457 F. Supp. 682 (D.D.C. 1978)
National Student Marketing Corporation was incorporated in the District of Columbia in 1966. The company experienced rapid growth. Its common stock rose from an initial public offering price of $6 per share in spring 1968 to a high of $144 per share by mid-December 1969.1 Interstate National Corporation was a Nevada insurance holding company. Cameron Brown served as its president, chief executive officer, principal shareholder, and director. Its outside legal counsel was the Chicago firm Lord, Bissell & Brook, with partners Max E. Meyer and Louis F. Schauer handling the account.2
In 1969 NSMC approached Interstate about a possible merger. On June 10, 1969, NSMC representatives presented the proposal to Interstate's directors. This resulted in an agreement in principle under which NSMC would acquire Interstate in a stock-for-stock transaction at a ratio of two NSMC shares for every three Interstate shares, with an estimated value of $37 million.3
The final merger agreement executed in August 1969 required each company to deliver a comfort letter from its independent accountants and opinion letters from counsel as conditions precedent. It also contained representations that the financial statements were true and correct and prepared in accordance with generally accepted accounting principles.4 Proxy materials sent to Interstate shareholders incorporated NSMC's proxy statement, which included unaudited consolidated financial statements for the nine months ended May 31, 1969, showing a profit of approximately $700,000.5 Peat Marwick, NSMC's accountants, determined that adjustments of $500,000 to deferred costs, $300,000 write-off of unbilled receivables, and $84,000 to paid-in capital were required retroactive to May 31, 1969. The firm prepared a draft comfort letter reflecting those changes that would convert the reported profit into a net loss.6
The closing occurred on October 31, 1969, at the New York offices of White & Case. Around 2:15 p.m., an unsigned version of the comfort letter was dictated by Peat Marwick partner Anthony Natelli and delivered to the conference room. Interstate representatives Brown, Meyer, and Schauer reviewed it, questioned NSMC officers Randell and Joy about the adjustments, received oral assurances that year-end earnings would still meet projections, and after a private caucus decided to proceed with the closing to meet a 4 p.m. filing deadline rather than delay for resolicitation.7 The merger documents were exchanged, the articles of merger were filed, and the transaction was consummated. Immediately afterward, Interstate principals including Brown and Meyer sold 59,500 shares of the newly acquired NSMC stock through White Weld for gross proceeds of nearly $3 million.8
The signed comfort letter, containing additional paragraphs stating that the adjustments would produce a net loss of approximately $80,000 for the nine-month period and recommending resolicitation of shareholders, arrived at Interstate's offices on November 3, 1969.9 After discussion among the former Interstate principals and consultation with counsel, the group decided against any effort to undo the merger or disclose the letter's contents to shareholders or the public.10 In early 1970, after negative press reports, NSMC's stock price collapsed. Private lawsuits followed and the SEC commenced a wide-ranging investigation that led to this civil action seeking injunctive relief.11 Most original defendants consented to judgments or settled. The remaining defendants at trial were Lord, Bissell & Brook, Meyer, Schauer, and Brown.12 The case was tried without a jury before Judge Barrington D. Parker in the United States District Court for the District of Columbia.13
Whether Brown and Meyer violated the antifraud provisions of the federal securities laws by consummating the Interstate-NSMC merger without disclosing the material adjustments contained in the Peat Marwick comfort letter?14
The antifraud provisions of section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 promulgated thereunder, and section 17(a) of the Securities Act of 1933 prohibit the sale or purchase of any security through fraud or through the use of materially false or misleading statements or omissions, provided there exists a sufficient nexus to a sale of a security, the omitted or misrepresented fact is material under the objective reasonable-investor standard articulated in TSC Industries, Inc. v. Northway, Inc., and the defendant acts with scienter.15
Yes. The ESTABLISHED FACTS establish that Brown and Meyer received the unsigned comfort letter at the October 31, 1969 closing, which disclosed adjustments converting NSMC's reported nine-month profit of approximately $700,000 into a net loss of approximately $180,000, and they proceeded with the merger without disclosing this information to Interstate shareholders even though the adjustments would have assumed actual significance in the deliberations of a reasonable shareholder.16
Brown and Meyer violated the antifraud provisions by consummating the merger without the required disclosure of material information.17
Whether Brown and Meyer violated the antifraud provisions by selling NSMC stock acquired in the merger without first disclosing the comfort letter information to purchasers?18
The antifraud provisions of section 10(b), Rule 10b-5, and section 17(a) are violated when a defendant sells securities without disclosing material information received prior to the point of irrevocable commitment, provided the information meets the TSC Industries materiality standard and the defendant acts with scienter.19
Yes. The ESTABLISHED FACTS establish that Brown and Meyer received the unsigned comfort letter before the merger closing and the subsequent sale of 59,500 shares of NSMC stock for gross proceeds of nearly $3 million, yet they sold the shares without disclosing the adjustments that converted the reported profit into a net loss, and the commitment to sell remained conditional on consummation of the merger.20
Brown and Meyer violated the antifraud provisions by selling the NSMC stock without first disclosing the material comfort letter information.21
Whether the attorney defendants aided and abetted the violations by failing to delay the merger closing or to take other corrective action after receiving the unsigned comfort letter?22
Aider-and-abettor liability under the antifraud provisions requires proof that a primary violation occurred, that the alleged aider and abettor had general awareness that his role was part of an overall improper activity, and that he knowingly and substantially assisted the violation, which may be shown by inaction when the defendant had a duty to disclose.23
Yes. The ESTABLISHED FACTS establish that Meyer and Schauer of Lord, Bissell & Brook were present when the unsigned comfort letter was delivered at the closing, participated in the private caucus, and took no steps to delay the closing or require resolicitation of Interstate shareholders despite the obvious materiality of the adjustments and their fiduciary responsibilities to the corporate client.24
The attorney defendants aided and abetted the primary violations through their failure to act after receiving the unsigned comfort letter.25
Whether the Commission demonstrated a reasonable likelihood of future violations by the defendants so as to warrant permanent injunctive relief?26
Under section 21(e) of the Securities Exchange Act of 1934 and section 20(b) of the Securities Act of 1933, the Commission must make a proper showing of a reasonable likelihood of future violations; proof of past violations alone is insufficient and the court must examine the totality of circumstances including the isolated nature of the conduct, absence of prior or subsequent misconduct, and the professional obligations of the defendants.27
No. The ESTABLISHED FACTS establish that the violations occurred during an isolated incident at the October 31, 1969 closing, the defendants had engaged in no similar misconduct before or after that date, and the attorney defendants' professional responsibilities as officers of the court provide assurance that future conduct will conform to the law.28
The Commission did not demonstrate a reasonable likelihood of future violations, and therefore permanent injunctive relief is not warranted.29