The opinion of the court was delivered by: MACMAHON
MacMAHON, District Judge.
The complaint in this action rambles for some thirty-four pages and alleges violations of ten statutes and six rules of the Securities and Exchange Commission ("SEC") by fifteen defendants. The presentation of the case upon the trial was confused, disjointed, unfocused, incoherent and, at times, incomprehensible. Nor were the post-trial briefs of any assistance whatever in marshalling the evidence and relating it to the legal contentions of the parties. This has placed an intolerable burden upon the limited time and resources of a busy trial judge in this congested district.
Criminal cases under the securities laws and mail fraud statutes, involving equally complex transactions, are routinely tried and disposed of in this court in a fraction of the effort and time devoted to this poorly presented case. Here, we have been put to the almost endless and certainly exhausting task of trying to bring order out of chaos. Nonetheless, we must deal with the issues of fact in light of the applicable law as best we can perceive them under the circumstances.
Essentially, defendants are charged with fraud in connection with a "best efforts, 50,000 units or none" public offering of 100,000 units of securities of Beneficial Labs, Inc. ("Beneficial") and with manipulation of trading in Beneficial securities with a design to inflate their price artificially and unload them on unsuspecting public investors.
The SEC seeks judgment permanently enjoining defendants from future violations and ancillary relief in the form of disgorgement of profits. A preliminary injunction was granted on May 28, 1974 following a hearing, and a plenary trial to the court was held on March 17, April 30, May 1 and May 2, 1975.
Only seven defendants now remain:
(1) Commonwealth Chemical Securities, Inc. ("Commonwealth"), a registered broker-dealer located in New York City, which, as underwriter, commenced a "best efforts, 50,000 units or none" public offering of 100,000 units of Beneficial securities on December 20, 1971.
(2) Robert Drucker ("Drucker"), vice-president and a director of Commonwealth, who, at the time of the alleged violations, was an officer and director of Vanguard Fund, Inc. ("Vanguard Fund") and of New York Hedge Fund, Inc. ("Hedge Fund"), formerly known as the Berkeley Dean Special Fund, Inc. Drucker was also president and a director of DK & B Management, Inc. ("DK & B") from 1971 through 1974.
(3) Julius Kleinman ("Kleinman"), president, treasurer and chairman of the board of directors of Commonwealth, who, at the time of the alleged violations, was an officer and director of the Hedge and Vanguard Funds. Kleinman was also vice-president, secretary and a director of DK & B.
(4) DK & B, the registered investment advisor to the Hedge Fund from October 24, 1972 to September 22, 1973 and to the Vanguard Fund from March 22, 1972 to July 16, 1973. Drucker and Kleinman are the principal officers and directors of DK & B.
(5) Mary Sharpe ("Sharpe"), Commonwealth's bookkeeper from August 1970 to June 1974.
(6) Zoltan Guttman, a/k/a Lou Goodman ("Guttman"), cashier and registered representative of Commonwealth from November 1970 to December 1973.
(7) Marlane Kleinman, a/k/a Marcia Klein ("Marlane Kleinman"), Kleinman's wife and a stockholder of Beneficial.
Essentially, the SEC asserts two claims:
First, it is alleged that certain defendants participated in a fraudulent offering of Beneficial securities. As mentioned above, Commonwealth, as underwriter, commenced a "best efforts, 50,000 units or none" public offering of 100,000 units of Beneficial securities on December 20, 1971. The offering represented that if 50,000 units were not sold by its termination date (not later than March 19, 1972) "all funds from subscribers will be refunded in full without interest." The SEC asserts that there was a short fall in the sale of the units and that defendants Commonwealth, Drucker, Kleinman, Sharpe and Guttman camouflaged the failure to sell the 50,000 minimum number by placing several thousand units in nominee accounts and by causing a closing to be held on March 10, 1972.
Second, the SEC claims that all defendants participated in a fraudulent scheme to raise the price of Beneficial securities artificially by manipulating trading after the March 10, 1972 closing, principally by using nominee accounts, by prearranged "swap" transactions with other broker-dealers, and by dumping large blocks of inflated units upon the Vanguard and Hedge Funds which were victimized by conniving fiduciaries, Drucker and Kleinman.
The complaint alleges that the foregoing acts constitute a number of violations of the securities laws.
On December 20, 1971, Commonwealth, as underwriter, commenced a public offering of 100,000 units of Beneficial securities, at a price of $2.25 per unit, under Regulation A,
the small issue exemption from registration. Each unit consisted of one share of common stock and one warrant, immediately exercisable for the purchase of another share of common at $2.25. According to its terms, the offering would fail unless at least 50,000 units were sold by its ninety-day termination date, March 19, 1972. The offering represented that all money received from subscribers would be deposited in a special bank account maintained by Commonwealth, as trustee for the subscribers, at the American Bank & Trust Company ("American Bank") and that all the subscribers' funds "will be refunded in full" if less than 50,000 units were sold by the termination date.
