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

Heading: Transactions Underlying Violations Charged

Text: 4 In order to understand the issues raised on appeal and our rulings thereon, we set forth the following statement of the events which culminated in this litigation-based on the district court's findings which are supported by substantial evidence adduced at trial. 2 5 In 1968, appellant Ira Feinberg (Feinberg, to be distinguished from his father, Samuel Feinberg, another appellant) was the sole owner of a corporation known as 133 County Road, Inc., the only activity of which was the operation of a 64-bed nursing home in Tenafly, New Jersey. In that same year, Feinberg met appellant Ivan Ezrine, a New York attorney specializing in securities laws. After several social and business meetings, Feinberg and Ezrine jointly decided to obtain public financing for Feinberg's nursing home business. 6 As a first step in the process of selling shares to the public, a new corporation-appellant Manor Nursing Centers, Inc. (Manor)-was organized on March 19, 1969. Manor acquired all the assets of 133 County Road and issued approximately 1.2 million shares of 5 cents par value common stock to Feinberg who then sold 62,000 shares to certain of his relatives and friends-appellants Samuel Feinberg (his father), Gladys Halford (his mother-in-law), Suzanne Marnane (his employee) and defendant Arthur Sutton (his friend). In addition, Feinberg acquiesced in Ezrine's request that nearly 138,000 shares of Manor be sold to two corporations which Ezrine controlled 3 -appellants Glendale, Inc. (Glendale) and Atlantic Services, Inc. (Atlantic). 4 7 Ezrine and Feinberg then decided that Manor would offer 350,000 shares of newly issued 5 cents par value common stock to the public at a price of $10 per share. After expenses, this offering would raise approximately $3 million for the operation of Feinberg's nursing home business. In addition, Ezrine and Feinberg decided that 100,000 shares held by Manor's stockholders would be offered at the same $10 price. After expenses, approximately $868,000 would then be paid to the selling stockholders in the following amounts: 8 Selling Shareholder Shares Offered Net Proceeds Feinberg 62,500 $542,500 Glendale 15,000 130,200 Atlantic 10,000 86,800 Samuel Feinberg 2,500 21,700 Marnane 2,500 21,700 Halford 2,500 21,700 Sutton 5,000 43,400 -------------- ------------ Totals 100,000 $868,000 9 To Ezrine was entrusted the preparation of the registration statement and all other documents necessary to offer Manor shares to the public. Ezrine also selected the accountant for the offering as well as the underwriter, defendant Benjamin Werner & Company, of which defendant Benjamin Werner is the owner. The evidence showed, however, that Ezrine consulted with Feinberg when questions arose about the offering and supporting documentation. 10 With respect to the issues raised on this appeal, it is important to note several representations which Manor and its principals made concerning the terms of the offering. First, the offering was presented on an all or nothing basis. This meant, according to the prospectus, that: 11 Unless all such 450,000 shares are sold to the public and the proceeds received therefrom within such sixty (60) day period (unless extended for an additional thirty day period), the offering will terminate and all funds will be returned, without interest, to subscribers. 12 Secondly, the prospectus stated that subscribers' funds will be maintained in escrow [and] will not be available for other use . . . . In this connection, the prospectus represented that [a]rrangements have been made with Chemical Bank for the escrow of the funds received during the course of such offering. Thirdly, the registration statement indicated that shares sold in the offering would be sold only for cash. 5 Finally, the documents prepared in connection with the Manor offering did not disclose that certain purchasers and participating brokerage firms would be offered or would receive special compensation for their agreement to participate in the offering. 13 The offering of Manor shares began promptly on December 8, 1969, the effective date of the registration statement. Contrary to the representation made in the prospectus, however, Benjamin Werner, the underwriter, had not arranged for an escrow account for the proceeds of the offering. No such account was ever established. 