Respondents also represented that the Smith Corporation stock was one of the best issues they had ever sold, that they themselves had purchased stock, and that other prominent persons had expressed their confidence by investing heavily in the stock. Thus, Bailey represented that this stock was one of the best issues he ever had and was probably the best buy in the stock market. Substantially identical representations were made by Stanko, Kirk, Waller and Bolhover. Stanko, Waller, Bolhover and Walker told many customers that they themselves or their families were making substantial investments in issuer's stock, when, in fact, Bolhover and Waller never bought any of the issuer's stock; Walker bought only 100 shares, and Stanko received 500 shares as a bonus and later sold 350 of such shares back to registrant. Stanko and Walker told at least four customers that certain locally prominent individuals and concerns had purchased large blocks of issuer's stock, statements subsequently conceded to have been false.

Bailey and Stanko represented that issuer's chain machine would revoluntionize the industry although both were ignorant of the manufacturing methods of issuer's competitors. In addition, Bailey, Stanko, Waller and Walker falsely represented that issuer had substantial orders for chain and chain assembly machines. Bailey represented that issuer had a substantial amount of irrevocable orders from abroad which were covered by deposits in New York banks and included a $100,000 order for a chain machine. Stanko told customers, among other things, that issuer had orders from Pontiac Motor Company for chain for timing gear; that it could "corner" the market because it manufactured chain at half the cost of other companies; that machines would be sold to Europeans and royalties from their chain output would inure to issuer's stockholders; that Smith Corporation had so many orders they could not be filled for at least two years; that issuer needed the proceeds from the offering to build 4 or 5 additional chain assembly machines to handle the expected volume of business, and that Europeans wanted to buy the patent for the machine but Smith Corporation refused to sell because of the machine's prospects. Waller told different customers that issuer had an order from Norway for a chain machine for $250,000, which was already deposited in an American bank, and would receive a royalty of 5¢ per chain on the output of this machine; that Smith Corporation had $1,000,000 in orders and made a 100% profit on chain, and that it had so many orders it could not fill them. Walker represented that issuer needed additional machines to fill its many orders from auto companies, that it would shortly close a million dollar deal with General Motors Corporation, and that there were several foreign

orders for chain machines and issuer would receive royalties on the output of these machines.

These representations were all false. As recited above, no substantial domestic or foreign chain orders were in effect at the commencement of the offering. There never was any order for chain assembly machines, nor orders or immediate prospects of orders from Pontiac Motor Company or General Motors Corporation, and the Smith Corporation did not own patents on the machine, but was only a licensee. Each of the individual respondents not only restated to customers the unjustifiable recitals as to dividends in the prospectus but made even more exaggerated claims. Thus, Bailey stated the stock was bound to pay high dividends within six to eight months; Stanko stated that a dividend of 10 cents a share would be paid within 60 days of September 1949 and would be continued because of issuer's tremendous backlog; Waller told one customer, who had informed him of her then precarious financial situation, that a dividend of 10 per cent (20¢) would be paid within 90 days and another customer that issuer's president would guarantee a quarter-point dividend within 90 days; Bolhover stated that dividend payments would start three months after the close of the issue, and in two years the dividends paid would cover the cost of the stock; Walker represented that the first dividend would be paid in September 1949; and Kirk informed a customer, who told him he wanted to dispose of certain stocks because they paid no dividends, that issuer's stock "pays a dividend," and the customer thereafter purchased Smith Corporation stock.

Each of the individual respondents falsely represented to customers that issuer's stock would substantially appreciate in value in a relatively short time, and some of the respondents, in addition, compared issuer's stock with other stocks which, to the customer's knowledge, had greatly appreciated. Thus, Bailey stated that the stock would go up 30 or 40 points; Stanko stated it might advance to between $8 and $10 within a year or two, looked even better than another stock which had advanced from $4 to $40 a share, and could be sold within thirty days after the close of the offering at a profit of $1 a share; Kirk stated it would go up to about $10 in one year and was comparable to another stock which had gone up to $25 or $30 a share in a couple of years; Waller represented that the stock should triple in value or would increase in value by one-third in 90 days or 25 cents a share in ten days; Walker stated a rise in value of issuer's stock to $30 or more would not be surprising and the stock was similar to that of a brewing company which had markedly increased in price; and Bolhover represented that the stock would double in value within a short time.

Stanko and Waller urged six different customers in August and September 1949 to buy stock soon because only a few shares were left and the issue would be closed out quickly. These statements, obviously designed to indicate that the stock was in demand and considered valuable by others, were misleading, because in fact the stock was difficult to sell and the offering was not closed until October 17, 1949, some 52 months after its commencement, at which time registrant still had at least 15,000 unsold shares.*

Prior to November 15, 1949, an engineer then recently employed by Smith Corporation told Bailey and Stanko that defects in dies used to make chain parts necessitated expensive modifications and accounted largely for the assembly machine's failure to attain the contemplated rate of chain production. This information indicated that issuer's chain production was lagging and that substantial additional funds were needed to remedy the stated defects. Nevertheless, Stanko and Waller thereafter sold a total of 450 shares to two customers by asserting their continued confidence in issuer, and without disclosing to these customers this new adverse information.

Registrant does not seriously dispute the falsity of the statements in the selling literature. However, it is contended that Bailey made a preliminary investigation of issuer's affairs sufficient to comply with registrant's duty as underwriter and that registrant was not responsible for the contents of the prospectus because these were based on information furnished by the issuer on which registrant was entitled to rely. While registrant acknowledges responsibility for such use as was made of the press release by its staff, it claims in mitigation that Bailey specifically instructed salesmen not to use selling literature other than the prospectus. And although registrant concedes that the record would support a finding as to oral misrepresentations by its salesmen, it denies that registrant's present stockholders made any misrepresentations, and urges that its responsibility for the salesmen's misstatements is not such as to warrant the imposition of a drastic sanction.

