The opinion of the court was delivered by: KRAM
SHIRLEY WOHL KRAM, U.S.D.J.
This matter is before the Court on the application of the Securities and Exchange Commission ("SEC") for preliminary injunctions, pursuant to 15 U.S.C. §§ 77t(b), 78u(d) and 78u(e), against Christos Netelkos, a/k/a Christopher J. Nickos, Charles Haig Gamarekian a/k/a Charles Haig, Arno Arndt a/k/a Ernst Arndt, and Trust and Investment, A.G., barring violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. The court initially granted a temporary restraining order as to the defendants. Subsequently, extensive hearings were held at which substantial amounts of evidence were adduced by the SEC. Defendants Arndt and Trust and Investment, A.G., did not appear, although it appears that they were properly served in Switzerland pursuant to Rule 4 of the Federal Rules of Civil Procedure. The application for a preliminary injunction against defendants Arndt and Trust and Investment, A.G., will be dealt with in a separate opinion. The other two defendants, Netelkos and Gamarekian, appeared, but limited their presentation to cross-examination of the SEC's witnesses, and presented only three witnesses of their own. When the SEC attempted to call defendants Netelkos and Gamarekian to testify, both refused, invoking their Fifth Amendment privilege.
The SEC in its complaint alleges that defendants Netelkos and Gamarekian violated a veritable laundry list of securities laws and regulations, and seeks preliminary and permanent injunctions against both.Specifically, the allegations are:
- that these defendants, along with others, have violated, are violating and will violate restrictions on selling, buying, offering or delivering unregistered securities, sections 5(a) and 5(c) of the Securities Act of 1933, 15 U.S.C. §§ 77e(a) and (c);
- that these defendants, along with others, violated, are violating and will violate the anti-fraud provisions, section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 781(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder;
- that these defendants, along with others, have aided and abetted, are aiding and abetting and will aid and abet, Falcon Sciences, Inc. in violating registration and reporting requirements, sections 12(g) and 13(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 781(g) and 78m(a), and Rules 12b-20, 13a-11 and 13a-13, 17 C.F.R. §§ 240.12b-20, 240.13a-11 and 240.13a-13 promulgated thereunder; and
- that defendant Gamarekian, along with another person, has aided and abetted, is aiding and abetting and will aid and abet Falcon Sciences, Inc., in violating the transfer agent provisions of sections 17A(c) and 17A(d) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78q-1(c) and 78q-1(d), and Rules 17Ad-6 and 17Ad-7, 17 C.F.R. §§ 240.17Ad-4, 240.17Ad-6 and 240.17Ad-7, promulgated thereunder.
The SEC is empowered by section 20(b) of the Securities Act of 1933, 15 U.S.C. § 77t(b), and sections 21(d) and 21(e) of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78u(d) and 78u(e), in its discretion and "whenever it shall appear . . . that any person is engaged or is about to engage in acts constituting a violation of any provision of (these) (titles) . . ." to bring an action in the proper district court of the United States . . . to enjoin such acts or practices, and upon a proper showing a permanent or temporary injunction or restraining order shall be granted without bond."
Before a preliminary injunction can issue, the SEC must demonstrate (a) a "strong prima facie case" of previous violations, and (b) "a reasonable likelihood that the wrong will be repeated." Securities and Exchange Commission v. Management Dynamics, Inc., 515 F.2d 801, 807 (2d Cir. 1975); Securities and Exchange Commission v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1100 (2d Cir. 1972); Securities and Exchange Commission v. Boren, 283 F.2d 312, 313 (2d Cir. 1960).
This Court has jurisdiction over such suits pursuant to section 22(a) of the Securities Act of 1933, 15 U.S.C. § 77v(a), and sections 21(e) and 27 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78u(e) and 78aa.
Venue is found in this court based on the fact that various of the acts which are alleged to constitute violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 occurred and are occurring within the Southern District of New York. 28 U.S.C. § 1391.
In addition, the SEC seeks other relief in the form of a continued freeze on the assets of the defendants, with significant restrictions on the use of those assets, pursuant to the general equitable powers of the Court.The SEC also seeks a contempt citation against defendant Netelkos for alleged violations of the Court's previously entered Freeze Order and limitations on dispostion of assets.
Each of the defendants was personally served with the summons and complaint along with the Order to Show Cause and the Temporary Restraining Order. As noted above, only two defendants were present at the hearing, although neither testified.
