S.E.C. v. Cavanagh
| Decision Date | 02 September 1998 |
| Docket Number | 2630 and 2631,Nos. 2629,D,s. 2629 |
| Citation | 155 F.3d 129 |
| Parties | Fed. Sec. L. Rep. P 90,277 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Thomas Edward CAVANAGH, U.S. Milestone, and William N. Levy, Defendant-Appellants, Karen Cavanagh, Cromlix, LLC, and Tamar Lehmann, Relief-Defendant-Appellants, Electro-Optical Systems, Corp., George Chachas, Thomas R. Brooksbank, Optimum Fund, Agira Trading, Ltd., Customer Safety, S.L., Cambiarios, S.L., Construcciones, S.L., Thomas A. Hantges, Cosimo Tacopino, Defendants, Donald & Co. Securities Inc., SHBL Associates Europe Ltd., Joseph Falco, Martin Hodas, Bernd Stieghorst, Erin Martin, Anthony S. Luttenberger, Ana P. Lopez, Metropolitan Trade Finance Ltd., Tim Timlin, Carmillo Monastra, Eugene Stricker, Arthur De Acutis, Jean-Pierre Neuhaus, Kenneth C. Kehoe, and Antonio V. Borotto, Relief-Defendants. ockets 98-6111, 98-6119 and 98-6129. |
| Court | U.S. Court of Appeals — Second Circuit |
Melinda Hardy, Securities & Exchange Commission, New York City (Larry P. Ellsworth, General Counsel, Paul Gonson, Richard M. Humes, Philip J. Holmes, Tracy M. McGowan, Securities & Exchange Commission, Washington, DC), for appellee.
Charles J. Hecht, Hecht & Steckman, New York City, for appellant Levy.
Diana D. Parker, Morvillo, Abramowitz, Grand, Iason & Silberberg, New York City, for appellant Lehmann.
Before: CABRANES, POOLER and REAVLEY, * Circuit Judges.
The Securities and Exchange Commission brought this enforcement action against multiple defendants for violations of the registration and antifraud provisions of the federal securities laws. 1 The SEC also named several relief defendants in the complaint and sought disgorgement of the stock at issue and all proceeds from sales of that stock. After a six day hearing, the district court entered a preliminary injunction in favor of the SEC. 2 William Levy, Tamar Lehmann, Thomas Cavanagh, Karen Cavanagh, U.S. Milestone, and Cromlix, L.L.C. For the reasons discussed below, we affirm.
Based on evidence introduced at the preliminary injunction hearing, the district court made the following findings of fact, which (except where otherwise noted) are effectively uncontested for purposes of this appeal. WTS Transnational, Inc., a Massachusetts corporation in the process of developing and producing a security fingerprint system, needed financing to continue. As of September 30, 1997, WTS had $10,000 in assets, $655,000 in current liabilities and no revenues. It had yet to produce or test a prototype of its unpatented fingerprint verification system.
Thomas Cavanagh is an investment banker who runs U.S. Milestone, an investment banking company specializing in Regulation S offerings. Levy, a New Jersey securities lawyer, is Milestone's legal counsel. Cavanagh and Levy agreed to work out financing for WTS. They located a shell corporation, Curbstone Acquisition Corp., which had registered 3,500,000 shares with the SEC and had essentially no assets. Curbstone's principals--including George Chachas--registered the 3,500,000 shares pursuant to an S-8 registration statement, which is used to register securities offered to directors of a corporation, employees, and consultants. 3 Chachas was an officer, director, and major shareholder of Curbstone. Chachas and three others owned approximately 97% of the shares in Curbstone, which shares are hereafter referred to as the management shares. Levy, Cavanagh, and Chachas worked out a reverse stock acquisition, whereby Curbstone would acquire WTS, and WTS's management would replace Curbstone's. The resulting entity was to be named Electro-Optical Systems Corporation (EOSC).
