Jaffee & Company v. Securities and Exchange Commission

• Decision Date: 18 June 1971
• Docket Number: No. 835,Docket 34859.,835
• Citation: 446 F.2d 387
• Parties: JAFFEE & COMPANY and Wilton L. Jaffee, Jr., Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

446 F.2d 387 (1971)

JAFFEE & COMPANY and Wilton L. Jaffee, Jr., Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 835, Docket 34859.

United States Court of Appeals, Second Circuit.

Argued May 25, 1971.

Decided June 18, 1971.

COPYRIGHT MATERIAL OMITTED

Jerome J. Londin, New York City (Carro, Spanbock & Londin, New York City, on the brief), and Wilton L. Jaffee, Jr., pro se, for petitioners.

Richard E. Nathan, Special Counsel, Washington, D. C. (Philip A. Loomis, Jr., Gen. Counsel; David Ferber, Solicitor, and James J. Sexton, Atty., Securities and Exchange Commission, Washington, D. C.), for respondent.

Before KAUFMAN, ANDERSON and MANSFIELD,^* Circuit Judges.

KAUFMAN, Circuit Judge:

Petitioners Jaffee and Jaffee & Co., a registered broker-dealer, seek review of an order of the Securities and Exchange Commission dated April 20, 1970, prescribing that each petitioner be disciplined on account of Jaffee's violations of Rule 10b-6, 17 C.F.R. § 240.10b-6, promulgated under Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b). We affirm the order with respect to Jaffee but hold that Jaffee & Co. was afforded inadequate notice that it would be disciplined derivatively on account of Jaffee's violations, rather than because of violations attributable directly to the Company, and hence set aside the order disciplining Jaffee & Co.

I.

None of the essential facts is in dispute. This proceeding was initiated by order of the Commission dated March 24, 1966, which directed a hearing into alleged violations of several provisions of the securities acts by several named respondents, including petitioners here.¹ All of the alleged infractions related to transactions between June 1963 and March 1964 in connection with a secondary offering of common stock in Solitron Devices, Inc., a designer and manufacturer of electronic products. Following a hearing extending for 10 days, the hearing examiner found that Jaffee, while he was the dominant partner in the since defunct partnership and broker-dealer of Jaffee & Leverton, had violated Rule 10b-6 as well as Section 5(b) of the 1933 Act and various antifraud provisions of both the 1933 and 1934 Acts. The examiner recommended that Jaffee be suspended for thirty days but dismissed the proceedings against Jaffee & Co. on the grounds that as a successor and not a mere continuation of the Leverton firm, it could not be held accountable for any of that firm's wrongdoings, and second, that Jaffee & Co. had insufficient notice to permit the imposition of derivative sanctions under Section 15(b) (5) of the Exchange Act, 15 U.S.C. § 78o(b) (5), the provision ultimately relied upon by the Commission.

The Commission granted the petitions for review which were filed by all respondents. Jaffee & Co., in light of the Examiner's favorable decision, did not petition for review. After oral argument, the SEC absolved Jaffee of all but the Rule 10b-6 violations and, rejecting the hearing examiner's finding of insufficient notice, disciplined Jaffee & Co. under Section 15(b) (5) of the 1934 Act on the sole ground that at the time the proceedings were instituted and during the hearings, Jaffee's interest in the firm exceeded 90%, even though the firm had not been in existence at the time Jaffee was found to have violated Rule 10b-6. Because of this disposition of the proceeding against Jaffee & Co., the SEC found it unnecessary to decide whether the firm might also be liable for any violations that may have been committed by Jaffee & Leverton, which the hearing examiner had added as an alleged participant in the various violations charged (but not as a respondent), over the objections of Jaffee & Co. The Commission ordered that Jaffee be suspended from associating with a broker or dealer and that Jaffee & Co.'s registration be suspended, each suspension to run for concurrent periods of twenty days. By order of the Commission the suspensions have been stayed pending the determination of this petition.

II.

We find no merit to Jaffee's primary arguments that he did not violate Rule 10b-6 because there was no "distribution" within the meaning of that provision in progress at the time he made several purchases of stock in Solitron; or, assuming there was a distribution, that the Commission did not show that his purchases were intentionally or actually manipulative. A registration statement for a secondary offering of 107,700 shares held by thirty-four holders of common stock in Solitron (or about 28% of the then outstanding common stock) was filed under Section 6 of the 1933 Act, 15 U.S.C. § 77f, and became effective on October 11, 1962. The largest block of this stock, consisting of 27,500 shares, was Jaffee's. The prospectus announced that the selling stockholders intended to offer the stock for sale on the over-the-counter market "in the proximate future" and appointed Lee & Co., a New York broker-dealer, "exclusive agent" for the offering. Among other things, each shareholder agreed to "comply with the provisions of Rule 10b-6."

