S.E.C. v. Adler

• Decision Date: 27 March 1998
• Docket Number: No. 96-6084,96-6084
• Citation: 137 F.3d 1325
• Parties: Fed. Sec. L. Rep. P 90,177, 11 Fla. L. Weekly Fed. C 1161 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Counter-Defendant-Appellant, v. Richard F. ADLER, Defendant-Appellee, Phillip L. Choy, Magatronic Trading, Limited, Domer L. Ishler, Defendants-Counter-Claimants-Appellees, Harvey L. Pegram, Defendant-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 1325

137 F.3d 1325

Fed. Sec. L. Rep. P 90,177, 11 Fla. L. Weekly Fed. C 1161

SECURITIES AND EXCHANGE COMMISSION Plaintiff-Counter-Defendant-Appellant, v. Richard F. ADLER, Defendant-Appellee Phillip L. Choy, Magatronic Trading, Limited, Domer L Ishler, Defendants-Counter-Claimants-Appellees Harvey L. Pegram, Defendant-Appellee.

No. 96-6084.

United States Court of Appeals, Eleventh Circuit.

March 27, 1998.

Lucinda McConathy, Christopher Paik, Paul Gonson, SEC, Washington, DC, for SEC.

J. Vernon Patrick, Jr., Alexander S. Lacy, William Marsh Acker, III, Elizabeth N. Pitman, David M. Overstreet, Patrick & Lacy, P.C., Birmingham, AL, for Pegram.

Ronald O. Gaiser, Jr., Gaiser & Associates, Birmingham, AL, for Adler and Choy.

Appeal from the United States District Court for the Northern District of Alabama.

Before ANDERSON and COX, Circuit Judges, and ALARCON ^*, Senior Circuit Judge.

ANDERSON, Circuit Judge:

In this case, the appellant Securities and Exchange Commission ("SEC") brought a civil action against appellees Harvey L. Pegram, Richard F. Adler, Philip L. Choy, Magatronic Trading Limited, ¹ and Domer L. Ishler, alleging violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); SEC Rule 10b-5, 17 C.F.R. § 240.10b-5; and § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a). The SEC seeks treble damages for these alleged violations under the Insider Trading Sanctions Act of 1984, 15 U.S.C. § 78u-1. The SEC argues that Pegram engaged in illegal insider trading in September 1989. The SEC argues that not only Pegram, but also the other appellees engaged in illegal insider trading in November 1992. We reverse and remand.

I. FACTS AND PROCEDURAL HISTORY

A. Pegram's 1989 Transactions

In 1984, Harvey Pegram, along with two business associates, founded Comptronix Corporation ("Comptronix"), which provides contract manufacturing services to original equipment manufacturers in the electronics industry. At that time, Pegram was made Vice President of Purchasing and Material Management for Comptronix, and a member of its Board of Directors. Pegram was also issued 869,897 shares of Comptronix Common Stock. In May 1989, Comptronix made an initial public offering of its stock. In the years prior to the initial public offering, the relationship between the Comptronix founders "disintegrated." In July 1989, Pegram was removed from his position as Vice President of Purchasing and Material Management and made Vice President of Marketing. On August 23, 1989, Pegram sued Comptronix and William Hebding, who was at that time the Chairman and CEO of Comptronix, seeking a declaratory judgment and damages. ² Immediately after Pegram's complaint was filed, Hebding asked Pegram to take an indefinite leave of absence from Comptronix and to cease contact with Comptronix customers. Pegram was eventually terminated in December 1989.

During the early part of 1989, Comptronix began receiving decreased orders from one of its largest customers, Conner Peripherals ("Conners"). On August 31, 1989, Comptronix issued a press release stating that it had "received less than anticipated orders from another major customer for disk drive products. As a result, management expects that sales and earnings for the second half of 1989 will be lower than previously anticipated, but still significantly higher than the levels of the previous year." On September 14, 1989, Pegram attended a meeting of the Comptronix Board of Directors. Pegram contends that "nothing new of a material nature" was said regarding the Conners account at this meeting, other than a statement reflected in the notes of Joe Ritch, the secretary and general counsel of Comptronix, that "Conners shaky possibly all business offshore." The SEC contends, and the revised minutes of the Board meeting reflect, ³ that Comptronix's CEO, William Hebding, reported to the Board that

The Company was expecting either a complete termination or a substantial reduction in the orders from Conners, which is the largest customer of the Company due to Conner moving much of its manufacturing off-shore. Mr. Hebding stated that because Conners was the Company's largest customer, when the information was disseminated the stock of the Company would likely drop substantially.