In offering the Smith Corporation stock, registrant, as underwriter, owed a duty to the investing public to exercise a degree of care reasonable under the circumstances of this offering to assure the substantial accuracy of representations made in the prospectus and other sales literature. Registrant did not fullfill that duty. Bailey testified that he doubted he would have taken the underwriting except for the Smith Corporation's contemplated chain business, since he knew that the company was "in bad shape." Bailey also knew that in the manufacture and sale of chain the corporation was embarking on a new and

Henry P. Rosenfeld, 32 S. E. C. 781 (1951).

untried business; that the automatic chain assembly machine had just begun production; and that unless the company could produce and sell substantial quantities of commercially acceptable chain at a profit the proceeds from the stock issue would be quickly consumed by overhead expenses.

Bailey states that he relied on his own observations as to the satisfactory operation of issuer's chain assembly and fender-cutting machines, but he does not claim to be qualified in these matters. And although the chain assembly machine jammed while Bailey was watching it, he did not request tests proving the rate of production attained, the quality of the product, or the very important representation that the chain assembly machine could achieve five times greater production than "conventional" means of production. Such tests would have demonstrated the falsity of these representations in the prospectus.5

Bailey testified that he saw some orders for moldings and for chain. However, he paid no attention to their dates and merely assumed they were still in effect. Even a routine examination of these orders would have disclosed that the letters of credit supporting the foreign orders had long since expired; that none of the three largest domestic orders were still in effect; and that the total of both foreign and domestic orders, even when still effective, was only a fraction of the amount recited in the prospectus.

Bailey emphasizes, as an exculpatory factor, his purported substantial reliance on information furnished him by the issuer. Such reliance did not constitute discharge of the duty to exercise reasonable care that rested on registrant as underwriter, or a defense to circulation of the materially misleading and deficient statements noted above. Moreover, where, as here, an issuer seeks funds from the public to finance a new and speculative venture, the underwriter must be particularly careful in verifying the issuer's obviously self-serving statements as to its operations and prospects. All individual respondents had copies of the press release and the prospectus, which, as shown above, contained inconsistent assertions on such material matters as the machine's capacity and production, and these discrepancies should

Stanko, who as registrant's sales manager bears a large part of the supervisory responsibility and who claims to have had some mechanical background, made this "investigation" of issuer's chain: "They gave us, every one of us, a sample chain to take home. Some of the boys put them on their bikes and said it was pretty good. That is the only thing I knew of." Stanko admittedly did not examine what he was told were orders. It may be noted that Bailey had considerable doubts as to the reputation of the father of issuer's president, who was licensor of the rights to the chain assembling machine and was described by respondent Bolhover as having "a beautiful imagination" and by an apprehensive investor as a "promotion man and not always was his word worth anything." Nevertheless Bailey made no objection to this man's spending much of his time at registrant's office throughout the offering period, where, with Bailey's and Stanko's knowledge, he addressed meetings of registrant's salesmen and furnished them information about the issuer.

have raised serious doubts as to the accuracy of the information furnished.

While Bailey claims to have instructed registrant's staff not to use anything but the prospectus, the record clearly shows that the release was given to many investors during the sale of issuer's stock; that the supervisory respondents, Bailey and Stanko, knew copies were available at registrant's office and could, presumably, be picked up readily by any salesman desirous of using them, and that Stanko himself used the release in many sales. If it was intended that the press release should not be used, excess copies of the release in registrant's office could readily have been disposed of.

We have found that, contrary to registrant's contention, Bailey and Kirk made various misstatements. In any event, Bailey, as registrant's president and its controlling person, must bear responsibility for the failure to verify the false and misleading contents of the prospectus which he directed the salesmen to use and which encouraged further oral exaggeration and misrepresentation by the salesmen in connection with their dealings with registrant's customers. Finally, when registrant learned during the course of the offering that the production improvements contemplated by the prospectus did not materialize, so that Bailey himself expressed doubts as to the competence of issuer's management, no attempt was made either to correct the prospectus or to discontinue its use.

On the basis of the foregoing, we find that the individual respondents willfully violated Section 17 (a) of the Securities Act and Sections 10 (b) and 15 (c) (1) of the Exchange Act and Rules X-10B-5 and X-15C1-2 under the latter statute." Under Section 15 (b) of the Exchange Act such willful violations by themselves constitute a basis for revocation of registrant's registration. In addition, registrant itself violated the provisions in question by failing to exercise appropriate care and supervision.

VIOLATION OF REGISTRATION PROVISIONS

The offering of the Smith Corporation stock was sought to be qualified pursuant to Regulation A under the Securities Act. That regulation makes available an exemption from registration for securities with an aggregate offering price not exceeding $300,000, provided

The composite effect of these provisions is to make unlawful the use of the mails or any means or instrumentality of interstate commerce by any person in order to effect a purchase or sale of a security where, inter alia, a device to defraud is employed, where an untrue statement or a misleading omission with respect to a material fact is made, or where such broker or dealer engages in any act, practice, or course of business which operates or would operate as a fraud or deceit upon a customer.

Regulation A was adopted by the Commission pursuant to its authority under Section 3 (b) of the Securities Act, which expressly makes exemptions from registration subject to such terms and conditions as the Commission may prescribe.