SEC v. Electronics Warehouse, Inc.

• Decision Date: 07 June 1988
• Docket Number: Civ. No. H-86-282(PCD).
• Citation: 689 F. Supp. 53
• Court: U.S. District Court — District of Connecticut
• Parties: SECURITIES AND EXCHANGE COMMISSION v. The ELECTRONICS WAREHOUSE, INC., et al.

689 F. Supp. 53

SECURITIES AND EXCHANGE COMMISSION v. The ELECTRONICS WAREHOUSE, INC., et al.

Civ. No. H-86-282(PCD).

United States District Court, D. Connecticut.

June 7, 1988.

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Catherine Croisant and R. Cervera, U.S. S.E.C., John W. McCormack, Boston, Mass., for plaintiffs.

William R. Murphy, George E. O'Brien, New Haven, Conn., for Barnett Bank.

Richard Chamberlin, Ft. Lauderdale, Fla., Joseph O'Brien and Edward W. Case, Adinolfi, O'Brien & Hayes, Hartford, Conn., for Calvo.

RULING ON MOTION FOR SUMMARY JUDGMENT

DORSEY, District Judge.

The Securities and Exchange Commission ("the Commission") brought this action against ten defendants, including William A. Calvo, Jr., against whom are alleged numerous violations of the securities laws in connection with a public offering of stock of The Electronics Warehouse, Inc. ("Warehouse"). Calvo was the attorney for the underwriter of the offering, Gallagher & Co. ("Gallagher"). Edward W. Bremer was President and the founder of Warehouse and Gary C. Granai was Warehouse's attorney.¹

The Commission alleges that Calvo violated Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a);² Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b);³ Securities & Exchange Commission Rules 10b-5⁴ and 10b-9;⁵ and that he aided and abetted Gallagher in violating Section 15(c) of the Exchange Act, 15 U.S.C. § 78o(c)⁶ and Securities & Exchange Commission Rule 15c2-4⁷ thereunder.

The complaint alleges that Warehouse made a "minimum-maximum" public offering of stock at $0.10/share which the Commission declared effective on November 8, 1984. According to the prospectus, during a specified period, funds from investors were to be held in escrow by the Barnett Bank of South Florida, N.A. ("Barnett Bank"). If a minimum of 12,000,000 shares was not sold and paid for during the specified period, all funds were to be returned to the investors.⁸ If 12,000,000 shares were sold and paid for during the period, the offering would be consummated and Warehouse would receive at least $964,000.

The Commission alleges that Bremer, Granai, Calvo, Gallagher, and Russ Gallagher, with the aid of other defendants, fraudulently extended the offering beyond the period specified in the prospectus; and that, in order to make it appear that the sale of stock was complete as per the offering, they obtained short term loans which were deposited into the escrow account and inflated the number of shares allegedly sold. The loans were then repaid from the offering proceeds, a fact which was neither disclosed in, nor contemplated by, the prospectus. Finally, the Commission charges that defendants failed to disclose the material fact that, on March 8, 1985, Bremer was indicted by a federal grand jury in Maryland on seventeen counts of mail fraud arising from an unrelated scheme.⁹

The Commission moves for summary judgment on Counts I, II, III and V against Calvo and for the entry of an injunction restraining him from future violations of the securities laws.¹⁰ Calvo contends that genuine issues of material fact exist as to the reasonableness of his conduct and the mental state with which he acted. Both parties have filed extensive submissions in support of their positions, including transcripts of testimony, affidavits and exhibits.

Summary Judgment

Rule 56, Fed.R.Civ.P., provides for the entry of summary judgment where the court determines from the materials presented by the parties that "there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." In ruling on a plaintiff's motion for summary judgment, the pleadings, affidavits and exhibits are to be construed liberally in favor of the defendant, resolving all ambiguities and drawing all reasonable inferences against the movant. American Int'l Group, Inc. v. London American Int'l Group, 664 F.2d 348, 351 (2d Cir.1981). However, once the plaintiff satisfies the initial burden of producing evidence in support of each element of its claim, the defendant may not rest upon mere denials in his pleadings. A party opposing summary judgment must demonstrate specific facts showing that there is a genuine issue of material fact, together with evidence which is "significantly probative" of those facts. SEC v. Murphy, 626 F.2d 633, 640 (9th Cir.1980). See also First Nat'l Bank of Arizona v. Cities Serv. Co., 391 U.S. 253, 290, 88 S.Ct. 1575, 1593, 20 L.Ed.2d 569 (1968). The opponent's version of the facts "must support a viable legal theory which would entitle him, if accepted, to a judgment as a matter of law." Mutual Fund Investors, Inc. v. Putnam Management Co., 553 F.2d 620, 624 (9th Cir.1977). At the summary judgment stage, the court's function is not to weigh the evidence, but to determine whether any genuine issue for trial exists. See Anderson v. Liberty Lobby, 477 U.S. 242, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986); SEC v. Research Automation Corp., 585 F.2d 31, 33 (2d Cir.1978).