Therefore, during the September 14 Board meeting, the Board adopted a resolution authorizing the company to purchase up to one million shares of its own stock in order to support public confidence in the company. ⁴

On September 19 through September 26, 1989, Pegram sold 20,000 shares of Comptronix stock. On October 6, 1989, Comptronix issued a press release stating that the company "had received less than anticipated orders from a major customer for disk drive products," the company "expect[ed] orders from this customer to decline even further in the fourth quarter [of 1989]," and that "[a]s a result, Comptronix anticipates that sales and earnings in the fourth quarter will be below the levels in the same period of 1988." ⁵ In response to the Comptronix press release, the price of Comptronix stock dropped from $3.63 to $2.63 over the next two trading days. The SEC maintains that by selling 20,000 shares of Comptronix stock before the October 6 press release, Pegram avoided $17,625 in losses.

Pegram contends that his September 1989 sales of Comptronix stock were not made as a result of any alleged material nonpublic information, but were part of a preexisting plan to sell Comptronix stock in order to buy an eighteen wheel truck for his son's business. First, Pegram emphasizes that he waited until September 19 to sell 20,000 shares of Comptronix stock because of a 120-day "lock-up" period following the initial public offering of Comptronix stock on May 19. ⁶ In an affidavit, Kenneth M. Sproul, Pegram's stockbroker, stated that on September 1, 1989, Pegram discussed his intention of selling 20,000 shares of Comptronix stock and that Sproul informed Pegram that the 120-day lockup agreement with Comptronix's underwriters would expire on September 14, 1989. Furthermore, as required by Comptronix company policy, Pegram obtained approval for a sale from Joe Ritch, Comptronix's general counsel on August 4, and September 16, 1989. ⁷ Finally, Pegram emphasizes that he sold only 20,000 of his 869,897 shares of Comptronix stock.

The district court granted Pegram's motion for summary judgment regarding the 1989 transactions in an unpublished order on May 2, 1995. After concluding that it was "questionable" whether the information Pegram acquired at the September 14 Board meeting was "material," the district court found that Pegram "rebutted any reasonable inference that he acted with scienter as is required under § 10(b), § 17(a), and Rule 10b-5" because (1) Pegram did not sell a significant portion of his stock; (2) Pegram's intention to sell was known by the general counsel of Comptronix; and (3) Pegram sold the Comptronix stock immediately after the lock-up period following Comptronix's initial public offering.

B. 1992 Transactions of Pegram, Choy, and Ishler

On November 15, 1992, the Comptronix Board of Directors held a special meeting that was attended by Richard Adler, an outside director of Comptronix, by telephone from Taiwan. None of the other appellees were present at this meeting. At the Board meeting, the Comptronix directors were informed about potential fraud in which Comptronix CEO and Vice-President William Hebding, President Allen Shifflet, and Treasurer Paul Medlin allegedly made $4 million in false accounting entries in order to support certain capitalized costs of the company. At this meeting, the Comptronix Board designated a Special Committee, of which Adler was a member, to oversee an investigation into the scheme. ⁸ After a week of investigation, another meeting of the Board of Directors was held on November 23, 1992, and the directors were informed that $16 million in false accounting entries had actually been made, that there were not legitimate capitalizable costs to offset these false entries, and that Comptronix's sales records and earnings had been misstated. Therefore, on November 25, 1992, Comptronix publicly announced that Hebding, Shifflet, and Medlin were suspended from all decision-making responsibilities at Comptronix and that the

Board of Directors has formed a Special Committee to investigate certain matters relating to the Company's financial statements. Based upon preliminary findings, the Special Committee believes that since 1989, certain members of the Company's senior management have caused the Company to overstate gross profit by improperly recording certain assets on its balance sheet and either overstating current sales or understating current cost of sales on its income statement. There will likely be material adjustments to the Company's historically audited financial statements.

This announcement resulted in a suspension of trading in Comptronix securities. When trading resumed by the end of the day, Comptronix common stock had lost 72 percent of its value, dropping from a closing price of $22 per share on November 24 to a closing price of $6 1/8 per share on November 25.

Richard Adler has maintained a social and business relationship with Harvey Pegram for over thirty years. On November 16, 1992, the day after Adler first learned of the potential fraud at Comptronix, Pegram, who was no longer an officer or director of Comptronix, placed a call to Adler's home in Taiwan at 7:53 a.m., Central Standard Time. Phone records indicate that this call lasted 72 seconds. ⁹ At 7:55 a.m., Pegram called his wife, Margie Pegram, at home. Margie Pegram called the Pegrams' stock broker at approximately 8:07 a.m. and placed an order to sell 50,000 shares of Comptronix stock at a limit price of $21 per share or better from a joint account she held with her husband. Between November 16 and November 24, 1992, the Pegrams sold 150,000 shares of Comptronix common...