FEINBERG, Circuit Judge:
This case raises the propriety of two orders of the District Court for the Southern District of New York entered at the instance of the Securities and Exchange Commission ("SEC"). One order granted a preliminary injunction restraining the three appellant corporations, inter alia, in the operation of their business as investment companies, and appointed Leslie Kirsch as receiver and trustee; the other authorized Mr. Kirsch to sell certain stock owned by one of the appellants. The ultimate issue before the court is whether the district court judge committed error in granting the equitable relief sought. Subject to a modification of the orders designed to give the corporations flexibility in dealing with a tax problem discussed below, the orders appealed from are affirmed.
The significance and propriety of the orders under attack are best assayed after a complete recital of the background and time table of the litigation to date. Appellants, defendants below, are S & P National Corporation ("S&P"), Smith-Palmer Machine Corporation ("Smith-Palmer"), and Southwest International Corporation ("Southwest"). Southwest is a wholly owned subsidiary of Smith-Palmer, and Smith-Palmer is a wholly owned subsidiary of S&P. Southwest and S&P are Delaware corporations; Smith-Palmer is an Illinois corporation. S&P, at the top of the corporate ladder, is a publicly owned corporation with approximately six hundred stockholders. Additional defendants, but not appellants, are David M. Milton and Ralph E. Still, both of whom have allegedly been intimately involved in the affairs of the corporations, as more fully set forth below.
On February 21, 1966, plaintiff SEC commenced an action praying for injunctive relief and the appointment of a receiver or trustee of the books, records and assets of the corporate defendants. The complaint alleged many long-continued and willful violations of the Investment Company Act of 1940 ("the 1940 Act"), 15 U.S.C. § 80a-1 et seq., and the Securities Exchange Act of 1934 ("the 1934 Act"), 15 U.S.C. § 78a et seq. The first three counts of the complaint aver that the corporate defendants have been investment companies for many years within the meaning of the 1940 Act, have failed to register under that Act, and have transacted business in violation of section 7 thereof, 15 U.S.C. § 80a-7.
In this action, by notice of motion, dated March 9, 1966 and returnable March 22, 1966, the SEC sought a preliminary injunction and appointment of a receiver. On March 11, 1966, while the
Prior to the adjourned return day of that motion, however, the corporations sought permission to sell 479,730 shares of stock of Great American Industries, Inc. ("GAI") owned by Southwest, the entity at the bottom of the corporate ladder. The shares are traded on the American Stock Exchange, and the market in the stock has been volatile. On January 31, 1966, the closing price of GAI was $2¾ per share; on February 28, 1966, $7 1/8 per share; and on March 30, 1966, $12 3/8 per share. Appellants' motion eventually came before Judge Murphy, who denied it on April 4, 1966, but advanced the return day of the SEC's motion from April 12 to April 8, 1966. A further hearing was held on April 6 at the request of appellants, who advised the court that they could not complete their papers in opposition to the SEC's motion until April 12. Accordingly, Judge Murphy reset the time of hearing on that motion for April 12. At the April 6 hearing, appellants also advised the court that a notice of annual meeting to the shareholders of S&P had been sent out, the meeting to be held in Dover, Delaware on April 12, 1966.
The meeting, indeed, took place on April 12, shortly before argument of the SEC motion for issuance of a preliminary injunction and appointment of a receiver. At the meeting, which was the first meeting of stockholders held in eleven years,
Although a welter of issues emerge from the record below, it is helpful to recall that the questions on appeal are whether the court below made erroneous findings of fact, misconstrued or misapplied the law, or abused its discretion in (1) granting the injunction; (2) appointing a receiver; and (3) rejecting the conditions sought by appellants on the sale of GAI stock.
