S.E.C. v. Southwest Coal & Energy Co.

• Decision Date: 28 August 1980
• Docket Number: No. 78-1130,78-1130
• Citation: 624 F.2d 1312
• Parties: Fed. Sec. L. Rep. P 97,620 SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee Cross-Appellant, v. SOUTHWEST COAL & ENERGY COMPANY, Defendant. Paul E. Cash and Jerry Heflin, Defendants-Appellants Cross-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1312

624 F.2d 1312

Fed. Sec. L. Rep. P 97,620

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee Cross-Appellant, v. SOUTHWEST COAL & ENERGY COMPANY, Defendant Paul E. Cash and Jerry Heflin, Defendants-Appellants Cross-Appellees.

No. 78-1130.

United States Court of Appeals Fifth Circuit.

Aug. 28, 1980.

Earl L. Yeakel, III, Austin, Tex., C. B. Harrison, Jr., Dallas, Tex., for defendants-appellants cross-appellees.

James H. Schropp, Washington, D. C., David N. Reed, Houston, Tex., Paul Gonson, Theodore S. Bloch, Washington, D. C., for SEC.

Appeals from the United States District Court for the Western District of Louisiana.

Before COLEMAN, Chief Judge, REAVLEY and HATCHETT, Circuit Judges.

REAVLEY, Circuit Judge:

The Securities and Exchange Commission ("SEC") brought this injunctive action against Southwest Coal & Energy Company and its owners and directors, Paul E. Cash, Jerry W. Heflin, and Philip H. Parsons, alleging that they had violated the registration and antifraud provisions, §§ 5(a), (c) and 17(a), of the Securities Act of 1933, 15 U.S.C. §§ 77e(a), (c) and 77q(a), and the antifraud provision, § 10(b), of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Prior to trial, Parsons accepted a consent judgment, and the district court dismissed as moot the case against Southwest Coal, following that corporation's dissolution. On July 19, 1977 the court entered a partial summary judgment in favor of the SEC on the § 5(a), (c) registration violation question and, accordingly, granted a permanent injunction against further violations of that section by Cash and Heflin. Finally, after a trial to the bench, the court on November 9, 1977 found that Cash and Heflin had contravened one of the antifraud provisions, § 17(a)(2) of the 1933 Act, and permanently enjoined them from committing any further violations. 439 F.Supp. 820, 826-27 (W.D.La.1977). The court held, however, that the SEC had failed to prove that Cash and Heflin had acted with the scienter requisite to violations of § 17(a) (1) of the 1933 Act, § 10(b) of the 1934 Act and rule 10b-5, and, therefore, declined to enter an injunction relating to future violations of these provisions. Each party appeals that aspect of the decision adverse to him. We affirm the judgment of the district court with respect to its disposition of the fraud issues under §§ 17(a) and 10(b) and rule 10b-5, but reverse the judgment on the alleged § 5 registration violation.

I. BACKGROUND

Southwest Coal & Energy Company, a Texas corporation, was formed by Cash, Heflin and Parsons on August 26, 1974 for the purpose of selling undivided interests in oil and gas leases pursuant to Schedule D of the exemption from the registration requirements of the Securities Act of 1933 provided in Regulation B, 17 C.F.R. §§ 230.300-.346 (1979). See 15 U.S.C. § 77c(b) (statute under which regulation was promulgated). Each man owned one-third of the common stock of Southwest and served as a director. Parsons acted as its president, maintaining the company's principal place of business in Shreveport, Louisiana, and overseeing its day-to-day sales operations. Cash and Heflin maintained offices in Dallas, Texas, from which they acquired leases and supervised the drilling and completion of all of Southwest's wells. They also were responsible for preparing the Schedule D offering sheets, 17 C.F.R. § 230.326 (1979), under which the interests were marketed. Between November 4, 1974 and November 20, 1975, Southwest filed 15 such offerings with the SEC, though it withdrew two and sold only 13.

In addition to their interests in Southwest, Cash and Heflin, either directly or through a holding company, together controlled several other oil and gas drilling companies whose principal business similarly included the sale of Schedule D securities. In numerous instances, these affiliated companies held leases adjacent to Southwest's. Maps accompanying Southwest's offering sheets depicted these leases and wells surrounding the Southwest lease in which interests were being offered, but did not disclose that these adjoining leases belonged to affiliated companies. Moreover, Southwest occasionally acquired leases from these commonly controlled enterprises, and, while the offering sheets relating to such leases indicated that they had been purchased from other drilling companies, the offering sheets did not disclose that the sellers were also Cash and Heflin companies. The offering sheets also did not indicate that Cash and Heflin, who made the decision whether to "complete" any given well, received what was essentially a commission from the money solicited from investors for well completion once that determination had been made.

