SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Gerson BLATT, Barton S. Udell, and John Pullman, Defendants-Appellants.
No. 76-2181.
United States Court of Appeals, Fifth Circuit.
Nov. 15, 1978.
1325
Gee, Circuit Judge, filed an opinion specially concurring and dissenting in part.
DISMISSED.
E. David Rosen, Miami, Fla., for Pullman.
Burton H. Finkelstein, Washington, D. C., Robert C. Josefsberg, Miami, Fla., David J. Levenson, David M. Lewis, Washington, D. C., for Blatt et al.
Mark A. Loush, Detroit, Mich., David Ferber, Sol., Irving H. Picard, Asst. Gen. Counsel, Frederick B. Wade, Atty., Alan Rosenblat, Asst. Atty. Gen., John P. Sweeney, Atty., S. E. C., Washington, D. C., David R. King, Atty., S. E. C., Salt Lake City, Utah, for plaintiff-appellee.
LYNNE, District Judge:
This appeal is from a final judgment entered by the District Court for the Southern District of Florida permanently enjoining appellants Gerson Blatt, Barton Udell and John Pullman from engaging in further conduct that would violate
This action centers around two acquisitions of Corporation of the Americas Limited (COAL) stock by Exquisite Form Industries, Inc. (Exquisite). Appellant Blatt, principal counsel to COAL, was the predominant figure in both transactions.
1. The Pullman Sale
In 1967, COAL was a small Florida real estate company. Use of a paradoxical accounting system made COAL an attractive target for acquisition: COAL‘s financial statement reflected large profits while its tax returns showed substantial losses.1
In December, 1967, Exquisite acquired approximately 92% of COAL‘s outstanding stock. At the time of the acquisition Exquisite‘s accountants concluded that 92% ownership was sufficient to permit it to “pool” its assets with COAL‘s. Exquisite was anxious to accomplish “pooling of interests” because of COAL‘s much greater profitability, as reflected on its financial statement.
In February, 1968, Blatt solicited Richard Sadowski, who was formerly president of COAL, to secure the purchase of various blocks of COAL shares which he had previously sold or given away. Through various misrepresentations, Sadowski induced sixteen shareholders to sell 47,730 COAL shares. Blatt arranged for the purchase of these shares for $59,662 by a Lichtenstein trust known as Delami. Pullman, Blatt‘s long-time client, controlled Delami and was its beneficiary.2
Exquisite‘s accountants determined that in order to give a “pooling-of-interests” accounting and tax treatment to the COAL acquisition in Exquisite‘s financial statements, it would be desirable for Exquisite to own 95% of the outstanding shares of COAL, instead of 92%. In July and Au
The trial court held that Blatt and Pullman violated
2. The Naitove Trust
For over two years after the 92% Exquisite acquisition the law firm of Blatt and Udell was counsel to COAL. Prior to June 9, 1969, Blatt and Udell were informed that Exquisite proposed a merger by which Exquisite would acquire 100% of COAL‘s outstanding shares. The merger was approved at a meeting of COAL shareholders on June 30, 1969, upon the strong recommendation of COAL‘s management.
The Blatt and Udell law firm assisted in the formalities of the merger, including the incorporation of the surviving company and necessary filings with the Florida Secretary of State. Udell signed the merger certificate as secretary of the new company.
Until May 6, 1969, Blatt held 13,700 shares of COAL as trustee. Beneficial owners of the shares included Blatt himself, who owned 4,067 shares, and Udell, his law partner, who owned 2,033 shares. On May 6, 1969, Blatt transferred legal title to the 13,700 shares to Willard Naitove, as trustee. Blatt‘s explanation for the change of trustee was that he intended to object to the merger and he did not wish to embarrass Exquisite by having the objection entered in the name of COAL‘s counsel.
On June 26, 1969, Naitove, as trustee, filed a timely objection to the merger pursuant to the Florida dissenters’ rights statute. Shareholders who did not object to the merger received one share of Exquisite stock for every three shares of COAL stock they owned. Eventually, Blatt negotiated a settlement of the Naitove trust objection by which the trust received one share of Exquisite stock for one share of COAL stock.4
The trial court found that Blatt and Udell did not disclose their beneficial ownership of COAL shares held in the Naitove trust to Exquisite. The court held that such omission was of a material fact, and, therefore, that Blatt and Udell violated
This appeal presents many issues, as appellants have attacked the trial court‘s findings of fact, conclusions of law and remedies. We affirm in part and vacate and reverse in part.
