Appeal from a judgment of the United States District Court for the Southern District of New York, Hon. Charles M. Metzner, Judge, holding defendants liable for violating 15 U.S.C. §§ 77l (2) and 78j(b). Reversed and remanded.
Mulligan, Van Graafeiland and Meskill, Circuit Judges. Van Graafeiland, Circuit Judge, concurring in part and dissenting in part.
This is an appeal from a judgment of the United States District Court for the Southern District of New York entered on January 13, 1976 following a nine-day bench trial before the Hon. Charles M. Metzner, District Judge. Defendants-appellants, Goldman, Sachs & Co. and its general partners (Goldman, Sachs), were found to have violated § 12(2) of the Securities Act of 1933, 15 U.S.C. § 77 l (2), and § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and the Securities Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5. The violations were based on a sale by Goldman, Sachs to plaintiff-appellee Franklin Savings Bank of New York (Franklin) of a Penn Central Transportation Company (Penn Central)*fn1 note. A judgment of $500,000 with interest and costs, was entered in favor of Franklin.*fn2 The district court opinion is reported at 406 F. Supp. 40.
Goldman, Sachs is a leading commercial paper dealer and was the exclusive dealer for Penn Central's notes. Dealers act as principals, buying from the issuer at one interest rate and selling to investors at a slightly lower rate. This "spread" constitutes the dealer's compensation. The commercial paper, dealt in by Goldman, Sachs consisted of short-term, unsecured promissory notes of industrial or finance corporations. Since the interest rates on the paper are only fractionally different from rates available on other money market instruments such as Treasury bills, the differential only becomes significant in investments of ninety days or less when large sums are involved. In 1969 and 1970 the average commercial paper transaction involved notes having a total face amount in excess of one million dollars.*fn3 It was a Goldman, Sachs' policy not to make sales under $100,000. This was neither a market nor an investment vehicle in which widows and orphans sought refuge.
New York State enacted a statute, N.Y. Banking Law § 235.12-a (McKinney 1971), effective June 1, 1968, which allowed savings banks to invest in commercial paper. Such banks were only permitted to purchase paper which an independent rating service designated by the State Banking Board had given its highest rating. The National Credit Office (NCO), a subsidiary of Dun & Bradstreet, an approved service, had rated the Penn Central paper "prime", its highest rating on August 1, 1968.
Soon after the passage of this law, Goldman, Sachs advised Franklin in writing of the services which the investment bank offered in the commercial paper field. The parties transacted business several times before March 16, 1970 when Franklin purchased from Goldman, Sachs a Penn Central note with a face value of $500,000 and a maturity date of June 26, 1970. The price paid by Franklin was $487,958.33. On June 21, 1970 Penn Central filed its reorganization petition in bankruptcy with the United States District Court for the Eastern District of Pennsylvania and is still in reorganization. Franklin tendered the note and payment was never received.
Penn Central was formed on February 1, 1968 by the merger of the New York Central and Pennsylvania Railroads. It was the nation's largest railroad and sixth largest nonfinancial corporation. By the time the bankruptcy occurred, there was outstanding $82,530,000 of commercial paper which Penn Central had been unable to either refinance or roll over and which was not supported by bank credit lines. Goldman, Sachs, the nation's largest commercial paper dealer, had sold all of this paper to approximately 60 lenders.*fn4
On February 4, 1970 Penn Central's financial statements for both the year 1969 and its last quarter were publicly announced. The loss for the year was $56.3 million, ten times greater than that of the previous year. In the fourth quarter, the company had lost $13.2 million. Disturbed by this news, Goldman, Sachs arranged a meeting with representatives of Penn Central for February 6. The day before the scheduled conference, Robert Wilson, a Goldman, Sachs general partner and a named defendant, called Jonathan O'Herron, a Penn Central vice president, attempting to convince Penn Central to buy back some of the approximately $15 million of Penn Central paper that the investment bank had in its inventory.
Wilson and the late Gustave Levy, another Goldman, Sachs general partner and a defendant, attended the February 6 meeting on behalf of the dealer. Penn Central was represented by O'Herron and David Bevan, chairman of that company's finance committee. Penn Central reported that its projected losses for 1970 would be no greater than its 1969 losses. Goldman, Sachs told O'Herron and Bevan that it would place a $5 million limit on the amount of Penn Central paper it would carry in its inventory. It also urged Penn Central to get 100% bank line coverage of its outstanding commercial paper; at that time, the bank line coverage was only 50%.*fn5 On February 9, Penn Central bought back $10 million worth of paper from Goldman, Sachs.
Brown Brothers Harriman & Co., an investment banking firm which had purchased as much as 15% of Penn Central's commercial paper on February 5, 1970 removed that company from its approved list.
In finding Goldman, Sachs violated § 10(b) of the 1934 Act and § 12(2) of the 1933 Act, the district court found that both the buy back of February 9 and the removal of Penn Central from the Brown Brothers approved list were material facts which affected the quality and credit worthiness of the note. The failure of Goldman, Sachs to disclose these facts was found to create liability under both acts.