SEC v. CKB168 Holdings, Ltd.
SEC v. CKB168 Holdings, Ltd.
2015 WL 13742421 (E.D.N.Y. 2015)
November 3, 2015
Mann, Roanne L., United States Magistrate Judge
Summary
The SEC sought an adverse inference instruction against the Foreign Defendants due to their alleged spoliation of relevant evidence, specifically, their corporate “back office data.” After the issuance of the Court's Report and Recommendation, the SEC was able to recover a “substantial volume of relevant information” from a hard drive that the Foreign Defendants had provided, including emails, promotional materials, and PowerPoint files. However, the hard drive did not contain other requested information, such as communications between the Foreign Defendants and third parties.
Additional Decisions
SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
CKB168 HOLDINGS, LTD., et al., Defendants
v.
CKB168 HOLDINGS, LTD., et al., Defendants
13-CV-5584 (RRM)
United States District Court, E.D. New York
Signed November 03, 2015
Counsel
Catherine Pappas, Pro Hac Vice, Securities and Exchange Commission, Philadelphia, PA, Daniel Joseph Maher, Pro Hac Vice, Nancy Tyler, Pro Hac Vice, Stacy L. Bogert, Devon Staren, United States Securities and Exchange Commission, Washington, DC, for Plaintiff.Jacob Frenkel, Pro Hac Vice, Shulman Rogers Gandal Pordy & Ecker, P.A., Potomac, MD, Allan Schiller, Schiller Law Group, P.C., John Vincent Golaszewski, Orans, Elsen, Lupert & Brown LLP, Francis Robert Denig, Michael Joseph Frevola, Holland & Knight LLP, New York, NY, Zhijun Liu, American Law Groups, PLLC, Allan Schiller, Flushing, NY, Peiwen Chang, Pro Hac Vice, Peiwen Chang, Cogswell Nakazawa & Chang LLP, Long Beach, CA, for Defendants.
CKB168 Holdings Ltd., Hong Kong, China, pro se.
WIN168 BIZ Solutions Ltd., Hong Kong, China, pro se.
CKB168 Ltd., Hong Kong, China, pro se.
CKB168 BIZ Solution, Inc., Hong Kong, China, pro se.
Cyber Kids Best Education Ltd., Hong Kong, China, pro se.
Hyng Wai Howard Shern, Hong Kong, China, pro se.
Rui Ling (Florence) Leung, Hong Kong, China, pro se.
Joan Congyi, Ma, Arcadia, CA, pro se.
Mann, Roanne L., United States Magistrate Judge
REPORT AND RECOMMENDATION
*1 This Report and Recommendation addresses issues that were referred back to the undersigned magistrate judge by the Honorable Roslyn R. Mauskopf. See Order Adopting in Part Report and Recommendation (Aug. 12, 2015) (“8/12/15 Order”), Electronic Case Filing (“ECF”) Docket Entry (“DE”) #262. Plaintiff Securities and Exchange Commission (the “SEC”) had filed two separate motions for sanctions, against defendants Hung Wai (Howard) Shern (“Shern”), Rui Ling (Florence) Leung (“Leung”), CKB168 Holdings Ltd., WIN168 Biz Solutions Ltd., CKB168 Ltd., CKB168 Biz Solutions Inc., and Cyber Kids Best Education Ltd. (together, the “Foreign Defendants”), under Rule 37 of the Federal Rules of Civil Procedure. SeeMotion for Sanctions (Nov. 7, 2014) (“11/7/14 Motion”), DE #193; Motion for Sanctions (Dec. 3, 2014) (“12/3/14 Motion”), DE #201.[1] The SEC’s second motion, at issue here, complained of the Foreign Defendants' failure to produce most of their corporate records, and requested an adverse inference jury instruction “that the unproduced evidence would have supported the SEC’s allegations that the corporate defendants had no plan and made no preparations to go public....” 12/3/14 Motion at 1.
