Otis & Co. v. Securities and Exchange Commission

• Decision Date: 18 September 1939
• Docket Number: No. 7805.,7805.
• Citation: 106 F.2d 579
• Parties: OTIS & CO. v. SECURITIES AND EXCHANGE COMMISSION.
• Court: U.S. Court of Appeals — Sixth Circuit

106 F.2d 579 (1939)

OTIS & CO. v. SECURITIES AND EXCHANGE COMMISSION.

No. 7805.

Circuit Court of Appeals, Sixth Circuit.

September 18, 1939.

Frank X. Cull, of Cleveland, Ohio (Bulkley, Hauxhurst, Inglis & Sharp, Richard Inglis, and Raymond G. Hengst, all of Cleveland, Ohio, on the brief), for appellant.

James A. Treanor, Jr., and James J. Caffrey, both of Washington, D. C. (Allen E. Throop, Thomas J. Lynch, and Herbert B. Cohn, all of Washington, D. C., on the brief), for appellee.

Before HICKS, SIMONS and ARANT, Circuit Judges.

ARANT, Circuit Judge.

Pursuant to Section 20(b) of the Securities Act of 1933, 48 Stat. 86, 49 Stat. 1921, 15 U.S.C. § 77t(b), 15 U.S.C.A. § 77t (b) and Section 21(e) of the Securities Exchange Act of 1934, 48 Stat. 899, 49 Stat.1921, 15 U.S.C. § 78u(e), 15 U.S.C.A. § 78u(e), the Securities and Exchange Commission brought suit to enjoin appellant from continuing activities alleged to violate Section 17(a) (2) of the Securities Act of 1933, 48 Stat. 84, 15 U.S.C. § 77q (a) (2), 15 U.S.C.A. § 77q(a) (2), and Section 9(a) (2) of the Securities Exchange Act of 1934, 48 Stat. 889, 15 U.S.C. § 78i (a) (2), 15 U.S.C.A. § 78i(a) (2). The trial court held that no violation of the Securities Exchange Act had been shown. However, it held that appellant had violated Section 17(a) (2) of the Securities Act and enjoined further violations thereof. This appeal is from the latter part of the decree.

Appellant contends that the facts found do not constitute a violation of Section 17 (a) (2) of the Securities Act; but argues that, even if there had been a violation of the Act, it was error to grant the injunction because the violation had ceased several months before suit was begun.

The provision of the Securities Act held to have been violated by appellant is as follows:

"Section 17 77q. (a) It shall be unlawful for any person in the sale of any securities by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, directly or indirectly * * *

"(2) To obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading."

There is no substantial dispute as to the facts.

Appellant and its predecessors have been engaged in investment banking and the sale of securities since 1899. Its main office is in Cleveland, and it has branch offices in other cities. Because it is a corporation, it is not eligible for membership in any stock exchange. Its principal business is that of underwriter and dealer in securities. It acquires large blocks of securities, generally from the issuer, but sometimes from individual holders, for distribution to its customers. It maintains a department which examines statistical information concerning securities that it may have under consideration for purchase and offer to its clientele. It also maintains an inventory of securities which it attempts to keep in proper balance with its sales requirements.

As a result of a conversation with one Coughlin, a large stockholder and director of the Murray-Ohio Manufacturing Company, on April 10, 1935, Daley, president of Otis and Company, became interested in the stock of the Murray-Ohio Company, then listed on the Cleveland Stock Exchange and quoted at $3 a share. Having previously assisted this company, appellant had received its financial reports periodically for several years. The information thus acquired led Daley to believe that its stock, of which very little was being sold, was being offered below its intrinsic value and that its selling price would soon reflect the marked improvement in the company's economic condition. Consequently, early in June, 1935, he undertook to acquire a block of 10,000 shares of its stock for distribution in over-the-counter sales. There were then outstanding only 60,000 shares and almost one-half of them were held by a few large stockholders. Daley approached these stockholders and induced five of them, on June 25, 1935, to agree to sell appellant 4,918 shares at $10.50, the current exchange quotation, one-half of which was to be delivered and paid for on or before July 8 and the balance on or before July 20, 1935. None of these stockholders was then willing to sell more of his holdings. The contract with each contained the following provision: "I will not sell any of the balance of my stock prior to sixty days from this date without your written consent." None of this stock was offered for sale during the sixty-day period.

