15.

Application to Enforce Administrative Subpoenas Duces Tecum of S.E.C. v. Knowles, 87 F.3d 413 (10th Cir.(Colo.), Jun 20, 1996) (NO. 95-1425)

 

United States Court of Appeals,

Tenth Circuit.

 

In the Matter of an APPLICATION TO ENFORCE ADMINISTRATIVE SUBPOENAS DUCES TECUM

OF the SECURITIES AND EXCHANGE COMMISSION, Applicant-Appellee,

v.

Gaye B. KNOWLES, Respondent-Appellant.

 

No. 95-1425.

 

June 20, 1996.

 

 

 Securities and Exchange Commission (SEC) filed ex parte application for order to show cause and application for order compelling former president of Bahamian companies to comply with administrative subpoenas duces tecum.   The United States District Court for the District of Colorado, Lewis T. Babcock, J., 902 F.Supp. 211, ordered respondent to comply, and he appealed.   The Court of Appeals, Murphy, Circuit Judge, held that district court had personal jurisdiction to enforce subpoena.

 

 Affirmed.

 

 

West Headnotes

 

[2] Witnesses 306

410k306 Most Cited Cases

 

Corporation possesses no right to exercise privilege against self- incrimination.  U.S.C.A. Const.Amend. 5.

 

[3] Witnesses 298

410k298 Most Cited Cases

 

Corporate officer cannot refuse to produce corporate documents on ground of self-incrimination.  U.S.C.A. Const.Amend. 5.

 

[4] Securities Regulation 86

349Bk86 Most Cited Cases

 

Securities and Exchange Commission (SEC) has power to require production of documents stored outside territorial boundaries of United States.

***********************************************************************************

*414 Raymond L. Robin, Olle, Macaulay & Zorrilla, Miami, Florida,  (David W. Stark, Amy J. Griffin, Otten, Johnson, Robinson, Neff & Ragonetti, P.C., Denver, Colorado, with him on the briefs), for Respondent- Appellant.

 

 Robert M. Fusfeld, Securities and Exchange Commission, Denver, Colorado,  (Simon M. Lorne, General Counsel, Jacob H. Stillman, Associate General Counsel, Katharine B. Gresham, Assistant General Counsel, Catherine A. Broderick, Counsel to the Assistant General Counsel, Securities and Exchange Commission, Washington, D.C., Paul Gonson, Solicitor, of Counsel, on the brief), for Applicant-Appellee.

 

 

 Before SEYMOUR, BRORBY, and MURPHY, Circuit Judges.

 

 

 

 MURPHY, Circuit Judge.

 

 This case arises out of the enforcement by the district court against the appellant, a foreign national, of two administrative subpoenas duces tecum issued by the Securities and Exchange Commission.   The appellant argues that the district court lacked personal jurisdiction to enforce the subpoenas.   The district court held that it did not need personal jurisdiction over the appellant to do so.

 

 The question presented is whether the appellant has the requisite minimum contacts to justify the district court's exercise of personal jurisdiction over him.   This court holds that he does and that the district court properly enforced the subpoenas.

 

I. BACKGROUND AND PROCEDURAL SETTING

 

 On June 14, 1995, and again on June 30, 1995, the Securities and Exchange Commission (the "SEC") issued administrative subpoenas duces tecum in the name of the appellant, Gaye B. Knowles.   The SEC served Knowles with the first subpoena by hand at LaGuardia Airport in New York City. It later served the second on Knowles's counsel in Miami, Florida.   These subpoenas were issued in connection with the Formal Order of Investigation in the nonpublic investigation conducted by the SEC out of its Denver, Colorado, office, In the Matter of the Rockies Fund, Inc., Redwood Microcap Fund, Inc., and Combined Penny Stock Fund, Inc., et al. [FN1]  The SEC issued these subpoenas pursuant to its authority under 15 U.S.C. § §  77s(b), 78u(b), and 80a- 41(b).

 

 

FN1. The Formal Order of Investigation is not a part of the record in this case;  the SEC claims that it is a nonpublic document.   The Formal Order was available to the district court for in camera inspection, but its scope and contents are in no way related to the issues here on appeal.

 

 

 Knowles is presently a Bahamian citizen and resident and has been so since 1951.   He is an independent investment consultant and, at the times the subpoenas were served on *415 him, was also the president of two Bahamian companies, Global Petrol Trading and Swiss EuroFund, Inc. [FN2] In the investigation, the SEC sought to determine whether bank accounts in the names of these two companies were used to bribe brokers in the United States to sell certain stock of American companies in violation of federal securities laws. The first subpoena directed Knowles to appear at a deposition and to produce certain personal documents and documents relating to the bank accounts of Global Petrol Trading.   The second subpoena directed the same and called for Knowles to produce documents relating to the bank accounts of Swiss EuroFund, Inc.

 

 

FN2. Since that time, Knowles has been advised that his employment with Global Petrol Trading and Swiss EuroFund, Inc., has been terminated.

 

 

 In response to the subpoenas,Knowles appeared for deposition in Miami, Florida, on July 12, 1995.   Knowles produced certain corporate documents pursuant to the subpoenas but objected to producing monthly banking statements and other banking documents of the two companies.   In order to enforce the subpoenas, the SEC applied to the district court in the judicial district where it is conducting the investigation, as authorized in 15 U.S.C. § §  77v(b), 78u(c), and 80a-41(c).

 

 The SEC filed an Ex Parte Application for an Order to Show Cause and Application for an Order Compelling Compliance with Administrative Subpoenas Duces Tecum.   The United States District Court for the District of Colorado subsequently issued an Order to Show Cause.   Thereafter, the SEC served Knowles with the Order to Show Cause outside his home in Nassau, Bahamas. Knowles responded to the Order to Show Cause and moved the district court to dismiss the SEC's application for lack of personal jurisdiction over him.

 

 In an Amended Memorandum Order and Opinion, the district court held that it did not need personal jurisdiction over Knowles in order to enforce the subpoenas against him.   It held, instead, that judicial enforcement of an administrative subpoena may be had where the agency can show that:  (1) the inquiry is conducted pursuant to a lawfully authorized, legitimate purpose; (2) it is reasonably relevant to an investigation which the agency has authority to conduct;  and (3) all administrative prerequisites have been met. See United States v. Powell, 379 U.S. 48, 57-58, 85 S.Ct. 248, 254-55, 13 L.Ed.2d 112 (1964);  SEC v. Blackfoot Bituminous, Inc., 622 F.2d 512, 514 (10th Cir.), cert. denied, 449 U.S. 955, 101 S.Ct. 362, 66 L.Ed.2d 220 (1980).   The district court determined that the SEC met this three-pronged burden and that Knowles had adduced no evidence to the contrary.   It therefore ordered Knowles to comply with the subpoenas within ten days.   This court subsequently granted Knowles's Motion to Stay the Amended Memorandum Order and Opinion pending appeal.   This appeal followed.

 

 On appeal, Knowles argues that the district court erred when it determined it did not need personal jurisdiction over him in order to enforce the subpoenas. He also argues that the district court could not properly exercise jurisdiction over him because of his lack of personal contacts with the United States.   In response, the SEC maintains that the district court had personal jurisdiction over Knowles based upon sufficient minimum contacts with the United States in relation to:  (1) the subpoenas;  (2) the matters under investigation by the SEC;  and (3) his general business.   In the alternative, the SEC argues that the minimum contacts analysis is not required because the district court had personal jurisdiction over Knowles based upon the SEC's service of the subpoenas on Knowles within the territorial limits of the United States.   The SEC does not argue that personal jurisdiction is not required in order to enforce the subpoenas, as the district court held.

 

II. JURISDICTION

 

 [1] This court has jurisdiction to review the Amended Memorandum Order and Opinion under 28 U.S.C. §  1291.   The district court's ruling on personal jurisdiction involves a question of law that is reviewed de novo.  Taylor v. Phelan, 912 F.2d 429, 431 (10th Cir.1990), cert. denied, 498 U.S. 1068, 111 S.Ct. 786, 112 L.Ed.2d 849 (1991).

 

 *416 [2][3][4] The issue here is a narrow one:  whether the district court had personal jurisdiction over Knowles to enforce the administrative subpoenas duces tecum.   The court notes at the outset that Knowles does not contend the SEC lacked the authority to issue the subpoenas under the tripartite test set out in Powell and Blackfoot.   He does not challenge the methods or places of service of process employed in serving either the subpoenas or the Order to Show Cause.   Moreover, Knowles does not seriously contend that he lacked capacity to produce corporate records in his possession or that the SEC could only secure production of the documents through service of subpoenas on Knowles's former corporate employers. [FN3] Therefore, we do not address these issues and limit this opinion to the question of the jurisdiction of the district court, based upon the extraterritorial service of the Order to Show Cause, to enforce the SEC's subpoenas duces tecum against Knowles. [FN4]

 

 

FN3. Over the course of this enforcement action, Knowles has hinted at possible problems or objections he may have with the scope of the subpoenas.   For instance, at his deposition, Knowles conceded that some of the documents requested in the subpoenas were in his possession, control, and custody and would be found at his residence, which also functioned as his office.   But Knowles has also noted that since he was terminated as president, he has been instructed to return all the documents belonging to Global Petrol Trading and Swiss EuroFund, Inc. Furthermore, Knowles's counsel stated at Knowles's deposition that the objection to the request for corporate documents was based on the fact that these were "private documents in a corporation."   He explained the subpoenas reflected that the corporations were not under investigation and that he thus believed the corporations were "outside the scope of the subpoena[s] issued by the SEC to compel documents from a Bahamian bank."   He therefore asserted a general privacy interest in "proprietary private information."   Knowles also indicated that he chose not to produce the requested documents because he was not a signatory on the bank accounts requested in the subpoenas and thus had no control over them.

Knowles, however, indicated in his testimony that some of the subpoenaed banking documents of which he was not the signatory were in his possession.   He did not produce these documents.   In his appellate filings before this court, Knowles does not elaborate on either the documents that are still in his possession or the "privilege" asserted in his deposition colloquy.   Instead, Knowles only employs the alleged differences between his personal capacity and the corporate capacities of both Global Petrol Trading and Swiss EuroFund, Inc., in order to make the argument that the corporate contacts are not his own personal contacts. We discuss this issue below.

Furthermore, the district court did not address the issue of what Knowles must produce or his general claims of corporate "privilege."   Although Knowles's "privilege" arguments are somewhat oblique, as we discern them they fail.   We note that a corporation possesses no right to exercise a privilege against self-incrimination and that a corporate officer cannot refuse to produce corporate documents on the ground of self- incrimination.  United States v. Rice, 52 F.3d 843, 846 (10th Cir.1995);  United States v. Hansen Niederhauser Co., 522 F.2d 1037, 1039 (10th Cir.1975).   To the extent that Knowles asserts that the SEC lacks the power to require production of documents stored outside the territorial boundaries of the United States, this issue has also been decided against his position.  Commodity Futures Trading Comm'n v. Nahas, 738 F.2d 487, 492 & n. 11 (D.C.Cir.1984) (citing cases).

 

FN4. Nor do we consider the issue of whether the district court acquired personal jurisdiction over Knowles as a result of his attendance at the scheduled deposition pursuant to the subpoenas.   The SEC does not contend that Knowles's attendance and production of some responsive documents waived his objections to the personal jurisdiction of the district court to enforce the subpoenas.   Therefore, this court will not address the issue of waiver.

***********************************************************************************

 

United States Court of Appeals,

Second Circuit.

 

D.L. CROMWELL INVESTMENTS, INC., Lloyd Bierne, David S. Davidson, Eric S.

Thomas, and Matthew Greenwald, Plaintiffs-Appellants,

v.

NASD REGULATION, INC., Defendants-Appellees.

 

Docket No. 01-7301.

 

Argued Sept. 19, 2001.

Decided Feb. 1, 2002.

 

 

 Securities brokerage firm, and individual brokers, sued investigative arm of National Association of Securities Dealers (NASD), seeking injunction barring NASD from compelling their testimony as part of civil securities fraud investigation. The United States District Court for the Southern District of New York, 132 F.Supp.2d 248, Kaplan, J., denied injunction, and firm and brokers appealed. The Court of Appeals, Jacobs, Circuit Judge, held that: (1) District Court did not abuse its discretion in consolidating trial on merits with hearing on preliminary injunction, and (2) NASD investigative unit was not acting as agent of federal government when it required brokers to provide evidence, precluding assertion of privilege against self-incrimination, regardless of pending parallel criminal investigation.

 

 Affirmed.

 

 

West Headnotes

 

[1] Federal Courts 813

170Bk813 Most Cited Cases

 

Court of Appeals reviews for abuse of discretion district court's decision to consolidate hearing for preliminary injunction with trial on the merits. Fed.Rules Civ.Proc.Rule 65(a)(2), 28 U.S.C.A.

