SECURITIES & EXCHANGE COM'N v. Galaxy Foods, Inc.
| Decision Date | 26 July 1976 |
| Docket Number | No. 73 C 1742.,73 C 1742. |
| Citation | 417 F. Supp. 1225 |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. GALAXY FOODS, INC., et al., Defendants. |
| Court | U.S. District Court — Eastern District of New York |
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William D. Moran, for plaintiff Securities and Exchange Commission by Franklin D. Ormsten, Allan M. Lerner, Harry L. Garmansky, Regina C. Mysliwiec, Julia B. Williams, New York City, of counsel.
Goidel, Goidel & Helfenstein, for defendants Kirschenblatt & Shevack by Alvin I. Goidel, New York City.
Plaintiff Securities and Exchange Commission ("SEC") brought this action pursuant to § 20(b) of the Securities Act of 1933 ("the Securities Act"), 15 U.S.C. § 77t(b), and § 21(e) of the Securities and Exchange Act ("the Exchange Act"), 15 U.S.C. § 78u(e), alleging violations by defendants of the § 5 registration provisions of the Securities Act, 15 U.S.C. § 77e, and the anti-fraud provisions of both acts, § 17(a) of the Securities Act and § 10(b) of the Exchange Act, 15 U.S.C. § 77q(a) and 15 U.S.C. § 78j(b). Named as defendants are Galaxy Foods, Inc. ("Galaxy") and Arthur Lieberman, Ralph Avni, Charles Horowitz, Bruce Katz, Steven Roth, Mark Glazer, Irwin D. Kirschenblatt, George Padilla and Arthur Shevack, all of whom were either directors, officers or franchisees of Galaxy. The relief sought includes, inter alia, a permanent injunction against future violations of the securities laws and disgorgement of profits.1
Prior to the hearing on the merits, defendants Lieberman, Avni, Horowitz, Katz, Roth and Glazer consented to the entry against them of a judgment, which included a broad permanent injunction against future violations of the securities laws and a provision for disgorgement of specified dollar amounts, without admitting or denying any of the substantive allegations of the complaint. During the hearing, which lasted eight days, Padilla also consented to the entry of a similar judgment against him and the matter proceeded to conclusion solely against Kirschenblatt and Shevack.
The following constitute the court's findings of fact and conclusions of law. Rule 52(a) F.R.Civ.P.
Galaxy was incorporated on September 2, 1971 by Lieberman, Avni and Rosenthal, each of whom acquired its issued and outstanding stock in approximately equal amounts in exchange for a total capital contribution of $100. Rosenthal became chairman of the board of directors and president; Avni became vice-president and Lieberman became secretary-treasurer.2
In October 1971, Galaxy rented a large room on Flatbush Avenue in Brooklyn which served as its principal business office. This room was subdivided into compartments and used by Galaxy's executives as individual offices. In March 1972, Galaxy rented a warehouse on Stanley Avenue in Brooklyn.
Galaxy's proclaimed business objective was to provide a free home delivery service of supermarket items. Galaxy's retail customers would order name brand supermarket items at competitive prices from a catalog prepared by Galaxy and Galaxy would fill those orders from inventory.
In order to make possible this new concept in food retailing, two important requirements had to be met: (1) salespeople had to be recruited to attract retail customers, and (2) working capital had to be raised to rent a warehouse and trucks, purchase and maintain an inventory and finance the establishment of a delivery system capable of processing thousands of individual orders. The single solution to these twin problems employed by Galaxy, i. e., the sale of franchises, is at the heart of the SEC's complaint in this action.
Franchises came in two forms: distributorships and field manager positions. A distributorship originally cost $3,000 but was raised to $5,000 in March 1972, and to $7,000 in October 1972. Field manager positions sold initially for $1,000 but increased to $2,000 in March 1972, and to $3,000 in October 1972.
As explained at meetings held by Galaxy, about which more will be said later, and in manuals produced by the company, distributors and field managers could earn money through Galaxy in two ways, referred to respectively as the retail and wholesale ends of the business.
The retail end of the business involved the actual sale of food to consumers. Distributors were offered a 15% commission on initial customer orders and a 5% commission on reorders. Field managers, in turn, were offered a 10% discount on initial orders and 3% on reorders.
