This appeal is from an order of Judge Kram in the District Court for the Southern District of New York,
The Proceedings in the District Court
The SEC’s amended complaint, dated September 30, 1983,
Turning to a different subject, the amended complaint alleged that from about October 1, 1969 the Economous caused ABT and Service to issue to customers ABT commercial paper (CP) maturing in 3 months or 6 months with face values of $250, $500 and $1000. Such notes, the SEC asserted, were securities within § 2(1) of the 1933 Act and not within the exemption from registration afforded by § 3(a)(3); they were also said to be securities within § 3(a)(10) of the 1934 Act. Their sale without registration thus was alleged to have violated § 5(a) and (c) of the 1933 Act. The complaint also alleged violations of § 17(a) of the 1933 Act and § 10(b) of the 1934 Act and Rule 10b-5, in a manner we shall discuss below.
In their answers to the amended complaint defendants averred that since 1963 the SEC had been aware of and had scrutinized on a regular basis the business activities of ABT, including the TB and CP programs after their inception, but never took any action until the institution of this suit. More specifically the answers alleged that about January 23, 1970, Mr. Economou voluntarily submitted himself to examination by four SEC attorneys concerning the mechanics and procedures of both the TB and CP programs and the brochures used in
The answers went on to allege that about May 19, 1983, Mr. Douglas Scarff, Director of the SEC’s Division of Market Regulation, had sent Mr. Economou a letter protesting against various representations purportedly made by ABT in connection with a prospective application for registration as a national securities exchange. This elicited a lengthy critical response from Mr. Economou, which he circulated to members of Congress, state securities and banking commissioners, other state administrative officials and the business editors of all newspapers in the nation. The answers claimed that shortly after the episode “the expressed attitude of the Commission’s staff at its New York Regional Office dramatically changed from one of cooperation to one of hostility.” On July 28, 1983, ABT received from the New York Regional Counsel a copy of the SEC’s draft complaint and ABT’s proposed consent to a permanent injunction. These documents related only to the TB program, named only ABT as a defendant, and were limited to violations of § 7(a) of the Investment Company Act and § 5(a) and (c) of the 1933 Act. These papers allegedly did not conform to ABT’s understanding in three respects:
(a) The papers called for the entry of a permanent injunction rather than a consent order;
(b) The terms of the proposed permanent injunction went beyond the discontinuance of the TB Program; and
(c) The cover letter said the Commission’s Staff intended to file the papers in Court during the week of August 8, 1983, although they knew that The American Board of Trade Government Fund, Inc. could not be declared effective by the Commission within that time-frame.2
The SEC waited until November 7, 1983, before moving for a preliminary injunction. This was supported by an affidavit of the Regional Counsel of the SEC’s New York Regional Office. The affidavit repeated most of the criticisms of ABT’s sales literature contained in the amended complaint. It added an allegation that in none of their sales literature or advertisements did the defendants disclose that they were subject to a preliminary and later to a permanent injunction issued by Judge Broderick of the District Court for the Southern District of New York in Commodity Futures Trading Commission v. The American Board of Trade et al., see
At defendants’ request the return date for the preliminary injunction motion was adjourned to January 30, 1984. Defendants submitted a lengthy affidavit of Mr. Economou. This detailed the multifarious activities of ABT and its affiliates and his views as to what a national market structure could be, and repeated in greater detail much of what was said in the answers. The SEC filed an affidavit responding to the claim that the relief sought by it was vindictive and retaliatory; it also moved to strike the paragraphs of the answers asserting such defenses and to stay discovery thereon; the latter was done. Copious memoranda were filed by all parties, and oral argument on the SEC’s motion for preliminary injunction was heard on February 10, 1984.
The motion was not decided until September 5, 1984. The judge began her opinion by stating, quite correctly, that:
For a preliminary injunction to issue in a securities case, the SEC must demonstrate (a) a prima facie case that a violation of the securities law has occurred, and (b) a strong likelihood that a violation will occur again in the future. Securities and Exchange Commission v. Commonwealth Chemical Securities, Inc.,574 F.2d 90 (2d Cir.1978).
