Securities and Exchange Commission v. Culpepper

• Decision Date: 10 September 1959
• Docket Number: Docket 25242.,No. 171,171
• Court: U.S. Court of Appeals — Second Circuit
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Garland L. CULPEPPER, Jr., Albert J. Grayson, George Phillip Barton, Rockwell Securities Corporation, A. J. Grayson & Co., Incorporated, and Brown, Barton & Engel, Defendants-Appellants.

270 F.2d 241 (1959)

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. Garland L. CULPEPPER, Jr., Albert J. Grayson, George Phillip Barton, Rockwell Securities Corporation, A. J. Grayson & Co., Incorporated, and Brown, Barton & Engel, Defendants-Appellants.

No. 171, Docket 25242.

United States Court of Appeals Second Circuit.

Argued April 8, 1959.

Decided September 10, 1959.

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John H. Kelley, New York City (Lee Feltman, New York City, of counsel), for Garland L. Culpepper, Jr. and Rockwell Securities Corporation.

Max M. Greenfield, New York City (Lichtig, Copland & Greenfield, New York City, on the brief), for Albert J. Grayson and A. J. Grayson & Co., Inc.

Milton E. Mermelstein, New York City (Gordon, Brady, Caffrey & Keller, and Stephen Bermas, New York City, on the brief), for George Phillip Barton and Brown, Barton & Engel.

Ellwood L. Englander, Special Counsel, Securities and Exchange Commission, Washington, D. C. (Thomas G. Meeker, General Counsel, and Alger B. Chapman, Jr., Atty., Securities and Exchange Commission, Washington, D. C., on the brief), for S. E. C.

Before HINCKS, LUMBARD and WATERMAN, Circuit Judges.

HINCKS, Circuit Judge.

On June 21, 1956, Micro-Moisture Controls, Inc. (Micro-Moisture), a Delaware corporation, issued 2,396,485 shares of unregistered stock in exchange for the assets of Converters Acceptance Corporation, Ltd. (Converters), a Canadian corporation, which in turn distributed these shares to its thirty-one stockholders. Twenty-six of them immediately granted John Herschorn, one of their number, irrevocable powers of attorney for the sole purpose of selling the stock. The Herschorn group, through the record ownership of more than 43% of the common stock of Micro-Moisture, was in common control with, or under the control of Louis Levin, who dominated and controlled Micro-Moisture after June 21, 1956. Herschorn sold at least 710,623 of these unregistered shares to various brokers and dealers, defendants in this action, who subsequently resold them to the public through the use of the mails.

Pursuant to Section 20(b) of the Securities Act of 1933 (15 U.S.C.A. § 77t (b)(2)), the Securities and Exchange Commission brought suit on January 9, 1957, to enjoin the defendants from further alleged violations of the registration provisions of Section 5(a) and (c) (15 U.S.C.A. § 77e(a) and (c)). A preliminary injunction issued by Judge Ryan, Securities and Exchange Commission v. Micro-Moisture Controls, Inc., D.C., 148 F.Supp. 558, was made final after a lengthy trial before Judge Edelstein. Judge Edelstein found, 167 F.Supp. 716, that it was "in the public interest" to enjoin the three appellants herein, who had sold an aggregate of 343,495 of the unregistered shares of Micro-Moisture, and the ten other defendants below, from using the channels of interstate commerce for the purposes of dealing in the stock of Micro-Moisture, unless a registration statement is in effect or unless the stock is exempt from the provisions of Section 5 of the Act. From this judgment the individual appellants and their wholly owned corporations, George Phillip Barton, and Brown, Barton & Engel (Barton), Albert J. Grayson and A. J. Grayson & Co., Inc. (Grayson), and Garland L. Culpepper and Rockwell Securities Corporation (Culpepper), appeal. Each of them claims error in the district court's ruling that they violated the Act and each further argues that even if violations be conceded the Court abused its discretion in issuing a permanent injunction. For the reasons hereinafter discussed we affirm the challenged judgment.

Section 5(a)¹ of the Act makes unlawful the use of the mails or interstate commerce for the purpose of selling securities unless a registration statement is in effect with the Commission. Section 4² excludes certain "exempted transactions" from the provisions of Section 5(a) and the plaintiff concedes the lawfulness of appellants' sales of unregistered Micro-Moisture stock if they did not act as "underwriters" within the meaning of Section 4.

The term "underwriter" is defined as "any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking." Section 2(11) (15 U.S.C.A. § 77b(11)). For purposes of this section the term "issuer" includes "any person directly or indirectly controlling³ or controlled by the issuer, or any person under direct or indirect common control with the issuer."