 

[2] Injunction 151

212k151 Most Cited Cases

 

In securities brokers' action challenging National Association of Securities Dealers' (NASD) compelling of brokers' testimony as part of civil securities fraud investigation, on grounds that compulsion violated brokers' privilege against self-incrimination given pending parallel criminal prosecution, district court did not abuse its discretion in consolidating trial on merits with hearing on brokers' motion for preliminary injunction;  brokers themselves had argued that question was urgent and could not be deferred, since they would be forced to choose between foregoing privilege or exposing themselves to NASD sanctions, and brokers had sufficient notice of consolidation since court had announced six days before hearing that main issue at hearing would be question of NASD's state action, upon which entire claim hinged.  U.S.C.A. Const.Amend. 5;  Fed.Rules Civ.Proc.Rule 65(a)(2), 28 U.S.C.A.

 

[3] Injunction 151

212k151 Most Cited Cases

 

To show prejudice from district court's consolidation of trial on merits with hearing on preliminary injunction, objecting party must point to some relevant evidence that it was prevented from presenting because of consolidation. Fed.Rules Civ.Proc.Rule 65(a)(2), 28 U.S.C.A.

 

[4] Constitutional Law 82(5)

92k82(5) Most Cited Cases

 

To establish Fifth Amendment violation, plaintiff must demonstrate that in denying plaintiff's constitutional rights, defendant's conduct constituted state action.  U.S.C.A. Const.Amend. 5.

 

[5] Constitutional Law 82(5)

92k82(5) Most Cited Cases

 

Private entity's actions are fairly attributable to government, for purposes of Fifth Amendment state action requirement, where there is sufficiently close nexus between state and challenged action, i.e. where: (1) state has exercised coercive power over private decision or has provided such significant encouragement, either overt or covert, that choice must in law be deemed to be that of state, or (2) private entity has exercised powers that are traditionally exclusive prerogative of state.  U.S.C.A. Const.Amend. 5.

 

[6] Criminal Law 393(1)

110k393(1) Most Cited Cases

 

[6] Securities Regulation 40.15

349Bk40.15 Most Cited Cases

 

Investigative unit of National Association of Securities Dealers, Inc.(NASD) was not acting as agent of federal government when it required securities brokers to provide evidence for civil securities fraud investigation, precluding assertion by brokers of their Fifth Amendment privilege against self-incrimination, regardless of pending parallel criminal investigation; despite similar evidentiary trails pursued by civil and criminal investigations, there was no direct evidence of government involvement in NASD investigation, and actions of investigative unit's subunit organized to assist in criminal investigations could not automatically be imputed to unit as a whole.  U.S.C.A. Const.Amend. 5.

 *156 Martin P. Russo, Peekskill, NY, for plaintiffs-appellants.

 

 Terri L. Reicher, Associate General Counsel, National Association of Securities Dealers, Inc., Washington, DC, John J. Flood, on the brief, for defendants-appellees.

 

 

 Before MESKILL, JACOBS, and CABRANES, Circuit Judges.

 

 

 

 JACOBS, Circuit Judge.

 

 Plaintiffs-appellants D.L. Cromwell Investments, Inc. ("Cromwell") and individual Cromwell employees, all members of the National Association of Securities Dealers, Inc. ("NASD"), have been the subject of ongoing investigations both by NASD Regulation, Inc. ("Regulation"), which is an investigatory arm of the NASD, and by federal prosecutors.  They have sued to enjoin NASD Regulation from compelling them--under threat of sanctions authorized by NASD Rule 8210--to submit to on-the-record interviews, arguing that NASD Regulation is a willing tool of the prosecutors and that the compelled interviews *157 would therefore violate their Fifth Amendment privilege against self-incrimination.

 

 They appeal from the judgment of the United States District Court for the Southern District of New York (Kaplan, J.), rejecting the claim on the finding that Regulation was not a state actor subject to constitutional restraint, but was rather a private party conducting a private investigation.  The preliminary injunction hearing was consolidated with the trial on the merits (over Cromwell's objection) after the district court heard testimony from witnesses for both Cromwell and NASD, and before the rendering of the decision.

 

 On appeal, appellants argue essentially:  (1) that they were prejudiced by the consolidation because in so doing the court denied their request for a necessary two-week delay to pursue discovery, and erroneously employed the merits-based "preponderance of the evidence" standard of proof rather than the less onerous "serious questions" standard available in preliminary injunction proceedings;  and (2) that the district court erroneously held that because Regulation is not a state actor, it cannot be subject to the Fifth Amendment restraint.

 

I

 

 Regulation is the regulatory arm of the NASD, a private, not-for-profit, self- regulatory organization registered with the Securities and Exchange Commission ("SEC"), of which appellants are members.  Regulation is responsible for "conducting investigations and commencing disciplinary proceedings against [NASD] member firms and their associated member representatives relating to compliance with the federal securities laws and regulations."  Datek Securities Corp. v. National Ass'n of Securities Dealers, Inc., 875 F.Supp. 230, 232 (S.D.N.Y.1995).  Regulation's Division of Enforcement ("DOE") conducts regulatory investigations and disciplinary hearings, and imposes sanctions that are subject to multiple layers of administrative and judicial review, including appeals within the NASD, and appeal to the SEC under a de novo standard.

 

 One group within the DOE--the Criminal Prosecution Assistance Unit ("the Unit")--assists federal and state authorities in their investigations of securities matters.  The Unit's activities are self-contained, and it performs no other function.  It is a small department consisting of a lawyer, an examiner, and an investigator.  It is sometimes granted access (pursuant to court order) to grand jury materials, which it is required to shield from the rest of the DOE and to not divulge.  Its one lawyer, Bruce Bettigole, is occasionally designated a Special Assistant United States Attorney as part of his duties.  See 28 U.S.C. §  543 (providing for the appointment of special attorneys to assist United States attorneys).

 

 Notwithstanding the separation of the Unit's duties from those of the DOE, there is some administrative overlap between it and the rest of DOE: Bettigole is subordinate to the Deputy Director and the Director of the DOE; Bettigole shares a secretary with a DOE lawyer;  the work-space of the Unit's examiner and its investigator is surrounded by DOE staff;  the Unit's telephone, fax, and computer services are shared with the rest of the DOE.

 

 The facts as found by the district court and supported by the record, demonstrate that in October 1998, the DOE opened an investigation concerning Cromwell's involvement in the trading of shares in Pallet Management Systems, Inc. ("Pallet").  Soon after, the United States Attorney for the Eastern District of New York and the *158 FBI opened their own investigations into the same transactions.

 

 In November 1998, the FBI (as part of its investigation) asked the Unit for certain documents concerning Pallet, which the Unit was aware related to Cromwell's involvement in Pallet.  The Unit turned over the documents.

 

 In March 1999, a DOE lawyer and a DOE examiner went to Florida to inspect Cromwell's books and gather documents.  Soon after, the FBI called the DOE lawyer, who conveyed general information to the FBI concerning the contents of the documents inspected in Florida.  In response to a later formal request, the DOE allowed the FBI access to the Cromwell documents.

 

 During the summer of 2000, the U.S. Attorney's Office for the Eastern District of New York and the DOE shared details about the progress of their respective investigations.  Specifically, prosecutors divulged to the DOE information from a cooperating witness.  Additionally, the DOE and prosecutors learned from each other that they were both investigating Pallet and Cromwell's involvement in Pallet.

 

 At this time, the Unit was assisting the U.S. Attorney's Office in the U.S. Attorney's efforts to secure a search warrant for Cromwell's Brooklyn office. After execution of the warrant by the U.S. Attorney, Bettigole and another Unit staff member reviewed the seized documents to determine whether any were relevant to a separate, long-standing, criminal investigation in which the Unit was involved.

 

 In November 2000, the DOE demanded certain documents from Cromwell.  Cromwell responded that many of the requested documents had been seized by federal agents.  A DOE staff member then asked Cromwell and the U.S. Attorney's Office for an inventory of the seized documents.  Cromwell supplied an illegible copy of the inventory, and the U.S. Attorney's Office told the DOE that the Unit already had the list.  The DOE soon obtained a legible inventory from the Unit, and later procured a number of the documents from the U.S. Attorney's Office.

 

 In December 2000, the Unit helped the U.S. Attorney's Office prepare a grand jury subpoena for materials related to Pallet to be served on an entity called Fiserv.  The terms of the subpoena allowed Fiserv to comply by electronic transmission, but because of a technological incompatibility between Fiserv and (both) the FBI and the U.S. Attorney's Office, Fiserv was allowed to comply by transmitting the information to the Unit.

 

 Subsequently, the DOE served demands (pursuant to NASD Rule 8210) for on-the-record interviews of individual appellants.  NASD Rule 8210 grants the DOE "the right to ... require a member ... to provide information orally, in writing or electronically ... and to testify at a location specified by [DOE] staff ... with respect to any matter involved in [an NASD] investigation." NASD Rule 8210(a)(1)(CCH).  Appellants commenced this suit to enjoin those demands.

 

 [1] We review the district court's decision to consolidate the hearing for a preliminary injunction with a trial of the action on the merits under Rule 65(a)(2) for abuse of discretion.  Abraham Zion Corp. v. Lebow, 761 F.2d 93, 102 (2d Cir.1985).  We review the district court's findings of fact for clear error and its holdings of law de novo.  White v. White Rose Food, 237 F.3d 174, 178 (2d Cir.2001).

 

II

 

 Under Fed.R.Civ.P. 65(a)(2), "[b]efore or after the commencement of the hearing of *159 an application for a preliminary injunction, the court may order the trial of the action on the merits to be advanced and consolidated with the hearing of the application."  Cromwell argues that in this instance the consolidation of the preliminary injunction hearing with the trial on the merits was an abuse of discretion.  See Abraham Zion Corp. v. Lebow, 761 F.2d 93, 102 (2d Cir.1985).

 

 [2] In its strongest formulation, Cromwell's argument is that while it had a fair shot (even without discovery) at securing preliminary relief by raising sufficiently serious questions to show a balance of hardships tipping decidedly in its favor, see Jolly v. Coughlin, 76 F.3d 468, 473 (2d Cir.1996) (internal quotations omitted), it would have needed further weeks of discovery in order to support its heavier burden at a trial on the merits, and that the district court, therefore, should have put off its ultimate decision once the district court had determined that preliminary relief was not warranted, and granted Cromwell's request for an opportunity to pursue its discovery request.

 

 The argument, however, is hard to square with Cromwell's contention, prior to the preliminary injunction hearing, that the question was urgent and could not be deferred.  Thus, when Cromwell was seeking a prompt hearing, it argued that Regulation's Rule 8210 demands would cause irreparable harm--there and then--by forcing individual appellants to choose between foregoing their Fifth Amendment privilege (and risking criminal prosecution) or exposing themselves to NASD sanctions. [FN1]  See Bery v. City of New York, 97 F.3d 689, 693 (2d Cir.1996) (holding that a movant for a preliminary injunction "must first demonstrate that it is likely to suffer irreparable harm in the absence of the requested relief").  The irreparable harm was said to arise from individual appellants' refusal to submit to the impending testimony, and the hearing sought was to decide what all parties saw as the sole issue of the case: whether Regulation is a state actor.

 

 

FN1. Specifically, Cromwell argued:  "Plaintiffs irreparably will be harmed if the preliminary injunction is not issued.... Regulation does not deny that ... [it] will swiftly move to have the individual Plaintiffs barred [from the securities industry] if they do not testify."  Plaintiffs' Reply Memorandum of Law in Support of Motion for Preliminary Injunction at 9, 9 n. 7, D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Feb. 8, 2001).

 

 

 The district court, upon recognizing the state action issue as "the whole ballgame," exercised discretion to order consolidation at the close of the hearing.  Transcript of Preliminary Injunction Hearing at 115, D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Feb. 15, 2001).  Cromwell, anticipating defeat, objected for the first time that an adjudication on the merits would require a two-week delay to pursue discovery, and argued that the delay for it would, in fact, cause no immediate harm, because if individual appellants refused to testify, the NASD itself would stay any suspension during the protracted NASD appellate procedure.  Sound or not, this argument contradicted the claim of urgency that evidently induced the court to immediately hear the preliminary injunction motion in the first instance.

 

 If the district court had been advised that Cromwell could avoid testifying without immediate suspension while it enjoyed an essentially automatic stay by virtue of the administrative appeals process, the court might have afforded additional time for discovery;  at the same time, however, the court might have put off consideration of preliminary relief, or conducted a hearing under less urgent circumstances.  In denying a delay for discovery, the district *160 court merely credited Cromwell's original position--based on its initial claim of inflexible urgency--and rejected its later and contradictory argument that the issue would keep almost indefinitely.  That decision was not an abuse of discretion.

 

 Additionally, Cromwell maintains on appeal that the district court failed to provide proper notice of its intent to consolidate.  Woe v. Cuomo, 801 F.2d 627, 629 (2d Cir.1986) ("Courts may consolidate a trial on the merits with a hearing on a motion for preliminary injunctive relief only after 'the parties ... receive clear and unambiguous notice [of the court's intent to do so] either before the hearing commences or at a time which will still afford the parties a full opportunity to present their respective cases.' ") (quoting Pughsley v. 3750 Lake Shore Drive Co-operative Bldg., 463 F.2d 1055, 1057 (7th Cir.1972)) (alterations in original);  Abraham Zion, 761 F.2d at 101 (citing University of Texas v. Camenisch, 451 U.S. 390, 395, 101 S.Ct. 1830, 68 L.Ed.2d 175 (1981)).