Securities and Exchange Commission v. American Board of Trade,
specifically, that letters from satisfied investors were on file with the SEC, that customers in the Bill Program own actual Treasury Bills, that such Bills are difficult for the average small investor to purchase, and the failure to disclose that the Bill Program was a pooled purchase arrangement whose assets were held in ABT’s name, subject to claims against ABT,
she held that these “were material in that a reasonable investor would rely on such information in making an investment decision,” citing the controlling authority, TSC Industries, Inc. v. Northway, Inc.,
that the SEC has made a strong prima facie case of prior violations and demonstrated a grave likelihood that violations will occur in the future if the defendants are not enjoined[,]
the court, apparently without giving the parties an opportunity to express themselves with regard to the terms of the injunction, ordered that each of the defendants be preliminarily enjoined
from violating the federal securities laws, including but not limited to the Securities Act of 1933, 15 U.S.C. § 77a et seq., the Securities and Exchange Act of 1934, 15 U.S.C. § 78a et seq., and the Investment Company Act, 15 U.S.C. § 80a-l et seq.
Id.
Defendants promptly filed a notice of appeal and moved in the district court to suspend or modify the preliminary injunction during the pendency of the appeal. The moving affidavits asserted that the ABT family now included two new organizations, The New Hampshire “Micro” Money Market Fund and The American Board of Trade Government Fund, Inc., whose registrations under the ICA had become effective on June 22, 1983 and August 16, 1984, respectively. The affidavits went on to point out that the CP program had reached a level of $55 million; that larger financial institutions had come increasingly.
Discussion
We think it appropriate to begin our discussion by emphasizing the gravity of an injunction against violation of the securities laws. The phrase “mild prophylactic”, used by Judge Clark in his dissenting opinion in SEC v. Capital Gains Research Bureau,
It is fair to say that the current judicial attitude toward the issuance of injunctions on the basis of past violations at the SEC’s request has become more circumspect than in earlier days.6
Finally, as we shall have occasion to observe later, the famous admonitions in Hecht Co. v. Bowles,
The TB Program
Appellants do not challenge the holding of the district court that sales made under the TB Program violated § 5(a) and (c) of the 1933 Act since no registration statement was in effect in regard to the Safekeeping Receipts. Such receipts were securities within the broad definition of § 2(1). Although many passages in ABT’s sales literature and forms suggest that it was selling TBs, there is no dispute that it was not. The very fact, stressed in the promotional literature, that the Government would not issue the bills with a face value of less than $10,000, whereas ABT offered to sell in denominations of $1,000, $5,000, or $10,000, or multiples thereof, insured that purchasers would not own identified, bills.
ABT does challenge the holding that the TB program rendered it an investment company as defined in § 3(a) of the ICA and that it was therefore required to register by § 8. Its argument hinges on the point that § 3(a)(1), which alone would apply, defines an investment company as any issuer which
is or holds itself out as being engaged primarily ... in the business of investing, reinvesting, or trading in securities.
ABT says that it does not fall within that definition since the TB program was a minor part of its business; indeed, it argues that the SEC has made no attempt to defend the holding of the district court in this regard. The SEC responds that while the district court may have used the wrong words, it reached the right result. Pointing to § 2(a)(8) which states that, for purposes of the ICA, an investment “company” may include “a trust, a fund, or any organized group of persons whether incorporated or not”, the SEC relies on Prudential Ins. Co. v. SEC,
Having said all this, we must add that, while no violation of law can be deemed innocuous, the violations found with respect to the TB program come closer to being so than in any successful SEC enforcement action within our experience. The unregistered securities were safekeeping receipts for the safest securities available in this country, United States Treasury Bills. A prospectus would not have significantly aided the investment decision but would have dealt mainly with the mechanics for_.the bank’s segregation of the TBs, the preservation of the rights of each purchaser, and ABT’s fee. There is no allegation, much less proof, that the bank which bought the TBs did not keep them properly segregated, that defendants diverted any of them to their own use, that the fees charged to the purchasers were not fully disclosed or were excessive, or that any investor ever suffered a loss or was in danger of doing so. To the contrary many of them wrote the SEC, albeit at ABT’s suggestion, to express their satisfaction with the program; there is no evidence that any complained.