This Court recommended that both of the SEC’s motions for sanctions be granted, see Report and Recommendation (Jan. 7, 2015) (“1/7/15 R&R”), DE #214, and neither Shern nor Leung filed a timely objection to the Report and Recommendation, see 8/12/15 Order at 4. After the issuance of the Report and Recommendation, the SEC was able to recover “a substantial volume of relevant information” from a hard drive that the Foreign Defendants had provided, id. at 3, but recovered no communications or records related to CKB’s purported initial public offering (“IPO”). See Letter in Response to July 10, 2015 Minute Entry For Pre-Motion Conference (July 17, 2015) (“7/17/15 Letter”), DE #256.[2] The SEC, therefore, urged the District Court to adopt the Report and Recommendation in full, notwithstanding the recovered information. See id. at 3. While agreeing to preclude the Foreign Defendants from offering testimony, as recommended in the R&R, Judge Mauskopf referred the issue of the adverse inference instruction back to this Court for further consideration in light of the new facts. See 8/12/15 Order at 5. For the reasons discussed below, this Court recommends that the SEC’s renewed motion be granted in substantial part.
FACTUAL BACKGROUND
*2 According to the SEC’s allegations, the Foreign Defendants are part of a multi-national pyramid scheme, of which Shern and Leung are the primary architects and beneficiaries. See 11/7/14 Motion at 3. For more than a year, the Court was inundated with discovery disputes involving the Foreign Defendants, who made a series of unsuccessful attempts to evade their discovery obligations.[3] During this time, the Court also directed the Foreign Defendants, on multiple occasions, to produce corporate records to the SEC. See Electronic Order (Aug. 8, 2014) (so-ordering the production schedule to which the Foreign Defendants had consented, which directed the Foreign Defendants to produce all responsive documents in September 2014); Memorandum and Order (Oct. 9, 2014) at 20, DE #179 (directing the Foreign Defendants to produce all responsive documents, on pain of sanctions, by October 16, 2014). On October 16, 2014, the Foreign Defendants produced approximately 15,000 pages of emails and email attachments from the personal email accounts of Shern and Leung, including promotional literature. See 12/3/14 Motion at 2. Although the documents disclosed included a modest quantity of emails between Shern and Leung’s personal email accounts and their corporate entities' email accounts, documents obtained from a search of the corporate email accounts were not independently produced, nor were any other corporate records, including financial statements and other standard books and records. Id.
The Foreign Defendants provided the SEC with a hard drive purportedly containing approximately 32 gigabytes of what they characterized as “back office data.” See Memorandum in Opposition (Dec. 12, 2014) (“12/12/14 Response”) at 1, DE #206. The Foreign Defendants declined to explain what they meant by “back office data,” stating only that what they produced was a “complete image of all information maintained on the corporate server.” Id. While not disputing that the hard drive could not be read or used in any manner, see 12/3/14 Motion at 2, the Foreign Defendants claimed that they too were unable to access the information in any usable format. See 12/12/14 Response at 2.[4]
In order to inform its determination regarding the propriety of sanctions, the Court directed the Foreign Defendants to provide additional information in sworn statements, including a description of the contents of the hard drive and the technological issues preventing access to the records contained on the drive; specifics concerning what efforts had been made to identify and produce corporate records; and when the Foreign Defendants first attempted to obtain a readable copy of the material on the hard drive. SeeMemorandum and Order (Dec. 18, 2014) at 2, DE #207. The Foreign Defendants, in perfunctory fashion, informed the Court that they “declined” to comply with the Court’s directive, purportedly based on the advice of their Hong Kong counsel. See Letter re: December 18, 2014 Order (Dec. 22, 2014), DE #208.
The SEC then sought an adverse inference instruction against the Foreign Defendants that the undisclosed evidence would have supported the SEC’s claim that the corporate Foreign Defendants had not made any plan or preparations to go public.[5] See 1/7/15 R&R at 23. Having been deprived of evidence from the Foreign Defendants as to whether there was a plan to go public, the SEC requested this adverse inference instruction as an appropriate remedy for the prejudice caused by the Foreign Defendants' spoliation of relevant evidence -- specifically, their corporate “back office data.” 12/3/14 Motion at 2. The Court concluded that: (1) the Foreign Defendants had an obligation to preserve the back office data; (2) in failing to do so, the Foreign Defendants acted with a culpable state of mind; and (3) the spoliated back office data was relevant to the SEC’s claims. See1/7/15 R&R at 18-23. Accordingly, the Court recommended that the SEC be granted its requested adverse inference instruction as an appropriate sanction against the Foreign Defendants. See id. at 24.
