S.E.C. v. G. Weeks Securities, Inc.

• Decision Date: 19 May 1982
• Docket Number: Nos. 80-1013,80-1145,s. 80-1013
• Citation: 678 F.2d 649
• Parties: Fed. Sec. L. Rep. P 98,683 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. G. WEEKS SECURITIES, INC.; G. Weeks Co., Inc.; Gerald D. Weeks; C. M. Hodge; John Kilpatrick; Patrick Michael and Randy Vallen, Defendants-Appellants.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 649

678 F.2d 649

Fed. Sec. L. Rep. P 98,683

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. G. WEEKS SECURITIES, INC.; G. Weeks Co., Inc.; Gerald D.

Weeks; C. M. Hodge; John Kilpatrick; Patrick

Michael and Randy Vallen, Defendants-Appellants.

Nos. 80-1013, 80-1145.

United States Court of Appeals, Sixth Circuit.

Argued Dec. 5, 1980.

Decided May 19, 1982.

Robert L. Kassel, Philip R. Brookmeyer, Anthony V. Labozzetta, New York City, N. Y., for defendants-appellants in both cases.

Bruce S. Kramer, David J. Cocke and Daniel B. Hatzenbuehler, Rosenfield, Borod & Kremer, Memphis, Tenn., for amicus curiae, Scott and Craig.

Steven J. Gard, Securities and Exchange Comn., Atlanta, Ga., John P. Sweeney, Harlan W. Penn, Paul Gonson, Ann Flannery, Washington, D. C., for plaintiff-appellee.

Before MARTIN, Circuit Judge, WEICK, Senior Circuit Judge, ^* and COOK, District Judge. ^**

BOYCE F. MARTIN, Jr., Circuit Judge.

This consolidated appeal challenges two preliminary injunctions issued against appellant G. Weeks Securities, Inc. and others. On December 5, 1979, the District Court preliminarily enjoined appellants from further violating the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. ¹ By separate order issued January 29, 1980, 483 F.Supp. 1239, the court expanded the injunction to prohibit violations of the registration provisions of the 1933 Act. ² This interlocutory appeal followed.

G. Weeks Securities, Inc. is a Delaware corporation registered with the state of Tennessee as a government securities dealer. G. Weeks Company is a municipal securities dealer registered with the Securities and Exchange Commission as a broker-dealer under Section 15(b) of the 1934 Act, 15 U.S.C. § 78o (b). The individual appellants are employees or former employees of these companies.

On October 26, 1979, the SEC brought civil enforcement proceedings against appellants, alleging that appellants were selling securities in violation of the anti-fraud and registration provisions of the securities laws. The substance of the SEC's charge is not at issue here and may be stated briefly. G. Weeks Securities and its agents were selling "standby with pair-off" contracts requiring the simultaneous purchase and sale for forward delivery of Government National Mortgage Association certificates. GNMAs are mortgage-backed certificates typically issued by mortgage bankers. The certificates are backed by the full faith and credit of the federal government and are specifically exempted from the registration provisions of the securities laws. 15 U.S.C. § 77c(a)(2). The SEC contended that G. Weeks Securities misrepresented to investors the nature of the standby transactions by telling them that: (1) the contracts involved purchases of GNMAs themselves; (2) the GNMAs would serve as collateral for all monies invested; (3) the full faith and credit of the U. S. Government guaranteed the investment; and (4) the GNMA certificates would be held in various banks. According to the SEC, the standbys were actually unsecured loans to G. Weeks Securities. The SEC also contended that the standby contracts were securities which should have been registered. Finally, the SEC alleged that G. Weeks Securities sold these securities while insolvent, concealing its precarious financial condition from investors. The SEC requested the District Court to order an accounting and to appoint a receiver for G. Weeks Securities.

The parties have treated this appeal as if it were from a final judgment on the merits. Although the underlying issues in this case are complex, the immediate problem is not. Our sole concern is whether the District Court abused its discretion in issuing the two preliminary injunctions. SEC v. Senex Corp., 534 F.2d 1240 (6th Cir. 1976).