Jaffee's liability was premised on his purchases of ten shares of Solitron on August 19, 1963 and an additional 7,600 shares at various times between December 26, 1963 and February 13, 1964. Jaffee's only sale of registered stock during this period was of a single block of 3,500 shares on October 30, 1963. As early as May, 1963, however, Lee & Co. had disposed of 16,300 shares owned by other participants in the offering and by March of the following year the total of registered stock sold had risen to 75,100 shares, or almost 75% of the total registered offering. Shortly thereafter, between October 20 and December 30, 1964, Jaffee sold an additional 16,900 shares of his registered stock.

These facts make out a clear violation of Rule 10b-6, which in relevant part prohibits any "person on whose behalf * * * a distribution is being made" or any person "who has agreed to participate or is participating in * * * a distribution * * * to bid for or purchase * * * any security which is the subject of such distribution * * * until after he has completed his participation in such distribution * * *." There are several exceptions to this prohibition, none of which Jaffee invokes to justify his purchases of Solitron. Jaffee does not dispute that had he been actively promoting the sale and had he in fact sold substantial blocks of his registered stock immediately following his purchases, he would have violated Rule 10b-6. See J. H. Goddard & Co., Securities Exchange Act Release No. 7618 (1965). Rather, Jaffee characterizes his offering under the prospectus and registration as a "shelf registration" because — whatever the intent of other participants may have been — Jaffee himself had no present intent to publicly distribute his registered stock immediately. Jaffee seeks to excuse the 3500 shares sold in October, 1963, as an "unsolicited transaction." His related argument — related because each approach would erode the prophylactic value of the rule — is that the Commission has not shown that Jaffee intended to manipulate the market, or did in fact manipulate it, or did in fact defraud any buyer or seller through his purchases and sales.

Difficult questions may arise with respect to an underwriter's purchase of registered stock where he claims a bona fide intent to "shelve" or keep for investment some portion of it. See Whitney, Rule 10b-6: The Special Study's Rediscovered Rule, 62 Mich.L.Rev. 567 (1964); Report of Special Study of Securities Markets of the S.E.C., H.R. Doc. No. 95, 88th Cong., 1st Sess., pt. I at 545-46 (1963). Similarly, Rule 10b-6(c) (3) provides that a person "shall be deemed * * * to have distributed securities acquired by him for investment" (at which point Rule 10b-6 ceases to apply), a provision which gives rise to close questions with respect to when an underwriter, for example, decides to "shelve" a "sour" issue, see 3 Loss, Securities Regulation 1595 (2d ed. 1961). But Jaffee does not and, on this record, could not successfully contend that at any time following the effective date of the registration statement he was holding his registered stock "for investment." His very registration of shares owned by him implied an intention to sell or distribute rather than to hold them for investment. Moreover, Rule 10b-6(a) (3) (xi) provides that for the purpose of determining the liability of an underwriter and others who purchase securities within a brief specified period before the commencement of a distribution, "the distribution shall not be deemed to commence * * * prior to the effective date of the registration statement," where the securities are registered under the 1933 Act, as here. Although the last-quoted provision does not refer to participants in a distribution generally, see Note, The SEC's Rule 10b-6: Preserving a Competitive Market During Distributions, 1967 Duke L. J. 809, 848-49 (1967), the use of the "effective" date of the registration statement to define the operative period of the rule is instructive here. The dangers of market manipulation that Rule 10b-6 was designed to eradicate, see Chris Craft Industries, Inc. v. Bangor Punta Corp., 426 F.2d 569, 577 (2 Cir. 1970) (en banc), were continually present so long as Jaffee's purchases might have artificially inflated the price of Solitron, thereby affording him an opportunity to sell his registered stock at a price higher than he would have received if the market had been permitted to seek its own level. The Commission was clearly justified in applying the rule during a period following the registration and before Jaffee had "completed his participation" in the distribution. See R. A. Holman & Co., Inc. v. Securities and Exchange Commission, 366 F.2d 446, 449 (2d Cir. 1966).

For similar reasons, and contrary to Jaffee's assertion, the Commission need not have shown that Jaffee actually intended to defraud the marketplace through his purchases....