*3 Following the issuance of this Court’s 1/7/15 R&R, the SEC informed Judge Mauskopf that information technology specialists with the Federal Bureau of Investigation had recently been able to successfully recover data on the hard drive. See Letter Regarding Data Produced by Foreign Defendants (Feb. 2, 2015), DE #215. While the SEC was able to recover a “substantial volume of relevant information,” the hard drive did not appear to contain other requested information, including (1) communications between the Foreign Defendants' personnel and officers, or between the Foreign Defendants and third parties, including investors; (2) information indicating how the Foreign Defendants directed or spent CKB’s revenues; or (3) material suggesting whether the Foreign Defendants had taken steps to explore a public offering. Id. at 2.
In light of the newly recovered information, Judge Mauskopf directed the SEC to file a letter addressing whether any of the issues raised in the 1/7/15 R&R had become moot. See Minute Entry (July 9, 2015). On July 17, 2015, the SEC responded to Judge Mauskopf’s order, urging her to adopt the R&R, notwithstanding the intervening developments. See 7/17/15 Letter. Defendants Shern and Leung were directed to file any response by July 24, 2015, see Minute Entry (July 9, 2015), but neither did so. Judge Mauskopf nonetheless concluded that “the subsequent recovery of the back office data may impact both the factual and legal underpinnings of Magistrate Judge Mann’s recommendation to impose an adverse inference sanction.” 8/12/15 Order at 4. Accordingly, on August 12, 2015, Judge Mauskopf issued an order referring the portion of the 1/7/15 R&R that recommends an adverse inference instruction against the Foreign Defendants back to this Court for further consideration in light of the newly discovered data. Id. at 5.
This Court then directed the SEC to serve and file a supplemental submission detailing the legal and factual bases for its continued request for an adverse inference instruction and specifying the precise language that it proposed be included in such instruction. See Memorandum and Order re Order Adopting Report and Recommendations (Aug. 31, 2015) at 3, DE #273. In a letter motion dated September 8, 2015, the SEC once more requested an adverse inference instruction against the Foreign Defendants, specifically: “that the unproduced evidence would have supported the SEC’s allegation that the corporate defendants had no plan and made no preparations to go public.” Amended Motion for Sanctions Against Defendants Howard Shern and Florence Leung (Sept. 8, 2015) (“9/8/15 SEC Letter”) at 1, DE #276. In the alternative, the SEC requested that the following fact be taken as established for purposes of this action: that “the corporate defendants had no plan and made no preparations to go public.” Id. The SEC offered to withdraw its requests for an adverse inference or directed finding of fact “[s]hould the Foreign Defendants simply admit that the requested material has never existed....” Id. at 4 n.3.
Defendant Leung responded in a filing dated September 18, 2015. See E-mailed Letter Response to Memorandum and Order from Rui Ling (Florence) Leung (Sept. 18, 2015) (“Leung Letter”), DE #283. Rather than address the specific issue before the Court -- i.e., the effect of the FBI’s recovery of information from the hard drive on the SEC’s entitlement to an adverse inference instruction -- Leung for the first time sought to justify her conduct in this case and explain away the lack of documentation of any plan to take CKB public:
On October 16[,] 2014, I had given to our US legal counsel at the time, all the documents that I had in my possession, custody and control. In my role as CKB’s CFO, I ensured that all our financial statements during the relevant accounting reference period had been audited and all taxes paid. I did not withhold any evidence or documents and gave everything that I had.
*4 I do not agree that just because there are no written records to show there was a plan to go public, then that would automatically mean that CKB had no plans and had made no preparations to go public.
