The opinion of the court was delivered by: MURPHY
In this action commenced on February 21, 1966, the Securities and Exchange Commission seeks by notice of motion dated March 9, 1966, returnable March 22nd and adjourned by consent to April 12, 1966, a preliminary injunction enjoining the corporate defendants S & P National Corporation, Smith-Palmer Machine Corporation and Southwest International Corporation, their officers and agents from (a) offering for sale or selling by the use of the mails and instrumentalities of interstate commerce any securities; (b) purchasing, redeeming, retiring or otherwise acquiring in the same manner any securities; (c) engaging in business in interstate commerce and from (d) controlling a company engaged in business in interstate commerce.
The Commission's grounds for such relief are: that the defendant corporations were and are investment companies within the meaning of § 3(a) of the Investment Company Act of 1940, 15 U.S.C. § 80a-1, et seq., and that none of them has registered with the Securities and Exchange Commission in accordance with the provisions of § 8 of that Act, 15 U.S.C. § 80a-8, and; that each of them has in the past engaged and consummated certain of the aforementioned acts sought to be restrained in violation of § 7 of the Investment Company Act of 1940, 15 U.S.C. § 80a-7.
In addition to claims of alleged violations of the Investment Company Act of 1940 it is also claimed that the directors of the defendant S & P National Corporation, which controls the other two corporate defendants, have abandoned or resigned their duties and offices and have left the management and affairs of such corporate defendants in the hands or under the control of persons whose past conduct in respect to such corporate defendants evidences knowing, willful disregard and contempt for the requirements of law applicable to such defendants, particularly § 15(d) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 o (d), and such conduct has caused the dissipation of assets of such corporate defendants and has prejudiced the interests of the public shareholders of the defendant S & P National Corporation.
The Commission moves also for the appointment of a receiver or trustee in order to preserve the assets of the corporate defendants and to render effective the relief prayed for.
From the affidavits submitted there is no dispute that the defendant S & P is publicly held and has been subject to the reporting requirements of § 15(d) of the 1934 Act since 1946; that defendant Smith-Palmer has been a wholly owned subsidiary of S & P since 1953; that Southwest has been a wholly owned subsidiary of Smith-Palmer since 1956. It is also undisputed that none of these corporations registered as an investment company under that Act.
It is evident that between 1958 through 1962 Southwest has been engaged in the business of owning securities "having a value exceeding 40 percentum of the value of such issuers total assets (exclusive of government securities and cash items) and on a non-consolidated basis." In 1963 that percentage fell to 36.2% and in 1964 to 39.8%. We are satisfied, however, that these lower percentages were caused principally by the lower market values of Southwest's principal investment holding, approximately 500,000 shares of Great American Industries, Inc. Those shares, however, in the last month and when the stock was suspended from trading early this month were selling at approximately 12, an increase of almost 10 points, to bring the percentage well over 75% of the value of Southwest's total assets. The price was slightly higher at the close of the market on April 15, 1966, after the suspension was lifted.
It is alleged, in opposition, that from late in 1956 through May, 1963, Southwest was primarily engaged in the real estate business through its ownership of Kraftville Corporation and Wellit Corporation and thus did not come, during that period of time, within the definition of an investment company, but after September, 1957, Kraftville was no longer a wholly owned subsidiary of Southwest. In May of 1963 the real estate property owned by Wellit was sold for $200,000, which certainly indicates that after September, 1957, Wellit's real estate operations represented but a small part of Southwest's total assets of nearly $2,500,000.
It seems clear, therefore, that these three corporations were investment companies who did not register with the Commission.
It has not been contested by the defendants that the following transactions were engaged in, which if the corporate defendants are investment companies, as we find they are, clearly indicate that § 7(a) (1) and (2) of the Investment Company Act of 1940 have been violated:
(1) A sale by Southwest in 1958 of 85,000 shares of Sterling Precision Corporation common stock on the American Stock Exchange; (2) further sales of more than 85,000 shares of Sterling Precision Corporation stock were made through brokers from 1958 and during 1960 and 1961 through the use of the mails; (3) there was a sale of promissory notes (securities as defined by § 2(a) (35) of the Investment Company Act of 1940 is part of a transaction which took place in Nassau, Bahamas, and thus involved interstate commerce; (4) in December, 1962, Southwest received approximately $190,000 as its interest in the sale of the shares of Balcrank, Inc. The proceeds were utilized in payment of Southwest's debt and thus to retire an evidence of indebtedness (a security as defined by § 2(a) (35)). The mails were used in connection with the retirement of the debt.
In violation of Subdivision (4) (5) of § 7(a) of the 1940 Act, Southwest has engaged in business in interstate commerce as defined by § 2(a) (18) as follows: (1) in 1960 and 1962 Southwest directly engaged in banking transactions in Chicago in connection with the renewal of certain loans secured by the shares of Balcrank, Inc.; (2) until 1963, Wellit Corporation, a wholly owned subsidiary of Southwest owned real estate in Missouri. Kraftville Corporation, a majority owned subsidiary of Southwest continues to own and lease real estate in New York and to own and lease parts of aircraft held for salvage in Florida. Since Mr. Still functions on behalf of Southwest and its subsidiaries, Southwest is engaged in business in interstate commerce through controlled companies. S & P and Smith-Palmer are also in violation of § 7(a) (3) through their control of Southwest.
The more difficult issue on this motion is whether or not the Commission has made out a strong prima facie case that the individual defendant, David M. Milton, controlled and was a director of S & P during the period of time 1952 to 1964 during which time it filed, pursuant to § 15(d) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 o (d) the required Form 10-K. If he was, such reports were false and misleading in failing to disclose his control and the identity of the directors of S & P.
Defendant Milton, by affidavit, states that he is not a director of S & P nor has he been or performed the functions of a director since 1958, nor has he exercised any influence over the management or policies of S & P, Southwest or Smith-Palmer since he resigned as a director of Southwest in December, 1958. He further states that he does not own directly or indirectly, beneficially or otherwise, a single share of stock of S & P. He admits that until February 1, 1966, he was Chairman of the Board and Chief Executive Officer of The Equity Corporation and a director or officer in a number of other major corporations in which Equity had a substantial stock interest. On ...