SECURITIES & EXCHANGE COM'N v. Senex Corporation

• Decision Date: 03 March 1975
• Docket Number: Civ. No. 74-53.
• Citation: 399 F. Supp. 497
• Court: U.S. District Court — Eastern District of Kentucky
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. The SENEX CORPORATION et al., Defendants.

399 F. Supp. 497

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. The SENEX CORPORATION et al., Defendants.

Civ. No. 74-53.

United States District Court, E. D. Kentucky, Covington Division.

March 3, 1975.

COPYRIGHT MATERIAL OMITTED

David P. Doherty, Asst. Director, Harris S. Ammerman, Washington, D. C., James E. Birchby, Denver, Colo., A. Barry Morewitz, Adele R. Geffen, Washington, D. C., for plaintiff.

Morris Weintraub, Newport, Ky., for defendants Senex Corp., Tarley, Alison, Jay, Malcolm & Co. and BFT, Inc.

Charles G. Atkins, Cincinnati, Ohio, Donald L. Johnson, Newport, Ky., for defendants A. J. Jolly and Mentor Corp.

James S. Cox, Memphis, Tenn., for defendant Thomas N. Street, Jr.

MEMORANDUM

SWINFORD, District Judge^*:

This enforcement action commenced by the Securities and Exchange Commission alleges violations of Section 17(a) of the Securities Act of 1933, 15 U.S.C. 77q(a), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), and Rule 10b-5, 17 C.F.R. 240.10b-5, growing from the offer and sale of $4,425,000 in City of Covington Health Care Revenue Bonds. The complaint seeks preliminary and permanent injunctions restraining the defendants and their agents from engaging in prohibited conduct in connection with this or other securities. On November 5, 1974, a consent judgment of permanent injunction was entered against defendants, Senex Corporation; Arthur Jay Tarley; Alison, Jay, Malcolm & Co. (formerly Stemac Management Corporation); and BFT, Inc. A hearing addressing the propriety of a preliminary injunction against the remaining defendants, A. J. Jolly, Mentor Corporation, and Thomas N. Street, Jr., was conducted over an extended period of time. The parties have filed written arguments and the record is before the court for decision.

I

Although involving numerous interlocking transactions and parties, the circumstances surrounding the Covington bond offering are largely uncontested. The testimony indicated that in January, 1971, A. J. Jolly and Arthur Jay Tarley formed the Senex Corporation to develop health care programs and facilities for the elderly and infirm. Beginning with his term as Campbell County Judge, Jolly had investigated and formulated various plans and projects designed to maximize the infusion of federal aid into municipal centers for health care. Through repeated exposure to and utilization of government regulations, Jolly developed "tri-level" projects in several Kentucky counties erected to provide continuing skilled nursing, intermediate care and personal care beds. The formation of Senex was intended to couple Jolly's knowledge of program formulation in this area with Tarley's expertise in the construction field.

In March, 1971, Jolly was contacted by Covington Mayor Claude Hensley regarding the development of a municipal nursing home. The city was informed that the project could proceed along alternate routes: (1) Senex could act as a consultant for a fixed fee and all risks would be assumed by the municipality; (2) Senex could assume the role of developer of a "turnkey" project¹ for a stated figure; its profits would depend upon the cost of the project, but the city would be relieved of any loss in the event the plan was aborted. The mayor opted for the second alternative, whereupon Jolly suggested the formation of a nonprofit company to operate the facility; the corporation and municipality should then draft a letter and resolution of intent reflecting a willingness to proceed in the event of the project's feasibility. The Covington Health Care Corporation (hereinafter: Health Care Corporation) was thereafter formed by Jolly and appropriate expressions of intent followed.

On October 13, 1971, the Health Care Corporation entered into a contract providing that Senex would construct the facility at a cost of $2,815,000 (later amended to $2,960,000); nearly a year later, Boggs Construction Corporation contracted with Senex to build the structure for approximately $2,312,000. This August 17, 1972, agreement provided that Boggs would assume all the obligations of the Senex contract with the Health Care Corporation. Jolly's involvement with the contracting parties was somewhat remote since he had divested himself of Senex stock during the summer of 1971; however, a concomitant agreement recited that Jolly would be retained as consultant to Senex and share equally in the profits generated by the Covington project. Jolly's activities on behalf of the plan were unaffected by his formation of the Mentor Corporation in October, 1971. Indeed, the mayor was assured of Jolly's continuing participation as the "social architect" of the project.