Turning first to the trial court‘s findings of fact, we reject appellants’ challenges. Our review is limited by the rule that “[f]indings of fact shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the trial court to judge of the credibility of the witnesses.”
Evidence in the record supports the trial court‘s inference that Blatt had access to and used this inside information. Exquisite‘s chief financial officer, Robert H. Solof, testified that at the time of the 92% acquisition of COAL, Exquisite‘s accountants would have preferred a 95% acquisition. Blatt was intimately involved in the negotiations between Exquisite and insider shareholders of COAL that culminated in the 92% acquisition on January 5, 1968. During the negotiations Exquisite‘s accountants used Blatt‘s law library and explained the “pooling” concept to him.
Certainly, the court could infer from these facts along with Blatt‘s subsequent actions that he learned of the Exquisite accountants’ uneasiness about “pooling” with 92% or less. In late 1967 Blatt approached Richard Sadowski, stating that his client needed a minimum of 50,000 shares to consummate a transaction with Exquisite. Contrary to Pullman‘s explanation that he simply felt that COAL was a good investment due to his confidence in COAL‘s president, Blatt‘s statement to Sadowski clearly indicates that Blatt had in mind a sale to Exquisite from the outset.
Blatt offered the shares in a letter to Exquisite on July 5, 1968. The letter stated in part that
During our negotiations at the end of last year, I recall several discussions with your staff regarding the advantages of acquiring sufficient stock in C.O.A.L. to permit a “pooling” and I believe the acquisition of these shares would enable the company to do so.
Blatt admits that he knew that Exquisite needed to acquire more stock for “pooling,” but claims that he was informed in June of a new rule of the American Institute of Certified Public Accountants requiring a 95% minimum. Significantly, Blatt offered no evidence of the existence of such a rule. Also, Blatt‘s letter to Exquisite made no mention of any new rule; instead, it implies that Blatt acquired his knowledge of pooling in late 1967.
Likewise, the court could infer that Blatt relayed his knowledge about pooling to Pullman. Pullman‘s testimony (by deposition) simply was not credible to the court. He testified that his first knowledge of COAL came from Blatt‘s telephone call, less than ten days before the purchase. In that call, according to Pullman, Blatt informed him merely that 47,730 shares were available at $1.25 per share; that Milton Pepper was president of the company; that the company “was going to earn approximately a dollar a share or thereabouts“; and that in Blatt‘s opinion it was a good buy. Pullman contends that with no further questioning of Blatt, his lawyer for over eleven years, he made the investment.
During the succeeding six months Pullman received no financial information or reports from COAL. He did not know whether the company‘s earnings had begun to approach one dollar per share, as predicted. Pullman‘s only knowledge about the company‘s progress came when he asked someone, presumably Blatt, “how is Milton doing?” The answer was “Fine. The company is doing great.”
In July Blatt asked Pullman at what price he would sell his shares. Pullman arrived at an asking price of $400,000 based upon his belief that stock was worth at least seven times earnings and that COAL was going to earn $1.00 per share. When the sale was consummated for $375,000 Pullman realized a profit of approximately $315,000 on his brief investment.
Looking at the entire record, we are not left with the “definite and firm conviction” that the lower court‘s finding was erroneous with respect to Pullman‘s knowledge. See United States v. U. S. Gypsum Co., 333 U.S. 364, 394-95, 68 S.Ct. 525, 92 L.Ed. 746 (1948).
The next finding challenged was that Blatt and Udell failed to disclose their bene
Appellants’ argument that Exquisite had record notice of their interest is not supported. The record discloses no evidence that the Naitove trust shares were ever recorded in COAL‘s transfer books in the names of the beneficial owners.
Having concluded that the challenged findings of fact are due to be affirmed, we turn to appellants’ challenges to the conclusions of law. Appellants first challenge the trial court‘s conclusion that Blatt‘s and Udell‘s failure to disclose their beneficial ownership of shares in the Naitove trust was an omission of a material fact.6 The Commission‘s theory was that Exquisite would have been under a duty to inform the minority shareholders that COAL‘s counsel believed the merger to be so unfair as to object on their own behalf, had Exquisite known of the beneficial ownership.
Thus, we at the outset examine Exquisite‘s duty to disclose Blatt‘s negative feelings. Exquisite told the COAL shareholders that COAL‘s management had determined the rate of exchange to be more than fair and “to generously reflect current values,” and that “management strongly recommends that you accept the offer.” In fact, COAL‘s president, Milton Pepper, perfunctorily signed the statement presented to him by Exquisite. Exquisite, the 97% owner of COAL, did not consult the management of COAL and never asked its president whether he thought the exchange was fair.