Id. at 2 (emphasis added).
Defendant Shern’s response, dated September 21, 2015, contained a similar excuse for the absence of such records. See Letter Response from Shern Hung Wai (Howard) to Memorandum and Order (Sept. 21, 2015) (“9/21/15 Shern Letter”) at 2, DE #284; Affidavit of Hung Wai (Howard) Shern (“Shern Aff.”), DE #284-1. In his letter, Shern stated that:
But I would just like to say that I got no chance to properly defend myself especially the SEC saying that I did not dispute that those documents were “missing” from my document production. Yes, there are no documents as all the preparations made were by conduct as this is the way of doing business with trust and confidence and the [C]hinese way of doing business.
9/21/15 Shern Letter at 2 (emphasis added). Shern added in his accompanying affidavit:
All my plans and intentions to lay the foundation to take the company public were brought into action by conduct. I did not make any extensive business proposal in writing as I have always conducted my way of business with trust and confidence especially in the [C]hinese way of doing business....
Shern Aff. ¶ 7 (emphasis added).
Because it thus appeared, from these statements, that defendants Leung and Shern were conceding that no documents ever existed evidencing any plans or preparations by the Foreign Defendants to take CKB public, the Court directed the SEC to draft a proposed stipulation to that effect. SeeOrder re Amended Motion for Sanctions Against Defendants Howard Shern and Florence Leung (Sept. 22, 2015), DE #286. The SEC promptly proposed the following stipulation:
Although defendants Shern and Leung claimed in communications with investors and co-defendants that CKB would soon conduct an initial public offering of its stock, no documents evidencing any plans or preparations to take CKB public ever existed.
Letter with Proposed Stipulation in Response to Court Order Dkt. No. 286 (Sept. 24, 2015), DE #287.
Shern rejected the SEC’s proposed stipulation in an email to the Court:
The stipulation is totally incorrect; what I mentioned in the affirmations is that we do not have a detailed plan, documented in established western business proposal format, for going public. Yet, we have taken concrete steps to prepare the company to go public, most notably, the re-structuring of the company separating its retail arm from the wholesale. Moreover, though not in established western business proposal format, we have documentation proof that we have plans of making the company public (albeit, we have never used the word “IPO” as it was still a long way until the plan could be actualised and initiated in 2014 the earliest.) Please see the attached 2 [P]ower[P]oint files (page 13 of the Nov[.] 2012 file & page 19 of the July 2013 file), both of which have high-lighted a plan of going public. Similar documentation proof can be found in the CKB168.com and then CKBmax.com (all of which are in the hand[s] of SEC for long).
*5 Letter with Attachments E-mailed to Chambers Dated 10/6/2015 from Howard Shern (Oct. 6, 2015) (“10/6/15 Shern Letter”), DE #288 (emphasis in original).
The Court invited the SEC to respond to Shern’s submission, see Electronic Order (Oct. 6, 2015),[6] which the SEC did via a letter dated October 12, 2015, see Reply in Support of the SEC’s Proposed Stipulation ... (Oct. 12, 2015) (“10/12/15 SEC Letter”), DE #290.[7] Unsurprisingly, the SEC took the position that the 10/6/15 Shern Letter “only reinforces why, if Shern will not agree to the SEC’s proposed stipulation, the Court should recommend” an adverse inference instruction. 10/12/15 SEC Letter at 1. The SEC also attached a series of emails sent between Shern and co-defendant Rayla Santos (“Santos”) in February 2013, see Appendix, attached to 10/12/15 SEC Letter at pp. 5-7, which referenced the Foreign Defendants' “extensive engagement with ‘lawyers and accountants,’ ” and thereby tended to undermine Shern’s rationalization for the absence of documentation of the plan to take CKB public, see 10/12/15 SEC Letter at 1-2 & nn.1-2.[8]Accordingly, the SEC reiterated its request for an adverse inference instruction, or, in the alternative, a ruling that the following fact be deemed established: “There are no documents supporting Foreign Defendants' claims that they made plans or preparations to go public.” Id. at 1.
