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responsibility for enforcement of the anti-fraud provisions is in no way lessened by the fact that the violator is involved in bankruptcy proceedings or that the sanctions afforded by the statute might be imposed in connection with an arrangement proceeding under Chapter XI. It pointed out that it was confronted with a choice between instituting an independent proceeding in a Federal district court having jurisdiction under Section 20 of the Securities Act or taking steps to bring to the attention of the bankruptcy court that proceedings therein were being employed in a manner violative of the Securities Act. The Commission noted that if it had obtained an injunction against further offerings or sales by Capitol Leasing Corporation through an independent action, the proceedings for arrangement in the bankruptcy court would have been rendered moot. It therefore appeared to the Commission both more seemly and more consonant with the best interests of the arrangement proceeding to apply to the bankruptcy court for relief.
The referee in bankruptcy denied the Commission's petition to intervene on procedural grounds and also decided that the Commission had not shown facts necessary to entitle it to relief. On review, district court held that it was error to deny the Commission leave to intervene but that the referee's holding that there was not adequate evidence in the record to support the Commission's claim could not be set aside as "clearly erroneous.” An appeal has been taken by the Commission to the Court of Appeals for the Tenth Circuit where the matter is now pending.
In Securities and Exchange Commission v. Paul Richter, doing business as Meade & Company, the court had preliminarily enjoined a registered broker-dealer from violating the net capital and bookkeeping requirements under the Securities Exchange Act of 1934 and had appointed a receiver of all of the defendant's assets. A bank moved the court for an order authorizing it to sell certain securities pledged to it by the defendant as collateral for loans. The receiver and the Commission opposed the motion on the grounds that at least certain of the stock certificates held by the bank contained forged endorsements, that many other complaints of forgeries had been received from defendant's customers, and that many customers complained of having bought or sold shares without having received certificates or money therefor. The court held that it appeared there might be a cloud on the bank's title to the certificates and therefore denied the bank's motion but without prejudice to another application on timely notice to all persons whose rights might be affected by a sale.
8 The Commission's application to dismiss the Chapter XI proceeding is discussed on
p. 95, supra.
S.D. N.Y., 63 Civ. 1620.
The decision of the Court of Appeals for the Second Circuit in Berko v. Securities and Exchange Commission 10 is of considerable significance to the Commission in connection with its enforcement activities directed against fraudulent sales of securities, particularly through so-called "boiler-rooms." As described in the last Annual Report,11 Berko had been found a cause of the revocation of the broker-dealer registration of Mac Robbins & Co., Inc. He sought review of that finding and the court had remanded to the Commission, which thereafter issued an Opinion and Order 12 reaffirming its previous finding. In April 1963, the court affirmed that order as being supported by substantial evidence. It stated that Berko worked in an office which was plainly established to be a "boiler-room" and which he knew to be a "boiler-room," and held that these facts justified the Commission in holding him chargeable with knowledge of the contents of brochures utilized by him which he should have known to be misleading. The court accepted the Commission's conclusion that a salesman working in a "boiler-room” has a higher duty to prospective customers than one working out of a legitimate sales operation, and does not meet his obligation when he has no knowledge of the issuer other than opinions and brochures furnished by his employer without an investigation of their correctness.
During the year, the Commission participated as amicus curiae in several cases in which there was an issue regarding the validity or interpretation of provisions of the Securities Acts, or the rules promulgated thereunder by the Commission. Among those cases were the following:
Kornfeld v. Eaton 13 was an action brought by stockholders of the Norwich Pharmacal Company under Section 16(b) of the Securities Exchange Act to recover on behalf of Norwich the profits realized by defendant Eaton, an officer and director of the company, through "short-swing” transactions in Norwich common stock. Although the purchase and sale of the stock by Eaton occurred within a 6-monti period, the purchase was made pursuant to the exercise of an option which had been granted to him by the company several years earlier. Following a demand by the plaintiffs that the company institute suit against Eaton to recover the profits from the transactions, Eaton paid to the company a sum computed in accordance with the Commission's Rule 16b-6, which limits the amount of profits that are recoverable from transactions of this type to the market increment occurring within the short-swing period surrounding the sale of the stock, thus
10 316 F. 2d 137 (C.A. 2, 1963). 11 28th Annual Report, p. 126. 12 Securities Exchange Act Release No. 6846 (July 11, 1962). 13 217 F. Supp. 671 (S.D.N.Y., 1963).
excluding the increment arising from the long-term holding of the option. The plaintiffs claimed that the rule is invalid, urging that it is inconsistent with the purpose of Section 16(b) and that it exceeds the Commission's statutory authority to exempt transactions from the operation of that Section. The district court, agreeing with the views expressed in a memorandum which the Commission filed as amicus curiae, rejected the plaintiffs' contentions and upheld the rule as a valid exercise of the Commission's rulemaking authority under the Act. Subsequent to the close of the fiscal year, the Court of Appeals for the Second Circuit affirmed. 14
Fuller v. Dilbert,15 was an action by the guarantors of a purchaser's obligations under a contract for the sale of stock to have the contract declared void as in violation of Section 5 of the Securities Act and Section 16(c) of the Securities Exchange Act. The sellers moved for summary judgment, and the Commission filed a memorandum amicus curiae. The contract was for the sale of a control block
a of unregistered stock, and it was contemplated that the purchaser would not take all of the stock himself but would designate unidentified other persons as co-purchasers or sub-purchasers. It was expressly provided, however, that purchaser “and his designees” would take only for investment so that the transaction would be exempt from the registration requirements of the Securities Act, under Section 4(1) of that Act, as a transaction not involving an “issuer, underwriter or dealer.” The Commission in its memorandum took the position that the contract could be performed without violating the Securities Act. Since any performances which violated the Securities Act would constitute a breach of the contract, the contract did not have to be declared void.
