The opinion of the court was delivered by: SWEET
The Securities and Exchange Commission ("SEC") seeks a declaration that defendants Martin Hecht ("Hecht") and Inventel Corporation ("Inventel") have violated Sections 5(a) and 5(c) of the Securities Act of 1933 ("the Securities Act"), 15 U.S.C. §§ 77e(a) and 77e(c) ("the registration provisions"), and Sections 17(a) of the Securities Act, 15 U.S.C. § 77q(a), Section 10(b) of the Securities Exchange Act of 1934 ("the Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder ("the antifraud provisions"). The SEC also seeks a permanent injunction barring the offering and sale of securities in the form of investment contracts. The declaration will be entered in the form of a judgment and the injunction will be granted as set forth below.
This action was commenced on September 30, 1980 by the filing of a complaint, and a motion for preliminary injunction was filed on December 19, 1980. The SEC sought to restrain the defendants, Aqua-Sonic Products Corp. ("Aqua-Sonic"), Ultrasonic Dental Products, Inc. ("Ultrasonic"), Leon Schekter ("Schekter"), M. Joshua Aber ("Aber"), Dentasonic, N.V. ("Dentasonic"), Melvin Hersch ("Hersch"), Hecht and Inventel from certain conduct about to be described. Discovery was expedited, the preliminary injunction motion was adjourned, and the defendants' motion for summary judgment seeking dismissal of the complaint for lack of jurisdiction was denied on June 3, 1981. Thereafter, all defendants except Hecht and Inventel entered into consent decrees and the SEC discontinued its action against them.
From June 10 to June 17, 1981 the SEC motion for preliminary injunction against Hecht and Inventel, the remaining defendants, was tried to the court and consolidated with the trial on the merits pursuant to F.R.Civ.P. 65(a). What follows are the court's findings of fact and conclusions of law.
Arthur Kuris ("Kuris") and Aber were neighbors and friends, the former being an inventor and patent holder and the latter an attorney. Kuris had obtained patents applying the principles of ultrasonic wave propagation to various fields, one of which was dentistry. A device under the trade name of Cavitron was developed and marketed. The Cavitron gained wide acceptability among dentists and employed ultrasonic waves to dislodge plaque in the course of dental prophylaxis. The operation of the Cavitron required a coolant which was provided by a spray of water originating from the customary sources.
Kuris conceived of an improvement of the Cavitron which would employ sterile water as the coolant for the ultrasonic process and would thereby reduce the risk of any contamination resulting from micro-organisms which might be found in tap water.
These new products for which Kuris held patent rights were termed Steri Products. One of the products, known as the Steri Prophy Unit, was designed as a complete, self-contained ultrasonic prophylaxis unit utilizing pre-packaged sterile water. The other Steri Product, called the Steri Satellite Unit, was designed to be affixed to existing dental equipment to supply pre-packaged sterile water.
After discussions with Aber, in early 1978 Kuris met with Aber's partners Hecht and Schekter to develop a plan to market and distribute these Steri Products. The lawyers had formed a professional corporation then called Schekter, Aber and Hecht, P.C. ("SAH"). As a consequence of these discussions, four corporations were established by Schekter, Aber and Hecht: Aqua-Sonic and Ultrasonic, New York corporations; Dentasonic, a Netherlands Antilles corporation; and Inventel, a Delaware corporation. Schekter, Aber and Hecht were the original shareholders of Dentasonic until November, 1978 when Kuris acquired a 19% interest. The shares in both Aqua-Sonic and Ultrasonic were held by sole shareholders, their respective principal officers. The original shareholders of Inventel were Schekter, Aber and Hecht until February of 1979, at which time the corporation redeemed the shares of Schekter and Aber, leaving Hecht the sole shareholder.
Immediately after incorporation, Dentasonic purchased from Kuris the patent and other related rights to the Steri Products for the United States and Canada for $ 406,500 payable in installments. Kuris retained a security interest in the patent and other rights conveyed to Dentasonic. Dentasonic sold only the United States marketing and manufacturing rights to the Steri Products to Aqua-Sonic, which had been incorporated in April 1978, for $ 26 million pursuant to an agreement dated June 1, 1978, this sum to be paid not only from a percentage of the proceeds from the sale by Aqua-Sonic of licenses to sell the Steri Products, but also from a percentage of the profits received by Aqua-Sonic from actual product sales. Until payment of the $ 26 million Dentasonic retained a security interest in the rights conveyed to Aqua-Sonic, held certain voting rights to all of Aqua-Sonic's stock and was given a security interest in certain accounts receivable and contract rights, certain inventory and inventory records, equipment, inventions, patent rights and trademarks in all products and proceeds of Aqua-Sonic.
