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COMMODITY FUTURES TRADING COMM. v. EQUITY FIN. GROUP

September 9, 2005.

COMMODITY FUTURES TRADING COMMISSION, Plaintiff,
v.
EQUITY FINANCIAL GROUP, LLC, et al., Defendants.



The opinion of the court was delivered by: ANN MARIE DONIO, Magistrate Judge

REPORT AND RECOMMENDATION

This matter comes before the Court for a Report and Recommendation concerning an issue relating to the claims of Sterling ACS, Ltd., Sterling Alliance Ltd., Sterling Casualty & Insurance, Ltd., Sterling Bank Limited, Sterling (Anguilla) Trust, Ltd., Sterling Investment Management, Ltd., and Strategic Investment Portfolio, LLC (collectively the "Sterling entities") in the above action.*fn1 Specifically, Plaintiff, Commodity Futures Trading Commission (hereinafter "CFTC"), objected to any distribution to the Sterling entities until such entities responded to the CFTC's requests for discovery. See Objection of the Commodity Futures Trading Commission to the Claims of the Sterling Entities [150] (hereinafter "CFTC Objection [150]"), at 2. The Court previously recommended approval of the interim distribution as proposed by the Receiver with modifications as set forth in the Report and Recommendation dated September 2, 2005.*fn2 This Report and Recommendation serves to address certain objections raised by the CFTC to Sterling's claims. Specifically, the CFTC seeks from Sterling the backup tape of two of the three computers of Defendant J. Vernon Abernethy that Abernethy stated he made in response to the Receiver's request to preserve the computer files relevant to this case.*fn3 Id. at 3-4; see also Declaration under Penalty of Perjury of J. Vernon Abernethy Pursuant to 28 U.S.C. § 1746 (hereinafter "Abernethy Decl.") at ¶ 4, attached as Exhibit F to CFTC's Reply to the Sterling Entities' Response to CFTC's Objections [169]. The Court conducted an evidentiary hearing with respect to the tape issue on May 13, 2005. For the reasons set forth herein, Sterling shall produce the backup tape to the CFTC, and failure to do so will result in Sterling's claims remaining on the disputed claims schedule.*fn4 I. BACKGROUND

This dispute centers around the production of a computer backup tape relating to two desktop computers and a laptop computer located in Abernethy's home office. Abernethy, a named defendant, testified during the evidentiary hearing that all three computers were used in his capacity as an agent for Tech Traders, a named defendant. He also testified that he used the computers as President of Sterling Casualty & Insurance, Ltd., as a member of Strategic Investment Portfolio, and as an agent of the Sterling Companies. See Transcript of Hearing on May 13, 2005 (hereinafter "Transcript"), at 14-15, 33; see also Abernethy Decl. at ¶¶ 5-6. He further testified that within twenty-four hours after meeting with the Receiver and counsel for the CFTC on April 7, 2004, he had an external backup tape media device created to image the two desktop computers. See Transcript at 15-16; see also Abernethy Decl. at ¶ 7. He testified that the tape contains electronic files pertaining not only to Tech Traders and the other parties in this matter, but also electronic files pertaining to Abernethy's work in his capacity as President of Sterling Casualty & Insurance, Ltd. and as a member of Strategic Investment Portfolio, as well as electronic files pertaining to his general tax practice, including confidential personal and financial information of his customers, and personal electronic files. See Transcript at 15, 17, 45; see also Abernethy Decl. at ¶ 15. Abernethy further testified that on or about April 13, 2004 he was visited in his home office by Walter Hannen, Coyt E. Murray (a named defendant in this matter), Howell Woltz, and Vernice Woltz, and that he observed Walter Hannen during the visit installing programs and downloading and creating files from the two desktop computers. See Transcript at 17, 20; see also Abernethy Decl. at ¶ 9. Abernethy further testified that he gave Walter Hannen the backup tape of the desktop computers in response to Hannen's request for a copy of the computer files. See Transcript at 21; see also Abernethy Decl. at ¶ 9. Abernethy also testified that Walter Hannen came to his office on another day during the week of April 12, 2004 and worked on both of the desktop computers. See Transcript at 23; see also Abernethy Decl. at ¶ 11. Abernethy stated that on April 22, 2004 he requested that Walter Hannen return the backup tape but was told that Vernice Woltz, the chief financial officer for the Sterling entities, had taken the tape to the Bahamas. See Transcript at 24; see also Abernethy Decl. at ¶ 12. Abernethy testified that between April 2004 and August 2004 he repeatedly requested that Walter Hannen return the backup tape, but the tape has not yet been returned. See Transcript at 24, 26; see also Abernethy Decl. at ¶ 13.

  The CFTC contends that Abernethy's computers contained relevant evidence and that Walter Hannen may have altered or destroyed that evidence. See CFTC's Reply to the Sterling Entities' Response to CFTC's Objections [169] (hereafter "CFTC Reply [169]") at 14. As the backup tape was created before Hannen's visit to Abernethy's home, the CFTC asserts that the tape "may contain the only remaining copy of that evidence." Id. The CFTC argues that the tape is necessary so that the CFTC can compare the files on the tape to those files on the computers from which the tape was made. See CFTC Objection [150] at 3-4. The CFTC further argues that the removal of the tape is in direct violation of the Consent Order of Preliminary Injunction Against J. Vernon Abernethy, which provides in relevant part that Abernethy and "each firm, corporation, partnership, association or other person or entity which holds or is a depository of his funds, securities, assets or other property of any kind, are prohibited from directly or indirectly transferring, withdrawing, removing or disposing of any such funds, securities, assets or other property." Id. at 3 (quoting Consent Order of Preliminary Injunction Against J. Vernon Abernethy dated August 23, 2004, at ¶ 4). The CFTC asserts that it has attempted to obtain the backup tape since August 2004 and was promised the tape during the deposition of Howell Woltz on December 10, 2004. Id. The CFTC further states that on March 21, 2005, Sterling informed the CFTC that it will only produce "hard copies of documents `which relate to the deposit or withdrawal of funds to or from Tech Traders.'" Id. The CFTC argues that the backup tape is not the property of the Sterling entities and that Sterling should be required to turn over the tape. CFTC Reply [169] at 151-6.