I. COUNTS I, II AND III

A. Scienter

Calvo does not dispute the existence of the fraudulent schemes alleged by the Commission with respect to the Warehouse offering, nor that the circumstances of the offering, recited above, violated the securities laws. His claim is that there are disputed issues of material fact as to whether he knowingly participated in the violations which occurred and whether he reasonably can claim that his behavior as attorney for the underwriter was without knowledge of the violations.

Violations of Sections 17(a)(1) and 10(b) and Rules 10b-5 and 10b-9 require a showing that defendant acted with "scienter" in employing a device, scheme or artifice to defraud. Aaron v. SEC, 446 U.S. 680, 100 S.Ct. 1945, 64 L.Ed.2d 611 (1980). A person acts with scienter when he intentionally or knowingly engages in the prohibited activities, see id. at 696, 100 S.Ct. 1945, 64 L.Ed.2d 611, or acts with reckless disregard for the truth or falsity of a material statement. See SEC v. Blavin, 760 F.2d 706, 711 (6th Cir.1985); Sirota v. Solitron, 673 F.2d 566, 575 (2d Cir.), cert. denied, 459 U.S. 838, 103 S.Ct. 86, 74 L.Ed.2d 80 (1982); Oleck v. Fischer, 623 F.2d 791, 794-95 (2d Cir.1980) (reckless conduct generally satisfies scienter); SEC v. Coven, 581 F.2d 1020, 1025 (2d Cir.1978), cert. denied, 440 U.S. 950, 99 S.Ct. 1432, 59 L.Ed. 2d 640 (1979). Recklessness has been defined as "`highly unreasonable conduct which is an extreme departure from the standards of ordinary care.'" Blavin, 760 F.2d at 711, quoting Ohio Drill & Tool Co. v. Johnson, 625 F.2d 738, 741 (6th Cir. 1980).

An aider and abettor in violations of Section 15(c) of the Exchange Act and Rule 15c2-4 also must have acted with scienter. Aider and abettor liability for Gallagher's alleged violation of Section 15(c) and Rule 15c2-4 requires a showing of (1) Gallagher's violation; (2) Calvo's "knowledge" of the violation; and (3) Calvo's substantial assistance in the violation. IIT, An Int'l Investment Trust v. Cornfield, 619 F.2d 909, 922 (2d Cir.1980) (Friendly, J.). See also Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 119 (2d Cir. 1982); Woodward v. Metro Bank, 522 F.2d 84, 97 (5th Cir.1975); Andreo v. Friedlander, Gaines, Cohen, Rosenthal & Rosenberg, 660 F.Supp. 1362, 1366 (D.Conn.1987) (Ruling on Motions for Summary Judgment). Where there is a duty of disclosure to the defrauded party, reckless conduct satisfies the scienter requirement for aider and abettor liability. See Sirota, 673 F.2d at 575 (aiding and abetting violation of Section 10(b)); Decker, 681 F.2d at 119; IIT, 619 F.2d at 923; SEC v. Spectrum Corp., 489 F.2d 535, 541 (2d Cir.1973).

A fiduciary duty is not a prerequisite to the use of recklessness as the standard by which scienter is proven in a case of aider and abettor liability. Attorneys may be liable as aiders and abettors where, if it is reasonably foreseeable that potential investors will rely on documents they draft, they omit material information or include erroneous information in reckless disregard of the truth. Morgan v. Prudential Group, Inc., 527 F.Supp. 957, 961 (S.D.N. Y.1981), aff'd mem., 729 F.2d 1443 (2d Cir. 1983). "Attorneys have a responsibility to not act in reckless disregard of the truth when using the information provided by clients in performing their professional duties and preparing offering memorandum and ... opinions" in connection with a securities offering. Andreo, at 1367. This is especially true where the Commission seeks an injunction which does not require proof of reliance upon reckless statements. Blavin, 760 F.2d at 711.

A defendant need only be shown to have been negligent in the omission or falsity of a statement of material fact or, as to whether a transaction or practice "would operate as a fraud or deceit upon the purchaser" of a security, to prove violations of Section 17(a)(2) and (3) respectively. Aaron, 446 U.S. at 697, 100 S.Ct. at 1955 (negligence standard for violations of Section 17(a)(2) and (3)).

B. The Warehouse Closing

The Commission's motion for summary judgment on Counts I, II and III is based upon Calvo's participation in the Warehouse offering and, in particular, in the closing of that offering on April 22, 1985. It is not disputed that the prospectus represented that the offering would remain open for not in excess of 150 days from the effective date of the prospectus and that all investor funds would be returned if the specified minimum number of shares were not sold and paid for by the end of that period. See Bremer Affidavit, Exhibit 4 (Prospectus); Calvo Transcript at 27, 67. The prospectus also represented that Warehouse would realize at least $964,000 if the minimum number of shares were sold. Prospectus at 2. The period of the offering was extended to 150 days by agreement of Gallagher and Warehouse, making the proper closing date April 7, 1985. See Bremer Affidavit, Exhibit 6; Calvo...