The opinion of the court was delivered by: MANSFIELD
MANSFIELD, District Judge:
Acting pursuant to § 20(b) of the Securities Act of 1933 (15 U.S.C.A. § 77t(b)) and § 21(e) of the Securities Exchange Act of 1934 (15 U.S.C.A. § 78u(e)), the Securities and Exchange Commission ("SEC" herein) seeks to enjoin North American Research and Development Corporation ("North American" herein) and 42 other defendants from committing further violations of the registration and anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, and the rules and regulations thereunder. However, as a result of default judgments, consents to the entry of preliminary injunctions, and failure to serve some of the named defendants, this decision on the SEC's motion for a preliminary injunction is confined to the remaining 21 defendants.
On this motion, hearings were held over a period of seven days to resolve issues raised by the parties' affidavits, at which oral testimony of 24 witnesses was received, and this decision is based not only upon affidavit proof submitted by the parties but, where facts were disputed, upon the Court's observation and careful appraisal of the witnesses who testified with respect to disputed issues.
The central figure in the financial saga leading to the SEC's application is the defendant Edward White, who was the principal originator of, and driving force behind, a scheme to acquire control of the issued stock of an inactive publicly-held corporation, North American (formerly named Utah Fortuna Gold Company) and, with the defendants Sam Freeman and Frank M. Naft, to promote distribution of the balance of the issued stock with a view to introducing it onto the over-the-counter market in the United States, creating a demand for it, instigating the trading of it, and running up its market price, all for the benefit of himself and a group of friends engaged in distributing it. A 52-year old, self-styled promoter and securities trader who has in recent years dealt principally in Canadian mining securities, White, at the times here involved, maintained residences in New York and Toronto, where he also operated an office and had eight brokerage accounts in Canada, and three accounts in the United States. His success in earlier promotions had given him a substantial following among friends in both countries. Prior to his becoming heavily involved in the mining business, both as an officer of mining corporations and a person engaged in developing exploration of mining claims, White had been associated as a registered representative with Hilton Securities Corporation, a New York broker-dealer.
In March, 1967, White let it be known among some of his friends that he wanted to acquire a corporate "shell", i.e., a publicly-held, inactive corporation having neither assets nor liabilities. His immediate plan was to place some Canadian mining claims in the shell and then promote market interest in the stock of the corporation itself. Although he testified that he desired control of a publicly-held corporation rather than of a closed or privately-held one because he wished to develop liquidity for his estate and to avoid underwriting expenses, the Court, on the basis of all of the proof before it, including testimony of various other witnesses conflicting with that given by White, finds that from the outset his purpose and that of his immediate friends was to acquire and distribute the balance of the shares of the shell (other than those directly acquired by him), to promote trading in the stock, and to increase the over-the-counter price of such shares on the basis of his prospective development of the company, with a view to their making an interim profit on the purchase and resale of such shares and White's eventually being in a position to realize a profit on his acquisition.
On April 27, 1967 White acquired control of such a worthless corporate shell, a Utah company called Utah Fortuna Gold Company, the name of which was later changed by him to North American. Although no market for its stock had existed for years, within three months, as the result of a carefully laid and executed plan of the White-Freeman-Naft trio, approximately 200,000 shares of its stock was distributed via Canadian accounts to broker-dealers and the public in the United States, trading of the stock was initiated on the over-the-counter market, and the price of the stock, as a result of the group's skillful promotion, was run up during the same short period from 1/2 cent per share over-the-counter to more than $6.00 per share, or more than 1200%, even though the corporation did not carry on any commercial operations during the period and its assets were of doubtful value. On July 20, 1967, the bubble burst when trading in the shares was suspended by the SEC. The underlying facts found by the Court are as follows:
Following White's advising his friends in March, 1967, of his interest in acquiring a publicly-owned shell, Sam Freeman, a Toronto stock trader,
who had been a close friend of White for 15 or 20 years, located such a company through an acquaintance, the defendant K. Ralph Bowman, of Salt Lake City, Utah. Bowman had been engaged in the securities business with a family broker-dealer firm, Ned J. Bowman Corporation, and later with the broker-dealer firm of Jonathan & Co., Inc., and has repeatedly been enjoined from violating §§ 5 and 17 of the Securities Act of 1933, the last injunction having been entered by the United States District Court for the District of Utah on January 26, 1965, in connection with Bowman's sale of stock of Thermal Dynamics Corp.
