Fontaine v. Securities and Exchange Commission

• Decision Date: 03 October 1966
• Docket Number: Civ. No. 525-65.
• Citation: 259 F. Supp. 880
• Parties: Charles E. FONTAINE and I.O.S., Ltd. (S.A.) d/b/a Investors Overseas Services, Plaintiffs, v. SECURITIES AND EXCHANGE COMMISSION, Manuel F. Cohen, Byron D. Woodside, Francis M. Wheat, Hugh F. Owens, Hamer H. Budge, as Chairman and members respectively, Defendants.
• Court: U.S. District Court — District of Puerto Rico

259 F. Supp. 880

Charles E. FONTAINE and I.O.S., Ltd. (S.A.) d/b/a Investors Overseas Services, Plaintiffs, v. SECURITIES AND EXCHANGE COMMISSION, Manuel F. Cohen, Byron D. Woodside, Francis M. Wheat, Hugh F. Owens, Hamer H. Budge, as Chairman and members respectively, Defendants.

Civ. No. 525-65.

United States District Court D. Puerto Rico, San Juan Division.

October 3, 1966.

COPYRIGHT MATERIAL OMITTED

Fiddler, Gonzalez & Rodriguez, San Juan, P. R., for plaintiffs.

Meyer Eisenberg, Washington, D. C., Candita M. Orlandi, Asst U. S. Atty., San Juan, P. R., for defendants.

ORDER

CANCIO, District Judge.

Investors Overseas Services ("IOS"), a Panamanian corporation with principal offices in Geneva, Switzerland, and its Puerto Rico branch manager, Charles E. Fontaine ("Fontaine"), have brought an action in this Court seeking to enjoin the Securities and Exchange Commission ("SEC") from conducting an administrative proceeding against IOS and certain of its principals and other associated persons for alleged violations of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78a et seq. IOS also seeks a declaratory judgment, pursuant to 28 U.S.C. § 2201, that it is not required to continue its registration as a broker-dealer with the SEC and could withdraw that registration without prejudice. The SEC moved to dismiss the complaint or, in the alternative, for summary judgment.

The Court has heard oral argument and has carefully and fully considered extensive memoranda and affidavits from both sides, including supplementary memoranda and affidavits regarding specific issues raised in this case.

I

IOS conducts a world-wide securities business. Its principal activity appears to be the sale to public investors of shares of The Fund of Funds ("FOF"), a $360,000,000 unregistered open-end investment company, based in Switzerland and controlled by IOS. FOF's portfolio consists primarily of shares of United States registered open-end investment companies (mutual funds) and to a lesser extent of shares of mutual fund management companies (which advise, sell and otherwise service and manage registered investment companies). IOS acts for FOF in the purchase and sale of the securities which form FOF's portfolio. These transactions take place in the United States. Whether IOS sells shares of FOF in the United States or to United States citizens and the extent of such activity by IOS, if it does take place, is a matter of dispute between the parties and an issue in the SEC's administrative proceeding.

IOS has been registered with the SEC since 1960 as a broker-dealer in securities, pursuant to the provisions of Section 15(b) of the Exchange Act, 15 U.S.C. § 78o(b). Under that Act, all registered broker-dealers are required to maintain and keep current specified books and records reflecting their day-to-day securities business. Section 17(a), 15 U.S.C. § 78q(a). These books and records are required to be made available to the SEC for its inspection so that it may fulfill its regulatory responsibilities to safeguard investors and maintain the integrity of the securities markets. If the registered broker-dealer is a non-resident of the United States, Rule 17a-7, 17 CFR 240.17a-7, specifically provides that the registrant shall keep a complete set of those books and records at a designated place within the United States, unless a specific undertaking is filed with the Commission in which the broker-dealer agrees to furnish such books and records at the SEC's offices in Washington or elsewhere in the United States, upon demand. IOS filed such an undertaking at the time of its registration with the SEC as a broker-dealer in 1960.

On November 29, 1965, the Commission made a formal demand, pursuant to IOS's undertaking and the provisions of Rule 17a-7, for the production of IOS's books and records relating to transactions with or for American customers. For reasons set forth below, IOS refused to produce such books and records, although it had advised the SEC it would provide it with a statistical breakdown of their contents. IOS instituted this action seeking declaratory relief, on December 14, 1965, alleging that the books and records of IOS were kept at its principal offices in Geneva, Switzerland; that certain provisions of Swiss law forbade their production by IOS for inspection by the SEC; and that, in light of Section 30(b) of the Exchange Act,¹ IOS was not required to produce its books and records relating to transactions outside the United States. IOS seeks to have this Court declare: (1) that IOS is not required to continue its registration and may withdraw it without prejudice (i. e., without going through any administrative proceeding which might be initiated by the SEC), (2) that Section 30(b) renders the SEC's demand unlawful, insofar as it relates to IOS's "business in securities without the jurisdiction of the United States", and (3) that its failure to comply with the demand does not constitute a violation of the Securities Exchange Act.²

On February 3, 1966 the SEC instituted an administrative proceeding against IOS, certain of its principals, and associated persons to determine whether they had violated the federal securities laws as set out in the Order for Proceeding before the Commission.³ IOS's failure to comply with the demand for production of its books and records is one of the alleged violations charged in that proceeding as a basis for revocation of IOS's registration as a broker-dealer.

