Medina, Moore and Feinberg, Circuit Judges.
These appeals require us to consider once again the scope of Section 5 of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and the SEC's frequently litigated Rule 10b-5. The District Court preliminarily enjoined appellants North American Research and Development Corp., Edward White, its controlling stockholder and Chairman of its Board of Directors, and K. Ralph Bowman, its Secretary-Treasurer and a member of the Board of Directors, from violating Sections 5(a) and (c) of the 1933 Act*fn1 and Section 10(b) of the 1934 Act,*fn2 together with Rule 10b-5,*fn3 with respect to the purchase, offer or sale of the unregistered common stock of North American.
The court below refused to enjoin appellees Lewis Dillman, the President of North American; Alfred Blumberg, a New York stockbroker; Martin Orenzoff, a chartist and friend of appellant White; and Lars Hagglof & Co., Ltd., a Canadian stock brokerage firm with extensive ties to White and his friends, from violating any of the securities laws pursuant to which the SEC sought relief with respect to transactions in North American unregistered common stock. The SEC appeals, contending that Dillman, Blumberg, and Orenzoff should have been enjoined under Sections 5(a) and (c) of the 1933 Act, Section 10(b) of the 1934 Act and Rule 10b-5, and that Lars Hagglof & Co., Ltd. should have been enjoined under Sections 5(a) and (c), supra. The opinion of the District Court is reported at 280 F. Supp. 106 (S.D.N.Y.1968). That part of the order preliminarily enjoining North American, White, and Bowman is affirmed; that part refusing to grant any relief against Dillman, Blumberg, Orenzoff, and Lars Hagglof & Co., Ltd. is vacated and remanded to the District Court for further proceedings consistent with this opinion.
As a background to the numerous law points raised by the various appellants on the main and cross-appeal, we think it will be helpful to sketch a bird's-eye view of the central scheme and its component parts. Edward White, a self-styled promoter and securities trader with extensive connections and interests in Canada and in the United States, is the originator of the scheme. His principal associates and collaborators throughout were Sam Freeman, a Toronto stock trader, and another Toronto friend, Frank M. Naft. The first step was to find a publicly-owned corporation whose assets had been sold and the proceeds distributed "leaving it a worthless, inactive, empty shell, with neither assets nor liabilities"; to get control of the shell; to buy up for purely nominal amounts the stock held by the minority stockholders who considered the stock of no value; to funnel the shares thus purchased into the custody of cooperating brokerage houses in Canada, and to gain complete control by transferring these shares to close friends and relatives; to dress up the shell with assets of the type that could readily be blown up as having enormous potential value, without any substantial expenditure of cash; then to begin the process of touting, by sales pressure on American brokerage houses, culminating in the inclusion of the stock in the Pink Sheets used in connection with the over-the-counter market. At this point the word was "up," and seemingly only the sky was the limit. We may say by way of anticipation that up to this point the scheme worked according to the standard of other similar fraudulent schemes and without a hitch. From a start of 1/2 cent or a penny a share and at about $2 a share when first appearing in the Pink Sheets, the stock rose to over $6 a share before the SEC suspended trading and made its application to the District Court for the Southern District of New York for the preliminary injunctive relief which was granted and is the subject of this appeal.
How was all this accomplished? Freeman had friends in Salt Lake City, one of whom was K. Ralph Bowman. Bowman knew Richard Whitney and Whitney's friend Donald Glenn, also of Salt Lake City. Thus it was that Robert A. Johnson was located. He did indeed know of just such a shell as the triumvirate of White, Freeman, and Naft, as Judge Mansfield characterized them, were seeking. It was an inactive, publicly-owned Utah corporation named Utah Fortuna Gold Company; and Johnson was Secretary-Treasurer, a director, and transfer agent. He was also an officer, director, and transfer agent of South Utah Mines, Inc., another Utah corporation, which was the owner of 1.2 million of the 1.8 million outstanding shares of Utah Fortuna. The controlling stockholder of South Utah was Mrs. Mabel McGarry, who owned between 70% and 80% of the South Utah stock. So Johnson, as Mrs. McGarry's business advisor and because of his position as a director and officer of South Utah, exercised a persuasive and decisive influence in the managerial and financial decisions of Mrs. McGarry with reference to the voting of the stock of South Utah. One of the key findings of Judge Mansfield was that Johnson was an "issuer," i.e., a person controlling Utah Fortuna "because his position as a director and officer of South Utah and his relationship with Mrs. McGarry enabled him to exercise a persuasive and decisive influence in the managerial and financial decisions made by her and South Utah" with respect to voting the stock owned by her. 280 F. Supp. at 121.
