U.S. v. Naftalin, 77-1290

Citation579 F.2d 444
Decision Date04 August 1978
Docket NumberNo. 77-1290,77-1290
PartiesFed. Sec. L. Rep. P 96,469 UNITED STATES of America, Appellee, v. Neil T. NAFTALIN, Appellant.
CourtUnited States Courts of Appeals. United States Court of Appeals (8th Circuit)

Joe A. Walters (argued and on brief), O'Connor & Hannan, Minneapolis, Minn. (argued), John B. Blatz, III, Minneapolis, Minn. (on brief), for appellant.

Thorwald H. Anderson, Jr., Asst. U. S. Atty., Minneapolis, Minn. (argued), and A. W. Danielson, U. S. Atty., Minneapolis, Minn., on brief, for appellee.

Before BRIGHT, ROSS and HENLEY, Circuit Judges.

HENLEY, Circuit Judge.

Neil T. Naftalin, appellant here and defendant in the district court, was indicted on eight counts of employing a scheme to defraud in the offer or sale of securities, in violation of § 17(a)(1) of the Securities Act, 15 U.S.C. § 77q(a)(1). Appellant was tried without a jury in the United States District Court for the District of Minnesota and found guilty on all eight counts. He was sentenced to five years imprisonment on each of the eight counts, to be served concurrently. This court has jurisdiction on appeal under 28 U.S.C. § 1291.

The alleged schemes to defraud consisted of appellant ordering five different brokers in eight separate transactions to sell stock listed on the New York Stock Exchange that appellant did not own at the time of the orders, either without disclosing that he did not own the stock or by affirmatively misrepresenting that he did own the stock. Counts I-V, VII and VIII of the indictment arose out of sell orders placed with various broker-dealers whereby the brokers became appellant's agents for the purpose of finding buyers for the stock and transferring the stock to the third party purchasers. Count VI, presently to be discussed separately, differs from the other counts in that the evidence adduced in support thereof shows that on August 28, 1969, H. S. Kipnis and Co., the brokerage house involved, purchased the securities mentioned in that count as a principal rather than acting as appellant's agent for the sale of the securities to third parties.

Appellant was the president and controlling shareholder of Naftalin and Co., Inc. (Company), a corporation registered as a securities dealer under federal and Minnesota securities laws. Prior to 1963, the Company operated a public business as a broker-dealer. After 1963, and at the time of the transactions involved in this case, the Company had ceased doing business with the public and was operated essentially as a one-man business with appellant conducting all of its affairs.

From 1966 until the time of the transactions involved in this case, appellant had been trading for the Company's account in a number of stocks. The pattern of trading which appellant established during this period, and particularly in the summer of 1969, was to place large sell orders in the Company's name with various broker-dealers for listed stocks. Delivery of the securities for these transactions was often made weeks or months after the settlement dates set forth in the confirmation slips prepared and mailed to the Company by the brokers. 1

Naftalin was, and is, a knowledgeable and sophisticated professional investor. It is possible that such a person can sell securities that he does not own without at the time disclosing he does not own them or representing falsely that he does own them. If before delivery of the securities is required the market price declines the seller can buy in the securities at a lower price and pocket the difference. Of course, if the market advances the seller suffers loss, and if he does not deliver the securities the broker through whom he sells suffers loss. To be sure, a seller lawfully may sell stock he does not own "short" if he discloses at time of sale that he is short and if he maintains appropriate brokerage accounts and otherwise trades according to prescribed procedures. However, the government charges in essence that undisclosed short sales misrepresented as sales of stock owned by the seller, I. e., "long" with intent to deceive the broker and take a free ride on the broker's money or credit are made unlawful by § 17(a)(1) of the Securities Act, 15 U.S.C. § 77q(a)(1). 2

Appellant never delivered any of the stock which he had agreed to deliver pursuant to the sell orders included in this case. With regard to Counts I-V, VII and VIII, when appellant failed to deliver the stock involved, the brokers ultimately purchased stock sufficient to cover the sales which they had arranged with third party purchasers. With perhaps one exception, the indictment transactions resulted in loss to the brokers. There is no evidence that any of the third party purchasers were deceived or defrauded in any way.

Appellant urges on appeal that the evidence adduced at trial was insufficient as a matter of law to support the district court's finding of fraud. While we are convinced there is no merit to that claim we pretermit further discussion of it and the factual details of the fraudulent acts at this juncture because we are not persuaded that the provision of § 77q(a)(1) under which appellant was put to trial is violated by the species of fraud practiced against the defrauded brokers who were not purchasers, and for that reason we reverse on all counts other than Count VI. 3

With respect to the counts now under consideration, the government argues that the issue is whether the government alleged and proved a device, scheme or artifice to defraud in the offer or sale of a security. And the government insists that 15 U.S.C. § 77q(a)(1) does not require that the purchaser be defrauded, so long as someone is defrauded in the offer or sale of securities.