 

 Cromwell, however, was on notice from the outset that its claim hinged on the issue to be decided at the preliminary injunction hearing.  The complaint emphasized the Fifth Amendment state actor question and that resolution of that discrete issue controlled disposition of what Cromwell, itself, termed its "very narrow " claim for injunctive relief.  Complaint at 1, D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Jan. 30, 2001) (emphasis in original).

 

 Moreover, the district court provided additional notice to Cromwell, announcing six days before the hearing that "[t]he issue is the state action issue;  essentially, whether these 8210 requests are fairly attributable to the government."  Transcript at 22, D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Feb. 9, 2001).

 

 In any event, even if the district court's comments were too "oblique" to "clear[ly] and unambiguous[ly] notice" the hearing as a trial on the merits, Woe, 801 F.2d at 629 (citing Pughsley, 463 F.2d at 1057), Cromwell cannot demonstrate that it suffered prejudice by consolidation. Abraham Zion, 761 F.2d at 101 ("Given the broad discretion accorded the district court by Rule 65(a)(2), the court's order of consolidation will not be overturned on appeal absent a showing of substantial prejudice in the sense that a party was not allowed to present material evidence.");  see also Irish Lesbian and Gay Organization v. Giuliani, 143 F.3d 638, 646 (2d Cir.1998) ("[A] failure to ... notify a party [of consolidation] which results in prejudice is grounds for reversal.").

 

 [3] To show prejudice, Cromwell must point to some relevant evidence that it was "prevented from presenting ... because of the consolidation."  Reese Pub. Co., Inc. v. Hampton International Communications, Inc., 620 F.2d 7, 12 (2d Cir.1980);  see also Johnson v. White, 528 F.2d 1228, 1231 (2d Cir.1975) ("[I]n order to obtain a reversal for such an error, a party must show, not only surprise but 'prejudice' in the sense of having other material evidence to introduce.").  On appeal, Cromwell points out that it rested on its affidavits at the close of the hearing--before the district court announced its decision to consolidate.  However, Cromwell has not alleged that it would have done otherwise had the district court's intent to consolidate been expressed more clearly.  Rather, Cromwell argues that consolidation allowed no interval for subsequent discovery.  See, e.g., Memorandum of Law in Support of Plaintiffs' Motion for New Trial Pursuant to FRCP 59(a), D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Mar. 9, 2001).  Any such prejudice, however, was caused by Cromwell's own tactical choice *161 to pursue immediate relief, not by the consolidation decision.

 

 Moreover, Cromwell's application for a two-week discovery period before a hearing on the merits looks very much like a fishing expedition.  On appeal, Cromwell specifies three witnesses it needed to depose:  present and former Regulation employees Roger Sherman, Linda Walters, and John Long. However, it failed to make that specific discovery request of the district court either at the hearing on the motion for a preliminary injunction or in its motion for a new trial.  At the hearing on the motion for a preliminary injunction, Cromwell asked generally for "two weeks to conduct discovery of the Department of Enforcement and [the Unit] so that we can gain the evidence."  Transcript of Preliminary Injunction Hearing at 119, D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Feb. 15, 2001).  In its motion for a new trial, Cromwell raises only its alleged recent discovery of the existence and timing of certain cooperating witness statements given to federal prosecutors.

 

 For the reasons stated, we hold that the district court properly consolidated the preliminary injunction hearing with a trial on the merits, and having done so, it correctly analyzed the state actor question under the preponderance of the evidence standard as opposed to the Jolly standard. See Inmates of Attica Correctional Facility v. Rockefeller, 453 F.2d 12, 24 (2d Cir.1971) (holding injunctive relief proper "if proved at trial by a fair preponderance of the evidence");  Jolly, 76 F.3d at 473.

 

III

 

 [4] To establish a Fifth Amendment violation, a plaintiff must demonstrate  "that in denying the plaintiff's constitutional rights, the defendant's conduct constituted state action."  Desiderio v. National Ass'n of Securities Dealers, Inc., 191 F.3d 198, 206 (2d Cir.1999), cert. denied, 531 U.S. 1069, 121 S.Ct. 756, 148 L.Ed.2d 659 (2001);  see also United States v. International Bd. of Teamsters, 941 F.2d 1292, 1295 (2d Cir.1991).  That is because the Fifth Amendment restricts only governmental conduct, and will constrain a private entity only insofar as its actions are found to be "fairly attributable" to the government.  See Lugar v. Edmondson Oil Co., 457 U.S. 922, 937, 102 S.Ct. 2744, 73 L.Ed.2d 482 (1982);  Corrigan v. Buckley, 271 U.S. 323, 330, 46 S.Ct. 521, 70 L.Ed. 969 (1926).

 

 [5] Actions are "fairly attributable" to the government where "there is a sufficiently close nexus between the State and the challenged action of the regulated entity."  Jackson v. Metropolitan Edison Co., 419 U.S. 345, 351, 95 S.Ct. 449, 42 L.Ed.2d 477 (1974).  That nexus exists either (1) where the state "has exercised coercive power [over a private decision] or has provided such significant encouragement, either overt or covert, that the choice must in law be deemed to be that of the State";  or (2) where "the private entity has exercised powers that are 'traditionally the exclusive prerogative of the State.' " Blum v. Yaretsky, 457 U.S. 991, 1004-05, 102 S.Ct. 2777, 73 L.Ed.2d 534 (1982) (quoting Jackson, 419 U.S. at 351, 95 S.Ct. 449);  see also Desiderio, 191 F.3d at 206.

 

 Under the Blum test, even heavily-regulated private entities generally are held not to be state actors.  Desiderio, 191 F.3d, at 206 ("[T]he fact that a business entity is subject to 'extensive and detailed' state regulation does not convert that organization's actions into those of the state.");  see also Jackson, 419 U.S. at 350, 95 S.Ct. 449 (holding that extensively regulated public utilities are not state actors).

 

 *162 It has been found, repeatedly, that the NASD itself is not a government functionary.  See, e.g., Desiderio, 191 F.3d at 206 ("The NASD is a private actor, not a state actor.  It is a private corporation that receives no federal or state funding.  Its creation was not mandated by statute, nor does the government appoint its members or serve on any NASD board or committee.");  United States v. Shvarts, 90 F.Supp.2d 219, 222 (E.D.N.Y.2000) ("It is beyond cavil that the NASD is not a government agency; it is a private, not-for-profit corporation.  It was not created by statute. None of its directors ... are government officials or appointees.  It receives no government funding ..., [and] its actions cannot be imputed to the government."), abrogated on other grounds by, United States v. Coppa, 267 F.3d 132 (2d Cir.2001);  United States v. Szur, 1998 U.S. Dist. LEXIS 3519, *39-46, 1998 WL 661484 (S.D.N.Y.1998) (rejecting defendant's claims that the NASD "acted pretextually in conducting their investigations");  see also Marchiano v. National Ass'n of Securities Dealers, Inc., 134 F.Supp.2d 90, 95 (D.D.C.2001) ("[T]he court is aware of no case ... in which NASD Defendants were found to be state actors either because of their regulatory responsibilities or because of any alleged collusion with criminal prosecutors.").

 

 Testimony in an NASD proceeding may entail exposure to criminal liability, but that in itself is not enough to establish the requisite governmental nexus.  Shvarts, 90 F.Supp.2d at 222 (holding that "questions put to the defendants by the NASD in carrying out its own legitimate investigative purposes do not activate the privilege against self- incrimination").  Cf. United States v. Solomon, 509 F.2d 863, 867-71 (2d Cir.1975) (holding no violation of the Fifth Amendment where the government relied on testimony compelled in an earlier proceeding before the heavily- regulated New York Stock Exchange).  To prevail, Cromwell must establish additional facts sufficient to satisfy the Blum test and to distinguish the present appeal from the general rule.  See Marchiano, 134 F.Supp.2d at 95 (finding no state action in Rule 8210 demand for testimony absent actual evidence of governmental encouragement ).

 

 [6] Here, the district court found "no direct evidence of such governmental involvement," and that finding is not clearly erroneous.  D.L. Cromwell Inv., Inc. v. NASD Regulation, Inc., 132 F.Supp.2d 248, 252 (S.D.N.Y.2001). Cromwell invites a contrary inference from the chronology of certain events: (1) that the Rule 8210 demands followed shortly after individual appellants contested grand jury subpoenas;  and (2) that the DOE refused to delay the Rule 8210 interviews until after completion of the Eastern District's criminal investigation.  Similarly, Cromwell invites inferences of state involvement based on:  (1) the administrative overlap between the Unit and the DOE;  (2) the statement of an unidentified FBI agent to an individual appellant that "we are working with the NASD--they know exactly what is going on";  (3) questions posed by the DOE regarding two documents that Cromwell believes had been seized previously by the FBI;  (4) the DOE's knowledge of certain government witnesses;  and (5) the provision of the Fiserv grand jury subpoena permitting delivery of responsive documents directly to the Unit.

 

 The district court, however, noted that these circumstantial inferences  "perhaps would not be drawn so readily by those whose judgment is not tinged with self interest."  D.L. Cromwell Inv., Inc., 132 F.Supp.2d at 252.  The district court found that the DOE and the authorities pursued similar evidentiary trails because their independent *163 investigations were proceeding in the same direction:  the possibly improper trading in Pallet. The court was not surprised that federal investigators would say they were working with the NASD, or that the Unit occasionally served as a point of transfer for subpoenaed parties (to deliver requested documents to the FBI when the subpoenaed parties experienced technical computer difficulties):  the Unit was in fact working with the government, and when it does it may well be a state actor.  But though the Unit is a subdivision of Regulation, the district court found that the Unit's role (if and when it is a state actor) cannot fairly and automatically be imputed to the rest of the DOE, which, according to the district court, was effectively "walled off" from the Unit. Id. at 253. True, the district court found that the administrative wall was not impermeable;  but it accepted Regulation's proffered indicia of good faith, and found no sinister counter-indications.

 

 The Unit and the DOE staff members testified consistently that the Rule 8210 demands issued directly from the DOE as a product of its private investigation, and that none of the demands was generated by governmental persuasion or collusion--either directly or through the Unit. As Cromwell recognizes, the DOE has a regulatory duty to investigate questionable securities transactions.  See, e.g, Plaintiffs' Reply Memorandum of Law in Support of Motion for Preliminary Injunction at 9, 9 n. 7, D.L. Cromwell v. NASD Regulation, 01 Civ. 728 (S.D.N.Y. Feb. 8, 2001) ("As associated persons active in the securities industry, [appellants] are well aware of ... Regulation's lawful policing of the industry ... [and] do not seek to have this Court exempt them from the regulation of Defendant.");  see also Szur, 1998 U.S. Dist LEXIS 3519, at *39, 1998 WL 661484 (finding such a duty).  The finding that it fulfilled that duty independent of governmental influence was not clearly erroneous.  We need not address whether the record would have supported contrary findings, inferences and conclusions.

 

CONCLUSION

 The judgment of the district court is affirmed.

 

END OF DOCUMENT

6.

Sentinel Trust Co. v. Namer, 172 F.3d 873 (Table, Text in WESTLAW), Unpublished Disposition, 1998 WL 887287 (6th Cir.(Tenn.), Dec 09, 1998) (NO. 98-5183)

 

NOTICE:  THIS IS AN UNPUBLISHED OPINION.

 

 

(The Court's decision is referenced in a "Table of Decisions Without Reported Opinions" appearing in the Federal Reporter.  Use FI CTA6 Rule 28 and FI CTA6 IOP 206 for rules regarding the citation of unpublished opinions.)

 

 

 

 United States Court of Appeals, Sixth Circuit.

 

SENTINEL TRUST COMPANY, a Tennessee Corporation, Plaintiff-Appellee,

v.

David I. NAMER, Defendant-Appellant.

 

No. 98-5183.

 

Dec. 9, 1998.

 

 On Appeal from the United States District Court for the Middle District of Tennessee.

 

 

 Before WELLFORD, SILER, and GILMAN, Circuit Judges.

 

OPINION

 

 PER CURIAM.

 

 **1 David Namer appeals from the order granting Sentinel Trust Company's motion for a preliminary injunction against him in a securities fraud action. Because the district court has broad discretion in granting an injunction, was entitled to draw an adverse inference from Namer's assertion of his Fifth Amendment right against self-incrimination, and has the power to craft such equitable relief as is necessary, we AFFIRM the district court's grant of the preliminary injunction.

 

I. BACKGROUND

 

 Sentinel Trust sued Namer for violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, and for fraud, negligence, and breach of fiduciary duty under Tennessee law Namer allegedly arranged for the fraudulent offer and sale of securities by eight different corporate entities between 1994 and 1996. Sentinel Trust served as trustee for these offerings. Specifically, Sentinel Trust alleged that Namer and others made misrepresentations in connection with the sale of the securities that materially affected investors' decisions to purchase them. It also alleged that all of the issuers had defaulted since the offerings in question.