On February 14, 1966, IOS amended its complaint herein and moved for a preliminary injunction against the SEC which would enjoin it from prosecuting its administrative proceeding until final disposition of the action before this Court. The SEC, in turn, moved to dismiss the complaint or, in the alternative, for summary judgment.

II

IOS's motion for preliminary injunction challenges the SEC's jurisdiction under the Exchange Act to require the production of IOS's books and records relating to its business as a broker-dealer which are kept in Switzerland and the validity of the SEC's demand for production pursuant to such requirement. IOS argues that these questions are now before this Court and they should be determined here before the SEC's administrative proceeding is permitted to continue.

The Securities and Exchange Commission, in its regulation of the securities industry, has the duty to inform itself and the Congress of matters relating to its jurisdiction. The Commission has a right to inquire into IOS's conduct to determine what acts or practices might be within its jurisdiction. In Endicott Johnson v. Perkins, (1943) 317 U.S. 501, 508; 63 S.Ct. 339, 343; 87 L.Ed. 424, 429, the Supreme Court held that an agency has the right to determine the question of its own jurisdiction, and could investigate areas of possible jurisdiction in order to decide that question. See also, Interstate Commerce Commission v. Goodrich Transit Co., (1912) 224 U.S. 194, 211-214; 32 S.Ct. 436, 439-441, 56 L.Ed. 729, 736-737; United States v. Morton Salt Co., (1950) 338 U.S. 632, 642-643, 652, 70 S.Ct. 357, 363-364, 368-369, 94 L.Ed. 401, 410-411, 416. It therefore follows that, where a registered broker-dealer is involved, the SEC must be free to inspect all of the books and records which are required to be kept under the Exchange Act.

The Court cannot permit IOS unilaterally to limit the scope of the SEC's inquiry to determine whether violations have occurred, by denying the SEC access to the very books and records most pertinent to that inquiry. The SEC cannot be asked to rely on statistical summaries of books and records which are supplied by the broker-dealer, without the opportunity for verification by review of the original records themselves. Moreover, the specific question which is raised in the administrative proceeding with respect to IOS, i. e., whether its registration as a broker-dealer should be revoked, is clearly within the jurisdiction and responsibility of the Commission. IOS seeks an order of this Court declaring that it may withdraw its registration without prejudice, but it has never requested withdrawal from the SEC. Section 15(b) (5) of the Exchange Act specifically provides that the SEC shall revoke an effective registration or take other disciplinary action against a registrant if it finds that such action is in the public interest and that the broker-dealer or any partner, officer, director or controlled or controlling person thereof has, inter alia, willfully violated any provision of the Securities Act of 1933, the Securities Exchange Act of 1934 or the Investment Company Act of 1940, or any rule thereunder. Section 15(b) (6) provides that withdrawal of a registration by a registrant shall be subject to such terms and conditions as may be imposed by the Commission in the public interest or for the protection of investors.⁴

That IOS's request for withdrawal should be made to the Commission and not to this Court is made clear by the relevant cases and the specific provisions of the Exchange Act and the Rules thereunder. The SEC may conduct proceedings and make its findings on what conditions may be necessary to protect the public interest before permitting withdrawal. Peoples Securities Co. v. Securities and Exchange Commission, (5 Cir., 1961) 289 F.2d 268; Blaise D'Antoni and Assoc. v. Securities and Exchange Commission, (5 Cir., 1961) 290 F.2d 688; cf. Columbia General Investment Corp. v. Securities and Exchange Commission, (5 Cir., 1959) 265 F.2d 559.

In Guaranty Underwriters, Inc. v. Johnson, (5 Cir., 1943) 133 F.2d 54, the Court affirmed a dismissal of an action seeking to restrain a revocation proceeding under Section 15(b) of the Exchange Act where a registered dealer had ceased doing business, applied for withdrawal and consented to revocation. The District Court there affirmed had observed:

"* * * There is quite a distinction in the position of one who could say, `I resigned,'

...