United States v. Lilley, Crim. No. 67-H-233

• Decision Date: 02 October 1968
• Docket Number: 68-H-228.,Crim. No. 67-H-233
• Citation: 291 F. Supp. 989
• Parties: UNITED STATES of America v. Lester L. LILLEY. UNITED STATES of America v. Malcolm G. BAKER, Jr.
• Court: U.S. District Court — Southern District of Texas

291 F. Supp. 989

UNITED STATES of America v. Lester L. LILLEY.

UNITED STATES of America v. Malcolm G. BAKER, Jr.

Crim. Nos. 67-H-233, 68-H-228.

United States District Court S. D. Texas, Houston Division.

October 2, 1968.

U. S. Atty., Morton Susman, and Asst. U. S. Atty., Malcolm Dimmitt, for the United States.

Wayne Fisher, of Fisher, Roch, Sales & Blackstock, Houston, Tex., for Lester L. Lilley.

Walter P. Zivley of Liddell, Dawson, Sapp & Zivley, Houston, Tex., for Malcolm G. Baker, Jr.

MEMORANDUM OPINION:

NOEL, District Judge.

These are related cases arising out of the collapse of Westec Corporation in August 1966. Both defendants are charged with violations of SEC Rule 10b-5, which provides as follows:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of a national securities exchange,

(1) to employ any device, scheme or artifice to defraud,

(2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading or

(3) to engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5, prescribed by the Securities and Exchange Commission pursuant to § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b).

On December 9, 1967, defendant Lester L. Lilley pled guilty to a one-count indictment charging that he "directly and indirectly, wilfully and knowingly, did employ a manipulative and deceptive device and contrivance * * * in that he did employ a device, scheme, and artifice to defraud, did make untrue statements of material facts * * * and did engage in acts, practices and a course of business which did operate as a fraud and deceit upon various persons, including brokers, dealers, and stock-holders of Westec Corporation, all in the following manner:

"That from on or about May 1, 1966, until on or about August 25, 1966, he and others acting in concert with him purchased approximately 470,000 shares of the common capital stock of Westec Corporation from various brokerage companies in the State of Texas and elsewhere at prices ranging from $45.00 to $60.00 per share, while at substantially the same time, the defendant * * * and others acting in concert with him, sold and arranged for the sale of a substantial number of said shares of said Westec Corporation common capital stock."

It was further alleged in the indictment to which Lilley pled guilty, that the "series of transactions in Westec Corporation common capital stock described hereinabove would and did create a false and misleading appearance of actual and apparent active trading in such stock and did raise its price and did cause and induce other persons to purchase such stock, all of which was then and there well known to the defendant, Lester L. Lilley, and such acts were committed and caused to be committed by him for such purposes."

On August 27, 1968, defendant Malcolm G. Baker, Jr., pled guilty to a one-count criminal information likewise charging violation of SEC Rule 10b-5 in that "on or about May 11, 1966 Baker and others acting in concert with him purchased approximately 13,000 shares of the common capital stock of Westec Corporation * * * which said purchases were intended to, and did, artificially maintain the price of Westec stock and did support the market price of said stock and prevent it from declining and would and did create a false and misleading appearance of actual and apparent active trading in such stock * * * and said acts were committed and caused to be committed by him for such purposes."

By pleading guilty to the indictment and information, defendants admitted each and all of the acts charged in them, respectively. Subject to their motions to which this memorandum opinion is addressed, defendants are now before the Court for sentencing.

The penalty provision of the Securities Exchange Act of 1934 is 15 U.S.C. § 78ff(a), which provides:

Any person who willfully violates any provision of this chapter, or any rule or regulation thereunder the violation of which is made unlawful or the observance of which is required under the terms of this chapter, * * shall upon conviction be fined not more than $10,000, or imprisoned not more than two years, or both, * *; but no person shall¹ be subject to imprisonment under this section for the violation of any rule or regulation if he proves that he had no knowledge of such rule or regulation. (Emphasis added to "no knowledge" clause.)

Pursuant to the "no knowledge" clause or exception of § 78ff(a), each defendant has moved to have imprisonment excluded from the sentence which this Court may impose. An evidentiary hearing has been held, at which each defendant took the witness stand. The only evidence of probative force consisted of the testimony of defendants. Each defendant testified that he had no knowledge of Rule 10b-5 at the time he committed the admitted acts.

In ruling on these motions the Court first must construe the penalty statute to determine the meaning and purpose of the "no knowledge" clause or exception and its applicability, if any, to the charges and facts. If the clause is found applicable, it must then be determined as to each defendant whether he has discharged his burden of proof.

The clause or exception is unusual in that it permits a defendant to rebut the presumption that he had knowledge of the rule or regulation under which he is charged. The provision has never been construed, although it has been held constitutional in the face of vagueness attack.¹

The first step, indeed the most essential step, in the construction of any statute is to ascertain the intent of the Congress in passing it. Unfortunately, in the case of this "no knowledge" clause, the evidence of such intent is somewhat obscure. The clause was added in the conference committee formed to compromise the differences in the bills passed by the Senate and the House of Representatives, which ultimately became the Securities Exchange Act of 1934. The report of the conference committee announced but did not explain the compromise² between the House and Senate versions of Section 32 of the Act. From the research conducted by counsel, and its own independent research, the Court is persuaded that no minutes or other records of the conference committee's deliberations exist. But earlier debates in both House and Senate cast some light on the purpose of the clause, for they reveal the fears generated by the spectre of a severe penalty ensuing from violation of a rule or regulation of the proposed new administrative body, of which the person charged had no knowledge.

The bill approved by the House had a more stringent punishment provision than the compromise contained in § 78 ff(a). It did not distinguish violations of rules from violations of the Act. For either kind of violation an offender might be fined or imprisoned or both.³ Representative Cooper, a member of the House Committee on Interstate and Foreign Commerce which had considered the bill, offered an amendment that would have limited criminal punishment to violations of the Act itself. The amendment was defeated. The House rejected Representative Cooper's argument that an administrative board should not be granted the "unlimited power to draft rules and regulations the violation of which is a...