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UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK Case No. 14-CV-1740 (PAC) PLAINTIFFS REPLY TO DEFENDANT JOHN BABIKIANS RESPONSE TO ORDER TO SHOW CAUSE AND EMERGENCY MOTION TO DISSOLVE AND/OR MODIFY THE TEMPORARY RESTRAINING ORDER AND ASSET FREEZE, AND TO DEFENDANTS EVIDENTIARY OBJECTIONS

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. JOHN BABIKIAN, Defendant,

Plaintiff Securities and Exchange Commission respectfully submits this Reply to: (1) Defendant John Babikians response to the Courts Order to Show Cause and emergency motion to dissolve and/or modify the temporary restraining order (TRO) and asset freeze (docket #21, cited herein as Resp.), and (2) Babikians evidentiary objections to the Declaration of Andrew McFall (docket #22). For the reasons set forth below, the Court should overrule the objections, deny Babikians motion, and enter a preliminary injunction in this matter. I. INTRODUCTION

This case involves a type of securities fraud commonly called scalping. On February 23, 2012, Babikian disseminated a massive email blast on the internet in which he recommended, or touted, a security to others, without disclosing his substantial position in the security and his plans to sell the very same security that he recommended others purchase. In the year before the touts, the security at issue, America West Resources Inc. (America West) (OTC: AWSR), had an average trading volume of approximately 15,400 shares per day, and its closing price on the day before the touts was $0.29 per share. On the day of the touts, before Babikian issued the 1

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email blast, there had been no trading in AWSR whatsoever. But in the immediate aftermath of Babikians touts, trading of AWSR exploded: in the 90 minutes left in the trading day, more than 7.8 million shares were traded and AWSRs share price hit an all-time high of $1.80 before closing at $1.29. It was during this window of artificially inflated volume and pricing a window that he created that Babikian sold well over one million shares of AWSR. Babikian is a Canadian citizen whose present whereabouts are unknown. He conceals his activities through a complicated web of alter-ego front companies and off-shore accounts conduct that renders his assets exceedingly difficult to locate and identify. While its investigation was ongoing, the Commission learned that Babikian was seeking to wire approximately $2.5 million from the United States to an account in the Middle East. The Commission also learned that certain real property in California in the name of a Babikian front company was about to be sold. To prevent the dissipation of Babikians ill-gotten gains and assets that might be applied to a civil penalty, the Commission sought both a TRO freezing assets and prejudgment writs under the Federal Debt Collection Procedures Act (FDCPA), 28 U.S.C. 3001 et seq. In support, the Commission submitted the Declaration of Andrew McFall (the McFall Declaration) (docket #15) and several exhibits that established the alleged fraud and connected Babikian to four assets that the Commission sought to secure. On the basis of this record, on March 13, 2014, the Court granted the Commissions requests for a TRO freezing assets and prejudgment writs of attachment orders that preserved the status quo. (Docket #4.) To effectuate and ensure compliance with the freeze imposed on the Defendants assets, id. at 2, the Courts order required Babikian to complete, by March 18, 2014, a verified written accounting of his accounts and assets for a time period that would encompass Babikians acquisition of AWSR and the fraudulent scheme alleged in the Complaint.

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The Courts Order also granted the Commissions application for expedited discovery concerning Babikian, his assets, and activities. Pursuant to this Order, the Commission served interrogatories, document requests, and requests for admission which Babikian was required to answer by March 20, 2014. (Ex. 1, First Set of Disc. Reqs.) Among other things, this discovery sought information concerning Babikians sales of AWSR, admissions concerning the authenticity of the email touts at issue, and other relevant information. Babikian has not provided the court-ordered accounting, and he has not sought an extension to do so. Nor has he answered the Commissions discovery requests as required. Babikian, however, now boldly asks this Court to decide factual and legal questions concerning the scope of the fraud, the amount of his ill-gotten gains, and the assets necessary to secure the Commissions claims, notwithstanding his refusal to comply with court mandates for disclosure of the very information necessary to accurately assess these matters information uniquely within Babikians custody and control. To aid in this effort, Babikian has filed thirty-nine pages worth of boilerplate objections, primarily hearsay allegations, to the McFall Declaration and its exhibits. These objections, however, are misplaced at the preliminary injunction stage. Because the Commission has established a strong likelihood that it will prevail on the merits, and because the Courts asset freeze and prejudgment remedies are entirely appropriate on the current record, Babikians motion to dissolve the asset freeze should be denied and a preliminary injunction should issue. II. BABIKIANS EVIDENTIARY OBJECTIONS ARE BASELESS AND SHOULD BE OVERRULED.

