Opinion ID: 766492
Heading Depth: 2
Heading Rank: 1

Heading: 1988 SEC Administrative Proceeding against NST

Text: 16 Regulation S-K, 17 C.F.R. S 229.401, mandates that certain information pertaining to corporate management and control persons be included in the periodic reports that public companies file with the SEC. Item 401(f) of that regulation requires disclosure of certain legal proceedings that occurred in the past five years and that are material to an evaluation of the ability or integrity of any director, person nominated to become a director or executive officer of the registrant. Item 401(f)'s six subparagraphs list the types of legal proceedings that must be disclosed. Items 401(f)(3) and (4) require disclosure when [s]uch person was the subject of any order, judgment, or decree, not subsequently reversed, suspended, or vacated of a court of competent jurisdiction or federal or state authority, and the order, judgment, or decree was related to certain specified behaviors. 17 C.F.R. S 299.401(f)(3)-(4) (emphasis added). 17 Since Yeaman was an officer and director of U.S. Card and Omega, the government alleged that Item 401(f) of Regulation S-K required the 1989 and 1990 Form 10-K reports of these companies to disclose the 1988 SEC order entered against NST. 2 The 1988 order found that NST had violated various securities laws on a number of occasions, 3 censured NST, directed it to take corrective measures, ordered it to retain an independent outside accountant to report on the implementation of those measures, and required NST's president to execute an affidavit verifying that the services of an independent accountant had been engaged. Yeaman was not a named party to the proceeding. 18 Before the District Court, Yeaman contended that Items 401(f)(3) and (4) only refer to persons who were named in the proceedings and thus that he had no duty to disclose the 1988 proceeding against NST. Concluding that this argument had no merit, the District Court contrasted the text of Items 401(f)(3) and (4) with that of Item 401(f)(2) in the same regulation. Item 401(f)(2) requires disclosure if the director or control person was convicted in a criminal proceeding or is a named subject of a pending criminal proceeding. See 17 C.F.R. S 299.401(f)(2) (emphasis added). The District Court observed: Although Item 401(f)(2) refers to `named subject,' Item 401(f)(3) and (4) merely refer to `the subject of,' which connotes a broader meaning than `named subject.' Surely, if (f)(3) and (f)(4) meant only `named subject,' the SEC could have explicitly stated so, as it did in (f)(2). (A.150) 19 The District Court went on to note that the government had alleged that it possessed evidence demonstrating that: (1) Yeaman was the director and president of Capital General; (2) Yeaman owned more than 90% of Capital General's stock; (3) Yeaman owned and controlled NST through Capital General; (4) Yeaman was president of NST in 1988 and already was or became its director; and (5) NST and Capital General were affiliates as defined in Rule 405 of the Securities Act, 17 C.F.R. S 230.405. (A.150-51) The Court held that if the government could prove these allegations at trial, then there would be no question that Yeaman was the `subject of' [the 1988 order entered against NST]. (A.151) 20 On appeal, Yeaman continues to assert that he was not the subject of the 1988 proceeding within the meaning of 17 C.F.R. S 229.401(f)(3) and (4) because he was not a named party to that proceeding. In support of this argument, he cites to the Uniform and Integrated Reporting Requirements: Directors and Executive Officers, Securities Act Release No. 33-5949, 1978 SEC LEXIS 1031, at  (July 28, 1978), which states: 21 Item 3 [now known as Item 401, or 17 C.F.R. S 229.401] makes it clear that disclosure of criminal convictions, criminal proceedings, orders, judgments, etc. is required only where the executive officer, director, or nominee for election as a director is a named party in the legal proceeding. 22 Yeaman avers that the word criminal in this SEC release does not modify the terms orders or judgments, and that the named party limitation therefore applies equally to civil orders and judgments. He concludes that we should defer to this interpretation of S 229.401(f)(3) and (4) by the Commission. 23 In order to understand what Item 3 makes clear, we must examine the above-quoted statement in context. Prior to 1978, Regulation S-K contained only Items 1 and 2. In 1976, the Commission proposed several amendments to Regulation S-K, including a new section requiring disclosures concerning directors and officers. Section (f) of this amendment as originally proposed is substantially similar to the current version of Item 401(f), except that Section (f)(2) required disclosure if [s]uch person was convicted in a criminal proceeding . . . or is the subject of a criminal proceeding which is presently pending. Disclosure of Management Background: Uniform Reporting Requirements, Exchange Act Release No. 34-12946, 10 S.E.C. Docket 834, 1976 WL 15989, at  (Nov. 2, 1976) (emphasis added). In response to comments received on this proposed amendment, Item 3(f)(2), as it was known upon its adoption in 1978, was amended to read: [s]uch person was convicted in a criminal proceeding or is a named subject of a pending criminal proceeding. Securities Act Release No. 33-5949, 1978 SEC LEXIS 1031, at  (emphasis added). The SEC's statement in the release cited by Yeaman is thus explaining a change in the originally proposed section dealing solely with criminal proceedings. It is accordingly clear that the word criminal was intended to modify orders, judgments, etc. as well as convictions and proceedings. We find it equally clear that the District Court properly regarded the difference between named subject in Item 401(f)(2) and subject in Item 401(f)(3) and (4) as deliberate and significant and properly concluded that the latter term is a broader concept. We thus reject Yeaman's reading of Item 401(f)(3) and (4). 24