A characteristic of most conspiracies to effect illegal ends, such as the one with which we are now concerned, is that peripheral members, or even those just below the prime movers, will not hesitate to chisel off relatively small emoluments for their personal profit, while at the same time furthering the objects and purposes of the high command. Johnson learned from Whitney that Freeman on behalf of his friend and client White was willing to pay $10,000 for control of Utah Fortuna. So the whole Salt Lake City crowd -- K. Ralph Bowman, Richard Whitney, Johnson, Donald Glenn, and Richard Whitney's brother Frank Whitney -- engineered an elaborate series of more or less contemporaneous transactions as a result of which White and his nominee Sonia Starr wound up with one million shares of Utah Fortuna,*fn4 for which White paid $10,000; Mrs. McGarry received a paltry $500; and Bowman, the two Whitneys, Johnson, and Glenn divided up most of the balance of the cash together with 100,000 shares of Utah Fortuna stock each to Glenn and Frank Whitney, which they chose to describe as "finder's fees." It may well be that the initial option to Richard Whitney and the sale from Richard Whitney to White were designed to insulate White from Mrs. McGarry, who came out a poor last in the distribution of the $10,000 paid by White. But this is by the way.
This little byplay, however, has significance not only because it ties each and every one of the participants into the scheme to help White to get control of Utah Fortuna, but also because it ties these same individuals in with White and Freeman in connection with the campaign of Richard Whitney, Johnson, and Bowman beginning on April 24, 1967 to acquire the remaining shares of Utah Fortuna, held by the minority stockholders, and to funnel these shares to two Toronto brokerage houses designated by White and Freeman. The proof is explicit that 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, and White told Richard Whitney that if he was able to buy any stock he should call J. P. Cannon & Co., Ltd. or Lars Hagglof & Co., Ltd. in Toronto, which would purchase it. Such was the zeal of the Salt Lake City participants in the over-all scheme that before White actually acquired control by the purchase from Richard Whitney of the one million shares on April 27, 1967, they had purchased for nominal sums from the minority stockholders no fewer than 188,500 shares of Utah Fortuna which, with the two 100,000-share allotments to Frank Whitney and Donald Glenn, came to a total of 388,500 shares, all acquired in anticipation of the acquisition of control by White on April 27, 1967. After April 27, 1967 other shares were acquired by the same participants, which by June 27, 1967 brought the total number to 753,000 shares. Every one of these shares wound up, as planned, with J. P. Cannon & Co., Ltd. and Lars Hagglof & Co., Ltd.; and they were all promptly registered in the names of close friends and relatives of the principal schemers. A large number of these shares were traced to sales on the over-the-counter market in New York City, and the first transaction after the stock appeared in the Pink Sheets was a sale of 25,000 shares "from the Toronto account in the name of Naft's wife, Corinne White." No amount of denials or so-called explanations by individual defendants on the witness stand could possibly convince any rational person that this series of events was purely coincidental and not by the design of those whom the SEC seeks to restrain. And so we come to another key finding (280 F. Supp. at 115-116):
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 we have already observed, the timing and execution by the various participants were precise and effective. We shall see that all these knowledgeable and experienced persons, many of whom had already been enjoined by the SEC for their participation in other illegal stock fraud transactions, knew the value of prompt and almost instantaneous action in order to produce the desired results. So, we shall now return to intervening events.
White had no sooner reached Salt Lake City to complete the one-million share control transaction than it was discovered that Bowman was the President and controlling stockholder of a certain Thermal Dynamics Corp., and Richard Whitney was Thermal's Secretary. This company owned a Pilot Plant at Helper, Utah that had not been in operation for almost three years. White had previously intended to transfer certain Canadian mining claims to the "shell." But he no sooner learned that the Thermal plant had been built to test the feasibility of producing pollution-free coke under an unpatented procedure known as the Storrs Process, to which Thermal Dynamics had the exclusive United States rights, than he saw "a prospect that would be more appealing to the imagination of prospective over-the-counter traders in the stock." The sale of control of Utah Fortuna to White took place on April 27, 1967, as we have already seen. The next day, April 28, saw White and Naft in Helper, Utah, verifying the possibilities of the Thermal Dynamics process and Pilot Plant. The result was that, a mere three weeks later, on May 19, 1967, the name of Utah Fortuna was changed to North American Research and Development Corporation, effective at a stockholders' meeting held on June 19, 1967; and White entered into an agreement with Bowman for the purchase by North American of all Thermal's assets, including its interest in the Storrs Process, for 330,000 shares of North American, plus a royalty on the coke produced by the process. Consistent with his original intentions, on May 26, 1967 White transferred to North American some unpatented copper mining claims located in the Northwest Territories of Canada which were purchased from Robert Rosenblatt for another 200,000 shares of North American stock (which were never delivered or issued). We need not describe these claims further than to say that there was little to show that they had any real value or substance. This and other subjects are treated so effectively and accurately in Judge Mansfield's opinion that we make no elaboration in this opinion.
