C.E. Carlson, Inc. v. S.E.C.

• Decision Date: 10 June 1988
• Docket Number: No. 86-2637,86-2637
• Citation: 859 F.2d 1429
• Parties: Fed. Sec. L. Rep. P 93,800, Fed. Sec. L. Rep. P 94,100 C.E. CARLSON, INC. and Charles E. Carlson, Petitioners, v. SECURITIES EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1429

859 F.2d 1429

Fed. Sec. L. Rep. P 93,800, Fed. Sec. L. Rep. P 94,100

C.E. CARLSON, INC. and Charles E. Carlson, Petitioners, v. SECURITIES EXCHANGE COMMISSION, Respondent.

No. 86-2637.

United States Court of Appeals, Tenth Circuit.

June 10, 1988.

Opinion and Denial of Rehearing Nov. 7, 1988.

Richard F. Thurston, Denver, Colo., for petitioners.

Ruth E. Eisenberg, Sr. Sp. Atty., Securities and Exchange Commission (SEC), Washington, D.C. (Paul Gonson, Sol., Washington, D.C., Daniel L. Goelzer, Gen. Counsel, Benjamin Greenspoon, Associate Gen. Counsel, Robert H. Rosenblum, Atty., SEC, Washington, D.C., with her on the brief), for respondent.

Before MCKAY and BALDOCK, Circuit Judges, and O'CONNOR, District Judge. ^*

BALDOCK, Circuit Judge.

Petitioner C.E. Carlson, Inc., is a registered securities broker-dealer, and petitioner Charles E. Carlson, is a registered broker and president of C.E. Carlson, Inc. The Securities and Exchange Commission (SEC) imposed sanctions on petitioners based on their activities in closing a public offering of common stock. Petitioners were unable to sell the minimum number of shares required by the prospectus to close the offering. They then attempted to avoid the failure of the offering by purchasing the remaining shares for Mr. Carlson and two limited partnerships which he controlled. The SEC determined that petitioners had violated certain antifraud provisions of the federal securities laws. ¹ The SEC upheld the decision of the administrative law judge (ALJ) imposing: 1) a two-month suspension of Carlson, Inc.'s broker-dealer registration, 2) an eight-month suspension of Mr. Carlson's association with any broker or dealer, and 3) a twelve-month prohibition on Carlson, Inc.'s or Mr. Carlson's participation in any securities offering. The sanctions were stayed pending this appeal.

In December 1981, Carlson, Inc. was the managing underwriter for a public offering of 30 million shares of Saratoga Mines, Inc. (Saratoga). Saratoga had been formed earlier that year for the exploration, development and processing of minerals, primarily gold and silver. The offering was on a best efforts, part-or-none basis. ² Carlson Inc. was to receive a ten-percent commission ($200,000) if the Saratoga offering was successful. The sale of the ten-cent shares was contingent on the sale of at least 20 million shares by March 23, 1982, with an option by Saratoga or Carlson, Inc. to extend the offering period for an additional ninety days. Proceeds from the offering were to be held in escrow until the requisite number of shares had been sold. If the requisite number of shares were not Mr. Carlson was an officer and director of Saratoga. He was also the managing partner of three other mining companies, Front Range Royalties, Ltd. (Front Range), Frontenac Mining, Ltd. (Frontenac) and AUCO, all of which had a strong financial interest in the success of the Saratoga offering. Mr. Carlson had a direct ownership interest in Front Range and AUCO and an indirect ownership interest in Frontenac. ³ The prospectus for the offering revealed that a substantial amount of the proceeds would be paid to Front Range for mining and milling equipment ($300,000) and to Frontenac to complete the acquisition of a 26.4% limited partnership interest in Frontenac ($550,000). Saratoga had acquired the physical assets of AUCO; in exchange, AUCO was to receive payment based on Saratoga's production. Moreover, AUCO was the general partner of Saratoga, Ltd., a limited partnership which would own 23% of Saratoga after the offering.

sold within the offering period, the offering would be terminated and the investors' funds would be returned.

As the prospectus makes clear, stock ownership in Saratoga was not for the risk-averse investor. Before the offering, Saratoga had a negative working capital position; its current liabilities exceeded it current assets by $312,365. The firm was "technically insolvent." The mining properties had no production and the mill had been operational for only three months. The firm had engaged in numerous non-arm's length transactions with related entities and the conflicts of interest between the firm and related parties, such as Mr. Carlson, were manifest. The offering price of the stock was completely arbitrary, unsupported by any recognized criteria of value. These factors were disclosed in the prospectus.

