Securities and Exchange Commission v. Frank

Decision Date22 January 1968
Docket NumberDocket 31667.,No. 169,169
Citation388 F.2d 486
PartiesSECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Martin FRANK, Defendant-Appellant, and Nylo-Thane Plastics Corp., Maurice Minuto, Olanda Minuto, Louis Braunston, Leonard Freedman, Defendants.
CourtU.S. Court of Appeals — Second Circuit

Sidney Feldshuh, New York City, for defendant-appellant, Richard Weinberger, New York City, on the brief.

Edward B. Wagner, Sp. Counsel (Philip A. Loomis, Jr., Gen. Counsel, Ellwood L. Englander, Asst. Gen. Counsel, Janet G. Gamer, Atty., Washington, D. C.), for Securities and Exchange Commission.

Before WATERMAN, FRIENDLY and SMITH, Circuit Judges.

FRIENDLY, Circuit Judge:

Martin Frank, an attorney, appeals, 28 U.S.C. § 1292(a) (1), from a temporary injunction issued by Judge Tyler in the District Court for the Southern District of New York, in an action by the SEC with respect to alleged violations of the fraud provisions of the securities laws, § 17(a) of the Securities Act of 1933 and § 10(b) of the Securities Exchange Act of 1934. The order enjoined Frank pendente lite from "drafting or causing to be drafted any offering circular, prospectus or other document or writing containing any untrue statements of material facts, or omissions to state material facts necessary in order to make the statements made in the light of the circumstances under which they were made, not misleading, concerning Nylo-Thane Plastics Corp.'s principal product, a chemical additive ingredient purportedly designed to reduce the time required in curing rubber * * *."

Nylo-Thane, a defendant in this action, had acquired from Maurice Minuto, whose wife owned two-thirds of its stock, a chemical additive designed to accelerate the curing of rubber. During 1966 it sold 100,000 shares at $3 per share in what purported to be an intra-state offering, in connection with which Minuto had retained Frank to represent it. An offering circular dated October 31, 1966, and an amended offering circular dated March 9, 1967, contained, under the heading "Business of the Company," references to the additive which are reproduced in the margin.1 Immediately after completion of the offering the stock rose as high as $17.50 per share.

On learning what it considered to be serious misrepresentations in the offering circular with respect to the additive, the SEC, on April 27, 1967, suspended trading in the stock. The company retained a new securities law specialist, who worked out with the Commission a letter correcting the misrepresentations. On May 26 the Commission instituted this action against the company, three officers or stockholders, a financial consultant, and Frank, to enjoin further misrepresentations. All the defendants save Frank, while neither admitting nor denying the allegations of the complaint, consented to entry of a permanent injunction. The Commission thereupon announced that it would not continue the suspension beyond May 27, when the current 10-day suspension order expired, advising investors to "consider carefully information made available by the company concerning its product and information made available in connection with the Commission's injunctive action before effecting transactions in this stock." Securities Exchange Act of 1934 Release No. 8089.

Frank having declined to join the other defendants in consenting to an injunction, the Commission on June 20 moved for a temporary injunction against him. The motion was supported by numerous affidavits and extracts from testimony by Frank and others at an administrative hearing which were alleged to show that he had been aware of the falsity of representations concerning the additive. Frank countered with a notice to take the depositions of various employees of the Commission, as to which the Commission obtained a stay, and with answering affidavits of himself and others. His position, broadly stated, was that the portion of the offering circular alleged to misrepresent the additive had been prepared by the officers of Nylo-Thane and that his function had been that of a scrivener helping them to place their ideas in proper form. Further affidavits were filed by both sides and the SEC's application was argued on July 19. Judge Tyler endorsed on the motion papers a memorandum opinion granting the injunction2 and this later issued.

