The opinion of the court was delivered by: COOPER
Plaintiff Securities and Exchange Commission instituted this action on March 25, 1971 by filing a complaint alleging numerous violations by the corporate and individual defendants of the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the rules and regulations enacted thereunder (Plaintiff's Complaint, March 25, 1971, pp. 1-2); requesting the issuance of an injunction restraining defendants from participating in any manner in the marketing of securities subject to Section 5 of the Securities Act, and the appointment of a receiver to administer the corporate defendants' assets. (Complaint, pp. 14-23).
Contemporaneously, an order to show cause why a preliminary injunction should not issue, containing a comprehensive temporary restraining order, was entered by this Court. (Plaintiff's Order to Show Cause, Temporary Restraining Order and Affidavits, March 25, 1971). On April 2, 1971 all parties to this litigation consenting, and pending disposition of plaintiff's motion, we entered an order creating an interim arrangement with the goal of allowing defendants to continue operation of certain segments of its business without prejudice to the interests of the investing public involved in the disputed transactions. (Stipulation, Undertaking, and Order Modifying and Extending Temporary Restraining Order, April 2, 1971). That order was amended on April 8, 1971 and provided for substitution of the fiscal agent and designated an independent accountant. On May 7, 1971, an order was entered upon consent of all parties further modifying the prior court orders so as to provide a more workable interim arrangement. (Order Further Modifying and Supplementing Temporary Restraining Order, May 7, 1971).
Focusing on what we consider to be the threshold and most likely determinative issue of this litigation, the parties were directed to present evidence as to whether participation in defendants' Government Bond Plan constituted an investment contract subject to the registration provisions of the 1933 Act. Pursuant thereto hearings were held May 12, 13, 14, 17, 18, 19, 21, 1971 and on May 26, 1971 we endorsed the motion papers:
"We have decided to grant plaintiff's application for a preliminary injunction and the appointment of a receiver. The Securities and Exchange Commission is directed to promptly submit on notice complete findings of fact and conclusions of law."
Plaintiff complied June 3, 1971, defendants on June 8, 1971.
Jurisdiction is based on Section 22(a) of the Securities Act, 15 U.S.C. § 77v(a), Section 27 of the Exchange Act, 15 U.S.C. § 78aa, and Section 214 of the Advisers Act, 15 U.S.C. § 80b-14.
This opinion constitutes our findings of fact and conclusions of law in accordance with Rule 52, F.R. Civ. P.
Capital Counsellors, Inc. ("Counsellors"), a Delaware corporation with offices located at 110 Wall Street, New York, New York, has been registered as a broker-dealer with the Commission since May 12, 1960 (Tr. 548)
and a member of the National Association of Securities Dealers, Inc. Counsellors oversees Capital Advisors, Inc. and manages the Atlantic Fund for Investment in U.S. Government Securities, the Government Bond Plan and the Put and Call Program.
Capital Advisors, Inc. ("Advisors"), the alter ego of Counsellors, shares common office space, personnel and telephone service. It has been registered as an investment adviser with the Commission since January 7, 1962. (Tr. 548). Advisors publishes and sells to subscribers a semi-monthly bulletin entitled "Money and Credit Reports," also two books "The Money Squeeze" and "Final Stages of the Money Squeeze."
J. Irving Weiss ("Weiss"), the protagonist in this litigation is a founder, president and director of Counsellors and its subsidiaries, and owns a portion of the equity securities of Counsellors.
Abraham B. Weiss, Weiss' brother, was a vice-president and director of both Counsellors and Advisors and owned a percentage of the equity securities of Counsellors.
The government bond plan, conceived by the Weiss brothers in February of 1967, combined the trading in government securities, treasury bills and long term government bonds with the anticipated fluctuation in interests to create a scheme for securing substantial profits.
Individuals were solicited to invest $10,000 for a unit "participation" in the plan. Defendants deposited these funds in short term commercial paper until a large enough number of investors enlisted, at which point a two year loan was negotiated by Weiss' efforts for the group.
The loan proceeds and cash subscriptions were then combined in what Weiss denominated a "syndicate." Each participant assumed a fraction of the loan in the amount of $91,000,
and united with a portion of his initial investment,
defendants purchased for his account a 90 day $100,000 face value treasury bill. The treasury bill was immediately pledged as collateral for the loan and deposited in an escrow account. (Tr. 575). Throughout this phase of the plan, each participant suffered a diminution of his equity as the loan's interest exceeded the profit realized from the treasury bill.
As treasury bills matured, they were rolled over by defendants.
