Friendly, Hays and Feinberg, Circuit Judges.
For the second time this term, see SEC v. Sterling Precision Corporation, 2 Cir., 393 F.2d 214, we are confronted with a close question of interpretation of § 17 of the Investment Company Act of 1940, 54 Stat. 815, setting limits on "Transactions of Certain Affiliated Persons and Underwriters." On this occasion we believe the district judge construed the relevant clause, § 17(d), too narrowly, reverse his judgment dismissing the complaint, and direct further appropriate proceedings.
Section 17(d), so far as here relevant, provides as follows:
(d) It shall be unlawful for any affiliated person of or principle underwriter for a registered investment company (other than a company of the character described in section 80a-12 (d) (3) (A) and (B) of this title), or any affiliated person of such a person or principal underwriter, acting as principal to effect any transaction in which such registered company, or a company controlled by such registered company, is a joint or a joint and several participant with such person, principal underwriter, or affiliated person, in contravention of such rules and regulations as the Commission may prescribe for the purpose of limiting or preventing participation by such registered or controlled company on a basis different from or less advantageous than that of such other participant.
Defendant Talley Industries, Inc. (hereafter Industries) is an "affiliated person" of defendant American Investors Fund, Inc. (hereafter Fund), a registered investment company, by virtue of Fund's owning 9% of Industries' voting shares, see § 2(a) (3) (B). As a result of discussions between Franz G. Talley, president of Industries, a company having a net worth of some $10 million, and Michael Kimelman, a partner in the brokerage firm of M. Kimelman & Co., in which Kimelman advanced General Time Corporation, a much larger corporation, as a candidate for acquisition by a merger with Industries, Talley gave Kimelman an order under which he bought 24,800 shares of General Time for Industries on December 26 and 27, 1967; the price was around $23 or $24 per share. This was only some 1% of the outstanding stock of General Time, a long way from what Talley thought would be needed to afford a prospect of success if he should decide to go forward with an acquisition or merger proposal.
On December 29, 1967, Talley telephoned Fund's office, and ultimately spoke to George A. Chestnutt, Jr., president of Fund and of Chestnutt Corporation, its investment adviser. Talley told him that Industries had bought stock in a certain company which he viewed as a possible merger candidate and that he had in mind that Fund also might wish to buy some stock. Chestnutt broke off the conversation to consult his counsel. The latter advised that Fund could follow Talley's suggestion so long as it "maintained complete independence in our acquisition of stock and didn't make any promises or arrangements" as to voting, disposition or otherwise. Chestnutt relayed this to Talley, who accepted Fund's proceeding in this manner. Talley then named the company, saying he thought it a good investment that might become better under a more aggressive management. He indicated that Industries intended to buy more General Time stock in the market, with an eye toward a merger; Chestnutt got the impression that Talley was thinking of terms that would yield around $45 in Industries securities for each share of General Time. Talley proposed that Kimelman get in touch with Chestnutt; the latter, after telling Talley that 10% of the General Time stock would be his legal limit, said he would study his own data on the company, would like to see Kimelman, and would think the whole thing over. Shortly thereafter Industries bought 42,000 shares of General Time.
Kimelman visited Chestnutt on January 3. Next day Chestnutt determined that Fund should take a position in General Time. He was motivated both by study of the company's earnings and by a belief that if Industries sought a merger, the stock would rise as a result of that offer or of others it might stimulate. On January 5 Fund placed an order with Kimelman for 205,000 shares, subsequently increased to 210,000, just under Fund's 10% limit, on a "not-held" basis, i.e., with the time of execution at the broker's discretion. Chestnutt reported this to Talley.
Chestnutt maintained close supervision of Kimelman's purchases, insisting that on days when Kimmelman had "not held" orders from other customers, shares should be allocated so as not to favor another customer over Fund. Industries was also making some purchases of General Time through Kimelman but at least on one occasion agreed to forego allocation and accept the most expensive shares. By February 15 Fund had acquired 210,000 shares at an average cost of $28.49 per share.
During the first week of January 1968, Talley discussed the situation, including his initial conversation with Chestnutt, with his counsel, who did not mention § 17(d). After some backing and filling unnecessary to recount, Industries resumed purchases of General Time toward the end of January. Talley talked to Chestnutt four or five times during January and reported how many shares he thought "were being acquired by the Kimelmans and himself and his friends and so on." He would give Chestnutt percentage figures of what "we have" and these rather obviously included the holdings of Fund. On February 5 Industries sold 40,000 shares to Donald Harrington, a friend of Talley's, who later increased his holdings to 104,500 shares. Finding that the record date for General Time's annual meeting was March 1, somewhat earlier than he had believed, and that Industries' own holding were only some 52,000 shares, about 2 1/2% of the stock as against the 10% he considered necessary for a meaningful merger proposal, Talley made a special bid on the advice of his investment bankers, Smith, Barney & Co., and against that of Chestnutt who thought this would drive the price up and would not get Industries the amount of stock it wanted. The bid, on February 19, 1968, was for 200,000 shares at 36 1/2. General Time denounced this as "grossly inadequate" and said it had a higher offer, on a tax-free basis, from another company. Only 66,437 shares were acquired.
On the afternoon of February 19, a meeting was held at Smith, Barney & Co. at the instance of the management of General Time. Talley proposed a merger and said "We and our associates own about a third of the stock" -- a figure which included Fund's holdings. Later that evening the management sent word to Talley it had decided to fight. Industries, which then owned 118,537 shares, about 5 1/2% of the total, went back into the market and quickly bought another 139,400 shares at prices ranging from 41 1/2 to 43 1/2. This brought its holdings to 257,937 shares, about 12 1/2%, at an average cost of $36.76 per share.
General Time's response was an action in the District Court for the Southern District of New York alleging inter alia a violation of 17(d) of the Investment Company Act and seeking an injunction against the voting of the stock, the obtaining of more, or any merger. Judge Bryan dismissed the action for lack of standing; General Time appealed. Meanwhile Industries selected ten nominees of an "Independent Stockholders Committee" for election as directors at the annual meeting of General Time on April 22, obtained a stockholders list only after litigation in Delaware, and sought to clear its proxy material with the SEC. On March 25 the SEC staff advised that the material would not be cleared unless Industries filed an application for approval of the acquisition of General Time stock by Fund and Industries under Rule 17d-1, which we reproduce in relevant part in the margin.*fn1 Industries filed such an application, with appropriate disclaimers of the need for doing so; a hearing was set for April 16; and the proxy material was cleared.
General Time then started a new action in the District Court for the Southern District of New York, claiming the proxy material was false and misleading in violation of § 14 of the Securities Exchange Act of 1934. Judge Tyler denied a preliminary injunction on April 11. On the next day Chestnutt was asked whether he would consider an offer for Fund's holdings in General Time from Del Coleman, president of Seeburg Corporation having its headquarters in Illinois. He countered by saying that he would be "down in front of the SEC testifying on the General Time situation next week, probably Tuesday" and might have to reveal anything that was said. Coleman first drew back ...