Blatt was not part of the management of COAL,7 but his inside knowledge of the company and the value of its stock was unquestionable and was familiar to Exquisite.8
Under
Well-established precedent in this circuit supports our view that Exquisite would have had a duty to disclose Blatt‘s dissent. In Reed v. Riddle Airlines, 266 F.2d 314 (5th Cir. 1959), the president and general manager possessed inside information about the value of his company‘s stock. We held that he had a fiduciary duty to disclose that information to minority shareholders before contracting to purchase their stock. See also Mansfield Hardware Lumber Co. v. Johnson, 263 F.2d 748 (5th Cir. 1959).
The case sub judice differs significantly from Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), relied upon by appellants. The Court held there that
Assuming then that Exquisite would have been duty bound to disclose Blatt‘s dissent, we turn to the closer question of whether Blatt‘s failure to disclose his beneficial ownership was material. The closeness of this issue results from Exquisite‘s existing knowledge of Blatt‘s unfavorable opinion of its offer. Upon hearing the details of the planned acquisition of the minority stock, Blatt told Exquisite‘s top officers that he intended to object to the merger. Exquisite indisputably knew that Blatt had record ownership as trustee and that he transferred the trusteeship to Naitove for purposes of objecting. In all probability, Exquisite knew that Blatt controlled the investment decision for the shares.
These circumstances present an appealing argument that Exquisite‘s duty to disclose would not have been changed by knowledge of Blatt‘s beneficial ownership—i. e., that it already possessed any such duty. However, notwithstanding Exquisite‘s knowledge, we hold the non-disclosure material.
Disclosure of Blatt‘s beneficial ownership effectively would have sealed the lid on Exquisite‘s duty. It would have removed any doubts that Blatt was acting merely on instructions from some undisclosed principal. It would have demonstrated that Blatt‘s belief about the unfairness of the transaction was so strong that he was willing to put his own shares on the line. Exquisite might have been more aware that it was suppressing a material fact—the fact that Blatt objected for his shares—rather than merely a casual opinion.
The record gives no indication whether Exquisite would have acted any differently with knowledge of Blatt‘s ownership.11 We should emphasize, however, that the test for materiality is objective.12
All that is necessary is that Exquisite, acting reasonably, would have considered the fact important in deciding its course of action. We conclude that a reasonable company would have considered Blatt‘s ownership important in deciding what to disclose to the minority shareholders.
Therefore, we hold that Blatt‘s failure to disclose his beneficial ownership was material. Disclosure to Exquisite was required under
The preceding discussion of the materiality of Blatt‘s non-disclosure applies similarly with respect to Udell. His failure to disclose his and Blatt‘s beneficial ownership to Exquisite was material, in violation of his duty not to mislead Exquisite.
We turn next to the issue of scienter. Subsequent to the decision of the court below, the Supreme Court decided Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), holding that proof of scienter is required in private damage actions brought under
Although the post-Hochfelder issue of scienter in an injunctive action is novel to this court, it has been much discussed by commentators.16 Other courts have reached differing conclusions.17
In Hochfelder, the lodestar for our inquiry, the Court found the language and history of
Hochfelder‘s analysis applies forcefully to the issue sub judice. If the language and history of
Historically, considerations of public policy have provided a means for distinguishing SEC actions from private damage suits. For example, in SEC v. Texas Gulf Sulphur, 401 F.2d 833, 868 (2d Cir. 1968) (concurrence), cert. denied 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1976), Judge Friendly wrote that under
Despite the appeal of such policy arguments, the language of the statute must control when sufficiently clear in its context.25 In our judgment the language of
Application of the requirement in damage actions has not produced a more precise
We are confident that “knowing” conduct satisfies the scienter requirement. Since the record on appeal conclusively indicates that each appellant acted with the requisite scienter, we are not compelled to remand for more specific findings.
We now turn to the propriety of the injunctive relief granted below. The court permanently enjoined appellants, Blatt, Pullman, and Udell from further violations of
This court has said that “[t]he granting or denying of injunctive relief rests within the sound discretion of the trial court and will not be disturbed unless there has been a clear abuse of it.” SEC v. MacElvain, 417 F.2d 1134, 1137 (5th Cir. 1969), cert. denied 397 U.S. 972, 90 S.Ct. 1087, 25 L.Ed.2d 265 (1970). While we adhere to that standard, we note that the seriousness of permanent injunctions recently has triggered closer appellate scrutiny of SEC injunctions than was found in earlier decisions.28
The trial court should consider several factors in deciding whether to issue an injunction in light of past violations.29 The critical question in issuing the injunction and also the ultimate test on review is whether defendant‘s past conduct indicates that there is a reasonable likelihood of further violations in the future. To obtain injunctive relief the Commission must offer positive proof of the likelihood that the wrongdoing will recur. SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 99-100 (2d Cir. 1978). The Commission needs to go beyond the mere fact of past violations. Id.
