The opinion of the court was delivered by: STEWART
The Securities and Exchange Commission ("SEC") has moved for findings of fact and conclusions of law and entry of an order of disgorgement against Robert L. Vesco, Norman P. LeBlanc, Milton F. Meissner, Ulrich J. Strickler, Stanley Graze, Richard E. Clay and Gilbert R.J. Straub ("the Vesco group"). This opinion constitutes findings of fact and conclusions of law as to some, but not all, of the matters included in the motion.
This action was brought by the SEC in November 1972 under section 27 of the Securities Exchange Act, 15 U.S.C. § 78aa (1976). Extensive hearings were held on a motion for preliminary injunction during the period March 20, 1973 to May 18, 1973. On September 21, 1973, we entered a default judgment of final injunction against LeBlanc, Bahamas Commonwealth Bank, Ltd. ("BCB"), Overseas Development Bank (Luxembourg) ("ODB Lux"), International Bancorp Ltd. ("IBL"), Value Capital Ltd. ("VCL"), Kilmorey Investments ("Kilmorey"), Global Holdings Ltd. ("GHL") and Global Financial Ltd. ("GFL"). A preliminary injunction was issued on November 8, 1973 against Vesco, Meissner, Strickler, Graze, Straub, Frederic J. Weymar, I.O.S. Ltd., the "Dollar Fund" management companies and Kilmorey. Default judgments were entered against Vesco, Meissner, Strickler, Clay and Straub in March 1978. LeBlanc and Vesco were held in civil contempt on October 4, 1978 after hearings in August and September 1978. Trial on the permanent injunction was scheduled to begin on December 20, 1978, but neither counsel for the non-settling defendants nor the defendants themselves appeared for trial.
During the course of discovery in this case, many of the individual and corporate defendants settled the litigation with the SEC. Settlements were reached between the SEC and the following individual defendants: Frank G. Beatty, Wilbert J. Snipes, James Roosevelt, Frederic J. Weymar, C. Henry Buhl III, Allan C. Butler, Laurence B. Richardson, John D. Schuyler, Edward A. Stoltenberg, Howard F. Cerny, Allan F. Conwill, Raymond W. Merritt and John S. D'Alimonte. Settelments were also reached with International Controls Corp. ("ICC") and the IOS Dollar Funds [including Fund of Funds, Ltd. ("FOF"), Venture Fund (International) N.V. ("Venture"), International Investment Trust ("IIT"), and Transglobal Growth Fund, Ltd. ("Growth")] and the respective management companies of the Dollar Funds. In addition to the foregoing, the complaint was dismissed against defendants Georges Phillipe, Bank Cantrade, Ltd. and Consulentia Verwaltungs, A.G.
The SEC now moves to convert the preliminary injunction, issued November 8, 1973, against Stanley Graze, into a permanent injunction. The Commission also moves for an order directing Vesco, LeBlanc, Meissner, Strickler, Graze, Clay and Straub to make an accounting to the court for all moneys misappropriated from the IOS Dollar Funds and from other IOS entities and to make restitution for such misappropriation.
The evidence presented at the 1973 hearings on the preliminary injunction, in the depositions designated by the SEC, and in the testimony and evidence submitted in August and September of 1978 supports a finding of a scheme by VESCO and his group to use ICC to obtain control over the IOS complex, and then to divert substantial assets from the IOS Funds into shell corporations and ultimately into accounts which could be used for the personal benefit of the Vesco group.
A. Vesco and ICC Acquire Control Over IOS
IOS, a Canadian company whose "troubled existence" has spawned numerous lawsuits, was essentially a holding company consisting of a complex of mutual funds and investment companies. Its assets consisted primarily of four mutual funds sometimes collectively referred to as the "Dollar Funds," since their investments were principally concentrated in United States securities. They were FOF (and FOF Proprietary Fund ("FOF Prop"), a wholly owned subsidiary), Venture, IIT and Growth. At the end of 1971, the total net assets of these funds exceeded $400 million. Control of these assets rested with four management companies, each of which had a management contract with one of the funds. These four companies were wholly owned by Transglobal Financial Services, Ltd., a subsidiary of IOS. IOS also held through subsidiaries various real estate, banking and insurance assets.