This has some relevance to the final question on this branch of the case. The sections of the 1933 and 1934 Acts that authorize the SEC to seek injunctions speak in terms of enjoining “any person [who] is engaged or about to engage in any acts or practices” that would constitute a violation. The ICA, § 42(e), speaks of a person who “has engaged or is about to engage” in any act that would violate the law. Where the defendant is not engaged in an ongoing violation, our cases require that the SEC make a “proper showing” of a “reasonable likelihood that the wrong will be repeated.” SEC v. Management Dynamics,
There was no sufficient evidence of “some cognizable danger of recurrent violation” with respect to the TB program. It is, of course, not fatal to the SEC’s case that the violations had ceased before the suit began. See, e.g., SEC v. Texas Gulf Sulphur, Inc.,
The CP Program
In contrast to the TB program, ABT does advance a substantial although ultimately a losing argument that the CP program did not require registration under the 1933 Act. Section 3(a)(3) exempts from the coverage of the Act:
Any note, draft, bill of exchange, or banker’s acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.
The ABT notes issued under the program had maturities of only 3 or 6 months.
The course of decisions under § 3(a)(3) of the 1933 Act exempting short term paper from registration requirements and § 3(a)(10) of the 1934 Act excluding such paper from the definition of security “unless the context otherwise requires” has made plain that these sections are not to be read literally. See, e.g., Exchange National Bank v. Touche Ross & Co.,
In Zeller v. Bogue Electric Mfg. Corp.,
The argument that notes such as those issued by the ABT in the CP program do not benefit from the § 3(a)(3) exemption to the 1933 Act is even stronger than was that for the holding in Zeller with respect to § 3(a)(10) of the 1934 Act. Section 3(a)(3) requires on its face that the note must arise “out of a current transaction or the proceeds of which have been or are to be used for current transactions.”
In contrast to the TB program the SEC makes no claim that defendants misrepresented the nature of what the customer was getting under the CP program. The item most strongly relied on in support of the fraud claims is defendants’ failure to disclose a preliminary injunction issued on July 13, 1979 and a later permanent injunction issued on October 25, 1981, by Judge Broderick of the District Court for the Southern District of New York in Commodity Futures Trading Comm’n v. The American Board of Trade, Inc., see
The SEC claims, in a footnote to its brief, that ABT’s sales literature also presented, in a highly misleading fashion, excerpts from laudatory letters sent by its customers to the Commission and other federal regulatory agencies. The specifications do not justify the charge. One piece of literature stated that these letters, from which comments were excerpted, “are on file with the ABT and with federal regulatory agencies to whom many of them were directed.” Another stated that “[t]he quotations below are from letters in our files. They also are in the files of federal regulatory agencies to whom many of these letters were first sent.” The alleged vices are two. One is that the literature did not disclose that many of the letters were sent at Arthur Economou’s request; we fail to see how this is material. The other is that “by stating that the letters are ‘on file’ with the Commission, the literature suggests that they are available for review and corroboration, as part of an official public file maintained by the Commission on ABT.” We discern no such suggestion; to the contrary, the statement that the letters are also “on file” with ABT negates one. The Commission does not help itself by relying on a reed as weak as this.
The other alleged misrepresentations all relate to the TB program. The most significant, which we have sustained as sufficient for a prima facie showing of violations of § 17(a) and Rule 10b-5 with respect to that program, is that investors would become the owners of Treasury Bills. The others are of lesser moment, particularly that Treasury Bills were difficult for a small investor to purchase— . something that was certainly true for a person wishing to make an initial investment of less than $10,000 and arguably so for investments of that amount or more. Since we held, however, that an injunction against the TB program must fall for a lack of sufficient evidence of likelihood of recurrence, the question becomes whether misrepresentations in connection with it were material in connection with the CP program. We hold they were not. Even assuming that the misrepresentations concerning the TB program were communicated to investors in the CP program, which is by no means clear, we perceive no substantial likelihood that a person contemplating the purchase of ABT’s commercial paper, which was issuable directly to him, would have been deterred by knowledge that ABT had represented that participants in the TB program would obtain ownership in actual Treasury Bills, when in fact they received only Safekeeping Receipts, which proved to be exactly as good.