I will address the allegations in the complaint in the order in which they appear above.
The gist of the complaint against these defendants is that they, personally and as representatives of Falcon Sciences, Inc. ("Falcon"), another defendant, misrepresented and omitted material facts from disclosure documents filed on behalf of Falcon with the SEC; sold unregistered and unauthorized or conterfeit shares of Falcon; failed to make required filings with the SEC; failed to maintain statutorily required transfer records; destroyed and altered transfer records; fraudulently created transfer records; concealed their role in the operation of Falcon; and siphoned and secreted monies belonging to Falcon. Given the overwhelming amount of credible evidence that the enumerated violations occurred, and the great likelihood that the defendants will violate the federal securities laws in the future if they are not enjoined, the SEC's application is GRANTED, except as noted below.
Falcon Sciences, Inc., is a publicly-held Utah corporation with its principal place of business in Colt's Neck, New Jersey. Falcon's primary business is the development and marketing of enhanced oil recovery ("EOR") technology. Enhanced oil recovery technology is used to increase the amount of crude oil recoverable from an oil well. It is used primarily after the oil well has stopped flowing or producing on its own. Typically EOR involves pumping water or chemicals under high pressure of high temperature into the well. The water or chemicals loosen the remaining oil from the oil-bearing substrate and displace it, causing the oil to move from the well to the well head, and thereafter to pipeline or wherever the well operator directs it. Obviously, this technology allows the well operator to recover previously unrecoverable oil, which can then be refined or sold. Much EOR development occurred after the Arab oil embargo of 1973, as the world market price of oil increased dramatically. These price increases made justifiable the use of expensive technology to recover oil which had previously been unprofitable.
Falcon was founded in 1977 as Falcon Enterprises, Inc., also a Utah Corporation. SEC Exhibit ("Exh.") 100, p. 4. The name of the corporation was changed in 1982. Exh. 100, P. 4. Thereafter, the company apparently acquired the assets of Reliance Oil and Gas Co. for $250,000 cash and the assumption of liabilities; acquired the assets of the Oil & Gas Capital Fund, Inc., for 1,847,500 shares of Falcon Common stock; acquired the assets of the Mentron Corporation for 3 million shares of Falcon common stock; and, "acquired a number of oil and gas leases" in exchange for 500,000 shares of Falcon common stock. Exh. 100, pp. 4-5.
As of March 1, 1983, the following perosns or entities were known to Falcon to own in excess of five percent of any class of Falcon securities: Paul J. Donnelly; Frank Mentone; Samuel Miller; and Frank Compana. Noticeably absent from this list is Robert Goodman, the holder of some two million shares, allegedly in trust. Exh. 100, p. 17. The following persons were identified as the executive officers and directors of Falcon as of that date: Allen M. Rahm (Director, CEO and Pres.); Kevin J. McCrary (Director, Exec. V.P. -Technical Committee); and Paul J. Donnelly (Director, Secretary and Treasurer). Exh. 100, p. 18.
Falcon acquired what appears to be its primary EOR technology by means of a non-exclusive license agreement entered into on April 20, 1982, with P.D. Utah Corporation. This contract called for Falcon to compensate P.D. Utah Corporation with 45 million shares of Falcon common stock.In return for these shares of stock, P.D. Utah Corporation, through its president, Paul Donnelly, apparently waived its rights to the EOR technology developed by an inventor named Christopher J. Nickos, in favor of a license directlly to Falcon. Exh. 100, p. 90. It is undisputed that Nickos is in fact defendant Christos Netelkos.
As compensation to Netelkos, Falcon obligated itself ot pay a royalty of 2 1/2% of the gross revenues derived from the use of the licensed technology. Exh. 100, p.89.P.D. Utah Corporation subsequently exchanged 40 million of its Falcon shares for 4 million shares of Falcon Class A Common Stock with a par value of one cent ($0.01) per share. Exh. 100, p. 4. Paul Donnelly, also a defendant in this action by reason of his holding the office of president of Falcon, is stated to be the sole shareholder of P.D. Utah Corporation.Exh. 100, P. 16.