A "due diligence" conference, attended by defendant Kleinman; Emanuel Brown, counsel to Commonwealth; John Feldman, president of Beneficial; and Alan Geiss, attorney for Beneficial, was conducted in December 1971 by a Mr. Bienenstock, an attorney for the SEC. The purpose of the conference was to inform the persons involved in the offering of their duties and obligations.
Accordingly, Bienenstock advised that all money received from subscribers should be deposited in a special account until the minimum number of units had been sold, but that, if the minimum number were sold before the termination date, a closing should be held at that point, and that further closings, if any, should be held weekly until the termination date of the offering. Bienenstock specifically instructed that the offering would fail if the minimum of 50,000 units were not sold by March 19, 1972 and that, in that event, all money received from subscribers would have to be returned.
The offering circular was amended on March 8, 1972 to indicate that "[the] within Offering was terminated on March 8, 1972. As of such date, 50,650 Units had been sold and paid for and the Company [Beneficial] received net proceeds of $94,033.75." This language clearly implied that by March 8, 1972 the goal had been surpassed and that Commonwealth had received and deposited the full purchase price for 50,650 units in the special account. The implicit representation was made express by Kleinman's advising the SEC in writing, on March 8, 1972, that Commonwealth had subscribers for 50,650 units and that a closing would be held within a few days.
He enclosed a list of subscribers and the number of units each had bought. Moreover, a closing was held on March 10, 1972, and Beneficial delivered certificates for 50,650 units to Commonwealth in exchange for two checks, totalling $94,033.75, drawn on the special account. That sum constituted the entire balance in the special account.
The SEC claims that, despite Bienenstock's specific instructions and the plain representation of the offering circular, the $94,033.75 deposited by Commonwealth was not the amount it should have received from subscribers if 50,650 units had in fact been sold, since the full price of the units, according to the offering, would be $113,962.50 ($2.25 per unit x 50,650).
Defendant explains the discrepancy as the full purchase price ($113,962.50) less Commonwealth's commissions ($19,928.75). While Commonwealth was entitled to commissions of $19,928.75 on the sale of 50,650 units under the terms of the offering, the bank statement shows that the special account never contained more than $94,033.75 at any time prior to the closing. This leads to two alternative inferences: either (1) that 50,650 units had not been sold, or (2) that Commonwealth had taken its commissions before depositing the subscribers' money into the special account. We will now explore the first of these inferences.
The SEC claims that, contrary to their representations, defendants failed to sell the minimum number of units and that defendants Drucker, Sharpe and Guttman placed several thousand units in nominee accounts to camouflage the failure.
Joanne Reichin, a former Commonwealth employee, testified that, upon Drucker's request, she furnished the names of four friends -- Sheila Goldberg, Mary Boilen, Sherry Ashen and Alice Greenblatt -- for use on nominee accounts. Those four names also appear on the list of subscribers sent by Kleinman to the SEC, showing that each had bought 2,000 units. Drucker admitted using those names on nominee accounts but denied using them for the purpose of camouflaging a failure of the offering. He claimed that the nominees were used because the true purchaser of the total 8,000 units, a Mr. Massad, instructed him to put the units in the names of nominees.
Drucker testified that on March 10, 1972 he sent these units to Massad in Massachusetts on a "delivery against payment" basis, through the American Bank, which gave him an immediate credit against delivery, but that, due to a mix-up, Massad's bank in Massachusetts was not informed of the transaction and returned the units. According to Drucker, the units
SEC v. Commonwealth Securities, Inc. 74 Civ. 1984-LFM were again sent to Massachusetts and were finally received on March 16, 1972, six days after the closing. Drucker also testified that, a few weeks later, Commonwealth, in a private transaction, repurchased the 8,000 units from Massad.
We find Drucker's testimony on this matter incredible. Defendants' failure to call Massad; Drucker's use of nominees selected by his subordinate, Reichin; Massad's failure to pay for his units before the termination date, as other subscribers had done; and Commonwealth's repurchase of the units in a private transaction shortly after the closing compel the conclusion that Massad was not a bona fide purchaser but a mere tool of the defendants for camouflaging the failure of the offering.
We find, therefore, that Commonwealth, contrary to the representations made in the offering circular, as amended, and in Kleinman's letter to the SEC, had not sold 50,650 units by March 8, 1972; nor had it received and deposited the sales price for such units.