 

 Sentinel Trust scheduled a deposition of Namer. Because he expected to be criminally indicted, Namer moved for a protective order to stay the proceedings in this case. The district court denied his motion and ordered the deposition to proceed. At the deposition, Namer invoked his Fifth Amendment right against self-incrimination, and declined to answer several questions.

 

 In order to prevent Namer from disposing of any profits from the offerings in the course of the suit, Sentinel Trust moved for a temporary restraining order. The district court denied Sentinel's motion for the temporary restraining order, but scheduled a hearing to consider whether to grant a preliminary injunction.

 

 At the hearing, neither side presented any live testimony. Sentinel Trust presented evidence by affidavit and by deposition. It also referred several times to Namer's invocation of his Fifth Amendment privilege at the deposition. In contrast, Namer's counsel failed to present any proof, relying solely on oral argument.

 

 The district court granted a preliminary injunction after the hearing. The injunction states, among other things, that:

(1) [Namer is] hereby restrained from parting with any property that represents funds received from purchasers of any of the Notes issued in any of the Secured Note Issuances alleged in the Verified Complaint, and any proceeds of such funds; (4) [Namer] shall report every two weeks to Plaintiffs' counsel with an accounting of all new income, along with the names and addresses of the clients to which the new income pertains.

 

 Namer appeals the district court's grant of the preliminary injunction.

 

II. ANALYSIS

 

 A. The district court did not abuse its discretion in granting a preliminary injunction without hearing live testimony

 

 1. Standard of review

 

 The district court's findings of fact supporting its decision to grant a preliminary injunction are reviewed under the "clearly erroneous" standard and its legal conclusions are reviewed de novo. See NAACP v. City of Mansfield, Ohio, 866 F.2d 162, 166 (6th Cir.1989) (holding that the district court's denial of a preliminary injunction to prevent the city from using existing eligibility lists in its hiring was proper). This court reviews the district court's overall decision to grant a preliminary injunction, however, under the "abuse of discretion" standard. See id. An abuse of discretion is found only when the appellate court has "a definite and firm conviction that the trial court committed a clear error of judgment." SEC v. Johnston, 143 F.3d 260, 262 (6th Cir.1998) (holding that the district court erred in refusing to distribute certain funds to plaintiffs) (quoting Bowling v. Pfizer, 102 F.3d 777, 780 (6th Cir.1996)). In the absence of a factual or legal error, "the district judge's weighing and balancing of the equities should be disturbed on appeal only in the rarest of cases." See NAACP, 866 F.2d at 166 (quoting Baja Contractors, Inc. v. City of Chicago, 830 F.2d 667, 674 (7th Cir.1987)).

 

 2. The district court's determination

 

 **2 In considering whether to grant an injunction, the district court must balance the following four factors: (1) the likelihood of the movant's success on the merits, (2) the irreparable harm that could result if the injunction is not issued, (3) the impact on the public interest of granting or denying the injunction, and (4) the possibility of substantial harm to others if the injunction is issued. See Basicomputer Corp. v. Scott, 973 F.2d 507, 511 (6th Cir.1992) (finding that the plaintiff had established irreparable harm sufficient to support the issuance of an injunction enforcing a covenant not to compete in an employment case).

 

 3. Absence of live testimony

 

 Namer argues that the district court should not have granted a preliminary injunction without first conducting an evidentiary hearing. In support of his argument, Namer cites Securities and Exchange Commission v. G. Weeks Securities, Inc., 678 F.2d 649 (6th Cir.1982). In Weeks, this court held that the district court in the case before it had abused its discretion by issuing a preliminary injunction without hearing live testimony. See id. at 651. Weeks, however, does not stand for the proposition that a court must always hear live testimony before issuing an injunction. Instead, the court held that the district court should not have resolved a disputed factual question in favor of the SEC without first hearing Weeks's live testimony. See id. At the same time, however, the court held that the district court did not need to hear live testimony on a second issue because the documentary evidence before the court on that issue was sufficient to resolve it. See id.

 

 As noted above, the court took into account Namer's invocation of the Fifth Amendment at his deposition in concluding that Sentinel Trust was likely to succeed on the merits. It also considered the pending grand jury proceedings against Namer in the Western District of Tennessee. Namer asserts, however, that the district court should have heard live testimony before granting the injunction. Although he states in his brief that "[i]t is clear that an evidentiary hearing would have allowed Appellant an opportunity to put on his own proof and cross-examine witnesses," Namer does not allege the existence of any specific proof or witness testimony that would have led the district court to deny the preliminary injunction.

 

 Namer also states that his counsel made clear at the hearing that he did not believe that the time had come to present whatever proof he had. Namer cites no case, however, that dictates that he is entitled to a second hearing simply because his lawyer mistakenly believed that he would have a later opportunity to present his proof. Weeks, Namer's best case, only states that when there is a disputed issue of fact and the documentary record is insufficient to resolve it, a party must have an opportunity to be heard and to present evidence. See Weeks, 678 F.2d at 651. Here the district court had before it sufficient documentary evidence to establish that a preliminary injunction was proper.

 

 **3 "[A] preliminary injunction is customarily granted on the basis of procedures that are less formal and evidence that is less complete than in a trial on the merits." Six Clinics Holding Corp. v. Cafcomp Sys., Inc., 119 F.3d 393, 400 (6th Cir.1997) (noting that the purpose of a preliminary injunction is to preserve the relative positions of the parties until trial). We thus conclude that the district court did not abuse its discretion in granting the preliminary injunction without hearing live testimony.

 

 B. The district court did not err when it drew an adverse inference from Namer's invocation of his Fifth Amendment privilege

 

 Namer argues that the district court improperly drew an adverse inference from his invocation of the Fifth Amendment privilege against self-incrimination. In Baxter v. Palmigiano, 425 U.S. 308, 319 (1976), however, the Supreme Court held that silence in the face of accusation is a relevant fact not barred from evidence in the civil context by the Due Process Clause. On this basis, the Court concluded that the Fifth Amendment "does not forbid adverse inferences against parties to civil actions." Id. at 318. Thus, in evaluating Sentinel Trust's likelihood of success on the merits, the district court in the present case properly considered the fact that Namer refused to answer certain questions at his deposition.

 

 C. The district court did not abuse its discretion by requiring Namer to give an accounting of his income to Sentinel Trust

 

 Namer contests the portion of the injunction requiring him to give an accounting of his income every two weeks as overly broad and unduly burdensome. In particular, he objects to the fact that the accounting relates to all income he receives, not just to income from the notes relevant to this litigation. In its analysis of whether Sentinel Trust would suffer irreparable harm without an injunction, however, the district court found that there was a substantial riskof assets being converted before Sentinel Trust could be made whole. Furthermore, Namer is already subject to a nearly identical injunction in litigation currently pending against him by the Securities and Exchange Commission. The accounting requirement of the injunction in the instant case thus does not impose an unreasonable burden upon him.

 

 In the absence of any abuse of discretion, this court should not disturb the district court's determination that the equities required the relief that it fashioned. See NAACP, 866 F.2d at 166. The district court's determination that an accounting was necessary was based upon its analysis of Sentinel Trust's likelihood of success on the merits: Courts of appeals should exercise restraint in reviewing such preliminary assessments of the merits, because such issues are properly fleshed out further at trial. See Doe v. Sundquist, 106 F.3d 702, 707 (6th Cir.1997).

 

III. CONCLUSION

 

 For all of the reasons stated above, we AFFIRM the district court's grant of a preliminary injunction and its requirement of a bi-weekly accounting by Namer.

 

END OF DOCUMENT

13.

U.S. S.E.C. v. Fehn, 97 F.3d 1276, 65 USLW 2251, Fed. Sec. L. Rep. P 99,330, 96 Cal. Daily Op. Serv. 7516, 96 Daily Journal D.A.R. 12,375 (9th Cir.(Nev.), Oct 09, 1996) (NO. 94-16136)

 

United States Court of Appeals,

Ninth Circuit.

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellee,

v.

H. Thomas FEHN, Defendant-Appellant.

 

No. 94-16136.

 

Argued and Submitted Oct. 17, 1995.

Decided Oct. 9, 1996.

 

 Securities and Exchange Commission (SEC) brought suit against attorney to enjoin his aiding and abetting violations of securities laws by company and its promoter.   The United States District Court for the District of Nevada, Mary Johnson Lowe, Senior District Judge, sitting by designation, granted injunction, and attorney appealed.   The Court of Appeals, Michael Daly Hawkins, Circuit Judge, held that: (1) SEC may bring injunctive actions against those who aid and abet violations of Securities Exchange Act's general antifraud provision and provision governing filing of supplementary and periodic information; (2) company and promoter violated securities laws by failing to correctly describe promoter's role and failing to disclose contingent liability stemming from earlier securities law violations; (3) disclosure requirements did not violate attorney's privilege against self- incrimination; (4) attorney lent substantial assistance to primary violations; (5) attorney had requisite scienter to establish aiding and abetting violation; and (6) evidence was adequate to support permanent injunction.

 

 Affirmed.

 

West Headnotes

 

[1] Federal Courts 776

170Bk776 Most Cited Cases

 

Challenge to Securities and Exchange Commission's (SEC) injunctive authority presented question of law, reviewable de novo.

 

[2] Securities Regulation 40.16

349Bk40.16 Most Cited Cases

 

[2] Securities Regulation 60.41

349Bk60.41 Most Cited Cases

 

Securities and Exchange Commission (SEC) may bring injunctive actions against those who aid and abet violations of Securities Exchange Act's general antifraud provision and provision governing filing of supplementary and periodic information.  Securities Exchange Act of 1934, § §  10(b), 15(d), 20(f), 15 U.S.C.A. § §  78j(b), 78o(d), 78t(f).

 

[3] Securities Regulation 2.30

349Bk2.30 Most Cited Cases

 

Section of Private Securities Litigation Reform Act authorizing Securities and Exchange Commission (SEC) injunctive actions for aiding and abetting certain violations of securities laws applied to appeal which was argued before statute was enacted; Act did not attach new legal consequences to events underlying SEC's injunction, but rather restored legal consequences that obtained at time of district court's judgment, but that may have been temporarily eliminated by Supreme Court's Central Bank decision.  Private Securities Litigation Reform Act of 1995, §  104, 109 Stat. 737.

 

[6] Securities Regulation 60.41

349Bk60.41 Most Cited Cases

 

Elements of aiding and abetting securities law violations, required for Securities and Exchange Commission (SEC) to pursue injunctive action, are: existence of independent primary violation; actual knowledge by alleged aider and abettor of primary violation and of his or her own role in furthering it; and substantial assistance in commission of the primary violation.  Private Securities Litigation Reform Act of 1995, §  104, 109 Stat. 737.

 

[7] Securities Regulation 60.18

349Bk60.18 Most Cited Cases

 

[7] Securities Regulation 60.28(2.1)

349Bk60.28(2.1) Most Cited Cases

 

Proof of primary violation of §  10(b) requires showing of misstatement or omission of material fact, made with scienter, and misstatement or omission must have been misleading; in case of omission of material fact, silence, absent duty to disclose, is not misleading.  Securities Exchange Act of 1934, §  10(b), 15 U.S.C.A. §  78j(b);  17 C.F.R. §  240.10b-5.

*******************************************************************************

[17] Securities Regulation 60.30

349Bk60.30 Most Cited Cases

 

Attorney who had hand in editing company's Form 10-Q's and failed to properly advise company and its promoter of material omissions, instead submitting those forms to Securities and Exchange Commission (SEC) for filing, lent substantial assistance to primary violations of antifraud provision of Securities Exchange Act and provision governing supplementary and periodic information, as required to support SEC action to enjoin aiding and abetting violations; attorney's efforts were not reasonable in light of well-established disclosure requirements imposed by SEC regulations.  Securities Exchange Act of 1934, § §  10(b), 15(d), 15 U.S.C.A. § §  78j(b), 78o(d);  17 C.F.R. § §  240.10b-5, 240.12b-20.

 

[18] Securities Regulation 40.16

349Bk40.16 Most Cited Cases

 

[18] Securities Regulation 60.30

349Bk60.30 Most Cited Cases

 

Company's attorney knowingly aided and abetted company's violations of Securities Exchange Act, as required to support Securities and Exchange Commission's (SEC) injunctive action, where attorney knew that representations in registration statement with respect to promoter's role were inaccurate, he must have known that Form 10-Q's he helped to prepare perpetuated this inaccuracy and contained additional untrue statements about promoter's historical relationship with company, and he knew there was material information about company that promoter did not wish to disclose in the 10- Q's.  Securities Exchange Act of 1934, § §  10(b), 15(d), 15 U.S.C.A. § §  78j(b), 78o(d);  17 C.F.R. § §  240.10b-5, 240.12b-20;  Private Securities Litigation Reform Act of 1995, §  104, 109 Stat. 737.

 

[19] Injunction 1

212k1 Most Cited Cases

 

Granting or denying of injunctive relief rests within sound discretion of trial court.

 

[20] Federal Courts 814.1

170Bk814.1 Most Cited Cases

 

District court's grant of permanent injunctive relief is reviewed for abuse of discretion or application of erroneous legal principle.

