Opinion ID: 302963
Heading Depth: 1
Heading Rank: 2

Heading: Violations of Antifraud Provisions of 1933 and 1934 Acts

Text: 36 The conduct of appellants in connection with the public offering of Manor shares, upon analysis, demonstrates beyond a peradventure of a doubt that they violated the antifraud provisions of the federal securities laws-Sec. 17(a) of the 1933 Act and Sec. 10(b) of the 1934 Act. 37 The gravamen of this case is that each of the appellants participated in a continuing course of conduct whereby public investors were fraudulently induced to part with their money in the expectation that Manor and the selling stockholders would return the money if all Manor shares were not sold and all the proceeds from the sale were not received by March 8, 1970. It is undisputed that, as of March 8, Manor and the selling stockholders had not sold all the 450,000 shares and that all the proceeds expected from the sale had not been received. Moreover, it is clear that all appellants knew, or should have known, that the preconditions for their retaining the proceeds of the offering had not been satisfied. Nevertheless, rather than complying with the terms of the offering by returning the funds of public investors, appellants retained these funds for their own financial benefit. This misappropriation of the proceeds of the Manor offering constituted a fraud on public investors and violated the antifraud provisions of the federal securities laws. See Superintendent of Insurance of the State of New York v. Bankers Life & Casualty Co., 404 U.S. 6, 10 n. 7 (1971); Richardson v. MacArthur, 451 F.2d 35, 40-41 (10 Cir. 1971); A. T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2 Cir. 1967); Cooper v. North Jersey Trust Company, 226 F.Supp. 972, 978 (S.D.N.Y.1964). As we said in A. T. Brod & Co. v. Perlow, supra, 375 F.2d at 397: We believe that Sec. 10(b) and Rule 10b-5 prohibit all fraudulent schemes in connection with the purchase or sale of securities, whether the artifices employed involve a garden type variety of fraud, or present a unique form of deception. In the instant case, we hold that the misappropriation [of the proceeds] is a 'garden variety' type of fraud . . . . Superintendent of Insurance of the State of New York v. Bankers Life & Casualty Co., supra, 404 U.S. at 10 n. 7. 38 All appellants also violated Sec. 10(b) of the 1934 Act and Rule 10b-9 promulgated thereunder by making a misrepresentation with respect to the terms of an all or nothing offering. Recognizing the great potential for fraudulent conduct on the part of persons in connection with public offerings of securities on an all or nothing basis, 13 the SEC in 1962 adopted Rule 10b-9, which provides in relevant part: 39 It shall constitute a 'manipulative or deceptive device or contrivance,' . . . to make any representation: 40 (1) to the effect that the security is being offered or sold on an 'allor-none' basis, unless the security is part of an offering or distribution being made on the condition that all or a specified amount of the consideration paid for such security will be promptly refunded to the purchaser unless (A) all of the securities being offered are sold at a specified price within a specified time, and (B) the total amount due to the seller is received by him by a specified date. . . . 41 Here, it is clear that all appellants knew that the offering was presented on an all or nothing basis. Moreover, the evidence established that appellants knew, or should have known, that all of the shares had not been sold and that all of the proceeds had not been received by March 8, 1970. Under the circumstances, there can be no doubt that representing that the offering would be on an all or nothing basis violated Rule 10b-9. 13a 42 It also is clear that appellants violated the antifraud provisions of the federal securities laws by offering Manor shares when they knew, or should have known, that the Manor prospectus was misleading in several material respects. After the registration statement became effective on December 8, 1969, at least four developments occurred which made the prospectus misleading: the public's funds were not returned even though the issue was not fully subscribed; an escrow account for the proceeds of the offering was not established; shares were issued for consideration other than cash; and certain individuals received extra compensation for agreeing to participate in the offering. These developments were not disclosed to the public investors. That these developments occurred after the effective date of the registration statement did not provide a license to appellants to ignore them. Post-effective developments which materially alter the picture presented in the registration statement must be brought to the attention of public investors. 14 The effect of the antifraud provisions of the Securities Act (Sec. 17(a)) and of the Exchange Act (Sec. 10(b) and Rule 10b-5) is to require the prospectus to reflect any post-effective changes necessary to keep the prospectus from being misleading in any material respect . . . . SEC v. Bangor Punta Corp., 331 F.Supp. 1154, 1160 n. 10 (S.D.N.Y.1971). Accord, Danser v. United States, 281 F.2d 492, 496-97 (1 Cir. 1960). See 1 Loss Securities Regulation 293 (2d ed. 1961, Supp. 1969). 