Everything had gone according to schedule, and the time had come for touting the stock in preparation for its appearance in the Pink Sheets. So White and Lewis Dillman, an American-citizen colleague of White's who lived in Canada and had become President of North American, collaborated on the preparation of a "Progress Report to the Shareholders." Supposedly prepared for distribution to the stockholders, who numbered fewer than one hundred, such was the industry and expedition of White and Dillman that one thousand copies of the Progress Report appeared in early July, 1967; and many of them promptly found their way to various brokerage houses in the United States. In the meantime, according to statements by defendants' counsel, the stock was traded in Canada. But Judge Mansfield held that none of these statements was "supported by reliable proof."
The Progress Report is a slick piece of work, but not slick enough. Judge Mansfield's characterization, which we approve, will suffice (280 F. Supp. at 117):
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 finding that the Progress Report was misleading and its distribution by the use of the mails or any means or instrumentality of interstate commerce a clear violation of Rule 10b-5 is supported by an abundance of proof, discussed in Part III of this opinion, and we find no basis upon which we could reject the finding as clearly erroneous.
Thus the stage was set for the introduction of the stock into the United States. White, Freeman, and Naft were personally active traveling about, talking to a number of broker-dealers in the United States, touting the stock and stirring up a demand in key cities of 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." 280 F. Supp. at 117. The details are set forth in Judge Mansfield's opinion and need not be repeated.
One of the firms visited by White in June, 1967 was Bateman Eichler, Hill Richards, Inc. of Los Angeles. An employee of that firm was a companion of White on this visit; and she testified, in the words of Judge Mansfield's opinion (280 F. Supp. at 118):
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.
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. It is easy to guess who made up these fractional figures out of thin air. So the upgrade of the stock commenced, stimulated by most of the broker-dealers who had been approached by White and his emissaries. Had it not been for the prompt and effective action of the SEC in issuing a Stop Order on July 20, 1967 and in promptly moving for injunctive relief, the predictions made by White and Freeman might have come true with disastrous results.
In our forthcoming discussion of the controlling legal principles, we must consider separately the violations of Sections 5(a) and (c) of the Securities Act of 1933 and the violations of Section 10(b) of the Securities Act of 1934, together with Rule 10b-5.
The Illegal Distribution of Unregistered Stock
All the dealings in North American stock described in the introductory part of this opinion involved transfers of unregistered stock. Despite the fact that North American's (Utah Fortuna's) stock was first issued "prior to or within sixty days after May 27, 1933," it is perfectly plain to us that the exemption from registration set forth in Section 3(a) (1) of the 1933 Act is not applicable.*fn5 The substance of the transactions as a result of which 1,200,000 shares of Utah Fortuna stock were transferred to White and his nominee Sonia Starr (1,000,000 shares) and to Frank Whitney and Donald Glenn (100,000 shares each) plus the 553,000 additional shares that found their way into the Toronto accounts, was a "new offering" within the meaning of Section 3(a) (1), which provides "but this exemption shall not apply to any new offering of any such security by an issuer or underwriter subsequent to such sixty days" after May 27, 1933.
The trial judge seems to have attributed undue significance to the date of April 27, 1967 when control passed to White. Thus, although he held that the secondary distribution of the 388,500 shares constituted a violation of Section 5 "regardless of whether White acquired a beneficial interest in those shares," he further held that Lars Hagglof's transactions involved shares purchased after April 27, 1967 and that the total number of the 364,500 shares sold to the Canadian accounts after April 27, 1967 were entitled to a Section 3(a) (1) exemption. He did this with some reluctance and "for the purposes of preliminary relief only," assuming that further protracted hearings were necessary to cover the transfers after April 27, 1967. We think this is an unduly restrictive view and one which is inconsistent with the findings we have already approved as not clearly erroneous. There was in fact no occasion for any further hearings. The joint action of the Toronto group on the one hand and the Salt Lake City group on the other had been thoroughly exposed to the light and included in appropriate findings.
Our holding is that in cases where such joint action is proved the beneficent purposes of the securities acts for the protection of investors and in the public interest can be accomplished only by treating such new distributions as jointly conceived and jointly consummated. Naturally enough this encompasses a considerable amount of "aiding and abetting" on the part of individual participants, whose conduct we hold properly to be subject to injunctive relief at the behest of the Securities and Exchange Commission. See SEC v. Culpepper, 270 F.2d 241 (2d Cir. 1959); cf. Gross v. SEC, 418 F.2d 103 (2d Cir. 1969) (Moore, J.). No part of the stock purchased and distributed by the co-conspirators was entitled to a Section 3(a) (1) exemption. It is quite immaterial that White did not distribute to the public any part of the 1,000,000 shares he and his nominee Sonia Starr acquired on April 27, 1967.
It will further clarify the situation if we trace the development of the scheme in terms of who were "issuers" and who were "underwriters," for the Securities Act of 1933 established a series of specific enactments and definitions so interrelated and integrated as to protect the investing public from the detrimental effect of the dissemination and distribution of unregistered securities. At the very center of this legislation is the provision that any security may be registered with the Commission by the filing of a registration statement in compliance with Section 6. The supplementary provisions and definitions are so designed as to prevent any circumvention of the registration requirement by ...