 

[21] Securities Regulation 171

349Bk171 Most Cited Cases

 

[21] Securities Regulation 176

349Bk176 Most Cited Cases

 

To obtain permanent injunction against aider and abettor of securities laws, Securities and Exchange Commission (SEC) had burden of showing there was reasonable likelihood of future violations of securities laws; while there is no per se rule requiring issuance of injunction upon showing of past violation, existence of past violations may give rise to inference that there will be future violations, and fact that defendant is currently complying with securities laws does not preclude injunction.  Private Securities Litigation Reform Act of 1995, §  104, 109 Stat. 737.

 

[22] Securities Regulation 171

349Bk171 Most Cited Cases

 

In action by Securities and Exchange Commission (SEC) to enjoin aider and abettor of securities laws, court, in predicting likelihood of future violations, must assess totality of circumstances surrounding defendant's violations, considering such factors as: degree of scienter involved; isolated or recurrent nature of the infraction, defendant's recognition of wrongful nature of his conduct; likelihood, because of defendant's professional occupation, that future violations might occur, and sincerity of his assurances against future violations.  Private Securities Litigation Reform Act of 1995, §  104, 109 Stat. 737.

 

[23] Securities Regulation 171

349Bk171 Most Cited Cases

 

Securities and Exchange Commission (SEC) was entitled to permanent injunction against attorney prohibiting his aiding and abetting violations of antifraud and disclosure provisions of Securities Exchange Act; although SEC cited no other securities law violations on attorney's part, attorney knew of primary violations, he lacked remorse, and his professional occupation tended to suggest risk of future violations.  Private Securities Litigation Reform Act of 1995, §  104, 109 Stat. 737.

 *1279 Gregory J. Sherwin, Fields, Fehn & Sherwin, Los Angeles, CA, for defendant-appellant.

 

 Simon M. Lorne, Lucinda O. McConathy, Jacob H. Stillman and  Catherine A. Broderick, Securities and Exchange Commission, Washington, D.C., for plaintiff-appellee.

 

 Appeal from the United States District Court for the District of Nevada, Mary Johnson Lowe, Senior District Judge, Presiding. [FN*] D.C. No. CV-92-00946- HDM.

 

 

FN* Honorable Mary Johnson Lowe, Senior United States District Judge for the Southern District of New York, sitting by designation.

 

 

 Before: GOODWIN and HAWKINS, Circuit Judges, and FITZGERALD,  [FN**] District Judge.

 

 

FN** Honorable James M. Fitzgerald, Senior United States District Judge for the District of Alaska, sitting by designation.

 

 

 MICHAEL DALY HAWKINS, Circuit Judge:

 

 This appeal requires us to apply Section 104 of the recently enacted Private Securities *1280 Litigation Reform Act of 1995, which expressly authorizes the Securities and Exchange Commission ("SEC") to bring injunctive actions against those who aid and abet violations of certain securities laws.

 

 California attorney H. Thomas Fehn appeals the district court's final judgment and permanent injunction order of April 1, 1994, which ordered Fehn to refrain from aiding and abetting violations of Section 10(b) and Section 15(d) of the Securities Exchange Act of 1934 and related regulations.   Fehn advances three distinct challenges to the district court's injunction.   He first contends that the Supreme Court's decision in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), which held that a private plaintiff may not maintain an action for aiding and abetting violations of Section 10(b) of the Securities Exchange Act, should extend to SEC injunctive actions like the one that precipitated this case.  Fehn argues, in the alternative, that even if Central Bank does not preclude the SEC's injunctive action against him, the district court erroneously concluded that he aided and abetted violations of Section 10(b) and Section 15(d) and related regulations.   Finally, Fehn contends that the district court abused its discretion in entering a permanent injunction against him.

 

 We have jurisdiction over this appeal from a final judgment pursuant to 28 U.S.C. §  1291.   We hold that extension of Central Bank to SEC injunctive actions is barred by Section 104 of the recently enactedPrivate Securities Litigation Reform Act of 1995, Pub.L. 104-67, 109 Stat. 737 (1995).   We affirm the district court's permanent injunction order because we conclude that the court correctly found that Fehn had aided and abetted violations of Section 10(b) and Section 15(d) of the Securities Exchange Act and related regulations, and did not abuse its discretion in permanently enjoining him from future aiding and abetting violations.

 

FACTUAL AND PROCEDURAL BACKGROUND

 I. The Initial Public Offering by CTI Technical, Inc.

 

 CTI Technical, Inc. was incorporated in Nevada in January 1987 by its promoter, Las Vegas resident Edwin "Bud" Wheeler.   Although Wheeler directed CTI's operations from the date of its incorporation, his status as company president and chief executive officer was not disclosed publicly until August 1988.   In June 1987, seeking to raise capital to acquire other businesses, CTI conducted a $200,000 "blind pool" initial public offering of securities ("IPO").

 

 The CTI offering was tainted by violations of state and federal securities laws.   First, CTI violated state blue sky laws by failing to register its securities with the states in which those securities were sold.   Second, although CTI filed a Form S-18 registration statement with the SEC, [FN1] it violated the Securities Act of 1933 and SEC regulations  [FN2] by failing to disclose that Wheeler was the promoter of the company and controlled its nominal directors.   Finally, Wheeler and Stoneridge Securities, Inc., underwriter for the IPO, attempted to defraud investors by manipulating the price of the securities in aftermarket trading.

 

 

FN1. We note that CTI in fact filed two Form S-18 registration statements containing substantially the same information;  this fact is not relevant to this appeal.

 

 

FN2. Regulation S-K, Item 401(f) & (g), 17 C.F.R. § §  229.401(f) & (g).

 

 

 II. The SEC Investigation of CTI's Initial Public Offering

 

 In early 1988, the SEC launched a formal investigation of CTI's IPO.  That investigation was to culminate in the SEC's September 1989 complaint against CTI and Wheeler.   As a result of the SEC's action, the defendants consented to a permanent injunction against future securities laws violations, and Wheeler was convicted of securities fraud for misstatements and omissions in CTI's registration statement. [FN3]

 

 

FN3. Wheeler's conviction was affirmed in United States v. Wheeler, No. 93-10522, 1994 WL 384183 (9th Cir. July 22, 1994) (unpublished disposition).

 

 

 *1281 In connection with the SEC investigation, defendant-appellant Fehn was retained to represent CTI and Wheeler, as well as CTI's underwriter and various CTI officers and directors.   Fehn is a California attorney who has specialized in securities law during nearly three decades of practice.   He has represented clients in connection with the registration and offering of securities under the Securities Act of 1933, compliance with reporting and disclosure requirements under the Securities Exchange Act of 1934, and litigation of various securities matters.   Prior to Fehn's retention in connection with the SEC investigation, Fehn's law firm had represented underwriter Stoneridge Securities during CTI's IPO.

 

 During the SEC investigation of CTI and Wheeler, Fehn became aware that CTI was not in compliance with certain reporting requirements of the Securities Exchange Act of 1934.   First, Fehn learned that after the IPO, CTI had failed to file Form 10-Q quarterly reports as required by Section 15(d) of the Securities Exchange Act and related regulations.   Second, Wheeler's investigative testimony before the SEC revealed that the Food and Drug Administration had banned sales of a diet product known as "Accupatch," CTI's main product and the source of gross sales of $1 million a month, and had impounded CTI's existing inventory of the product.   CTI's registration documents, however, failed to disclose these FDA actions.

 

 Fehn advised Wheeler that CTI was required to file the quarterly Form 10-Q's, and that it must disclose, in particular, the FDA's restriction of its Accupatch product.   He also discussed with Wheeler whether the Securities Exchange Act required disclosure, in the Form 10-Q's, of Wheeler's and CTI's apparent violations of the Securities Act of 1933 in connection with the IPO. Wheeler flatly refused to make such disclosures.   Fehn later testified that he told Wheeler it was his professional opinion that such disclosures were unnecessary under the regulations, and furthermore could impair Wheeler's ability to assert his Fifth Amendment privilege against self-incrimination with respect to those earlier violations.

 

 Because Wheeler wished to limit CTI's expenses, he had a non-lawyer employee of CTI--rather than Fehn--draft the Form 10-Q's. Fehn gave Wheeler a copy of Regulation S-K, which outlines disclosure requirements for Form 10-Q, an instruction booklet describing how to fill out a Form 10-Q, and a sample Form 10-Q.   The employee prepared a draft of the Form 10-Q for the quarter ending March 31, 1988, which disclosed the FDA's ban on CTI's Accupatch product. However, the Form 10-Q mischaracterized Wheeler's true role in CTI, describing him as CTI's recently appointed CEO and president rather than the individual who in fact had promoted, incorporated, and controlled the company since its inception.   The form also failed to disclose the potential civil liability stemming from Wheeler's and CTI's earlier violations of state and federal securities laws.   Fehn reviewed and edited the draft of the Form 10-Q, incorporating financial statements he had obtained from CTI's accountant. Fehn maintains that he made no substantive changes to the document, and, in particular, did not delete from the report any information the SEC later contended was improperly omitted.   Fehn's secretary mailed the final Form 10-Q to the SEC, where it was filed in August 1988.

 

 Based on CTI's Form 10-Q for the quarter ending March 31, 1988, Fehn's law firm prepared and mailed two other Form 10-Q's, for the quarters ending December 31, 1987, and June 30, 1988, respectively.   These forms, too, mischaracterized Wheeler's relationship to CTI, and failed to mention contingent liabilities stemming from CTI's and Wheeler's earlier securities law violations.   Fehn insists that his involvement in the preparation of these later Form 10-Q's was minimal, but the SEC points out that editing notations in Fehn's handwriting appeared on drafts of these Form 10-Q's.   These Form 10-Q's were filed in November 1988.

 

 III. The SEC Injunctive Action Against Fehn

 

 In November 1992, the SEC filed a complaint against Fehn, alleging that in preparing and filing the three Form 10-Q's, Fehn had aided and abetted violations of Sections *1282 10(b) and 15(d) of the Securities Exchange Act, 15 U.S.C. § §  78j(b) and 78o(d), and violations of Rules 10b-5, 12b- 20, and 15d-13, 17 C.F.R. § §  240.10b-5, 240.12b-20, and 240.15d-13. Pursuant to Section 20(b) of the Securities Act of 1933, 15 U.S.C. §  77t(b), and Sections 21(d) and 21(e) of the Securities Exchange Act of 1934, 15 U.S.C. § §  78u(d) and 78u(e), the SEC brought an action to permanently enjoin Fehn from future securities laws violations.   The SEC alleged that CTI and Wheeler had violated Section 10(b) and Section 15(d) by preparing and filing Form 10-Q's that contained false accounts of Wheeler's role in the promotion, formation and management of CTI and his control over CTI stock and directors, and failed to disclose "material contingent liabilities" stemming from CTI's violations of state and federal securities laws in connection with its 1987 IPO.   Additionally, the SEC alleged that Fehn had knowingly lent "substantial assist[ance]" to Wheeler and CTI in the preparation and filing of the faulty Form 10-Q's.

 

 On April 1, 1994, following a bench trial, the district court entered final judgment against Fehn, based on its findings that Fehn had aided and abetted violations of Sections 10(b) and 15(d) of the Securities Exchange Act, the Act's antifraud and reporting provisions, respectively, along with Rules 10b-5, 12b-20, and 15d-13.   Because it concluded that there was a reasonable likelihood of future violations on Fehn's part, the district court entered an order permanently enjoining Fehn from future aiding and abetting violations of the securities laws.   Fehn timely appealed.

 

ANALYSIS

 

 Fehn raises three challenges to the district court's permanent injunction order.   First, he argues that the Supreme Court's decision in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), issued just two weeks after the permanent injunction order in this case, precludes SEC injunctive actions such as the one brought against him.   Failing that challenge, he argues that the district court erred in finding that he aided and abetted violations of Sections 10(b) and 15(d) of the Securities Exchange Act and related regulations.   Finally, he insists that the district court abused its discretion in entering a permanent injunction against him.

 

 I. The SEC's Authority to Enjoin Aiding and Abetting Violations of the Securities Laws after Central Bank

 

 [1] Because Fehn's challenge to the SEC's injunctive authority presents a question of law, we review this issue de novo.  Campbell v. Wood, 18 F.3d 662, 681 (9th Cir.) (en banc), cert. denied, 511 U.S. 1119, 114 S.Ct. 2125, 128 L.Ed.2d 682 (1994).

 

 We note that Fehn's argument may well be precluded by recent congressional action.   Concerned that Central Bank might be extended to eliminate the SEC's power to enjoin aiding and abetting violations, Congress recently enactedlegislation reinforcing the SEC's authority to enjoin the aiding and abetting of primary violations of several securities laws. [FN4]  That legislation, Section 104 of the Private Securities Litigation Reform Act of 1995, Pub.L. 104-67, 109 Stat. 737 (1995), appears to prevent lower federal courts from extending the logic of Central Bank to SEC injunctive actions.

 

 

FN4. This legislation also allows the SEC to seek money penalties in civil actions for aiding and abetting, but that aspect of the legislation is not at issue here.