Issuance of an injunction
The court below concluded that a prima facie case had been made that at least from 1957, the three corporate defendants were investment companies within the meaning of the 1940 Act. It is not disputed by appellants that the status of the three corporations is judged together because the lower two on the corporate ladder are each wholly owned by a parent. Section 3 of the 1940 Act defines an investment company and provides:
Judge Murphy found that for the fiscal years ending November 30, 1958 to and including November 30, 1962, Southwest had been engaged in the business of owning securities "having a value exceeding 40 per centum of the value of such issuer's total assets (exclusive of Government securities and cash items) on an unconsolidated basis." The actual percentages in those years, according to the record,
Appellants are correct, although barely so, that in 1963 and 1964 Southwest's securities did not exceed forty per cent of its assets. (The percentage dropped to 36.2 per cent in fiscal 1963 and 39.8 per cent in fiscal 1964.) This would be significant if appellants, although required to register in the five years prior to fiscal 1963, automatically changed their status due to the temporary drop in the value of their securities in the two later years. However, once registered, an investment company can "de-register" only upon an SEC finding that it has ceased to be an investment company and an SEC order which, for the protection of investors, "may be made upon appropriate conditions." 15 U.S.C. § 80a-8(f); cf. 15 U.S.C. § 80a-13(a) (4). The SEC urges that since an investment company long operating unlawfully should not be better off than one complying with the law, appellants did not lose this status with the drop in the market. The argument is persuasive but it is not necessary to lay down a broad general rule. Appellants were required to register for five years, dropped just under the forty per cent requirement in the two succeeding years, but went well over it again with the rise in the value of the GAI stock. Under the circumstances of this case, therefore, it is enough to hold that Judge Murphy was clearly justified in concluding that the forty per cent formula of section 3(a) (3), 15 U.S.C. § 80a-3(a) (3), was satisfied and that appellants were investment companies.
In effect, section 3(a) (3) creates a presumption that a company is an investment company, which is refuted if a company demonstrates that it falls within one of the exceptions of the 1940 Act for companies that are essentially industrial corporations but have over forty per cent of their assets in marketable securities. Kerr, The Inadvertent Investment Company: Section 3(a) (3) of the Investment Company Act, 12 Stan. L.Rev. 29, 46 (1959); see Bessemer Sec. Co., 13 S.E.C. 281 (1943). Appellants argue that they do fall within the exception provided by section 3(b) (1) of the 1940 Act, 15 U.S.C. § 80a-3(b) (1), which provides:
Appellants argue that from November 1956 to May 1963, Southwest was primarily engaged in phases of the real estate business through Wellit Corporation, a wholly-owned subsidiary. On the latter date, Wellit sold its assets and has since remained dormant. Judge Murphy pointed out that Wellit's assets were sold for only $200,000, which "represented but a small part of Southwest's total assets of nearly $2,500,000,"
Appellants did not seriously dispute below or in this court the occurrence of these transactions; they unsuccessfully argued primarily, as already indicated, that the transactions were not improper because the corporations were not investment companies. Appellants also relied on another exception contained in section 7 of the 1940 Act, 15 U.S.C. § 80a-7, which, after prohibiting unregistered investment companies from engaging in certain transactions, specifically states that:
Appellants claim that their activities since 1956 have all been steps incidental to their dissolution. While the court below did not expressly deal with this contention, its rejection implicit in the finding that appellants violated the 1940 Act was clearly justified on the record before it. It stretches credulity to suggest that "transactions * * * which are merely incidental to * * * dissolution" could have stretched over eleven years especially when at no time did S&P disclose any intention to liquidate either to its shareholders or in its periodic reports to the SEC. While there is no doubt that appellants ardently desire dissolution now and may have temporarily been interested in dissolution in 1956, the findings of the court below were based upon status and transactions since 1956, and were justified on the record before it.
We therefore conclude that the record below amply supports the district court's preliminary determination that appellant corporations never registered as investment companies, engaged in transactions improper under section 7 of the 1940 Act for unregistered investment companies, and were, in fact, investment companies. Therefore, the court's conclusion that the corporations had violated the 1940 Act and were threatening to continue to do so was, on the record before it, correct. This of itself would have justified the entry of a preliminary injunction below. Thus, section 42(e) of the 1940 Act, 15 U.S.C. § 80a-41(e), provides in part:
See SEC v. Keller Corp., 323 F.2d 397 (7th Cir. 1963); SEC v. Fiscal Fund, Inc., 48 F.Supp. 712, 714 (D.Del.1943).
