management

PLC, __ F. Supp. 2d __, 2012 WL 479576, at *42 (S.D.N.Y. Feb. 14, 2012); see SEC v.

Daifotis, No. C 11-00137, 2011 WL 3295139, at *5 (N.D. Cal. Aug. 1, 2011); SEC v. Mercury

Interactive, LLC, No. 5:07-cv-02822-WHA, 2011 WL 5871020, at *3 (N.D. Cal. Nov. 22,

2011); SEC v. Geswein, No. 10-cv-1235, 2011 WL 4565861, at *2 (N.D. Ohio Sept. 29, 2011);

SEC v. Radius Capital Corp., No. 2:11-cv-116, 2012 WL 695668 (M.D. Fla. Mar. 1, 2012).4

Liability under Section 17(a)(2) is not limited to defendants who “make” a false

statement. In SEC v. Tambone, 550 F.3d 106, 125 (1st Cir. 2008), reh’g en banc granted and

opinion withdrawn, 573 F.3d 54 (2009), and opinion reinstated in relevant part, 597 F.3d 436,

450 (2010) (en banc), the First Circuit explained that Section 17(a)(2) does not require that the

seller must himself make that untrue statement. Rather, the issue is whether a defendant used the

“to obtain money or property,” regardless of its source. Id. at 127. The court went on to state:

“Specifically, primary liability may attach under section 17(a)(2) even when the defendant has

not himself made a false statement in connection with the offer or sale of a security.” Id. at 128

(emphasis added). In short, Stoker’s reliance on the Supreme Court’s decision in Janus in

support of his motion for summary judgment is misplaced.

4 Contra SEC v. Kelly, No. 08-4612 (CM), 2011 WL 4431161, at *5 (S.D.N.Y. Sept. 22, 2011) (holding that SEC must prove that defendant made a materially misleading statement to support a claim pursuant to Section 17(a)(2)). The Commission believes Kelly was wrongly decided because it failed to address any of the arguments detailed above, despite the fact that they were raised in that case. Hence, Kelly is of little persuasive value on this issue. See SEC v. Sentinel Management Group, Inc., No. 07 C 4684, 2012 WL 1079961, at *15 (N.D. Ill. Mar. 30, 2012) (rejecting Kelly, because it did not address the policy reasons underlying Janus).


14

B. Stoker Obtained Money Or Property By Means Of A False Statement

Section 17(a)(2) requires evidence that a defendant obtained money or property, “by

means of” a false statement. While someone who makes a false statement to solicit investments

certainly violates Section 17(a)(2), see, e.g., SEC v. KPMG, LLP, 412 F. Supp. 2d 349, 375

(S.D.N.Y. 2006), such conduct is not required to violate that provision. A defendant may also be

primarily liable under Section 17(a)(2) if he assists in the preparation of false statements used to

offer or sell securities, see SEC v. Wolfson, 539 F.3d 1249, 1264 (10th Cir. 2008), or if he

“uses” a false statement prepared by himself or another, see Tambone, 550 F.3d at 127. There is

legally sufficient evidence that Stoker violated Section 17(a)(2) under either of these theories.

1. Stoker Participated In The Preparation Of Marketing Materials

The evidence demonstrates that, as the deal manager for Class V III, Stoker was

responsible for reviewing the pitch book to make sure it was accurate and for approving it before

it could be finalized. Facts ¶ 1. The offering circular for Class V III was based on an offering

circular for another CDO for which Stoker was the deal manager, Facts ¶ 8, and Stoker actively

sought to have his standardized deal documents used in all new CDOs. Facts ¶ 2. Further, as

deal manager, Stoker was responsible for providing information to outside counsel for inclusion

in the offering circular and he was responsible for providing counsel with information regarding

any differences between Class V III and the CDO on which the offering circular for Class V III

was based. Facts ¶¶ 77-78. Although Stoker substantially edited the draft offering circular, he

made no changes or edits to the sections stating that CSAC selected the assets or to the section

describing Citigroup’s position as initial swap counterparty. Facts ¶ 8.