We thus conclude that, as to the CP program, the SEC did not make out a prima facie case under § 17(a) of the 1933 Act or § 10(b) of the 1934 Act or Rule 10b-5, and reach the final question, namely, whether defendants should be preliminarily enjoined from making sales of ABT
This question differs from that which we encountered with respect to an injunction against further sales under the TB program in the important respect that here there is a “cognizable danger of recurrent violation,” see United States v. W.T. Grant Co., supra,
Since the record and briefs contained nothing with respect to the feasibility of registering short term paper which was the subject of more or less continuous issuance, we requested the parties to submit post-argument letters on the point. The SEC advised that such registration could be effected pursuant to its “shelf-registration” Rule 415(a)(l)(ix), 17 C.F.R. § 230.-415(a)(l)(ix), which became effective on December 31, 1983. This would allow registration “in an amount which, at the time the registration statement becomes effective, is reasonably expected to be offered and sold within two years from the initial effective date of the registration.” 17 C.F.R. § 230.415(a)(2). At the time of registration, defendants would be required to undertake, pursuant to Item 512(a) of Regulation S-K, 17 C.F.R. § 229.512(a), to file post-effective amendments to their registration statement to keep the prospectus current; an indenture with respect to the notes would also have to be qualified under the Trust Indenture Act. The SEC did not “believe that effective registration of these securities is likely to take longer than a few months, provided that defendants and their counsel exercise good faith diligence in preparing the registration statement and in responding to staff comments on the filing.” Defendants do not challenge the possibility of registration under Rule 415, although they do dispute the SEC’s assertion that similar registration had been possible since 1968. Their case is rather that the process would be time consuming, both because these would be the first registration of and qualification of a trust indenture relating to short term paper and because of the SEC’s asserted animus against them. Defendants point out in their brief, as they had in their motion for a stay in the district court, that under the preliminary injunction in the CFTC proceeding heavily relied on by the SEC, they were permitted to continue servicing existing customers.
We think defendants have demonstrated the need for a stay of an injunction against continued sales of CP reaching beyond the issuance of our mandate. The details of this must be left primarily to the district court. We direct only the following: The injunction, limited to the sale of ABT commercial paper without registration as it must be in the light of this opinion, shall be stayed for a further period of four months from the issuance of our mandate. If within that period ABT submits a registration statement under the SEC’s Rule 415 and applies to qualify a trust indenture, and gives appropriate notice to holders of its commercial paper, the stay shall be extended for such further period or periods as the court finds to be realistically required to enable the registration and qualification to become effective and to permit ABT to sell or exchange or redeem outstanding notes. The court shall give further consideration to the question whether, in light of our rulings and the serious collateral consequences involved, there is any need for even a limited injunction with respect to
We repeat in conclusion that in framing its further orders the district court should have ever present in mind the Supreme Court’s statement in Hecht Co. v. Bowles, supra,
The historic injunctive process was designed to deter, not to punish. The essence of equity jurisdiction has been the power of the Chancellor to do equity and to mould each decree to the necessities of the particular case. Flexibility rather than rigidity has distinguished it. The qualities of mercy and practicality have made equity the instrument for nice adjustment and reconciliation between the public interest and private needs as well as between competing private claims.
On the other hand we warn persons contemplating violation of the securities laws that this opinion is not to be read as a departure from our historic hospitality to SEC enforcement actions or as encouraging resistance to consent orders. Our partial reversal here rests on a combination of circumstances rarely encountered — the SEC’s long delay in taking action with respect to violations it knew to exist, the essentially harmless character of such violations as we have found, defendants’ continued expressions of willingness to desist from them and the actual discontinuance of the TB program, the failure of the district court to give detailed consideration to the justification or need for injunctive relief as to some of the violations, the inordinate breadth of the injunction that was issued, and the harm to investors from abrupt discontinuance of the CP program. In a case where one or more of these factors is absent, the result may well be different.
The preliminary injunction issued by the district court is reversed and the cause remanded with directions to enter, after obtaining the views of the parties, a new injunction limited to the issuance, sale or exchange of ABT’s commercial paper unless this is duly registered under § 6 of the 1933 Act, such injunction to contain provisions for a further stay as outlined above. No costs.
