S.E.C. v. Koracorp Industries, Inc.

• Decision Date: 06 February 1978
• Docket Number: Nos. 76-2547 and 76-2964,s. 76-2547 and 76-2964
• Citation: 575 F.2d 692
• Parties: Fed. Sec. L. Rep. P 96,370 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. KORACORP INDUSTRIES, INC., et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 692

575 F.2d 692

Fed. Sec. L. Rep. P 96,370

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. KORACORP INDUSTRIES, INC., et al., Defendants-Appellees.

Nos. 76-2547 and 76-2964.

United States Court of Appeals, Ninth Circuit.

Feb. 6, 1978.

Rehearing Denied May 24, 1978.

David Ferber (argued), Washington, D. C., for plaintiff-appellant.

Richard J. Archer (argued), of Sullivan, Jones & Archer, Ralph Golub (argued), Goldstein Barceloux, & Goldstein, San Francisco, Cal., Jack I. Samet (argued), of Ball, Hunt, Hart, Brown & Baerwitz, Los Angeles, Cal., G. Douglas Floyd (argued), of Pillsbury, Madison & Sutro, San Francisco, Cal., for defendants-appellees.

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

Before CARTER and HUFSTEDLER, Circuit Judges, and SMITH, ^* District Judge.

HUFSTEDLER, Circuit Judge:

The Securities and Exchange Commission ("SEC") brought these two suits to obtain injunctions preventing the defendants from committing future violations of the antifraud and reporting provisions of the federal securities laws. The district judge granted defendants' motions for summary judgment. The SEC appeals, contending that since material issues of fact are in dispute, the district court abused its discretion in granting summary judgment. We agree with the SEC with respect to all of the defendants except Arthur Andersen & Co. ("Andersen"). With respect to Andersen, we conclude that there was no genuine dispute as to any material fact, summary judgment was permissible, and the district court acted within the scope of its discretion in denying the injunctive relief sought.

Defendant Koracorp Industries, Inc. ("Koracorp") is a corporation, engaged in a number of business enterprises, whose common stock is publicly traded on the New York and Pacific Coast Stock Exchanges. Defendant Koratec Communications, Inc. ("KCI") was a wholly-owned subsidiary of Koracorp whose principal business was the publication of a controlled-circulation advertising magazine, "Homemaking with a Flair" ("Flair"), which was used for direct mail promotion. Defendant Weil was the president of KCI, defendant Cunningham was a vice president and director of Koracorp, and defendant Helfat was chief executive officer and president of Koracorp.

According to evidence presented by the SEC, Weil was the chief architect of the fraud. Weil's compensation depended in part upon the volume of KCI's business. Weil was able to increase his compensation by causing to be placed and carried on KCI's books millions of dollars of uncollectible, and sometimes wholly fictitious, accounts receivable. The SEC claimed that Weil also used these overbooked receivables to conceal kickbacks that were paid to him by corporations with which KCI did business. KCI's financial statements were consolidated with Koracorp's. When KCI's stack of receivables collapsed, Koracorp had to reverse over five million dollars which had been improperly shown as income on its books.

Defendant Andersen, Koracorp's accounting firm, first became aware of irregularities in KCI's accounts receivable while preparing its audit of Koracorp's 1970 financial statement. Andersen received a poor response from selected KCI customers with whom it attempted to confirm receivables. When its examination of contracts and collections failed adequately to support receivables in the amounts recorded, Andersen insisted that KCI's 1970 reserves for uncollectible accounts be increased, and it furnished Koracorp with critical comments concerning the inadequate documentation of transactions at KCI. In its 1971 and 1972 audits, Andersen again attempted to obtain confirmation for KCI's receivables from its customers, and repeatedly cautioned Koracorp about the deficient control procedures and the inadequate written documentation of transactions at KCI. The SEC produced evidence that the principals of KCI, with the assistance, or at least the passive neglect, of one or more of the principals of Koracorp, tried to cover up the overbooked receivables of KCI. By early May, 1973, the accounts receivable of KCI had grown to almost six million dollars, of which five million dollars was long past due or had never been billed. Cunningham and Helfat were aware of the receivables debacle, and Helfat directed that an internal investigation be conducted.

