The opinion of the court was delivered by: POLLACK
In the past few weeks the court has spent an enormous amount of time going through the very complete submissions by all parties to the applications before the court and has made what it considers to be a thorough examination of the applicable law. Accordingly, the court is prepared to render the following decision.
The SEC initiated this matter in a private investigation ordered on November 15, 1972, by an order entitled "In the matter of Realty Equities Corporation of New York." The complaint in this suit, essentially an enforcement proceeding, was filed on March 8, 1974. In its prayer for relief the plaintiff requests that the court issue a preliminary injunction as well as an order appointing a receiver to take control of all the books, records, assets and business of defendant Republic National Life Insurance Company ("Republic") and to conduct its affairs until further order of this court.
The SEC has now moved for preliminary injunctions against all defendants and an appointment of a receiver of Republic. Certain of the defendants have either consented to or are in the process of consenting to final injunctions satisfactory to the Commission. The preliminary injunctions requested seek to prevent the remaining defendants from engaging in further violations of Section 10(b) of the Exchange Act [15 U.S.C. 78j(b)] and Rule 10b-5 thereunder [17 CFR 240.10b-5] by employing any manipulative or deceptive device, scheme or artifice to defraud; by making untrue statements of material fact or omitting to state material facts necessary to make statements made not misleading; and by engaging in any transaction, practice or course of business which operates or would operate as a fraud or deceit upon any person. The application further seeks to enjoin the defendants Republic, Westheimer, Fine, Berger & Co., and seven of Republic's officers, four of whom are former directors, from violating or aiding violations of Section 13(a) of the Exchange Act of 1934 [15 U.S.C. 78m] and the rules promulgated thereunder by filing annual, periodic and other reports with the SEC containing untrue statements of material facts or omitting to state material facts necessary to make statements made not misleading.
In addition to the foregoing relief, the application requests on order appointing a receiver to take control of all the books, records, assets and business of defendant Republic and to conduct its affairs until further order of this court and empowering and directing the receiver to conduct investigations, oversee an independent accounting into the financial and other affairs of Republic, to report his findings to the court and to take appropriate action based thereon.
The defendant Republic and its seven officer defendants oppose the grant of an injunction and of a receiver and have made a cross motion to dismiss the complaint under Rules 12(b)(1) and 12(b)(7) or in the alternative to transfer this suit pursuant to 28 U.S.C. 1404(a) to the Northern District of Texas. PMM (Peat, Marwick, Mitchell & Co.), an accounting firm, opposes the grant of an injunction against that firm. WFB (Westheimer, Fine, Berger & Co.), an accounting firm, opposes the grant of an injunction against them and cross moves to dismiss the complaint under Rule 12(b)(6) or in the alternative to require the plaintiff to replead Counts V and VI with particularity to conform with the requirements of Rule 9(b) of the Federal Rules of Civil Procedure.
The SEC opposes the several cross motions to dismiss the complaint or to restate the fraud claims with particularity and opposes a transfer of the suit to Texas.
The application for provisional remedies was not served until some three months after the inception of this suit, that is, on June 3, 1974. No application was made for a temporary restraining order. The application before the court consists of the SEC's notice of motion and a covering affidavit to which are annexed 65 exhibits and 3 volumes containing 23 depositions, totaling some 1,800 pages of transcripts. This material was gleaned from the private investigation mentioned above. Defendants correctly point out that these exhibits and depositions contain a melange of sharply contradictory documentation and testimony on virtually every substantive issue herein.
However, that serious violation of federal securities law occurred does not seem to be strongly denied; responsibility for such violations is denied by the opposing parties.
Republic is a life insurance company duly organized and existing under Chapter 3 of the Texas Insurance Code, V.A.T.S. Republic's principal place of business is in Dallas, Texas. Pursuant to Texas law, Republic is subject to plenary regulation, and is regulated, by the Commissioner of Insurance of the State of Texas. It is claimed to have total life insurance in force well in excess of ten billion dollars and total assets of nearly half a billion dollars. Its total stockholders' equity at the end of 1973 is said to have been in excess of $30,000,000 under "statutory accounting" applicable to insurance companies, and $75,000,000 under the more commonly applied standard of "generally accepted accounting principles."
Republic is authorized to do business and is doing business in 49 states of the United States, the District of Columbia and Puerto Rico, and the single state in which it is not authorized to do business and does no business, is the State of New York. Its stockholders number in excess of 22,500, of whom 21 per cent reside in the State of Texas, and well over half of whom reside in the south, the southwest, and the far west.
