Otis & Co. v. Securities and Exchange Commission

• Decision Date: 01 June 1949
• Docket Number: No. 10058.,10058.
• Parties: OTIS & CO. v. SECURITIES AND EXCHANGE COMMISSION et al.
• Court: U.S. Court of Appeals — District of Columbia Circuit

176 F.2d 34 (1949)

OTIS & CO. v. SECURITIES AND EXCHANGE COMMISSION et al.

No. 10058.

United States Court of Appeals District of Columbia Circuit.

Argued December 17, 1948.

Decided June 1, 1949.

Writ of Certiorari Granted October 17, 1949.

Messrs. Thurman Arnold, Washington, D.C. and Joseph L. Weiner, New York City, with whom Messrs. Abe Fortas, Milton V. Freeman, and Norman Diamond, Washington, D. C., were on the brief, for appellant.

Mr. Louis Loss, Associate General Counsel, Securities & Exchange Commission, Washington, D.C., with whom Messrs. Edward H. Cashion, E. Russel Kelly, C. J. Odenweller, Jr., and Alfred Hill, Attorneys, Securities & Exchange Commission, Washington, D.C., were on the brief, for appellees.

Before STEPHENS, Chief Judge, and WILBUR K. MILLER and PROCTOR, Circuit Judges.

Writ of Certiorari Granted October 17, 1949. See 70 S.Ct. 89.

WILBUR K. MILLER, Circuit Judge.

Otis & Company, an investment banking house, was one of three underwriters which contracted to purchase an issue of common stock of Kaiser-Frazer Corporation. Among the conditions precedent in the underwriting agreement was that on February 9, 1948, the closing day, there should be no material litigation pending against Kaiser-Frazer. On the morning of that day, and before the purchase of the stock had been consummated, one Masterson sued Kaiser-Frazer in a state court in Detroit, seeking to enjoin the contemplated sale. Assigning the pendency of that suit as one of its reasons for so doing, Otis cancelled the underwriting contract.

On February 13, 1948, Kaiser-Frazer sued Otis in a New York state court charging that it had fraudulently caused Masterson to file the Detroit suit in order to terminate the underwriting agreement.

Five days later the Securities and Exchange Commission ordered its staff to make what it termed a "private investigation" to determine whether certain antifraud provisions of the Securities and Exchange Act of 1934¹ had been violated by the underwriters. Thereafter, and on March 23, 1948, the Commission ordered a public investigation to be made. Pursuant to that order extensive hearings were conducted at which Otis was allowed to observe but was not permitted to cross-examine witnesses nor to introduce evidence.

It was indicated during the investigation that Otis or Cyrus S. Eaton, its controlling stockholder, had consulted Harrison and Hull, attorneys at law of Cleveland, Ohio, concerning the Masterson suit. Because of that indication the Commission subpoenaed Harrison and Hull, who declined to give the name of their client until compelled to do so by the United States District Court at Detroit after the Commission instituted therein a subpoena enforcement proceeding. They then disclosed that their client was Eaton. After much additional evidence had been taken in various cities, the investigation was reconvened in Washington and Harrison and Hull were again called as witnesses. They refused, on the ground of attorney-client privilege, to testify concerning the communications between them and Eaton. The Commission directed its presiding officer to rule that evidence already received made a prima facie showing that Eaton had consulted the attorneys concerning the perpetration of a fraud, and that therefore the attorney-client privilege was unavailable. Harrison and Hull continued to decline to answer.

Following this, and on June 25, 1948, the Commission filed a complaint in the United States District Court for the District of Columbia praying that Harrison and Hull be required to appear before the Commission or its hearing officer to answer questions concerning conversations between them and their client, and their activities in his behalf relating to the subject matter of the investigation, and any other questions material to the investigation except those the answers to which might be self-incriminatory. Eaton and Otis were permitted to intervene.

The Commission recited in the complaint its belief that evidence in the record of its public investigation amounted to a prima facie showing that Eaton had consulted the attorneys in connection with the filing of a collusive and fraudulent lawsuit. In support of its complaint, the Commission filed the affidavit of one of its staff which purported to set forth the evidence in the record regarded by the Commission as establishing the prima facie fraud. Later the Commission offered the entire record of its public investigation, the transcript of which contained more than five thousand pages.

