Opinion ID: 302963
Heading Depth: 1
Heading Rank: 4

Heading: Ancillary Relief Granted

Text: 67 In addition to granting the SEC's request for injunctive relief, the district court ordered appellants to disgorge all the proceeds, profits and income received in connection with the public offering of Manor stock; appointed a trustee to receive such funds, to distribute them to defrauded public investors and to report to the court on the true state of affairs; and, to prevent a wasting of assets, ordered a temporary freeze on appellants' assets pending transfer of the funds to the trustee. With the exception of one aspect of these provisions of the district court's order, we hold that the grant of this ancillary relief was a proper exercise of the district court's equity powers. 68 It is now well established that Section 22(a) of the 1933 Act, 15 U.S.C. Sec. 77v(a) (1970), and Section 27 of the 1934 Act, 15 U.S.C. Sec. 78aa (1970), confer general equity powers upon the district courts. SEC v. Texas Gulf Sulphur Co., supra, 446 F.2d at 1307; SEC v. S & P National Corporation, 360 F.2d 741, 750 (2 Cir. 1966); Lankenau v. Coggeshall & Hicks, 350 F.2d 61, 63 (2 Cir. 1965); Esbitt v. Dutch-American Mercantile Corporation, 335 F.2d 141, 143 (2 Cir. 1964). 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. Thus, while neither the 1933 nor 1934 Acts specifically authorize the ancillary relief granted in this case, [i]t is for the federal courts to adjust their remedies so as to grant the necessary relief where federally secured rights are invaded. J. I. Case Co. v. Borak, 377 U.S. 426, 433 (1964). Accord, Deckert v. Independence Corporation, 311 U.S. 282, 288 (1940). Moreover, as the Supreme Court said in Mills v. Electric Auto-Lite Co., 396 U.S. 375, 391 (1970): [W]e cannot fairly infer from the Securities Exchange Act of 1934 a purpose to circumscribe the courts' power to grant appropriate remedies. It is true that Mills and Borak involved relief to private litigants. Nevertheless, we recently said that we deem the above statement [in Mills] to be fully applicable in enforcement actions by the SEC. SEC v. Texas Gulf Sulphur Co., supra, 446 F.2d at 1308. Accordingly, we reiterate our previous holding in Texas Gulf Sulphur that the SEC may seek other than injunctive relief to effectuate the purposes of the federal securities laws. 446 F.2d at 1308. 69 Appellants contend that, even if the district court had the power to grant ancillary relief, the relief granted was inappropriate in this case. We hold, with the exception of the one aspect of the district court's order referred to below, that the grant of ancillary relief in the instant case was supported by ample precedent. 70 Clearly the provision requiring the disgorging of proceeds received in connection with the Manor offering was a proper exercise of the district court's equity powers. The effective enforcement of the federal securities laws requires that the SEC be able to make violations unprofitable. The deterrent effect of an SEC enforcement action would be greatly undermined if securities law violators were not required to disgorge illicit profits. As Judge Waterman said in SEC v. Texas Gulf Sulphur Co., supra, 446 F.2d at 1308: It would severely defeat the purposes of the Act if a violator of Rule 10b-5 were allowed to retain the profits from his violation. Accord, SEC v. Golconda Mining Co., 327 F.Supp. 257, 259 (S.D.N.Y.1971). We hold that it was appropriate for the district court to order appellants to disgorge the proceeds received in connection with the Manor offering. 71 Having held that ordering the refunding of the proceeds was a proper exercise of the district court's equity powers, we hold that the court erred in ordering appellants to transfer to the trustee all the profits and income earned on such proceeds. As we noted in SEC v. Texas Gulf Sulphur Co., supra, 446 F.2d at 1308, the SEC may seek other than injunctive relief, so long as such relief is remedial relief and is not a penalty assessment. We believe that ordering the disgorging of profits and income earned on the proceeds is in fact a penalty assessment. This provision of the order cannot be justified as remedial relief to purchasers of Manor shares. As defrauded purchasers in a private enforcement action, public investors would be entitled to recover only the excess of what they paid over the value of what they got. Levine v. Seilon, Inc., 439 F.2d 328, 334 (2 Cir. 1971). While not conclusive, we think that it is significant that defendants in private litigation would not be required to pay defrauded purchasers the profits on the proceeds. See Janigan v. Taylor, 344 F.2d 781, 786 (1 Cir. 1965). Moreover, refunding the profits on the proceeds cannot be justified as compensation to the issuing corporation for harm done to it by its officers and employees. See SEC v. Texas Gulf Sulphur Co., supra, 446 F.2d at 1308. The concept of harm to the corporation should not apply here, particularly where one appellant, Feinberg, now completely controls the corporation and any compensation paid to the corporation would simply go into his pocket. Furthermore, as previously noted, Manor is now only a corporate shell. 