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Securities and Exchange Commission v. Monarch Fund

decided: October 23, 1979.

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF-APPELLEE,
v.
MONARCH FUND, ASPEN FUND II AND BRUCE B. PAUL, DEFENDANTS-APPELLANTS.



Appeal from an order of the United States District Court for the Southern District of New York, Charles E. Stewart, Jr., Judge, finding a violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by the SEC. Reversed.

Before Van Graafeiland and Newman,*fn* Circuit Judges, and Bonsal, District Judge.*fn**

Author: Bonsal

Defendants Monarch Fund ("Monarch"), Aspen Fund II ("Aspen"), both family investment partnerships, and Bruce B. Paul ("Paul"), manager of the partnerships, appeal from the decision of the District Court for the Southern District of New York holding that defendants violated Section 10(b) of the 1934 Securities Exchange Act ("1934 Act"), As amended, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5.

On September 13, 1973, the Securities and Exchange Commission ("SEC") instituted this action against defendants alleging violations of Section 10(b) and Rule 10b-5 on the ground that defendants had traded in the stock of Bio-Medical Sciences, Inc. ("Bio-Medical") on the basis of material inside information that had not been disclosed to the public. The trial was held in May, 1978, and on November 28, 1978 by Memorandum decision, the district court held that defendants had violated Section 10(b) and Rule 10b-5 and granted plaintiff SEC injunctive relief and disgorgement of defendants' profits. This appeal followed. We reverse.

Facts

In 1970, Bio-Medical was in its early stages of development. Its business consisted of developing, manufacturing, and marketing certain medical and other instruments and devices. It had not yet engaged in the manufacture of these products, but had been engaged in development and testing the products, which included a disposable clinical thermometer.

By the end of 1970, it became clear to the management of Bio-Medical that it would need additional financing. In January, 1971, Bio-Medical's Board of Directors decided to seek $5 million through a private placement of convertible debentures. Francis J. Clancey, a specialist in evaluating pharmaceutical companies, was retained as a finder to secure private institutional financing for Bio-Medical, with instructions to maintain the confidentiality of the proposed private placement. On April 13, 1971, arrangements were completed for the private placement of $5 million of debentures with a conversion price of $40 per share of common stock.*fn1 The closing was held on April 28, 1971, and on that day Bio-Medical first announced the private placement to the public in the form of a press release. Reuters-Ultronics Report carried the announcement at 3:36 p. m. and the Dow Jones broad tape carried it at 3:44 p. m.

In 1971, defendant Paul was self-employed, managing investments for himself and his family. Aspen and Monarch were private investment partnerships that invested funds of the Paul family.

In 1969, Paul became interested in Bio-Medical at the time of its first public offering of securities. Beginning in early 1970 and continuing through August, 1972, Paul, on behalf of the family investment partnerships, purchased and sold a total of 16,300 shares of Bio-Medical common stock on the over-the-counter market.

In March, 1971, Paul heard from several sources that Bio-Medical might be seeking private financing. During February and March of that year, he discussed Bio-Medical with Frederick C. Waldron ("Waldron"), the president of F. C. Waldron & Co., Inc., an investment adviser company of which Paul was a major stockholder. In mid-March, Waldron informed Paul that he had heard that a placement of institutional financing for Bio-Medical was imminent in the form of a note convertible into common stock at $40-$50 per share, that insurance companies might be involved, and that he had heard the names Prudential and El Paso mentioned.

Paul sought to verify this information. He contacted Marvin Carton ("Carton"), vice-president of Allen & Company, which had participated in an earlier financing for Bio-Medical, who informed Paul that he had also heard that Bio-Medical was negotiating a $5 million financing with several major institutions including Prudential.

In March, 1971, Waldron introduced Paul to Burton Blank ("Blank"), a director of Bio-Medical and a partner in F.I. Salomon & Co., underwriter for Bio-Medical's 1969 public offering. At trial, Paul testified that he had questioned Blank on the financing of Bio-Medical and that Blank's "response was that the company is working on the financing and we expect it to be done shortly 27 . . ." Appendix at 288.

In March and April of 1971, Paul traded in Bio-Medical stock on the over-the-counter market on behalf of the family investment partnerships, as follows:

Number of Shares Price Date

Purchases 500 $51 March 31, 1971

100 $53 1/2 March 31, 1971

300 $55 March ...


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