SEC v. Scott

• Decision Date: 14 June 1983
• Docket Number: No. 82 Civ. 1166 (WCC).,82 Civ. 1166 (WCC).
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Michael C. SCOTT a/k/a Michael E. Cole and Raymond L. Dirks, Defendants.
• Court: U.S. District Court — Southern District of New York

565 F. Supp. 1513

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Michael C. SCOTT a/k/a Michael E. Cole and Raymond L. Dirks, Defendants.

No. 82 Civ. 1166 (WCC).

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

June 14, 1983.

COPYRIGHT MATERIAL OMITTED

Donald N. Malawsky, New York Regional Administrator S.E.C., New York City, for plaintiff; Anne C. Flannery, Linda N. Cassano, William G. McCabe, Sherry L. Stenson, Legal Intern, New York City, of counsel.

Michael C. Scott, pro se.

Arkin & Arisohn, P.C., New York City, for defendant Raymond L. Dirks; Stanley S. Arkin, Marc Bogatin, New York City, of counsel.

OPINION AND ORDER

CONNER, District Judge:

This case involves yet another skirmish in the long-running battle between the Securities and Exchange Commission (the "SEC" or the "Commission") and defendant Raymond L. Dirks ("Dirks"), a well-known, if controversial, securities analyst. In February of 1982, the SEC commenced this action seeking to enjoin Dirks, defendant Michael C. Scott ("Scott") and three other defendants from further violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a), Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b) and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. The Commission alleges that defendants committed such violations by causing the securities of Cayman Islands Reinsurance Corporation, Ltd. ("Cayman Re") to be sold pursuant to a materially misleading prospectus. According to the complaint, defendants affirmatively misrepresented in the prospectus that: (1) Cayman Re would invest the proceeds of the offering primarily in liquid, fixed income securities; (2) Cayman Re would manage its own portfolio of investments; and (3) Cayman Re would enter the reinsurance business. The SEC further alleges that the prospectus was materially misleading because it failed to disclose that (1) there was a pre-existing agreement between Cayman Re and John Muir & Co. ("Muir"), the underwriter of the Cayman Re offering in which Dirks was a limited partner at the time, to invest as much as $2.5 million of the proceeds of the offering in speculative securities recently underwritten by Muir; (2) there was a plan to invest the remaining proceeds in a Canadian real estate venture (the "Marsta Cessions transaction"); (3) Scott, Cayman Re's chief executive officer, had been convicted of fraud, which adversely affected Cayman Re's ability to obtain a reinsurance license in the Cayman Islands; and (4) during the prospectus delivery period approximately $1.6 million of Cayman Re's proceeds from the offering were invested in new equity securities that had been underwritten by Muir, thus resulting in a duty to amend the prospectus to disclose this material use of the proceeds.

Before trial, the SEC resolved its claims against three of the defendants by stipulation and order.¹ Dirks, however, has vigorously contested the Commission's allegations both at the trial, which was conducted by this Court without a jury, and in his post-trial submissions. Despite his aggressive defense, Dirks did not testify during the case but instead relied on his Fifth Amendment privilege against self-incrimination, as did Scott during pretrial discovery. Although the SEC presented its evidence against Scott at trial, he chose not to appear for the proceedings or to file post-trial papers. He has, however, indicated to the Court that he disputes the accuracy of the Commission's allegations.²

This Opinion incorporates the Court's findings of fact and conclusions of law, Rule 52, F.R.Civ.P. For the reasons set forth below, I conclude that Scott violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 and accordingly should be permanently enjoined from future violations thereof. The Court also finds that Dirks violated those antifraud provisions of the securities laws but declines to issue an injunction against him because of the SEC's failure to establish a reasonable likelihood that he will commit future violations. In explaining these conclusions, the Court will first review generally the evidence adduced at trial concerning the Cayman Re offering. Following that background discussion, the Court will then set forth separate conclusions concerning the individual defendants based on the admissible evidence as to each. Finally, the Court will detail the various considerations that justify the granting of equitable relief against Scott and the denial of such relief against Dirks.

I. Background

Cayman Re is the embodiment of an idea developed by William E. Thompson ("Thompson") and others to incorporate an offshore reinsurance company that would be capitalized through a public offering in the United States. Reinsurance is a segment of the insurance business in which an insurer who has accepted a risk then passes a portion of that risk to another company, a procedure not unlike that of a bookie laying off his bets. Thompson and the other founders put up the initial capitalization of $100,000 and Cayman Re was incorporated on June 26, 1979 under the laws of the Cayman Islands.

