Rockies Fund, Inc. v. S.E.C.

• Decision Date: 15 November 2005
• Docket Number: No. 04-1255.,04-1255.
• Citation: 428 F.3d 1088
• Parties: ROCKIES FUND, INC., et al., Petitioners v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — District of Columbia Circuit

428 F.3d 1088

ROCKIES FUND, INC., et al., Petitioners v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 04-1255.

United States Court of Appeals, District of Columbia Circuit.

Argued September 14, 2005.

Decided November 15, 2005.

On Petitions for Review of an Order of the Securities and Exchange Commission.

Edward J. Meehan argued the cause for petitioners The Rockies Fund, Inc., et al. With him on the briefs was David E. Carney.

David A. Zisser argued the cause and filed the briefs for petitioner John C. Power.

Leslie E. Smith, Senior Litigation Counsel, Securities & Exchange Commission, argued the cause for respondent. With her on the brief were Giovanni P. Prezioso, General Counsel, and Eric Summergrad, Deputy Solicitor.

Before: SENTELLE and RANDOLPH, Circuit Judges, and WILLIAMS, Senior Circuit Judge.

Opinion for the Court filed by Circuit Judge SENTELLE.

SENTELLE, Circuit Judge.

The Rockies Fund and directors Stephen Calandrella, Charles Powell, and Clifford Thygesen (collectively, "Rockies Fund petitioners") along with John Power petition for review of an order of the Securities and Exchange Commission ("SEC" or "Commission") sanctioning them for various violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, among other provisions. Calandrella petitions for review of an additional sanction for violation of Section 57(k)(1) of the Investment Company Act of 1940. All petitioners argue that the SEC's findings lack substantial evidence. In addition, Rockies Fund petitioners ask us to vacate the sanctions imposed by the SEC.

We agree with Rockies Fund petitioners and Power that the SEC lacked substantial evidence for its finding of stock manipulation under Section 10(b) and Rule 10b-5. We also agree with petitioner Calandrella that the SEC lacked substantial evidence for its finding of a Section 57(k)(1) violation. The SEC's findings of Section 10(b), Rule 10b-5, and other violations for improper securities disclosures are supported by substantial evidence. Accordingly, we grant the petition for review, partially vacate the Commission's order, and remand for further proceedings.

I. Background

A. Factual Background

The events giving rise to this action occurred between 1993 and 1995. During that time, Stephen Calandrella, Charles Powell, and Clifford Thygesen served as directors of the Rockies Fund and as officers or directors of the Fund's portfolio companies. Registered as a business development company, see 15 U.S.C. § 80a-2(a)(48), the Rockies Fund was required to manage its portfolio companies.

Prior to this period, petitioner John Power, his brother Mark, and Raymond Stanz ran a line of "faux" jewelry stores called Mirage Concepts. In 1993, Power sought to expand Mirage by acquiring the assets of a bankrupt competitor. To raise the needed capital, Power collaborated with his friend Calandrella. They used one of Calandrella's companies, a shell corporation called Silver State Casinos, as an acquisition vehicle. They named the new endeavor Premier Concepts, Inc., and sought NASDAQ listing. Suffering early disappointments, Premier did not achieve NASDAQ listing until 1997.

In February 1994, Premier conducted a private placement of stock and warrants. The stock was initially priced at $1.00 per share. The Rockies Fund participated in Premier's acquisitions and purchased Premier shares in 1994 and 1995. In March 1994, Stanz took control of Premier. Friends and relatives purchased the bulk of shares, but the stock generated little further interest. Despite the inactivity, Premier apparently never attempted to foster market interest through solicitation.

Ranald Butchard, friend to both Power and Calandrella, purchased 200,000 shares in Canada during the initial offering pursuant to SEC Regulation S, which governs securities sales made outside the United States. See 17 C.F.R. §§ 230.901-.905 (2005). Holding roughly twenty percent of the outstanding shares, he became Premier's largest investor. When Premier failed to meet NASDAQ listing requirements, Butchard inquired about selling his shares. Power and Calandrella agreed to find purchasers for Butchard's shares because of the stock's thin market.

