The opinion of the court was delivered by: GOETTEL
When Sir Walter Scott wrote "Oh what a tangled web we weave, when first we practice to deceive," he must have foreseen the Knickerbocker Insurance Company. The transactions that caused the demise of Knickerbocker, and which form the basis of this action, were indeed a tangled and fraudulent web, and they have made uncovering the facts of the company's downfall a most difficult task.
The New York Superintendent of Insurance brought this suit as the liquidator of Knickerbocker, alleging that the defendants conspired to and did defraud the company. Federal securities claims, as well as pendent state claims, are alleged. Specifically, the Superintendent asserts violations of section 10(b) of the Securities Exchange Act of 1934 (the 1934 Act), 15 U.S.C. § 78j(b), and section 12(2) of the Securities Act of 1933 (the 1933 Act), 15 U.S.C. § 77 l. State claims are alleged under N.Y. Gen. Bus. Law § 352-c (McKinney 1968), and New York common law. The case was tried to the Court and the evidence revealed the following events.
In the beginning of 1970, the Knickerbocker Insurance Company, a New York stock casualty company, was having difficulty meeting the capital requirements imposed by the New York State Insurance Department. The company was a whollyowned subsidiary, and the chief asset, of Universal Knickerbocker Company ("Universal"), a publicly-held holding company. Universal was experiencing serious financial difficulty of its own. Both companies were controlled by Frederick Guminick, who has since sought solace in a foreign land and was not named in this action.
The Insurance Department conducted an investigation of Knickerbocker's capital structure. Knickerbocker retained the law firm of Milgrim Thomajon & Jacobs to represent it in the investigation. Robert Thomajon negotiated an agreement with the Superintendent allowing Knickerbocker several months to raise the necessary capital to satisfy the Department's regulations. Universal had made an attempt to supplement capital funds by floating a loan from a Canadian company called Scottish and York, and as security for the loan, Universal had pledged all of the stock of Knickerbocker. The loan came due in June and, if not met, would result in the loss of Knickerbocker to Scottish and York.
Throughout the spring of 1970, Universal continued to investigate potential sources for new financing, but by June, its efforts had been unavailing. Knickerbocker remained in difficulty under the Insurance Department's standards, and the company was directed to supplement its capital or undergo rehabilitation by the state. Unfortunately for Universal, this order occurred at the same time that the loan from Scottish and York was about to come due. Universal, therefore, faced the unhappy prospect of losing Knickerbocker, either to Scottish and York as the result of a default on the loan, or to the Insurance Department through a rehabilitation proceeding. Since Knickerbocker was the primary asset of Universal, its loss would have meant the certain collapse of Universal. New financing was desperately needed.
Defendant, Jay M. Freedman, the only defendant pursued in this action,
arrived on the scene sometime in June. He was apparently brought into the matter as a consultant to help Guminick and Universal in the search for fresh funds. Freedman's father, a prominent Chicago insurance executive, was the subject of early discussions as a potential source of money. It appears, however, that by mid-June, Freedman's father had decided not to get involved in any Knickerbocker rescue effort. As an alternative, Freedman suggested to Guminick the idea of talking to Francis Salazar of Denver, an attorney who represented various financial interests. Salazar allegedly put Guminick in touch with a flamboyant financier named James L. Hamilton. It is unclear when Hamilton first spoke to Guminick, but it is clear that Freedman knew Hamilton through previous dealings and had good reason to question Hamilton's business integrity.
Sometime around June 15, 1970, the directors of Knickerbocker who formed its Executive Committee, Guminick, Eugene Lieber and Leonard Lampert, held an emergency meeting. They discussed several options regarding potential sources for refinancing, but found them all equally unavailable. The minutes of the Executive Committee make it appear that on that date, the committee approved the purchase of 270,000 shares of Westland Minerals Corp. ("Westland") as an investment for the ailing Knickerbocker. There is, however, substantial reason to question whether such an authorization was actually made on that day. In fact, it appears that the minutes were drawn up later, as part of the screen for the scheme that was subsequently devised to save Universal from default on its loan from Scottish and York.
