Berko v. Securities and Exchange Commission

• Decision Date: 07 December 1961
• Docket Number: No. 56,Docket 26904.,56
• Parties: Irwin BERKO, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

297 F.2d 116 (1961)

Irwin BERKO, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 56, Docket 26904.

United States Court of Appeals Second Circuit.

Argued October 30, 1961.

Decided December 7, 1961.

Robert J. Ward (of Aranow, Brodsky, Bohlinger, Einhorn & Dann), New York City (William M. Kaplan and I. Stephen Rabin, of Aranow, Brodsky, Bohlinger, Einhorn & Dann, and Arthur Gerwin, New York City, on the brief), for petitioner.

Allan F. Conwill, Securities and Exchange Commission, Washington, D. C. (Peter A. Dammann, Gen. Counsel, David Ferber, Asst. Gen. Counsel, Sidney D. Goldberg, Sp. Counsel, and Faith Colish, Atty., Securities and Exchange Commission, Washington, D. C., on the brief), for respondent.

Before CLARK, FRIENDLY and MARSHALL, Circuit Judges.

MARSHALL, Circuit Judge.

This case arises on a petition from an order of the Securities and Exchange Commission. The Commission instituted proceedings under 15 U.S.C.A. §§ 78o(b) and 78o-3(b) (4) to determine whether the broker-dealer registration of MacRobbins & Co. Inc. should be revoked and whether certain persons, including petitioner, were each the cause of a revocation order if entered. The brokerage firm and its principal officer entered into a stipulation admitting violations of the registration requirements of the Securities Act of 1933, and the anti-fraud provisions of that Act and the Securities Exchange Act of 1934. Its registration was revoked. The Commission also took evidence and found that nine salesmen, including petitioner, were a cause of revocation.¹

MacRobbins, Inc. was a co-underwriter of an issue of stock of Sports Arenas, Inc. (Sports), a corporation engaged in the operation of bowling alleys. Before and after the initial stock issue had been sold out, MacRobbins' principal business was trading in Sports' shares. The sales method employed involved sending brochures to an apparently selected list of customers who were encouraged to inquire further. If a recipient of a brochure showed any interest in the stock, one of the firms' salesmen would contact him and attempt to sell some stock. The Commission found that one, and perhaps both, of the brochures described in its opinion were misleading.² At the time, Sports, a new company, was suffering initial operating losses. It further found that nine of the salesmen made misleading statements relating to Sports stock.

The Commission's only findings specifically directed to petitioner Berko were that he "represented to a customer who purchased 60 shares of Sports stock in October 1958 at $7.00 per share that there was a good possibility that the price of the stock would rise as high as $15.00 within a year." The Commission further stated, in reference to the activities of the salesmen as a group, "The highly optimistic statements * * * implied that there was an adequate and reasonable basis for them. However, no such basis existed. Financial statements which showed the losses sustained by Sports were available, prior to the representations made * * * yet all of the salesmen * * * disclaimed any knowledge of Sports' financial condition, apparently made no effort to ascertain it and, despite their asserted lack of such vital information, neither withheld nor qualified their optimistic statements." The Commission's ultimate conclusion was, "The individuals who participated in the violations either knew there was no adequate basis for the optimistic statements made and that their other representations were false or misleading, or they were grossly careless or indifferent as to the existence of an adequate basis for their statements or as to the truth or adequacy of the material facts they represented."³

The SEC's findings boil down to the following propositions. Berko predicted Sports would rise to 15 within a year. There was no adequate basis for this statement because Sports, a firm in business for approximately one year, was suffering initial operating losses. Petitioner should have known of the losses and disclosed them. The SEC concedes Berko's statement was a reasonably accurate prediction of what actually happened, although it contends there was no basis for it when made. It further concedes Sports has become a profitable organization.

Counsel for the Commission has argued before us that we should take into account the whole context of the "boiler room" operation, e. g. specialization in one stock, use of misleading brochures, a large volume of sales over the long-distance telephone, and lack of knowledge or disclosure of the real condition of the company. Indeed, it was stated that the Commission is particularly interested in this case because it is seeking more effective means of dealing with "boiler rooms." As the Commission stated in its opinion, "We have had occasion to condemn the technique of using numerous salesmen to sell a large volume of shares of one issuer by long-distance telephone without any knowledge of the financial condition of the issuer or any effort to obtain such information, and without disclosure to prospective purchasers of adverse financial information and the absence of any reasonable basis for the optimistic statements and predictions made." We applaud the efforts of the Commission in seeking better means of dealing with "boiler room" operations and agree fully with the thrust of the last-quoted statement. This statement would appear to be sufficient to condemn a brokerage firm or those in control.

The present case, however, involves the liability of an employee of the firm who exercised no control over its operations and apparently did not engage in a continuous course of fraudulent conduct. Moreover, the findings and apparent legal theory of the Commission itself are not restricted to "boiler room" operations. The only finding is that Berko made the prediction. The only legal theory is that this statement should have been accompanied by disclosure of the losses and that it lacked an adequate basis. In neither aspect do we find an element peculiar to so-called "boiler room" operations.

Moreover, although the Commission has characterized petitioner as lacking knowledge of Sport's "financial condition" and has found his statement to be without an "adequate basis," it points only to his ignorance of the initial operating losses to support its finding. But a company's "financial condition" and the existence of an "adequate basis" for optimistic statements about it clearly depend upon many factors other than initial operating losses....