Another stockholder, Bernet, who controlled 2,500 shares, declined at that time to sell any of his stock and promised to sell none for sixty days unless he did so through appellant. He died shortly thereafter and, without knowledge of this promise, his son ordered the sale of 1,025 shares on the Cleveland Stock Exchange. Appellant had purchased 460 of these shares before their source was ascertained. Young Bernet was then informed of his father's promise and immediately cancelled his sale order as to the balance; however, he sold the remainder shortly after the expiration of the period covered by his father's promise.

Two other stockholders whose holdings aggregated 7,200 shares were approached on behalf of appellant but declined to sell, and none of their stock came into the market during the sixty-day period stipulated in the withholding agreements mentioned above.

Shortly after the April 10 conversation between Coughlin and Daley, referred to above, appellant made an investigation of Murray-Ohio stock, decided that it would be an attractive investment for its customers, and entered the market on May 9, buying at 4½. From that date until the middle of November, appellant dominated the buying side of this stock on the Cleveland Stock Exchange. From May 9 to June 25, 1935, it purchased 82% of the stock sold on the Exchange; from June 25th, when the withholding agreements were made, to August 26, when they expired, it purchased 91%; in September, October and November, it purchased 62%. Its purchases ceased on November 20, 1935, two days after the Securities and Exchange Commission began an investigation of its activities in Murray-Ohio stock.

Between May 9 and November 20, the exchange quotation rose from 4½ to 19.

On June 25, 1935, appellant began its over-the-counter distribution of the 4,918share block of stock through its several offices. The sales kit, dated June 25, 1935, and similar memoranda were mailed to its customers and to its salesmen, who were authorized to use it as a basis for their sales talk and to issue copies to customers on request.

These memoranda stated that appellant recommended Murray-Ohio stock as "an attractive speculation at current price levels," stated that "higher earnings for the company * * * should affect the market price accordingly," and offered the stock "at the market." There was evidence that appellant's salesmen called these statements to the attention of customers when the stock was being offered and sold. From June 26 to July 10, it distributed 4,934 shares at approximately the price quoted on the Cleveland Stock Exchange.

The Commission charged that appellant in its over-the-counter sales, failed to disclose all material facts necessary to prevent the representations made from being misleading, as required by Sec. 17(a) (2) of the Securities Act.

Appellant contends that it was not required to disclose either the withholding agreements or its purchasing activities. Withholding agreements were said to be a commonly used method of stabilizing the market, and their use for this purpose beneficial to both distributor and purchaser. It was also argued that purchases for the purpose of stabilization are approved by the Securities and Exchange Act of 1934 and legal under either Act when made for the purpose of replenishing supply.

The trial court found that appellant made no disclosure of its withholding agreements or of its extensive stock exchange purchases while its salesmen, pursuant to its instructions, were offering the stock "at the market." The Court said:

"I agree with counsel for plaintiff that these references to market price and current price levels could refer only to stock exchange quotations and that these imply `a price standard which normally reflects the operation of a free and open market in the sale and purchase of securities.' And that the defendant's customers by such omission to state the facts respecting withholding agreements and the market price situation, were led to believe that they were paying a price established in the normal way on the stock exchange without having been affected by artificial restriction of supply, and without stimulation of demand substantially by the defendant alone. The withholding agreements kept 17,000 out of 60,000 shares off the market while defendant was disposing of its approximately 5,000 shares. This in itself was a material fact which I think the law requires shall be communicated to defendant's customers. Plaintiff claims a much larger...