Johnson-Bowles Co., Inc. v. Division of Securities of Dept. of Commerce of State of Utah

• Citation: 829 P.2d 101
• Decision Date: 19 February 1992
• Docket Number: No. 900558-CA,JOHNSON-BOWLES,900558-CA
• Parties: Fed. Sec. L. Rep. P 96,894 COMPANY, INC., and Marlen Vernon Johnson, Petitioners, v. DIVISION OF SECURITIES OF the DEPARTMENT OF COMMERCE OF the STATE OF UTAH, Respondent.
• Court: Court of Appeals of Utah

Page 101

829 P.2d 101

Fed. Sec. L. Rep. P 96,894

JOHNSON-BOWLES COMPANY, INC., and Marlen Vernon Johnson, Petitioners, v. DIVISION OF SECURITIES OF the DEPARTMENT OF COMMERCE OF the

STATE OF UTAH, Respondent.

No. 900558-CA.

Court of Appeals of Utah.

Feb. 19, 1992.

Certiorari Denied June 17, 1992.

John M. Coombs and Craig F. McCullough, Salt Lake City, for petitioners.

R. Paul Van Dam and David Sonnenrich, Salt Lake City, for respondent.

Before JACKSON, ORME and RUSSON, JJ.

AMENDED OPINION ¹

RUSSON, Judge:

Petitioners Johnson-Bowles Company, Inc., and Marlen Vernon Johnson (collectively, the Johnsons) appeal from a final agency order of the Division of Securities of the Utah Department of Commerce (Division), suspending the Johnsons' registration for one year and placing both on two years probation subsequent to their suspension. We affirm.

I. FACTS

On August 10, 1990, following a formal hearing, the Securities Advisory Board of the Division of Securities issued an order suspending Johnson-Bowles's registration as an agent for one year, and placed both on an additional two years probation.

Prior to January 22, 1989, the Johnsons were involved in the practice of selling short ² certain shares of U.S.A. Medical Corporation (U.S.A. Medical). As of January 22, 1989, the Johnsons were short 53,500 shares of U.S.A. Medical. On January 23, 1989, U.S.A. Medical effected a ten for one forward split ³ of its securities, thus increasing the Johnsons' short position from 53,500 to 535,000 shares. Shortly after the split, the price of U.S.A. Medical's stock increased ten-fold to approximately one dollar per share, roughly the same price per share as before the split.

On February 6, 1989, the Johnsons received notice of a buy-in ⁴ from Otra Clearing Corporation (Otra) of 150,000 shares of U.S.A. Medical securities, giving the Johnsons until February 15 to effect delivery. At the same time, the Johnsons began to furnish the Division of Securities with information regarding alleged problems with U.S.A. Medical and its securities. On February 15, the Johnsons informed Otra in writing that they would not honor the buy-in notice, claiming that they considered U.S.A. Medical's common stock to be unregistered securities and, as such, refused to "engage or participate in an unlawful distribution of unregistered securities."

On February 16, 1989, Johnson-Bowles filed a 10b-5 securities fraud action in federal court, seeking a preliminary injunction and declaration that Johnson-Bowles's outstanding contracts and obligations to certain brokerage firms and clearing corporations to whom Johnson-Bowles owed shares of U.S.A. Medical were void for illegality. On February 17, the court granted the temporary restraining order as to Midwest Clearing Corporation, a corporation upon which many broker-dealers rely for their own securities clearing activities and apparently the entity that concerned Johnson-Bowles the most, thus preventing Midwest from effecting any buy-ins against the Johnsons for ten days.

On March 1, 1989, following a hearing on the Johnsons' motion for a preliminary injunction, the federal district court made numerous findings of fact, including the following:

2. The Court finds that the stock of U.S.A. Medical was unlawfully issued, has never been registered with any proper regulatory authority, is not exempt from such requisite registration and has been and is continuing to be traded illegally.

3. The stock of U.S.A. Medical has been and continues to be traded as part of a fraudulent scheme and device to manipulate and artificially inflate the price of that stock in violation of the securities laws.

4. The Court finds, however, that the plaintiff, Johnson-Bowles, knew or should have known about the alleged irregularities as to non-registration, non-exempt status and illegal trading in the stock after it became a market maker, and it is charged with knowledge of these irregularities.

5. The Court finds that the relative burden between Johnson-Bowles and other parties as well as damage to the public interest has not been shown by a preponderance of the evidence and that there is a failure of burden of proof to establish those elements.

The court then entered an order denying the Johnsons' motion.

On the same date, the Utah State Division of Securities issued an order denying the availability of all transactional exemptions for U.S.A. Medical securities, pursuant to Utah Code Ann. § 61-1-14(3) (1989) of the Utah Uniform Securities Act, which order was made permanent on March 27, 1989. In addition, on March 6, the United States Securities and Exchange Commission (SEC) suspended trading in the securities of U.S.A. Medical for ten days, which order lapsed after the SEC did not renew it.