Thus, there is evidence that Stoker was responsible for both the pitch book and the

offering circular, personally determined provisions that should be included in them, and edited


15

those provisions he thought necessary. A reasonable juror could conclude that Stoker’s decision

not to edit the sections of the pitch book and offering circular that contained the misleading

statements and omissions about Citigroup’s role in selecting the assets for Class V III and the

$500 million proprietary short position it took, while editing other sections is an act or omission

for which he is personally responsible.

Stoker’s claim that the drafting of the pitch book and offering circular for Class V III was

“shared,” Def. Mem. at 8, does not absolve him of responsibility for the misleading statements

and omissions in these documents. Regardless what role others had in the drafting of the Class V

III marketing materials, Stoker played a central role in that process and therefore, may be held

liable for violating Section 17(a)(2). Donald Sheldon, 51 S.E.C. 59, 88 n.130 (1992), aff’d, 45

F.3d 1515 (11th Cir. 1995) (deficiencies in supervision do not absolve individual of liability for

violations of securities law); Kenneth R. Ward, Exch. Act Release No. 3-9327, WL 1447865, at

*12 (Mar. 19, 2003), aff’d 75 Fed. Appx. 320 (5th Cir. 2003) (complicity of others does not

relieve individual of liability for his acts). Further, Stoker’s argument that counsel were involved

in the preparation of certain portions of the pitch book and offering circular, Def. Mem. at 9-12,

does not absolve him of responsibility for the misstatements and omissions in that document. It

is well-settled that a defendant cannot rely on advice of counsel unless he has made full

disclosure of all the pertinent facts to counsel. See United States v. Beech-Nut Nutrition Corp.,

871 F. 2d 1181, 1194 (2d Cir. 1989) (citing Williamson v. United States, 207 U.S. 425, 453

(1908). In this case, there is ample evidence that although Stoker knew or reasonably should

have known that the pitch book and offering circular did not fully and accurately disclose

Citigroup’s role in selecting assets for Class V III and that it made a proprietary bet against those

assets, he did not disclose that information to counsel who were reviewing those documents.


16

Similarly, Stoker’s claim that CSAC was responsible for certain portions of the pitch

book and offering circular does not absolve him of responsibility because there is substantial

evidence that he knew or reasonably should have known that portions of the marketing materials

for Class V III were not complete and were inaccurate and, therefore, he had a duty to include

complete and accurate information in the documents. Facts ¶¶ 1, 77-78.

2. Stoker “Used” Misleading Statements To Obtain Money Or Property

There also is legally sufficient evidence that Stoker violated Section 17(a)(2) by using the

marketing materials for Class V III. The uncontroverted evidence establishes that on February 6,

2007, Stoker personally sent a copy of the pitch book to a prospective investor touting Class V

III as a “top-of-the-line CDO squared.” Facts ¶ 83. There also is uncontroverted evidence that

on February 7, 2007, Stoker personally provided a copy of the preliminary offering circular to

Ambac, the largest investor in Class V III, which lost approximately $305 million. Facts

¶¶ 84, 98. These facts are legally sufficient to support a finding by a reasonable juror that Stoker

used the materially misleading marketing materials for Class V III to obtain money or property.

C. The Class V III Marketing Materials Contained Material Omissions

Section 17(a)(2) prohibits the obtaining of money or property “by means of any untrue

statement of a material fact or any omission to state a material fact necessary in order to make

the statements made, . . . not misleading.” 15 U.S.C. § 77q(a)(2). A misstatement or omission is

material if there is “a substantial likelihood that the disclosure of the omitted fact would have

been viewed by the reasonable investor as having significantly altered the ‘total mix’ of

information made available.” TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).

There is more than sufficient evidence for a jury to conclude that Citigroup’s failure to disclose


17

is role in selecting 25 assets for Class V III and its naked short position on those assets would

have significantly altered the “total mix” of information about Class V III.

There is no dispute that neither the pitch book nor the offering circular for Class V III

disclosed the role that Citigroup played in the selection of the assets for Class V III. Stoker

concedes that both those documents repeatedly stated the assets were selected by CSAC. Def.

