Other Litigation and Legal Work

The General Counsel represents the Commission in all litigation in the United States Supreme Court and the courts of appeals, defends the Commission and its employees when they are sued, prosecutes administrative proceedings under Rule 2(e), and appears amicus curiae on behalf of the Commission in significant private litigation under the Federal securities laws. In this litigation, the General Counsel seeks to insure that the objectives of the Commission's enforcement program are attained, that judicial interpretations of the Federal securities laws afford adequate protection to investors, and that the Commission is able to discharge its statutory responsibilities, unimpeded by law suits against the agency or its staff.

In fiscal year 1983 the Division of Corporate Regulation represented the Commission in court appearances in corporate reorganizations where there was a substantial public investor interest.

Key 1983 Results

The General Counsel represented the Commission in 239 litigation matters during the past fiscal year, many of which are still pending. Forty-four appellate and Supreme Court cases were concluded, 38 favorably to the Commission. There were 52 appellate cases before the Supreme Court and Federal courts of appeals in which a party subject to a Commission injunctive action challenged the lower court's resolution of the case in a manner favorable to the Commission or, much less frequently, the Commission challenged an adverse decision. Of these appeals, 16 were concluded, with only two outcomes unfavorable to the Commission. The foregoing compares with the following cases in fiscal 1982: a total of 251 matters, of which 62 were appellate cases in which a party subject to Commission injunctive action challenged the lower court's resolution of the case in a manner favorable to the Commission, or the Commission challenged an adverse decision. Of those appellate cases 34 were concluded, two of which were unfavorable to the Commission.

There were also 19 appellate actions seeking to overturn Commission orders, primarily those issued in Commission administrative proceedings or those affirming self-regulatory organization disciplinary proceedings against broker-dealers. Thirteen of these appeals were concluded, with only one adverse result. In fiscal year 1982, there were 38 such actions.

In 53 cases during the year (compared to 58 such instances in fiscal year 1982) Commission participation as a friend of the court in litigation conducted by private parties was considered in order to afford the court the benefit of the Commission's views on significant questions of concern to the Commission. Amicus briefs were filed, and 13 private cases in which the Commission participated were concluded. Only one of these resulted in a decision adverse to the

views which the Commission advocated.

In addition, the General Counsel handled more than 115 other proceedings before the Commission or in the Federal trial courts, compared to 90 in fiscal year 1982. These included 35 suits brought against the Commissioners or the Commission's staff, and 46 suits, including actions under the various public information statutes, seeking access to Commission documents. In fiscal year 1982, there were 23 suits brought against the Commissioners or the Commission's staff, and 19 suits under the various public information statutes.

During the fiscal year, 79 debtors with publicly issued securities outstanding entered Chapter 11 reorganizations. The Division of Corporate Regulation entered its appearance in 15 of these cases, with assets of $1.9 billion and about 75,000 public investors.

Litigation

Appeals in Commission Injunctive Actions-This litigation consists primarily of appeals in which a defendant attempts to reverse a trial court's entry of an injunction. Occasionally, however, the Commission appeals the denial of injunctive relief. These appeals frequently raise highly significant issues concerning the scope and interpretation of the securities laws.

One case which was litigated during the fiscal year raised the constitutionality of enjoining an investment adviser from publishing a newsletter recommending securities investments.85 The defendant in that case had been criminally convicted of fraud and misappropriation of customers' funds, and the Commission therefore barred him from the investment advisory industry. Notwithstanding the bar, the district court, on First Amendment grounds, refused to issue an injunction against further newsletter publication. On appeal, the Commission asserted that investment advisory newsletters constitute commercial speech which may be subject to a greater degree of regulation than political or ideological speech. The Commission further urged that, because of the delicate fiduciary relationship between an investment adviser and his client, there is need to protect the public by barring unfit persons. (On January 18, 1984, the court of appeals reversed the opinion of the district court.)

