United States v. Hill

• Decision Date: 09 April 1969
• Docket Number: Crim. No. 12396.
• Parties: UNITED STATES of America, Plaintiff, v. David L. HILL, Defendant.
• Court: U.S. District Court — District of Connecticut

298 F. Supp. 1221

UNITED STATES of America, Plaintiff, v. David L. HILL, Defendant.

Crim. No. 12396.

United States District Court D. Connecticut.

April 9, 1969.

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COPYRIGHT MATERIAL OMITTED

Jon O. Newman, U. S. Atty., Hartford, Conn., Willis H. Riccio, S.E.C., Boston, Mass., for plaintiff.

Charles G. Albom, New Haven, Conn., for defendant.

MEMORANDUM OF DECISION

CLARIE, District Judge.

Upon application of the United States Attorney and the Securities & Exchange Commission (SEC), the defendant, Dr. David L. Hill, has been summoned before this Court to show cause why he should not be held in criminal contempt of this Court's permanent injunction of July 17, 1967. The Government alleges that since the entry of the injunction, the defendant Hill has undertaken actions which violate §§ 5 and 17(a) of the Securities Act of 1933 and the injunction; it now seeks a contempt judgment and an order for appropriate remedies. The Court finds that the defendant is in contempt of Court, in that he did violate the terms of the injunction by selling securities which were required to be registered under § 5 of the Act and by omitting to state necessary material facts as required by § 17(a) when he sold said securities.

On June 28, 1967, the SEC applied to the Court for injunctive relief against Southport Instruments, Inc. and Hill alleging that they had violated § 5(a) and (c) (the unlawful sale of unregistered stock) and § 17(a) (the fraud provisions) of the Securities Act of 1933, 15 U.S.C. §§ 77e(a), (c), 77q(a). An injunction order was stipulated and consented to by the parties on July 17, 1967 and a copy was served on Hill on July 19, 1967.¹ Basically, paragraphs a, b, and c of the injunction closely track the statutory language and prohibit the defendants from directly or indirectly violating § 5(a) and (c) of the Act with respect to the securities of Southport or "any other securities." The injunction does not "apply to any security exempt from the provisions of § 5." This preserves to the defendants the "exempted securities" provisions of § 3 of the Act; the parties have also treated it as preserving the "exempted transactions" provisions of § 4. Paragraph d of the injunction applies to the sale of Southport common stock and "any other securities" and closely tracks § 17(a), embodying the full reach of § 17(a), but also barring certain enumerated practices.

Before examining each claimed violation of the injunction, the general factual setting must be presented. The enterprises involved here were formed in 1960 to engage in activities related to nuclear instrumentation and computers. Since 1962, Hill has conducted his operations primarily through two corporations; namely, Southport which changed its name to Nanosecond Systems, Inc. in 1967 (referred to hereafter as Nanosecond) and Particle Measurements, Inc. (PMI), the parent of Nanosecond.

Hill founded Nanosecond and has been its controlling stockholder since inception. He has maintained this control in part through Bonnybrook Charitable Trust, a Nassau Trust, in which he holds a substantial interest. Bonnybrook was formed by Hill for the benefit of his family and he exercises control over it. During the period under consideration, Hill and Bonnybrook controlled, directly or indirectly through PMI, 79.2% of the outstanding shares of Nanosecond. (final prospectus, pp. 5, 25).

Nanosecond has been engaged primarily in research and development of new products and has incurred substantial losses since its inception. Consequently, there has been an almost constant need for outside funds. At the time of the 1967 injunction Nanosecond was in the process of preparing a registration statement under the Act to cover the sale of common stock. The registration statement was filed with the SEC on August 28, 1967. At that time, he had expected it to become effective within about two months. However, Nanosecond's filing went through six amendments, several involving substantial rewrites, and did not become effective until over 16 months later, on December 30, 1968.