As of March 23, 1982, 20 million shares of Saratoga had not been sold, so the offering was extended for an additional 90 days, until June 22. As of mid-April, approximately 75 percent of the shares had been sold. Although the offering period had been extended into June, Mr. Carlson decided to close the offering in early May. On May 4, he and another representative of his firm contacted members of partnerships affiliated with Saratoga, who purchased 450,000 shares. As of May 4, the offering was 3,145,000 shares short of the minimum amount. An additional 740,000 shares were sold, largely to persons or entities related to Mr. Carlson's associate. That left the offering 2,405,000 shares ($240,500) short of the minimum. Mr. Carlson then arranged for Front Range to purchase 700,000 shares ($70,000) and Frontenac to purchase 1,500,000 shares ($150,000). Mr. Carlson also purchased 205,000 shares ($20,500). These sales were possible because of a series of loans facilitated by Mr. Carlson, his associate and the secretary of Saratoga. A firm controlled by the associate, Triad Investment, Inc., lent $150,000 to Frontenac and $20,000 to Front Range. Two investors lent $50,000 to Front Range and $10,000 to Carlson, Inc. at the request of Saratoga's secretary. Mr. Carlson, in his various capacities, signed short-term promissory notes for these amounts. He then personally borrowed $20,500 from Carlson, Inc. The proceeds from these loans were then used to purchase Saratoga stock.

As planned, the offering closed on May 6. Carlson, Inc. received its $200,000 underwriting commission, Front Range received $328,272 and Frontenac received $250,000. Front Range and Frontenac repaid the loans that enabled them to purchase Saratoga stock. Front Range also lent Saratoga's president, Arden Larson, $25,000.

Of course, these facts are capable of differing interpretations concerning the liability of petitioners. The ALJ, however, found:

Carlson's decision to close the offering on May 6, 1982 instead of June 22 was obviously based on his realization that Record vol. II, doc. 8 at 11. These findings form the factual basis of the decisions below holding that petitioners violated federal securities laws by borrowing funds to purchase the minimum number of shares necessary to close the offering and then repaying those loans with proceeds from the offering. This was done to avoid refunding amounts paid by the public investors.

public investors were no longer interested and the fact that both Saratoga and its president, Larson, were urgently in need of money. Saratoga depleted its financial resources and was at least $180,000 in debt. This included two $15,000 notes to officers and directors which were due on May 18, 1982, and an obligation to Larson who had not received a salary for six months. In addition, Larson testified that in April 1982 he learned that a $20,000 payment on his home mortgage was due on May 7, 1982 and he asked Carlson for help.

On appeal, petitioners contend that 1) the SEC erred in not specifying which factors about petitioners' transactions were objectionable, 2) petitioners' conduct was not violative of the federal securities laws because a) the prospectus disclosed that shares might be purchased by the issuer and b) the public investors' funds were withdrawn from escrow only after the requisite number of shares had been sold, 3) petitioners' defense of advice of counsel was rejected erroneously, 4) petitioners were wrongly denied discovery on their selective prosecution defense, which should have prevailed, and 5) the sanctions imposed were excessive. We affirm.

Our review of the SEC's factual findings is limited to determining whether those findings are supported by substantial evidence. 15 U.S.C. Sec. 77i(a) (1933 Act Sec. 9(a)); 15 U.S.C. Sec. 78y(a)(4) (1934 Act Sec. 25(a)(4)); Edward J. Mawod & Co. v. SEC, 591 F.2d 588, 593 (10th Cir.1979). Substantial evidence means more than a scintilla. Consolidated Edison Co. v. NLRB, 305 U.S. 197, 229, 59 S.Ct. 206, 216, 83 L.Ed. 126 (1939). "It means such relevant evidence as a reasonable mind might accept as adequate to support a conclusion." Id. If the evidence is capable of rational interpretation that would favor either side, the SEC's findings will not be overturned on appeal. Davy v. SEC, 792 F.2d 1418, 1421 (9th Cir.1986).

Section 17(a) of the 1933 Act prohibits fraudulent conduct in connection with the offer or sale of securities, including the use of any scheme to defraud and the omission of material facts necessary to make statements not misleading. Section 10(b) of the 1934 Act prohibits the use of manipulative or deceptive devices in connection with the purchase or sale of securities. Rule 10b-9(a)(2) ⁴ prohibits the making of a misrepresentation regarding a part-or-none offering. Rule 10b-5 ⁵ prohibits fraudulent conduct in connection with securities transactions The SEC determined that these provisions had been violated because an underwriter or issuer may not represent that securities are being sold on a part-or-none basis unless the offering is contingent on the refund of subscriber funds if the minimum number of shares at the specified price are not sold by a date certain. Once the part or none representation has been made, it may not be circumvented by transactions primarily designed to create the appearance of a successful offering in order to avoid the refund feature of the offering. SEC v. Coven, 581 F.2d 1020, 1028 n. 16 (2d Cir.1978), cert. denied, 440 U.S. 950, 99 S.Ct. 1432, 59 L.Ed.2d 640 (1979). Rule 10b-5 and ...