Before CLARK, KAUFMAN, and HAYS, Circuit Judges.
Until restrained by the temporary order and preliminary injunction initially obtained by the Securities and Exchange Commission in this action, defendant Rapp engaged in the sale of stock of Taylorcraft, Inc., as a stockbroker under the name of Webster Securities Company. In this business he employed twelve salesmen, of whom defendant Benjamin Shuman was one. In this action brought pursuant to § 20(b) of the Securities Act of 1933, 15 U.S.C. § 77t (b), the S.E.C. sought a permanent injunction against Rapp and his salesmen to prohibit specific violations of § 17(a) of the Act, 15 U.S.C. § 77q(a). The effect of the injunction would be to enjoin Rapp and his men from selling Taylorcraft without making many changes in their sales "pitch"; at stake also is the defendants' liability to the cancellation of their registrations as broker-dealers, which may follow the issuance of any permanent injunction. Securities Exchange Act of 1934, § 15(b), 15 U.S.C. § 78o(b). The S.E.C. appeals from the dismissal of its complaint by the district court. The only appellees now before us are Rapp and Shuman; as to the other salesmen named in the complaint, they either were not served or have consented to injunctions, or the action has been discontinued as to them, or - in one case - the S.E.C. has not appealed.
The S.E.C.'s complaint charged, inter alia, that Rapp's salesmen, selling by telephone after the mailing of "reports," pictured Taylorcraft, Inc., a maker of light planes, as presenting a remarkable opportunity for "growth" investment. Prospective buyers were told that the company, by virtue of government contracts and recent acquisition of another company, was "in a position to do an annual volume in excess of $5 million per year." The complaint, however, charged that for some months the company had produced nothing, and in the previous year (1957) had sustained a net loss of some $30,000; moreover, the newly purchased subsidiary had not operated for two years prior to its acquisition, and had substantial liabilities which Taylor-craft had assumed. Coupled with alleged statements that the stock would rise, from its current price of $1, to $8, per share "in a short time," these were charged to be, paraphrasing § 17(a) of the Securities Act of 1933, omissions of "material facts necessary in order to make the statements made in the light of the circumstances under which they were made not misleading," and thus violations of the Act.
At trial, the S.E.C. first introduced a "Special Report on Taylorcraft," of which 50,000 copies had been sent to prospects. This report, framed as a standard market report, began:
"We recommend the immediate purchase of Taylorcraft, Inc. common stock O-T-C priced around $1.00 per share.
"Taylorcraft, Inc., after some time for retooling and redesigning, now has perfected a product and is preparing a highly efficient means to produce the Taylorcraft Fiberglass plane for a large and growing market. We believe Taylorcraft today is on the threshold of a period of substantial growth and expansion. The fantastic market for civilian aircraft, coupled with an aggressive management and pioneering spirit, all combine to provide an exceptionally promising future for Taylorcraft, Inc. We feel that one must know the facts before one can judge. Therefore, we have attached a few of the questions and answers that we have asked ourselves before we felt that we could recommend to our clients the purchase of Taylorcraft. We are sure that after you have considered these questions, you will reach the same conclusion as we have, and will purchase Taylorcraft without any hesitation."
After some general discussion of the light-plane market, and the potential market for the fiberglass planes and other products that Taylorcraft produced, the report went on:
"Question No. 8: What has been holding Taylorcraft Corporation back from more prominence in the aircraft field?
"Answer: One must understand that the Armed Forces, with huge resources and finance, manpower and equipment at their disposal need from completion of engineering blueprints to the first plane off the line, 10 1/2 million man hours for one heavy jet bomber and approximately 1/2 million man hours for one nonjet bomber. Auto manufacturers spend years creating a revolutionary new model. Here's how Taylorcraft, a much smaller, but forward looking company, have spent their time. The first fiberglass plane blueprints were completed in January, 1954. The hand made prototype made its first flight in October of 1954. Then, the development towards CAA approval. This approval, with highest operating rating was received in May, 1955, after which limited production, largely hand made, and with partial development of tooling going on at the same time, to July, 1956. Now, refining and perfecting models - then all-out concentration on developing overall, high efficiency tooling. This work brings us to the present and has now been completed."
Next, the report described Poe Machine and Engineering Company, the newly acquired subsidiary. Poe was described as "the designer and manufacturer of slitting machines" that had "received U.S. patents" and were produced "for several steel firms." The company's activity was described in the present tense.
The report's last "Question," No. 10, was, "What opportunities are there for capital gains in the stock in Taylorcraft?" The "Answer":
"We feel, with higher earnings in store for the company, as they intend and expect, they will be in a position to do an annual volume in excess of $5 million per year. This goal can only be attained by mass production. With competitive companies doing 5 to 10 times this amount, the management feels it ha5 not set its goals too high - especially when you consider the rise in the price of the stock of the Piper Corporation which in 1937 had a range of from $1 3/8 to as high as $21 1/2 and is currently trading at approximately $15. We feel that a great deal of the success of the Piper Corporation was due to the design ...