The standard for obtaining injunctive relief against future violations of the securities laws is a frequent subject of appeals in Commission enforcement actions. This year the Commission appealed the refusal of a district court to enjoin a defendant whom that court found to have violated antifraud, reporting and proxy provisions of the securities laws.86 The Commission maintained that, in declining to grant an injunction, the court erroneously afforded undue weight to a single factor-whether the defendant's occupation at the time of trial provided an opportunity to commit future violations. The Commission urged that, consistent with investor protection, the proper analysis requires consideration of various factors, including the egregious nature of the defendant's past violations, not merely current occupation.

In another case, the Commission successfully resisted an attempt to vacate a consent injunction entered in 1976.87 In the defendant's appeal from the district

court's refusal to vacate the injunction, the court of appeals relied on the district court's findings that there was no harm to the defendant flowing from the decree and that the injunction continued to protect investors. The court of appeals recognized that "significant governmental interests" were involved in efforts to vacate consent decrees, noting that consent injunctions allow the Commission to secure the protections of an injunction while preserving its own, and judicial, resources. In exchange for the defendant's consent, the Commission surrenders its right to the entry of findings of fact. The court of appeals was "reluctant to upset this balance of advantages and disadvantages" by dissolving consent injunctions, “unless it is clearly inequitable for the decree to continue in effect."88 Petitions to Review Commission Orders-Petitions to review Commission orders arise from Commission administrative proceedings and from Commission orders on review of disciplinary action by national securities exchanges and the National Association of Securities Dealers, Inc. Like appeals in injunctive actions, these administrative cases frequently involve issues central to the Commission's enforcement program and thus to the integrity of the securities markets. In one such case, the court of appeals upheld Commission sanctions imposed on a securities salesman based on findings that, without disclosure to his customers, the salesman charged excessive markups and illegally sold unregistered securities.89 In another case, the court of appeals affirmed the Commission's determination that a broker introducing accounts to a clearing broker has a duty to disclose material information concerning the credit-worthiness of its customers.90

Commission Participation In Private Litigation-The Commission also participates as a friend of the court in private litigation which raises significant securities laws issues or other issues of concern to the Commission. Private actions serve to supplement the Commission's own enforcement program, deterring violations as well as affording relief to injured investors. Also, because the Federal securities laws provide for both governmental enforcement actions and private remedies, decisions in private cases which interpret provisions of those laws may have precedential effect in Commission enforcement actions.

Early in 1983, the Supreme Court adopted the position urged by the Commission in a case which concerned the relation between the express and implied remedies available to investors under the Federal securities laws (Herman & McLean v. Huddleston).91 In a strongly worded opinion, the Supreme Court emphasized the remedial purposes of the securities laws and the necessity of construing them broadly to protect investors. Consistent with this analysis, the Court held that the availability of the express remedy for falsehoods in registration statements in Section 11 of the Securities Act does not prevent defrauded purchasers from suing under Exchange Act Rule 10b-5 as well. The Supreme Court also agreed with the Commission that the standard of proof in private antifraud cases is a preponderance of the evidence, not the more stringent clear and convincing evidence standard.

At the request of the Supreme Court, the Commission also filed a brief in response to a petition for review of Walck v. American Stock Exchange in which the court of appeals had held that private parties cannot seek damages from a

stock exchange under Section 6 of the Exchange Act for failure to enforce its rules.92 The Commission's brief disagreed with the conclusion of the court of appeals, pointing out that an implied right of action against exchanges is wellrecognized and that the existence of such a right is important to investor protection. The Commission stated, however, that review should not be granted because of the limited precedential value of the case, which interpreted the language of Section 6 prior to its amendment in 1975. Consistent with the Commission's recommendation, the Supreme Court denied review.

In 1983, the Commission participated in several private actions which considered the scope of the term "security." In two such cases, the Commission disagreed with lower court decisions requiring instruments that come within the term "note" in the definition of "security" also to meet the test for "investment contract," another term in the definition, in order to qualify as securities.93 In briefs filed in these cases, the Commission expressed concern that the exclusive use of the investment contract test for determining whether instruments are securities would restrict the coverage of the securities laws and limit investor protection.

In another case raising this basic jurisdictional issue, the Commission argued that time deposits issued to persons in the United States by a foreign bank are securities if issued in investment-as distinguished from commercial-transactions.94 The Commission argued that, merely because the foreign issuer is a bank, the securities laws should not be construed to deny United States residents protection; where instruments, unregulated by Federal banking agencies, are offered to the general public as investments, the securities laws should apply.