Also on March 1, the Johnsons received notice from Otra that it had effected its buy-in of 150,000 shares of U.S.A. Medical stock and that, pursuant to buy-in procedures, the Johnsons were responsible for the purchase price of that stock. On March 21, the Johnsons notified the National Association of Securities Dealers (NASD), of the notice from Otra. The letter from the Johnsons to the NASD stated in relevant part:

On March 1, 1989 at 2:00 p.m. (M.S.T.), Otra Clearing called, buying in 150,000 shares of U.S.A. Medical Corp. The buy-in price was $.70 based on guaranteed delivery of 148,000 (P.B. Jameson, seller) and the buy-in price of $.50, 2,000 shares (R.A. Johnson, seller).

It is Johnson-Bowles Company, Inc.'s position that these buy-ins were illegal. First, shares of stock in U.S.A. Medical Corp. were unlawfully issued, were never lawfully registered and do not qualify for any valid exemption under federal or state law. As such, any trading of or transaction involving U.S.A. Medical stock has been, would have been and is unlawful under Section 5 of the Securities Act of 1933, 15 U.S.C. § 77e, and Section 10 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b).

Second, all open trades or outstanding contracts for the purchase or sale of shares of U.S.A. Medical Corp. are illegal contracts and therefore unenforceable. The enforcement or performance of any and all such open trades or contracts would constitute and serve to complete illegal trades and unenforceable contracts. This would violate securities law.

Sometime after the Division's March 1 order suspending exemptions for U.S.A. Medical securities, the Johnsons purchased a total of 397,900 shares of U.S.A. Medical securities from six Utah residents and one New York resident. The Johnsons stated that they purchased the U.S.A. Medical securities to satisfy outstanding contracts for the delivery of those securities to several broker-dealers and clearing corporations. Additionally, on March 20, 1990, the Johnsons purchased 54,000 shares of U.S.A. Medical from another source. Mr. Johnson testified that he made this purchase as a possible means to satisfy a pending NASD arbitration proceeding between Johnson-Bowles and Otra regarding the latter's buy-in. Mr. Johnson further testified that he later used the 54,000 shares as security for an outstanding accounting debt. As a result of the Johnsons' purchase of U.S.A. Medical securities, the Utah State Division of Securities determined that the Johnsons had engaged in dishonest and unethical conduct violative of the Division's March 1, 1989 order and other provisions of the law, and initiated an agency action against the Johnsons.

II. PROCEDURAL HISTORY

On April 27, 1989, the Division initiated an agency action against both Mr. Johnson and Johnson-Bowles, naming each in a separate petition containing three counts. Count I alleged willful violation or willful noncompliance with agency rules. Count II alleged that Johnson and Johnson-Bowles had engaged in dishonest or unethical practices in the securities business. Count III alleged that Johnson and Johnson-Bowles had, in violation of Division rules, recommended to a customer "the purchase, sale or exchange of any security without reasonable grounds to believe that such transaction or recommendation is suitable for the customer based upon reasonable inquiry concerning the customer's investment objectives, financial situation and needs, and any other relevant information known by the broker-dealer." The Division subsequently amended its petitions, removing Count I and re-alleging Counts II and III of the original petitions.

On May 24, 1989, the Division brought a motion to convert the proceedings from informal to formal. Over the Johnsons' objection, the said motion was granted on July 14.

On July 3, 1989, the Johnsons brought a motion pursuant to Rule 12(b)(1) of the Utah Rules of Civil Procedure to dismiss the Division's proceedings against them, arguing that the Division lacked subject matter jurisdiction to discipline them. The Johnsons asserted that they had purchased the stock in order to comply with NASD rules, which carry the full force and effect of federal law, and therefore necessarily take precedence over state law. After a hearing, the motion was denied by an Administrative Law Judge (ALJ). Pursuant to Utah Code Ann. § 63-46b-12 (1989) and applicable Department of Commerce rules, the Johnsons filed for agency review of the denial of their 12(b)(1) motion by the ALJ, which request was denied by the Division director.

On September 27, 1989, the Johnsons filed a motion to dismiss the Division's amended petition for failure to state a claim. The Johnsons' motion was granted as to Count II of the amended petitions, but denied as to Count I, leaving the "dishonest and unethical practices" cause of action intact.

On November 28, 1989, the Johnsons filed a motion for summary judgment on the Division's amended petitions on several grounds. The Division filed a cross-motion for summary judgment. Both motions were denied by the ALJ. The Johnsons filed a request for agency review of the ALJ's denial of their motion for summary judgment, which request was...