DISCUSSION
Pursuant to Rule 37 of the Federal Rules of Civil Procedure, courts enjoy broad discretion in deciding whether and how to fashion sanctions for violations of a party’s discovery obligations. See Design Strategy, Inc. v. Davis, 469 F.3d 284, 294 (2d Cir. 2006). Rule 37 provides for a range of possible sanctions for discovery derelictions.[9] In determining what particular sanctions may be appropriate under the Rule, courts consider factors such as “(1) the willfulness of acts underlying noncompliance; (2) the efficacy of lesser sanctions; (3) the duration of noncompliance; and (4) whether the noncompliant party was on notice that it faced possible sanctions.” Sentry Ins. A Mut. Co. v. Brand Mgmt., Inc., 295 F.R.D. 1, 5 (E.D.N.Y. 2013) (citing Agiwal v. Mid Island Mortg. Corp., 555 F.3d 298, 302-03 (2d Cir. 2009) ); accord SEC v. Setteducate, 419 F.App'x 23, 24 (2d Cir. 2011). The goal in imposing Rule 37 sanctions is, “insofar as possible ... [to] restor[e] the prejudiced party to the same position [it] would have been in absent the wrongful [withholding] of evidence by the opposing party.” Linde v. Arab Bank, PLC, 269 F.R.D. 186, 195 (E.D.N.Y. 2010) (quoting Kronisch v. United States, 150 F.3d 112, 126 (2d Cir. 1998) ), appeal dismissed, 706 F.3d 92 (2d Cir. 2013).
*6 The adverse inference instruction that the SEC seeks arose out of the Foreign Defendants' alleged “spoliation” of relevant evidence, specifically, their corporate “back office data.” 12/3/14 Motion at 2. Spoliation is “the destruction or significant alteration of evidence, or the failure to preserve property for another’s use as evidence in pending or reasonably foreseeable litigation.” Byrnie v. Town of Cromwell, Bd. of Educ., 243 F.3d 93, 107 (2d Cir. 2001) (quoting West v. Goodyear Tire & Rubber Co., 167 F.3d 776, 779 (2d Cir. 1999) ). “In order to establish that sanctions for spoliation are warranted, the moving party must establish: (1) that the non-movant had an obligation to preserve the evidence; (2) that the non-movant acted culpably in destroying the evidence[;] and (3) that the evidence would have been relevant to the moving party’s case, in that a reasonable fact finder could conclude that the evidence would have been favorable to the moving party.” Mastercard Int'l, Inc. v. Moulton, No. 03 Civ. 3613 VMMHD, 2004 WL 1393992, at *3 (S.D.N.Y. June 22, 2004) (citing Residential Funding Corp. v. DeGeorge Funding Corp., 306 F.3d 99, 107 (2d Cir. 2002)). Significantly, the actual destruction of evidence is not a prerequisite to an adverse inference instruction; the nonproduction of evidence or failure to preserve may give rise to spoliation-type sanctions. See Residential Funding, 306 F.3d at 106-07, 109, 113.
In issuing its Report and Recommendation of January 7, 2015, this Court considered each of the above factors in concluding that an adverse inference sanction was appropriate. See 1/7/15 R&R at 18-23. The Court now reiterates its previous findings that the Foreign Defendants had an obligation to preserve the back office data, and that this data was relevant to the SEC’s claims. See id. at 18-19, 21-23. In light of the FBI’s eventual recovery of some of the back office data, the Court reconsiders (1) whether the Foreign Defendants acted with a culpable state of mind, and (2) whether the SEC’s requested sanctions are appropriate.