The seven individual defendants in this action who are sued here as officers of Republic are all residents of Dallas, Texas.
Republic's records relating to the subject matter of this action are maintained in Republic's home office in Dallas. The affidavit on behalf of the defendants states that they comprise approximately 96,000 pages of documents. Defendants say that a substantial portion of such documents are required by Republic for its current use and any production of such documents outside Dallas would impose a severe and continuing burden upon Republic; that such records are being regularly consulted by seven Examiners of the Commissioner of Insurance of the State of Texas, as well as by the Supervisor and Deputy Supervisor designated by him; and that duplication of this great mass of documents would in itself impede the investigation now being conducted by the Texas, Oklahoma, Indiana and Montana authorities representing insurance departments of those states.
On February 27, 1974 -- the SEC suit was filed on March 8, 1974 -- the Texas Commissioner of Insurance issued an order placing Republic in a state of supervision pursuant to Texas Insurance Code art. 21.28-A. The supervision procedure (which is administratively initiated) was created by the Texas Legislature in 1967 as a threshold remedy which would be more effective in resolving the less serious cases of insolvency than receivership (which is judicially initiated). The legislature concluded that receivership was too drastic a remedy for many cases and often caused more harm than good.
The Commissioner's order prohibited, except with his approval, Republic from inter alia encumbering specified assets; investing its funds except by depositing funds received in the bank accounts of the company established at date of the order, in government bonds, and in certificates of deposit in state or federal banking institutions; incurring any debt or obligation for the acquisition of any investments other than the above; or altering the insurance operations in violation of the Insurance Code. In accordance with the purpose of supervision, the order did not restrain Republic from conducting the ordinary business of insurance. Republic was also required to schedule its investments and value of property secured by lien, required to correctly reflect the values of its investments, to present a proper financial statement, and to prepare plans to dispose, upgrade or correct deficiencies of any investments.
Later official orders issued by the Texas Commissioner include the direction to the officers of Republic to notify the Commission of the fullest cooperation of the company and its personnel with the investigation and evaluation of the company's financial and investment affairs by the Commissioner's Examiners and by the Supervisors, and the direction that Republic's officers and members of its board shall take appropriate action to assert any appropriate claim or demand on behalf of the company to recover any company assets wrongfully used, taken or wasted, which may have been misappropriated in breach of any duty owed to the company by any person.
On February 28, 1974, the Commissioner appointed a Supervisor who was directed to assume joint control with Republic of all records concerning Republic's investments. On April 29, 1974, an additional Supervisor was appointed whose primary duties were to retain special counsel (since selected) and to investigate with the special counsel Republic's potential causes of action for breach of fiduciary duty as well as any actions others might have against Republic for breach of duty.
On April 29, 1974, the Commissioner continued the state of supervision after a public hearing at which Republic showed the extent of compliance with the original order. During the period of supervision Republic's directors approved new investment procedures, the president resigned effective June 30th, and seven of the twelve directors resigned, including six of the eight members of the finance and investment committee. The directors who resigned were replaced by local commercial and investment bankers and lawyers, each of whom received the prior approval of the Commissioner.
The SEC has persuasively indicated, at least for present purposes, that in essence this case presents an outrageous example of massive and serious violations of the securities laws by Realty Equities and by Republic involving numerous sham transactions designed to artificially inflate the reported income and assets of Realty and of Republic and also permitting the rakeoff by Realty for no real consideration of many millions of dollars of Republic's funds. The SEC argues that the significant facts asserted in the complaint have not been denied. As previously stated, the opposing parties on this application deny that the charges pertain to them. The SEC contends that in November, 1970, Arthur Anderson would not certify Republic's 1970 financial statements unless full disclosure was made of Republic's investment in Realty Equities and affiliates and unless other conditions were met. The SEC says that Republic's response was to terminate Arthur Anderson & Co. as its auditor. Republic's 1970 financial statements were not certified by an outside accounting firm but were signed by defendant Stanley, Republic's actuary.
Several months later, Republic engaged PMM as its auditors and PMM has since certified Republic's financials for 1970, 1971 and 1972, each time allegedly without insisting on any disclosure of Republic's investment in, and involvement with, Realty Equities. The Commission charges that PMM was well aware that Arthur Anderson & Co. had been terminated because it had insisted on such disclosure.
Realty Equities also went through changes of its accountants in part of the time period involved herein. WFB has supplied affidavits showing that in early February, 1972, Realty Equities requested that WFB ...