14 From the very outset, Werner encountered difficulty in selling Manor shares and requested assistance from Ezrine and Feinberg. In response to Werner's request, Ezrine and Feinberg personally solicited brokerage firms, various corporations and individuals in an attempt to interest them in the Manor offering. 15 As a result of his inquiries, Feinberg arranged to meet with representatives of a New Jersey-based brokerage firm, Carlton Cambridge & Co., Inc., and ultimately with one of its principals, appellant Christos Netelkos, who demanded special compensation as a condition to participating in the Manor offering. After conferring with Ezrine, Feinberg agreed to give Netelkos, at no cost, 15,000 Manor shares, issued in the name of Lausanne Investment Company, a dormant company previously organized by Ezrine. 6 Feinberg also agreed to guarantee a $250,000 bank loan to Netelkos with funds received from the offering. In exchange for the free shares and the loan guarantee, Netelkos agreed that he and Carlton Cambridge would sell 142,500 Manor shares. Of these 142,500 shares, 5,000 eventually were purchased by Carlton Cambridge for its customers and 40,000 were purchased by Orvis Brothers, another broker-dealer, for its customers. The remainder-97,500 shares-were to be purchased by appellants Method Leasing Corporation and Upton Corporation, each of which was owned and controlled by Netelkos. As stated above, the Manor prospectus did not disclose the existence of any special compensation offers or agreements. 16 In an effort to find additional willing buyers, Ezrine arranged a meeting with defendant Deneso Corporation and its principals, defendants Joseph Delmonico and Jack Naiman. At the meeting which both Feinberg and Ezrine attended, Delmonico and Naiman refused to participate in the Manor offering without some form of special compensation. After several subsequent conversations, the Deneso group agreed to purchase 170,000 Manor shares in exchange for an arrangement whereby Deneso would be protected from any loss as a result of its subscription and Ezrine would cause appellant Glendale to repurchase Deneso's Manor shares at a substantial profit to Deneso. 7 This arrangement with Deneso was not disclosed in the Manor prospectus. Thus, at the same time that unsuspecting public investors were being offered and were buying Manor shares at the full price of $10 per share, Netelkos and Deneso were purchasing Manor shares for substantially less than the price announced in the prospectus. 17 Needing the proceeds of the offering to take advantage of certain business opportunities, Manor and its principals decided to hold a closing of the offering on February 20, 1970, several weeks prior to the March 8 selling deadline. It soon became apparent, however, that not all of the 450,000 Manor shares had been purchased. Rather than cancel or postpone the closing, Feinberg and Ezrine attempted to dispose of all the remaining shares by engaging in a series of transactions which violated the terms of the offering. 18 As a first step, Carlton Cambridge was informed that its selling commission on the 142,500 Manor shares which had been allotted to it and Netelkos-$142,500-would be paid in securities rather than cash. Carlton Cambridge and Netelkos therefore subscribed to 142,500 shares but paid for only 128,250, despite the explicit provisions of the Manor offering that shares would be sold only for cash and that selling commissions could not and would not be paid until all 450,000 shares had been sold. 19 Even after disposing of these 14,250 shares, the Manor offering was not fully subscribed. Ezrine and Feinberg then participated in several transactions designed to sell an additional 39,200 Manor shares. First, Ezrine accepted 5,000 Manor shares in lieu of his $50,000 legal fee as special counsel to Manor for the offering, notwithstanding that the registration statement by its terms precluded sales of securities for consideration other than cash. In addition, appellants Glendale and Atlantic, the two corporations controlled by Ezrine which were selling stockholders, purchased a total of 21,700 shares. Contrary to the terms of the prospectus, however, these 21,700 shares were purchased with checks which were drawn against the proceeds of the offering-proceeds to which Glendale and Atlantic were not entitled until all the Manor shares had been sold and full payment had been received. Similar to Glendale's and Atlantic's premature use of the proceeds, Feinberg drew a check against the proceeds of the offering for $133,000 payable to Great Oil Basin, a corporation controlled by Ezrine, in purported repayment of a loan made by Great Oil Basin to Manor. Ezrine on behalf of Great Oil Basin then endorsed the check and purchased 12,500 Manor shares. It is clear that Ezrine purchased the Manor shares on behalf of his corporations knowing that each of these transactions violated the explicit language of the prospectus and registration statement which he had prepared. 