72 The only plausible justification for this part of the court's order is that the deterrent force of requiring the disgorging of the profits on the proceeds is essential to effective enforcement of the federal securities laws. In balance, however, we believe that the injunctive relief and the requirement that the proceeds be returned are sufficient deterrence to further violations. While compelling the transfer of the profits on the proceeds arguably might add to the deterrent effect of the court's order, this in our view does not justify arbitrarily requiring those appellants who invested wisely to refund substantially more than other appellants. Accordingly, we reverse that part of the court's order which provides for disgorgement of the profits and income earned on the proceeds, and remand to the district court for modification of its order so as to require appellants to transfer to the trustee only the proceeds received in connection with the Manor offering, together with interest at the New York legal rate from the date appellants received the proceeds. See SEC v. Texas Gulf Sulphur Co., 312 F.Supp. 77, 93 (S.D.N.Y.1970), aff'd, 446 F.2d 1301 (2 Cir.), cert. denied, 404 U.S. 1005 (1971). 73 Appellants also contend that the district court abused its discretion by appointing a trustee to receive the proceeds, to distribute them to defrauded public investors and to report to the court on the true state of affairs. Despite the absence of explicit statutory authority, however, we repeatedly have upheld the appointment of trustees or receivers to effectuate the purposes of the federal securities laws. SEC v. S & P National Corporation, 360 F.2d 741, 750 (2 Cir. 1966); Lankenau v. Coggeshall & Hicks, 350 F.2d 61, 63 (2 Cir. 1965); Esbitt v. Dutch-American Mercantile Corporation, 335 F.2d 141, 143 (2 Cir. 1964). 74 Moreover, while the appointment of trustees should not follow requests by the SEC as a matter of course, the appointment of a trustee in this case was an appropriate exercise by the district court of its equity powers. 27 Because of the conflicting accounts of the Manor offering given by various appellants and the numerous bootstrap transactions, it was impossible for the district court to determine, on the record before it, the total amount of proceeds collected and the exact amount each appellant received. Thus, the appointment of a trustee to help preserve the status quo while the various transactions were unraveled was necessary to obtain an accurate picture of what transpired. Moreover, without the appointment of a trustee, it would be difficult to implement the court's order to refund the misappropriated proceeds to defrauded public investors. In view of appellants' fraudulent conduct, it was not unreasonable for the court to conclude that it could not rely on appellants to locate purchasers of Manor shares and to refund to them the proceeds of the offering. Accordingly, we cannot say that the district court was unjustified in deciding that these circumstances warranted the appointment of a trustee with specific powers. See SEC v. Bowler, 427 F.2d 190, 198 (4 Cir. 1970); SEC v. Keller Corporation, 323 F.2d 397, 403 (7 Cir. 1963). 28 75 While we find that the temporary freeze of appellants' assets presents a more difficult question, we likewise hold that it was not an inappropriate exercise by the district court of its equity powers. 76 At the outset, we believe that the 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. One of the chief reasons for requiring defendants to refund illegally obtained proceeds of a public offering is to compensate defrauded investors. To effect this purpose, there 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. 77 Here, while the question is a close one, we are satisfied that in balance the district court's decision temporarily to freeze appellants' assets was justified. Because of the fraudulent nature of appellants' violations, the court could not be assured that appellants would not waste their assets prior to refunding public investors' money. Moreover, at the time the court's order was entered, a great deal of uncertainty existed with respect to the total amount of proceeds received and their location. Appellants' failure to present evidence to remove this uncertainty warranted a measure designed to preserve the status quo while the court could obtain an accurate picture of the whereabouts of the proceeds of the public offering. In addition, the continued failure of some appellants to furnish the information necessary to a complete understanding of the current situation justified extension of the temporary freeze until appellants have refunded the proceeds. 29 Under the circumstances, we hold that there is no basis for disturbing the district court's finding that a temporary freeze was necessary to protect the public interest. 78 We have considered appellants' other claims of error and find them to be without merit. 79 The judgment of the district court is affirmed in all respects except to the extent that it orders disgorgement of the profits and income earned on the proceeds of the public offering; as to this, we reverse and remand for modification of the order in accordance with this opinion.