Although Frank makes much of this being the first instance in which the Commission has obtained an injunction against an attorney for participation in the preparation of an allegedly misleading offering circular or prospectus, we find this unimpressive. As this court said in United States v. Benjamin, 328 F.2d 854, 863 (2 Cir.), cert. denied, 377 U.S. 953, 84 S.Ct. 1631, 12 L.Ed.2d 497 (1964), "In our complex society the accountant's certificate and the lawyer's opinion can be instruments for inflicting pecuniary loss more potent than the chisel or the crowbar." A lawyer has no privilege to assist in circulating a statement with regard to securities which he knows to be false simply because his client has furnished it to him. At the other extreme it would be unreasonable to hold a lawyer who was putting his client's description of a chemical process into understandable English to be guilty of fraud simply because of his failure to detect discrepancies between their description and technical reports available to him in a physical sense but beyond his ability to understand. The instant case lies between these extremes. The SEC's position is that Frank had been furnished with information which even a non-expert would recognize as showing the falsity of many of the representations quoted in fn. 1, notably those implying extensive and satisfactory testing at factories and indicating that all had gone passing well at the test by the Army Laboratories. If this is so, the Commission would be entitled to prevail; a lawyer, no more than others, can escape liability for fraud by closing his eyes to what he saw and could readily understand. See Bentel v. United States, 13 F.2d 327, 329 (2 Cir.), cert. denied, 273 U.S. 713, 47 S.Ct. 109, 71 L.Ed. 854 (1926); United States v. Benjamin, supra, 328 F.2d at 861. Whether the fraud sections of the securities laws go beyond this and require a lawyer passing on an offering circular to run down possible infirmities in his client's story of which he has been put on notice, and if so what efforts are required of him, is a closer question on which it is important that the court be seized of the precise facts, including the extent, as the SEC claimed with respect to Frank, to which his role went beyond a lawyer's normal one, Compare Securitites Act of 1933, § 11 (a).

Although the moving affidavits of the SEC investigator and others gave ample basis for belief that the circular conveyed what executives of Nylo-Thane must have known to be a misleading impression of the extent to which the additive had proved valuable in practice or even in theoretical testing, the only specific statements as to what Frank knew were that he had seen letters from Genruco Processing Co. and the Army, dated December 6, 1965, and August 4, 1966, respectively, and that Braunston, president of Nylo-Thane, had told him that the Army tests indicated use of the additive resulted in "sulphur bloom" and that "the Company cannot always guarantee that the additive will work."

While the letter from Genruco was not in the SEC's papers, the investigator quoted a statement "that there had not been enough time to have all the physical * * * (properties) * * * checked out." The Army report recited favorable effect with one rubber compound, lack of effect with another, but "prominent blooming" in the former. An answering affidavit of Braunston gave the text of the letter from Genruco a portion of which, not quoted by the SEC investigator, was highly enthusiastic about the additive but which did clearly indicate that factory trials were yet to be made. Braunston added a letter from Vulcanized Rubber and Plastics Co., dated November 30, 1966, given to Frank, which was also optimistic, and denied making the statements the investigator had attributed to him. An answering affidavit by Minuto included a report from Armstrong Rubber Co. dated June 10, 1965, of a rather technical nature, allegedly shown to Frank and claimed to differ materially — to the advantage of the additive — from one described in an affidavit of an Armstrong chemical engineer which the SEC had submitted. Minuto also denied that he or Braunston had ever mentioned "sulphur bloom" to Frank, and asserted that the phenomenon was due to the Army's using a compound with excessive sulphur content and could easily be corrected. A reply affidavit of the SEC investigator sought to respond to these and other claims; among other things it cited testimony by Minuto at an administrative hearing that he had told Frank about the sulphur bloom, and contended that Minuto had told Frank that the additive tested by the Army reduced the abrasive resistance of the final product and that Braunston had reported that the Army tests were inconclusive. Supplemental affidavits submitted by Frank's lawyer and by Braunston sought to rebut these charges.

Frank contends that the order granting a preliminary injunction is procedurally defective in two respects. First, no evidentiary hearing was conducted though the affidavits revealed a dispute about the critical facts. Second, the judge's memorandum did not set forth adequately the necessary findings of fact as required by Rule 52(a).3

Decisions on the extent to which F.R. Civ.P. 65 requires a district court to take evidence rather than rely on affidavits before granting or refusing a temporary injunction reflect a tension between the need for speedy action and the desire for certainty and complete fairness. In recognition of the former, Rule 65(b) authorizes a temporary restraining order which may be issued without a hearing....

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