("Thermal" herein), a company that had been engaged in 1964 in the construction and development of a pilot plant in Helper, Utah, for testing of a process for manufacture of coke that might be burned without air pollution. Thermal was later to play a major role in the activities of White and his group in promoting the distribution and trading of stock of North American (Utah Fortuna), the corporate shell acquired through Bowman.
Upon receiving Freeman's inquiry, Bowman, through a Salt Lake City friend and associate in the Thermal venture, one Richard Whitney
("Whitney" herein) and Whitney's friend Donald Glenn, also of Salt Lake City, was put in touch with one Robert A. Johnson of Salt Lake City, secretary-treasurer, director and transfer agent of an inactive, publicly-owned Utah corporation named Utah Fortuna Gold Company (later named North American). Utah Fortuna had been incorporated in January 1933. During 1964 the assets of the corporation were sold and proceeds distributed, leaving it a worthless, inactive, empty shell, with neither assets nor liabilities. In March, 1967, when Whitney met Johnson, Utah Fortuna had approximately 50 stockholders (Tr. 1082), largest of which was South Utah Mines ("South Utah" herein), another Utah corporation, the owner of 1.2 million of its 1.8 million outstanding shares. South Utah and Utah Fortuna were under the common control of Mrs. Mabel McGarry (who owned between 70% and 80% of the South Utah stock). Mrs. McGarry, Johnson and one Florence Williams were the officers and directors of both companies, and Johnson was the transfer agent for both.
Upon learning from Whitney of Freeman's interest (on behalf of his client White) in acquiring control of the shell and his willingness to pay $10,000 for it, Johnson advised that a sale of control could be arranged. Thereupon he informed Mrs. McGarry, president of South Utah, of the possibility of selling control and obtained from her authority to sell the 1.2 million Utah Fortuna shares owned by South Utah, or 66% of Utah Fortuna's outstanding stock at a price between $500 and $1,000.
Armed with authority to sell control of Utah Fortuna (North American), Johnson notified Whitney that he would provide him with an option for the 1.2 million Utah Fortuna (North American) shares, which represented control. It was agreed that 1 million shares, representing control, would be offered by Whitney to Freeman's client (White) for $10,000, and that if the sale was consummated, the proceeds would be distributed as follows: after Mrs. McGarry and South Utah were paid $1,000, the remainder of the fund, comprising $9,000 plus 200,000 shares, was to be divided:
Glenn 1,501.25 plus 100,000 shares
Frank Whitney, 1,501.25 plus 100,000 shares
Richard Whitney's brother
In implementation of the foregoing arrangements, Johnson, on April 20, 1967, executed a written "10-day option" from South Utah to Whitney, given without any immediate payment, to purchase 1.2 million Utah Fortuna (North American) shares at $4,750 (P's Ex. 2),
and on April 26, 1967, South Utah's Board of Directors passed a resolution authorizing Johnson to sell its stock to Whitney.
Upon learning of the availability of the shell Freeman advised White. Thereupon White confirmed his interest by telephone to Bowman, and on April 26, 1967, White, together with another Toronto friend, Frank M. Naft
and an attorney, Stanley Kanarek,
flew to Salt Lake City, where on April 27, 1967, Whitney, as "Seller", entered into an agreement with White and one Sonia Starr for the sale of 1 million shares of Utah Fortuna for $10,000.
These shares have not been subsequently redistributed to the public.
In the meantime beginning on April 24, 1967, Whitney, Johnson and Bowman began a program of acquiring most of the remaining Utah shares outstanding (over and above the 1.2 million shares that were the subject of the option to Whitney) for sale to two firms in Toronto designated by White and Freeman. Freeman advised Bowman by telephone from Toronto that any shares acquired by him would be purchased by the firm of J.P. Cannon & Co., Ltd. of Toronto, Canada, and White told Whitney that if he was able to buy any stock he should call J.P. Cannon & Co. or Lars Hagglof & Co. in Toronto who would purchase it.
J.P. Cannon & Co. was a Toronto broker-dealer with which White had had extensive dealings, so much so, White testified, that he regularly held telephone conferences four times a day with Robert Fleischer, a registered representative of that firm. On April 24, 1967, Freeman, also a client of J.P. Cannon, instructed Fleischer to purchase 100,000 North American (Utah Fortuna) shares to be offered from Salt Lake City for the accounts of Lillian Freeman, his wife, and Bella Freedman, his mother-in-law. On the same date Frank M. Naft instructed Fleischer to buy 48,500 shares to be offered from Salt Lake City to the account of his wife.
