United States v. Naftalin
| Decision Date | 21 May 1979 |
| Docket Number | No. 78-561,78-561 |
| Citation | 60 L.Ed.2d 624,99 S.Ct. 2077,441 U.S. 768 |
| Parties | UNITED STATES, Petitioner, v. Neil T. NAFTALIN |
| Court | U.S. Supreme Court |
Respondent engaged in a fraudulent "short selling" scheme, by placing orders with brokers to sell certain shares of stock which he believed had peaked in price and which he falsely represented that he owned. Gambling that the price would decline substantially before he was required to deliver the securities, he planned to make offsetting purchases through other brokers at lower prices. But the market price rose sharply before the delivery date so that respondent was unable to make covering purchases and never delivered the securities. Consequently, the brokers were unable to deliver the securities to the investor-purchasers and were forced to borrow stock to make the delivery. In order to return the borrowed stock, the brokers had to purchase replacement shares on the open market at the now higher prices, a process known as "buying in." While the investors were thereby shielded from direct injury, the brokers suffered substantial financial losses. The District Court found respondent guilty of employing "a scheme and artifice to defraud" in the sale of securities in violation of § 17(a)(1) of the Securities Act of 1933, which makes it unlawful "for any person in the offer or sale of any securities . . . directly or indirectly . . . to employ any device, scheme, or artifice to defraud." The Court of Appeals, while finding the evidence sufficient to establish that respondent had committed fraud, vacated the conviction on the ground that the purpose of the Securities Act was to protect investors from fraudulent practices in the sale of securities and that since respondent's fraud injured only brokers and not investors, respondent did not violate § 17(a)(1).
Held: Section 17(a)(1) prohibits frauds against brokers as well as investors. Pp. 771-779.
(a) Nothing on the face of § 17(a)(1) indicates that it applies solely to frauds directed against investors. Rather, its language requires only that the fraud occur "in" an "offer or sale" of securities. Here, an offer and sale clearly occurred within the meaning of the terms as defined in § 2(3) of the Securities Act. And the fraud occurred "in" the "offer" and "sale," as the statute does not require that the fraud occur in any particular phase of the selling transaction. Pp. 772-773. (b) The fact that § 17(a)(3) makes it unlawful for any person in the offer or sale of any securities to engage in any transaction, practice, or course of business which operates as a fraud or deceit "upon the purchaser," does not mean that this latter phrase should be read into § 17(a)(1), since each subsection of § 17(a) proscribes a distinct category of misconduct. Pp. 773-774.
(c) Neither this Court nor Congress has ever suggested that investor protection was the sole purpose of the Securities Act. While prevention of fraud against investors was a key part of the purpose of the Act, so was the effort "to achieve a high standard of business ethics . . . in every facet of the securities industry," SEC v. Capital Gains Bureau, 375 U.S. 180, 186-187, 84 S.Ct. 275, 279-280, 11 L.Ed.2d 237, and this conclusion is amply supported by the legislative history. Pp. 774-776.
(d) Moreover, frauds against brokers may well redound to the detriment of investors. Although the investors in this case suffered no immediate financial injury, the indirect impact upon investors in such a situation can be substantial. And direct injury to investors is also possible. Had the brokers in this case been insolvent or unable to borrow, the investors might have failed to receive their promised shares. Placing brokers outside the aegis of § 17(a)(1) would create a loophole in the statute that Congress did not intend. Pp. 776-777.
(e) Although the Securities Act was primarily concerned with the regulation of new offerings of securities, the antifraud prohibition of § 17(a) was meant as a major departure from that limitation, and was intended to cover any fraudulent scheme in an offer or sale of securities, whether in the course of an initial distribution or in the course of ordinary market trading. Accordingly, the fact that respondent's fraud did not involve a new offering does not render § 17(a)(1) inapplicable to that fraud. Pp. 777-778.
(f) Since the words of § 17(a)(1) "plainly impose" a penalty for the acts committed in this case, it would be inappropriate to apply the rule that ambiguity as to the scope of a criminal statute should be resolved in favor of lenity. Pp. 778-779.
