Moore, Friendly and Adams,*fn* Circuit Judges.
This appeal raises important questions regarding the application of the Investment Company Act of 1940 ("the 1940 Act"), 15 U.S.C. § 80a-1 et seq. As we view the case, the central issue is whether Fifth Avenue Coach Lines, Inc. ("Fifth") had become an investment company within the meaning of § 3(a) (1)*fn1 of the 1940 Act (15 U.S.C. § 80a-3 (a) (1)) by June 30, 1967. Also presented is the question whether an injunction prohibiting further violations of § 10(b) of the Securities Exchange Act of 1934 ("the 1934 Act"), 15 U.S.C. § 78j(b), is justified against the defendants, Victor Muscat and Roy M. Cohn.
The Securities and Exchange Commission ("SEC") sought an injunction*fn2 in the District Court for the Southern District of New York against the individual defendants to prevent further violations of the 1934 Act and the 1940 Act, and requested the appointment of a receiver for Fifth. The Honorable Edward C. McLean, United States District Judge, in a decision at 289 F. Supp. 3 (1968), found Fifth to be, as of June 30, 1967, an investment company which, because it had not registered under the 1940 Act, was acting in violation of § 7(a) of the Act (15 U.S.C. § 80a-7(a)).*fn3
Fifth's officers, directors, and agents, including the defendants, were found to be responsible for the failure of Fifth to register under the 1940 Act, and were enjoined from various activities which might be in violation of the Act. The Court found that Muscat, Cohn and Edward Krock also violated § 10(b) of the 1934 Act in a transaction between Fifth and an affiliated company, Gray Line Corporation ("Gray Line"),*fn4 and enjoined these defendants from further violations of that Act.*fn5 The District Court appointed for Fifth a receiver, who registered it as an investment company under the 1940 Act, and who has supervised Fifth's operations for the past two years. Judge McLean's order extended beyond the time of Fifth's registration, and has continued to restrict the activities of the individual defendants.*fn6
Fifth has appealed from the portion of the District Court's judgment declaring it to be an investment company, and from the order appointing a receiver. Muscat has appealed from the segment of the order enjoining violations of § 10(b) of the 1934 Act. The scope of Cohn's appeal is broader, apparently attacking both the Exchange Act portion and the Investment Company Act portion of Judge McLean's injunction against him. Defendant Thomas A. Bolan did not appeal because he was not enjoined from doing anything after the registration of Fifth as an investment company. Krock appealed but withdrew such appeal before oral argument. The facts are recited in extenso in the District Court's opinion, and only those necessary to our decision will be repeated here. We have, however, set forth in an appendix a partial list of the transactions which the SEC alleges are violations of the 1940 or 1934 Acts.
Until March, 1962, Fifth operated in New York City one of the nation's largest privately owned municipal transit systems. Fifth's transformation from a company primarily engaged in the transportation business began in March, 1962, when the City of New York acquired by condemnation all the bus lines of Fifth within the City. Since that time, Fifth and the City have been litigating Fifth's claims for compensation for such taking. The City satisfied Fifth's claim with respect to physical assets in October, 1966, and only recently settled Fifth's claims with respect to going concern assets and other intangibles. From 1962 to 1966, however, Fifth had little to do except to litigate these claims and to resolve old tort claims remaining from its period as an operating company. The receipt in 1966 of an initial condemnation award of more than $11,500,000, free of all liabilities, consequently breathed new life into Fifth.
After the City had taken Fifth's operating assets, a group composed of Krock, Muscat and Robert L. Huffines, Jr., acquired control of Fifth through a pyramid of interlocking shareholdings at the peak of which rested Defiance Industries, Inc. (Defiance). In 1966, Defiance had only one class of stock outstanding, consisting of 892,894 shares of common stock. Of this total, Muscat owned about 27% and Huffines about 9%. Huffines sold his Defiance stock to William P. Ruffa, an attorney in the firm of Saxe, Bacon & Bolan, to which Cohn is "of counsel." Ruffa, however, acted merely as nominee for the stock which was owned by Muscat and Cohn. As of December 12, 1966, Cohn owned 7% of Defiance, Bolan and Krock each owned 1%, and Muscat 27%, totaling for this control group 36% of Defiance's stock.
Defiance, in turn, owned about 32% of BSF Company, a registered investment company. BSF owned 20% of Gray Line, an inactive corporation. BSF also owned 9% of Fifth, and Gray Line owned 23% of Fifth, the only substantial asset of Gray Line. Surface Transit, Inc., a wholly-owned subsidiary of Fifth, owned 33% of Gray Line and Fifth itself owned 45% of Gray Line. Thus, in this circle, BSF, Fifth and Surface together owned 98% of Gray Line, while BSF and Gray Line owned 32% of Fifth. The remainder of Fifth's stock, however, was owned by about 2,000 public shareholders. Further control over BSF was obtained by Cohn and Bolan through the purchase of 18,735 shares of BSF stock on July 6, 1966, Cohn taking 16,735 shares and Bolan 2,000 shares. Moreover, when Fifth received its condemnation award from the City, it purchased about 3.4% of Defiance's stock. There were several other companies which eventually touched Fifth in the pyramid topped by Defiance, but the above describes the basic skeleton.
In addition to being officers and directors of many of the other companies in the group, Muscat, Bolan, and Krock formed the executive committee of Fifth's Board of Directors. Muscat was president of the company, Bolan was secretary, and Krock the treasurer. Others on the ten-man board of directors included Krock's personal physician, Krock's son-in-law, who was a director of BSF and American Steel and Pump Corp. (57% owned by BSF), and a vice president and controller of American Steel. Saxe, Bacon & Bolan were general counsel for most of the companies in the group including Fifth. Cohn was neither an officer nor director of any of the companies, but the District Court found him to be an active participant in controlling the affairs of Fifth and Defiance.
In a letter dated July 28, 1966, accompanying Fifth's annual report to its shareholders for 1965, Muscat (as president of the company) stated that as soon as the condemnation award was paid by the City, "the Company intends to make proper and advantageous investments for the benefit of the Company." The annual meeting was held on August 10, 1966, and Cohn there read another letter from Muscat to the shareholders stating in part:
"There are bargains available today in the form of investments in transportation, in related fields, and in brand new fields -- bargains which others cannot take advantage of because they do not have the cash available.
"We have been actively exploring several of these opportunities and we will be ready to move forward boldly when the funds are paid over to us.
"We have waited more than four years. But we will be in a position to put the money to work profitably for ...