The opinion of the court was delivered by: GURFEIN
Plaintiff ("Jefferies"), a broker member of the New York Stock Exchange, sues to rescind a transaction in which it acted as a broker for the defendant Arkus-Duntov ("Duntov") in the sale of 24,475 shares of common stock of Equity Funding Corporation of America ("Equity Funding"). It also seeks to enjoin the payment of two certified checks made by it to Duntov and to the defendant United Missouri Bank of Kansas City ("United Bank") in the respective amounts of $192,256.35 and $217,448.08, drawn in payment for the stock sold.
A temporary restraining order was signed by this Court on April 3, 1973 enjoining the payment of the two checks by the Chase Manhattan Bank, N.A. ("Chase") on condition that the plaintiff post a bond for the full amount of the checks, $409,704.43, and setting the matter down for hearing on a preliminary injunction on April 9, 1973 at 10 a.m.
The hearing was begun on April 9 and was adjourned after the completion of the plaintiff's case, subject to the immediate taking of the deposition of Duntov by the plaintiff and the resumption of the hearing on April 10 at 3 p.m. The hearing continued on April 10 and was concluded that evening.
The affidavits admitted in evidence by consent and the oral testimony reveals the following.
Duntov was on March 26, 1973 an Executive Vice-President of Equity Funding. He was also a member of its five man executive committee and of its nine member board of directors.
On March 26, 1973 Jefferies was asked by North American Equity Corporation ("North American"), a broker dealer which was a 100% subsidiary of Equity Funding, to sell 24,475 shares of Equity Funding common stock on the Stock Exchange. Jefferies effected the sales on the New York Stock Exchange that day at prices ranging from 16 1/2 to 17 3/8. There was no disclosure to Jefferies at the time of the order that the sale was for the account of Duntov, or that he was an Executive Vice President and a director of Equity Funding.
The settlement date for the March 26 sales was April 2. Before the settlement date arrived, on March 27 at 12:45 p.m. E.S.T., the next day after the sales in question, the New York Stock Exchange halted trading in Equity Funding common stock. On March 28 the Securities and Exchange Commission ("Commission") suspended trading in all securities of Equity Funding. On April 2, the board of directors, including Duntov, voted to have Equity Funding consent to a final judgment of permanent injunction sought by the Commission. They also "informed the corporation that they will resign their directorships upon the appointment of a new board of directors . . ." (para. 3 of consent to final judgment).
On April 3, 1973 the Commission instituted an action in the United States District Court for the Central District of California charging that Equity Funding was engaged in acts and practices constituting violations of Sections 10(b), 13(a) and (b) and 14(a) of the 1934 Act. Specifically, the complaint alleged that Equity Funding engaged in "a massive and prolonged effort to alter its books and records, principally those of Equity Funding Life Insurance Company (EFLIC), to show the sales of insurance policies, the receipt of premium payments, the creation of assets and the establishment of reserves, when, in fact, such insurance policies had not been sold, premium payments had not been received, assets did not exist, and the reserves had not been established." The complaint further alleges that Equity Funding "acting through certain of its officers and employees and those of its subsidiaries, principally EFLIC, caused insurance policy files to be created and maintained in the names of fictitious persons, persons whose policies had lapsed, persons who had applied for but were denied insurance, [and] caused insurance policies to be issued to persons upon which no premiums were paid and caused the face amount of existing policies to be increased without the knowledge of the policyholder." It is also alleged that Equity Funding "caused said policies and fictitious insurance policies to be sold or conveyed to co-insurers and re-insurers and received therefrom payments of monies in excess of premiums purportedly received by EFLIC on the initial sales" and that Equity Funding "caused death claims on said fictitious and false policies to be presented to the co-insurers and re-insurers in order to collect death benefits thereon, and surrendered a number of said fictitious and false policies in order to receive the cash surrender values thereon." Finally, the Commission's complaint asserts that Equity Funding "caused financial statements to be prepared and disseminated to the investing public reflecting substantial earnings which were in fact false and fictitious" and that it "caused such false and fictitious financial statements to be filed with the Commission and other regulatory agencies, including the New York Stock Exchange and the state insurance authorities, and in such manner did thereby willfully, fraudulently and falsely report and represent the financial condition of Equity Funding Corporation and its subsidiaries."
As indicated, Equity Funding consented to the injunction on April 3.
Earlier on April 2 the California Insurance Department instituted an action in the Superior Court of the State of California entitled "Payne, Insurance Commissioner v. Equity Funding Life Insurance Company" in which the Commissioner asked the Court to appoint a conservator for EFLIC, a subsidiary of Equity Funding. The verified application stated that the California Insurance Commissioner had been notified by the Illinois Insurance Commissioner that $24,000,000 in bonds, represented by EFLIC to have been on deposit with the American National Bank of Chicago were not on deposit as represented. The California Commissioner also charged that there were life insurance policies recorded on the books of EFLIC which were wholly fictitious.
