990 F. Supp. 2d 462
S.D.N.Y.2014Background
- SEC alleges that Garber, Yellin, Feinstein and related entities bought over a billion unregistered penny-stock shares and resold them without complying with registration requirements, relying on false claims of Regulation D/Rule 504 exemptions.
- Accredited investor status (key to the exemption) depends on "income" or net worth; the rule does not define "income" by reference to federal tax law.
- SEC sought production of the individual defendants’ complete federal tax returns (Request No. 13); defendants objected based on a quasi-privilege protecting tax returns and produced only the first page (summary of income/AGI).
- Judge Scheindlin reviewed first pages and in camera full returns; she found the first pages showed generally high income for Garber and Feinstein, but Yellin’s 2010 reported income/AGI fell below the accredited threshold. She reserved ruling on accredited status and directed briefing on full-return production.
- Magistrate Judge Francis applied the two-prong test (relevance and compelling need) and ordered production of complete returns, concluding returns are relevant to accredited-investor status and the SEC has a compelling need because (a) the rule’s "income" is not tied to tax figures alone, and (b) the SEC must be able to test the reliability and composition of reported income.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether complete federal tax returns must be produced | SEC: Returns are relevant to whether defendants were accredited investors; full returns necessary to assess income composition and reliability. | Defs: Tax returns are quasi-privileged; first page (income/AGI) suffices to show accredited status and full returns are irrelevant/private. | Court: Ordered full returns. Returns are relevant and SEC has compelling need because "income" is not defined by tax law and SEC must test reliability and sources of income. |
| Burden of showing alternative sources to avoid production | SEC: N/A (seeking discovery). | Defs: Burden on SEC to show no adequate alternative to full returns (first page sufficient). | Court: Places burden on producing party to suggest alternatives; here first pages insufficient for evaluating "reasonable expectation" and income composition, so full returns required. |
| Relevance of adjusted gross income (AGI) vs. "income" under Rule 501 | SEC: "Income" is flexible and not tied to AGI; SEC must review full returns to determine which items count. | Defs: AGI/first page demonstrates income; details of how income was earned are irrelevant. | Court: AGI is not dispositive; because Rule 501 does not define "income" by tax law, SEC allowed to explore line items in full returns. |
| Privacy/quasi-privilege protection for tax returns | SEC: Privacy interest outweighed by need to prove or disprove accredited-investor defense. | Defs: Courts are cautious ordering tax returns; production should be limited. | Court: Acknowledged caution but found compelling need and ordered production subject to confidentiality protections. |
Key Cases Cited
- SEC v. Ralston Purina Co., 346 U.S. 119 (1953) (places burden on issuer to show exemption applicability)
- SEC v. Cavanagh, 445 F.3d 105 (2d Cir. 2006) (discusses burdens in SEC exemption contexts)
- Trilegiant Corp. v. Sitel Corp., 272 F.R.D. 360 (S.D.N.Y. 2010) (articulates two-prong test for tax-return discovery: relevance and compelling need)
- Smith v. Bader, 83 F.R.D. 437 (S.D.N.Y. 1979) (recognizes privacy/public interest reasons for courts' caution in ordering tax-return disclosure)