 

 

 A. Section 104 of the Private Securities Litigation Reform Act of 1995

 

 [2] Section 104 of the Private Securities Litigation Reform Act amended the heading to 15 U.S.C. §  78t by inserting the underlined portion:  "Liability of controlling persons and persons who aid and abet violations."   Section 104 also added an entire new subsection to 15 U.S.C. §  78t.   New subsection 78t(f) reads:

(f) Prosecution of persons who aid and abet violations

For purposes of any action brought by the Commission under paragraph (1) or (3) of *1283 Section 78u(d) of this title, [FN5] any person that knowingly provides substantial assistance to another person in violation of a provision of this chapter, or of any rule or regulation issued under this chapter, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided.

 

 

FN5. The paragraphs in Section 78u(d) to which Section 104 refers empower the SEC to enjoin securities violations and to seek money penalties in civil actions, respectively.  15 U.S.C. §  78u(d)(1) & 78u(d)(3).

 

 

 By its clear terms, Section 104 provides that aiding and abetting a violation of Chapter 2B, which encompasses 15 U.S.C. §  78a through §  78kk, is itself a violation, and as such is subject to injunctive actions and civil actions for money penalties by the SEC under 15 U.S.C. § §  78u(d)(1) and 78u(d)(3).   Both Section 10(b), 15 U.S.C. §  78j(b), and Section 15(d), 15 U.S.C. §  78 o(d), fall within Chapter 2B. Section 104 of the Private Securities Litigation Reform Act thus authorizes SEC injunctive actions for the aiding and abetting of violations of Sections 10(b) and 15(d) and related regulations, and thereby reverses any impact Central Bank might have had on the SEC's power to enjoin aiding and abetting of these securities provisions.

 

 Legislative history confirms that Section 104 was intended to override  Central Bank 's apparent elimination of the SEC's power to enjoin the aiding and abetting of securities law violations.   Discussion of the proposed legislation is contained in Senate Banking Committee Report No. 104-98 on the Senate version of the bill, S. 240.   That report makes clear the drafters' intent to authorize the SEC to enjoin those who aid and abet such violations:

Prior to the Supreme Court's decision in Central Bank of Denver v. First Interstate Bank of Denver, courts of appeals had recognized that private parties could bring actions against persons who "aided and abetted" primary violators of the securities laws.   In Central Bank, the Court held that there was no aiding and abetting liability for private lawsuits involving violations of the securities antifraud provisions.

The Committee considered testimony endorsing the result in Central Bank and testimony seeking to overturn this decision.   The Committee believes that amending the 1934 Act to provide explicitly for private aiding and abetting liability actions under Section 10(b) would be contrary to S. 240's goal of reducing meritless securities litigation.   The Committee does, however, grant the SEC express authority to bring actions seeking injunctive relief or money damages against persons who knowingly aid and abet primary violators of the securities laws.

 

 S.Rep. No. 98, 104th Cong., (1995) (emphasis added).

 

 The Conference Report adopted S. 240's Section 104 as part of the combined bill, H.R. 1038.   See 141 Cong. Rec. S17,965-03, *S17,984 (daily ed. Dec. 5, 1995) (statement of Sen. Moseley-Braun).   Although the Conference Report does not discuss the purpose of Section 104, floor statements by several senators consistently describe Section 104 as a provision to reinstate the SEC's power to enjoin the aiding and abetting of the securities laws. Introducing the conference bill, Senator D'Amato remarked:

The conference report also reinstates the SEC's authority--which the Supreme Court put into question in the Central Bank of Denver case--to bring actions against defendants who knowingly aid and abet securities fraud.

 

 141 Cong. Rec. S17,933-04, *S17,934 (daily ed. Dec. 5, 1995) (statement of Sen. D'Amato).

 

 Sen. Dodd stated that the legislation:

restores enforcement authority to the Securities and Exchange Commission. That was lost ... in the 1994 Supreme Court case, the Central Bank case. We, in this bill, restore what the Central Bank took away from the SEC here.

...

[T]he bill restores the ability of the Securities and Exchange Commission to pursue those who knowingly aid and abet securities fraud.

 

 *1284 141 Cong. Rec. S17,933-04, *S17,957 (daily ed. Dec. 5, 1995)  (statement of Sen. Dodd).

 

 Sen. Reid noted that "[t]he compromise agreement authorizes the SEC to bring enforcement actions against those who aid and abet a securities fraud, thus reversing the Supreme Court's Central Bank decision as it applies to the SEC."  141 Cong. Rec. S17,965-03, *S17,977 (daily ed. Dec. 5, 1995) (statement of Sen. Reid).

 

 Finally, in complaining about the bill's failure to create an express private cause of action against aiders and abettors, Sen. Sarbanes stated:

This bill, unfortunately, restores only the SEC's ability to go after aiders and abettors of violations of the securities laws and then only in part--only in part.   The provision in the bill is limited to violations of section 10(b) of the Securities Exchange Act and to defendants who act knowingly.

 

 141 Cong. Rec. S17,933-04, *S17,937 (daily ed. Dec. 5, 1995) (statement of Sen. Sarbanes).

 

 These statements by legislators reinforce our conclusion that Section 104, by its terms, empowers the SEC to enjoin the aiding and abetting of "violation[s] of .. provision[s] of [[C]hapter 2B], or of any rule or regulation issued under [[C]hapter 2B]," which includes 15 U.S.C. §  78a through §  78kk. Section 104 thus covers the type of injunctive action in this case, which sought to enjoin Fehn's alleged aiding and abetting of violations of Section 10(b) and Section 15(d) of the Securities Exchange Act, 15 U.S.C. § §  78j(b) & 78o(d).   Given the unique timing of events in this case, however, we must determine if Section 104 applies to the events underlying this particular injunctive action.

 

 B. Whether Section 104 of the Private Securities Litigation Reform Act of 1995 Applies to this Case

 

 [3] A threshold consideration is whether Section 104 applies to this appeal, which was argued before Section 104 was enacted.   The district court's final judgment against Fehn and permanent injunction order were entered April 1, 1994.   At that moment, it was the well-settled law of this Circuit that there existed a private right of action for aiding and abetting violations of Section 10(b).   See Hauser v. Farrell, 14 F.3d 1338, 1343 (9th Cir.1994). [FN6]  Just eighteen days later, on April 19, 1994, the Supreme Court issued its decision in Central Bank, eliminating the implied private cause of action for aiding and abetting violations of Section 10(b) of the Securities Exchange Act.   This decision, which was premised on the Court's conclusion that the statute did not prohibit aiding and abetting, threw into doubt the viability of SEC injunctive actions like the one brought against Fehn.  Central Bank, 511 U.S. at ----, 114 S.Ct. at 1455. [FN7]  Fehn thereafter appealed to this Court, arguing that Central Bank should extend to SEC injunctive actions.   On December 22, 1995, two months after oral argument in this appeal, Congress overrode a presidential veto to enact the Private Securities Litigation Reform Act of 1995.   Section 104 of the Act prohibits precisely what Fehn seeks in this appeal:  the extension of Central Bank to SEC injunctive actions.

 

 

FN6. Also at issue in this appeal is Fehn's potential liability for aiding and abetting violations of Section 15(d) of the Securities Exchange Act, 15 U.S.C. §  78o(d).   Although aiding and abetting liability under Section 15(d) is not nearly as well-established as that under Section 10(b), it does pre-date Central Bank.   See SEC v. Arthur Young & Co., 590 F.2d 785, 786 (9th Cir.1979).

 

 

FN7. Dissenting in Central Bank, Justice Stevens warned:

[T]his case concerns only the existence and scope of aiding and abetting liability in suits brought by private parties under §  10(b) and Rule 10b-5.   The majority's rationale, however, sweeps far beyond even those important issues.   The majority leaves little doubt that the Exchange Act does not even permit the Commission to pursue aiders and abettors in civil enforcement actions under §  10(b) and Rule 10b-5.

Central Bank, 511 U.S. at ----, 114 S.Ct. at 1459-60 (Stevens, J., dissenting).

 

 

 This sequence of events is unusual in that the SEC's authority to enjoin aiding and abetting existed at the time of the final judgment against Fehn, was arguably precluded two weeks later by Central Bank, and was reinstated several weeks after the appeal was argued.   Although the Private Securities Litigation *1285 Reform Act does not expressly make Section 104 applicable to conduct and events that precede its enactment, principles governing the retrospective application of statutes indicate that Section 104 applies to Fehn's appeal.

***********************************************************************************

[6] We note that Congress employed language identical to that used by lower federal courts in articulating the elements of aiding and abetting under Section 10(b) before Central Bank eliminated private causes of action for aiding and abetting.   Before Central Bank, the elements of aiding and abetting under Section 10(b) were:  (1) the existence of an independent primary violation;  (2) actual knowledge by the alleged aider and abettor of the primary violation and of his or her own role in furthering it;  [FN11] and (3) "substantial assistance" by the defendant in the commission of the primary violation.  Hauser, 14 F.3d at 1343.   The new Section 104 defines aiding and abetting as follows:  (1) the defendant acted "knowingly," (2) the defendant "provide[d] substantial assistance," and (3) that assistance was given "to another person in violation of a provision of this chapter, or of any rule or regulation issued under this chapter."   The elements of the new Section 104 clearly mirror the elements this Court and others traditionally used to define aiding and abetting under Section 10(b).   In our view, the symmetry between the elements of aiding and abetting before Central Bank and after Section 104 is a strong indication that Congress intended Section 104 to preserve the definition of aiding and abetting as it existed pre-Central Bank.

 

 

FN11. We acknowledge that other decisions by this Court have defined this element as "actual knowledge or reckless disregard."  Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir.1991) (emphasis added). We do not address this discrepancy because Section 104, by its plain terms, requires "know[ledge]" as an element of aiding and abetting.

 

 

 The legislative history surrounding Section 104 bolsters our conclusion.   The statements contained in that history consistently make clear that the amendment's purpose is to negate any effect Central Bank might have had on the SEC's authority to bring injunctive actions against aiders and abettors of certain securities law violations.   Based on the language of the new Section 104 and its legislative history, we conclude that Section 104 simply restores the pre-Central Bank status quo with respect to SEC injunctive actions.

 

 The elements of aiding and abetting under Section 15(d) are more difficult to discern, simply because there are virtually no pre-Central Bank decisions among the lower federal courts defining aiding and abetting liability for violations of Section 15(d).   In this Circuit, Arthur Young recognized aiding and abetting liability under Section 15(d), but did not enumerate what the SEC must prove to establish it.  Arthur Young, 590 F.2d at 786. As noted above, however, Section 104 employs the distinctive language defining the elements of aiding and abetting under Section 10(b).   Based on the language of the new Section 104, we conclude that application of a similar test is appropriate in the context of Section 15(d), namely:  (1) the existence of an independent primary violation;  (2) actual knowledge by the alleged aider and abettor of the primary violation and of his or her own role in furthering it;  and (3) "substantial assistance" in the commission of the primary violation.  Hauser, 14 F.3d at 1343 (setting forth elements of aiding and abetting liability under Section 10(b)).

 

 B. Whether Fehn Aided and Abetted Violations of Sections 10(b) and 15(d) of the Securities Exchange Act and Related Regulations

 

 Fehn's challenge to the district court's final judgment is multi-faceted. First, he contends that the district court erred in finding primary violations of Sections 10(b) and 15(d) of the Securities Exchange Act, insisting that *1289 these provisions and their implementing regulations did not require disclosure of Wheeler's role as promoter, or of the contingent liabilities stemming from CTI's and Wheeler's earlier securities law violations.   In the alternative, he contends that such a disclosure requirement was trumped by Wheeler's Fifth Amendment privilege against self- incrimination.  He also argues that Wheeler lacked the requisite scienter for commission of the primary violation.   Second, Fehn argues that, even if there were primary violations of Sections 10(b) and 15(d) and related regulations by CTI and Wheeler, Fehn did not "substantial[ly] assist" those violations.   Finally, he insists that he did not possess the requisite scienter for aiding and abetting liability because his professional advice to CTI and Wheeler was offered in good faith.   We review de novo the district court's conclusions of law, and we review for clear error its findings of fact.  Campbell, 18 F.3d at 681.

 

1. The Existence of a Primary Violation

a. Disclosure Requirements under Section 10(b) and Section 15(d)

 

 Section 10(b), the central antifraud provision of the Securities Exchange Act, 15 U.S.C. §  78j(b), makes it unlawful "for any person, directly or indirectly":

To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

 

 15 U.S.C. §  78j(b).

 

 Rule 10b-5 further defines the conduct prohibited under Section 10(b), making it unlawful:

(a) [t]o employ any device, scheme, or artifice to defraud,

(b) 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

(c) 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.