Other official actions occurred within a few days of the large stock sale by Duntov, with the likelihood that there were rumblings to important officers earlier. Moreover, on March 12, 1973 the Illinois Insurance Department had begun a surprise audit of the financial condition of EFLIC. Preliminary investigation disclosed that a substantial number of bogus policies had been issued by EFLIC and that 20 million dollars of bonds listed as its assets and purportedly held by the American National Bank of Chicago were not there. The investigation, commenced on March 12, had advanced so far by April 2 that on the latter date a verified petition was filed in the case of People ex rel. Fred A. Mauck, Director of Insurance of the State of Illinois v. Equity Funding Life Ins. Co., & Equity Funding Corp. of America (No. 73-1019-Cr) in the Circuit Court for the 18th Judicial Circuit, DuPage County, Illinois.
On April 3 Equity Funding and EFLIC were ordered to cease and desist from various activities including the selling of life insurance in Illinois.
Although, in the time available, the plaintiff has been unable to pinpoint exactly when the executive officers and directors learned of the serious violations that were uncovered in the Illinois investigation, it is a fair inference that notice must have been brought home to the directors of Equity Funding that all was not ship-shape some time before the suspension of trading on March 28. The sales of stock here involved were made only a week before official court action by the Commission and the Insurance Commissioners. It is a fair inference that the Illinois investigation, by then two weeks old, had come into the ken of directors and officers like Duntov, although Duntov has denied knowing that it was anything but a routine triennial examination.
The sudden sale of 24,475 shares plus about an additional 16,000 shares, representing about 80% of Duntov's holdings (49,911 shares) of Equity Funding within a week before the board agreed to a consent injunction is highly suspicious. That is particularly true because in November, 1972 Duntov sold only 300 shares and in December, 1972 only 900 shares. In the two and a half years before the March 26, 1973 trades he never sold more than 2,000 shares in a month, and only in March, 1971 did he sell as many as 2,000 shares.
Let us now revert to the activities of Jefferies from March 26 when it received the order to sell from North American to the present. On March 26, Jefferies sold the entire block of 24,475 shares to member firms. The Stock Clearing Corporation by a balance order told Jefferies to deliver a net balance of 19,300 shares to Hayden, Stone, a member firm, and the balance to other brokers. On March 29, confirmation slips had been received by Jefferies from North American indicating that delivery of the 24,475 shares would be made by United Bank.
On the settlement date, April 2, a total of 24,475 shares were presented at the New York office of Jefferies; certificates representing 13,000 shares were presented by United Bank and certificates for the remaining 11,475 shares were presented by the Franklin National Bank ("Franklin"). The confirmations from United Bank had not shown on their face the name of "Duntov" but the certificates were all in the name of "Yura Arkus-Duntov," and the securities control ticket of Franklin showed "R/N/O Yura Arkus-Duntov," and directed payment to be made to the latter at 60 East 40th Street, New York. The confirmations from North American also disclosed that the sale was for the account of "Yura Arkus-Duntov."
On April 2, pursuant to written instructions from Franklin and United Bank, Jefferies drew the two checks on Chase, as stated above. Later on April 2, the settlement date, John Muscara, an officer of Jefferies in charge of its clearance department, told Adam A. Halaszynski of the Los Angeles office of Jefferies that one of the checks had been made to "Yura Arkus-Duntov." Inquiry was made in Los Angeles and Muscara was informed by his Los Angeles office that Duntov was an officer of Equity Funding and an insider, which Muscara had not known up to that time. The information was given to Muscara at about 9 a.m. New York time on April 3. By that time Muscara had already delivered the checks for the proceeds of sale.
When Muscara found out that Duntov was an officer and presumably an insider of Equity Funding, he made the decision to call Hayden, Stone and "invite" them to return the stock. Hayden, Stone still had the shares in their possession, and gave them back to Jefferies that day, reversing the transaction. The opposite number to Muscara at Hayden, Stone, a Vice-President named Anthony Fidele, testified that he knew nothing of Jefferies "inviting" the stock back. All Fidele knew was that his cashier saw the name "Duntov" on the stock certificates and recognized him as an officer of Equity Funding. Hayden, Stone refused to accept delivery, on Fidele's version, on April 2.
This left Jefferies holding 19,300 shares of the stock which it had sold to Hayden, Stone for the account of Duntov, but with two checks outstanding for $409,704.43 which it had sent out on April 2, after assuming that it had been credited by the stock ...