Following that investigation, Weil, in early August, 1973, admitted to Helfat that almost all of KCI's 1972 accounts receivable from advertising were uncollectible. Koracorp directed Andersen to conduct a special investigation into the accounts receivable situation at KCI. Andersen learned that substantially all of the 1972 confirmed accounts were now disavowed by customers and that the information obtained during the 1972 audit had been misrepresented. On August 7, Koracorp informed the New York and Pacific Coast Stock Exchanges and the SEC, and on August 8, the SEC suspended all trading in Koracorp's securities. On September 10, 1973, Andersen withdrew its auditor's report on Koracorp's 1972 financial statement. The original 1972 financial statement reported earnings per share of $0.27. After restatement in early 1974, by which time five million dollars of improperly stated income of KCI had been reversed, the 1972 revised financial statement showed a loss of $1.02 per share. Trading in Koracorp's securities was not permitted to be resumed until early 1974.

Meanwhile, at a special Koracorp board of directors' meeting on August 7, 1973, the board was informed by Cunningham of KCI's overstated accounts receivable and by Helfat of Weil's offer to purchase Flair. The board agreed to the sale of Flair to Weil, contingent upon his resignation as president of KCI. On August 24, 1973, the Koracorp board of directors requested Helfat's resignation as president and director of Koracorp, but retained him as a special consultant at full salary with all fringe benefits. The board also removed Cunningham from his position as vice president, after he refused to resign. Cunningham remained as a director of Koracorp until May, 1975. Both Cunningham and Helfat received bonuses based upon Koracorp's original 1972 earnings of $0.27 per share.

After a two-year investigation, the SEC filed these complaints in November, 1975. The SEC alleged that Weil was directly responsible for overbooking accounts receivable and for diverting funds from KCI by collecting illegal kickbacks from Flair's customers. These kickbacks were made to corporations that he and his wife owned, defendants Western Gateway Corp., Verve, Inc., Associated Graphics, Inc., and Allison Production Affiliates, Inc. The SEC also alleged that Helfat and Cunningham knew about the fraud and participated in the cover-up by failing to disclose to the Koracorp board and to the public their knowledge of the spurious accounts receivable, the illegal kickbacks to Weil, and the other irregularities in KCI.

The SEC contended that Andersen was negligent in its audits of Koracorp and in its failure to uncover the KCI scheme. The SEC did not claim that Andersen did any affirmative acts in connection with violations of the securities laws by the principals of Koracorp and KCI, nor did it contend that Andersen had any actual knowledge of the fraud or of the reporting irregularities.

The SEC sought injunctions against the ten individual and corporate defendants to prevent their participating in any future violations of the federal securities laws. At the initial hearing before the district court, the court accepted suggestions by the defendants that the nature of the defendants' activities in connection with the violations was not significant in deciding whether injunctions should issue. The court accordingly restricted the inquiry into the conduct of the parties after the exposure of the fraud in August, 1973. The court also limited discovery to post-August, 1973, matters, "so that they (the defendants) can use that as a basis for motions for dismissal or summary judgment."

The SEC and Andersen both filed motions for summary judgment. The remaining defendants also accepted the district court's invitation by filing motions for summary judgment. We reverse summary judgment in favor of the defendants, other than Andersen, because the district court improperly allocated the burden of persuasion on motion for summary judgment, and triable issues of material fact foreclosed judgment in those defendants' favor. We affirm summary judgment for Andersen because no material issues of fact remained in dispute, and the district court did not abuse its discretion in denying injunctive relief against Andersen.

I

Everyone agrees that the manipulation of KCI and Koracorp, the cover-up activities in which these corporations were engaged, and the diversion of funds from KCI in the form of "commissions" or "kickbacks" involved serious violations of the securities laws conducted over a period of several years. Everyone also agrees that, after the collapse of KCI and the exposure of the fraud, violations ceased. No violations had occurred for about eighteen months before the district court granted summary judgment to the defendants. Finally, everyone agrees that the evidence presented to the district court concerning the nature and extent of the participation of the various defendants in the violations was sharply conflicting.

Weil, Helfat, Cunningham, Koracorp, and KCI convinced the district court that all of the disputed facts were immaterial because each of them had conceded, solely for the purpose of the summary judgment, that each was potentially liable in some unidentified respect for the violations. The nature of these concessions is aptly described in one of the defendants' briefs: "(T)he moving Defendants conceded, in the court below, the existence of conflicts in the evidence concerning culpability in 1973." In addition to these "admissions," the defendants offered evidence tending to prove...