Babikian challenges the Commissions reliance on the McFall Declaration on the grounds that this sworn declaration and its exhibits are not admissible evidence. Babikians core contention is that the exhibits constitute hearsay, without any business records declarations or 3

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any other evidence to justify an exception to the hearsay rule, Resp. at 2, and that the Commission therefore cannot establish a likelihood of success on the merits. This threshold argument need not detain the Court. As the Supreme Court has recognized, the purpose of a preliminary injunction is merely to preserve the relative positions of the parties until a trial on the merits can be held. See University of Texas v. Camenisch, 451 U.S. 390, 395 (1981). Given this limited purpose a preliminary injunction is customarily granted on the basis of procedures that are less formal and evidence that is less complete than in a trial on the merits. Id. Consistent with this principle, courts at the preliminary injunction stage may rely on otherwise inadmissible evidence, including hearsay statements. See Mullins v. City of New York, 626 F.3d 47, 51-52 (2d Cir. 2010) (We agree with these courts and conclude that hearsay evidence may be considered by a district court in determining whether to grant a preliminary injunction. To hold otherwise would be at odds with the summary nature of the remedy and would undermine the ability of courts to provide timely provisional relief.); SEC v. Musella, 578 F. Supp. 425, 427-28 (S.D.N.Y. 1984) (granting a preliminary injunction on the basis of hearsay evidence without holding an evidentiary hearing, where the defendant proffered no evidence to conflict the raw facts presented by the plaintiff in affidavits). In this case, as in Musella, defendant has not proffered conflicting evidence to contest the raw facts. Indeed, apart from conclusory evidentiary objections, Babikian fails to dispute any of the facts presented by the Commission. Nor could he. The Commissions facts are reliable. The Court has before it a sworn declaration that compiles an investigative record connecting Babikian to the fraudulent scheme. The exhibits themselves include records from established internet and email service providers, Babikians brokerage accounts, and America Wests transfer agent, all produced by the originators of the records to the Commission. Moreover, the

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Commissions summaries of these records are appropriate in the TRO/preliminary injunction context and do not constitute impermissible lay opinions. The Court therefore is well within its discretion to give full weight to this evidence. That is particularly so where, as here, defendant has failed to answer written discovery seeking information about some of very same facts and records recounted in the McFall Declaration, and where defendant has failed to rebut the Commissions strong showing of likelihood of success on the merits. 1 III. THE COURTS ASSET FREEZE AND PREJUDGMENT WRITS UNDER THE FDCPA ARE APPROPRIATE AND WARRANTED.

Babikian next argues that the Court should modify or dissolve its equitable asset freeze and its prejudgment writs under FDCPA. These contentions rest on a flawed understanding of the remedies lawfully available at this stage of the proceedings, and should be rejected. a. The Commission Anticipates Seeking an Order for Disgorgement of at least $1,915,670, and Civil Penalties of at least the Same Amount. Based on information presently known (i.e., in the absence of additional civil discovery to which the Commission is entitled), Babikian sold at least 1,383,655 shares of AWSR from an omnibus Swiss account in the 90 minutes of inflated trading activity that he caused following his email touts. See Docket #15, McFall Decl. 51-52. 2 Using the average sale price for AWSR

