SEC v. Steadman
| Decision Date | 01 May 1991 |
| Docket Number | Civ. A. No. 89-2026-LFO. |
| Citation | 798 F. Supp. 733 |
| Court | U.S. District Court — District of Columbia |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Charles W. STEADMAN, Steadman Security Corporation, Steadman Financial Fund, Steadman Investment Fund, Steadman Oceanographic, Technology & Growth Fund, Steadman American Industry Fund, and Steadman Associated Fund, Defendants. |
David S. Horowitz, U.S.S.E.C., Philadelphia, Pa., for plaintiff.
Peter J. Nickles, Coleman S. Hicks, Jay T. Smith, Covington & Burling, Washington, D.C., for defendants.
Plaintiff Securities and Exchange Commission ("SEC") seeks to enjoin defendants Charles W. Steadman, Steadman Security Corporation ("SSC"), Steadman Financial Fund, Steadman Investment Fund, Steadman Oceanographic, Technology & Growth Fund, Steadman American Industry Fund, and Steadman Associated Fund (collectively "the Funds") from violations of federal securities laws. During a period from 1971 to 1988 the Funds sold shares to residents of the states but did not register under state securities laws ("Blue Sky laws"). The SEC asserts that, as a result of defendants' failure to register under state laws, the Funds accrued undisclosed and unrecognized liabilities for fees, penalties, and shareholder rescission suits. The SEC further contends that defendants' failure to recognize this liability from 1971 to 1989 resulted in material misstatements of net asset value ("NAV") of the Funds' shares.
SEC alleges the following eight causes of action against defendants: (1) That defendants' misstatements of NAV defrauded investors, violating section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a), section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5; (2) that SSC, aided and abetted by Steadman, used the mails in connection with a fraud in violation of sections 206(1) and (2) of the Investment Advisers Act of 1940 ("Advisers Act"), 15 U.S.C. §§ 80b-6(1) & (2); (3) that the Funds, aided and abetted by Steadman, violated section 22(c) of the Investment Company Act ("ICA") of 1940, 15 U.S.C. § 80a-22(c), and Rule 22c-1, 17 C.F.R. § 270.22c-1; (4) that defendants failed to disclose material facts in reporting to the SEC in violation of section 34(b) of the ICA, 15 U.S.C. § 80a-33(b); (5) that from November, 1985 to May, 1986 defendant SSC performed advisory services for the Funds without approval from the boards of trustees in violation of section 15(a) of the ICA, 15 U.S.C. § 80a-15(a); (6) that SSC, aided and abetted by Steadman, improperly maintained custody of client funds in violation of section 206(4) of the Advisers Act, 15 U.S.C. § 80b-6(4), and Rules 206(4)-2(a)(2)(ii) and (a)(5), 17 C.F.R. § 275.206(4)-2(a)(2)(ii) and (a)(5); (7) that defendant SSC failed to file required forms in violation of section 204 of the Advisers Act, 15 U.S.C. § 80b-4, and Rule 204-1(a)(1), 17 C.F.R. 275.204-1(a)(1); and, (8) that SSC failed to file proper reports in violation of section 17A(d)(1) of the Exchange Act, 15 U.S.C. § 78q-1(d)(1) and Rule 17Ad-13(a), 17 C.F.R. 240.17Ad-13(a).
The SEC moved for preliminary injunction in the early stages of this case. On August 4, 1989, an evidentiary hearing on that motion was held. Before the motion for preliminary injunction was decided, however, the parties entered into settlement negotiations. In October, 1990, the SEC moved for summary judgment on all charges except those arising under section 15(a) of the ICA, 15 U.S.C. § 80a-15(a). In support of and in opposition to the summary judgment motion, the parties presented supplemental briefs and affidavits and oral argument. However, the case was not resolved on summary judgment and proceeded instead to trial. On November 7 and 8, 1990, the parties presented evidence on all factual matters not addressed at the preliminary injunction and summary judgment stages. Witnesses ratified earlier deposition testimony and the parties supplemented the record with designated portions of that deposition testimony.
Defendant Charles Steadman is Chairman of the Board, President, Chief Executive Officer, and Treasurer of SSC and Chairman of the Board of Trustees and President of each fund. Steadman is a graduate of the Harvard Law School and served as legal counsel to mutual funds organized by the Steadman family from the early 1950's to the early 1960's. From the early 1960's on, Steadman has served as an officer and director of mutual funds owned by the family. See Transcript (November 7, 1990) ("1990 Tr. I") at 125-26 and 144. SSC is a Delaware corporation owned by United Securities, Inc., which maintains offices in Washington, D.C. United Securities is a Maryland corporation whose sole shareholders are the three adult children of Mr. Steadman. SSC became registered with the SEC as an investment adviser on December 31, 1971.