I. The Foreign Defendants Acted with a Culpable State of Mind
To support the imposition of spoliation sanctions, the Court must find that the Foreign Defendants acted with a “culpable state of mind.” Residential Funding, 306 F.3d at 107. The spoliation need not be knowing, so long as it was negligent. See Yu Chen v. LW Rest., Inc., No. 10 CV 200(ARR), 2011 WL 3420433, at *11 (E.D.N.Y. Aug. 3, 2011); Rabenstein v. Sealift, Inc., 18 F.Supp.3d 343, 362 (E.D.N.Y. 2014) (“A culpable state of mind ‘must, at a minimum, constitute simple negligence.’ ”) (quoting Dataflow, Inc. v. Peerless Ins. Co., No. 3:11–CV–1127 (LEK/DEP), 2013 WL 6992130, at *6 (N.D.N.Y. June 6, 2013) ). In its 1/7/15 R&R, the Court found that the Foreign Defendants were, at a minimum, grossly negligent in failing to preserve their corporate records in readable form, and thus acted with a sufficiently culpable state of mind to support spoliation sanctions. See1/7/15 R&R at 19-21. The events of the past ten months do not undermine this finding.
Though the SEC was eventually able to obtain some data from the hard drive, the hard drive did not contain “any documents or communications related to efforts to go public, internal corporate [communications] or communications with investors, corporate minutes, financial statements, or tax information.” See 9/8/15 SEC Letter at 2; Declaration of Devon Leppink Staren (Sept. 8, 2014) ¶ 4, DE #276-1. These requested materials have, therefore, never been produced. See 9/8/15 SEC Letter at 2; 1/7/15 R&R at 21 (noting that the Foreign Defendants described the contents of the hard drive as including “a complete image of all information maintained on the corporate server”).
Two plausible explanations exist for this lack of production: either (1) some or all of the requested materials existed at some point, and the Foreign Defendants destroyed or otherwise failed to preserve them, or (2) the requested materials never existed at all. Assuming that the first scenario is correct, this Court has already found that the Foreign Defendants acted, at a minimum, with gross negligence in failing to preserve the requested materials -- a sufficiently culpable state of mind to support spoliation sanctions. See 1/7/15 R&R at 21.
*7 The second scenario -- that the requested materials never existed in the first place -- might be the more likely one, especially given the admissions made by Shern and Leung in their letters. See Leung Letter at 2 (“... [T]here are no written records to show there was a plan to go public ....”); 9/21/15 Shern Letter at 2 (“Yes, there are no documents as all the preparations made were by conduct as this is the way of doing business with trust and confidence and the [C]hinese way of doing business.”). Nonetheless, when given the opportunity to stipulate to the non-existence of the requested materials -- a stipulation that would have obviated the need for this Report and Recommendation -- Leung failed to respond, see Electronic Order (Oct. 6, 2015), and Shern submitted two PowerPoint presentations as “documentation proof that we have plans of making the company public....” 10/6/15 Shern Letter. Despite Shern’s contention, these presentations -- even had they been timely disclosed -- contain nothing more than vague and aspirational references to future shareholders, see, e.g., PowerPoint 2 at 14 (“60% stock ownership of CKB168 will be given back to these ‘loyal angels’ with CKB168 going public”), and in no way satisfy the SEC’s request for “documents or communications related to efforts to go public, internal corporate [communications] or communications with investors, corporate minutes, financial statements, or tax information,” 9/8/15 SEC Letter at 2.[10]
Assuming that the requested materials never existed in the first place, the Foreign Defendants could not be said to have acted with a culpable state of mind in failing to preserve them. Nonetheless, the culpability standard can also be met by a party’s bad-faith conduct during the discovery process. See, e.g., Burns v. Imagine Films Entm't, Inc., 164 F.R.D. 594, 599 (W.D.N.Y. 1996) (“Open and unequivocal defiance of a court order is sufficient to support a finding of bad faith or wilful misconduct.”); Thomas E. Hoar, Inc. v. Sara Lee Corp., 900 F.2d 522, 524 (2d Cir. 1990) (affirming lower court’s imposition of discovery sanctions on a party whose conduct “clearly amount[ed] to either wilful disobedience of prior orders of this court, or a ‘total dereliction of professional responsibility amounting to gross negligence’ ”); Jones v. Niagara Frontier Transp. Auth., 836 F.2d 731, 735 (2d Cir. 1987) (affirming the imposition of “the harsh sanction of dismissal” on a plaintiff who “refused willfully and repeatedly to answer any questions at a court-ordered deposition”). By refusing -- for months, and after repeated requests -- either to produce the requested materials or to state unequivocally that they do not exist, the Foreign Defendants have demonstrated their bad faith. The Foreign Defendants' conduct amounts to either “wilful disobedience” of this Court’s orders to comply with discovery requests, or represents a “total dereliction” of their responsibility to preserve and maintain corporate records. See Thomas E. Hoar, 900 F.2d at 524. In either event, the Foreign Defendants have demonstrated a sufficiently culpable state of mind to support sanctions under Rule 37.
