S.E.C. v. Smyth

• Decision Date: 10 August 2005
• Docket Number: No. 04-11985.,04-11985.
• Citation: 420 F.3d 1225
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Richard P. SMYTH, Michael J. Becker et al., Defendants, Arnold E. Johns, Jr., Defendant-Appellant.
• Court: U.S. Court of Appeals — Eleventh Circuit

420 F.3d 1225

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Richard P. SMYTH, Michael J. Becker et al., Defendants Arnold E. Johns, Jr., Defendant-Appellant.

No. 04-11985.

United States Court of Appeals, Eleventh Circuit.

August 10, 2005.

Michael K. Wolensky, Ethan H. Cohen, Schiff Hardin, LLP, Atlanta, GA, for Johns.

Leslie E. Smith, SEC, Washington, DC, for SEC.

Appeal from the United States District Court Northern District of Georgia.

Before EDMONDSON, Chief Judge, and TJOFLAT and KRAVITCH, Circuit Judges.

TJOFLAT, Circuit Judge:

In this case, the Securities and Exchange Commission obtained a judgment against Arnold E. Johns, Jr., for $743,127.02, which represented the profits he reaped from insider trading in the shares of Vista 2000, Inc. Johns appeals the judgment, contending that the procedure the district court employed in determining the profits he should disgorge denied him due process. We agree and therefore vacate the judgment and remand the case for further proceedings.

I.

Johns was president and a director of Vista 2000, Inc. (Vista), a Delaware corporation based in Roswell, Georgia, from February 1995 to the summer of 1996.¹ Vista designed and sold a variety of consumer safety products, including trigger guards for firearms and radon and carbon monoxide detectors for homes. When Johns joined the company, Vista was a public company, having completed an initial public offering in October 1994. Johns answered to Richard Smyth, Vista's CEO and the officer primarily responsible for the company's day-to-day operations.

Johns signed on with a starting annual salary of $125,000, and he received options to purchase Vista stock—up to 200,000 shares—at an exercise price of $1.28 per share. As president, Johns acquired a wealth of material and adverse inside information about the company, and he ultimately exercised some of his options and sold the resulting shares of stock before any of this information became public.

Almost immediately after coming to Vista, Johns was called upon to perform functions in the role of "Chief Financial Officer." Specifically, Smyth charged him with signing and filing the quarterly Form 10-Q for the period ending March 31, 1995.² Although Vista hired Michael Becker in June 1995 to take over its financial reporting duties, Johns also signed and filed the 10-Q for the period ending June 30, 1995. Both quarterly forms had been prepared by other employees at Vista and contained materially incorrect information due to the method used to calculate quarterly earnings and shares outstanding. Johns felt that the content of the June 30 10-Q was misleading and expressed his concern to Smyth, telling him that he would not sign the document. Smyth instructed him to sign it, and Johns relented, and he signed and filed the 10-Q.

In May and August 1995, Vista issued press releases indicating that it had acquired Alabaster, Inc. The May release stated that the product lines of the two companies had already been integrated; the August release gave an effective acquisition date of June 30. Both of these statements were false. Johns confronted Smyth, insisting that the press releases were inaccurate, but the misstatements stood uncorrected.

In December 1995, Steven Cunningham, Vista's outside counsel, advised Becker that the company's 10-Qs would have to be restated because of the improper method Vista had employed in computing earnings per share. Becker went to Smyth, and Smyth disregarded Cunningham's advice. The 10-Qs were not amended. Later that month, Johns contacted Cunningham to discuss the possibility of exercising his options. On December 21, 1995, Johns exercised some of his options in a cashless exercise. Around the same time, Vista's new controller, Mary Beth Warwick, told Johns that the company's books were not in order.

On February 7, 1996, Cunningham sent a letter to Johns and Smyth reiterating his concerns about the company's 10-Qs for the periods ending March 31, June 30, and September 30, 1995, and instructing them to tell the officers and directors not to sell any Vista securities until the misstatements in the 10-Qs had been cured. Two days later, Johns exercised additional options; he sold stock the exercises had yielded at various times over the remaining days of the month. Altogether, the sales yielded nearly $550,000. At Johns's selling points, Vista's stock was trading at prices ranging from $10.56 to $12.50 a share.

