Opinion ID: 503142
Heading Depth: 2
Heading Rank: 3

Heading: Amount of Inquiry Called For--Standard of Care and Breach

Text: 34 The SEC has notified broker-dealers of their obligation to inquire when distributing unregistered securities: 35 [A] dealer who offers to sell, or is asked to sell a substantial amount of securities must take whatever steps are necessary to be sure that this is a transaction not involving an issuer, person in a control relationship with an issuer or an underwriter. For this purpose, it is not sufficient for him merely to accept self-serving statements of his sellers    without reasonably exploring the possibility of contrary facts. 36 The amount of inquiry called for necessarily varies with the circumstances of particular cases. A dealer who is offered a modest amount of a widely traded security by a responsible customer, whose lack of relationship to the issuer is well known to him, may ordinarily proceed with considerable confidence. On the other hand, when a dealer is offered a substantial block of a little-known security either by persons who appear reluctant to disclose exactly where the securities came from, or where the surrounding circumstances raise a question as to whether or not the ostensible sellers may be merely intermediaries for controlling persons or statutory underwriters, then searching inquiry is called for. 37 Distribution By Broker-Dealers of Unregistered Securities, Exchange Act Release No. 4445, 27 Fed.Reg. 1251 (1962) (Feb. 2, 1962) (footnote omitted) (quoting SEC v. Culpepper, 270 F.2d 241, 251 (2d Cir.1959)). 38 Kane argues that he fully discharged his obligations under the standards set forth above, and therefore he did not violate sections 5(a) and 5(c). The Commission found that Kane did not make the required inquiry. This finding is supported by substantial evidence. 39 Kane gave an account of his inquiry. He testified that Hanson called to let him know that Hanson had a block of stock to sell. Kane asked who the sellers were. Hanson, according to Kane, replied that they were friends of the corporation. Kane then asked if any of the stock was being sold by officers, directors, insiders or control people. Hanson replied no, that the sellers were friends of the corporation. Hanson then asked that the trades be handled through the Toronto Dominion Bank. Kane agreed, and the transactions at issue began. 3 40 Assuming that Kane's account is the true story of the December 10th phone call with Hanson, we find that there is, nevertheless, substantial evidence to support the Commission's finding that Kane failed to discharge his obligation to inquire. 41 The Commission found Kane's inquiry insufficient because: (a) Kane knew that Grandma Lee's was not registered with the SEC as of March 1981, and had no reason to believe that registration had occurred in the interim; (b) the 150,000 shares, which represented 5.4% of Grandma Lee's common stock available to trade, was a substantial block; and (c) Kane did not seek any objective opinion that the shares were tradeable, but rather, relied on the self-serving statements of the very corporate officer who was to act as the customer in the transaction. 42 It is clear that Kane believed that the shares were unregistered. In fact, he defended against the Commission's charges largely on a basis that he reasonably believed that the shares were exempt from registration requirements. Kane actually had sufficient information to cause him to believe that the shares were probably not exempt. He had received a draft of the Private Placement Memorandum for the Series C shares, and Grandma Lee's Annual Report for 1981. 43 The placement memorandum discussed the fact that 43% of Grandma Lee's common stock was held in a voting trust. The Report discussed the outcome of the Private Placement, i.e., that it was subscribed to in large part by possible control persons. Due to Kane's reputation for thoroughness and the fact that he himself was a potential investor in Grandma Lee's, we assume he read these documents and knew that the 150,000 shares could, and very likely did, include a block of converted Series C shares which were nonexempt, unregistered securities. Under the circumstances, we think that Kane's reliance on the self-serving statements of his seller without reasonably exploring the possibility of contrary facts demonstrates behavior that does not comply with the Act. See Culpepper, 270 F.2d at 251. 44 Finally, Kane filled out the account form on December 14, 1981. Seventy-five thousand shares had already been traded. By that date, Kane knew full well that Hanson was to function as the operator of the account--not persons from the Toronto Dominion Bank. We believe that Kane's own actions in making false statements on the account form and concealing from Becker's legal department and his branch manager all mention of Hanson's connection with the transaction strongly indicates that Kane actually was suspicious as to Hanson's statement, if actually made, that the shares came from friends of the corporation. Further inquiry was required. See Wasson, 558 F.2d at 887.