43 While appellants admit that public investors were defrauded, they seek to exculpate themselves from liability for their acts by arguing that they acted in good faith. Appellants' contention that their good faith should bar liability under the antifraud provisions of the federal securities laws, however, must be assessed in light of the Supreme Court's admonition that securities legislation enacted for the purpose of avoiding frauds must be construed flexibly to effectuate its remedial purposes. SEC v. Capital Gains Bureau, 375 U.S. 180, 195 (1963). It is now well established that [b]efore there may be a violation of the securities acts there need not be present all of the same elements essential to common law fraud . . . . Globus v. Law Research Service, Inc., 418 F.2d 1276, 1290-91 (2 Cir. 1969). Accord, SEC v. Capital Gains Bureau, supra, 375 U.S. at 193-95. Moreover, in an enforcement proceeding for equitable or prophylactic relief, such as the one here, we have held that mere negligence is a sufficient basis for liability. Hanly v. SEC, 415 F.2d 589, 597 (2 Cir. 1969); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 854-55 (2 Cir. 1968) (en banc), cert. denied sub nom. Coates v. SEC, 394 U.S. 976 (1969). 15 Accordingly, appellants' claim that they acted in good faith, even if accepted, would not bar their liability under Sec. 17(a) of the 1933 Act or Sec. 10(b) of the 1934 Act. 44 We hold, however, that the evidence established that appellants, with the exception of Samuel Feinberg, Marnane and Halford, did not act in good faith. Feinberg, 16 as the district court properly found, has had considerable experience in complex financing arrangements. Thus, it would strain credulity to suggest that Feinberg did not know that the closing on February 20 was invalid. Any doubt about the invalidity of the closing, moreover, must have been completely dissipated by the news that the Netelkos and Deneso checks had been returned for insufficient funds. In addition, even assuming Feinberg reoffered the Netelkos and Deneso shares in good faith, he knew that neither he nor Ezrine had been successful in selling them all and that more than 200,000 of the 450,000 shares involved in the offering were retired without having been purchased. Nevertheless, Feinberg did not attempt to return the proceeds of the offering until the SEC had begun its investigation. In view of these circumstances, it cannot be said that the district court was clearly erroneous in finding that Feinberg knowingly had participated in the fraud. As Judge Learned Hand said in a similar context, . . . the cumulation of instances, each explicable only by extreme credulity or professional inexpertness, may have a probative force immensely greater than any one of them alone. United States v. White, 124 F.2d 181, 185 (2 Cir. 1941). 45 Ezrine's claim that he acted in good faith likewise is belied by the evidence adduced at trial. 17 As an experienced securities lawyer, he was well aware that failure to correct a misleading prospectus and retention of the proceeds even though the issue had not been fully subscribed constituted violations of the antifraud provisions of the securities laws. Indeed, Ezrine's knowledge that the federal securities laws required public disclosure of developments which occurred subsequent to the effective date of the registration statement is indicated by his supplementing the Manor prospectus on February 24 to reflect Carlton Cambridge's participation in the offering as an underwriter. 46 The district court also properly found that Netelkos knowingly violated the antifraud provisions. 18 While Netelkos admits that the prospectus was misleading in several material respects, he claims that he was under no duty to inform public investors that the prospectus did not present an accurate picture. The evidence shows, however, that Netelkos was actively involved in selling the issue and therefore was obligated to bring to the attention of offerees any developments which made the prospectus misleading in any material respect. Moreover, since Netelkos did not pay for his shares, it is clear that he retained some of the proceeds of the offering knowing that all of the 450,000 shares had not been sold and that all of the proceeds had not been received. 19 47 As for appellants Samuel Feinberg, Marnane and Halford, the evidence did not show, nor did the district court find, that they had acted in bad faith. Nevertheless, the court correctly held that these appellants had violated the antifraud provisions of the 1933 and 1934 Acts. Each of these appellants received signals which should have alerted them to the fact that the Manor issue was never fully subscribed. On February 20, 1970, all of the selling shareholders received checks from the underwriter representing the proceeds due them from their sales. Four days later, these appellants learned that payment on the checks had to be stopped because the underwriter did not have sufficient funds on deposit to honor the checks. At this point, these appellants should have inquired about the progress of the offering, for if the arrangements described in the prospectus had been followed and the entire issue had been sold, there would be no reason for the underwriter not to have had sufficient funds to cover the checks. Nevertheless, there is no evidence that these appellants even questioned any of the principal figures about the status of the offering. Samuel Feinberg, Marnane and Halford ultimately were paid the amounts of money to which each would have been entitled had the entire issue been sold. These appellants received checks drawn on Manor's account which were signed by Ira Feinberg. Rather than raising any questions as to why the first checks were not honored and why they