The Commission also urged in several cases that shareholders and their companies can sue for injunctive and other equitable relief to enforce Section 13(d) of the Exchange Act.95 That provision requires persons who acquire more than 5% of the securities of an issuer, and thus could potentially effect changes in corporate control, to disclose their holdings and certain other information to the investing public. In one such case, the Court of Appeals for the Seventh Circuit ruled, in accordance with the Commission's position, that such a right of action is consistent with congressional intent.96 Other cases raising this issue are pending.

Litigation Involving Trading On Nonpublic Information-Trading on the basis of material nonpublic information-a practice which impairs confidence in the integrity of the securities markets-has been the subject of a number of recent cases. Last year, in Dirks v. SEC, the Supreme Court set aside the Commission's censure of an officer of a securities brokerage firm who had conveyed adverse nonpublic information received from officers and employees of a corporation to potential sellers.97 This conduct caused institutions to sell $17 million of securities to public investors who did not know that the securities were in fact virtually worthless. The decision strongly reaffirmed that both insider and tippee trading on the basis of nonpublic, material information is prohibited under the Federal securities laws. But the Supreme Court rejected the Commission's theory that a corporate outsider assumes the fiduciary duties of his inside sources by receiving confidential corporate information from them. However, the Court stated that outsiders can acquire a duty to disclose or abstain from trading in

several situations. First, outsiders may become fiduciaries of the shareholders when they receive confidential information solely for a corporate purpose. Second, outsiders acquire derivatively the fiduciary duties of their inside sources when they obtain confidential corporate information from insiders who transmit it with the expectation of direct or indirect personal benefit, or make a gift of the confidential information to the recipient.

Following the Supreme Court's ruling in that case, the Commission successfully opposed the Supreme Court review in United States v. Newman, in which the defendant had been criminally convicted for trading on confidential information concerning possible takeovers. His confederates misappropriated the information from their employer, investment banking firms, and their clients.98 The defendant purchased securities of the companies that were the subject of the proposed takeovers and, after the stock rose as a result of announcement of the takeovers, sold at a profit. The court of appeals held that the proscriptions of the antifraud provisions are not limited to situations where the fraud is perpetrated on the purchaser or seller of securities.99 The defendant's subsequent petition for Supreme Court review argued that the misappropriation by the defendant and his confederates did not give rise to liability under the securities laws, but involved only the breach of state law contractual or fiduciary obligations. The government, in response, emphasized the broad, remedial nature of the antifraud provisions, the nexus between the fraud and the defendant's purchase and sale of securities, and the fact that the misappropriated information concerned proposed purchases of securities by clients of the investment bankers.

The Commission also filed a friend of the court brief in a related private action for damages. The plaintiff in that case sold shares of a target company on the same day that the criminal defendant purchased the securities.100 The district court dismissed the complaint on the ground that any duty owed to the investment banking firms and their clients did not give rise to a separate duty to the target company's shareholders. In its brief, the Commission recognized that persons who gain superior market information by reason of acumen, industry, or intelligence owe no disclosure duty to those with whom they trade. The Commission argued that, nonetheless, a person who purchases securities on the basis of nonpublic information which he knows to have been misappropriated, owes a duty of disclosure to the selling shareholders-independent of any other relationship. Otherwise, the Commission argued, the law would encourage theft of information. The court of appeals rejected the Commission's position, commenting that such a holding would grant a private plaintiff a "windfall."101 In so doing, the court of appeals distinguished its earlier decision in the criminal case: the critical defendants traded on the basis of misappropriated information, in violation of duties owed to their employers and the firms' clients; the defendants did not, however, violate any duty owed to persons, like the plaintiff, with whom they traded in the market.

Commission Action Under Rule 2(e)-Under Rule 2(e) of its Rules of Practice, 102 the Commission may suspend or bar professionals (generally lawyers and accountants) from practicing before it if they have violated the Federal securities laws or engaged in unethical professional conduct in their Commission