While we agree with the government's statement of the issue in this case, we do not agree with the government's analysis of the requirements of 15 U.S.C. § 77q(a)(1). It is clear that as between appellant and the brokers, there was no offer or sale of securities. Appellant made phone calls to the various brokers, during which he allegedly made a number of fraudulent statements, but he did not propose to sell any securities to the brokers alleged to have been defrauded. Appellant did request that the brokers find purchasers for appellant's stock and did authorize sales for his account. A stockbroker does not become the purchaser of stock when an owner requests that the broker sell certain of the owner's securities. The ordinary relationship of a stockbroker to his customer is that of principal and agent. See Galigher v. Jones, 129 U.S. 193, 9 S.Ct. 335, 32 L.Ed. 658 (1889); McMann v. Securities and Exchange Commission, 87 F.2d 377 (2d Cir. 1937). And the facts here clearly indicate that the stockbrokers were acting as agents of appellant, with the limited authority to find persons willing to purchase appellant's stock and subsequently to transfer the stock to the purchasers.

The third party purchasers to whom the brokers sold were not deceived or defrauded in any way. They received the securities from the brokers and paid the price they had contracted to pay.

The legislative purpose in enacting 15 U.S.C. § 77q(a)(1) was to protect investors from fraudulent practices in the sale of securities. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); Securities and Exchange Commission v. International Chem. Dev. Corp.,469 F.2d 20, 26 (10th Cir. 1972); Superintendent of Ins. of the State of New York v. Bankers Life & Cas. Co., 300 F.Supp. 1083, 1094 (S.D.N.Y.), Aff'd,430 F.2d 355 (2d Cir. 1970), Rev'd on other grounds, 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971); Dolgow v. Anderson, 43 F.R.D. 472, 482 (E.D.N.Y.1968).

As Mr. Justice Powell noted in Ernst, supra, 425 U.S. at 194, 96 S.Ct. 1375, federal regulation of transactions in securities emerged as part of the aftermath of the market crash in 1929. In the decade prior to 1933 the investing public suffered losses through investments in worthless securities estimated at twenty-five billion dollars. S.Rep.No. 47, 73rd Cong., 1st Sess., 2, to accompany S. 875 (April 27, 1933). At the time there was national concern with public sales of worthless stock to persons who had no means of adequate protection and emphasis upon protecting the investing public from exploitation through sales of unsound, fraudulent and worthless securities. In a message to the Congress President Franklin D. Roosevelt on March 29, 1933 said in part:

In spite of many State statutes the public in the past has sustained severe losses through practices neither ethical nor honest on the part of many persons and corporations selling securities.

Of course, the Federal Government cannot and should not take any action which might be construed as approving or guaranteeing that newly issued securities are sound in the sense that their value will be maintained or that the...

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4 cases
  • Pacific Dunlop Holdings Inc. v. Allen & Co. Inc., 91-2346
    • United States
    • U.S. Court of Appeals — Seventh Circuit
    • May 7, 1993
    ...short. He argued successfully to the Eighth Circuit that section 17(a) forbids such fraud only against investors, not brokers. 579 F.2d 444, 447 (1978). The Supreme Court reversed, holding that section 17(a) applied to the entire selling process. 441 U.S. at 772-73, 99 S.Ct. at Allen notes ......
  • United States v. Naftalin
    • United States
    • U.S. Supreme Court
    • May 21, 1979
    ...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, Stephen M. Shapiro, Washington, D. C., for petitioner. Joe A. Walters, Minneapolis, Minn., for respondent. Mr. Justice BRENNAN delivered the opini......
  • U.S. v. Naftalin
    • United States
    • U.S. Court of Appeals — Eighth Circuit
    • October 4, 1979
    ...that § 17(a)(1) was not violated by certain fraudulent practices directed toward brokers who were not investors. United States v. Naftalin, 579 F.2d 444 (8th Cir. 1978), Rev'd, --- U.S. ----, 99 S.Ct. 2077, 60 L.Ed.2d 624 (1979). The Supreme Court, however, disagreed and reversed and remand......
  • Philbosian v. First Financial Securities Corp.
    • United States
    • U.S. District Court — District of Colorado
    • October 8, 1982
    ...has been interpreted to apply to offers and sales and purchases of securities. The motion to dismiss on this ground is denied. U.S. v. Naftatin, 579 F.2d 444, rev'd on other grounds, 441 U.S. 768, 99 S.Ct. 2077, 60 L.Ed. 624, on remand, 606 F.2d 809, McAndrews & Forbes Co. v. American Barma......

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