subsequently were paid by checks drawn on Manor's account, they simply accepted the money. In view of their failure to make any inquiry whatsoever, it is clear that these appellants deliberately closed their eyes to facts which they, as selling shareholders who were to receive a substantial financial benefit, were under a duty to see and to act accordingly. See United States v. Benjamin, 328 F.2d 854, 862 (2 Cir.), cert. denied, 377 U.S. 953 (1964). Whether their conduct be termed lack of due diligence or negligence, the district court properly held that these appellants violated Sec. 17(a) of the 1933 Act and Sec. 10(b) of the 1934 Act.III. Violations of Prospectus-Delivery Requirement of 1933 Act 48 In addition to concluding that appellants had violated the antifraud provisions of the federal securities laws, the district court also correctly held that they had violated the prospectus-delivery requirement of Section 5(b)(2) of the 1933 Act. 49 Section 5(b)(2) prohibits the delivery of a security for the purpose of sale unless the security is accompanied or preceded by a prospectus which meets the requirements of Section 10(a) of the 1933 Act, 15 U.S.C. Sec. 77j(a) (1970). 20 To meet the requirements of Sec. 10(a), a prospectus must contain, with specified exceptions, all the information contained in the registration statement . . . . In turn, the registration statement, pursuant to Section 7 of the 1933 Act, 15 U.S.C. Sec. 77g (1970), must set forth certain information specified in Schedule A of the 1933 Act, 15 U.S.C. Sec. 77aa (1970). Among the items of information which Schedule A requires the registration statement, and therefore the prospectus, to contain are the use of proceeds (item 13), the estimated net proceeds (item 15), the price at which the security will be offered to the public and any variation therefrom (item 16), and all commissions or discounts paid to underwriters, directly or indirectly (item 17). 50 The Manor prospectus purported to disclose the information required by the above items of Schedule A. The evidence adduced at trial showed, however, that developments subsequent to the effective date of the registration statement made this information false and misleading. 21 Moreover, Manor and its principals did not amend or supplement the prospectus to reflect the changes which had made inaccurate the information which Sec. 10(a) required the prospectus to disclose. We hold that implicit in the statutory provision that the prospectus contain certain information is the requirement that such information be true and correct. See SEC v. North American Finance Co., 214 F.Supp. 197, 201 (D.Ariz.1959); Eugene Rosenson, 40 S.E.C. 948, 952 (1961). 22 A prospectus does not meet the requirements of Sec. 10(a), therefore, if information required to be disclosed is materially false or misleading. Appellants violated Sec. 5(b)(2) by delivering Manor securities for sale accompanied by a prospectus which did not meet the requirements of Sec. 10(a) in that the prospectus contained materially false and misleading statements with respect to information required by Sec. 10(a) to be disclosed. 51 Manor contends, however, that Sec. 5(b)(2) does not require that a prospectus be amended to reflect material developments which occur subsequent to the effective date of the registration statement. This contention is premised on the assumptions that the prospectus spoke only as of the effective date of the registration statement and that the prospectus contained no false or misleading statements as of the effective date-December 8, 1969. Assuming the Manor prospectus was accurate as of December 8, 1969, appellants' claim is without merit. 52 In support of their argument that the prospectus need not be amended or supplemented to reflect posteffective developments, appellants cite an administrative decision in which the SEC held that it will not issue a stop order with respect to a registration statement which becomes misleading subsequent to its effective date because of material post-effective events. Funeral Directors Manufacturing and Supply Co., 39 S.E.C. 33, 34 (1959). See also Charles A. Howard, 1 S.E.C. 6, 10 (1934). Under this line of SEC decisions, a registration statement need not be amended after its effective date to reflect post-effective developments. 23 These decisions, however, are not apposite here. Assuming that the registration statement does speak as of its effective date and that Manor did not have to amend its registration statement, 24 appellants were obliged to reflect the post-effective developments referred to above in the prospectus. Even those SEC decisions holding that the registration statement need not be amended to reflect post-effective developments recognize that the prospectus must be amended or supplemented in some manner to reflect such changes. See Charles A. Howard, supra, at 10. In addition, as noted above in Part II of this opinion, the effect of the antifraud provisions of the 1933 and 1934 Acts is to require that the prospectus reflect post-effective developments which make the prospectus misleading in any material respect. There is no authority for the proposition that a prospectus speaks always as of the effective date of the registration statement. 25 53 We hold that appellants were under a duty to amend or supplement the Manor prospectus to reflect post-effective developments; that their failure to do so stripped the Manor prospectus of compliance with Sec. 10(a); and that appellants therefore violated Sec. 5(b)(2).