Notes
. This superseded a complaint filed on August 19, 1983. The initial complaint was limited to the sale of securities under the Treasury Bills program described below in alleged violation of § 5(a) and (c) of the Securities Act of 1933 and the sale of such securities without defendant, American Board of Trade, having registered as an investment company under § 8 of the Investment Company Act. The complaint, which named ABT as the sole defendant, made no allegations in respect of the commercial paper program described below and did not assert that defendants had made fraudulent misrepresentations in violation of § 17 of the Securities Act or § 10(b) of the Securities and Exchange Act or Rule 10b-5 issued thereunder.
. We do not altogether understand ABT’s first objection. ABT’s letter of April 23, 1981, had proposed "a consent order prohibiting, in connection with [the] Treasury Bill Program, any violation of the registration requirements of the Investment Company Act of 1940 or the Securities Act of 1933." This sounds to us like a permanent injunction; if ABT had meant that it
. The judge took no position on the failure to disclose the state legal proceedings since "the SEC ha[d] not briefed these issues and therefore apparently no longer relie[d] on them.” SEC v. American Board of Trade,
. Although the TSC case arose under § 14(a) of the 1934 Act, it has been widely accepted as setting the standard for materiality under the antifraud sections of the 1933 and 1934 Acts. See Loss, Fundamentals of Securities Regulation 550 & n. 92 (1982).
. The district court should not have relied on the "diverting the Court’s attention” argument. Although the allegations of improper motivation by the SEC may well be lacking in merit and may not have been sufficient to require a hearing, see United States v. Moon,
. See also SEC v. Blatt,
. The Treasury Department is authorized to issue T-Bills "in denominations (maturity value) of $10,000, $15,000, $50,000, $100,000, $500,000, and $1,000,000." 31 C.F.R. § 309.3. Through combinations of bills in these amounts the Treasury accommodates investments in $5,000 increments over the initial investment of $10,000.
. ABT’s suggestion that we have overruled Zeller is without merit. Exchange Nat’l Bank v. Touche Ross & Co., supra, dealt with a different question, namely, under what circumstances a note with a maturity exceeding nine months might not be a security within § 3(a)(10) of the 1934 Act because it evidenced a loan from a bank — a situation not covered by the letter from the Federal Reserve Board, infra note 9, the House Report on the 1933 Act, or SEC Release No. 33-4412. We thought that in such a case "the best alternative now available may lie in greater recourse to the statutory language,”
. The “current transactions” language has its origin in a letter from the Secretary of the Federal Reserve Board to the Chairmen of the House and Senate Committees in 1933, quoted in Exchange Nat’l Bank v. Touche Ross & Co., supra,
. "[A] note or evidence of indebtedness issued in a primarily mercantile or consumer, rather than an investment, transaction not involving a distribution.”
. Although the legislative history of § 3(a)(3) is sparse, it is clear that one of the principal reasons short term commercial paper was exempted from the registration requirements of the 1933 Act was that Congress believed that unso
. This is the SEC’s consistent litigation posture. See, e.g., SEC v. Richmond, SEC Lit.Rel. No. 9163 (Aug. 19, 1980); SEC v. Freeman [1978] Fed.Sec.L.Rep. (CCH) ¶ 96,361 (N.D.Ill.1978). But cf. SEC v. Warren,
. SEC v. Manus, [1981-82] Fed.Sec.L.Rep. (CCH), ¶ 98,307 (S.D.N.Y.1981); SEC v. Freeman [1978] Fed.Sec.L.Rep. (CCH) ¶ 96,361 (N.D.Ill.1978); Chris-Craft Industries, Inc. v. Independent Stockholders Committee,
. The district court’s position, that defendants should have made provisions long before for the prospect of being forced to redeem millions of dollars worth of commercial paper on short notice, fails to take into account the SEC's long acquiescence in the program.
. Alternatively, the SEC should seriously consider whether a "so-ordered” undertaking would not be sufficient for the single violation, the sale of unregistered CP, which we have held to justify an injunction in this case.