Mem. at 12-13. Stoker’s claim is that the disclosure that CSAC picked the assets was accurate

and no further disclosure was required. Id. There is, however, substantial evidence that

Citigroup played a significant role in selecting the 25 assets for Class V III that was not

disclosed. Stoker admitted CSAC had agreed to act as asset manager for a CDO squared even

though it didn’t get to pick the assets. Facts ¶ 59. This admission is corroborated by the fact that

the selection of assets for Class V was unusual and both the timing and the substance of

Citigroup’s identification of assets for Class V III were inconsistent with Citigroup’s normal

procedures for identifying assets for a CDO. Facts ¶¶ 14(c)-(d), 16, 17. The reason for this

departure from normal procedures was because Citigroup wanted to use Class V III as a

proprietary trade—not merely as a means of obtaining the structuring fees it normally received

for acting as an arranging bank for a CDO. Further, CSAC’s agreement to include the 25 assets

Citigroup proposed within an hour of the proposal would cause a reasonable juror to question

whether CSAC actually selected these assets or merely acquiesced to Citigroup’s request without

any independent evaluation of the assets.5

Stoker’s failure to include in the marketing materials any disclosure of Citigroup’s

significant role in the selection of 25 assets of which he knew or reasonably should have known

Facts ¶ 14(m).

5 The assessment of the credibility of the witnesses upon whose testimony Stoker relies to support his argument is an issue for the jury and, therefore, their testimony is not sufficient to support a claim for summary judgment in the face of evidence to the contrary. See Redd v. New York Div. of Parole, __ F.3d __, 2012 WL 156403, at *6 (2d. Cir. May 4, 2012).


18

is further exacerbated by the omission of any disclosure that Citigroup had taken a naked short

position on those very assets. Stoker’s claim that the disclosure in the pitch book and offering

circular that Citigroup was the initial swap counterparty for all the synthetic assets in Class V III

was sufficient, Def. Mem. at 14-17, is incorrect as a matter of fact and law. First, there is

substantial evidence that Citigroup’s naked short position on the 25 assets was not the same as its

position as the initial swap counterparty. Facts ¶ 23. To the extent Citigroup purchased

protection on the 25 assets as a proprietary trade, Citigroup was not acting as the “intermediary”

or an “administrator moving money around,” that Stoker believed was the function of the initial

swap counterparty. Facts ¶ 76. Further, there is evidence that potential investors did not

understand the disclosure of Citigroup’s role as initial swap counterparty as disclosing that

Citigroup had taken a naked short position on 25 of the assets in Class V III. Facts ¶ 23.

Second, Stoker’s claim that the disclosure that Citigroup may provide the synthetic assets

in Class V III with or without off-setting positions was sufficient to put investors on notice of its

naked short position on 25 select assets ignores the actual facts. At the time Citigroup began

marketing Class V III, it already had taken a naked short position on 25 assets and at least two

weeks before the CDO closed, Citigroup in internal correspondence that it intended to keep those

positions after Class V III closed. Facts ¶ 28. Indeed, the evidence suggests it was Citigroup’s

intent to take a naked short position on assets in Class V III from its inception. Facts ¶ 14(a)-(h),

59, 53, 59, 61-63. Therefore, the Citigroup’s disclosure that it “may” hold a short position on

some assets in Class V III and that it “may” have interests adverse to the investors was

misleading and failed to provide full disclosure of all the risks that already existed. See

Rombach v. Chang, 355 F.3d 164, 173 (2d Cir. 2004) (“Cautionary words about future risk

cannot insulate from liability the failure to disclose that the risk has transpired.”); Slayton v. Am.


19

Express Co., 604 F.3d 758, 770 (2d Cir. 2010); see also Dolphin and Bradbury, Inc. v. SEC, 512

F.3d 634, 640 (D.C. Cir. 2008) (there is a clear distinction between disclosing a future event that

might occur and disclosing actual knowledge that it will occur).

Third, Stoker’s argument fails to acknowledge that the adequacy of the disclosures

cannot be based upon a consideration of each separate disclosure in isolation, but rather whether

the “representations or omissions, when considered together and in context, would affect the

total mix of information and thereby mislead a reasonable investor . . . .” Halperin v. eBanker

USA.Com, Inc., 295 F.3d 352, 357 (2d Cir. 2002). Therefore, the proper consideration is not

whether the failure to disclose Citigroup’s role in selecting assets for Class V III was material or

whether the failure to disclose that Citigroup took a naked short position on assets in Class V III

was material. Rather, the proper inquiry is whether the disclosure of Citigroup’s role in selecting

assets and its decision to take a naked short position on those very assets would have been

viewed by a reasonable investor as significantly altering the total mix of information about Class

V III. Based on the evidence described above, a reasonable juror could conclude that Stoker

knew or reasonably should have known that the disclosures included in the marketing materials

for Class V III did not adequately disclose these relevant facts.