Butchard subsequently sold 180,000 shares between June and September 1994. Because he had purchased his stock under Regulation S, his shares were restricted by Regulation S's resale provision and therefore not freely tradeable. Counsel advised Butchard that he could not legally sell his shares unless he sold publicly. The shares went first to Premier's market-maker, Hanifen Imhoff, and were then bought by associates of Calandrella, Power, and Butchard. Purchasers included Nathan Katz and Arthur Nacht, both of whom learned of Premier through Callendrella. Katz made purchases of 25,000 shares on June 15, 10,000 shares on June 30, and 10,500 shares on August 19. Calandrella lent Katz money for at least some of the purchases. Nacht made a single purchase of 10,000 shares on August 30. Other purchasers included Power's personal companies, Power Curve and Redwood, and his brother, Brian Power. Power Curve and Redwood each bought 25,000 shares on June 15 and June 23, respectively. Brian Power bought 7,000 shares on June 17. Power also arranged for a business associate, under the name Neon Rainbow, to purchase 10,000 shares on June 17. Rounding out the trades, Butchard found a few buyers himself.

John Power also owned a number of shares. Power engaged in what he admitted to be "wash sales," buying Premier stock from, and/or selling it to, entities that he controlled, as well as his brother Brian, with whom he apparently did not have an arms-length relationship. Power testified that he undertook the transactions (1) to take advantage of the settlement policies of his Canadian broker, which allowed him, by way of trades between his accounts, to receive de facto short-term loans from that broker, apparently in the same way that a U.S. investor, conducting a wash sale between a U.S. margin account and some other account, receives a loan from the broker for the margin account; and (2) to generate cash for himself or his brother, depending on whoever needed it most at the moment. On July 8, John Power purchased 5,000 shares from his brother and 14,000 shares from Power Curve. He then sold 17,000 shares back to Power Curve on July 25. Power Curve sold 14,000 shares to Brian Power on August 17. Brian then sold 14,500 shares to his brother John on August 25. Brian Power made a further 1,500 share sale to Power Curve on September 19. Finally, on October 21, John Power sold 4,250 shares, 2,500 to his own IRA account and 1,750 to his minor child.

Over the bulk of Butchard's trades in June 1994, Premier's price fluctuated from $1.00 to $1.25. Power's trades from July until October, combined with Butchard's remaining August trades, took place during a period of consistent price increases for Premier stock. From $1.25 in June, the stock rose to $2.50 by October 21. A few months after the last of Power's trades, the price had returned to $1.00 per share.

The Rockies Fund also took part in Premier's initial offering. It held over 100,000 shares of restricted Premier stock and an additional 750 unrestricted shares. See 17 C.F.R. § 230.144(a)(3) (2005) (defining restricted securities). The restrictions limited the Fund's ability to trade the shares which accounted for between ten and forty percent of Fund assets. In six quarterly reports to the SEC, though, the Fund incorrectly listed all of its Premier shares as unrestricted.

In the same quarterly filings, the Fund used the quoted market price for unrestricted shares as the value for its Premier holdings. That method did not comport with the methods listed in its 1983 prospectus, which required the Fund to discount restricted shares from the unrestricted market price. Generally accepted accounting practice also called for discounting restricted stock. Under methods approved by outside counsel Clifford Neuman, however, the Fund did not discount its restricted shares.

The Fund claimed an additional 200,000 Premier shares in its SEC filing of September 30, 1995. The purchase stemmed from an oral agreement negotiated by Power. The Fund's board, however, did not approve the purchase until November 15, 1995, or pay for the shares until December 1995.

The Fund's involvement with Premier extended beyond share ownership and into management. During Premier's nascent stages, Power and Calandrella had a managerial dispute, which resulted in Power's withdrawal from Premier and Stanz's replacement by one of Calandrella's associates. After Stanz was removed as head of Premier, he threatened to sue both the Fund and Calandrella. Under the provisions of a settlement agreement, the Fund agreed to buy Stanz's 85,000 shares for $85,000. In addition, the Fund, Stanz, and Calandrella all signed a mutual release from liability for events surrounding Premier's acquisitions. Calandrella signed the mutual release without discussing it with other Fund directors.

B. Procedural Background

The SEC instituted administrative proceedings against petitioners under Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5, and other provisions. Following an evidentiary hearing, the ALJ's initial decision found that Power and Calandrella had violated Section 10(b) and Rule 10b-5 by manipulating Premier's stock through matched orders and wash sales. The ALJ also found that the Fund had violated Section 10(b) and Rule 10b-5, as well as Section 13(a) and Rules 12b-20, 13a-1, and 13a-13, by misclassifying, overvaluing, and misrepresenting ownership of Premier stock in quarterly SEC filings. Further, the ALJ found Calandrella in violation of Section 57(k)(1) of the Investment Company Act and Rule 10b-5 for improperly accepting compensation and not reporting the consequent conflict of interest to the board.

The ALJ imposed sanctions of $500,000 on Calandrella and...