It is Hill's actions in sustaining the Company through this registration period which form the basis for the current action. Through a series of complex moves in 1965, PMI became a parent of Nanosecond, holding as of September 30, 1968, 885,999 shares constituting 70% of the stock. Hill and Bonnybrook own 93.3% of the outstanding PMI common stock. To finance the companies, PMI sold $895,900 worth of short-term notes to various individuals between July 1967 and October 1968. These were 6-month subordinated notes, bearing interest at 6%. Beginning at least as early as October 1967, and applied retroactively to the notes then outstanding, PMI also issued with each note a right to apply the principal amount of the note to the purchase of Nanosecond common stock within 25 days of the effective date of the Nanosecond registration statement at varying prices of $5, $8, or $10. Nanosecond disclosed in its December 30, 1968 prospectus that 122,500 shares had been reserved to cover these rights. It is the sale of the PMI notes and rights which is challenged here.

Section 5 Violations

At the outset the Court notes that the scope of paragraphs a, b, and c of the injunction is coterminous with § 5(a) and (c) of the Act and that a violation of these subsections constitutes a violation of the injunction. Given this fact, in order to avoid confusion, this Opinion will analyze the issues in terms of a violation of § 5.

Hill has advanced a number of claims to support his position that there were no § 5 violations in the sale of the PMI notes. He claims that the notes and perhaps the conversion rights are exempt under § 3(a) (3) of the Act, 15 U.S.C. § 77c(a) (3), as short-term notes; that the conversion rights are exempt under §§ 5(a) and 5(c) which permit an issuer to offer to sell securities after a registration statement has been filed but requires that it postpone the final sale and delivery until after the registration statement has become effective; and that the entire offering of notes is exempt under § 4(2), 15 U.S.C. § 77d(2), as a private placement not constituting a public offering.

Initially, to violate § 5, it is required that the offeror "make use of any means or instruments of transportation or communication in interstate commerce or of the mails." Hill cannot persuasively contend that the requisite interstate activity has not been shown. The evidence revealed sales in at least 10 states and one foreign country (PX-V); there is an admitted telephone call between Hill in Connecticut and Traub, a note purchaser, in Massachusetts; there is also evidence of an envelope which contained a Nanosecond prospectus mailed to Glueck, another purchaser (PX-EE).

3(a) (3) Exemption

Hill's first claim is that he is entitled to an exemption under § 3(a) (3) which states, that except as expressly provided, the Act shall not apply to:

Any note, draft, bill of exchange, or banker's acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.

Before determining whether the 3(a) (3) exemption is available, the first analytical problem is whether the note and the conversion right received by the investors should be deemed as one security or two separate instruments. An examination of these instruments indicates that they represent a single security. By its terms the conversion right was tied to the note because the right to convert was exercisable only by the noteholder of record. The conversion right would thus not have been separately negotiable. With this interpretation, there is no possible basis for claiming that the security issued, a convertible note, was exempt under § 3(a) (3). However, even assuming that Hill issued two separate instruments to the investors, it is clear that the notes do not qualify for the § 3(a) (3) exemption.

There has been little administrative or judicial construction of the scope of the 3(a) (3) exemption. The legislative history indicates that both the House and Senate Committees intended to exempt commercial paper which was not generally sold to the public or advertised for public sale. In addition the House Report emphasized that exempted paper would be of the type "available for discount at a Federal Reserve Bank." Securities Act Release No. 4412 (1961). The SEC has also taken the position that the paper must be eligible for discount at a Federal Reserve Bank to qualify under 3(a) (3). It has also stressed that the assets covering such paper must be easily convertible into cash and comparable to liquid inventories of an industrial company. Securities Act Release No. 4412 (1961). It is clearly evident here that in no way can the PMI notes in issue be deemed within the 3(a) (3) exemption. These notes were offered and sold solely to members of the public. They were highly speculative and bore no resemblance to the high grade paper issued or accepted by finance houses. Perhaps most importantly, neither PMI nor Nanosecond had assets easily convertible into cash to support these notes. In fact during the period in question, the only way PMI could repay its outstanding notes was through the sale of additional notes. The 3(a) (3) exemption was not intended, and does not extend, to cover financing by an insolvent company in its speculative attempt to launch an enterprise. This is precisely the kind of financing for which Congress considered it necessary that a company complete the registration requirements of Act.

An Offer Permissible under 5(a) and 5(c).

Defendant advanced the position that the conversion rights to purchase Nanosecond stock after the registration became effective, were permitted under §§ 5(a) and 5(c). The Court...