D. Stoker Obtained Money Or Property As Required By Section 17(a)(2)

Stoker’s argument that the Commission must present evidence he personally obtained

money or property as a result of any alleged misstatements to prove he violated Section 17(a)(2),

Def. Mem. at 17, distorts both the language and purpose of that provision, ignores precedents

interpreting other similarly-worded statutory provisions, and would lead to absurd results.


20

1. Stoker Deprived Victims Of Money Or Property

Section 17(a) which prohibits both schemes to defraud and obtaining money or property

by means of false statements, was modeled after the mail fraud statute, which contains the same

two prohibitions.6

Here, the evidence demonstrates that as a result of Stoker’s failure to disclose that Citigroup

played a significant role in selecting 25 assets for Class V III and then taking a naked short

position on those assets, Ambac lost approximately $305 million. Facts ¶ 98. This evidence is

legally sufficient to establish that Stoker obtained “money or property” under Section 17(a)(2).

See Robert A. Prentice, Scheme Liability: Does It Have a Future After

Stoneridge?, 2009 Wisc. L. Rev. 351, 365 n.77 (2009) (“Rule 10b-5’s scheme to defraud

language was copied from section 17(a) of the 1933 Act. . . . Congress derived that language, in

turn, from the mail-fraud statutes, which is currently codified at 18 U.S.C. § 1341 (2006)”).

Interpreting the “obtaining money or property” language of the mail fraud statute, the Second

Circuit has “held that a ‘defendant does not need to literally ‘obtain’ money or property to violate

the statute.’” United States v. Males, 459 F.3d 154, 158 (2d Cir. 2006) (quoting Porcelli v.

United States, 404 F.3d 157, 162 (2d Cir. 2005)). Rather, “it is sufficient that a defendant’s

scheme was intended to deprive another of property rights, even if the defendant did not

physically ‘obtain’ any money or property by taking it from the victim.” Id.; see also United

States v. Shellef, 507 F.3d 82, 109 (2d Cir. 2007). Because Section 17(a)(2) was modeled after

the mail fraud statute, it too should be read as requiring only that a defendant deprive his victims

of money or property. See United States v. Crispo, 306 F.3d 71, 79 (2d Cir. 2002) (“fraud

statutes that use the same relevant language, should be analyzed in the same way”).

6 The mail fraud statute renders it unlawful to “devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises.” 18 U.S.C. § 1341 (emphasis added).


21

2. Stoker Obtained Money or Property

Even if Section 17(a)(2) is read to require that a defendant literally obtain money or

property (and not simply deprive his victim of such) by means of false statements, that

requirement can be satisfied in a number of ways. By its terms, Section 17(a)(2) renders it

unlawful to, “in the offer or sale of any securities . . . , directly or indirectly . . . obtain money or

property by means of any untrue statement of a material fact or any omission . . . .” (Emphasis

added). In Tambone, the First Circuit court “read the ‘directly or indirectly’ language to modify

the ‘to obtain money or property’ clause at the start of sub-section (2) of the statute.” Tambone,

550 F.3d at 128 n.29. In other words, Section 17(a)(2) renders one liable for “indirectly

obtaining money by means of an untrue statement.” Id. at 128 (emphasis in original). Thus, a

defendant can violate Section 17(a)(2) by directly or indirectly obtaining money or property by

means of a false statement.

While Section 17(a)(2) requires the defendant “obtain money or property” as a result of a

fraud, it does not specify for whom that money or property must be obtained. Section 17(a)(2)

“does not require that the person alleged to have made the false or misleading statement . . .

obtain money or property for [him]self.” SEC v. Delphi Corp., No. 06-14891, 2008 WL

4539519, at *20 (E.D. Mich. Oct. 8, 2008). Thus, where an individual is acting as an agent of a

company, the “obtained money or property” element is satisfied when the defendant obtains the

money or property for his principal or employer. Id.

