Dirks v. S.E.C.

• Decision Date: 18 May 1982
• Docket Number: No. 81-1243,81-1243
• Citation: 681 F.2d 824,220 U.S.App.D.C. 309
• Parties: , Fed. Sec. L. Rep. P 98,669 Raymond L. DIRKS, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 824

681 F.2d 824

220 U.S.App.D.C. 309, Fed. Sec. L. Rep. P 98,669

Raymond L. DIRKS, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 81-1243.

United States Court of Appeals District of Columbia Circuit.

Argued Jan. 7, 1982.

Decided May 18, 1982. ^*

Petition for Review of an Order of the Securities and Exchange commission.

David Bonderman, Washington, D. C., with whom Lawrence A. Schneider and David Hird, Washington, D. C., were on the brief, for petitioner.

Michael K. Wolensky, Associate Gen. Counsel, S. E. C., Washington, D. C., with whom John P. Sweeney, Asst. Gen. Counsel, Paul Gonson, Sol., and Andrew W. Sidman, Atty., S. E. C., Washington, D. C., were on the brief, for respondent.

Before WRIGHT, TAMM and ROBB, Circuit Judges.

Opinion filed by Circuit Judge J. SKELLY WRIGHT.

Circuit Judge ROBB concurs in the result.

Circuit Judge TAMM dissents.

J. SKELLY WRIGHT, Circuit Judge:

This case requires us to review the Securities and Exchange Commission's interpretation of its Rule 10b-5 in light of the Supreme Court's most recent discussion of Rule 10b-5 and the statutory provisions upon which it rests. The Commission (SEC) has censured petitioner Raymond Dirks, vice president in a broker-dealer firm, for aiding and abetting violations of Rule 10b-5 by repeating information he had learned from former employees of a corporation to investors likely to sell their shares of the corporation's stock to members of the public without access to the same information. Dirks asks this court to reject the SEC's interpretation of Rule 10b-5 on the authority of Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), claiming that the Supreme Court's analysis in that case forbids the SEC to punish him under Rule 10b-5 for what he did.

We have before us both sensational facts and difficult issues of law and policy. ¹ The information Dirks passed on to his clients was no mere "tip": in two weeks of concerted effort, at times resembling something from detective fiction, Dirks investigated and confirmed rumors of massive fraud by the Equity Funding Corporation of America (Equity Funding), ² an insurance holding company whose stock traded on the New York Stock Exchange. Largely thanks to Dirks one of the most infamous frauds in recent memory was uncovered and exposed, while the record shows that the SEC repeatedly missed opportunities to investigate Equity Funding.

The issues of law and policy concern the role of private securities analysts who investigate corporate frauds. Securities analysts can be an important source of information for the public, supplementing an often overtaxed SEC enforcement staff and the press. There is some danger that the threat of liability under Rule 10b-5 may dampen the zeal of analysts in ferreting out the truth about corporate practices.

We recognize that concern, but we also recognize its limits. Private analysts may not keep information they have discovered from the SEC, while their clients dump fraudulent securities on an uninformed public. In this case, we defer to the SEC's judgment about what will best serve the long-range interests of the public and accomplish the statutory purposes behind Rule 10b-5. Therefore, we reject Dirks' argument based on Chiarella as well as several other challenges he presents.

I

Because the SEC has chosen merely to censure Dirks, and has not taken any other action against him in connection with this case, we need not consider whether all of Dirks' actions discussed by the SEC and the administrative law judge who first heard the case violated Rule 10b-5. A single willful violation of Rule 10b-5 or the statutes upon which it is based provides the SEC with discretion to impose the lightest administrative penalty available to it. See 15 U.S.C. § 78o (b)(4)(D)(1976). Therefore, we confine our recitation of the facts to Dirks' least ambiguous actions.

The critical events in this case occurred in March 1973. During that period Raymond Dirks was an officer of Delafield Childs, Inc., a registered broker-dealer that served a clientele composed primarily of institutional investors. Dirks himself specialized in providing investment advice about the insurance industry, and he was apparently highly respected within the investment community for his knowledge of insurance companies and his willingness to go beyond mere financial data in evaluating investments.

