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SEC v. AMERICAN BD. OF TRADE

UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK


August 15, 1986

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
THE AMERICAN BOARD OF TRADE, INC., ARTHUR R. ECONOMOU, PHYLLIS H. ECONOMOU, and THE AMERICAN BOARD OF TRADE SERVICE CORP., Defendants

The opinion of the court was delivered by: KRAM

MEMORANDUM OPINION AND ORDER

SHIRLEY WOHL KRAM, U.S.D.J.

By order to show cause dated August 7, 1986, the Securities and Exchange Commission ("SEC") sought an order to freeze the funds and other assets of the defendants' unregistered commercial paper program. The order to show cause was returnable on August 8, and the Court heard oral argument on that date. At the conclusion of the argument, the Court issued a temporary restraining order ("TRO") barring the defendants from dissipating any assets from their commercial paper program for a period of ten days. SEC v. ABT, No. 83 Civ. 6213 (SWK), slip op. (S.D.N.Y. August 8, 1986). The Court also set a briefing schedule on the SEC's application for an order freezing the assets. *fn1"

 The Court set a tight briefing schedule on the motion to freeze the assets because of the seriousness of the issue and because the defendants had notice, at least since a pre-trial conference held on July 28, 1986, that the SEC would be making this application. Moreover, at a pre-trial conference held on May 30, 1986, the defendants were orally ordered by the Court not to transfer or dissipate assets. Thus, the defendants have had ample time to formulate a response to the SEC's application, and they cannot legitimately complain of any unfair surprise by, or lack of notice of, this application.

 Currently before the Court is the SEC's application to freeze the funds and assets of the defendants' unregistered commercial paper program. The freeze order would last until the Special Master issues his report and the Court formulates and implements a wind-down program. The SEC's application must be considered in the context of the current posture of this case. On July 25, 1985, this Court entered a preliminary injunction against the corporate defendants ("ABT"). That injunction prevented ABT from issuing unregistered commerical paper. That injunction was stayed by its own terms for an extended period of time. After the defendants failed to register their commercial paper program the Court, in an order dated May 30, 1986, lifted the stay of that injunction. The May 30 order also precluded the defendants from redeeming maturing commercial paper. The defendants appealed this Court's injunction, and this Court was affirmed on August 8, 1986. See SEC v ABT, 798 F.2d 45 (2d Cir. 1986). Thus, there is no longer any doubt as to the appropriateness of this Court's injunction and of the unlawfulness of defendants' commercial paper program.

 On July 31, 1986, the Court appointed a Special Master to complete a full accounting of the financial condition of the ABT entities, and to assist in implementing a wind-down of the defendants' commercial paper program. The appointment of a Special Master was necessitated by the defendants' unwillingness and inability to present the Court and the SEC with an accurate picture of their financial condition. The Special Master is to present his report to the Court by October 1, 1986. It is against this background, and based on the entire record in this case, that the SEC now seeks to freeze the funds and assets of the defendants' commercial paper program; a program which is currently subject to a preliminary injunction.

 The SEC's position is easily summarized. It contends that as of May 19, 1986, the last date for which financial information has been produced, the defendants had $83.2 million in outstanding commercial paper and only $23.1 million in liquid assets to apply towards this liability. Thus, the defendants are grossly insolvent. Moreover, the defendants' can no longer raise money through the sale of commercial paper. In view of this, it is imperative to preserve the assets of the commercial paper program to prevent irreparable harm to the commercial paper holders, who number approximately 9,100, according to the SEC.

 The SEC further contends that the defendants have depleted the available assets through expenditures on advertisements for the sale of ABT and bulletins distributed to the noteholders. The SEC does not object to the existence and distribution of the advertisements and bulletins. Rather, it simply objects to any expenditure which depletes the assets of the commercial paper program; assets which appropriately belong to the 9,100 commerical paper holders. The SEC also submits, presumably as evidence of the defendants' intentions to further deplete assets, that on June 2, 1986 the defendants raised the discount rates on their commercial paper to 10%. Thus, the SEC simply wants to prevent any further dissipation of the commercial paper program's assets. Its concern, and the Court's concern, is heightened by the defendants' apparent gross insolvency. The SEC is not seeking to freeze all of the defendants' assets; only the assets of the commercial paper program are to be frozen. Moreover, the SEC is not seeking to close the defendants' business or to have a receiver appointed.

 The defendants' response to the SEC's contentions are unresponsive and contradictory. At oral argument on the SEC's TRO application the defendants contended that the SEC's moving papers were untrue and an attempt to mislead the Court. This contention is frivolous, unsupported, unresponsive and dismissed out of hand. The defendants alternatively argued that a freeze order was inappropriate in view of their pending appeal before the Second Circuit Court of Appeals.

 On August 8, however, the Second Circuit issued its opinion affirming this Court's injunction. That opinion was issued subsequent to oral argument. Thus, this contention is no longer meritorious.

 In their reply papers to the SEC's application, which consists solely of a four page affidavit of Arthur Economou, the defendants apparently no longer object to an order freezing the assets of the unregistered commercial paper program. Rather, they ask that assets which are not a part of the commercial paper program not be frozen. Neither the Court nor the SEC has a problem with this proposition in general at this point in time.