On June 26th, a shareholders' meeting of Universal was held at the office of Knickerbocker, and Mr. Freedman was present at the meeting. During the meeting, Guminick had several telephone conversations with Denver attorney Salazar. The evidence is unclear on when it was first suggested that Hamilton be contacted and brought into a rescue attempt. It is apparent, however, that a possible short-term solution for the Universal and Knickerbocker problems was devised by Guminick, Hamilton, Salazar and Freedman. The plan was to transfer a substantial amount of Knickerbocker's funds to the parent, Universal, so that Universal would not default on its loan from Scottish and York. With this immediate problem solved, Universal would be saved from collapse and could spend more time searching for a further infusion of new funds.
The screen for this transfer was the purported purchase by Knickerbocker of Westland stock. Immediately after the June 26th meeting, Freedman and Thomajon, the attorney for Knickerbocker, took a Knickerbocker check for $175,000, payable to Freedman, to Denver. In Denver, they met with Hamilton and Salazar. Freedman endorsed the check in blank and gave it to Hamilton, who then endorsed it and deposited most of it in a personal account in the First National Bank of Denver. Hamilton then withdrew $167,500 from a business account (James L. Hamilton and Associates) and wired it back to Universal's account in the Banker's Trust Company in New York City. With this new "financing," Universal was able to meet the payment of the Scottish and York loan and avoid the loss of its insurance company subsidiary.
No transfer of Westland stock, however, was made at this time, nor does it appear that one was intended. Schweitzer and Raymond, the alleged selling principals for Westland, did not appear at the Denver meeting of Hamilton, Salazar, Freedman and Thomajon. A second trip to Denver was made by Freedman and others in July, and at this time a certificate for Westland stock was produced. The certificate was for shares owned by Petroleum Credit Corp., a subsidiary of Westland, and, although not noted on the certificate, the shares were restricted, not tradeable, and had little market value.
(The sham nature of this purported securities transaction is also indicated by the fact that the date of transfer of the certificate was five days prior to the date of issue of the shares.) In any event, the Knickerbocker money was not directly used to pay for the Westland stock. Rather, it was "laundered" by the Denver transfers and returned to Universal in New York, with Hamilton keeping $7,500 of it as a "fee." It appears that in "exchange" for the Westland stock Universal placed some of its Knickerbocker shares in escrow with Salazar.
In addition, Hamilton apparently agreed, as part of a long-range plan for Universal, to loan Universal $1,000,000. This loan was to be extended about one month after the Denver transaction. Hamilton's checks, however, were dishonored, and he failed to attend a meeting in New York at which some of the other principals were expecting him to make good on his promised loan. When the loan did not come through, Knickerbocker was thrown into receivership.
Freedman's admitted involvement in these events is that he accompanied the Knickerbocker check to Denver after helping to bring Guminick, Hamilton and Salazar together; that he was present at the Denver bank when the check was deposited; that he returned to Denver for the second meeting concerning the supposed delivery of Westland stock; and that he attended the subsequent meeting in New York with Guminick, Salazar and others who were awaiting Hamilton's arrival with the $1,000,000 loan for Universal. At that meeting, on August 18, 1970, Knickerbocker paid Freedman $6,500 for his fees and expenses in connection with the Denver trips.
As stated above, the expected rescue by Hamilton, however, never materialized, and the group awaiting his arrival learned, to its substantial chagrin, that he had given them "The Sting" and disappeared from the Denver airport, adding salt to the wound by expropriating Salazar's limousine to facilitate his escape.
The Superintendent argues that Freedman was the "grease that turned the wheel of this conspiracy" to defraud Knickerbocker. In response to this troubling metaphor, Freedman contends that he was unaware that the check he took to Denver was part of a laundering operation intended to shift funds from Knickerbocker to Universal. He also maintains that he had no knowledge of the Westland "purchase" or the use of ...