The evidence introduced at the hearing demonstrated that after the licensing agreement became effective, and possibly before, Netelkos was an active participant in the day-to-day operation of Falcon under the name Christopher J. Nickos.As Nickos, Netelkos had an office at Falcon's Colt's Neck facility, had a secretary there, drafted and mailed correspondence on Falcon stationery for other people's signatures, drafted Falcon contracts, and supervised Falcon field personnel. Donnelly Dep. pp. 53-54. Netelkos also attended virtually every meeting of Falcon's board of directors, despite the fact that he had no official postition on the board. Donnelly Dep. p. 54; Hearing Transcript ("Transcript") p. 128. Netelkos also ordered a secretary at Falcon to sign Falcon's president's name to Falcon checks payable to him personally, and for a broad variety of personal expenses. Sciotto Dep. pp. 115-137.
Similarly, Charles Haig Gamarekian, then known to the employees of Falcon and others as Charles Haig, was also an active participant in the daily management of Falcon. Specifically, Gamarekian ran the stock transfer operation for Falcon, which functioned as its own transfer agent after April, 1982. He ordered the person doing the necessary record keeping as to what to enter in the computer used for that purpose. Transcript p. 23.He instructed the same person to destroy cancelled Falcon Stock certificates. Transcript p. 26. And he had physical possession of and apparent control over the blank stock certificates. Transcript p. 28. In addition, Gamarekian spent virtually all of his working day at Falcon, contacting broker-dealers to promote sales of Falcon stock. Transcript p. 21; Donnelly Dep. p. 167. His other activities included dealing with at least one chemical supplier on behalf of Falcon, Donnelly Dep. pp. 185-187, and involving himself in field tests of Falcon's EOR device, Donnelly Dep. p. 186.
With respect to the activities of both these individuals while at Falcon, the SEC also introduced an enormous amount of documentary evidence. This evidence included cancelled checks made payable to both, either in the names they used at Falcon, the names of their spouses, or nominee names. Exhs. 1100, 1200. The SEC also introduced a Form 10 (General Form for Registration of Securities) filed by Falcon on April 11, 1983, which fails to mention either Netelkos or Gamarekian. Exh. 100. Nor do various other Falcon press releases and filings with the SEC disclose these associations or the activities of the defendants in Falcon's operations. Exhs. 101-109. These omissions are particularly glaring in light of the fact that Netelkos assisted in the preparation of at least one Falcon financial statement, Donnelly Dep. pp. 30-42, and that Gamarekian assisted in the drafting of a Form 8K for Falcon after he had purportedly left the employ of Falcon, Transcript p. 131. Nor is it revealed in any of the documents introduced by the SEC that Netelkos and Gamarekian controlled Reliance Oil & Gas Corporation ("Reliance"). As noted above, most of the assets of Reliance were acquired by Falcon in transactions in 1982. Notably, testimony at the hearing also revealed much the same pattern of behavior by the defendants at Reliance as was testified to as the norm at Falcon: control without titles; signing, or ordering, checks, contracts and letters signed in other peoples' names; and, a general lack of disclosure. Transcript pp. 218-219; Sciotto Dep. pp. 5-15.Equally notable is the fact that much of this parallel testimony came from different witnesses but concerned the activities of the same two people: Netelkos and Gamarekian.
In a similar vein, other transactions entered into by Falcon were with companies either controlled by Netelkos or in which he played a significant role. Specifically, in 1982, Falcon announced a contract with Hemisphere Energy Resources ("Hemisphere"). Exh. 105. Netelkos controlled Hemisphere by his position there, which was either president or vice-president, depending upon which piece of evidence one believes. Compare Exh. 380.3 #0 with Exh. 350, p. 20. There was apparently no claim by Falcon that this was an arms-length transaction; however, neither was it disclosed that Netelkos was an officer of Hemisphere and occupied a position of authority at Falcon. And, although Falcon apparently rescinded this transaction later, the fact remains that disclosure of Netelkos' involvement with Hemisphere was never made.
Finally, both Netelkos and Gamarekian were deposed by the SEC in the course of the investigation. Exhs. 340,370 and 390. Both Netelkos and Gamarekian invoked their respective Fifth Amendment privileges and refused to answer virtually all the questions put to them. Those questions included inquiries as to the respective defendants' roles in the management and operation of Falcon and various other companies with whom Falcon dealt; the respective defendants' roles and actions in the issuance and transfer of Falcon securities and the preparation and filing of documents required by the Federal securities laws; and, the respective defendants' roles in the management and operation of Falcon and various other companies with whom Falcon dealt; the respective defendants' roles and actions in the issuance and transfer of Falcon securities and the preparation and filing of documents ...