The other ground advanced by plaintiffs in support of their contention that the contract was void was predicated on the fact that certain shares included in its terms, which had been bequeathed to the sellers by their father, had not as yet been distributed to them at the time the contract was executed. It was urged that the sellers therefore did not "own" the stock which they were purporting to sell and that, since they were insiders, the contract was void as being in violation of Section 16(c) of the Securities Exchange Act, which prohibits any sale by an insider of equity securities of his corporation if he "does not own the security sold." The Commission urged, among other matters, that there is no particular form of legal or equitable title required to satisfy the requirements of ownership within the meaning of this Section, although some property interest is clearly required.
14 Docket No. 28315. 16 32 F.R.D. 60 (S.D. N.Y., 1962).
Though it cannot be said what this property interest might be in every case, the sellers here could be considered to "own" the equity securities, without giving rise to the abuses with respect to "short sales" which the statute seeks to prevent.
The district court denied summary judgment on the ground that there were issues of fact which could not be decided upon affidavits or motion papers.
In Borak v. J. I. Case Co.,16 plaintiff, a stockholder of J. I. Case Co., sought a declaration that the 1956 merger between Case and American Tractor Corporation was void, as well as damages and other retrospective relief, claiming that the merger had been approved at a stockholders' meeting at which proxies, solicited in violation of Section 14(a) of the Securities Exchange Act and the proxy rules thereunder, were voted. The district court, relying upon the case of Dann v. Studebaker-Packard Corp.," held that it had no jurisdiction under the Exchange Act to award damages and other retrospective relief, that claims for such relief were claims arising under state law and that the state security-for-expense statute was therefore applicable to the complaint insofar as it sought other than declaratory relief. Plaintiff appealed and the Commission filed a brief amicus curiae urging the court of appeals to hold that in a private suit based upon Section 14(a) and the proxy rules thereunder a Federal district court has jurisdiction under Section 27 of the Act to grant damages or any other retrospective relief as the merits of the particular case may require. The court of appeals adopted the Commission's posi tion and reversed, expressly disagreeing with the Dann decision insofar as it held to the contrary. Subsequent to the end of the fiscal year the Supreme Court granted certiorari.18
The fiscal year saw further significant developments in litigation under the Investment Company Act of 1940.
The institution of action in the case of Securities and Exchange Commission v. Midwest Technical Development Corporation 19 was described in the last Annual Report.20 In that case the Commission charged certain officers and directors of that corporation, a registered closed-end investment company, with gross abuse of trust and various violations of the Investment Company Act. The primary charge of gross abuse of trust stemmed from the activities of certain directors in purchasing the same securities which the investment company pres ently held in, or proposed to introduce into, its portfolio of securities.
16 317 F. 2d 838 (C.A. 7, 1963).
17 288 F.2d 201 (C.A. 6, 1961).
18 32 U.S. Law Week 3173 (November 12, 1963).
10 D. Minn. 4-62 Civ. 142.
20 28th Annual Report, pp. 130-131.
In addition to charging that irreconcilable conflicts of interest resulted from the directors' ownership of portfolio securities, the Commission also alleged in its complaint that the personal securities-trading activities of the directors constituted the effecting of transactions in joint arrangements and joint enterprises with the investment company in violation of Section 17(d) of the Investment Company Act and Rule 17d-1 thereunder. It was also charged that the defendants caused the investment company to enter into prohibited transactions with affiliated persons in violation of Section 17 (a) of the Investment Company Act, that the company had violated Sections 13 and 21 of the Act in issuing guarantees which in effect were indirect loans contrary to its stated investment policy, and that it had issued senior securities in violation of Section 18 of the Act.
On July 5, 1963, the district court issued its opinion. It agreed with the Commission that the activities of the directors in purchasing securities which were also represented or were intended to be included in the investment company's portfolio constituted joint arrangements in violation of Section 17(d) of the Act and Rule 17d-1 thereunder. The court held, however, that such conduct alone or together with the other violations alleged did not constitute gross abuse of trust. The court viewed the evidence as showing that the directors did not fully appreciate the conflicts of interest which were involved and that they unintentionally failed to seek approval of the joint transactions from the Commission. The court also held, among other things, that the issuance of the guarantees by the investment company in connection with loans made by third persons to companies in which the investment company had invested, or in which it intended to invest, violated the investment company's investment policy concerning the amount of loans which the company could make without stockholder approval.
Securities and Exchange Commission v. United Benefit Life Ins. C0.21 is an action by the Commission to enjoin the defendant, a Nebraska corporation, from the offering and sale of a contract described by the company as an Annual Flexible Fund Retirement Annuity. In its complaint, the Commission contended that the contracts being sold are securities within the meaning of the Securities Act and that they may not be offered for public sale without prior registration with the Commission under that Act. The Commission further contended that certain guarantees of partial repayment made by the company to the purchasers of the contracts also constituted a security required to be registered with the Commission under the Securities Act.
In addition, the Commission contended that the defendant had created and manages a separate fund for the purpose of investing in
21 D. D.C. No. 3096–62.