By the spring of 1970, IOS had fallen on bad times, and accounting personnel determined that it was experiencing liquidity problems and needed cash. Vesco learned of IOS's financial position soon thereafter. At this time, he held the position of President and Chief Executive Officer and twenty-six percent of the common stock of ICC, a Florida corporation engaged in the manufacture of machinery and technical instruments. ICC's shares were registered with the SEC and were (and are now) traded on the American Stock Exchange. At an ICC board meeting in September 1970, Vesco presented a loan agreement calling for ICC to lend $10 million to IOS. The Board approved the loan agreement and, in connection with the transaction as agreed upon, designated Vesco and Meissner, then Vice President and Treasurer of ICC Investments Ltd. ("IIL"), a wholly owned subsidiary of ICC, as members of the Board of Directors, Executive Committee and Finance Committee of IOS. Vesco assumed the position of Chairman of the Finance Committee. On September 4, 1970 IIL entered into a loan agreement with IOS, which was subsequently amended twice, under which IIL loaned $5 million to IOS and made available an additional $5 million over a period of several months. Pursuant to the second amendment in January 1971, IIL limited its credit obligation to $5 million and the note evidencing this indebtedness was made payable on demand. Also, IOS agreed to make deposits of $5.5 million in banks designated by IIL and to pledge such accounts to IIL to collateralize IOS' debt to IIL. IOS also agreed to reimburse ICC for expenses incurred by ICC on IOS business.
On January 15, 1971, Linkink Progressive Corp. S.A. ("Linkink"), a Panamanian shell corporation under Vesco's control, purchased about 6 million shares of IOS preferred stock from Bernard Cornfeld, the former principal shareholder of IOS. In May 1971, Hemisphere Financial Services Ltd. ("HFS") (formerly known as American Interland Ltd.), a wholly owned subsidiary of ICC, purchased all outstanding shares of Linkink from Red Pearl Bay, S.A., another Panamanian shell corporation. By March of 1971, the Board of Directors of ICC authorized the formal purchase of IOS shares. HFS then purchased 3,629,739 of IOS stock option shares, in direct contravention of an injunction issued by the Ontario Supreme Court. From January 1971 to December 1971, ICC through its subsidiaries HFS and IIL, acquired approximately 45 percent of the outstanding IOS preferred shares and 28 percent of the outstanding IOS common shares. The preferred shares as a class were entitled to elect two-thirds of the IOS Board of Directors. On February 25, 1971, Vesco was elected Chairman of the Board of IOS.
B. The Spin-off of IOS Assets
As we have already stated, IOS' principal assets, other than mutual funds, were its banking operations, insurance operations and real estate. In October 1971, IOS transferred its principal banking operations, including ODB Lux, to IBL, a new Bahamian corporation, in return for various notes, debentures and common stock. Weymar, a former director of Butlers Bank and a Vesco associate, had purchased the stock of BCB. Simultaneously with its acquisition of the banking assets, IBL sold 30 percent of its shares to Weymar in exchange for all the common stock of BCB. Then in October 1971, the IBL shares received by IOS were distributed to its shareholders. ICC received 1,760,767 common shares of IBL and $1,760,767 of $1 par value 7 percent debentures of IBL. Thus ICC controlled 22 percent of IBL which, when added to the 30 percent owned by Weymar, totaled 52 percent.
A similar transaction was effected with respect to the real estate and insurance assets. By an agreement dated December 14, 1971, IOS transferred to VCL, a Bahamian corporation, certain substantial real estate and insurance assets, including (1) the shares of IOS Real Estate Holdings Ltd. ("IOSREH"), which managed property and held the voting shares of Investment Properties International Ltd. ("IPI"),
(2) the shares of IPI Management Co., Ltd. and Resources Services Ltd.,
(3) the shares of certain IOS insurance companies, (4) the right to acquire certain rights and shares of mutual fund management and related companies, and (5) the right to acquire from IOS its equitable right, title and interest in the voting or management shares of certain mutual funds, including the Dollar Funds. In return for these assets, VCL transferred its shares to IOS, which were then distributed to the shareholders of IOS. ICC received through its subsidiaries the sum of 2,360,767 common shares of VCL, giving it a 38 percent controlling interest in VCL. Thus, by the end of 1971, Vesco had achieved substantial control of IOS and spun-off its banking, real estate and insurance assets into new corporations controlled by ICC.