On March 22, 1996, Cunningham resigned as Vista's counsel, citing the company's continued refusal to follow his advice on the conduct of its affairs. On March 26, 1996, Vista issued a press release indicating that it would be amending its 10-Qs and other filings to reflect a net loss of $5,000,000 for 1995.³ On March 26, Vista's stock was trading at $12.875 a share. The next day, on a volume nearly five times that of March 26, the stock declined twenty-two percent in value to close at $10.062 a share.

On April 15, 1996, Vista issued another press release stating that Smyth had resigned and that its audit committee had found "material accounting and financial improprieties that the Company will have to remedy through the issuance of restated financials for several historical periods." The stock, which had been in a steady decline since the March 26 press release, declined further, sliding to $2.50 a share by April 18.

At some point during 1996, the Securities and Exchange Commission (SEC) launched an investigation into Vista's financial affairs. Its investigation culminated in this lawsuit, which the SEC brought against Johns, Smyth, and two other Vista officers on May 25, 2001.⁴

II.

In its complaint, the SEC alleged that Johns violated various provisions of the Securities Act and the Securities Exchange Act, and rules promulgated thereunder, and engaged in insider trading while an officer at Vista.⁵ As remedies, the SEC sought a permanent injunction barring Johns from further violation of the securities laws and the disgorgement of his insider-trading profits. Johns, in his answer, denied liability and asserted several affirmative defenses, none of which is relevant here.⁶ Following some discovery, Johns and the SEC entered into a stipulation under which Johns withdrew his answer to the extent that it denied liability and consented to the issuance of a permanent injunction. The stipulation reserved for further proceedings the amount of the profits Johns would disgorge; that is, Johns reserved the right to litigate the amount of the disgorgement and prejudgment interest.⁷ The parties attached to the stipulation the "Order of Permanent Injunction" they would present to the district court.

On October 30, 2002, the district court entered the Order of Permanent Injunction (hereafter "consent decree" or "decree"). The consent decree contains sweeping injunctive provisions, each of which enjoins Johns, "his agents, servants, employees and attorneys, and those persons in active concert or participation with him who receive actual notice of this Order of Permanent Injunction" from disobeying one or more of the securities laws cited in the SEC's complaint.⁸ Regarding the SEC's claim for disgorgement and prejudgment interest, the decree replicates the stipulation by providing that the claim would "be resolved upon motion of the [SEC] Commissioner at a later date."⁹

On July 21, 2003, the SEC moved the district court to determine the amount of disgorgement and prejudgment interest and to "enter final judgment" against Johns. The motion asserted that the SEC was entitled to disgorgement in the sum of $421,563. The SEC arrived at this amount by calculating the losses Johns avoided, using the April 18, 1996 value of the stock—$2.50 a share—as the baseline, and reasoning that by that date the market had absorbed the negative information announced by Vista on April 15.¹⁰ Using this disgorgement amount, the SEC claimed that $321,564.02 in prejudgment interest was also due.

Johns opposed the SEC's motion. Treating it as a motion for summary judgment Johns argued that the motion should be denied since material issues of fact concerning the appropriate disgorgement figure remained to be litigated. Although he had admitted facts sufficient to make out a case for disgorgement, he had not stipulated to any specific amount due, and thus "the calculation of the amount of `losses avoided,' if any, [we]re in material dispute." Johns concluded his opposition to the SEC's motion by stating that "the Court must consider the unrelated events, not even addressed by the SEC, that led to the sharp decline in Vista's stock price of approximately 68.7 percent between the time of [his] last transaction in February 1996 and the public announcement of April 15, 1996." According to his formula, Johns avoided losses of only $39,442.81. He also contended that he was entitled to offset any amount owed by $192,000, the cost of the exercise of the 150,000 options at issue in the case. Thus, if his position prevailed, he would owe nothing in avoided losses. Johns formally moved the court to hold an evidentiary hearing to establish the facts essential to his "unrelated events" legal argument. He also informed the court that he was still waiting to depose one of the SEC's key witnesses.

The district court denied Johns's request for an evidentiary hearing on the grounds that he failed to detail the "unrelated events" that led to the decline in the price of Vista shares, and the position he espoused had no support in the law. The legal effect of the court's ruling was that the SEC's submission was unassailable; the SEC need only establish a "reasonable approximation" of losses Johns avoided, and, in the court's view, its submission did that. The court therefore entered judgment against Johns in the sums the SEC requested: $421,563 in disgorgement and $321,564 in prejudgment interest. Johns now appeals. Because Johns withdrew his answer to the complaint's allegations...