The SEC claims that defendants Sharpe and Guttman also participated in this attempt to camouflage the failure of the Beneficial offering by placing a number of units in nominee accounts.
Defendant Sharpe opened an account at Commonwealth in the name of her mother, Nellie Pyles, and purchased 1,000 Beneficial units before the termination date. Sharpe testified that she intended to give any profits to her mother. Soon after March 8, 1972, however, she sold 500 units at a small profit, took the check for the proceeds which she had drawn to the order of Nellie Pyles, endorsed her mother's name, and deposited the funds in her own bank account. The profits realized on this sale were never given to her mother. In fact, Nellie Pyles was completely ignorant of this account and of the transactions allegedly conducted for her benefit.
Sharpe explained that, because of some forgotten dispute with her mother, she failed to give her the profits. We find this "gift" explanation incredible and, therefore, conclude that Sharpe did use her mother's name to cloak her own interest in the account.
Sharpe also testified that she opened this account and made the purchase only after consulting with Mr. Brown, counsel to Commonwealth. Brown did not squarely corroborate Sharpe but testified generally that, in response to several inquiries, he advised that it would not be improper for the relatives of Commonwealth employees to buy Beneficial units provided they were bona fide purchasers. Clearly, this does not exculpate Sharpe, for Nellie Pyles was not a bona fide purchaser; it was Sharpe alone who made the purchase, controlled the account, and received the profits from the sale of the units.
We find on a balance of all of the evidence, including Sharpe's relationship as Commonwealth's bookkeeper, the timing of the transaction, the then significance of 1,000 units to the target quantity, and the spurious explanation given on the stand, that Sharpe was knowingly attempting to aid and participate in the fraudulent closing of the offering, with some stake in its success, even though there is no direct evidence that the funds used were not her own or that she acted at the express request of Drucker, Kleinman, or anyone else.
The SEC also claims that defendant Guttman was beneficially interested in an account at Commonwealth in the name of "Sylvia Pavel, custodian for Yitzchok." Kleinman listed that account as a subscriber for 1,000 units in his letter to the SEC.
The evidence shows that Pavel is Guttman's counsin and that Yitzchok is Pavel's son. Guttman testified that he had a loose, verbal arrangement to make loans to Pavel for the purchase of securities. According to Guttman, sometime in late 1971, Pavel opened an account at Commonwealth with funds supplied, at least in part, by Guttman. Guttman admitted that Pavel never signed a "new account card," that he suggested that Pavel buy some Beneficial units, and that 1,000 units were bought using funds from the account. Those funds, Guttman said, had been realized from the sale of other securities. Guttman also testified that, after the closing, he directed that the units be sold and that the proceeds were sent to Pavel. He claimed that, soon thereafter, he received a "loan" from Pavel, but denied having any beneficial interest in the account.
Guttman's testimony is incredible. Not a scrap of paper was offered to support his story. More significantly, his testimony is contradicted by his own prior admissions to the SEC that the Beneficial units were purchased "with my funds, basically," and that "the stock is for my interest." Finally, Drucker testified, on cross-examination, that Guttman had told him that he had a "partnership interest" in the Pavel account.
The evidence is overwhelming that Guttman had an interest in the Commonwealth account carried as "Sylvia Pavel, custodian for Yitzchok." He admitted that he was the source of at least some of the funds used to buy the Beneficial units, that he had suggested their purchase, that he had discretionary authority over the account which he exercised when he directed the sale of the units, and that he had received a "loan" after the units had been sold. As was the case with Sharpe, in light of all the circumstances there considered, which are even more significant here, we find that Guttman knowingly participated in this fraudulent scheme by causing this purchase to camouflage the failure of the Beneficial offering.
It seems unnecessary, in view of the above findings, to discuss the second possible inference that could be drawn from the discrepancy in the bank statement, that is, that the discrepancy was caused by Commonwealth's taking its commissions before depositing the subscribers' funds. Defendants, however, have urged that inference, and we should, therefore, consider it.
Defendants failed to present any creditable evidence that their contention is true, but, even if it were, they would, nevertheless, be liable for making false representations. The offering circular expressly represents that all money received from subscribers would be deposited in the special account, not that the underwriter would first deduct commissions and then deposit only the remainder. Nor did defendants even attempt to answer the troublesome question of how Commonwealth could take its commissions in good faith before it was entitled to them under the terms of the offering, viz., before the successful closing? Absent participation in a fraudulent engineering of the closing, no one could be prescient enough to know that a particular offering will succeed before that event actually occurs. In short, we reject defendants' contention that the discrepancy was caused by the premature taking of commissions as wholly untenable and inconsistent with the facts which we have already found.
We turn now to the second claim that, after the closing, the defendants artificially manipulated the ...