 It is apparently undisputed by the defendants that the Court has the authority to enter an appropriate freeze order such as the one sought by the SEC in its application. The defendants' consent notwithstanding, it is indisputable that the Court, as part of its equity jurisdiction, can enter such an order. See SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1103-1106 (2d Cir. 1972). The Second Circuit has explained:

 Once the equity jurisdiction of the district court has been properly invoked by a showing of a securities law violation, the court possesses the necessary power to fashion an appropriate remedy.

 Id. at 1103. In the instant case, the Court has already determined that the defendants violated the federal securities laws by issuing unregistered commercial paper, and has enjoined them from continuing this practice. The very serious question remains, however, how to protect and compensate the 9,100 holders of the defendants' commercial paper. It is that question which the Court now must address.

 "... [T]he decision to order a temporary freeze on defendants' assets as ancillary relief in an SEC enforcement action requires particularly careful consideration by the district court." Manor Nursing Centers, Inc., at 1105. The Second Circuit has stated:

 ...[T]here may be circumstances where a district court should temporarily freeze defendants' assets to insure that they will be available to compensate public investors. Freezing assets under certain circumstances, however, might thwart the goal of compensating investors if the freeze were to cause such disruption of defendants' business affairs that they would be financially destroyed. Thus, the disadvantages and possible deleterious effect of a freeze must be weighed against the considerations indicating the need for such relief.

 Id. at 1106.

 In the instant case, the problem of compensation to public investors is significant. The full gravity of the situation at this point is impossible to determine largely because of the defendants' total failure to maintain, and produce to the Court, accurate financial records. This failure was so great as to necessitate the appointment of a Special Master to construct this information for the SEC and the Court.

 Accepting the defendants' own prior statements as true for purposes of this motion -- statements which are now over two months old in any event -- there is in excess of $80 million in commercial paper held by approximately 9,100 public investors and less than $24 million in liquid assets to satisfy these liabilities. Moreover, the defendants have not even suggested, let alone demonstrated, that their gross insolvency has significantly improved in the past two months. *fn2"

 The freeze order sought by the SEC would apply solely to funds and assets of the enjoined commercial paper program. Moreover, since that program is now entirely frozen there should be no legitimate expenses incurred as ancillary to the operation of that program. *fn3" The freeze order is also for a limited duration. The assets would remain frozen only until the Special Master's report is completed and a wind-down program approved and implemented. Indeed, the assets to be frozen are those to be utilized as part of the wind-down program and rightfully belong to the 9,100 noteholders in any event.

 The Court is aware that a freeze order may cause some disruption to the business affairs of the defendants. The narrowly tailored freeze order outlined above, however, should minimize the disruption. Any disruption which occurs despite the properly tailored order is occasioned by the defendants' conduct and by their failure to thus far produce an accurate, comprehensive financial picture of their business operations and of the commercial paper program in particular. Thus, it is the defendants, and not the public investors, who should bear the consequences of any disruption. The need to freeze assets is greatly heightened by Economou's affidavit of compliance dated August 13, 1986. This affidavit outlines a significant depletion of funds, to the tune of over $5 million in only the past six weeks.

 At oral argument, and in an opposing affidavit, Arthur Economou argued that in excess of $1.2 million frozen by this Court's August 8 TRO are customers' funds from the defendants' trading programs. This contention is not only unsupported; it is contradicted by Economou's earlier statements to the Court. Annexed to the affidavit of Arthur Economou dated May 20, 1986, was exhibit B. This was submitted at the Court's request and apparently prepared at Economou's request. Exhibit B is entitled "ABT Service Corp. Commercial Paper Program Cash Inflow/Outflow From Oct. 4, 1985." The exhibit outlines the liquid assets derived from and attributable to the defendants' unlawful commercial paper program. It was clearly presented to the Court as such when it was first submitted to the Court. At oral argument the defendants' argued for the first time, in stark contrast to and in direct contradiction of their earlier submissions, that some portion of the "exhibit B" funds are not attributable to the commercial paper program. In Economou's affidavit of August 12, 1986, he argues that in excess of $1.2 million in customers' trading funds were erroneously included in exhibit B of bis earlier affidavit. Defendants' position is neither credible nor supported by a shred of evidence. The Court thus rejects this contention at this time. The defendants can attempt to support their contentions with adequate, credible, documentary evidence. If they do, the court will reconsider its position.

 In view of the foregoing, the Court concludes that the carefully tailored freeze order sought by the SEC should be granted. Accordingly, it is hereby:

 ORDERED that, pending further order of this Court, all assets, funds and other property of defendants' unregistered notes program are temporarily frozen and defendants, their agents, officers, employees, servants, and attorneys, and those persons in active concert or participation with them, and each of them, be and hereby are preliminarily enjoined from dissipating, liquidating, assigning, transferring, encumbering or otherwise disposing of any funds, assets or other property, of their unregistered notes program, including but not limited to all of the assets delineated in exhibit B annexed to the affidavit of Arthur Economou dated May 20, 1986.

 This order shall remain in place until the Special Master's Report is completed and the Court has approved and implemented a wind-down program. This order applies with equal vigor to any assets, funds or property previously acquired, in whole or in part, by the defendants with funds from the sale of commercial paper.

 SO ORDERED.


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