Securities and Exchange Commission v. Van Horn

• Decision Date: 14 December 1966
• Docket Number: No. 15470.,15470.
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. G. N. VAN HORN, Bert Chesnut and Commercial Capital Corporation, Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

371 F.2d 181 (1966)

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee, v. G. N. VAN HORN, Bert Chesnut and Commercial Capital Corporation, Defendants-Appellants.

No. 15470.

United States Court of Appeals Seventh Circuit.

December 14, 1966.

COPYRIGHT MATERIAL OMITTED

John J. Enright, Chicago, Ill., Arvey, Hodes & Mantynband, Chicago, Ill., of counsel, for appellants.

Philip A. Loomis, Jr., David Ferber, Sol., Ellwood L. Englander, Asst. Gen. Counsel, Leonard S. Machtinger, Joan H. Saxer, Attys., S. E. C., Washington, D. C., John I. Mayer, S. E. C., Chicago, Ill., Richard P. Stein, U. S. Atty., Indianapolis, Ind., for appellee.

Before HASTINGS, Chief Judge, MAJOR, Senior Circuit Judge, and CASTLE, Circuit Judge.

MAJOR, Senior Circuit Judge.

This appeal is from an order entered July 12, 1965, by the District Court for the Southern District of Indiana, in an action for an injunction brought by the Securities and Exchange Commission (SEC), pursuant to Sec. 20(b) (15 U.S. C.A. § 77t(b)), alleging violations of Secs. 17(a) and 5(a) and (c) of the Securities Act of 1933 (15 U.S.C.A. § 77q (a) and 15 U.S.C.A. § 77e(a) and (c)) (sometimes referred to as the Act). The order was directed at seventeen defendants (seven firms and ten individuals), of which only Commercial Capital Corporation (CCC), its president, G. N. Van Horn, and its secretary, Bert Chesnut, appeal. (These appellants will be referred to as such to distinguish them from other defendants.) The individual appellants by stock ownership controlled CCC.

The complaint consisted of four counts. Count 1 charged appellants and eleven other defendants with the fraudulent sale of stock of Air and Space Underwriters, Inc. (ASU) under Sec. 17(a); Count 3 charged appellants with the fraudulent sale of CCC stock under the same anti-fraud section, and Count 4 charged appellants with selling and delivering unregistered ASU stock in violation of Sec. 5. Appellants were not named in Count 2, hence it is not here involved.

After a lengthy hearing the District Court (Judge Dillin) made findings of fact, conclusions of law and entered the order under attack, preliminarily enjoining appellants and other defendants.

With minor exceptions, hereinafter noted, appellants take no issue with the findings as made by the District Court.¹ The contentions they advance in the main involve questions of law. For instance, they state as a contested issue:

"Whether alleged violations of the anti-fraud provisions of the Securities Act of 1933 (15 USC Sec. 77q(a)) are preliminary enjoinable when a finding as to scienter or fraudulent intent is explicity omitted and/or there is no evidence to support such a finding."

A resolution of the issue thus posed is controlling as to Count 1. It is also relevant as to Count 3. Further, as to this Count appellants argue that the findings are not supported in certain respects and that the conclusions of the Court are "predicated upon findings of alleged untrue statements and material omissions not within the SEC's claim, as pleaded."

As a further contested issue they state:

"Whether the alleged violation of the registration requirement for stock under the Securities Act of 1933 (15 USC Sec. 77e) is preliminary enjoinable when uncontradicted evidence at injunction hearing shows a prima facie and probable defense and/or the findings of fact do not deal with evidence bearing on defense."

This issue relates only to Count 4. Appellants, as will subsequently be more fully shown, interposed as a defense to this Count that the transactions described therein were exempt under the terms of the Act.

CCC, a securities dealer controlled by the individual appellants, was organized by them in 1960. It was instrumental in organizing ASU, which was incorporated in Indiana May 16, 1963. ASU owned all the stock of Air and Space Manufacturing, Inc. (ASM). These corporations were organized to develop and manufacture gyroplanes. ASU obtained all the property of Peace River Manufacturing Corporation and Umbaugh Aircraft Corporation, corporations in reorganization under Chapter X of the Bankruptcy Act which had previously attempted to develop and manufacture gyroplanes.