Although Babikian represents that he will refuse to answer discovery in this case on Fifth Amendment grounds, Resp. at 4, he has not formally invoked the privilege. Were Babikian to invoke the privilege, this Court would be warranted in drawing an adverse inference against him. See Musella, 578 F. Supp. at 429-30. Babikian should be no better off by virtue of the fact that he has not formally invoked the privilege while representing that he will, particularly where his evasion of discovery has stymied the Commissions efforts to expeditiously marshal proof in advance of the preliminary injunction hearing. As set forth in the Commissions earlier filings, Babikian acquired at least 1,466,667 shares of AWSR from the issuer, and over time he deposited all of these shares in Swiss bank Frankfurter Bankgellschaft (Schweiz) AG (Frankfurter Bank). Trading records for February 23, 2012 show that sixteen separate blocks of AWSR sales were executed from the Frankfurter Bank account, with the total number of shares sold in the last 15 of these blocks totaling 1,466,667 the exact number of shares that the Commission presently can tie to Babikian. However, because some AWSR shares were held in the Frankfurter Bank account before Babikian transferred his 1,466,667 shares, and because approximately 83,000 AWSR shares remained in the account at the close of trading on February 23, 2012, the Commission conservatively attributes only 1,383,655 of the shares sold from the account on February 23, 2012 to Babikian. If Babikian cooperates in civil discovery, the Commission quite reasonably anticipates that
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stock sold from the Swiss account that day ($1.3845), Babikian realized gross proceeds of $1,915,670. Babikian does not appear to dispute these facts; however, Babikian argues that any calculation of his ill-gotten gain must offset his cost basis. That is not the law. It is well-settled that disgorgement is an equitable remedy designed to deprive a wrongdoer of his unjust enrichment and to deter others from violating the securities laws. SEC v. Hughes Capital, 124 F.3d 449, 455 (3d Cir. 1997); see also SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1104 (2d Cir. 1972) (The effective enforcement of the federal securities laws requires that the SEC be able to make violations unprofitable.). To prove disgorgement, the Commission need only establish a prima facie case of the profits illegally obtained from the violations. See SEC v. First Jersey Securities, Inc., 890 F. Supp. 1185, 1210 (S.D.N.Y. 1995), affd in part, revd in part, 101 F.3d 1450 (2nd Cir. 1996). A reasonable approximation of profits causally connected to the violation is sufficient. Zacharias v. SEC, 569 F.3d 458, 473 (D.C. Cir. 2009). Once the Commission has made its prima facie case for a reasonable approximation of ill-gotten gains, the burden shifts to the wrongdoer to establish that the approximation was not reasonable, with any risk of uncertainty falling on the wrongdoer whose illegal conduct created the uncertainty. See SEC v. First City Financial Corp., Ltd., 890 F.2d 1215, 1232 (D.C. Cir. 1989). AWSR was thinly-traded: its trading volume over the prior year averaged approximately 15,400 shares per day, and barely 7,000 AWSR shares had been traded in the entire week leading up to February 23, 2012. Under normal market conditions, then, it would have taken Babikian months or longer to incrementally sell his substantial position in AWSR, and he could only have done so at AWSRs prevailing low price. But by virtue of his fraud, Babikian created conditions
this number may increase, and that the Commission may identify additional sales of AWSR by Babikian. (See Docket #15, McFall Decl. 51-52.)