C. The Plan to Close-End the Funds
1. ABC N.V. and VCL-IPI-PRL
At the close of 1971, the four Dollar Funds had over $440,000,000 in net assets. Each of the Funds relied heavily in its investment strategy, as stated in the prospectus of each of the Funds, on investments in the United States securities market. All of the Funds were open-ended and highly liquid.
Vesco determined to alter the structure and investment strategy of the Funds by close-ending the Funds. Initially, he intended to carry this out by forming a global corporation to which substantially all the IOS assets would be transferred in return for a one-third interest. ICC would own another one-third interest and the remaining third would be sold to the public. The code name for the proposed corporation was ABC N.V. Essential to the plan was an estimated $150 million believed to be locked into the Funds, the so-called "hot money" which could not be redeemed because it was thought to have been invested in violation of the laws of the investors' countries.
Such a reorganization of IOS into ABC N.V., however, was not accomplished. By early 1972, Vesco had changed his plan to one in which the assets of the various funds (which in large part were readily marketable U.S. securities) would be liquidated and the liquid assets would be reinvested in the new entity, ABC N.V. Vesco envisaged that the new entity was to be a subsidiary of FOF Prop which would purchase $50 million in the stock and debentures of ABC N.V. It was also contemplated that Venture Fund and IIT would make substantial investments in ABC N.V. Since the securities of the latter would have no ready market, close-ending was necessary to avoid the eventuality of insufficient cash for redemptions.
Vesco asked a New York law firm to review his plan. At a meeting in mid-January at the firm's office in New York, a group of lawyers drafted a confidential memorandum analyzing the proposed transaction and concluding that such actions might constitute a breach of fiduciary duty by the directors and investment managers of the Funds.
At a subsequent meeting at ICC in Fairfield, New Jersey on January 27, 1972, the ABC N.V. transaction was considered by a group including Vesco, Beatty, Clay, and various lawyers and accountants. The mechanics of setting up the new entity were discussed, as well as the question of how much notice or time must be given to fund-holders prior to close-ending their funds.
Vesco also discussed a proposal for the amalgamation of VCL and two valuable entities outside VCL, IPI and GRNP. The code name for the new IOS real estate entity was Newco. Under the proposal, VCL was to receive 10,000 Class A shares of Newco in exchange for the 10,000 voting shares of IPI, which had been placed in VCL pursuant to the December 14, 1971 agreement. VCL was also to receive an additional 6,000,000 non-voting shares of Newco in exchange for other VCL assets including among other things the management contracts for IPI and GNRP, and former IOSREH real estate management assets. The aggregate book value of the foregoing VCL assets was $13 million. Newco was to acquire the net assets of IPI (approximately $95,000,000) for 10,800,000 Newco non-voting shares. VCL was receiving far too many shares for the asset it was contributing compared with the small number of shares IPI was receiving for contributing assets valued at over seven times the VCL assets. It was also contemplated that Newco would acquire the net assets of GNRP (less the 5,100,000 IPI common shares held by GNRP) which net assets had a book value of $31 million for 2,200,000 Newco non-voting common shares.
Both the ABC N.V. and the Newco
transactions were opposed by the lawyers who considered the transactions because they considered them of doubtful legality and unfair. It also appeared that ICC, as a controlling shareholder of VCL, could be charged with a breach of fiduciary duty because of the unfair structure of the proposed transactions. When Vesco informed IOS' Canadian counsel of his intention to pursue the proposed plans, the latter submitted his resignation from any further representation of IOS entities.
2. The Kilmorey Transaction
The SEC investigation, which culminated in this proceeding, was begun in the latter part of 1971 and was well underway by the spring of 1972. The minutes of an ICC board meeting on March 9, 1972 indicate that Vesco noted "the harassment tactics used by the Securities and Exchange Commission in its issuance of subpoenas to third parties in connection with its investigation of the Corporation had been injurious to the Corporation's reputation . . .". The minutes of March 28, 1972 state that Vesco "gave an intensive review of the status of the Securities and Exchange investigation of the Corporation and the harassing tactics being employed" by the SEC. These minutes then state that the Corporation had received an offer from Kilmorey Investments Ltd.
to purchase ICC's interest in IOS. The board approved the sale.