It was on the basis of these material omissions that the district court subsequently based its finding that Cash and Heflin had violated one of the antifraud provisions, § 17(a)(2) of the Securities Act of 1933. The court reasoned, for example, that the illustration of the other companies' leases and wells adjacent to those in which Southwest was marketing interests, without the disclosure that these companies were affiliated with Southwest, could mislead an investor to believe that several independent companies had investigated the area and decided to drill there. 439 F.Supp. at 824.

On November 25, 1975 the State of Texas brought suit in two state courts against Cash, Heflin and a number of their companies not including Southwest for alleged violations of the registration and brokers' licensing provisions of the Texas Securities Act, Tex.Rev.Civ.Stat.Ann. arts. 581-7(A)(1), 581-12 (Vernon 1964 & Supp.1980). Temporary restraining orders precluding further improper sales of securities, dated that same day, were entered against all defendants and, after the actions were consolidated and a hearing held, a similar temporary injunction issued on December 18, 1975. Southwest, nonetheless, continued to sell a few Schedule D interests, but did not disclose to investors the existence of the injunction or the litigation. Finally on January 20, 1976, due to the injunctions entered against two of Southwest's directors and controlling shareholders and several affiliate corporations, the SEC formally suspended all Regulation B exemptions under which Southwest had been marketing its interests, and all sales ceased.

II. REGISTRATION VIOLATION

A. "Unavailability" of Regulation B Exemption

The district court based its summary judgment determination that § 5(a), (c) ¹ had been violated on the notion that, since the entry of the injunction against Southwest's directors and affiliates had rendered the Regulation B exemption "unavailable" to Southwest under 17 C.F.R. § 230.306(a)(2) (1979), ² the exemptions under which it had been operating were automatically rendered ineffective upon the issuance of that injunction. ³ Consequently, those few sales executed after the entry of the injunction were held to have been without benefit of exemption (or, of course, registration) and, therefore, to have been in violation of § 5(a), (c).

There is no dispute that the issuance of the injunction here made the Regulation B exemption "unavailable" to Southwest pursuant to § 230.306(a) (2). All parties further acknowledge that this made Southwest ineligible to qualify for a Regulation B exemption for any subsequent offering ⁴ and that it furnished adequate grounds for the January 20, 1976 formal suspension of the exemptions covering all of Southwest's existing offerings. 17 C.F.R. § 230.334(a)(1) (1979). ⁵ See Tabby's International, Inc. v. SEC, 479 F.2d 1080 (5th Cir. 1973) (post-filing occurrence of contingency making exemption unavailable is ground for suspension of exemption under analogous provisions of Regulation A, 17 C.F.R. §§ 230.251-.263 (1979)); 3 L. Loss, Securities Regulation 626 (2d ed. 1961). Cash and Heflin part company with the SEC and the district court, however, as to the independent effect of "unavailability" on exemptions previously secured for Southwest's outstanding offerings.

Cash and Heflin contend that when an exemption is secured for a particular qualified offering of securities by the filing of the requisite materials with the SEC ⁶ and a post-filing event viz., the issuance of the injunction here transpires that admittedly would have precluded the offeror from qualifying his offering for the exemption had the event occurred before the filing or use of the Regulation B materials, this occurrence does not automatically render ineffective the exemption previously secured for the offering then outstanding. The occurrence or contingency only furnishes a ground for formal suspension of these outstanding exemptions. The criteria for "availability" and "unavailability," Cash and Heflin argue aside from the express adoption in § 230.334(a)(1) of "unavailability" as a ground for formal suspension pertain only to the eligibility of an offeror to qualify a given offering for the exemption at the outset. "Availability" does not relate to the continued vitality of an exemption once secured; this is relegated solely to the formal suspension mechanism. We agree and, therefore, reject the district court's ruling on this point. ⁷

That the "availability" or "unavailability" of an exemption under § 230.306(a) relates only to the threshold eligibility of an offeror to obtain an exemption for a new offering is demonstrated by the language of the pertinent provisions and the overall structure of Regulation B. First, § 230.306(a)(1)-(6), which delineates the various situations in which an exemption will not be available, speaks only to disqualifying events that occur within specific periods "prior to the filing or use of such offering sheet." (Emphasis added). Similarly, § 230.306(c) further provides that even if one of these disqualifying contingencies has occurred, the offering may still proceed if the offeror can...