Weiss predicted in his promotional literature and lectures that in the very near future interest rates would soar; this would create the proper market condition for defendants to advise the participants to transfer their holdings from treasury bills to depressed long term low interest bearing government bonds. Despite the widespread unavailability of credit during this chaotic situation, the earlier margin purchase of treasury bills insured each participant access to $100,000 to subsidize the acquisition of long term bonds. Thus the purchase of treasury bills, even at a net loss to the participant, was an integral part of the bond plan. The newly acquired long term government bonds would be substituted for the treasury bills as collateral for the loan.
Finally, Weiss had forecast a rapid retreat in interest rates which enhanced the value of the long term bonds. The participants were to realize substantial profits when the bonds would be sold after climbing in price in response to falling interest rates.
In all, defendants managed the marketing of some thirty-three (33) syndicates comprising over six hundred (600) public investors (Tr. 606) controlling some seventy (70) million dollars of treasury bills. (Tr. 596). In promoting the bond plan, defendants concededly employed the means and instrumentalities of interstate commerce and of the mails. (Tr. 589).
Plaintiff contends that participation in the Government Bond Plan as outlined above and operated by defendants clearly constitutes a security as defined by Section 2(1) of the 1933 Act, 15 U.S.C. § 77b(1). Defendants resist this characterization in a two fold argument: (a) an essential element of an investment contract, the expectation of "profits solely from the efforts of the promotor" SEC v. Howey, 328 U.S. 293, 298-299, 66 S. Ct. 1100, 1105, 90 L. Ed. 1244 (1946), is absent inasmuch as defendants merely advise the participants at the propitious moment to purchase long term bonds, the profit making phase of the plan (Tr. 953-5) and, (b) a no action letter of November 17, 1967 (P. Ex. 5) was issued by the Commission staff after reviewing with defendants the necessity for registration of the bond plan. (Tr. 956).
In disposing of the position thus advanced by defendants, for purposes of this motion we treat both arguments simultaneously, for we view the presentation of the plan, as relied upon by the Commission and which formed the basis of the no action letter, as not creating an investment contract. However, defendants' deviation in a number of significant respects from this approved design both amply substantiates the presence of each element of an investment contract and pierces the protective shield of the no action letter.
Deviations from no action letter
1. sophistication of investors
In their initial written correspondence with the Commission, defendants' counsel represented that the "program is designed for sophisticated and wealthy investors able to invest in multiples of $10,000." (P. Ex. 4, September 25, 1967 letter, p. 1). Further, in that same letter, counsel stated that "Counsellors has individually negotiated and contracted with approximately 55 investors to date,
and well-to-do and sophisticated enough in money matters to realize the speculative risks, as well as the opportunities," and concluded that "the number and type of investors intended to be attracted thereby are not suitable subjects for regulation." (P. Ex. 4, p. 4). Weiss testified at the hearing that it is "still true" that the participants in the plan are all well-to-do and sophisticated." (Tr. 570, 697).
Although we recognize that the five investors who testified at the hearing were called by the Commission,
we note that defendants failed to present any investor to counter our impression that by and large the participants in the bond plan did not possess either characteristic. Defendants acknowledged that one, Miss Beissner, could not afford the Government Bond Plan. (Tr. 701).
Weiss characterized another investor witness as "sophisticated according to the information he gave me" (Tr. 702). He was referring to Mr. Rudin, a sixty-eight year old part-time window cleaner with a level of formal education equivalent to "something like public school" (Tr. 445-6), who had amassed $60,000 in life savings at the time he entered the bond plan.
(Tr. 492) While we found Mr. Rudin extraordinarily alert and possessed of a keen mind, we consider his closing remarks enlightening on his business sophistication and acumen. "I am very confused. I get mixed up with figures and records and I can never remember. I don't remember when was even yesterday, not even." (Tr. 497).
These witnesses were apparently representative of the larger number of participants in the bond plan.
(Tr. 697-700). As to the "customer [having] a personal appointment with one of the Weiss brothers" (P. Ex. 39, p. 2), Weiss testified that this representation was no longer true, and further, that defendants never advised the Commission in writing that they no longer intended to personally confer with every prospective investor.
2. management of government securities
We view defendants' repeated representation that investors would have "the power to control the purchase and sale of the U.S. Government securities in the escrow account and thus the sole responsibility for management decision" (P. Ex. 4, September 25, 1967 letter, p. 3) as the critical factor leading to the Commission's issuance of the no action letter. (Tr. 889-92). We conclude that the participant in the bond ...