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that allowed him to accomplish a truly unnatural feat: the sale of over 1.3 million shares of AWSR on a single trading day, in just 90 minutes, at grossly inflated prices. Under these circumstances, all of Babikians gross proceeds (at least $1,915,670) are causally connected to his fraud, and Babikian is not entitled to an offset for the purchase price of the stock that he bought months earlier. Cf. SEC v. Happ, 392 F.3d 12, 31-32 (1st Cir. 2004) (rejecting insider trading defendants alternate disgorgement calculation, based on his actual profits, where defendant offer[ed] no causal link between his cost basis and the losses he avoided through insider trading). 3 It is this disgorgement figure -- $1,915,670 -- that drives the amount of the commensurate civil penalty pursuant to Section 20(d) of the Securities Act [15 U.S.C. 77t(d)], and Section 21(d)(3) of the Exchange Act [15 U.S.C. 78u(d)(3)]. 4 b. The FDCPA Authorizes Prejudgment Writs to Secure the Anticipated Civil Penalties. In addition to an equitable asset freeze to preserve the Commissions disgorgement remedy, the Court granted the Commissions application under the FDCPA to secure the civil
While the Commission disputes the applicability of any offset under these facts, Babikian arguably could seek an offset equal to the proceeds from a hypothetical sale of the few thousand shares of AWSR that he could have sold under normal trading conditions before his touts, at the previous days closing price ($0.29/share). Babikian, however, has not marshaled any evidence to establish such an entitlement; and such a de minimus offset would not materially impact the analysis of the asset freeze and prejudgment remedies about which he now complains. It also bears noting that, while Babikians cost basis in AWSR is a wholly inappropriate offset for purposes of calculating his ill-gotten gains, Babikians calculation of his cost basis as approximately $1,365,991 (Resp. at 5-6) is factually wrong. Babikian spent $1 million and converted an additional $21,875 in interest to obtain his 1,466,667 AWSR shares. See Docket #15, McFall Decl. 40-42. Babikian appears to concede that his scalping conduct violated the federal securities laws, but he argues that a sizeable civil penalty will not be warranted here because of a boilerplate disclaimer that accompanied his email touts. (Resp. at 7-11.) This argument strains credulity. As set forth in the Commissions memorandum of law in support of the TRO application, the disclaimer did not disclose that the putative sender of the touts a Babikian alter-ego called Centro Azteca was, in fact, Babikian; that Babikian, in fact, already did have a substantial position in America West; that Babikian had already caused those shares to be poised for immediate sale; or that Babikian intended to sell in excess of a million shares once he artificially manipulated the market for that security. Indeed, insofar as the disclaimer stated only that the owner of the penny stock website may have interests in the touted securities, the disclaimer itself constituted a material misstatement, see SEC v. Blavin, 760 F.2d 706, 712 (6th Cir. 1985), and is strong evidence of Babikians intent to defraud. See generally SEC v. Zandford, 535 U.S. 813, 819 (2002) (Exchange Act substitute[s] a philosophy of full disclosure for the philosophy of caveat emptor).
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penalties sought in this matter. Because the FDCPA writs issued upon an appropriate evidentiary showing, the burden is now on Babikian to make an affirmative showing as to why the debt is probably not valid, United States v. Teeven, 862 F. Supp. 1200, 1211 (D. Del. 1992), or to establish some other defense to the attachments under 28 U.S.C. 3101(d)(2). This is a burden Babikian has not met. Contrary to his central assertion, the Commissions prejudgment claim for civil penalties is a claim on a debt for purposes of the FDCPA. To begin, as set forth in the Commissions initial memorandum of law, the plain language of the FDCPA explicitly includes penalty within the definition of the term debt. 28 U.S.C. 3002(3)(B). Lest there be any doubt, in Board of Governors v. Pharaon, 169 F.3d 110, 114 (2nd Cir. 1999), a case Babikian does not cite, the Second Circuit explicitly rejected the argument that a debt under the FDCPA must be final to be actionable. Pharaon involved a district courts reliance on the FDCPA in issuing an asset freeze in connection with a TRO, pending the outcome of an administrative proceeding at the conclusion of which a civil penalty would become due. Noting that the FDCPAs definition of debtor included someone against whom there is a claim for a debt, the Second Circuit squarely held that the FDCPA permitted the district court to grant such a prejudgment remedy. See id. at 114 ([B]y authorizing prejudgment remedies in an action asserting a claim for an amount owing to the United States, Congress clearly intended to authorize the use of such remedies prior to a formal determination that such amount must be paid to the United States by a certain date.). 5 On the force of this controlling
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Babikians cites the magistrate courts decision in United States v. Cap Quality Care, Inc., 400 F. Supp. 2d 295 (D. Me. 2005) for the proposition that the FDCPA is inapplicable when the government is seeking to freeze assets in a prejudgment context. Cap Quality involved an effort by the government to use the FDCPA to prevent a defendant from wasting money on a defense lawyer in a parallel criminal proceeding a far cry from the use of prejudgment writs in this case, to secure tangible assets before they can be transferred and rendered unreachable. In any event, Cap Quality has been criticized and not followed by other courts, and the Commission respectfully submits that it is an incorrect statement of the law. See United States ex rel. Doe v. DeGregorio, 510 F. Supp. 2d 877, 884 (M.D. Fla. 2007) (distinguishing Cap Quality and issuing prejudgment remedies under the FDCPA in a penalty case); United States of America v. Lighthouse Disaster Relief et al., 06-161-D-M2 at 7 n.2 (M.D. La. July 11, 2006) (To the

