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Securities and Exchange Commission v. American Board of Trade Inc.

decided: December 26, 1984.


Appeal from an order of the District Court for the Southern District of New York, Shirley Wohl Kram, Judge, 593 F. Supp. 335 (1984), in an action by the Securities and Exchange Commission, preliminarily enjoining defendants from violating the federal securities laws.

Friendly, Pierce and Pratt, Circuit Judges.

Author: Friendly

FRIENDLY, Circuit Judge:

This appeal is from an order of Judge Kram in the District Court for the Southern District of New York, 593 F. Supp. 335 (1984). It concerns the propriety of the court's issuing, on the suit of the Securities and Exchange Commission (SEC), a preliminary injunction broadly enjoining defendants from violating any of the federal securities laws in a case where the most serious alleged violations, to wit, failure to register certain securities, had been known to the SEC for 14 years, defendants had offered to discontinue the offending programs and had discontinued one, the SEC made no claim that any investor had been or had been likely to be financially hurt, and the injunction went far beyond any misconduct that was proved or even alleged. We hold that the district court abused its discretion, reverse the preliminary injunction which it ordered, and remand for the issuance of a more limited injunction as described in the conclusion to this opinion.

The Proceedings in the District Court

The SEC's amended complaint, dated September 30, 1983,*fn1 alleged as follows: Defendant, American Board of Trade (ABT), a Delaware corporation having its principal place of business in New York City, advertises itself as a "membership organization of franchised dealers & brokers serving the commodities, securities & investment communities." Defendants Arthur N. Economou and his wife, Phyllis H. Economou, are respectively the president and the vice president and secretary of ABT and a subsidiary, The American Board of Trade Service Corporation (Service), also a defendant; both have been controlling persons of ABT and Service at all relevant times. From about October 1, 1969, the Economous caused ABT to purchase 3-month and 6-month Treasury Bills (TBs) from a Milwaukee, Wisconsin, bank (the Bank), which had acquired them from the Treasury. The Treasury issues such bills periodically on a discount basis in minimum face amounts of $10,000. Through advertisements and sales literature the Economous caused ABT to offer customers interests in TBs in denominations of $1,000, $5,000, and $10,000 and multiples thereof. ABT instructed the Bank how many TBs to purchase; the Bank registered these in Service's name. On the day the bills were issued, ABT mailed to customers a Safekeeping Receipt for the bills purchased and a refund check equal to the discount on each customer's investment as established at the Treasury auction, less a fee for ABT. When bills matured, customers received their face value or, upon request, might have the proceeds reinvested. This course of dealing was alleged to have constituted a sale of the Safekeeping Receipts without the latter having been registered under the Securities Act of 1933 (the 1933 Act) and thus to have been a violation of § 5(a) and (c) of that Act. Also this course of action allegedly constituted ABT an investment company and made its sale of the Safekeeping Receipts in the absence of registration a violation § 7(a) of the Investment Company Act (ICA). The amended complaint went on to allege violations of § 17(a) of the 1933 Act and § 10(b) of the Securities and Exchange Act of 1934 (the 1934 Act) and the SEC's Rule 10b-5, which we will discuss below.

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 advertising them. The answers further alleged that by letter dated April 17, 1970, Mr. Economou stated to the SEC staff that Service "is prepared to phase out and discontinue the sale of commercial paper if [the] Commission feels it is desirable to do so," but that the SEC took no further action. Renewed inquiry by the SEC into ABT's activities took place in early 1971, mid-1972 and early 1974. In November 1980 the SEC initiated a further investigation of the TB program. The SEC staff was said to have expressed to ABT the opinion that ABT had met all its fiduciary responsibilities under the program but also advised that the program should be restructured as a registered investment company and that its promotional literature should be modified. An agreement was allegedly reached as embodied in a letter from ABT's general counsel to the SEC's senior trial counsel at the New York Regional Office, whereby ABT would register an investment company which would sell interests in a pool of United States government obligations, repurchase agreements of such obligations, bank certificates of deposit and bankers' acceptances, with the simultaneous entry of a consent order prohibiting, in connection with the Treasury Bill program, any violation of the registration requirements of the ICA or the 1933 Act. ABT's consent was to be given without its admitting that any such violation had occurred, and the TB program was to remain in operation until the registration of the new investment company became effective. On or about March 4, 1982, ABT was informed that the SEC had granted its staff authority to proceed. ABT claimed it had promptly made the necessary modification in the TB promotional literature and delivered to the New York Regional Office drafts of papers necessary to the registration of the proposed The American Board of Trade Government Fund, Inc. After responding to comments of the Regional Office, ABT filed the registration with the SEC, requesting expedited consideration, a request in which the Regional Office concurred.

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.*fn2

Allegedly as a result of learning on August 9, 1983, "that the settlement, as had been proposed, could not be consummated, ABT voluntarily discontinued [the TB] Program effective 4:00 p.m. that day and immediately notified the Commission's New York Regional Office by telephone of the action," confirming this by letter the next day. The TB program had been wound down by February 16, 1984, seven months before the preliminary injunction was issued. The answers pleaded an affirmative defense that the SEC had brought the action in retaliation for the criticism expressed in Mr. Economou's letter of June 22, 1983, and charged the SEC with harassing ABT and the Economous in violation of various constitutional rights.

The SEC waited until November 7, 1983, before moving a preliminary injunction. This was supported by an affidavit of the Regional Counsel for 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 473 F. Supp. 1177 (1979), were required to disgorge all premiums obtained from commodities options transactions in foreign currencies for the period June 1, 1978 through July 13, 1979, and were the subject of cease and desist orders issued by two state commissions in September 1977 and February 1983, of the original complaint in this case, and of a state show cause order issued a few weeks before the date of the affidavit.

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 had occurred, and (b) a strong likelihood that a violation will occur again in the future. Securities and Exchange Commission ...

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