On December 8, 1997, WTS and Curbstone signed the Acquisition Agreement. The agreement provided for a closing on or prior to January 16, 1998. In late December 1997, Chachas, Levy, and Cavanagh arranged for the sale of Curbstone shares to third parties, with the actual sales to be made after the closing on the Acquisition Agreement. Chachas submitted a letter of resignation from his position as officer and director with Curbstone on December 12, after the Acquisition Agreement was executed, but before the transaction closed; Chachas and Thomas Brooksbank, acting as Curbstone's board, accepted their own resignations on December 18, 1997. The SEC alleges that, after the acquisition closed on December 18, Cavanagh and Chachas drove up the price of EOSC shares by purchasing small lots at high prices, issuing false and misleading press releases about WTS, and controlling the supply of EOSC shares through the third parties to which the management shares had been sold. Cavanagh also distributed hundreds of thousands of shares to friends, relatives and associates, often without consideration. Tamar Lehmann's husband, who introduced Cavanagh to WTS's management, was one of these people; he directed that the shares be deposited in his wife's account.
The district court found that the SEC established a substantial likelihood of success in proving that Levy--along with the other defendants--violated Section 5 of the Securities Act of 1933 by selling and offering to sell unregistered securities. Because the court also found that the SEC demonstrated a substantial likelihood of proving that Levy was likely to violate the registration requirement in the future, the court enjoined him from future violations of Section 5. In addition, the court entered an order freezing Levy's assets to the extent of all proceeds received from the sale of EOSC shares. The court also found a substantial likelihood that several defendants other than Levy violated the anti-fraud provisions of the securities laws. As to Lehmann, because the SEC established a substantial likelihood of demonstrating that she had no legitimate entitlement to the proceeds of the shares given to her by her husband, the court granted a freeze order covering those proceeds.
This court reviews a grant of a preliminary injunction for abuse of discretion. 4 A preliminary injunction will be upheld unless the issuing court "[a]ppl[ies] legal standards incorrectly or rel[ies] upon clearly erroneous findings of fact." 5 A preliminary injunction enjoining violations of the securities laws is appropriate if the SEC makes a substantial showing of likelihood of success as to both a current violation and the risk of repetition. 6 An asset freeze requires a lesser showing; the SEC must establish only that it is likely to succeed on the merits. 7 Unlike a private litigant, the SEC need not show risk of irreparable injury. 8
Levy appeals from the portion of the preliminary injunction enjoining him from future violations of the registration requirements of Section 5 of the Securities Act of 1933. 9 Section 5 provides that it is unlawful for any person to use the channels of interstate commerce to sell a security "[u]nless a registration statement is in effect as to [such] security," or to offer to sell or offer to buy a security "unless a registration statement has been filed as to such security." 10 Once the SEC has made a prima facie case, the burden shifts to the defendant to show that the securities were exempt from the registration requirement. 11
Before the acquisition, four controlling persons, including Chachas, held nearly all of Curbstone's outstanding 3.5 million shares, which had been issued to them in 1996 pursuant to a Form S-8 employee benefit plan registration. Levy argues that the SEC did not present a prima facie case that the sale in December 1997 violated Section 5 because the Curbstone shares had been registered on the S-8 form in 1996. Levy contends that once a registration statement is filed for any sale of a security, subsequent sales of that security do not need to be registered.
Levy does not cite any legal authority to support his argument, which contradicts the long-standing reading of Section 5. A registration statement permits an issuer, or other persons, to make only the offers and sales described in the registration statement. 12 As two commentators stated:
[I]t is really the offering or sale of the particular security that is registered and not the security itself--that is, once a security has been sold pursuant to a registration statement, subsequent sales are not themselves sales for which a registration statement is in effect. Each sale of a security, then, must either be made pursuant to a registration statement or fall under a registration exemption. 13
Although the language of Section 5 standing alone does not clearly indicate whether a registration statement must be filed for each offering of a security, other portions of the Act, regulations and the SEC's interpretive statements overwhelmingly support the SEC's position in this case. For example, Section 4 provides exceptions to the registration requirement of Section 5 for specific transactions, 14 indicating that registration of a security is transaction-specific.
Moreover, the regulations for registering securities specifically provide that a registration statement and any post-effective amendments will "become effective upon filing with the Commission if: (1) The registration statement is for registering additional securities of the same class(es) as were included in an earlier registration statement for the same offering." 15 This language indicates that registration statements are filed for offerings and not for securities. Similarly, the regulations allow for "delayed or continuous offering and sale of securities" if certain requirements are met. 16 The logical conclusion is that registration is normally for a single, defined offering of securities. The instructions to the Form S-8 registration statement advise all potential registrants that the registration statement does not apply to resales of the securities previously sold pursuant to the registration...
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