 

****************************************************************************************************

 

2. Fehn's "Substantial Assistance" in the Primary Violation

 

 [17] The term "substantial assistance" has been interpreted to include "participation in the editing" of information for the purpose of marketing securities.  Molecular Technology Corp. v. Valentine, 925 F.2d 910, 918 (6th Cir.1991).   Fehn admits that he reviewed the initial draft Form 10-Q prepared by Wheeler's non-lawyer employee, and admits that he personally altered that document.   Although he claims to have had less involvement in the preparation of subsequent Form 10-Q's, these documents, too, reflect Fehn's editing notations, and were prepared by Fehn's law firm.   Because Fehn had a hand in the editing the Form 10-Q's, and because he failed to properly advise Wheeler and CTI of the *1294 material omissions in the Form 10-Q's, instead submitting those forms to the SEC for filing, we conclude that Fehn lent the requisite "substantial assistance" to the primary violation of Section 10(b) and Section 15(d) of the Securities Exchange Act and related regulations.

 

 Fehn urges us that he acted in good faith in rendering professional advice to CTI and Wheeler, and that this alleged good faith precludes a finding that he rendered "substantial assistance" in the primary violations of Sections 10(b) and 15(d).   He relies on In re Carter and Johnson, [1981] Fed. Sec. L. Rptr. (CCH) ¶  82,847 (Feb. 28, 1981), in which the SEC explained that "[s]o long as a lawyer is acting in good faith and exerting reasonable efforts to prevent violations of the law by his client, his professional obligations have been met."   Carter, at ¶ ¶  84,172-73.   We reject Fehn's argument because we find that his efforts were not "reasonable" in light of the well-established disclosure requirements imposed by the aforementioned SEC regulations.   Rules 10b-5 and 12b-20 clearly prohibited the misstatements and omissions contained in CTI's Form 10-Q's.

 

 We observe, furthermore, that effective regulation of the issuance and trading of securities depends, fundamentally, on securities lawyers such as Fehn properly advising their clients of the disclosure requirements and other relevant provisions of the securities regulations.   Securities regulation in this country is premised on open disclosure, and it is therefore incumbent upon practitioners like Fehn to be highly familiar with the disclosure requirements and to insist that their clients comply with them.

 

 We acknowledge the inherent tension between representing a client in criminal or civil litigation--which entails professional obligations such as the duty of confidentiality and the need to advise clients of their privilege against self- incrimination--and counseling a client in connection with regulatory compliance.   Commentators have described the tension that arises where a lawyer is called upon to perform a "legal audit" of his own client, such as when a lawyer advises an issuer of securities about the need to disclose certain negative corporate information:

What is unusual about such employment, of course, is that the client has in effect hired the lawyer for the very purpose of revealing information that otherwise would be confidential.

 

 Geoffrey C. Hazard, Jr. & W. William Hodes, 1 The Law of Lawyering:  A Handbook on the Model Rules of Professional Conduct §  2.3, at 101 (Aspen Law & Business, 2nd ed. 1990).

 

 This dilemma is especially pronounced in cases where, as here, a lawyer attempts to represent a client in an SEC investigation of previous disclosure violations and, at the same time, attempts to advise that same client as to ongoing disclosure requirements.   We note that ABA Model Rule of Professional Conduct 2.3 makes a special provision for cases where a lawyer is asked by a client to evaluate that client's internal information for the use of an outside party, such as a government agency.   Model Rule 2.3(a)(1) provides that

[a] lawyer may undertake an evaluation of a matter affecting a client for the use of someone other than the client if ... the lawyer reasonably believes that making the evaluation is compatible with other aspects of the lawyer's relationship with the client. (emphasis added)

 

 In offering an example of the practical implications that flow from this requirement, the Comment to Model Rule 2.3 cautions that

[I]f the lawyer is acting as advocate in defending the client against charges of fraud, it would normally be incompatible with that responsibility for the lawyer to perform an evaluation for others concerning the same or a related transaction.

 

 We express no opinion as to whether Fehn's representation of Wheeler and CTI in connection with the SEC investigation was "compatible" with counseling these same parties about compliance with SEC disclosure requirements.   What is clear, however, is that the SEC disclosure requirements mandated disclosure of Wheeler's role as CTI's promoter and of the contingent liabilities stemming from CTI's and Wheeler's earlier securities law violations.   In failing to make the Form 10-Q's comply with these disclosure *1295 requirements, Fehn "substantially assist[ed]" in the primary disclosure violations.

 

3. Fehn's Scienter in Aiding and Abetting the Primary Violation

 

 The new Section 104, in authorizing SEC injunctive actions against aiders and abettors of the securities laws, makes clear that the requisite scienter for aiding and abetting liability is "knowingly."   This requirement is in keeping with the traditional scienter necessary to give rise to aiding and abetting liability under Section 10(b).   See Hauser, 14 F.3d at 1343 (requiring "actual knowledge" of the primary wrong and of the aider and abettor's "role in furthering [that violation]").

 

 [18] Fehn's knowledge of the primary violations was plainly established in this case.   First, Fehn knew that the representations in CTI's registration statement with respect to Wheeler's role as promoter were inaccurate.   In light of the information Fehn possessed when he undertook to review and edit the Form 10-Q's, Fehn must have known that the Form 10-Q's he helped to prepare perpetuated this inaccuracy and, furthermore, contained additional untrue statements about Wheeler's historical relationship with CTI.   Second, Fehn knew there was material information about CTI that Wheeler did not wish to disclose in the quarterly Form 10-Q reports, since Wheeler informed Fehn in no uncertain terms of his refusal to disclose in the Form 10-Q's his potential liability for past securities law violations.   The "knowledge" element was therefore clearly established in this case.

 

 III. The Entry of the Permanent Injunction against Fehn

 

 [19][20] Fehn's final challenge to the permanent injunction is that the district court abused its discretion in entering a permanent injunction against him because it erroneously failed to consider facts relevant to the propriety of a permanent injunction.   The granting or denying of injunctive relief "rests within the sound discretion of the trial court." SEC v. Goldfield Deep Mines Co. of Nevada, 758 F.2d 459, 465 (9th Cir.1985) (citing SEC v. Arthur Young & Co., 590 F.2d 785, 787 (9th Cir.1979)).   A district court's grant of permanent injunctive relief is therefore reviewed for an abuse of discretion or application of an erroneous legal principle.  United States v. Yacoubian, 24 F.3d 1, 3 (9th Cir.1994).

 

 We first consider what factors we must examine in evaluating the propriety of the district court's decision to permanently enjoin Fehn from the future aiding and abetting of violations of Sections 10(b) and 15(d) of the Securities Exchange Act.   Before Congress enacted Section 104 of the Private Securities Litigation Reform Act, we followed the standard outlined in SEC v. Murphy, 626 F.2d 633 (9th Cir.1980).   We conclude that this standard remains appropriate in the context of Section 104, since we can find no indication that Congress, in enacting Section 104, intended to vary the pre-Central Bank standard for injunctive actions.

 

 [21] To obtain a permanent injunction, the SEC "had the burden of showing there was a reasonable likelihood of future violations of the securities laws."  Id. at 655 (citations omitted).   We acknowledge that there is "[n]o per se rule requiring the issuance of an injunction upon the showing of [a] past violation," SEC v. Koracorp Indus., Inc., 575 F.2d 692 (9th Cir.), cert. denied, 439 U.S. 953, 99 S.Ct. 348, 58 L.Ed.2d 343 (1978), but, as we explained in Murphy, "[t]he existence of past violations may give rise to an inference that there will be future violations;  and the fact that the defendant is currently complying with the securities laws does not preclude an injunction."  Murphy, 626 F.2d at 655.

 

 [22] In "predicting the likelihood of future violations," we must assess  "the totality of the circumstances surrounding the defendant and his violations," and we consider such factors as

(1) the degree of scienter involved;  (2) the isolated or recurrent nature of the infraction;  (3) the defendant's recognition of the wrongful nature of his conduct;  (4) the likelihood, because of defendant's professional occupation, that future violations *1296 might occur;  (5) and the sincerity of his assurances against future violations.

 

 Id. (citations omitted).

 

 [23] Applying these factors to this case, we conclude that the evidence was adequate to support the permanent injunction issued by the district court. Although the second factor weighs in Fehn's favor, since the SEC cites no other securities law violations on Fehn's part, other factors weigh against him. First, it was established at trial that Fehn aided and abetted violations of key antifraud and disclosure provisions of the Securities Exchange Act. Second, as discussed above, the SEC established that Fehn possessed the requisite knowledge to aid and abet the primary violations by CTI and Wheeler. Although Fehn denies, and the SEC does not allege, that he intended to defraud investors, that degree of scienter is not necessary to prove aiding and abetting.   Third, Fehn's lack of remorse is apparent in his continued insistence on the validity of his advice to Wheeler with respect to the scope of the Fifth Amendment privilege.   Fourth, Fehn's professional occupation tends to suggest a risk of future violations, since a significant portion of his past practice involved representing clients in connection with the Securities Exchange Act of 1934.   Finally, the sincerity of Fehn's assurances against future violations is difficult to gauge, but we note that sincere assurances of an intent to refrain from aiding and abetting future violations are insufficient, without more, to militate against an injunction.  Id. at 656.

 

 Based on our consideration of the relevant factors, we conclude that the district court did not abuse its discretion in permanently enjoining Fehn from future violations.   Although Fehn has foresworn future violations, in our view, other factors ultimately weigh in favor of the injunction entered below.

 

CONCLUSION

 

 We affirm the district court's final judgment against Fehn and its order permanently enjoining Fehn from future aiding and abetting of violations of Sections 10(b) and 15(d) of the Securities Exchange Act of 1934 and related regulations.

 

END OF DOCUMENT

31.

S.E.C. v. Enterprises Solutions, Inc., 142 F.Supp.2d 561, Fed. Sec. L. Rep. P 91,462 (S.D.N.Y., Jun 06, 2001) (NO. 00 CIV. 2685 (MGC))

 

United States District Court,

S.D. New York.

 

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,

v.

ENTERPRISES SOLUTIONS, INC., Herbert S. Cannon, Dr. John A. Solomon,

Defendants,

and

Rowen House, Ltd., and Montville, Ltd., Relief Defendants.

 

No. 00 Civ. 2685(MGC).

 

June 6, 2001.

 

 Securities and Exchange Commission (SEC) brought fraud enforcement action against company purportedly involved in Internet security software development, company's CEO, and company's founder/consultant, who had history of criminal and regulatory violations. Following bench trial, the District Court, Cedarbaum, J., held that: (1) consultant's significant involvement in management was material omission; (2) CEO and consultant acted with scienter in concealing consultant's role; (3) CEO and consultant were liable both as primary violators and as control persons; (4) CEO failed to show good-faith reliance on in-house counsel; (5) press release which described its software as "bondable" and having "high integrity" was materially misleading; (6) statements on web site that company had developed suite of products and established customer relationships were materially misleading; and (7) permanent injunction and third-tier statutory penalties were warranted against consultant.

 

 Judgment for SEC.

 

West Headnotes

 

[1] Witnesses 309

410k309 Most Cited Cases

 

Fifth Amendment does not prohibit drawing adverse inferences when party in civil action invokes privilege against self-incrimination.  U.S.C.A. Const.Amend. 5.

 

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[21] Securities Regulation 150.1

349Bk150.1 Most Cited Cases

 

In exercise of its equity powers, district court may order disgorgement of profits acquired through securities fraud.  Securities Exchange Act of 1934, §  10(b), 15 U.S.C.A. §  78j(b);  17 C.F.R. §  240.10b-5.

 

[22] Securities Regulation 171

349Bk171 Most Cited Cases

 

Permanent injunction was warranted against company's founder/consultant, who had history of criminal and regulatory violations, as remedy for securities fraud consisting of concealing from public his role in managing company; besides having history of fraud, consultant had been principal architect of scheme to conceal his involvement with company, including his equity interest, and still had ability to affect company's activities through his ownership of holding entities.  Securities Exchange Act of 1934, §  10(b), 15 U.S.C.A. §  78j(b);  17 C.F.R. §  240.10b-5.

 

[23] Securities Regulation 171

349Bk171 Most Cited Cases

 

Permanent injunction prohibiting securities fraud defendants from committing further violations is appropriate where there is likelihood that, unless enjoined, violations will continue.  Securities Exchange Act of 1934, §  10(b), 15 U.S.C.A. §  78j(b);  17 C.F.R. §  240.10b-5.

 

[24] Securities Regulation 171

349Bk171 Most Cited Cases

 

Factors in whether imposition of injunctive relief is warranted in securities fraud action include: (1) history of past violations; (2) whether present violation was founded on systematic wrongdoing, rather than an isolated occurrence; (3) degree of culpability of defendants; and (4) whether defendants have admitted wrongdoing.  Securities Exchange Act of 1934, §  10(b), 15 U.S.C.A. §  78j(b);  17 C.F.R. §  240.10b-5.

 

[25] Securities Regulation 149

349Bk149 Most Cited Cases

 

"Third-tier" statutory penalties were warranted against company's founder/consultant as remedy for securities fraud consisting of knowing misrepresentations as to company's development of saleable Internet security software, and massive sale of consultant's stock in company just before Securities and Exchange Commission (SEC) suspended trading; conduct involved deceit and resulted in substantial losses.  Securities Exchange Act of 1934, §  10(b), 21(d)(3)(B)(iii), 15 U.S.C.A. § §  78j(b), 78u(d)(3)(B)(iii);  17 C.F.R. §  240.10b-5.

