Appeal by William N. Levy, A.J. Carno, Inc., and Anthony Nadino of preliminary injunctions entered by Carter, J., restraining further violations of the antifraud and registration provisions of the securities laws, and appeal by Samuel D. Hodge from entry of similar permanent injunction. Affirmed as to Levy, vacated and remanded as to Hodge, and vacated in part as to Carno and Nadino.
Kaufman, Chief Judge, Oakes and Gurfein, Circuit Judges.
One indication of the scope of the securities law violations charged in this case is that eighteen defendants were made parties to this action by the Securities and Exchange Commission [SEC]. Ten defendants consented to the issuance of permanent injunctions against them prior to the entry of judgment below, and another four determined not to appeal. Each appellant was enjoined from future violations of the registration and antifraud provisions of the securities laws, §§ 5(a), 5(c) and 17(a) of the Securities Act of 1933, § 10(b) of the Securities Exchange Act of 1934, and rule 10b-5. Preliminary injunctions were issued against William N. Levy, A.J. Carno, Inc. [Carno], and Anthony Nadino after a two-day hearing before Judge Carter, and a permanent injunction was entered against Samuel D. Hodge after he failed to appear at the hearing pursuant to the district court's order. We affirm as to Levy, vacate in part as to Carno and Nadino, and vacate and remand as to Hodge.
The diffuse facts need only be limned with broad strokes to provide the necessary background for our decision. Management Dynamics [MD] was a company whose shares, issued in exchange for services or in private placements, were held by several hundred individuals and traded in over-the-counter market, though they were never registered with the Commission. In late 1971 or early 1972 a builder and developer named Edwin Barrett told Levy -- a director of MD -- of his desire to operate his business through a publicly-held company. In June 1972 Levy suggested MD as a suitable "shell;" it was publicly held and traded, had little debt, and was inactive. Barrett agreed to put approximately $100,000 into MD in exchange for 2.7 million shares of its common stock, subject to an increase in the number of authorized shares from 2 million to 8 million.
This agreement was made public in a letter to MD shareholders dated August 15, 1972 which was written and signed by Levy. A financial statement reviewed by Levy accompanied the letter. In addition to announcing a special shareholders' meeting to ratify the agreement with Barrett, the letter described the "Proposed Business" of the company as encompassing a broad range of real estate development activities. The notes to the financial statement listed two options to acquire land in Bass River Township, New Jersey, and in Harleysville, Pennsylvania, as some of the assets contributed by Barrett. Judge Carter found this communication misleading because it failed to disclose Barrett's indispensability to the company's operations and the various contingencies hedging successful development of the land subject to the options. The MD shareholders ratified the agreement with Barrett and the increase in authorized shares on September 6, 1972.
Judge Carter also found misleading a letter dated October 25, 1972 and a press release dated October 13, 1972, sent to shareholders and other requesting information about MD. Levy had reviewed each of these communications before they were mailed. The letter stated that financing was expected by February 15, 1973 for a project to construct garden apartments in Red Hill, Pennsylvania, although at the time there was little certainty that this prophecy would be fulfilled. The letter went on to mention the option for land in Bass River Township, without noting that successful completion of the project would require approval by local, state, and federal government units on a variety of matters, including zoning and the environmental aspects of the construction of a sewage facility. The letter also discussed a planned residential development near Landsdale, Pennsylvania which apparently was identical with the Harleysville option listed in the August 15 letter. Although the October letter noted that the project was "contingent upon the successful achievement of zoning changes," the district court found failure to disclose the "indeterminate nature of the option" misleading, perhaps because the letter did not describe the massive nature of the zoning change required to permit high density residential construction on land then classified as agricultural.
The press release described an MD plan to build a retirement community on 700 acres of land in Burlington County, N.J., on which the company had secured an option. The release noted that the option was subject to passage of a local ordinance to permit such construction, to which there appeared to be "no obstacle," and the obtaining of state permission to erect a sewage recovery plant. The district court found the release misleading for its failure to indicate that the required approval might not be given, and that the necessary financing -- over $1,000,000 of purchase price and more than $25,000,000 in mortgage financing -- might not be obtained.
Judge Carter found these misstatements and omissions sufficient to establish a violation by Levy of the antifraud provisions. He was of the view that the totality of Levy's conduct warranted the issuance of a preliminary injunction against him since Levy's responsibility for the communications was clearly established. He had written the August letter and reviewed the October mailings. He was also familiar with the securities field which had been a major part of his legal practice since 1969. In sum, his violations could not be described as inadvertent.
The judge also found that Levy had violated the registration provisions in connection with a series of events which may best be labelled the "Watson transaction." In October 1972, Levy suggested to the MD board of directors that they issue unregistered shares at $1.10 a share through one Peter R. Watson, who claimed to be the agent for certain individuals who sought to invest in the restricted shares of small companies. A condition of the sale was that the certificates bear no legend identifying them as unregistered securities, since Watson's purported principal desired to avoid any obstacles which might prevent transfer of restricted stock even after the requisite holding period. In addition, Levy testified, Watson's principal insisted on being shown the stock certificates for 560,000 shares issued in Watson's name, which would be exact facsimiles of the shares he would receive.
Levy advised the board that an arrangement of this sort would be proper if Watson signed an investment letter indicating knowledge that the stock was restricted. No such letter was ever signed. The board authorized the issuance of the 560,000 shares in 5000 share lots, which Levy advised were sufficiently large to lead any reasonable purchaser to ask the transfer agent or company whether the shares were restricted. Although the board directed Levy to retain the certificates until Watson identified the purchaser and placed the purchase price in escrow, Levy turned the certificates over to Watson in Florida in mid-October. Approximately one week later Levy suggested to the board, at Watson's request, that 400,000 additional shares be issued under similar conditions. These certificates were forwarded to Watson in Dallas, Texas.
The saga of MD stock now shifts scenes. In November or December, Anthony Nadino, vice-president of A.J. Carno, Inc., received a telephone call from an unknown individual who stated that he was from California, and who identified himself as "Buzz." The caller inquired about the market price in MD stock and size of that market, and stated that he had 100,000 shares for sale. At Nadino's request, "Buzz" furnished the specific numbers of the certificates. Nadino communicated with the transfer agent, who informed him that these shares had been issued in Watson's name. Another 200,000 of Watson's shares had been delivered to the Central Cleveland International Bank in New York City as potential collateral for a loan.
As might be imagined, Watson never succeeded in selling MD stock to his European principal, and in December Levy requested the return of the 960,000 shares. MD received shipment of 710,000 shares and the receipt for the 200,000 shares at the Central Cleveland Bank soon thereafter, but the remaining 50,000 shares were not received until January 28, 1973. The district court found that Levy's action in authorizing and delivering the MD shares without restrictive legend enabled Watson to offer them for sale, and constituted a violation of the registration provisions which justified issuance of a preliminary injunction.
The remainder of the case presented for our consideration relates to trading in MD stock by certain broker-dealers. The SEC's theory of the events, as recounted in its brief, provides a useful backdrop for evaluating the actual findings of the district court. According to the Commission, Global Securities, Inc. decided in the fall of 1972 to tout MD stock -- using the two shareholder letters and the press release prepared by MD -- and to distribute it to its customers. MD had theretofore been traded only infrequently, and the only quotations appearing in the "pink sheets" in June and July 1972 were bids of $0.375 per share. Global was aided in this endeavor by Samuel D. Hodge, who in October 1972 purchased a one-third interest in Global and became its vice president, loaned the company $25,000, and sold it (and other firms) some of his own MD shares.
Global enlisted three over-the-counter firms -- Mayflower Securities, Fairfield Securities, and appellant Carno -- to place quotations for MD stock in the pink sheets, and to resell to Global, at a profit, the MD shares which they purchased. This arrangement, naturally enough, created the appearance of a far greater interest in the stock than if Global alone had entered quotations. Although they had little or no information about the company or its financial prospects, the broker-dealers engaged in active and continuous trading in MD until December 8, 1972, when the SEC suspended trading. The vast bulk of their sales were to Global, who in turn resold MD to its customers at prices as high as $6 per share -- reflecting a rise in the price of the stock from about 38 cents in a six-month period. At that price, the company's market value would be estimated to be some $24,000,000, which, of course, was far in excess of any realistic assessment of its worth.
Judge Carter's findings of fact as they relate to Carno and its vice-president Nadino are far more limited than the elaborate theory sketched by the SEC. Nadino was found to have begun trading in MD stock in June 1971, although at the time he knew nothing about the company. The material about MD which Carno possessed, including the August and October communications, did not provide meaningful information about the nature of MD's business, property, or past earnings, and the quotations submitted were based solely on the market for MD shares. Of the 11,226 MD shares purchased by Carno between September 28, 1972 and November 15 of the same year, 9825 were sold to Global.
The district judge found that the quotation of MD at prices which bore no relation to the activities of the company violated the antifraud provisions of the 1934 Act and rule 10b-5. Judge Carter concluded that the record established the maintenance of "artificially high prices" and "fictitious quotation and manipulation of MD shares," and preliminarily enjoined Carno and Nadino from further violations. In addition, the court held that this activity by the brokers who were maintaining a market in MD stock "aided" the Watson transaction by providing a purchase price on which sales of unregistered stock could be based. The judge granted a preliminary injunction restraining Carno and Nadino from violating the registration provisions as well.
Initially, we direct our attention to appellants' claim that the district court applied the incorrect legal standard in granting preliminary injunctions against them. The thrust of their contention is that SEC injunction actions, like those in suits between private parties, are governed by the criteria which we articulated in Sonesta ...