  In response to the CFTC's objections, the Sterling Entities contend that they only learned of the CFTC's interest in the backup tape in or about September 2004. See Memorandum of Law and Fact in Response to the Objections Filed by the CFTC [165] (hereinafter "Sterling Br.") at 3. Sterling states that Abernethy's computer was the property of Sterling Casualty & Insurance and that Sterling agreed to have the computer analyzed, tested, and returned to Sterling. Id. at 4. Sterling thus argues that the CFTC has a copy of every file existing on the computer as well as a report of which files have been deleted over time. Id. Further, with regard to the tape, Sterling argues that the tape was a copy of the Sterling computer that the CFTC already analyzed, and Sterling asserts that it informed the CFTC that it would forward "documents in any way relevant to" this action to the CFTC. Id. In addition, Sterling asserts that the CFTC agreed to produce a copy of the "deleted files" report created during the CFTC's analysis of the computer and that Sterling agreed to produce any of the deleted files which existed on the backup tape. Id. at 5. Sterling contends that the CFTC never produced such report. Id. Moreover, Sterling disputes that it has violated the Consent Order of August 23, 2004. Sterling first argues that the backup tape is the property of Sterling and is a copy of the hard drive of a computer that belongs to Sterling, and thus the Consent Order allegedly does not apply. Id. at 12-13. Moreover, Sterling contends that the tape was sent to the Sterling offices in the Bahamas in April 2004, before the entry of the Consent Order. Id. at 13. Sterling argues that because the entities are not parties to this action, they are not subject to requests for production and have never been served with a subpoena. Id. Finally, Sterling objects to production of the remaining files on the tape because they are allegedly proprietary, confidential, and not relevant to this matter. Id. at 14.

  The CFTC filed a reply to Sterling's response disputing the representation by Sterling that the backup tape was a copy of a computer owned by Sterling. Specifically, the CFTC states that the laptop computer that is claimed to be Sterling property was not backed up, but rather Abernethy directed the imaging of his two desktop computers. CFTC Reply [169] at 13-14. The CFTC thus argues that the tape is not the property of Sterling and that the tape contains Abernethy's personal files. Id. at 14-15. Further, as the CFTC only analyzed the laptop computer, the CFTC contends that it does not have copies or reports of what information was on the two desktop computers prior to the visit by the Sterling principals. Id. at 15. To the extent the backup tape contains some documents that the CFTC already has, the CFTC argues that it is still entitled to those documents. Id. Finally, the CFTC argues that in addition to Sterling's violation of the Consent Order entered in August 2004, Sterling's taking and retention of the backup tape is also a violation of the Statutory Restraining Order, which "prohibits Defendants' agents and `all persons insofar as they are acting in active concert or participation with [defendants]' from directly or indirectly `[d]estroying, altering, concealing or disposing of any books, records, electronically stored data or other documents, wherever stored concerning the Defendants. . . .'" CFTC Reply [169] at 15. The CFTC thus asserts that Sterling should be required to turn over the tape. Id. at 16.

  II. FINDINGS OF FACT

  The Court held an evidentiary hearing in this matter on May 13, 2005 in which Abernethy gave sworn testimony with regard to the backup tape. After reviewing all of the evidence submitted by the parties and considering the evidence received at the evidentiary hearing, for purposes of deciding the CFTC's objection to Sterling's claim for distribution, and for purposes of resolution of this discovery issue, the Court makes the following findings of fact.

  1. J. Vernon Abernethy ("Abernethy") resides at 413 South Chester Street, Gastonia, North Carolina and has a home office at the same address. Transcript of Hearing on May 13, 2005, at 131-4.

  2. Abernethy used three computers, one Hewlett Packard laptop computer, one Acer 56 Max desktop computer, and one Acer 36X desktop computer, in his home. Transcript of Hearing on May 13, 2005, at 14.

  3. Shortly after meeting with Elizabeth Streit, Esquire, counsel for the CFTC, and Stephen Bobo, Esquire, the Equity Receiver, Abernethy arranged for Ken Houser at Southeastern Systems to make a Colorado backup tape of the two desktop computers, identified as "JVA" and "JVERNON". Transcript of Hearing on May 13, 2005, at 15-16, 46.

  4. Abernethy paid for the tape, and his own tape drive was used to make the tape. Transcript of Hearing on May 13, 2005, at 15-16, 46.

  5. Abernethy also placed files of the laptop computer on a CD. Transcript of Hearing on May 13, 2005, at 17, 39-40.

  6. After the backup tape of the two desktop computers was created, Abernethy was visited on or about April 12, 2004 by Walter Hannen, Harold Woltz, Vernice Woltz, and Coyt ...


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