 *565 Securities and Exchange Commission by Charles Stodghill,  Carleasa Coates, Leo J. Kane, John Field, Washington, DC, for Plaintiff S.E.C.

 

 Tighe Patton Armstrong Teasdale by Thomas Earl Patton, Washington, DC, for Defendant Herbert S. Cannon.

 

 Martin & Adams by Kenneth A. Martin, Washington, DC, for Defendant John A. Solomon.

 

 Corrigan & Morris by Stanley C. Morris, Los Angeles, CA, for Defendant John A. Solomon.

 

OPINION

 

 CEDARBAUM, District Judge.

 

 This is a civil enforcement action brought by the Securities Exchange Commission ("the Commission") against Enterprises Solutions, Inc. ("ESI" or "the company"), its president and CEO John A. Solomon, and Herbert S. Cannon, whom the Commission alleges controlled the company.  The Commission suspended trading of ESI stock on March 30, 2000, and instituted this suit shortly thereafter. The Commission named Rowen House, Ltd. and Montville, Ltd., both Gibraltar corporations, as relief defendants, alleging that they were also controlled by Cannon and used by him to sell thousands of shares of ESI stock at inflated prices.  On May 1, 2000, I granted the Commission's motion to freeze the assets of Rowen House and Montville held by the Manhattan brokerage firm Wall Street Equities, Inc. S.E.C. v. Enterprises Solutions, Inc., No. 97 Civ. 0883(MGC) (S.D.N.Y. May 1, 2000) (order granting preliminary injunction).

 

 The Commission alleges that ESI violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, by knowingly and intentionally failing to disclose in its November 18, 1999 Form 10-SB Registration Statement (the "Registration Statement") Cannon's involvement with the company, and the fact that C.E.A., Inc. had gone into bankruptcy while Solomon was its CEO. The Commission also alleges that ESI made material misrepresentations in press releases issued on March 14, 2000 and March 28, 2000, and on the ESI website. The Commission asserts both primary and control person liability against Solomon and Cannon for these violations.

 

 On October 12, a consent judgment was entered against ESI, enjoining it from committing further securities violations.  In connection with the consent judgment, ESI agreed, among other things, to produce documents and make witnesses available to the Commission.  S.E.C. v. Enterprises Solutions, Inc., No. 00 Civ. 2685 (S.D.N.Y. Oct. 12, 2000) (Consent Judgment against Enterprises Solutions, Inc.).

 

 From January 8, 2001 through January 16, 2001, I conducted a bench trial of the Commission's claims against defendants Cannon and Solomon.  The Commission presented as witnesses John Solomon, Jack Skidell, owner of the brokerage firm Colin Winthrop & Co., Inc., and Salvatore Cerruto, a stock trader at Wall Street Equities.  In addition to the live testimony, the Commission submitted excerpts, agreed to by all parties, from the depositions *566 of Herbert Cannon;  Nina Cannon, former secretary and director of ESI and Herbert Cannon's daughter;  Roger Schell, executive vice president and head of engineering at ESI;  and Neal Milch, a free-lance investor who had considered investing in ESI in late 1999 and early 2000.  Defendant Cannon's deposition testimony consisted of invocations of the Fifth Amendment privilege against self-incrimination.

 

 Defendants presented no witnesses.

 

FINDINGS OF FACT

 

 After examining all of the evidence, observing the demeanor of the witnesses who testified in the courtroom, and considering the credibility and plausibility of all the testimony, I make the following findings of fact.

 

 Background

 

 ESI is a Nevada corporation that was originally incorporated in 1987 under the name Sedgewicke Business Alliance, Inc. In 1994, the company changed its name to American Casinos International, Inc. ("ACII") and entered the casino gaming business.  In March 1999, the company changed its name to ESI. Following the change of its name to ESI, the company purported to be in the business of internet security software.  Until the summer or early fall of 1999, however, ESI was merely a corporate shell with no employees or facilities.  Wayne Kight was the nominal president of the company, but Herbert Cannon made most of the managerial decisions.

 

 Herbert Cannon is the principal of HSC Consulting, Inc., a consulting firm based in Boca Raton, Florida.  Until March 20, 2000, ESI retained Cannon and HSC Consulting to provide consulting services, for which Cannon received $3,000 a month.

 

 At the time that the Registration Statement was filed with the Commission, Cannon owned an undisclosed number of shares of ESI common stock through his ownership of Worldnet Communications, Inc. and Romsley Ltd. The Commission proved by a preponderance of the credible evidence that, in addition to these shares, Cannon was the beneficial owner of a large number of ESI shares held by Rowen House, Ltd., Humphrey, Ltd., Montville, Ltd., Effingham, Ltd. and Coltmill, Ltd., Gibraltar companies that share an address at 1 Coral Road, Suite 2A, Gibraltar (collectively the "Gibraltar entities").

 

 [1] The documents establishing the accounts of the Gibraltar entities with the brokerage firms Colin Winthrop and Wall Street Equities were signed by "Elizabeth A. Plummer."  Nevertheless, Jack Skidell and Salvatore Cerruto, the stock brokers who handled the accounts, testified that Cannon directed nearly all the purchases and sales of securities for those accounts.  In addition, the signatures on several of the documents purportedly signed by Plummer are suspiciously different.  Of the documents that were notarized, most were notarized in Palm Beach County, Florida, some by Cannon's wife.  The most persuasive evidence of Cannon's ownership of the Gibraltar entities is a resolution of the ESI Board of Directors on February 7, 2000, which approved the issuance of 198,500 shares of restricted common stock to Rowen House "in repayment of the $198,500 loaned to the company, including the loan from HSC Consulting Inc." Thus, ESI repaid a loan from Cannon's consulting firm by issuing stock to Rowen House.  When asked at his deposition whether he owned any equity interest in the Gibraltar entities, Cannon invoked the Fifth Amendment privilege against self-incrimination. [FN1]  *567 Further, Neal Milch testified that while he was considering investing in ESI in early 2000, Cannon told him that he owned 500,000 of ESI's 5,200,000 outstanding common shares and 500,000 warrants to buy additional common shares. [FN2]  As no other evidence has been offered to explain the manner in which Cannon owned those shares, the inference that he owned them through the Gibraltar entities is strengthened.

 

 

FN1. Cannon's invocation of the privilege in a civil case permits the inference that he did, in fact, own shares in ESI through the Gibraltar entities.  See Baxter v. Palmigiano, 425 U.S. 308, 318-20, 96 S.Ct. 1551, 47 L.Ed.2d 810 (1976) (Fifth Amendment does not prohibit drawing adverse inferences when a party in a civil action invokes the privilege against self-incrimination);  LiButti v. United States, 107 F.3d 110, 121 (2d Cir.1997).  Cannon argues that the mere invocation of privilege, alone, may not support an adverse finding.  See United States v. Stelmokas, 100 F.3d 302, 311 (3rd Cir.1996) (requiring independent evidence to support adverse inference drawn from invocation of the privilege); United States v. Village of Island Park, 888 F.Supp. 419, 432 (E.D.N.Y.1995) (same).  In any event, the Commission has presented sufficient independent evidence to support the adverse inference.

 

 

FN2. The Milch testimony was received as an admission of a party opponent only with respect to Cannon.  Fed.R.Evid. 801(d)(2).

 

 

 When ESI filed the Registration Statement with the Commission, Humphrey owned 275,001 shares, 5.9% of the outstanding common stock, and was the largest shareholder of ESI. Rowen House owned 244,168 common shares, 5.2% of the outstanding common stock.

 

 Cannon has a history that precluded him from openly serving as an officer or director of ESI. In 1985, Cannon pleaded guilty to a charge of conspiracy to defraud the United States in the collection of income tax.  In 1987, he was convicted under New York's larceny statute in connection with the mishandling of funds of a chartered bank, and he also pleaded guilty in those proceedings to two counts of failure to pay state income tax.  In 1988, Cannon again pleaded guilty to one count of conspiracy to defraud the federal government. In 1994, he was sentenced by the United States District Court for the District of New Jersey to five years probation and 500 hours of community service, and ordered to pay $10,000 in court costs, for selling fraudulent coal mine tax shelters to investors.  The coal mines at issue did not engage in any actual mining operations.  In 1988 and 1993, the Commission obtained civil judgments against Cannon enjoining him from further violating provisions of the securities laws.  In addition, in August of 1987, the Commission issued an order barring Cannon from the securities industry.

 

 John A. Solomon is the current president and chief executive officer of ESI. He began his employment with ESI on October 14, 1999. Prior to his employment with ESI, Solomon's principal management experience was with a private software company called CEA, Inc., for which he served as senior vice president of operations and, later, as chief executive officer.  CEA went into bankruptcy in 1995, while Solomon was the CEO. Solomon personally entered bankruptcy shortly thereafter.

 

 Between 1995 and 1999, Solomon worked as a consultant.  In November 1996, he filed a disability claim for depression and anxiety with UNUM Life Insurance Co. of America and received approximately $6,400 per month in disability payments until at least April 2000.  In late December 1999, despite having been nominally employed by ESI for more than two months, Solomon submitted an "Insured's Progress Statement" to UNUM in connection with his disability claim in which he represented that he had not engaged *568 in any occupation since his last report.  On an April 17, 2000 Insured's Progress Statement, Solomon stated that he was "participat[ing] in running a high tech company" on a "part time basis."  From October 1999 until at least April 2000, Solomon received disability payments from UNUM as well as compensation from ESI.

 

 Organization of ESI

 

 In the summer of 1999, while working on network security applications for Novell, Inc., Roger Schell, Rich Lee and Gary Baker put together an engineering plan to design internet security software.  Schell was the senior engineer and had extensive experience in the field of computer security.  He taught computer science at the Naval Postgraduate School after receiving his Ph.D. in 1971.  He then served as deputy director of the Department of Defense ("DOD") Computer Securities Center.  After leaving the DOD, he helped form Gemini Computers, a company specializing in computer security.  He left Gemini in 1993 and, in 1994, joined Novell, Inc., a network operating system company.  Lee and Baker worked under him at Novell.

 

 The engineering plan involved taking existing security technology developed by Gemini and Novell and redesigning it for the Internet.  After an unsuccessful relationship with Sistex, a wholly owned subsidiary of Infotex, a company for which Cannon had been a consultant, Schell was advised by Bob Pollock, president of Sistex, to talk to Cannon about obtaining capital from investors.  Pollock also served ESI as a consultant.

 

 In approximately June of 1999, Schell met with Cannon in Florida.  At that meeting, Schell described his engineering plan to Cannon.  Schell hoped to develop an Internet security product that could be certified by the National Security Agency at the highest security level, "Al," within two years.  The theory was that the product would be so secure that an insurer would issue a bond guaranteeing the information the product was securing.  Schell's plan referred to the fully evaluated and certified security product as "bondable." Schell also hoped to develop certain "pre-release products" within a period of 12 to 16 months.  These products would not be certified, but could be sold to customers as part of the process of developing a certified product.  He estimated that the project would require an initial investment of $5 million for the first year and $10 to 30 million for further development.  Cannon said that he knew of individuals who would be willing to invest in the project.  It was Schell's understanding that Cannon and his associates would supply the initial investment, and that the company would seek outside investment for further funding.

 

 Cannon proposed using ESI as the corporate entity through which the project would be funded.  Cannon described ESI as a corporate shell with no employees, no facilities and no chief executive.  Although he described himself as a consultant to ESI, Cannon said that he would provide management leadership for the company until a chief executive could be found.  He offered Schell the position of chief executive, but Schell declined because he preferred to focus on engineering, which he believed was the key to the success of the project. Cannon referred to a board of directors, but described it as a "temporary transitional board" and described the directors as place holders.  Schell testified that it was his understanding that Cannon would be his boss if he was hired by ESI. Cannon did not disclose his criminal convictions or regulatory problems to Schell.

 

 After this meeting, Schell forwarded to Cannon the resumes of Rich Lee and Gary *569 Baker.  He also sent Cannon a description of the engineering objectives that needed to be met before the company could market any products. The most important requirement on this list was access to Novell and Gemini intellectual property, without which there could be no product development.

 

 Schell testified that these engineering requirements were never met while he was with the company.  The company entered into a teaming agreement with Gemini, pursuant to which ESI was authorized to distribute Gemini products under its own label.  That agreement did not provide ESI with access to Gemini's source code.  Further, under the teaming agreement all enhancements and developments of Gemini products would be owned exclusively by Gemini.  ESI, through Cannon, was in the process of negotiating an acquisition of Gemini, but that transaction fell through after the Commission suspended trading of ESI stock.

 

 Schell further testified that during his employment with ESI, no actual product development took place because the company never acquired access to the necessary Gemini and Novell intellectual property and never obtained the technical tools required to develop products.  The company's only product to date, ESIGuard, is actually a 1995 Gemini product called GemGuard marketed under the ESI label.  GemGuard was an adaptation of an earlier Gemini product. The earlier product had received A1 certification at the time, but the GemGuard product had never been evaluated.  In Schell's opinion, neither GemGuard nor ESIGuard was a "bondable" product.  Although certain potential customers, AIG Insurance and Market Data, had tested the product, they never purchased it, and no product was sold by ESI. