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Securities and Exchange Commission v. Spectrum

decided: December 4, 1973.


Appeal from an order of the United States District Court for the Southern District of New York, Charles H. Tenney, Judge, denying the Securities and Exchange Commission a preliminary injunction against Stuart Schiffman for violations of the federal securities laws. Reversed and remanded.

Kaufman, Chief Judge, Smith and Oakes, Circuit Judges.

Author: Kaufman

KAUFMAN, Chief Judge:

The securities laws provide a myriad of safeguards designed to protect the interests of the investing public. Effective implementation of these safeguards, however, depends in large measure on the members of the bar who serve in an advisory capacity to those engaged in securities transactions. The standard of diligence demanded of the legal profession to meet this responsibility is a matter on which we are required to comment in the resolution of this appeal.

On April 2, 1971, the Securities and Exchange Commission filed a complaint charging twelve defendants,*fn1 including the appellee, Stuart Schiffman, with participation in a partially successful scheme to distribute over one million unregistered shares of the common stock of Spectrum, Ltd. in violation of the registration provisions of the Securities Act of 1933 (15 U.S.C. § 77e) and the antifraud provisions of that Act (15 U.S.C. § 77q(a)) and of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)). Although the Commission has obtained permanent injunctions against at least ten of the defendants,*fn2 it was unsuccessful in its effort to gain preliminary injunctive relief against Schiffman, an attorney who allegedly prepared an opinion letter on the basis of which some of the unregistered securities were sold. Judge Tenney, after reviewing the affidavits, cross-affidavits, exhibits, and depositions filed by the SEC and by Schiffman, denied the SEC's request for an evidentiary hearing, on the grounds that there were no material facts in dispute, and concluded that Schiffman's conduct, although perhaps negligent,*fn3 did not rise to a violation of the securities laws. Upon a careful examination of the record, we find the existence of a highly material factual conflict. Accordingly, we reverse and remand to Judge Tenney for an evidentiary hearing in which the disputed issues can be resolved.


A detailed account of the intricacies of the multi-party stock manipulation venture which prompted this action, the principal features of which were unchallenged below,*fn4 is set forth in the extensive supporting affidavit filed by the SEC. For purposes of this appeal, however, we limit our recitation to background information necessary for an understanding of Schiffman's alleged role in the scheme.

In September, 1969, Louis Marder, representing the Westward Investment Corporation, and Bernard Goldenberg and Joseph Dye, representing Spectrum, Ltd., agreed to a merger of Westward into Spectrum. The purpose of this merger was to provide a vehicle for the distribution of unregistered Spectrum securities which could later be sold to an unwitting public.

Section 5(c) of the 1933 Act states that "it shall be unlawful for any person, directly or indirectly . . . to sell . . . any security unless a registration statement has been filed as to such security." 15 U.S.C. § 77(e). To avoid this registration requirement, a plan was devised, principally by Marder and Goldenberg, which relied on a two-step procedure for securing exemption from Section 5. First, a large block of unregistered Spectrum common stock would be issued to the shareholders of Westward in the merger of Westward into Spectrum. This stock would be exempt from the registration mandate of Section 5 pursuant to Commission Rule 133,*fn5 which provided that the exchange of shares between a surviving corporation and the shareholders of a disappearing corporation in the course of a merger would not be considered a "sale" within the purview of Section 5.*fn6 Second, under Section 4(1) of the 1933 Act, the recipients of this unregistered Spectrum stock would be able to dispose of these securities, again without the filing of a registration statement as a predicate to the transaction, as long as the seller was not deemed to be "an issuer, underwriter or dealer" under the Act.

For Marder, who controlled Westward, successful implementation of this plan presented one obvious stumbling block--Rule 133 classified a controlling shareholder of the "constituent corporation" (Westward) as an "underwriter" and, therefore, a person not qualified for exemption under Section 4(1). Accordingly, prior to the merger Marder commenced distributing some of his Westward shares to various friends, many of whom, as the court below found, were in fact unaware of their status as Westward shareholders. Following the merger, Marder intended to effect the sale of the Spectrum stock received by his acquaintances in transactions which, because of the stock's nominal ownership by non-controlling former Westward shareholders, would appear to satisfy the criteria for a Section 4(1) exemption.

The stage was set for the successful charade upon consummation of the Spectrum-Westward merger on November 10, 1969. Of the 4,596,465 shares of Spectrum stock issued in the exchange, approximately one million shares went to Marder's corps of nominees. By obtaining the necessary stock powers from these individuals, Marder was in a position to begin the illicit sale of unregistered Spectrum securities.

On the day of the merger, November 10, Spectrum's general counsel, Morton Berger, wrote an opinion letter to Spectrum's transfer agent in which he instructed the agent on the proper classification of the Spectrum shares then being issued. Berger's letter, based upon representations by Goldenberg and Marder, included his opinion that the merger complied with the requirements of Rule 133 and that certain recipients of the newly-issued Spectrum stock should receive shares labelled "restricted"--i.e. not for public sale--because these former Westward shareholders, whom Berger listed, were considered to be "underwriters" pursuant to Rule 133(c). Berger concluded his letter by opining that the remaining former Westward shareholders, whose names Berger did not recite, could be issued Spectrum securities without a restrictive legend.*fn7

On November 25, 1969, Berger wrote a second letter, this time to the president of Spectrum, in which he listed those persons who had received unrestricted shares of Spectrum stock pursuant to the merger. This letter, however, was not in the form of an opinion letter.

Retracing our steps, on November 13 and November 28, 1969, Marder delivered for sale a total of 125,000 shares of unrestricted Spectrum stock, nominally owned by William and John Doyen, to Michael Gardner, a principal at the registered broker-dealer firm of Gardner Securities. Gardner balked at the sale of these unregistered securities, despite their unrestricted nature, insisting upon an opinion letter which stated that these shares were considered exempt from the registration requirements of Section 5. Although Marder possessed the Berger letters of November 10 and November 25, Gardner viewed them as insufficient, ...

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