Securities and Exchange Com'n v. Keller Corporation

• Decision Date: 08 October 1963
• Docket Number: No. 14116.,14116.
• Citation: 323 F.2d 397
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. The KELLER CORPORATION, Mid-Continent Securities Corp., Earl Bullock, F. Ray Bess, Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

323 F.2d 397 (1963)

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. The KELLER CORPORATION, Mid-Continent Securities Corp., Earl Bullock, F. Ray Bess, Defendants-Appellants.

No. 14116.

United States Court of Appeals Seventh Circuit.

October 8, 1963.

Don A. Tabbert, John R. Carr, Jr., Donald A. Schabel, Indianapolis, Ind., Buschmann, Carr, Schabel & Tabbert, Indianapolis, Ind., of counsel, for appellants.

Walter P. North, Washington, D. C., Thomas B. Hart, Chicago, Ill., David W. Mernitz, Asst. U. S. Atty., Indianapolis, Ind., David Ferber, Associate General Counsel, John A. Dudley, Sp. Counsel, Robert L. McCloskey, Attorney, Securities and Exchange Commission, Washington, D. C., for appellee.

Before HASTINGS, Chief Judge, and DUFFY and CASTLE, Circuit Judges.

HASTINGS, Chief Judge.

This action was brought in the district court by plaintiff Securities and Exchange Commission (SEC) against defendants, The Keller Corporation (Kellco), Mid-Continent Securities Corporation (Midco), Earl Bullock, F. Ray Bess, Leonard J. Thornburg and Walter C. Olsen.

SEC sought to enjoin all defendants from violating Section 17(a) of the Securities Act of 1933, 15 U.S.C.A. § 77 q(a),¹ to enjoin Kellco from violating Section 7(a) of the Investment Company Act of 1940, 15 U.S.C.A. § 80a — 7(a),² and for the appointment of a trustee and receiver for the assets of both Kellco and Midco pursuant to Section 42(e) of the Investment Company Act of 1940, 15 U.S.C.A. § 80a — 41(e).³

The district court entered an order granting a preliminary injunction against all defendants, except Olsen and Thornburg, appointing a trustee and receiver for Kellco, and taking under advisement the appointment of a trustee and receiver for Midco. From this order defendants, except Olsen and Thornburg, appealed.

Errors relied on for reversal concern the sufficiency of the evidence to support some of the findings, the lack of equitable or statutory grounds to support the appointment of the trustee and receiver for Kellco, the impropriety of some of the powers and duties conferred on the trustee and receiver, the lack of equitable or statutory authority to support the preliminary injunction and the breadth of such injunction.

The following facts seem well established by the record in this case.

Midco was incorporated in the State of Indiana in April, 1959, under the name Hoosier Securities Exchange, Inc. by Bullock, who became its president, and other persons. In July, 1959, Midco purchased all stock of Kellco (then Keller Securities Corporation), and Bullock became its president. In August, 1959, Bess became executive vice president of Kellco. Since that time there has been substantial identity between Midco and Kellco. Their meetings have often been held jointly and their business affairs closely intertwined.

Midco has been registered with the State of Indiana as a securities dealer continuously since 1959. However, from August, 1959 through October, 1961, Midco did not directly engage in the securities business but operated through its wholly owned subsidiary, Kellco.

In September, 1961, Bullock and Bess visited the Chicago Regional Office of SEC and inquired whether a corporation could sell monthly payment certificates in a common pool of securities solely to persons in Indiana without registering as a mutual fund. They were advised that what they proposed would constitute a "mutual fund" requiring registration with SEC.

Contrary to the advice of SEC, in October, 1961, Bullock and Bess commenced a program substantially the same as that which they had discussed with SEC in September. Midco resumed operations as a securities dealer. Kellco ceased being a securities dealer and became a diversified investment company.

Kellco reclassified its authorized capital stock from 1000 shares of $5.00 par value into 100,000 shares of no par value. Of the reclassified stock, 20,000 shares were issued to Midco in exchange for the Kellco stock owned by it and having a net worth of less than $30,000. 16,000 shares were reserved for sale to the officers and directors of Kellco and Midco, at $1.00 per share, including 3,000 shares each for Bullock and Bess. 4,000 shares were set aside as prizes for salesmen.

The remaining 60,000 shares were registered with the Indiana Securities Commission for sale to the public at $10.00 per share. These shares were purchased by Midco, the purchase price being paid by a non-interest bearing note executed by Midco to Kellco in the amount of $510,000, or $8.50 per share. A report was filed with the Indiana Securities Commission stating that the stock had been "fully distributed."