Citigroup directly profited from Class V III when investors paid the bank $34 million in

structuring fees, Facts ¶ 100, and when Citigroup obtained at least $250 million from the naked

short positions it took on the 25 assets it selected. Facts ¶ 101. Thus, there is evidence from

which a reasonable juror could conclude that Stoker obtained money or property for Citigroup.


22

Stoker’s argument that imposing liability upon him would create “negligent aiding and

abetting,” misapprehends the doctrine of respondeat superior. Def. Mem. at 18. A corporation

may only act through its officers, employees and agents. Suez Equity Investors, L.P. v. Toronto-

Dominion Bank, 250 F.3d 87, 101 (2d Cir. 2001). Therefore, the actions of an officer that are

within the scope of his authority and done for the benefit the corporation are imputed to the

corporation. See Bank of China v. NBM LLC, 359 F.3d 171, 179 (2d Cir. 2004). Thus,

Citigroup’s primary liability for violating Section 17(a)(2) is based on Stoker’s commission of a

primary violation of that statute—not because he aided and abetted Citigroup’s violation.

Stoker was employed by Citigroup as a director in the CDO group and he was the lead

structurer for Class V III. Facts ¶ 1. Stoker’s preparation of the pitch book and offering circular,

and his efforts to market Class V III were intended to result in a profit for the corporation that

employed him. Stoker’s actions resulted in precisely the harm that Section 17(a)(2) was

intended to remedy – obtaining money from investors for Citigroup through the use of untrue

statements of fact. See Delphi Corp., 2008 WL 4539519, at *20.

Even assuming that the “obtain money or property” provision of Section 17(a)(2) were

interpreted to require evidence that Stoker directly received “money or property” obtained as a

result of the misstatements, there is evidence to support that requirement. Stoker was paid a

salary and a bonus by Citigroup for his work as a structurer of CDOs. Facts ¶ 31. His

compensation was based on both qualitative and quantitative considerations, including the

revenue he generated. Id. In 2006, Stoker was paid a salary of $150,000 and a guaranteed bonus

of $1.05 million, and in February 2007, Stoker negotiated a salary of $150,000 and a guaranteed

bonus of $2.25 million for 2007. Facts ¶ 102.


23

Stoker’s suggestion that he cannot be liable under Section 17(a)(2) unless there is

evidence he received a commission directly attributable to his work on Class V III, superimposes

a tracing requirement on the “obtain money or property” requirement that is not supported by the

plain language of the statute or the principles of respondeat superior. Whether an agent/officer

is paid by commission or by a salary, he receives compensation for actions taken on behalf of his

principal. Whether Stoker violated Section 17(a)(2) is not dependent on how he was

compensated for his work on behalf of Citigroup, but rather, whether his involvement in the

structuring and marketing of Class V III was within the scope of the employment for which he

was compensated. See Delphi Corp., 2008 WL 4539519, at *20. Since Stoker’s conduct

described above occurred while he was lead structurer on Class V III, there is a “factual nexus”

between his compensation and the misleading statements and omissions in Class V III Stoker

claims is required. Def. Mem. at 18.

III. Stoker Participated in a Scheme Under Section 17(a)(3) 7

A. A Violation Of Section 17(a)(3) May Be Based On Misrepresentations Or Omissions_____________________________________________________

Stoker’s argument there is no evidence he violated Section 17(a)(3) is predicated on the

incorrect assertion that the Commission must present evidence of conduct beyond

misrepresentations or omissions. Def. Mem. at 21. Section 17(a)(3) is violated when a

defendant directly or indirectly: “engage[s] in any transaction, practice, or course of business

which operates or would operate as a fraud or deceit upon the purchaser” of any security. 15

7 In his Motion for Summary Judgment, Dkt. No. 43, Stoker only requests summary judgment on the Section 17(a)(2) claim. However, in his memorandum in support of his motion, Stoker argues he also is entitled to summary judgment on the Section 17(a)(3) claim. Therefore, the Commission has provided its opposition to summary judgment on both claims.


24

U.S.C. § 77q(a)(3). Section 17(a)(3) “quite plainly focuses upon the effect of particular conduct

on members of the investing public.” Aaron v. SEC, 446 U.S. 680, 697 (1980).