On March 27, 1972, Vesco wrote a letter to the SEC informing it of ICC's intention to divest itself of IOS shares and their sale to present members of IOS management. Immediately preceding the deadline for ICC's filing with the SEC of its Form 10-K, ICC sold the shares of its two subsidiaries, HFS and IIL, which held the IOS shares (approximately 17,600,000 preferred and 6,000,000 common) to Kilmorey. Prior to the closing, Vesco removed the IBL and VCL shares from HFS and IIL and distributed them as dividends to ICC so that ICC received a 22 percent interest in IBL and a 38 percent interest in VCL. HFS and IIL executed unsecured promissory notes totaling about $650,000 in payment of certain intercompany indebtedness. Also as consideration for the sale of the subsidiaries holding the IOS shares, ICC received $200,000 in cash and an unsecured promissory note from Kilmorey in the amount of $300,000.
The most substantial consideration, however, purported to be a tax indemnification agreement given to ICC by Kilmorey to indemnify ICC against tax liabilities arising from its investments in IOS. There was testimony indicating that the sole reason for the tax indemnification agreement was so that a $1 million profit would be reported on the transaction. No note supporting the agreement was given by Kilmorey, and the collectability of amounts owed under the agreement was to say the least unclear.
A Form 10-K and press release filed in early April 1972 announced the termination of ICC's control of IOS and its subsidiaries. These statements did not disclose the non-arms length nature of the transaction or the questionable likelihood of payment under the tax indemnification agreement, or Vesco's continued participation in and control of IOS, VCL, IBL and IPI. The Kilmorey transaction accomplished Vesco's objective not only of removing the IOS shares from ICC, but also of separating those shares from the VCL and IBL shares held by ICC.
D. Transfer of Depository Functions for the Dollar Funds
A traditional selling point of the IOS funds, which was emphasized in their prospectuses, was that substantial and established financial institutions, such as the Bank of New York and Credit Suisse, acted as custodians of cash and securities.
In the period March through October 1972, Vesco and his Group embarked upon a plan to remove independent banks from any control over the cash and securities of the Funds, and to place the Dollar Fund moneys and securities with two banks owned by IBL, BCB and ODB Lux. Vesco and his associates could then exploit the Dollar Funds' assets at will. In addition, this aspect of the scheme would provide a ready source of liquid deposits to bolster the financial condition of BCB and ODB Lux.
In March 1972 ODB Lux was made depository of cash for FOF, IIT and Venture Fund in place of Credit Suisse, which had acted as cash depository for these funds until that time. Credit Suisse had total assets of $2.7 billion; for the year ended December 31, 1971, ODB Lux had assets of $24 million and capitalization of $1,250,000. The transfer was made despite the opposition of Solomon, an accountant who was an investment advisor and portfolio manager of IOS funds (he resigned in January 1972 after Vesco arrived on the scene). Solomon testified that he told Vesco that "[ODB Lux] was a tiny bank, and by the standards of the amount of funds we were talking about was probably terribly undercapitalized. I felt that they did not have the mechanical or administrative machinery to handle this. And, lastly, I felt that the prospectus represented to fund buyers that they would have a sizeable international independent bank looking over the custodial function of their funds."
In April 1972 American National Bank & Trust Company of New Jersey was made cash depository for Growth Fund and FOF Prop, in place of Bank of New York ("BONY"). In the fall of 1972, ODB Lux also became the cash depository of these two Funds. Subsequently, BCB was made sub-custodian of cash for ODB Lux and by November 1972 the latter had transferred $176,920,000 to BCB.
Until April 1972 BONY had been custodian of all securities for Venture Fund, FOF, FOF Prop and Growth Fund. It was also sub-custodian for all United States securities of IIT, the primary custodian being Montreal Trust Co. On April 26, 1972 American National was appointed custodian of securities for all of the Funds. Subsequently, in ...