910 F.2d 1028 (2nd Cir. 1990), 90-6091, S.E.C. v. Unifund SAL

Docket Nº:90-6091, 90-6103.
Citation:910 F.2d 1028
Party Name:17 Fed.R.Serv.3d 633 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. UNIFUND SAL and Tamanaco Saudi & Gulf Investment Group, Defendants-Appellants, Fondation Hai, Holding Protection, Ltd., Robert Rossi, and Certain Purchasers of the Common Stock and Options to Purchase the Common Stock of Rorer Group, Inc., Defendants. Nos. 1308, 1318, 1
Case Date:August 03, 1990
Court:United States Courts of Appeals, Court of Appeals for the Second Circuit
 
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Page 1028

910 F.2d 1028 (2nd Cir. 1990)

17 Fed.R.Serv.3d 633

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee,

v.

UNIFUND SAL and Tamanaco Saudi & Gulf Investment Group,

Defendants-Appellants,

Fondation Hai, Holding Protection, Ltd., Robert Rossi, and

Certain Purchasers of the Common Stock and Options

to Purchase the Common Stock of Rorer

Group, Inc., Defendants.

Nos. 1308, 1318, 1319, 1430, Dockets 90-6093, 90-6057,

90-6091, 90-6103.

United States Court of Appeals, Second Circuit

August 3, 1990

Argued April 27, 1990.

Page 1029

Phillippe M. Salomon, New York City (Willkie Farr & Gallagher, New York City, on the brief), for defendant-appellant Unifund SAL.

Pamela W. Weiss, Miami, Fla. (Samuel I. Burstyn, Miami, Fla., on the brief), for defendant-appellant Tamanaco Saudi & Gulf Investment Group.

Thomas L. Riesenberg, Asst. Gen. Counsel, Securities & Exchange Comm'n, Washington, D.C. (Paul Gonson, Solicitor, Daniel L. Goelzer, Gen. Counsel, Phillip D. Parker, Assoc. Gen. Counsel, Joseph A. Franco, Susan Nash, Rada L. Potts, Securities & Exchange Comm'n, Wash., D.C., on the brief), for plaintiff-appellee.

Before VAN GRAAFEILAND, NEWMAN and KEARSE, Circuit Judges.

JON O. NEWMAN, Circuit Judge:

This is an appeal by two securities purchasers from a preliminary injunction obtained by the Securities and Exchange Commission in a case of alleged insider trading. This case is unusual in that, as the Commission acknowledged at oral argument, it is the first insider trading case in which the Commission has sought relief against alleged tippees before identifying the alleged tipper. Unifund SAL ("Unifund") and Tamanaco Saudi & Gulf Investment Group ("Tamanaco") appeal, respectively, from the March 1 and February 14, 1990, orders of the District Court for the Southern District of New York (Shirley Wohl Kram, Judge) granting a preliminary injunction at the request of the Commission. The injunction (a) prohibits violation of section 10(b) of the Securities and Exchange Act, 15 U.S.C. Sec. 78j(b) (1988), and rule 10b-5, 17 C.F.R. Sec. 240.10b-5 (1989), (b) freezes appellants' accounts, subject to trading approved by the Commission, and (c) bars disposal or alteration of appellants' books and records. Appellants challenge the injunction for lack of personal jurisdiction, improper service, improper procedure in conducting the injunction hearing, and insufficient evidence to warrant any relief. We affirm, with modifications, the injunction to the extent that it freezes accounts and preserves records, and vacate the prohibition on future violations as insufficiently supported.

Background

The case concerns trading in the stock and stock options of Rorer Group, Inc.

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("Rorer"), a United States pharmaceutical company incorporated in Pennsylvania. Rorer common stock is listed on the New York Stock Exchange, and option contracts for its common stock are listed on the American Stock Exchange. In the summer of 1989, Rorer began confidential merger negotiations with Rhone-Poulenc, S.A. ("Rhone"), a French corporation. The discussions intensified in December and in early January 1990. In mid-January, prior to any public announcement of merger negotiations, massive trading occurred in Rorer stock and options. On January 12 the volume of shares traded was six times the average daily volume of the previous 20 days. On January 10 the volume of options traded doubled from the prior day, doubled again on January 11, and on January 12 reached nearly ten times the average daily volume in the prior month.

Reacting to the trading volume, officials of Rorer and Rhone accelerated their negotiations, and on January 15 Rorer announced that it had engaged in merger discussions with an unidentified company. On that day Rorer stock rose from $52 a share to $63 a share. An agreement in principle to merge with Rhone was announced three days later.