The Supreme Court has expressly rejected the notion that one subsection of Section 17(a)

should be read to narrow another. See United States v. Naftalin, 441 U.S. 768, 774 (1979)

(“[e]ach succeeding prohibition is meant to cover additional kinds of illegalities-not to narrow

the reach of prior sections.”); see also United States v. Bilotti, 380 F.2d 649, (2d Cir. 1967);

Joseph v. Wiles, 223 F.3d 1155, 1163 (10th Cir. 2000). Further, the Supreme Court made clear

in Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972) that a defendant may be

found to have engaged in a “course of business” or “scheme” that operates as a fraud upon the

purchaser of a security even when the underlying conduct was “primarily a failure to disclose.”

Id. at 153. Similarly, evidence of a plan to induce investors to purchase Class V III notes

without disclosing to them material facts that could have been expected to influence their

decisions to purchase is a “course of business which operates . . . as a fraud,” in violation of

Section 17(a)(3). In this case there is ample evidence that Class V III was conceived and

structured by Citigroup as a transaction to position it to profit from the downturn in the United

States housing market and that Stoker played a key role in that transaction.

B. Class V III Was Intended As A Means For Citigroup To Profit From ThePoor Performance of Class V III’s Assets ___________________________

The evidence demonstrates that based on the increased demand for protection on CDOs,

particularly for Constellation and President deals, the CDO Group decided to structure and

market a CDO squared for the express purpose of purchasing protection on specific assets,

including Constellation and President deals. Facts ¶¶ 40-41, 45, 50, 53, 55. The evidence

supports the conclusion that Citigroup’s proprietary trade was part of a strategy to emulate

Magnetar’s strategy. Id. Stoker was personally involved in furthering this plan by forwarding


25

proposed lists of assets to CSAC for inclusion in the CDO; preparing models showing the profit

Citigroup could make; and recommending specific assets be included in the portfolio. Facts ¶¶

14(b) & (i), 56, 60. The evidence further demonstrates Citigroup played a substantial role in

selecting the assets for this CDO, which became Class V III, and was extremely successful in

having the assets on which it wished to purchase protection included. Facts ¶¶ 19, 62-63. The

assets Citigroup selected for Class V III were of a lower quality than the other candidate assets

proposed by CSAC, exhibited riskier structures and were more likely to default in the event of a

downturn in housing prices than the other candidate assets identified by CSAC on December 21,

2006. Facts ¶ 70. In fact, the 25 assets Citigroup selected performed much worse than the other

assets CSAC proposed and the other assets in Class V III. Facts ¶¶ 94-97.

During the time Citigroup was structuring Class V III, Citigroup also was aware that the

performance of sub-mortgages and CDOs containing sub-prime mortgages was deteriorating—

especially those that were originated in 2006. Facts ¶ 103. Coincidentally, all but one of the 25

assets Citigroup selected were CDOs that closed in 2006. Facts ¶ 105. Also, as early as

September 2006, Citigroup was aware that the default rate of a CDO squared could double, if as

few as five or ten percent of the CDO assets included in it were “weak.” Facts ¶ 104. Even

before Class V III closed, Citigroup had decided to retain the short position on the 25 assets in

Class V III on which it had purchased protection. Facts ¶ 28.

This evidence could lead a reasonable juror to conclude that, from its inception, Class V

III was intended as a means for Citigroup to position itself to profit if there was a downturn in

the housing market by allowing it to buy protection on a set of assets that had a higher likelihood

of failure than other potential assets. Moreover, the evidence is legally sufficient to establish that

Class V III was a transaction that operated as a fraud on investors because it was done in the


26

guise of Citigroup’s normal role as the arranging bank for a CDO, in which it typically profited

from the fees that it charged for structuring the CDO – not by betting against the securities it had

structured and then marketed to investors. Facts ¶ 99. Also, Citigroup’s decision to take a naked

short position on the synthetic assets was different from its role as the initial swap counterparty

for those assets, Facts ¶ 23, and investors were unaware that Citigroup had taken a naked short

position on any of the synthetic assets in Class V III, let alone on the 25 assets it asked to be

included in the transaction. Facts ¶ 86.