After extensive argument, District Judge Morris filed an opinion in which he held that the evidence which was before the Commission and before him, together with all reasonable inferences to be drawn therefrom, did not make "the requisite prima facie showing of fraud to pierce the attorney-client privilege * * *." Accordingly the District Court ordered, on October 28, 1948,

"* * * That the order sought by the plaintiff Securities and Exchange Commission to enforce the subpoenas directed to the defendants in so far as they call for testimony and evidence relating to communications with their client Cyrus S. Eaton or require a disclosure of such communications be and it is hereby denied, * * *"

After the case had been argued before Judge Morris, but long before he had decided it, the Securities and Exchange Commission on August 11, 1948, entered an order entitled "In the matter of Otis & Company, 2000 Terminal Tower Building, Cleveland, Ohio," which recited at length the history of the underwriting agreement, and which included the following:

"The Commission, as the result of a public investigation, has obtained information which tends, if true, to show that:

* * * * * *

"H. The underwriting agreement provided that it could be terminated by the underwriters if at the time for settlement any material litigation were pending or threatened against K-F, except as disclosed by the registration statement. For the purpose of evading its obligations under the underwriting agreement through this provision, the registrant through Eaton caused a lawsuit against K-F to be filed on February 9, 1948, before 10:00 A. M. in the Circuit Court for the County of Wayne, Michigan. At the time and place for settlement the registrant refused to consummate the underwriting agreement and asserted that it was released from its obligations thereunder because of the lawsuit. The registrant omitted to state to K-F, the co-underwriters, and purchasers that it had caused the said lawsuit to be filed."

The order of August 11 directed that for the purpose of determining whether to suspend or expel Otis from membership in the National Association of Securities Dealers, Inc., a hearing before the Commission or its designated officer be held on September 20, 1948. Upon the application of Otis and Eaton, Judge Letts of the District Court enjoined the Commission from taking any action whatever pursuant to its order of August 11, 1948, pending the decision of Judge Morris. A portion of the recital of Judge Letts' order was as follows:

"* * * it appearing that the holding of such a hearing may involve interference with the jurisdiction of this Court in the above entitled matter, and it further appearing that it is necessary to protect the jurisdiction of this Court,

"It is hereby ordered, * * *"

That injunction expired by its terms on October 28, 1948, when Judge Morris entered a final order. Within a few hours after its entry, the Commission activated its order of August 11, 1948, by directing that a hearing commence on November 15, 1948,

"* * * to determine whether to revoke or suspend the broker-dealer registration of Otis & Company, and whether to suspend or expel the said company from membership in the National Association of Securities Dealers, Inc., * * *" On November 10, 1948, Otis sued the Commission in the United States District Court for the District of Columbia to enjoin it from proceeding pursuant to its orders of August 11 and October 28, 1948,

"* * * insofar as those orders relate to or involve the termination of the underwriting agreement between plaintiff and Kaiser-Frazer Corporation, or the alleged instigation of a stockholder's derivative suit for the alleged purpose of avoiding plaintiff's obligations under said underwriting contract; * * *"

It prayed

"That the Court declare that the judgment of this Court of October 28, 1948, is binding as res judicata on the defendant Commission and that it is without power to conduct the proposed inquiry into the alleged instigation of the Masterson suit."

The complaint related the story of the whole matter and, with respect to the hearing set for November 15, contained the following allegation:

"27. In said hearing the Commission proposes to reintroduce the evidence obtained by it in the so-called public investigation which it has already held to constitute prima facie proof that the Masterson suit was inspired by plaintiff through said Eaton, and again to pass upon that evidence. The Commission proposes to do this despite the fact that this Court, through Judge Morris, has determined that such evidence does not constitute even a prima facie showing thereof. On information and belief, plaintiff alleges that the Commission does not have and cannot produce any evidence in addition to that in the record of its so-called public investigation which has heretofore been passed upon by this Court. (The Commission's order of August 11, 1948, contains allegations not considered in the S.E.C. action; as to those matters no relief is here sought if properly severed for hearing.)"

The Commission moved to dismiss the complaint on the ground "(a) that the Court lacks jurisdiction over the subject matter and (b) that the complaint fails to state a claim against the defendants upon which relief can be granted." The District Court dismissed the complaint and this appeal followed.

The applicability of the doctrine of res judicata is...