Dirks regularly provided investment advice to a number of institutions that he knew had invested or might be interested in investing in insurance company stocks. As far as the record shows, he had no formal relationship with these institutions; he simply tried to be aware of their investment objectives and strategies, and to inform them whenever he developed information that he thought would be of interest to them. Under the custom of the industry, Dirks received no direct compensation from these clients. Rather, if they thought the information Dirks gave them was valuable, they would direct some of their brokerage business through Delafield Childs, thus giving Dirks' firm a chance to earn brokerage commissions. ³

On March 6, 1973 Dirks received a telephone call from Ronald Secrist, who had recently been fired from his job with Bankers National, a New Jersey life insurance company that had been acquired by Equity Funding four years earlier. Secrist told Dirks that he had information about fraud and illegality at Equity Funding, and the two men arranged a meeting for the next day.

Dirks and Secrist met for several hours on March 7. Secrist made a series of detailed but nearly incredible allegations about Equity Funding: mainly that one of its subsidiaries had created false insurance policies and records to inflate its sales figures, but also that it was selling partnerships in nonexistent real estate, that its top officers had Mafia connections which they used to threaten the lives of employees who objected to the fabrications, and that the accounting firm of Haskins & Sells had dropped the Equity Funding account out of disagreement with the company's business practices. Although Secrist had neither personal knowledge nor documentation to support any of his charges, Dirks developed a hunch that Secrist was not merely a vindictive former employee trying to get back at the people who fired him. Therefore, Dirks decided to investigate Secrist's allegations.

Dirks' investigation had three major phases, the first two of which are not very important to the issues in this appeal. He began by examining publicly available data on Equity Funding's insurance sales. He compared Equity Funding's ratio of sales to sales force with that of its competitors, but he decided that the figures neither confirmed nor refuted the possibility that Equity Funding was fabricating insurance policies. Second, he contacted other people in the investment community who followed Equity Funding stock-many of them because they had invested in it-to see if they knew anything that could prove or disprove the rumors. This inquiry, too, was generally fruitless; most of the people with whom Dirks spoke did not believe there was any truth in Secrist's story. Through one informant Dirks did learn that Secrist's allegations about Haskins & Sells were untrue. The accounting firm had lost Equity Funding's business to a competitor and would be glad to get it back.

Nevertheless, Dirks continued to talk to Secrist regularly, and he continued to suspect that some of Secrist's charges might be justified. Dirks also telephoned Equity Funding's chairman, Stanley Goldblum, who denied that there was any fraud at Equity Funding and invited Dirks to visit the company's headquarters in Los Angeles.

Dirks flew to Los Angeles on March 19 to begin the third phase of his investigation. He spent most of the day on March 20 with Patrick Hopper, a former vice president of Equity Funding who had retired to live the life of a wealthy beach bum. Hopper had been Secrist's superior for a time at Banker's National, and it was Hopper who had suggested to Secrist that he tell his story to Dirks after Secrist lost his job. Hopper told Dirks that Secrist tended to exaggerate things, but that he-Hopper-tended to believe the gist of Secrist's allegations about phony insurance. In 1971 Hopper had been following Equity Funding's life insurance sales on a week-by-week basis until late October, when the company stopped circulating weekly reports. When the final figures for that year appeared in early January, Hopper had noted that the final figure for life insurance sales was almost double what his running total had been in October. He also saw the sales figures for what had previously been the best of the company's five sales districts, and they were far less than a fifth of the total insurance sales figures for 1971.

Hopper also reported that he had attended a dinner in New York with several other Equity Funding officers, and that some of them had joked openly at the table about "the Y business"-according to Secrist, the euphemism by which the insurance fabrication program was known within the company. Beyond that, Hopper had no direct knowledge of fraud at Equity Funding. But on the afternoon of March 20, he and Dirks sought out another former Equity Funding employee, Frank Majerus, who Hopper suspected might know something concrete. After a great deal of coaxing, Majerus admitted that he had been involved in altering the company's insurance-in-force figures for 1970.

Dirks spent much of the next day, March 21, with the top management of Equity Funding. The company's officers continued to deny, and even to ridicule, the notion that there was anything amiss at Equity Funding. But over the next two days Dirks contacted four other men whose names had been given him by Hopper and Secrist. Two had worked as computer technicians for Equity Funding, one had worked for the company that programmed Equity Funding's computers, and one...