C. Stoker Was A Key Participant In A Transaction He Knew Or Reasonably Should Have Known Was Intended As A Proprietary Trade___________

The evidence establishes that Stoker was aware that the CDO Group intended the Class V

III as a proprietary trade to profit in the event of poor performance of the housing market. This

is apparent from: (1) Stoker’s discussions with Quintin in October 2006, about buying protection

on certain assets; (2) Quintin’s request that Stoker structure a CDO that could be used to execute

a proprietary trade; (3) the models Stoker prepared analyzing what profit Citigroup would make

by taking short positions on the collateral in the CDO squared; (4) the list of assets on which

Quintin wished to purchase protection that Stoker forwarded to Khan and to CSAC; (4) Stoker’s

suggestions concerning what assets to include in the CDO squared—assets that he knew were the

type that Magnetar favored for taking short positions because of their structure; and (5) Stoker’s

admonition to his supervisor not to tell CSAC of Quintin’s intent to use Class V III as a

proprietary trade. Facts ¶¶ 14(a)-(b), 53, 56, 60-61.

The evidence also establishes Stoker knew the procedures employed to select the assets

for Class V III were inconsistent with the normal procedures at Citibank. Stoker admits that: (1)

he did not normally send a list of potential assets for inclusion in a deal to a sales person at

Citigroup; (2) he did not normally suggest specific assets for inclusion in a CDO he was


27

structuring; (3) it was unusual for a sales person at Citigroup to send a proposed portfolio to a

manager in advance of doing a deal; and (4) the give and take between an asset manager and an

arranging bank at the beginning of a deal generally did not include discussions of specific assets.

Facts ¶¶ 14(c) & (i), 16, 57.

These facts, coupled with Stoker’s knowledge that CSAC had agreed to sell $250 million

of protection directly to Citigroup could cause a reasonable juror to conclude Stoker understood

Class V III was not a typical CDO by Citigroup, but proposed for a special purpose—to provide

a vehicle for Citigroup to profit at the expense of the investors to whom it was marketing the

transaction. Also, a reasonable juror could conclude from this evidence that if Stoker did not

actually know Class V III’s true purpose was to provide Citigroup a means of profiting at the

expense of the investors, he was put on notice that it was possible, if not probable, and therefore

had a duty to make further inquiries of others in the CDO Group to determine if that was

Citigroup’s intent. Further, a reasonable juror could conclude that Stoker acted negligently

because he never made any further inquires or informed the attorneys who were assisting in the

preparation of the offering circular that Class V III was intended as a proprietary trade. Facts

¶¶ 77-78. Instead, he took an active role in structuring and marketing Class V III without

including in the marketing materials any disclosure that would put investors on notice of

Citigroup’s substantial role in selecting assets for Class V III and that it had made a proprietary

bet those assets would perform poorly.

CONCLUSION

For the reasons set forth above, the Court should deny Stoker’s motion for summary

judgment on the Commission’s claims that he violated Section 17(a)(2) and (3) of the Securities

Act.


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Dated: Washington, D.C. Respectfully submitted,

May 23, 2012/s/ Jeffery T. InfeliseJeffery T. Infelise (DC0456998)Assistant Chief Litigation CounselJane M. E. PetersonAssistant Chief Litigation CounselAndrew FellerSenior AttorneyU.S. Securities and ExchangeCommission – Enforcement Division100 F Street, N.E.Washington, D.C. 20549(202) 551-4481(202) 772-9246 (fax)[email protected]@[email protected]

CERTIFICATE OF SERVICE

I hereby certify that this document filed through the ECF system will be sent

electronically to the registered participants as identified on the Notice of Electronic Filing (NEF)

and paper copies will be sent to those indicated as non registered participants on May 23, 2012.

s/Jeffery T. InfeliseJeffery T. Infelise


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SERVICE LIST

John W. KekerJan Nielsen LittleSteven K. Taylor Brook DooleyKeker & Van Nest LLP633 Battery StreetSan Francisco, [email protected]@[email protected]@kvn.com

Attorneys for Brian H. Stoker


SEC - Opposition to Stoker summary judgment motion

Documents

Transcript of SEC - Opposition to Stoker summary judgment motion