SECURITIES & EXCHANGE COM'N v. Harwyn Industries Corp.

• Decision Date: 29 March 1971
• Docket Number: No. 70 Civ. 2693.,70 Civ. 2693.
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. HARWYN INDUSTRIES CORPORATION et al., Defendants.
• Court: U.S. District Court — Southern District of New York

326 F. Supp. 943

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. HARWYN INDUSTRIES CORPORATION et al., Defendants.

No. 70 Civ. 2693.

United States District Court, S. D. New York.

March 29, 1971.

COPYRIGHT MATERIAL OMITTED

Kevin Thomas Duffy, Regional Administrator, S.E.C., New York City, for plaintiff; William D. Moran, Donald N. Malawsky, Marvin G. Pickholz, and Ira Lee Sorkin, New York City, of counsel.

Segal & Hundley, New York City, for defendants Harwyn Industries Corp. and Harvey R. Siegel; Marvin B. Segal and Robert L. Beerman, New York City, of counsel.

Gartenberg, Ellenoff, Lehrer & Stein, New York City, for defendant Irving L. Gartenberg.

Feldshuh & Frank, New York City, for defendant Academic Development Corp.; Sidney Feldshuh, Richard Weinberger, Donald P. Miller, New York City, of counsel.

Weinstein & Levinson, New York City, for defendant Hyman Temkin; Samuel Weinstein, New York City, of counsel.

Steven B. Duke, New Haven, Conn., for defendants James W. Feeney, Xanadu Properties, Inc., Ramon N. D'Onofrio.

Royall, Koegel & Wells, New York City, for defendants JKM Industries, Inc. and J. Kevin Murphy; Norman S. Ostrow and James J. Maloney, New York City, of counsel.

Bittel, Langer, Blass & Corrigan, Miami, Fla., for defendant Motel Trailer Distributors, Inc.;. Gerald J. Beyer, Miami, Fla., of counsel.

Kronish, Lieb, Shainswit, Weiner & Hellman, New York City, for defendant Stephen Kirshner; Reginald Leo Duff, New York City, of counsel.

Penn & Burns, New York City, for defendant Wayne Slockbower; Richard E. Burns, New York City, of counsel.

Stradley, Ronon, Stevens & Yound, Philadelphia, Pa., for defendants FSI, Inc. and Harold C. Yates; Webster, Sheffield, Fleischmann, Hitchcock & Brookfield, New York City, of counsel.

MANSFIELD, District Judge.

In this action the Securities and Exchange Commission ("the Commission") seeks to plug up what some have treated as a loophole in the federal securities laws permitting a company, by "spinning-off" its subsidiary's shares to the parent's stockholders without registration, to convert the subsidiary into a public corporation whose unregistered shares would be actively traded on the market. The suit is brought under § 22(a) of the 1933 Securities Act, 15 U.S.C. § 77v(a), and § 27 of the 1934 Securities Exchange Act, 15 U.S.C. § 78aa. The Commission alleges violations of the registration requirement of § 5 of the 1933 Act, 15 U. S.C. § 77e, and of the antifraud provisions of both the above securities acts, § 17(a) of the 1933 Act, 15 U.S.C. § 77q(a) and § 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Preliminary injunctive relief is sought, Rule 65, F.R.Civ.P., § 20(b) of the 1933 Act, § 21(e) of the 1934 Act, against all 15 defendants on the basis of their participation in a series of transactions involving stock distributions by Harwyn Industries Corporation ("Harwyn") to its shareholders.

The scheme involved three coordinated steps: (1) the acquisition by the subsidiaries of assets of other corporations in exchange for issuance of controlling interests in the subsidiaries to those contributing such assets, (2) the "spin-off" distribution by the parent, Harwyn, to its stockholders of the unregistered shares of its subsidiary owned by it, and (3) the development of an over-the-counter trading market in the unregistered shares thus spun-off. Although the motion for a preliminary injunction was made many months ago, we deferred decision because of the pendency of settlement discussions. No such settlement, however, was reached, despite several conferences in open court. Because there is little dispute over the basic facts on which the litigation is based, our decision relies on undisputed facts appearing from the affidavits and other voluminous papers submitted by the parties. SEC v. Frank, 388 F.2d 486, 490 (2d Cir. 1968).

Harwyn was incorporated in 1958 under the name Harwyn Publishing Corporation and engaged in the printing business. In 1965 it changed its name by substituting "Industries" for "Publishing." On June 22, 1961, a registration statement filed pursuant to the requirements of the 1933 Securities Act, Form S-1, became effective, covering a public offering of 131,000 shares of its common stock. The stock is traded over-the-counter, and Harwyn has approximately 600 public shareholders. Harwyn is not a public reporting company in that it is not required to file reports with the Commission. Harvey R. Siegel ("Siegel") is its President and Chairman of its Board of Directors. Irving L. Gartenberg ("Gartenberg"), an attorney, is, and has been since 1962, its Secretary, a member of its Board of Directors, and general counsel.