We recently held that the burden is on a broker-dealer to prove his claimed exemption from the provisions of the Act, Gilligan, Will & Co. v. Securities and Exchange Commission, 2 Cir., 267 F.2d 461, following the rationale of Securities and Exchange Commission v. Ralston Purina Co., 346 U.S. 119, 73 S.Ct. 981, 97 L.Ed. 1494. In the case now before us not only did the appellants fail to discharge this burden but we find ample evidence supporting the conclusion that each of them was an "underwriter." For the trial court reasonably found the Herschorn group to be in common control with, or under the control of the issuer. Thus each of the individuals in the control group was an issuer for purposes of defining "underwriter." It is undisputed that Culpepper purchased directly from Herschorn the 5,000 shares of unregistered stock which he had sold publicly by September 10, 1956. The evidence also clearly demonstrates that Barton dealt directly with Herschorn as the attorney for the two shareholders of Converters from whom he purchased 66,945 shares of Micro-Moisture stock, and in the absence of contrary evidence we must conclude that they were two of the stockholders found to be in common control of, or controlled by, the issuer. The fact that these two stockholders owned only 1½% of the issued Micro-Moisture stock does not make erroneous the conclusion that they were "under direct or indirect common control with the issuer." (Emphasis added.) Thus it appears that both Culpepper and Barton purchased directly from an issuer with a view for sale and were underwriters within the meaning of the Act.

Grayson purchased all the shares which he resold to the public from other brokers. And so he argues that he could not be an "underwriter" since he did not directly purchase shares from the control group nor have any privity of contract with such group. This argument is vulnerable on at least two grounds.

First. In an early case we noted the underlying policy of the Act, that of protecting the investing public through the disclosure of adequate information, would be seriously impaired if we held that a dealer must have conventional or contractual privity with the issuer in order to be an "underwriter." Securities and Exchange Commission v. Chinese Consol. Benev. Ass'n, 2 Cir., 120 F.2d 738, certiorari denied 314 U.S. 618, 62 S.Ct. 106, 86 L.Ed. 497. Indeed, the Act includes within the definition of underwriter one who "participates or has a direct or indirect participation in any such undertaking." Grayson purchased at least 207,000 of the unregistered shares of Micro-Moisture from defendant below, McGrath Securities, a wholly owned broker-corporation of Robert C. Leonhardt. On July 9, 1956, Grayson and Leonhardt had borrowed from the same New York bank $100,000 and $50,000, respectively. Herschorn, pursuant to his powers of attorney delivered 300,000 shares of Micro-Moisture stock involved in the Converters transaction as collateral security for these loans and the loan proceeds were turned over to Levin, the president of Micro-Moisture. On the same day Levin borrowed $60,000 from the same bank, pledging 120,000 shares of Micro-Moisture stock which had been issued in the same Converters transaction. Moreover, Grayson had previously participated in a similar accommodation loan in helping to swing the Peeby transaction, hereinafter discussed, but relevant to this case in that it paralleled the Converters merger transaction. Thus the evidence abundantly demonstrates Grayson's closeness with the control group and amply supports the conclusion that Grayson "participated" in the underwriting if that word is to be given a reasonable interpretation.

Second. Quite apart from these considerations, we also held in the Chinese Consol. Benev. case, supra, that Section 4(1) was intended to exempt only trading transactions between individual investors with respect to securities already issued and not to exempt distributions by issuers or acts of other individuals who engage in steps necessary to such distributions, even if such individuals themselves do not come within the definition of "issuer, underwriter, or dealer." Grayson consciously engaged in steps necessary to the consummation of the public distribution of shares by the issuer and he can not invoke the exemption provided by Section 4(1).

Culpepper also challenges the finding that he acted as an "underwriter" in selling 45,000 shares of unregistered stock which he received as repayment of a stock loan from defendant below, Robert C. Leonhardt. Elaborate arguments were made by the Commission to counter the appellant's thesis that since the loan repayment was not a "purchase from an issuer" Culpepper could not be an underwriter as to this stock. In light of what has been said, it suffices here to merely reiterate that a direct or indirect participation in the distribution brings a dealer within the definition of underwriter. Culpepper, one of the largest stockholders of Micro-Moisture, had recently resigned as president of that company and was serving as a consultant at the time of the Converters transaction. He knew or reasonably should have known that the stock he received in repayment of his "free"⁴ stock loan was unregistered stock emanating...