SAH developed certain materials for Aqua-Sonic describing its proposed method of doing business ("the promotional materials") to be set forth more fully below. In short, Aqua-Sonic proposed to sell to licensees the right to sell Steri Products in certain specified geographical areas. Ultrasonic was described as an optional sales agent for the licensees. Inventel, which was not described, entered into a letter agreement with Aqua-Sonic by which Aqua-Sonic agreed to pay Inventel $ 2.2 million, ostensibly as a finder's fee for bringing about the sale of the rights in the Steri Products from Dentasonic to Aqua-Sonic and for past and future consulting services. Under the letter agreement, Aqua-Sonic agreed to pay Inventel a portion of the proceeds from the sale of licenses and the sale of the Steri Products and related patents or trademarks.
The Promotional Materials
After the corporations were organized, in the course of the preparation of the promotional materials, SAH sought an opinion of another law firm, Messrs. Baer, Marks & Upham, with respect to the applicability of the securities law to the proposed enterprise. SAH received a memorandum in or about May, 1978 from an associate of that firm, Barry Mandel, a prescient lawyer as things have turned out, to the effect that the license arrangement might be considered an investment contract. The partners at SAH directed one of their associates to research the issue in the summer of 1978, and after considerable discussion concluded otherwise. The promotional materials were modified as set forth below and the enterprise proceeded.
A market consultant was retained and for $ 500 provided an analysis of the available market based primarily on the use of Cavitron, and the marketing practices in the industry which included the use of so-called dental depots, in effect, wholesale houses offering dental supplies to all kinds of dentists, a focal element in the licensing plan. Also, Kuris obtained and passed on to Hecht a letter from a Dr. Henry Goldman, an apparently well-regarded dental authority, which could be construed as an endorsement of the Steri Products. The letter was described succinctly by Hecht in his investigative testimony, who realized the need to overcome the resistance of dentists who were going to be told that their present machines were unhygienic. Hecht likened their attitudes to those of the 19th century surgeons who would say to Pasteur "Get out of here Louis." In addition, an article in the Journal of Periodontology entitled "Microbial Contamination of Dental Units and Ultrasonic Scalers" was obtained.
Prototype models had been developed, and Logical Technical Services ("LTS"), an engineering firm specializing in electronic applications, was retained in late 1978 to convert them into finished marketable products.
With these preparations in hand or in contemplation, certain documents were prepared to be used in the enterprise. During the period from on or about May 1, 1978 through August 31, 1978, these promotional materials were developed and used in discussions with potential licensees or their representatives. These included:
(a) an Information Memorandum describing the Steri Products and the nature of the offering, with exhibits attached thereto including a tax opinion letter prepared by SAH and financial illustrations projecting sales of the products and revenues.
(b) the Aqua-Sonic license and security agreement and notes payable to Aqua-Sonic (prior to inclusion of the so-called Advertising Fund to be discussed below), and related instructions.
(c) a document entitled "An Offer to Act as Sales Agent."
(d) the Ultrasonic sales agency agreement, security agreements, and notes payable to Ultrasonic (prior to inclusion of the Advertising Fund), and related instructions.
(e) a reprint of the aforementioned article by Arthur Gross (and others) from the Journal of Periodontology.
(f) a four-page document entitled "Confidential for Professional Use Only."
During the period from on or about September 1, 1978 through October 31, 1978, the following documents were used in a two-pocketed packet, the second version of the offering package.
(a) a new Information Memorandum Relating to Exclusive Rights revised to reflect, among other things, certain management changes at Aqua-Sonic, the tax opinion letter and financial illustrations.
(b) the Aqua-Sonic license and security agreement and notes payable to Aqua-Sonic and related instructions.
(c) a document entitled "An Offer to Act as Sales Agent."
(d) the Ultrasonic sales agency agreement, security agreements, and notes payable to Ultrasonic and related instructions.
(e) two large professional photographs of what appeared to be a completed Steri Prophy Unit and Steri Satellite Unit such as would be sold.
(f) The Journal of Periodontology article.
(g) a copy of a letter dated September 12, 1978, to Aqua-Sonic from E. A. Greenlee, President of LTS, concerning the commercial production of the Steri Products.
(h) a copy of the letter dated August 22, 1978, to Kuris from Dr. Henry Goldman.
A third and final version of the materials in use after November 1, 1978, consisted of the documents contained in the second version plus the following documents:
(a) a letter dated November 1, 1978 signed by defendant Hersch with attachments relating to the creation of the Steri Products, Advertising Fund and supplemental tax opinion by SAH.
(b) a package of revised closing documents relating to the license, sales agency and Advertising Fund, and
(c) a revised summary of the offering entitled "Confidential for Professional Use Only-Summary of Revised ...