Midco then resold approximately 30,000 shares of the Kellco stock to the public at prices ranging from $10.00 to $14.00 per share. Many of these sales were in effect barter transactions. Midco would purchase from the buyer of the Kellco stock, stock owned by such buyer in other corporations.

The Kellco stock was sold without using the prospectus filed with the Indiana Securities Commission. This prospectus would have disclosed, inter alia, that Midco was receiving a 15% commission on the sale of the stock. It would have permitted investors to ascertain from the financial statements included therein the dilution of the equity of the public stockholders through the allocation of stock to the officers and directors at a fraction of its selling price to the public.

On September 7, 1962, SEC informed defendants that they were suspected of being in violation of the Investment Company Act of 1940. On September 13, 1962, SEC began an examination of the books and records of Midco and Kellco. This examination disclosed that the last sale of stock by Midco to the public was on August 14, 1962. The examination was completed on October 5, 1962, and no further examination was made.

Defendants rescinded several sales of Kellco stock at the request of purchasers. However, in at least one instance, the rescission was not accomplished until after repeated demands by the purchaser who finally turned the matter over to an attorney.

On November 30, 1962, SEC filed its complaint against defendants in the district court.

On December 7, 1962, Kellco and Midco each held meetings of their respective boards of directors and adopted resolutions authorizing the corporate officers to do acts and things necessary to carry out a program of dissolution of the business of Kellco.

The district court found as a fact "that from on and before November 1, 1961, to the date hereof December 20, 1962 the defendants, * * * in the offer and sale of securities by the use of the mails, have been and * * * are now, * * * employing a device, scheme and artifice to defraud intended purchasers and holders of securities issued and to be issued by Kellco, and sold and to be sold by Midco on behalf of Kellco and Midco. * * *"

In support of this finding, the court found, inter alia, that Bullock and Bess published in newspapers a consolidated balance sheet for Midco and Kellco which falsely overstated assets and retained earnings and concealed actual operating losses, concealed a deficit net retained earnings figure and a deficit earned surplus. Bullock and Bess incorporated the same false financial statement in a brochure used in selling Kellco stock. This brochure reported that Midco paid a dividend in 1961, without mentioning that the dividend was at least in part a return of capital.

The court further found that in selling Kellco stock, Bullock and Bess concealed from the purchasers the facts that: (1) Kellco had not received cash from the sale of 60,000 shares of its stock represented as having been sold and distributed at a public offering price of $10.00 per share but instead had received a non-interest bearing note of Midco; (2) that officers and directors of Midco and Kellco had received the same class of stock at $1.00 per share; (3) that Midco was receiving an underwriter's commission of at least $1.50 on every share sold; (4) that the Kellco stock was being sold at artificial and arbitrarily predetermined escalating prices set by Bullock and Bess; and (5) that Midco was taking other securities in trade for Kellco stock and in so doing Midco was paying prices above the actual market for those securities and passing them on to Kellco at the inflated price. This further diluted the interest of the stockholders in Kellco.

The court found "that from on or about March 20, 1962, to the date hereof, * * *" Bullock and Bess mismanaged Kellco. The court further found that Kellco had never registered with SEC pursuant to Section 8(a) of the Investment Company Act, 15 U.S.C.A. § 80a — 8(a).⁴

The district court entered conclusions of law "that since on or before February 1, 1962, to the date hereof, Kellco has been and is an investment company within the meaning of Section 3 of the Investment Company Act of 1940 (15 U.S.C. § 80a — 3)" and "that the defendants, * * * have engaged, are engaged and * * * are about to engage in acts and practices which constitute and will constitute violations of Sections 17 (a) (1), 17(a) (2) and 17(a) (3) of the Securities Act of 1933, as amended * * *, and Sections 7(a) (1) and 7(a) (2) of the Investment Company Act of 1940, as amended * * *."

The court entered a preliminary injunction pursuant to Section 20(b) of the Securities Act of 1933, 15 U.S.C.A. § 77t(b)⁵ and Section 42(e) of the Investment Company Act of 1940.

The court appointed a trustee and receiver of all records, claims and assets of Kellco, pending a final determination of the matter. The court acted under authority of Section 42(e) of the Investment Company Act of 1940, and also on the basis of the inherent powers of the court as a court of equity.

Appellants' principal grounds urged for reversal are now set out in some detail.

They contend that the findings of fact that the fraudulent scheme, mismanagement and activity as an investment company continued to the date of the...