Even before the company was incorporated, Thompson approached Muir about underwriting Cayman Re's initial public offering. Thompson, who served as Cayman Re's chairman of the board, testified that Muir was selected because that brokerage house had recently underwritten a new issue for Aneco Reinsurance Co. Ltd. ("Aneco"), which the Cayman Re principals believed was similar in concept to their own project. Specifically, Thompson understood that Dirks had been involved in the Aneco underwriting and thus his initial discussions and correspondence about Muir's involvement with Cayman Re were with Dirks.

During the spring of 1979, Thompson and Dirks developed the preliminary plans for the offering and negotiated the terms on which Muir would be retained as underwriter.³ Ultimately, on August 22, 1980, Cayman Re and Muir executed a letter of intent under which Muir would underwrite $12 million of Cayman Re securities on a firm commitment basis. As then contemplated, the arrangement involved the issuance of 1,750,000 shares at $7.50 per share. Thompson signed the letter of intent on behalf of Cayman Re and John S. Sullivan, a general partner, executed the document for Muir.

In addition to developing plans for the underwriting itself, Thompson and the other Cayman Re principals also worked closely with Muir in establishing the company's investment objectives for the underwriting proceeds. The initial draft prospectuses, which Thompson prepared and sent to Dirks, stated that Cayman Re would invest these funds in liquid, fixed income securities. At one of the early meetings concerning the investment strategy, however, Dirks suggested that Cayman Re invest a portion of the proceeds in equity securities and that Muir, because of its track record, be retained as investment adviser in connection with such equity acquisitions. After some consideration, Cayman Re accepted this proposal at a January 10, 1980 meeting in Muir's offices, which was attended by Thompson, Dirks, Robert Sterling ("Sterling"), a Muir employee, P. Bruce Wright ("Wright") and Gerald Freedman ("Freedman"), partners in Trubin Sillcocks Edelman & Knapp ("Trubin Sillcocks"), legal counsel to Cayman Re for the underwriting. During that meeting Thompson announced Cayman Re's decision to have Muir manage a portion of the proceeds. The remaining funds, Thompson reported, were to be invested by two other managers, J. Henry Schroder and Continental Illinois Bank. In a January 14, 1980 memorandum to the Cayman Re principals,⁴ Thompson summarized the events of the January 10 meeting and gave the following report on the investment situation:

It became obvious that one factor key to the completion of this project was allowing Muir to in fact have a part of our portfolio for investment.

I was glad to have been able to say that in our Cayman directors meeting we decided to give a portion ($3-5 million) of our funds to the other two managers, allowing for Muir to have a portion. We told Muir they could invest some of our funds from the beginning. No figure was discussed, but I would hope no more than 15-25% would be under their management (see management of investment funds memorandum accompanying this memo).

They agreed that their portion would also fall under Continental Illinois' custodial management account, so that we can be rendered a master account once a month.

Despite his statement to the Cayman Re principals that the Muir investment was "key" to the completion of the offering, Thompson testified at trial that Dirks never stated to him that Muir's retention as investment adviser was a necessary precondition to its participation in the underwriting. Nevertheless, after Cayman Re decided to invest a portion of the proceeds with Muir, a series of meetings was held to develop the investment guidelines. At one of these meetings, held on March 4, a disagreement arose between the Cayman Re principals and Sterling, who was working on the investment side of the project for Muir. In attendance at the meeting were Thompson, Wright, Freedman, Dirks, Sterling, Paul V. Miller ("Miller"), Cayman Re's president, and Henry Rothman ("Rothman") of Booth Lipton & Lipton ("Booth Lipton"), Muir's legal counsel for the underwriting. Sterling took the position that Muir, as investment manager, should be bound only by very loose guidelines. He insisted that the sole restriction placed on Muir by the prospectus should be the statement that Muir would do its best to maximize results. Not surprisingly, the Cayman Re principals objected to this vague language and turned to Dirks to resolve the matter. Dirks agreed that concrete investment guidelines were necessary and told Sterling that his position was "crazy." Dirks basically agreed with Thompson's proposed guidelines, which Wright listed in a ...