Appellants contend that the District Court abused its discretion by issuing the injunctions before allowing them to present "live" testimony. Specifically, appellants complain that they did not receive adequate notice and a fair hearing under Federal Rule of Civil Procedure 65 because their witnesses were not heard in rebuttal to the SEC's prima facie case. That case was established by the testimony of numerous SEC witnesses in the course of six hearings held prior to the issuance of the injunctions.

We agree in part with this argument. The anti-fraud injunction turned on disputed factual questions concerning whether appellants misrepresented the true nature of the standby with pair-off and whether G. Weeks Securities was insolvent at the time it sold these contracts. Rule 65 requires a hearing before a preliminary injunction may issue. A hearing implies the opportunity to be heard and to present evidence. Detroit & Toledo Shore Line R. Co. v. Broth'd of Local F. & E., 357 F.2d 152 (6th Cir. 1960). Observance of the Rule's hearing requirement is particularly important where the facts are disputed:

"But if the allegations of a complaint are denied by a defendant, (as was true in this case) he is entitled to a hearing, which includes the right to offer evidence in support of his factual claims * * * A hearing embodies the right to be heard on the controverted facts, as well as upon the law." (citations omitted).

Id. at 153-154, quoting Carpenter's Dist. Council v. Cicci, 261 F.2d 5, 8 (6th Cir. 1958).

We hold that the District Court abused its discretion by resolving disputed factual questions in favor of the SEC without first hearing the appellants' live testimony. Accordingly, that injunction is reversed and remanded so that the District Court can hold a hearing at which appellants may offer their version of the disputed facts.

We turn now to the registration injunction. We believe that order properly issued because the District Court had before it adequate documentary evidence upon which to base an informed, albeit preliminary conclusion that the standby with pair-off contracts were securities subject to registration. Where the resolution of the questions to be considered in issuing a preliminary injunction turns on legal rather than factual conclusions, the taking of oral testimony by both sides is not a prerequisite to a fair hearing. SEC v. Frank, 388 F.2d 486 (2d Cir. 1968).

Appellants, in the documentary evidence and briefs they submitted both to the District Court and this court, vigorously deny representing to the investing public that the standby with pair-off involved the actual purchase of GNMAs or that the transaction was somehow backed or collateralized by government securities. Instead, they maintain that the transaction involved only forward contracts for the future purchase and sale of GNMAs. At least one court has held that such contracts enjoy the same exemptions as GNMAs purchased on the cash market. See Bache Halsey Stuart, Inc. v. Affiliated Mortgage Investments, 445 F.Supp. 644 (N.D.Ga.1977). On the basis of this authority, appellants argue that the standby with pair-off, like other forward GNMA contracts, need not be registered. However, an analysis of the documentary evidence submitted to the District Court does not, as a matter of law, permit such a conclusion.

The following example, provided by appellants themselves, illustrates how the standby with pair-off operated:

(a) GWS agrees to sell a GNMA bond to customer A for settlement in 120 days at a price of $95. The current market price is $95.

(b) Simultaneously, customer A agrees to sell to GWS a GNMA bond on a standby basis for settlement in 120 days at a price of $101. "Standby basis" means that the customer need not sell to defendant, but may sell to outside investors if the price of the bond rises above $101.

(c) Customer A pays a commitment fee of $5.15 to GWS.

(d) If, in 120 days, the price of the bond is below $101, customer A will elect to deliver the bond to GWS. Because both parties have simultaneous obligations to buy and sell, no actual exchange takes place. GWS makes a $6 payment to customer A, which represents a return of the commitment fee, plus stated interest.

(e) If the market price in 120 days is higher than $101, customer A may purchase the bond from defendant and sell it on the open market.

This scheme guaranteed the investor a positive return on his money. If the market fell, G. Weeks Securities would nevertheless return the standby commitment fee plus a stated amount of interest. Conversely, if it rose, at least the same amount would be returned and if the increase in price was large enough, above 101 in the example, the investor would reap an additional return in the form of profits taken on the cash market from the sale of the GNMA on which he...