In accordance with the advice received from White and Freeman from Toronto, Bowman, Whitney and Johnson began, on April 24, 1967 (the date when Freeman and Naft gave instructions to J.P. Cannon & Co. in Toronto), a program of acquiring most of the North American (Utah Fortuna) shares outstanding over and above the 1.2 million that had been the subject of the option to Whitney, and selling them to the Cannon and Hagglof firms in Toronto. Through the use of the company's stock transfer records, between April 24 and April 27, 1967, Johnson by personal solicitation acquired 188,500 shares from stockholders located in or about Salt Lake City which he sold to Bowman and Whitney, who in turn sold them at once through Griffith C. Lindquist, d/b/a Lindquist Securities Corp., a Salt Lake City broker-dealer, to J. P. Cannon in Toronto. On April 27, 1967, at the same time when Whitney exercised the option for purchase of the 1.2 million North American (Utah Fortuna) shares from South Utah and sold 1 million shares to White for $10,000, he simultaneously arranged with Johnson to have 100,000 shares (of the remaining 200,000) issued to Frank Whitney (his brother) and sold immediately at 1 cent per share through Lindquist to J. P. Cannon and another 100,000 shares issued to Glenn, who sold these shares on the same day to Hagglof. In all, during the period from April 24 to June 5, 1967, the Salt Lake City group (consisting of Johnson, Bowman and Whitney) acquired, in addition to the 200,000 shares from South Utah, 553,000 shares from other North American stockholders located in or near Salt Lake City, all of which were sold to the Cannon and Hagglof firms in Toronto as instructed by White, Freeman and Naft.
As the shares sold by the Salt Lake City group were transferred to Cannon or Hagglof in Toronto, they were placed in several accounts in the names of relatives and close friends of White, Freeman and Naft, including accounts in the names of Naft's wife (Corinne White), sister (Eleanor Joseph); Freeman's wife (Lillian Freeman), mother-in-law (Bella Freedman), and brother-in-law (Robert A. Smith); a secretary (Margaret Raphael) employed in the Toronto office of Freeman, Cooper & Naft; Morris Cooper, a close business associate of Freeman and Naft; Cooper's wife (Esther Oventhal), and mother-in-law (Frances Oventhal).
By June 27, 1967, as a result of the foregoing transactions, approximately 96.8% of the 1.8 million shares of North American outstanding was thus under the control of the White-Freeman-Naft trio, including the 1 million shares held by White and his friend Sonia Starr, and the 753,000 shares acquired through Cannon and Hagglof held in the names of friends and relatives of the trio. The Court is convinced from the proof of all of the surrounding circumstances, including the systematic acquisition of the stock, the close relationship between the trio and the parties in whose accounts the stock was held in Toronto and the subsequent distribution of the shares, that the 753,000 shares were acquired in Toronto with a view to the distribution of all or a very substantial portion of it in the United States.
As the White-Freeman-Naft trio, during the period from April 24 to June 27, 1967, were thus acquiring almost all outstanding North American shares, they were simultaneously laying the groundwork for distribution of the 753,000 shares held in Toronto, a program that was closely tied in to White's efforts to promote his newly-acquired corporate shell. Although he had originally planned to use the company as a vehicle for market exploitation of Canadian mining shares to be placed in it, which he testified were difficult to market in the United States through a Canadian enterprise, a new opportunity was presented immediately upon his acquisition of control and was quickly seized upon by him and his associates as a prospect that would be more appealing to the imagination of prospective over-the-counter traders in the stock. On his April 27, 1967 visit to Salt Lake City to acquire control of Utah Fortuna, White was accompanied by Naft, the same individual who thereafter participated with Freeman in arrangements for acquisition of the Utah Fortuna stock in the names of Canadian accounts. On April 28, 1967, White accompanied Naft from Salt Lake City to Helper, Utah, to visit the inoperative pilot plant owned by Thermal Dynamics Corporation which had been built to test production of pollution-free coke under a patent process known as the Storrs Process. The owner of Thermal was none other than K. Ralph Bowman who had assisted White to obtain control of Utah Fortuna (North American), and Thermal's secretary was Whitney, the purported seller of control of Utah Fortuna to White. After seeing the pilot plant, White decided to use the Storrs Process as a vehicle for promotion of Utah Fortuna, the name of which was appropriately changed to North American Research and Development Corporation.