As to this charge by the SEC, it is undisputed that S&P was required to file Form 10-K reports pursuant to section 15(d) of the 1934 Act and has shown marked reluctance in the past to make such filings.
The court below characterized this record as "far from conclusive" but nevertheless "sufficient * * * to at least create a strong prima facie case" for the SEC.
In addition to disputing the findings as to Milton's control and abandonment by the named directors, appellants argue that factual issues with respect to control have been presented which must initially be determined by the SEC under section 2(a) (9) of the 1940 Act, 15
In other words, appellants argue that the SEC has primary jurisdiction to determine whether Milton "controlled" S&P which must be exercised before the court can do so, citing such cases as Great No. Ry. v. Merchants Elevator Co., 259 U.S. 285, 42 S.Ct. 477, 66 L.Ed. 943 (1922), and Far East Conference v. United States, 342 U.S. 570, 72 S.Ct. 492, 96 L.Ed. 576 (1952). These decisions did indicate that a court should defer in certain circumstances to the primary jurisdiction of an administrative agency on disputed questions of fact whose determination has been left to that agency. However, appellants' argument is misplaced. In finding "control" by Milton and, therefore, false and misleading reports, the court below was dealing with the 1934 Act, which requires periodic reports. Rule 12b-2 issued under the 1934 Act defines "control" as "the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." This definition contains no provision for a primary SEC determination of this issue. Moreover, even if the definition of the 1940 Act were applicable, the SEC itself has decided that the type of issue before the court below does not have to be decided first by the SEC if a prima facie case for relief can be made out in the court. See Fundamental Investors, Inc., Investment Company Act Release No. 3596 (1962); cf. Goldstein v. Groesbeck, 142 F.2d 422, 154 A.L.R. 1285 (2d Cir.), cert. denied, 323 U.S. 737, 65 S.Ct. 36, 89 L.Ed. 590 (1944).
Thus, an examination of the record and proceedings below discloses that on the issue of the propriety of the preliminary injunction, the court's findings of fact were not clearly erroneous, its application of the law was correct, and it did not abuse its discretion. Appellants argue that the injunction is too broad and should have been confined to preventing future violations of the 1940 Act. However, appellants have pointed out that the only real business of the corporations in the last few years has been the ownership of securities.
Appointment of a receiver
The sequence of events leading up to the appointment of a receiver is set forth in great detail above.
While the 1934 Act does not contain a similar explicit provision for appointment of a trustee or receiver, "there is little reason to doubt that equitable power to do so exists." See Lankenau v. Coggeshall & Hicks, 350 F.2d 61, 63 (2d Cir. 1965). However, appellants vigorously urge that, in any event, the district judge abused his discretion in appointing a receiver in this case.
In assessing the exercise by the court below of its discretion, the following factors should be considered: the long continued violations of both the 1934 and 1940 Acts prima facie established in the record; the lack of a shareholders' meeting for eleven years with the sudden emergence of new officers and directors on the very day of argument on the SEC's motion for a receiver; the two hasty attempts to dissolve the corporations after the SEC filed its suit in the court below (one by an interested stockholder in the state courts in Delaware, and the other by the insistent request of appellants to the court below that they be allowed to call a special meeting to adopt plans leading to dissolution); the connection between at least one and possibly more of the present officers and directors and those who have controlled the corporations over the past eleven years; the prior abandonment for all practical purposes of at least the publicly held corporation by those represented to be its directors; the three year lapse from 1962 to 1965 in the filing by S&P of any of its Form 10-K reports; the fact that the corporations for all practical purposes are not conducting any substantial business now except for the holding of securities; the possibility that dissolution might release liabilities for past violations of the 1940 Act; and the need to get correct information as quickly as possible to public stockholders of S&P not affiliated with the management group.