II. A Two-Part Adverse Inference Instruction is an Appropriate Sanction
“The determination of an appropriate sanction for spoliation, if any, is confined to the sound discretion of the trial judge, ... and is assessed on a case-by-case basis.” Fujitsu Ltd. v. Fed. Express Corp., 247 F.3d 423, 436 (2d Cir. 2001) (citations omitted). Adverse inference instructions are the typical sanction imposed in cases of spoliation. Residential Funding, 306 F.3d at 106, 108. An adverse inference sanction is appropriate regardless of whether the spoliation was willful or negligent, as “the risk that the evidence would have been detrimental rather than favorable should fall on the party responsible for its loss.” Id. at 108 (citing Turner v. Hudson Transit Lines, Inc., 142 F.R.D. 68, 75 (S.D.N.Y. 1991) ).
Here, the SEC seeks the following alternative sanctions: (1) an instruction that the jurors may infer that the unproduced evidence would have supported the SEC’s allegation that the corporate defendants had no plan and made no preparations to go public; or, in the alternative, (2) that the Court deem as established the fact that there are no documents supporting Foreign Defendants' claims that they made plans or preparations to go public. See 10/12/15 SEC Letter at 1. While the SEC’s request is not unreasonable, out of an abundance of caution the Court concludes that the decision as to which scenario is the correct one -- i.e., spoliation of evidence versus the non-existence of such evidence at any time -- should be left to the trier of fact. Accordingly, the Court recommends that the jury be given a pair of permissive adverse inference instructions:
*8 (1) From the fact that the Foreign Defendants produced no evidence of any actual plans or preparations to take CKB public, the jurors may infer that no such documents ever existed and that the Foreign Defendants had no plan and made no preparations to take CKB public.
(2) To the extent that the jurors find that any unproduced evidence ever existed, they may infer that the unproduced evidence would support the SEC’s allegation that the Foreign Defendants had no plan and made no preparations to go public.
The two-part approach accounts for the fact that, while it is clear that the Foreign Defendants' conduct was culpable, the jury should decide whether it was culpable because they spoliated or willfully failed to produce any documents related to an alleged IPO, or because these documents never existed in the first place. Both scenarios warrant adverse inferences against the Foreign Defendants. Cf. Jones v. J.C. Penney’s Dep't Stores, Inc., 228 F.R.D. 190, 196 (W.D.N.Y. 2005) (“Repeated failure of a party ordered to produce documents will also support ordering as a sanction that a fact, the ascertainment of which may be dependent upon the requested discovery, be deemed established for purposes of trial.”).
CONCLUSION
For the foregoing reasons, the Court recommends that the SEC’s amended motion for sanctions (DE #276) be granted in substantial part, and that the District Court instruct the jurors that, in assessing the evidence, they are entitled to draw the two adverse inferences described above.
Any objections to this Report and Recommendation must be filed with the Honorable Roslynn R. Mauskopf by November 27, 2015. Failure to file timely objections may waive the right to appeal the District Court’s Order. See 28 U.S.C. § 636(b)(1); Fed. R. Civ. P. 72; Small v. Sec'y of Health & Human Servs., 892 F.2d 15, 16 (2d Cir. 1989).
The Clerk is requested to docket this Report and Recommendation into the ECF system and to mail and email copies to defendants Shern and Leung at the following addresses:
For defendant Shern:
Flat D, 4/F Yee Hing Court
13 Tak Hing Street
Jordan, Kowloon
Hong Kong, China
Hshern@hotmail.com
For defendant Leung:
Flat E, 5/F Hilton Tower
96 Granville Road
Tsim Sha Tsui
Hong Kong, China
Florence_Leung@hotmail.com
SO ORDERED.