Both distributors and field managers were instructed to hire salespeople to recruit retail customers by offering the salespeople a 5% commission on initial orders and 1% commission on reorders. Franchisees could thus establish sales organizations consisting essentially of salespeople doing the actual "leg work" and yielding the franchisee the difference between the commission received from Galaxy and the lower commission paid the salesman.
The wholesale end of the business refers to the sale of franchises by existing franchisees. Distributors and field managers were encouraged to interest others, called "sponsoring," in purchasing distributorships or field manager positions. A distributor would receive a commission of $1,250, $2,000 or $2,450, depending on the prevailing selling price, for sponsoring a distributor, and $400, $750, or $1,050 for sponsoring a field manager. A field manager could earn $300, $500, or $750, depending on the prevailing franchise selling price, if he sponsored a distributor or field manager. Additionally, if a field manager sponsored a distributor, his distributor would receive the difference between the prevailing distributor commission, e. g., $1,250, and the commission received by the field manager, i. e., $300. Similarly, if a field manager sponsored another field manager, his distributor would receive the difference between the prevailing field manager commission, e. g., $400, and the commission paid the sponsoring field manager, i. e., $300.3 Thus, approximately 35-40% of the selling price of franchises was paid as commissions to sponsoring franchisees.
The contract signed by Galaxy franchisees limited the number of distributorships Galaxy could sell to "60 per one million population per state" and specified a quota of 1,079 for New York State distributorships.4
Sales of franchises were accomplished through the medium of sales presentations given at "Opportunity Meetings" held by Galaxy. These meetings were held three to four times a week at different hotels in the New York City and Long Island area. Group size at the meetings ranged from as few as 10 to as many as 200.
Lieberman, Horowitz, Roth and Katz were the regular and, for practical purposes, the exclusive speakers at these meetings. They always spoke from the same prepared text, which had been drafted by them, Rosenthal and Avni. Speakers were not permitted to deviate from the script.
The purpose of the presentation was to explain the Galaxy concept to prospective investors, called "prospects," whom sponsors had brought to the meetings. The speakers also explained in great detail the retail and wholesale commissions to be earned. A blackboard diagram was used to demonstrate how a distributor could earn as much as $60,000 per year from the retail end of the business after only three months in Galaxy.5 Statements by the speakers relating to how much money one could earn in Galaxy were greeted with cheers and applause by existing franchisees and Galaxy management.6
After the first speakers explained the retail and wholesale ends of the business, there was a guest speaker, usually Lee Horowitz or one of the other top Galaxy officials, who promised that Galaxy would itself recruit and distribute to franchisees 8-10,000 retail customers when retail operations began.
Galaxy distributors and managers were instructed to invite prospects to these meetings but to tell them little or nothing about the Galaxy operation itself. The inducement to attend the meetings was to be simply the opportunity to earn large sums of money. Distributors and managers were told to drive new, expensive automobiles, to wear expensive clothing and to carry large amounts of cash, all to convey to the prospect an illusion of success attributable to association with Galaxy.7 Once a prospect was lured to a meeting, Galaxy's management did the rest via their established sales presentation.
In addition to Opportunity Meetings, Galaxy held "Sunday Step-Up Meetings",8 which were designed to obtain commitments, and checks, from the prospects. This process was referred to as "closing the deal" and "getting the check" ("GTC", in Galaxy parlance).
At these meetings, which after March 1972 were held in Galaxy's rented warehouse, one speech was given by either Lee, Horowitz, Katz or Roth. Another feature of these meetings, adopted around June 1972 and referred to as "Pay-Day", was the distribution of commission checks to existing franchisees. The one distributing the checks would either call out the amount or ask a prospect to come up and call out the amount. The speaker would usually emphasize that the franchisees receiving checks had just recently joined Galaxy.
Towards the end of the meeting, prospects were called to the front of the room and asked whether they wished to join Galaxy as a distributor or as a field manager, a question implicit with an assumption. The response was greeted with cheering and applause.
The tremendous exhibitions of enthusiasm at these Opportunity and Step-Up Meetings, the cheering and applauding and the check distributions, were all part of a conscious theme on the part of Galaxy's management to create a high-pressure atmosphere in which the prospect was enveloped and imbued with an almost irrational desire to join — this process was referred to by Lieberman as "jack-up."
Bi-weekly or monthly training sessions were held for new franchisees from October 1971 until ...
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