20 The purchases by the corporations controlled by Ezrine did not result in the complete subscription of the Manor offering. Feinberg and Ezrine then permitted the distribution of over 14,000 Manor shares to certain of Manor's trade creditors in full payment of outstanding indebtedness, notwithstanding that the registration statement stated that Manor securities would be issued only for cash. 21 Despite these various transactions which contravened the stated terms of the offering, there still remained 11,368 shares of Manor stock for which no purchaser had been found. Feinberg purchased these shares for his friends, with all but $200 of the total $113,368 coming from checks drawn against the proceeds of the offering. 22 Through the device of these various bootstrap transactions (purchasing shares by checks drawn against proceeds) and the issuance of shares for consideration other than cash, Manor and its principals were able to make it appear that all 450,000 shares had been sold. It is obvious, however, that Benjamin Werner, the underwriter, received far less than the $4.5 million in proceeds necessary to a valid closing. Moreover, through their participation in the various transactions outlined above, appellants Manor, Feinberg, Ezrine, Atlantic, Glendale, Netelkos, Method Leasing and Upton knew that a valid closing had not occurred. 23 Despite the fact that all the proceeds from the offering had not been received, Werner issued checks to Manor and the selling stockholders on February 20, 1970. Apparently concerned about the risk involved in relying upon the large number of uncertified checks which he had received, Werner did advise the bank to delay payment on his checks for one day to permit clearance of the uncertified checks he had been tendered. 24 On February 24, 1970, the first business day after the purported closing, Ezrine caused a sticker amendment to the Manor registration statement to be filed with the Commission. 8 Although the amendment purported to disclose the full underwriter's compensation Carlton Cambridge was to receive, it significantly omitted any mention of the additional compensation appellant Netelkos had demanded and received from Manor. The amendment also explicitly represented that the entire Manor issue had been sold. At no time thereafter was this representation amended to reflect that the issue was not sold. No further amendment to the registration statement was ever filed with the Commission. 25 On February 24, the same day the sticker amendment was filed, Werner learned that checks issued by Deneso and Netelkos at the closing, totaling approximately $2.5 million, had been returned for insufficient funds when presented for payment. Werner informed Ezrine and Feinberg of this development. Following Ezrine's instructions, Werner stopped payment on the checks he had issued at the closing. Werner's check to Feinberg, however, for more than $559,000, the amount to which Feinberg was entitled if the offering had been completely subscribed, could not be stopped because Werner's bank erroneously had certified the check to Feinberg's bank. With this money, Feinberg purchased a $250,000 certificate of deposit with which to furnish collateral for the loan he had promised to guarantee for Netelkos. 9 26 Upon the return of the Netelkos and Deneso checks for insufficient funds, it became painfully obvious to Feinberg and Ezrine that the distribution of the proceeds did not comply with the terms of the offering, since all of the proceeds had not been received. Nevertheless, rather than recapturing and returning the public investors' money, Ezrine and Feinberg embarked on a frantic campaign either to collect the money from Deneso and Netelkos or, failing in that effort, to reoffer their shares. 27 Feinberg's subsequent attempts to collect the $832,500 from Netelkos proved to be futile. Moreover, Netelkos defaulted on the $250,000 loan which Feinberg had guaranteed with proceeds from the offering, and Feinberg was called upon to repay the loan. Some months after the closing, Netelkos did give Feinberg and Manor approximately $200,000. Netelkos also returned his 83,250 shares and the 15,000 shares issued in the name of Lausanne Investment Company. These 98,250 shares, which were retired by Manor, were never sold. 28 Ezrine likewise was unable to collect on the Deneso check. In early March 1970, with the March 8, 1970 deadline fast approaching, Ezrine decided to reoffer the Deneso shares. On March 4, with Feinberg's knowledge, Ezrine arranged to sell 60,000 Manor shares to a David Haber of New York City. The district court found that Haber's purchase was induced by Ezrine's oral promise to protect him against loss on his investment and to give him $60,000. On March 5, Haber returned the shares, and Ezrine renewed his promise to pay Haber the guaranteed profit of $60,000. 