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precedent, the civil penalty sought in this action is a claim for a debt and the FDCPA applies. 6 The Commission therefore requests that the prejudgment remedies in this case remain in place. c. At this Stage of the Proceedings, the Commission is not Over-Secured. Babikians remaining arguments concern the scope of the equitable asset freeze and the prejudgment writs issued pursuant to the FDCPA. At present, without the benefit of Babikians verified accounting or answers to written discovery, the Commission has identified only four Babikian assets, each of which was putatively owned in the name of an alter-ego front company: (1) NetJets proceeds in the amount $2,545,289, (2) real property at 1401 N. Laurel Avenue, Los Angeles, CA, which was listed on the internet as pending sale, (3) real property at 4455 Emerson Loop Rd., The Dalles, OR, and (4) 1401 Londonderry Place, Los Angeles, CA. See Docket #15, McFall Decl. 55-73. Each of the foregoing is presently subject to the asset freeze and a prejudgment writ, to secure the total sum of the Commissions anticipated disgorgement remedy (at least $1,915,670), civil penalty (at least $1,915,670), prejudgment interest, and 10% FDCPA surcharge a total that the Commission calculates to be at least $4,145,952. With respect to the only liquid asset the NetJets proceeds of $2,545,289 the Commission recommends that these funds be transferred to the Courts registry in their entirety. At such time, the FDCPA writ of garnishment over these funds will be terminated by operation of law, because the garnishee will no longer have Babikians property in its possession. See 28
extent that [Cap Quality] supports Defendants position, the Court declines to adopt it, finding it to be an incorrect statement of the law.) (unpublished decision, attached hereto as Ex. 2). The decision in Grupo Mexicano de Desarrollo S.A. v. Alliance Bond Fund, Inc., 527 U.S. 308 (1999), which Babikian extensively quotes, is inapposite. The issue there was whether, in an action for money damages, a United States District Court has the power to issue a preliminary injunction preventing the defendant from transferring assets in which no lien or equitable interest is claimed. 527 U.S. at 310. The distinguishing fact here is that, in issuing the prejudgment writs, this Court relied on a specific grant of statutory authority the FDCPA and not the Court's general equitable powers under the Judiciary Act of 1789. See Grupo Mexicano, 527 U.S. at 326 (finding a case distinguishable because that court relied on its powers under the statute authorizing issuance of tax injunctions). Babikians reliance on SEC v. ETS Payphones, Inc., 408 F.3d 727 (11th Cir. 2005), is similarly misplaced. ETS Payphones held that disgorgement was not a prejudgment remedy covered by the FDCPA, but the court reserved judgment on the applicability of the FDCPA to the Commissions claim for civil penalties. Id. at 735.
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U.S.C. 3205(c)(10)(B). The proceeds should be maintained in the Courts registry to partially secure the Commissions anticipated remedies and penalty until further order of this Court. With respect to the real property, although the Commission sought writs of attachment based on these properties believed values, it is of course actual market value and Babikians equity in the properties that matter most. And on those issues, the Commission lacks sufficient information at this early stage in the proceedings to confidently represent to the Court whether with these properties and the NetJets proceeds the Commission is, in fact, adequately (or over-) secured. 7 Accordingly, while the Commission is open to limiting the extent of one or more of its writs of attachment so long as it remains fully secured, it is reluctant to do so at this stage without sufficient information concerning the true values of, and Babikians equity interests in, the three real properties at issue. The burden of producing such information rests with Babikian. IV. CONCLUSION

For the foregoing reasons, the Commission respectfully requests the Court overrule Babikians evidentiary objections, deny his motion to dissolve and/or modify the TRO and asset freeze, and enter a preliminary injunction until a final adjudication of this case on the merits. Respectfully submitted, ______/s/________________________ Matthew P. Cohen (pro hac vice) Michael J. Roessner, MR4195 Attorneys for Plaintiff 100 F Street, N.E., Mailstop 5985 Washington, D.C. 20549 (202) 551-7276 (Cohen) cohenma@sec.gov
By way of illustration, since the initiation of this action the Commission has learned that, in late December 2013, Babikian granted a 50% interest in the 1401 Laurel Avenue property to an alter-ego front company of his ex-wife. (Ex. 3, Deed of Transfer.) The draft settlement statement for the sale of this property shows that the sellers gross proceeds likely will total $1,903,742. (Ex. 4, Draft Settlement Statement.) Consequently, it appears that an asset that the Commission initially believed to be worth as much as $2,595,000 (see Docket #15, McFall Decl. 70) may only secure $951,871 (50% of $1,903,742) of the Commissions civil penalty claim.
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