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Securities and Exchange Commission v. Koenig

decided: November 3, 1972.


Smith, Kaufman and Hays, Circuit Judges.

Author: Hays

HAYS, Circuit Judge:

This is an appeal from an order of the United States District Court for the Southern District of New York preliminarily enjoining and restraining defendants-appellants from violations of various provisions of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., § 78m, and certain Rules promulgated thereunder.*fn1 In addition, the court below appointed a limited receiver for the corporate defendant Ecological Science Corporation (hereinafter "ECO"). In its opinion, the district court noted that after an "exhaustive review of the entire record" it had based its conclusions of law on undisputed facts and for that reason it did not find it necessary to hold an evidentiary hearing. We affirm the order of the district court.

Defendant-appellant Koenig is president, chief executive officer and chairman of the board of directors of ECO, a Florida corporation the common stock of which is held by over 8,000 stockholders. ECO's stock is listed for trading on the American and Pacific Coast Stock Exchanges.*fn2

The thrust of appellants' arguments is (1) that the district court's finding of three specific instances of federal securities law violations was in error; (2) that appellants were entitled to and were denied an evidentiary hearing; and (3) that the court below abused its discretion in appointing a limited receiver with the power, inter alia, to supervise ECO's public disclosures, investigate and make a public report on certain "secret securities transactions" brought about by the individual defendants in this case and make preparations for and hold a shareholders' meeting at which directors would be elected.

The complex financial foundation and the bitter legal battles underlying this proceeding are described in the opinion of the district court, Current CCH Fed.Sec.L.Rep. para. 93,536, and we adopt its statement of the background of this case. We will refer to certain particulars only for the purpose of illuminating our decision on the points raised by the appellants.


A. The Foreign Recapitalization Scheme

The district court found that between June 1 and September 1, 1971, defendant Koenig and another named defendant, Cesare De Franceschini, an ECO director, under the guise of "recapitalizing" four of ECO's European subsidiaries, effected the transfer of voting control of those subsidiaries to an Italian partnership created and controlled by Koenig and a Liechtenstein holding company controlled by De Franceschini. ECO's board of directors were not informed of the action taken by Koenig and De Franceschini and the transaction was not disclosed in any of the various reports ECO was required to file with the Securities and Exchange Commissions.*fn3

The so-called recapitalization scheme occurred at a time of great internal strife among the management and directors of ECO. The corporation was experiencing financial difficulties and appellant Koenig was under pressure to resign his posts with the corporation. The transfer of voting control of four valuable and profit-making ECO subsidiaries to Koenig and his ally was obviously a material fact that a reasonable investor (or potential investor) in ECO would have considered important in making his investment decision. See Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-154, 92 S. Ct. 1456, 31 L. Ed. 2d 741 (1972); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968), cert. denied, Coates v. SEC, 394 U.S. 976, 89 S. Ct. 1454, 22 L. Ed. 2d 756 (1969). The failure to include this information in the annual report for 1971 and the quarterly reports for the year required by Section 13(a) of the Securities Exchange Act of 1934 and Rules 13a-1 and 13a-13 to be filed with the Commission, was a material omission and constituted a violation of those provisions.*fn4 See SEC v. Great American Industries, 407 F.2d 453 (2d Cir.), cert. denied, 395 U.S. 920, 89 S. Ct. 1770, 23 L. Ed. 2d 237 (1969); Heit v. Weitzen, 402 F.2d 909 (2d Cir. 1968), cert. denied, 395 U.S. 903, 89 S. Ct. 1740, 23 L. Ed. 2d 217 (1969).

B. The Teacher's Loan

On August 3, 1971, at a time when ECO was undergoing severe financial problems, the corporation, through Koenig its president, issued a press release to the Dow Jones wire service. The release stated in part:

"On July 28, 1971, the Company renegotiated the terms of approximately $14 million in loans from the Union Bank, its prime lender. Under the renegotiated agreement, $4 million is due upon demand and the remainder is due on 4/15/72. The Company has other demand loans and overdraft privileges with various banks in the U.S. and Europe. If the $4 million loan is called by Union Bank or other demand loans are called by other banks, that event could give Union Bank the right to declare the remainder due immediately. Union Bank has stated that it has no present intention of calling the demand loan."

What the release failed to mention was that on July 28, 1971, Teacher's Insurance and Annuity Association informed ECO that it would not provide the corporation with a $4 million loan which ECO had planned to use to repay the demand loan from Union Bank. Moreover, the press release, while also discussing ECO's European prospects, did not mention the proposed transfer of voting control among its European subsidiaries. By reason of these failures to disclose material information, the press release violated ...

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