We have no difficulty in holding that the Commission carried its burden and that the trial court did not abuse its discretion in permanently enjoining Blatt and Pullman. Blatt was the apparent mastermind of the two violations. As the district court concluded, the nature and extent of his wrongdoing more than adequately sup-
With due respect for the discretion of the learned trial judge, we reach a different result with respect to appellant Udell. We find that the Commission failed to demonstrate a reasonable likelihood of future violation. Although we have concluded that Udell violated
The trial court acted properly within its equitable powers in ordering Pullman to disgorge the profits that he obtained by fraud.30 This restitution merely forces the defendant to give up to the trustee the amount by which he was unjustly enriched. SEC v. Manor Nursing Centers, 458 F.2d 1082, 1104 (2d Cir. 1972); 2 Moore Federal Practice ¶ 38.24[2] at 190.5 (1977). The purpose of disgorgement is not to compensate the victims of the fraud, but to deprive the wrongdoer of his ill-gotten gain. SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir. 1978).
Disgorgement is remedial and not punitive. The court‘s power to order disgorgement extends only to the amount with interest by which the defendant profited from his wrongdoing. Any further sum would constitute a penalty assessment. In SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082 (2d Cir. 1972), the court held that the trial court erred in ordering restitution of income earned on ill-gotten profits. The court held that the defendant could be compelled only to disgorge profits and interest wrongfully obtained.
The court ordered Blatt and Pullman to share in paying the trustee‘s expenses in collecting and disbursing the disgorged funds.31 Pullman‘s foreign residency and web of foreign bank accounts and business entities create potential problems for the trustee‘s collection of the funds.
The established practice for compensating trustees and receivers in actions of this nature is that compensation should come from the funds recovered. See, e. g., SEC v. First Securities Co. of Chicago, 528 F.2d 449, 454 (7th Cir. 1976) (per curiam); SEC v. Capital Counsellors, Inc., 512 F.2d 654 (2d Cir. 1975). Those who benefit from the trustee‘s actions bear the expense. See generally Mills v. Electric Auto-Lite Co., 396 U.S. 375, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970); Trustees v. Greenough, 105 U.S. 527, 532, 26 L.Ed. 1157 (1881).
The Commission insists that the court here must employ its formidable equitable powers32 to fashion a remedy that will not allow the frustration of justice. However, the facts before us suggest some likelihood that restitution may be had without the court‘s departing from the accepted practice and without the court ordering what would be a penalty assessment. Blatt did not receive any profits directly from Pullman‘s sale of stock to COAL, but he did receive “legal fees” from Pullman which the Commission has represented to be $3500. Richard Sadowski received approximately $12,000 for his efforts in soliciting sellers for Pullman.33 Certainly, the court‘s
equitable power is broad enough to permit it to order defendants to pay the trustee‘s expenses, up to the amount of the fee realized by each defendant for his assistance in executing the fraud.
We hold that the trial court erred in its general order requiring Pullman, Blatt and Sadowski to pay the trustee‘s expenses. The trustee‘s compensation and expenses should be paid out of the disgorged funds. The court below may require Blatt and Sadowski to pay an amount not exceeding the fees they received for their role in the fraud.
The judgment of the district court is affirmed in all respects except its injunction of Udell and its order taxing the costs of the trustee. We reverse and remand for modification of the order in accordance with this opinion.
AFFIRMED IN PART; VACATED IN PART; REVERSED AND REMANDED.
GEE, Circuit Judge, specially concurring and dissenting in part:
I find myself unable to concur in the judgment or opinion insofar as the injunction against Blatt rests on a determination that he violated
There is no such thing as a floating legal duty: such obligations must be attached at each end. Blatt and Udell each owed a duty not to mislead those who sold to or bought from him. Only Exquisite did this. Exquisite had a like duty to the other minority shareholders who bought from it. I am unable, however, to translate these discrete obligations into a duty running from Blatt or Udell to the other shareholders. Hence to this extent only, I respectfully dissent from the able opinion of the court.