Difficulties surrounding the Covington nursing home planning were apparently ignited by the publication of an adverse feasibility report by the A. T. Kearney and Company, Inc. (hereinafter: Kearney), which had been commissioned by the Rosedale Manor, a nursing home in Kenton County, Kentucky. Although the parties disagree concerning its scope and bias, the Kearney report generally concluded that the region could not support another facility. Meeting with the Northern Kentucky Health and Welfare Planning Council (hereinafter: Planning Council) on December 9, 1971, Jolly recognized the necessity for properly based feasibility studies; accordingly, Senex on December 17, 1972, contracted with the nationally recognized Arthur D. Little, Inc. (hereinafter: Little) for the preparation of a study forecasting the need for a nursing home complex. A report tendered in January, 1972, paralleled the conclusions reached by the Kearney study and Little's services were terminated shortly thereafter. Concerned about the impact of the Kearney and Little reports, the Covington mayor on January 18, 1972, asked that the Planning Council study the problem and issue recommendations. The inquiry was hampered, however, by difficulties in securing copies of the Little report: Although Jolly had previously indicated to the Council that the study would be supplied, efforts to secure a copy culminated in a March 22, 1972, letter from Tarley indicating that the survey was the property of the bond underwriter (which had not at that time been appointed), and disbursement would be inconsistent with the aims of the project. Although disputed at the hearing, some evidence indicated that copies of the report had been furnished to the Planning Council chairperson and the mayor, and that the inability to secure the report was only indirectly attributable to Jolly.

Efforts to obtain a satisfactory feasibility study were furthered in a March 17, 1972, contract engaging Block, McGibony and Associates, Inc. (hereinafter: Block McGibony), another well recognized firm, to undertake a Northern Kentucky study. On May 31, 1972, Block McGibony rendered its final report concluding that the project was feasible. Additional suggestion of the project's desirability was offered in a "Consultant's Report" by the Mentor Corporation, an enterprise formed by Jolly during 1971. Although the date of the initial report is uncertain, Jolly's testimony that a peripheral task in all municipal contracts was the preparation of a "need survey" indicates that the preliminary Mentor conclusions were revealed soon after the inception of the project. Each of the various compilations of the Mentor study concluded that the construction was meritorious. Refuting the Kearney report, the March 3, 1972, Mentor survey stated:

"(T)HE FACT THAT THE PROPOSAL HAS BEEN REVIEWED BY A SOPHISTICATED INVESTMENT BANKER WITH THE RESULT THAT IT IS WILLING AND ANXIOUS TO INVEST A SUM IN EXCESS OF $4,000,000 WITH NO SECURITY OTHER THAN THE PROJECT ITSELF, IS THE BEST POSSIBLE PROOF OF ITS FEASIBILITY."

The undisputed inaccuracy of the quoted statement is rebutted by Jolly's explanation that the assertion represented his contemporaneous understanding that financing had been located. Although directed to the Senex Corporation, the Mentor Report contained a lengthy examination of the area need for the proposed center, suggested operating guidelines, and a summary of the various governmental aid programs available to the aged; further, the report was incorporated — with Jolly's permission — into the bond prospectus used in acquainting city officials and investors with the issue.

On May 1, 1972, the Health Care Corporation hired Stemac as fiscal advisor at a fee of 3% of the face amount of the bond issue. Representing the firm as a recognized expert in the field of municipal finance, Tarley did not disclose that he had purchased the inactive broker-dealer several months earlier for $1,000. Unsuccessful attempts to locate a bond underwriter for the project resulted in Stemac's appointment in that capacity as well — again without disclosure of Tarley's ownership — in a contract providing for purchase of the entire issue by the underwriter at a discount with payment to be made on August 30, 1972.

Stemac's principal agent was Thomas N. Street, Jr., a former employee of A. S. Hart & Co., a municipal bond house in Memphis, Tennessee. Street was primarily responsible for preparing a prospectus, a task which he had undertaken several times in the past. It is undisputed that the prospectus incorporated no reference to the $648,000 "spread", the negative feasibility studies, or the interlocking ties among the corporate entities associated with the promotion. Rather, the booklet referred to the favorable studies and detailed the anticipated methods of financing and operation.

The prospectus was used not only in searching for an underwriter and securing final acceptance of the project by city officials but also in obtaining a favorable financial rating and selling the bonds themselves. Employing the prospectus and favorable feasibility reports, Street and Tarley approached Standard and Poor's Corporation and Fitch's Investor's Service. On July 13, 1972, Standard and Poor's declined to rate the bond in a letter...