The Funds are five no-load, open-end management investment companies organized as common law trusts under the laws of the District of Columbia. In 1971-72, the Funds had net assets of approximately $130-135 million and 75,000 shareholder accounts. See 1990 Tr. I at 117-18. However, as of mid-1989, the Funds' net assets were approximately $28.9 million in over 25,000 shareholder accounts. Complaint & Answer ¶ 12. The Funds' shareholders include residents of all fifty states. SSC supervises the Funds' relations with federal and state regulatory bodies pursuant to investment advisory agreements with each of the Funds and subject to the direction of the Trustees of the Funds.
Prior to 1971, the Funds maintained sales offices and employed sales personnel in various locations in the United States and were registered under the Blue Sky laws of the applicable jurisdictions. In 1971 the Funds changed their manner of doing business. They closed their sales offices, terminated their sales personnel, and operated thereafter strictly on a "mail order" basis. In conjunction with this switch to mail order sales, the Funds ceased renewing registrations under state Blue Sky laws and allowed then existing registrations to lapse. In the majority of states, the Funds have not been registered since the early 1970's, although in two states the Funds were registered as late as 1978.
Defendants assert that the decision to discontinue state registrations was based on an opinion letter written in the early 1970's by Carl Shipley, a private attorney who was general counsel to at least three of the five funds and Director of the Oceanographic Fund, Inc. See Plaintiff's exhibit ("Pl. ex.") 14. Peter Nunn, the Coopers & Lybrand accountant who was responsible for auditing defendants' financial statements, also relied upon Shipley's opinion. See 1990 Tr. I at 87; Designated Deposition of Peter Nunn ("Nunn Dep.) at 43; Transcript of Hearing on Motion for Preliminary Injunction (August 4, 1989) ("1989 Tr.") at 59. However, neither Steadman nor Nunn have seen a copy of the original opinion letter since the early 1970's. 1989 Tr. at 76 & 91-92. Unable to produce the 1971 letter, which Steadman and Nunn remembered as being several pages long, defendants instead produced from a file used in 1974 board meetings a single page, unsigned, undated letter on SSC stationary addressed to the Steadman American Industry Fund from Carl Shipley, General Counsel, opining that state registration was unnecessary. See 1990 Tr. I at 87 & 108, see also infra at § III-B. Steadman testified that this letter was not the original one relied on by defendants in 1971. 1990 Tr. I at 108.
On September 25, 1974, at meetings of the boards of directors, four of the five Funds resolved to conduct distribution on a mail order basis, following a discussion of the costs of state registration. See Pl. ex. 14. Mr. Steadman testified that Shipley's opinion was discussed extensively at those meetings. 1990 Tr. I at 107. However, neither the resolution nor the minutes of the meetings make any reference to a decision to permit state Blue Sky law requirements to lapse or to Mr. Shipley's legal opinion that registration was not required.
Upon the advice of Mr. Steadman and SSC the Funds took the position that sales were effected only in the District of Columbia, a jurisdiction that does not require registration. This position was disclosed to shareholders, who were required upon application to sign a statement of understanding that the Funds' shares were not registered "under the local laws of the various states" and that the rights of the applicant were governed exclusively by the laws of the District of Columbia and the United States. See Steadman Declaration (July 31, 1989) ("1989 Steadman decl.") at ex. 3. Similarly, beginning in 1971, the Funds' prospectuses stated: See id. at ex. 2. The prospectuses made no mention of state laws requiring registration, of Supreme Court decisions upholding state application of Blue Sky laws, or of the risk that the states could assert fines and penalties and investors could rescind purchases upon a determination that state law in fact required registration. See, e.g., Hall v. Geiger-Jones Co., 242 U.S. 539, 550, 37 S.Ct. 217, 220, 61 L.Ed. 480 (1917); Travelers Health Ass'n v. Virginia, 339 U.S. 643, 70 S.Ct. 927, 94 L.Ed. 1154 (1950).
From at least 1970 until May 26, 1988, defendants forwarded the Funds' prospectuses and investment applications to residents of the various states through the mails, almost exclusively upon written or telephone request by potential investors. However, at times, though not continuously, defendants also solicited investors directly. For example, defendants sent...
To continue reading
Request your trial
-
Boeckman v. A.G. Edwards, Inc.
...blue sky laws in the states in which shares are sold, entailing annual filings and fees with state regulators. See SEC v. Steadman, 798 F.Supp. 733, 736-37 (D.D.C.1991). 4. "A fund ... typically retains a transfer agent, which is responsible for the issuance, transfer and redemption of shar......