In the offering and sale of common capital stock of ASU (Count 1), the Court found that appellants and other defendants made the following material statements, each of which was untrue:

"(a) ASU or ASM has a backlog of orders in excess of 3,000 planes with an estimated value in excess of $40,000,000;

(b) ASU or ASM has a large asset consisting of deposits on gyroplanes;

(c) ASU or ASM is now or shortly will be in mass production of gyroplanes amounting to at least three per day;

(d) ASU or ASM will sell the gyroplanes at an amount less than $14,000 per plane;

(e) ASM owns two patents on parts of the gyroplane;

(f) The design of the plane is protected by an F.A.A. type certificate; and

(g) An F.A.A. type certificate has been issued as to the Model 18-A (untrue until May 4, 1965)."

Referring to the offering and selling of the same stock, the Court found that appellants and other defendants had omitted to state the following material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading:

"(a) ASM is committed to sell one demonstrator gyroplane to each of the approximately 150 gyroplane dealers or distributors at a price of $12,000;

(b) It will cost approximately $15,850 to manufacture each of the 150 demonstrator planes, so that ASM will lose a total of approximately $577,500 in fulfilling its commitments to its dealers.

(c) ASM must supply its dealers with one demonstrator plane each before it can sell any planes for re-sale to the public. As of May 27, 1965 a total of six aircraft had been completed. As of July 7, 1965, a total of 23 aircraft had been completed.

(d) Approximately 20 demonstrator aircraft were paid for in full, and the money expended by previous management. ASM is obliged to spend approximately $300,000 out of current funds to honor these contracts.

(e) Dealers and distributors hold $3,500,000 of ASM 4%, non-cumulative preferred stock. The preferred stock has priority over dividends on the common stock in the amount of $140,000 per year.

(f) All of the assets of ASM are pledged on a loan to Talcott & Co., which loan bears interest of 12% per annum."

Appellants, referring to the findings just quoted, on brief state:

"Fully adequate evidence was adduced to support the Court\'s finding that the untrue statements and material omissions were uttered or withheld, as the case may be, by defendants involved in various kinds of sales of the stock at various times, including CCC and Van Horn. * * * Repetition of much of the untrue or misleading information by Van Horn and CCC was undisputed. The charge against them, and Chesnut, turns upon the issue of scienter or fraudulent intent."

Thus, we come to the important issue as to whether "scienter or fraudulent intent" must be proven and found as a prerequisite to the allowance of injunctive relief under Sec. 17(a).²

The record indicates that the District Court, without so deciding, was of the view that fraudulent intent was a necessary element of proof under the first clause, having to do with a "device, scheme, or artifice to defraud." Assuming such to be the case, we think it is of no consequence here because the Court expressly held that fraudulent intent was not essential under clauses 2 and 3, and its order was bottomed solely thereon.

Appellants in support of their argument that proof of a fraudulent intent is essential cite three District Court cases, Securities and Exchange Commission v. Glass Marine Industries, Inc., D.C., 208 F.Supp. 727; Securities and Exchange Commission v. Carlton (D.C. Colorado 1939, not reported), and Weber etc. v. C.M.P. Corp. etc., D.C., 242 F. Supp. 321. A reading of these cases reveals that they are distinguishable and furnish scant, if any, support for appellants' contention. We need not dwell on them for the reason that, assuming they support appellants' contention, we are convinced that they are contrary to sound reasoning, as well as the weight of authority. In this connection it is pertinent to note that appellants on brief state:

"The Appellants do not pretend that the issue of scienter as an element in an SEC injunction case is well settled. It has never been settled, to Appellants\' knowledge, at an appellate level."

In view of the plain language employed by Congress, it would be presumptuous on our part to hold that the applicability of the clauses involved is dependent on intent to defraud. Not only did Congress fail to include such a requirement, but legislative history indicates that it did so deliberately. An earlier version of the Securities Act of 1933 passed by the Senate³ would have required that the Commission prove wilfulness and "intent to defraud" even for an injunction. The House version contained no such requirement.⁴ In conference, the House version of Sec. 17(a) was adopted⁵ and became the law.

In describing the statute, Justice William O. Douglas, then a professor at Yale Law School and later chairman of the Commission, stated:

"Section 17 makes unlawful all schemes to defraud. Likewise it makes unlawful even innocent acts to obtain money or property by means of untrue statements of material facts or omissions to state material facts * *. Furthermore Section 20 gives the Commission power to investigate any violation of the Act and to obtain injunctive relief against such violations. So it is evident that a violation of Section 17 even though innocent would be grounds for such investigation or injunction."⁶

SEC, as did the District Court, relies heavily upon Securities and Exchange Commission v. Capital Gains Research Bureau, Inc., et al., 375 U.S. 180, 84 S. Ct. 275, 11 L.Ed.2d 237, in support of its contention that proof of scienter or intent to defraud was not required. In that case SEC...