While we do not think that appointment of receivers should follow requests by the SEC as a matter of course, we cannot say that the trial judge was unjustified in concluding that prior violations of the 1940 Act, false reports under the 1934 Act, and the absence of corporate management were sufficient reason for the appointment of a receiver. Lankenau v. Coggeshall & Hicks, supra; Esbitt v. Dutch-American Mercantile Corp., 335 F.2d 141 (2d Cir. 1964); SEC v. Keller Corp., 323 F.2d 397 (7th Cir. 1963); Los Angeles Trust Deed & Mortgage Exch. v. SEC, 285 F.2d 162 (9th Cir. 1960), cert. denied, 366 U.S. 919, 81 S.Ct. 1095, 6 L.Ed.2d 241 (1961); SEC v. Fiscal Fund, Inc., 48 F.Supp. 712, 714 (D.Del.1943). If the only purpose of the receivership were to bring about a quick liquidation, we might feel otherwise; see Lankenau, supra; Los Angeles Trust, supra. But the primary purpose of the appointment was promptly to install a responsible officer of the court
Conditions surrounding the sale of GAI stock
Appellants do not object to the sale of the GAI stock because it is obviously in the best interests of all concerned that the high market price be obtained before it may disappear.
Appellants argue with conviction that unless proper steps are taken, large sums in unnecessary taxes may have to be paid. Without meaning to pass in any way on the accuracy of appellants' statements of the underlying facts or of the feasibility of their tax proposal based on these facts, we recite briefly appellants' argument that a tax saving can be effected: Appellants claim that the basis of the GAI stock in the hands of Southwest is low in comparison with its current fair market value, so that there would be a substantial gain realized on any sale. If Southwest sells this stock, it will have to pay a capital gains tax on the difference between its basis and the net profits of sale. If Southwest and then Smith-Palmer liquidate under section 332(a) of the Internal Revenue Code, there would be no additional tax on these liquidations into S&P. On the subsequent liquidation of S&P, however, its stockholders would presumably realize a capital gain on the difference between their basis for the S&P stock and the value of money and other property distributed to them in liquidation of S&P. In short, appellants raise the specter of two capital gains taxes, one at the corporate level due from Southwest, and one at the stockholder level payable by the S&P stockholders. Appellants urge that if Southwest distributes the GAI stock immediately (rather than the proceeds of its sale) to Smith-Palmer, and Smith-Palmer distributes the same stock to S&P in complete liquidation, these liquidations would remain tax-free under section 332 (a) of the Internal Revenue Code. Next, S&P, then owning the stock, could adopt a plan of complete liquidation under section 337 of the Internal Revenue Code and thereafter itself sell the GAI stock. If this course is followed, appellants predict that no gain or loss would be recognized to S&P on the sale, although its stockholders would still pay a capital gains tax on the liquidation of S&P. According to appellants, the one capital gains tax their proposal purports to eliminate may amount to as much as $1 million.
The trustee has stated that he too would desire legitimately to avoid taxes. However, he pointed out to the court below that the nature of the market is such that any delay — even a two-week delay required for the calling of corporate meetings to adopt plans of liquidation — could be fatal. Appellants rejoin that they are not attempting to prevent sale of GAI stock in the meantime, but would like to see the benefits of liquidations preserved for any stock that may still be unsold
The SEC has noted that there may be substantial causes of action available to the corporations or their stockholders as a result of transactions entered into over the past years while appellant corporations were unregistered investment companies.
The issue raised of effecting a tax saving is a serious one and may involve a substantial sum of money, although, according to the trustee's statement in court, a considerable portion of the GAI stock has already been sold. On the other hand, the concern of the SEC that the public shareholders of S&P would be asked to proceed in the dark in adopting far reaching resolutions with possible conclusive legal effect is understandable. It seems to us that the parties below should be given an opportunity to resolve the matter with preservation to each of their essential interests. Accordingly, appellants' plea in this court that they at least be allowed to set in operation the procedural steps for holding special corporate meetings at some time in the future to adopt plans of liquidation should be granted, although the proposed resolutions and accompanying statements
Appellants raised other issues in the pleadings and papers below which they did not press with fervor; e. g., that the SEC was guilty of laches;