The heavy trading volume prompted the Commission to investigate. It quickly identified unusually large Rorer stock and option transactions in brokerage accounts maintained by foreign investors, including appellants Unifund and Tamanaco. Unifund is an investment company based in Lebanon and incorporated under Lebanese law. Tamanaco is an investment company incorporated in Panama. On January 4 Unifund purchased 40,000 shares of Rorer for approximately $2 million through the Beirut office of Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch"). From January 4 through 12 it bought 810 Rorer call option contracts for approximately $300,000. After the merger announcement, Unifund liquidated its position, making $564,000 on the stock and $980,000 on the options. On January 10, Tamanaco purchased 500 Rorer call options for approximately $150,000 through Compagnie Financiere Esperito Santo ("Esperito Santo"), a Swiss bank in Lausanne. Two days later Tamanaco bought an additional 100 call options through the same bank. The purchases were made through Esperito Santo's account at the Lausanne branch of Dean Witter Reynolds Inc. ("Dean Witter"). Within one week the value of the options quadrupled, producing a profit of approximately $660,000.

On January 17, two days after the merger announcement, the Commission filed this lawsuit against Unifund and other purchasers of Rorer stock and obtained a temporary restraining order. Tamanaco had not yet been identified as the name of one of the purchasers. The TRO barred future violations of section 10(b) and rule 10b-5, required retention of unsold Rorer stock and options as well as the proceeds from those securities that had already been sold, and froze defendants' accounts. The TRO permitted trading in Rorer options and in the frozen accounts with the Commission's permission. The January 17 order also provided for expedited discovery and for service by various means, including mailing or overnight courier delivery to defendants or their banks and brokers as agents. The Commission served Unifund by sending the complaint and the TRO by overnight courier to Merrill Lynch in New York for forwarding to Unifund in Beirut. A Unifund official later confirmed receipt of the papers from Merrill Lynch. 1

On January 30, at what was to have been a hearing on a motion for a preliminary injunction, all defendants except Tamanaco agreed to a ten-day extension of the TRO. Tamanaco insisted on going forward in defense of the SEC's motion for a preliminary injunction. At this time, Tamanaco identified itself as one of the purchasers. After hearing argument, Judge Kram reserved decision as to Tamanaco and, by order entered February 2, extended the TRO against all defendants until February 14.

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The District Court also appointed a special master to supervise discovery. Though the parties accuse each other of responsibility for the ensuing difficulties in arranging for discovery, it is clear at least that the special master entered an order requiring Unifund and Tamanaco each to produce in London on February 9 an official who could testify to the company's trading in Rorer securities and that neither company complied with this requirement.

On February 9, the Commission renewed its request for a preliminary injunction and sought a hearing for February 13. The Commission and Unifund agreed to postpone the hearing and to continue the TRO until February 22. Tamanaco objected to any further hearing, contending that the record in support of a preliminary injunction against it could not be expanded beyond the evidence presented on January 30. The District Court disagreed. The Commission then presented evidence concerning Tamanaco; Tamanaco declined to offer evidence. On February 14, the District Court granted the preliminary injunction against Tamanaco and, following further hearings, entered a similar injunction against Unifund on March 1.

In an opinion dated March 2, Judge Kram detailed the basis for issuing the injunction. Rejecting the challenge to personal jurisdiction, the District Judge ruled that the required contacts with the United States were established by the following facts: (a) the options were traded through foreign offices of American broker dealers, (b) Rorer is a United States corporation, (c) Rorer options are traded exclusively on the American Stock Exchange, and (d) the option purchases are cleared through the Options Clearing Corporation, a United States company. These factors, the Court concluded, demonstrated that the defendants executed their trades with "the clear foreseeability of their effect in the United States." The Court also rejected Unifund's challenge to the service of process that had been made through the New York office of Merrill Lynch. 736 F.Supp. 465.

On the merits, Judge Kram stated that the standard for a preliminary injunction requested by the Commission is a strong prima facie case of a violation of section 10(b) and a reasonable likelihood that the wrong will be repeated. She found this standard met by various items of circumstantial evidence. Initially, she relied on the unusual trading activity in Rorer securities by Tamanaco and Unifund. There was evidence that in the Espirito Santo account at Dean Witter in Lausanne, through which the Tamanaco's Rorer options had been purchased, no other options had been traded since August 1989. Unifund's January 4 purchase of 40,000 Rorer shares represented 13 percent of the total Rorer shares traded that day. Unifund's stock purchase was nearly twice the size of its next largest investment in any company, even when those investments were aggregated over time. Moreover, its prior equity positions had been partially hedged, but its position in Rorer was not.

To show that the purchases were based on inside information, Judge Kram relied on the following circumstances. On January 10...

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