On May 19, 1967, three weeks after acquiring control of North American, White (on behalf of North American) entered into an agreement with Bowman, president and controlling stockholder of Thermal, for the purchase by North American of all of Thermal's assets, including its patent application on the Storrs Process, the anti-air pollution device that converted coal into coke, for 330,000 North American shares plus a royalty on coke produced by the process. White's next move was on May 26, 1967, to transfer to North American some unpatented copper mining claims located in the Coppermine River area of the Northwest Territories of Canada, which were acquired from one Robert Rosenblatt for 200,000 shares of North American stock which were to be, but never were, issued. Although the property that was the subject of these claims was close to areas where ore had been discovered, there were no mines on the property, no ore had been extracted from it, and North American could not determine without substantial exploration and development (which it did not have the funds to finance) whether the property contained any such ore.
Having thus vested the corporate shell with the kind of "assets" that might, with salesmanship, entice investors in speculative securities, the group's next step was to prepare a sales brochure in the form of a "Progress Report" that might lend apparent substance to the company, following which they commenced drumming up interest on the part of possible buyers of the company's stock and arranging for the marketing of the Toronto-held shares in the United States. On June 19, 1967, a meeting of North American's stockholders was held in Utah at which White, appearing with proxies from 1.5 million out of a total of 1.8 million shares outstanding,
was elected chairman of the board and Lewis Dillman, another of his Canadian colleagues, became president. K. Ralph Bowman was chosen as secretary-treasurer. White and Dillman then set to work preparing the "Progress Report" which described generally the air pollution problem faced by American cities and pointed out that a research study indicated that the Storrs Process would enjoy a large market area in coal mining centers in the western part of the United States. The "Progress Report," without providing any financial information, conveys the impression that North American was well capitalized and ready to continue profitable operation of its pilot plant to meet a large market demand, with a program for locating processing plants in or near coal mining centers, which would be either "directly owned" by it or "by others under a leasing or royalty agreement". The report was distributed to stockholders and various stock brokers in the United States in early July, 1967, and was one of the principal selling media used to effect distribution into the United States of approximately 200,000 shares held in the Toronto accounts.
With the stage thus set for the introduction of the stock into the United States, White, Freeman and Naft began talking up the North American stock to various broker-dealers in the United States, stirring up a demand for it and arranging for simultaneous introduction of the shares from Toronto to key cities in the United States with a view to having the stock open up for trading on the over-the-counter market in the United States on or about June 27, 1967. In addition to devoting their personal efforts to implementation of the foregoing scheme, White, Freeman and Naft enlisted the support of numerous other persons, including broker-dealers, registered representatives, a securities chartist, and others. A series of witnesses called by Commission counsel testified in detail to these promotional activities in various locations of the United States, both prior to and after the introduction of the stock from Canada into the United States market at the end of June, 1967. This proof reveals that White personally discussed the stock with broker-dealers and registered representatives in Toronto, Los Angeles and New York, including J.P. Cannon & Co.; Lars Hagglof & Co. (with which he arranged for purchase of shares for Jack Wayne of New York City); Howard Alweil (Vice President, Bateman Eichler, Hill Richards, Beverly Hills office); Joseph Klein (Vice President, Bache & Co., Beverly Hills office); Rex Reno (Roberts, Scott & Co., Inc., San Diego, Laguna Beach and Los Angeles); Duke Hunter (Wellington Hunter Associates, Jersey City); Martin Orenzoff, a securities chartist; Alfred Blumberg (President, S.J. Rothman Corp., broker-dealer, New York City); Judy Cannon (Bateman Eichler); Ray Weiss, a trader with Allessandrini & Co., a New York broker-dealer; and Ray Lee, a trader with N. L. Sandler, a Canadian securities firm.
An example of how White operated is gained from testimony of several representatives of the Beverly Hills office of Bateman Eichler, Hill Richards and of Bache & Co. Following the June 19, 1967 North American stockholders meeting in Salt Lake City, White and Freeman flew to Los Angeles where they engaged in a series of conversations with officers and registered representatives of these brokerage firms in which they painted a glowing prospect for North American's future, based on their description of the Storrs Process and the great prospective market for anti-pollution coke. Lacking any detailed information or financial reports, White and Freeman resorted to typical touting tactics, including dramatic presentation of samples of the coke represented to have been successfully produced at the pilot plant in Helper, Utah, even though it had not operated since 1964.
Following such talks, White advised representatives in the brokerage concerns visited by him that the stock would "open up" in the Los Angeles market on June 26 or June 27 at about $2 per share, emanating from J.P. Cannon & Co. of Toronto, and recommended to friends in effect that they get in on the ground floor and purchase some shares as soon as the market opened. Among these friends was Miss Judy Cannon, an employee of the Bateman Eichler firm, who became a companion of White on his June, 1967 visit. She testified to conversations between White and Freeman in which, when Freeman stated that they would get the market price of the stock up to $100 a share, White countered that they could not take up the price of the stock that high for the reason that if they did so they would have the "SEC on their neck", and "That they were going to take it slowly up to $10. That it can't move too fast because it was bad for a stock to move too fast." Although certain testimony given by Miss Cannon and other witnesses was contradicted by White, after careful observation of the witnesses I find their testimony to be credible and reject that given by White.