The actions of which the Commission complains involved four corporations which were wholly-owned subsidiaries of Harwyn as of November 1968—Cleopatra Cosmetics Corporation ("Cleopatra"), NTRR, Inc. ("NTRR"), Motel Trailer Distributors, Inc. ("Motel"), and Prospectus Press, Inc. ("Prospectus").

Cleopatra was incorporated on May 13, 1963, and was an active subsidiary of Harwyn in the business of distributing cosmetics. Counsel for Harwyn inquired of the Commission, both in New York and in Washington, regarding the need for registering a "spin-off" distribution of Cleopatra stock to the Harwyn shareholders, but there is no indication that any view on the question was offered by the Commission in reply. On November 21, 1968, the Board of Directors of Cleopatra authorized a distribution of 127,500 Cleopatra shares held by Harwyn to its shareholders, one share of Cleopatra being distributed for every four shares of Harwyn held as of December 6, 1968. The distribution was payable December 30, 1968, and was effected on that date. Seventy-five thousand five hundred shares were distributed to Harwyn insiders (presumably Siegel and Gartenberg), and the remaining 52,000 shares were distributed to the public shareholders of Harwyn. A notice as to the source of the distribution, required by N.Y. Business Corporation Law, McKinney's Consol.Laws, c. 4, § 510(c), was sent to the shareholders of Harwyn.

On November 7, 1968, well before the distribution had been authorized, an attorney in Gartenberg's office wrote to the National Quotation Bureau to arrange for trading in the shares of Cleopatra. The letter set forth basic but somewhat skimpy information concerning Cleopatra, i. e., its name, address, state of incorporation, number of shares issued, etc., and did not reveal anything about the business of the company. Beginning on January 6, 1969, Cleopatra stock was quoted on the over-the-counter listings, or "pink sheets," published by the National Quotation Bureau.

The Harwyn insiders who received Cleopatra shares were prevented by law from trading their Cleopatra shares without registering them pursuant to § 5 of the 1933 Securities Act. Stop transfer orders with respect to such shares were placed with Cleopatra's transfer agent, Bankers Trust Company.

On approximately January 13, 1969, negotiations were commenced concerning the possibility of an exchange of investment stock between Harwyn and certain individuals who were to become, after completion of the exchange, the principals of Cleopatra, the name of which was to be changed to Academic Development Corporation ("Academic"). These individuals included Hyman Temkin ("Temkin"), who became President and Chairman of the Board of Academic, James W. Feeney ("Feeney"), who succeeded Temkin as President and a director of Academic, and Ramon D'Onofrio ("D'Onofrio"), who was to become Secretary-Treasurer and a director of Academic. It appears that D'Onofrio may have been the most active in conducting these negotiations. A 16-page agreement was signed on January 18, 1969, embodying the terms of the exchange. Cleopatra was to issue 872,500 new shares of common stock (amounting to 87% of the stock in Cleopatra after issuance) in exchange for stock in two publicly traded companies—49,000 shares of Educational Science Programs ("ESP") and 53,000 shares of Academic Systems and Management Corp. ("Systems"). Of the 872,500 Cleopatra shares, 254,000 were to go to Temkin, 254,000 to Feeney, and 253,500 to. Xanadu Properties, Inc. ("Xanadu"), a corporation engaged primarily in holding securities. Xanadu's President, Muriel Barter, is D'Onofrio's wife. D'Onofrio acted as "attorney-in-fact" for Xanadu and all of the parties who participated in the above transaction. Sixty-nine thousand shares were paid to Hill, Thompson, Magid & Co., Inc. ("Hill, Thompson") as a finders fee. The remaining 42,000 Cleopatra shares were distributed among three associates of the D'Onofrio group.

The agreement, Art. 3(d), recognized that the shares of ESP and Systems obtained by Cleopatra were to be acquired for investment, and Cleopatra consented to their being legended with the statement that they were not registered under the 1933 Securities Act. The agreement further provided, Art. 4(c), that the Cleopatra shares newly issued in exchange for the ESP and Systems stock were acquired for investment and would be similarly legended. There is no evidence that the restriction implicit in the legending has been violated in any way. Temkin has, however, made certain transfers which are allegedly exempt.

Article 9 of the agreement provided that if Cleopatra were to register any stock for sale to the public, e. g., stock held by D'Onofrio and his group, the Harwyn insiders could register up to 40,000 shares of their Cleopatra stock. After two years, Cleopatra agreed to file a registration statement covering the shares held by Harwyn insiders and those held by Hill, Thompson. In the event of any such registration, each selling shareholder was to pay his pro rata portion of the underwriting and registration costs.

Cleopatra was required to adopt a name other than Cleopatra pursuant to the agreement, Art. 8, Harwyn reserving to itself "all right, title and...