603 F.2d 1126 (5th Cir. 1979), 77-2415, Steadman v. S.E.C.

Docket Nº:77-2415.
Citation:603 F.2d 1126
Party Name:Charles W. STEADMAN, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
Case Date:October 04, 1979
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit
 
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Page 1126

603 F.2d 1126 (5th Cir. 1979)

Charles W. STEADMAN, Petitioner,

v.

SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 77-2415.

United States Court of Appeals, Fifth Circuit

October 4, 1979

Rehearing Denied Nov. 27, 1979.

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[Copyrighted Material Omitted]

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Peter J. Nickles, Gregg H. Levy, Washington, D. C., for petitioner.

Paul Gonson, Jacob H. Stillman, Mark B. Goldfus, Frank A. Wilson, Attys., Harvey L. Pitt, Gen. Counsel, Securities & Exchange Comm., Washington, D. C., for respondent.

On Petition For Review of an Order of the Securities and Exchange Commission.

Before WISDOM, GODBOLD and TJOFLAT, Circuit Judges.

TJOFLAT, Circuit Judge:

The petitioner in this case, Charles W. Steadman, is the president, chairman of the board, and sole beneficial owner of all the voting stock in Steadman Security Corporation (SSC), an investment adviser registered with the Securities and Exchange Commission (SEC or the Commission). SSC, either directly or through wholly-owned subsidiaries, is the adviser to and manager of several mutual funds known collectively as the Steadman Funds. Steadman petitions for review of the SEC's decision of June 29, 1977, In re Steadman Security Corp., --- S.E.C. ---, (1977-1978 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 81,243 (1977), which found Steadman, SSC, and the subsidiaries in violation of several provisions of the securities laws. 1 Because of these violations, the Commission entered an order that would (1) bar Steadman permanently from associating with any investment adviser, (2) prohibit his affiliation with any registered investment company, and (3) suspend him for one year from associating with any broker

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or dealer. No sanctions were ordered against the corporate respondents, and they do not join in this appeal. Steadman raises several points of error in his petition, most of which we find to be without merit. We grant the petition in part, however, and remand the case to the Commission for reconsideration of the sanctions.

The violations found by the Commission relate to several different aspects of Steadman's management of the mutual funds through the corporations he controlled. See note 1 Supra. The violations we shall discuss concern Steadman and SSC's loan relationships with the banks used by the funds, the method of repayment to the funds of advisory fee overcharges, the retention by a broker-dealer subsidiary of tender solicitation fees paid for the tender of shares held by the funds, and the failure of Steadman and SSC to file timely reports with the Commission. We shall also examine the burden of proof to be applied in SEC disciplinary proceedings and the factual showing necessary to support the harsh sanctions in this case. As we review each of these areas, the relevant facts will be presented.

I. THE BANKING RELATIONSHIPS

Between 1965 and 1968, Steadman and SSC borrowed substantial amounts of money from the Riggs Bank of Washington, D.C., 2 the same bank where the Steadman Funds kept their checking accounts. 3 In 1968, SSC began an expansion program to acquire the management rights to additional mutual funds. To finance these acquisitions, SSC applied to the Riggs Bank for a $2 million unsecured loan. The bank turned down the request, finding that the additional debt load on SSC, whose operations had not been profitable, would be too large. Steadman then retained two prominent investment bankers to aid his quest for capital; one of them successfully arranged a $3 million loan to SSC from the Chase Manhattan Bank in New York.

At about the time the Chase loan was negotiated, Steadman and SSC recommended to the directors of several of the mutual funds that the funds transfer their bank accounts to Chase. The directors were told that the New York bank's custodial fees were lower, that it would be advantageous to be closer to the New York securities market, and that there had been problems with the Riggs Bank. They were not told about the loan to SSC. The transfer of accounts was approved.

Riggs called its personal loans to Steadman when the accounts were transferred (SSC had no loans outstanding from this bank at the time). Steadman obtained a collateralized loan from the First National Bank of Washington to repay the Riggs loans. The First National loan was called in 1970 when the value of the collateral declined, but Steadman received a 90-day extension. Two days later, one of the funds purchased a 90-day certificate of deposit from First National in an amount in excess of the loan. To repay his First National loan, Steadman obtained a loan from yet another bank, the National Bank of Washington. Soon afterwards, the custodial accounts for one of the Steadman funds were transferred from St. Louis to the National Bank. The fund's directors were not told about the loan to Steadman when they approved the transfer.