The Clerk of the Court has since entered a certificate of default against all of the entity defendants. See Clerk’s Entry of Default (July 29, 2015).
For the sake of convenience, and following the parties' practice in their filings, this Report and Recommendation refers to “CKB” generically as the entity that Shern and Leung contend was pursuing an IPO. It is unclear which of the now-defaulted foreign entity defendants supposedly had plans to go public, in large part because -- as will be discussed, infra -- no evidence has been produced that any CKB entity had plans to go public.
The Court assumes familiarity with the prior rulings in this case, and incorporates by reference its previous findings and analyses.
According to the Foreign Defendants, they had contracted with a third-party vendor in Malaysia “to create, host, and maintain their corporate records,” but, due to the Foreign Defendants' default on payments to the vendor, the vendor had terminated its services and refused to provide any further assistance in accessing the documents in a usable format. 12/12/14 Response at 1-2. Notably, the issue regarding the third-party vendor had first been brought to the Court’s attention during a telephonic proceeding on August 7, 2014; at that time, counsel for the Foreign Defendants stated that the vendor was insisting upon approximately $25,000 for its assistance and that the Foreign Defendants would have to petition the District Court for a modification of the preliminary injunction freezing their assets, so as to release funds for that purpose. The Foreign Defendants never filed such a petition.
The SEC also sought, and this Court recommended granting, an adverse inference instruction that the undisclosed evidence would have supported the SEC’s claim that the corporate Foreign Defendants relied on sales to investors for “virtually all” of their revenues. See 1/7/15 R&R at 23. The SEC recently withdrew this request. See Amended Motion for Sanctions Against Defendants Howard Shern and Florence Leung (Sept. 8, 2015) (“9/8/15 SEC Letter”) at 2, DE #276.
The two attached PowerPoint files appear to be promotional and marketing materials targeted toward potential investors. SeeCyber Kids Best (Oct. 6, 2015) (“PowerPoint 1”), DE #288-1; Creating a Good Future for Your Children (Oct. 6, 2015) (“PowerPoint 2”), DE #288-2.
Defendant Leung did not respond to the SEC’s proposed stipulation.
In one of these emails, sent on February 17, 2013, Shern and defendant Rayla Melcher Santos discussed a recent editorial titled “Is CKB168 a Pyramid Selling Scheme?” Shern reassured Santos that: “That was why we were so busy for two months time working with lawyers and accountants to restructure the company. And that is why [n]ow we are not owners of CKB.” See10/12/15 SEC Letter at 1 n.1 (citing Appendix at 6).
Sanctions for failing to comply with a discovery order include “(i) directing that the matters embraced in the order or other designated facts be taken as established for purposes of the action, as the prevailing party claims; (ii) prohibiting the disobedient party from supporting or opposing designated claims or defenses, or from introducing designated matters in evidence; (iii) striking pleadings in whole or in part; ... (vi) rendering a default judgment against the disobedient party; or (vii) treating as contempt of court the failure to obey any order ...,” Fed. R. Civ. P. 37(b)(2)(A), as well as imposing monetary sanctions in the form of reasonable attorney’s fees and expenses, see Fed. R. Civ. P. 37(b)(2)(C). The same sanctions are available where “a party or a party’s officer, director, or managing agent -- or a person designated under Rule 30(b)(6) ... -- fails ... to appear for that person’s deposition....” Fed. R. Civ. P. 37(d)(1)(A)(i).
The existence of promotional materials claiming to potential investors that CKB would go public was never in question, see10/12/14 SEC Letter at 2, and, indeed, forms the basis for the SEC’s allegations, see Complaint (Oct. 9, 2013) ¶¶ 2-4, DE #1. The production of these materials in no way rebuts the SEC’s theory that the materials were themselves a tool used in a scheme to dupe investors.