After thus putting out the bait and sowing the promotional seeds in the United States, the final step in the consummation of the scheme was to arrange for quotation of the shares in the Pink Sheets in the United States, the introduction of shares from the Canadian accounts to broker-dealers previously contacted, and the continued stimulation of public investor interest through distribution of the "Progress Report" to registered representatives and investors, accompanied by further sales talks. Wellington Hunter, a Jersey City broker-dealer, was induced by White and Naft to quote North American shares in the Pink Sheets beginning on June 27, 1967, at $2 1/4 bid, $2 3/4 offered and to commence trading the stock by purchase of 25,000 shares from the Toronto account in the name of Naft's wife, Corrine White. At the instance of Guido Volante of Dunhill Securities, Vincent Martinelli, a broker-dealer, quoted the stock in the Pink Sheets at the same time. Beginning in early July, 1967, trading in the shares in the United States was stimulated by North American's distribution of the "Progress Report" to various broker-dealers and investors.
The opening of the market in the United States signalled the purchase of North American shares by most of the broker-dealers to whom the group had talked, including Dunhill, which commenced trading on June 27, 1967, by purchasing shares from one of the Toronto group's Canadian accounts (Dombrofsky, Morris Cooper's sister) and later from another (Frances Oventhal, Cooper's mother-in-law). As a result of an earlier visit by Blumberg in June to Toronto, during which White and Cooper furnished him with promotional information with respect to North American, Blumberg told various investors in and about New York that the stock was a good buy and would increase in value, and furnished copies of the "Progress Report" to some. Thereafter some of these investors bought shares through Dunhill, which distributed 47,700 shares acquired from Canada to about 35 customers in the United States.
Beginning on the opening date, June 27, 1967, the Bateman Eichler firm, as a result of the earlier efforts of White and Freeman, bought 40,000 North American shares from J.P. Cannon, plus 26,425 shares from other broker-dealers in the United States, which it distributed to approximately 50 investors. Similar purchases of North American shares from Canada were made by Roberts Scott & Co., Inc. of San Diego and Laguna Beach, Calif., for distribution to its customers, after White had discussed North American with Rex Reno, a registered representative of the Roberts Scott firm.
The purchases of shares by certain investors in the United States were stimulated not only by the foregoing activities but also by the defendant Martin Orenzoff, a securities analyst and chartist who travelled with White on a trip to Los Angeles in June, 1967. Orenzoff told one registered representative (Miss Myrna Lebowitz of Coggeshall & Hicks) about the patent acquired by North American for extraction of coke from bituminous coal for the purpose of cutting down air pollution and stated that it was "an interesting speculation", providing the same representative with copies of the "Progress Report". In addition Orenzoff told a person having a number of discretionary accounts (Miss Eileen Sini of Jessup & Lamont) about North American, that it had a process for removing pollutants from coke and was an interesting speculation, as a result of which she purchased North American shares for two of her accounts.
Ramon Bowman (K. Ralph Bowman's brother) also assisted in the promotion and the sale of North American shares. On May 17, 1967, he purchased 120,000 North American shares from his brother and 6,140 shares from Richard Whitney. Mrs. Lee Phifer testified that in July, 1967 at Laguna Beach, Calif., Bowman gave her a brochure which contained the pictures contained in the "Progress Report", that he pointed out that the process could be used in Los Angeles and Tokyo, and that except for additional money the company was "all ready to go". Bowman then used the White sales technique of producing a piece of the coke which he showed to Mrs. Phifer, informing her that the process would stop air pollution and smog, all with the result that a few days later she purchased 225 shares of North American.
As a result of the foregoing efforts, from June 27, 1967, the date when North American shares were first listed in the Pink Sheets in the United States, until July 20, 1967, when the SEC suspended trading in the stock, 197,397 shares were sold from Canada into the United States. All of these shares were derived from those acquired by the Bowman-Whitney-Johnson group and sold to Hagglof and Cannon in Toronto during the period from April 24 to June 5, 1967. Of the 197,397 shares, 144,397 shares came directly from the Toronto accounts where they were held in the names of friends and relatives of White, Freeman ...