8 Cir., 579 F.2d 444, reversed.
Joe A. Walters, Minneapolis, Minn., for respondent.
The question presented in this case is whether § 17(a)(1) of the Securities Act of 1933, 48 Stat. 84, as amended, 68 Stat. 686, 15 U.S.C. § 77q(a)(1), prohibits frauds against brokers as well as investors. We hold that it does.
Respondent, Neil Naftalin, was the president of a registered broker-dealer firm and a professional investor. Between July and August 1969, Naftalin engaged in a "short selling" scheme. He selected stocks that, in his judgment, had peaked in price and were entering into a period of market decline. He then placed with five brokers orders to sell shares of these stocks, although he did not own the shares he purported to sell. Gambling that the price of the securities would decline substantially before he was required to deliver them, respondent planned to make offsetting purchases through other brokers at lower prices. He intended to take as profit the difference between the price at which he sold and the price at which he covered. Respondent was aware, however, that had the brokers who executed his sell orders known that he did not own the securities, they either would not have accepted the orders, or would have required a margin deposit. He therefore falsely represented that he owned the shares he directed them to sell.1
Unfortunately for respondent, the market prices of the securities he "sold" did not fall prior to the delivery date, but instead rose sharply. He was unable to make covering pur- chases, and never delivered the promised securities. Consequently, the five brokers were unable to deliver the stock which they had "sold" to investors, and were forced to borrow stock to keep their delivery promises. Then, in order to return the borrowed stock, the brokers had to purchase replacement shares on the open market at the now higher prices, a process known as "buying in." 2 While the investors to whom the stocks were sold were thereby shielded from direct injury, the five brokers suffered substantial financial losses.
The United States District Court for the District of Minnesota found respondent guilty on eight counts of employing "a scheme and artifice to defraud" in the sale of securities, in violation of § 17(a)(1).3 App. 24-25; App. to Pet. for Cert. 15a-20a. Although the Court of Appeals for the Eighth Circuit found the evidence sufficient to establish that respondent had committed fraud, 579 F.2d 444, 447 (1978), it nonetheless vacated his convictions. Finding that the purpose of the Securities Act "was to protect investors from fraudulent practices in the sale of securities," ibid., the court held that "the government must prove some impact of the scheme on an investor," id., at 448. Since respondent's fraud injured only brokers and not investors, the Court of Appeals concluded that Naftalin did not violate § 17(a)(1). We granted certiorari, 439 U.S. 1045, 99 S.Ct. 719, 59 L.Ed.2d 703 (1978), and now reverse.
Section 17(a) of the Securities Act of 1933, subsection (1) of which respondent was found to have violated, states:
In this Court, Naftalin does not dispute that, by falsely representing that he owned the stock he sold, he defrauded the brokers who executed his sales. Brief for Respondent 7-8, 11; Tr. of Oral Arg. 17-18. He contends, however, that the Court of Appeals correctly held that § 17(a)(1) applies solely to frauds directed against investors, and not to those against brokers.
Nothing on the face of the statute supports this reading of it. Subsection (1) makes it unlawful for "any person in the offer or sale of any securities . . . directly or indirectly . . . to employ any device, scheme, or artifice to defraud . . . ." (Emphasis added.) The statutory language does not require that the victim of the fraud be an investor—only that the fraud occur "in" an offer or sale.
An offer and sale clearly occurred here. Respondent placed sell orders with the brokers; the brokers, acting as agents, executed the orders; and the results were contracts of sale, which are within the statutory definition, 15 U.S.C. § 77b(3). Moreover, the fraud occurred "in" the "offer" and "sale." 4 The statutory terms, which Congress expressly intended to define broadly, see H.R.Rep.No.85, 73d Cong., 1st Sess., 11 (1933); 1 Loss 512 n. 163; cf. SEC v. National Securities, Inc., 393 U.S. 453, 467 n. 8, 89 S.Ct. 564, 572 n. 8, 21 L.Ed.2d 668 (1969), are expansive enough to encompass the entire selling process, including the seller/agent transaction. Section 2(3) of the Act, 48 Stat....
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