10 29 Between March 5, when Haber returned the 60,000 Manor shares, and March 8, the last offering date for sale of the shares, Ezrine was unable to find any purchasers. Ten days after the offering period had expired, however, Ezrine arranged to sell 60,000 Manor shares to the Daytona Beach General Hospital. Any facade of compliance with the terms of the offering was now completely dropped. Not only were the shares sold after the selling deadline, but they were sold at a price of $11 per share, rather than the original price of $10. Ezrine also represented that Manor agreed to furnish Daytona with extra compensation. 11 30 Ezrine's efforts thus resulted in the sale of only 60,000 of the 170,000 Deneso shares. The remaining 110,000 shares were retired by Manor. As a result of Netelkos' and Deneso's failure to pay for their shares, therefore, more than 200,000 of the 450,000 shares involved in the Manor offering were never sold. Despite this, neither Ezrine nor Feinberg informed the SEC that, contrary to the representation made in the sticker amendment filed on February 24, 1970, the issue had not been completely subscribed. In addition, notwithstanding that all 450,000 shares had not been sold, appellants did not attempt to return the money obtained from the public investors. Moreover, while some appellants claim they derived no financial benefit from the offering, the evidence shows that Manor and the other appellants received and retained at least $1.3 million in cash proceeds from public investors. 12 31 There can be no doubt that Feinberg and the corporations which he controlled derived a substantial financial benefit from the offering. Feinberg received a valid check from Werner for $559,000 on the day of the purported closing. It is undisputed that from March 5, 1970 to May 1970 Manor received and retained more than $1 million in proceeds from the offering. Moreover, appellant Capital Cities Nursing Centers, Inc., which succeeded to the business and operations of Manor by virtue of a transaction in which Manor sold its assets to Capital Cities on July 27, 1970 and which, as the district court found, is simply a new name for Manor, also derived financial benefit from the offering by acquiring Manor's assets which included some of the proceeds of the offering. In addition, the SEC presented evidence that appellant Manor Construction Company, a company controlled by Feinberg, accepted between $100,000 and $200,000 in proceeds from the sale of Manor stock. 32 Ezrine, as well as Glendale and Atlantic, claim that they retained no proceeds from the Manor offering. Sometime after the purported closing on February 20, however, Ezrine and an affiliated company, Great Oil Basin, sold 17,000 Manor shares to the public for $170,000. At least $125,000 of the money Ezrine used to make the original purchase of these shares came from the public investor funds received by Manor at the closing. 33 The SEC also presented evidence that appellants Samuel Feinberg, Marnane and Halford, as well as defendant Sutton, received in cash the money to which they would have been entitled had the issue been fully subscribed. The checks which originally had been issued by Werner on February 20, 1970 to these selling shareholders were not honored. More than a month later and after the March 8, 1970 selling deadline, however, Ira Feinberg drew checks totaling $108,500 payable to the order of Samuel Feinberg, Halford, Marnane and Sutton. These appellants have not returned these funds; Sutton did consent, however, to an order requiring him to pay into the registry of the court the $43,000 received in connection with the Manor offering. See note 1 supra. 34 Appellant Netelkos also has retained some proceeds from the offering. Feinberg guaranteed a $250,000 loan for Netelkos by purchasing a certificate of deposit with some of the proceeds of the offering. When Netelkos defaulted on the loan, the bank called upon Feinberg to pay the loan. While Netelkos has paid some money to Feinberg, it does not appear that he has repaid the entire $250,000. 35