Neither Steadman's nor SSC's loans were disclosed in the mutual funds' prospectuses. The Commission found that this was material information that Steadman had a duty to reveal. His failure to do so was in willful violation of section 17(a) of the Securities Act of 1933 (Securities Act), 15 U.S.C. § 77q(a) (1976), section 10(b) of the Securities Exchange Act of 1934 (Exchange

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Act), 15 U.S.C. § 78j(b) (1976), rule 10b-5, 17 C.F.R. § 240.10b-5 (1978), and sections 206(1) and (2) of the Investment Advisers Act of 1940 (IAA), 15 U.S.C. § 80b-6(1), (2) (1976). Steadman contends that the Commission erred in finding the omitted information material, and that even if it were material, he cannot be held in violation of these statutes absent a finding that he acted with scienter, I. e., an intent to deceive or defraud.

A. Materiality

Steadman agrees that TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976), defines the applicable standard of materiality but argues that the Commission misapplied that standard in this case. The TSC case states: "An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding (the matter before him)" Id. at 449, 96 S.Ct. at 2132. The Commission concluded that Steadman's practice of borrowing heavily, for himself and SSC, from the same banks where the funds had accounts created a potential for subordinating the funds' interests to his own. Deposits are the source of money that banks lend out for interest. Steadman needed large loans. His self-interest in currying the good favor of the banks might have led him, the Commission speculated, to keep unduly large amounts idle in the funds' non-interest-bearing accounts to the benefit of the banks but the detriment of the funds' shareholders. The SEC made no finding that this had in fact occurred and specifically declined to find that the funds' custodial accounts were a quid pro quo for the loans. Regardless of whether there was a connection between the loans and the accounts, the Commission decided that "Steadman had disabled himself from looking at the funds' checking account balances in a wholly disinterested way, with an eye single to the funds' best interest. Investors had a right to know this." --- S.E.C. at ---, (1977-1978 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 81,243, at 88,339-7 (footnote omitted). Therefore, the loans were material under the TSC standard. Id. at --- (1977-1978 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 81,243, at 88,339-9.

Steadman argues that the SEC found only a Potential conflict of interest, and TSC requires an actual conflict before liability may be imposed. This misreads TSC. The relevant part of the TSC opinion involved the nondisclosure of facts that may have indicated possible market manipulation in the context of a proxy solicitation, a completely different context than what is involved here. More importantly, the Court was addressing the sufficiency of the plaintiff's case for summary judgment, I. e., whether the omission was material as a matter of law. The Court was not called upon to decide the quantum of evidence necessary to establish a material omission at trial. The Court reaffirmed in TSC that the issue of materiality is a mixed question of law and fact and that divining the significance of the inferences a reasonable investor would draw from a given set of facts is peculiarly within the competence of the trier of fact. Turning again to the facts of the case before it, the Court said that facts suggesting that one corporation controls another may be material even though in actuality there is no control; the influence of the one company over the affairs of the other would be of importance to shareholders. 426 U.S. at 453 & n.15, 96 S.Ct. at 2134-35. Here, the Commission is the trier of fact. It decided that, under the circumstances of this case, the potential for Steadman's abuse of his influence over where the funds did their banking was sufficiently great that shareholders would want to know about the loans. That finding is not wrong as a matter of law, and we affirm it. 4

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B. Scienter

Steadman strenuously urges that scienter an intent to deceive, manipulate, or defraud is a necessary element of any enforcement action by the SEC under the antifraud provisions of the securities laws. Since the Commission failed to find that Steadman acted with the requisite intent, he would have us set aside its decision and order. There is some support for this position. In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214, 96 S.Ct. 1375, 1391, 47 L.Ed.2d 668 (1976), the Supreme Court decided that scienter must be proved in a private damage action under rule 10b-5. Whether that holding should be extended to Commission enforcement actions under the statutes that Steadman was found to have violated is the question before us...

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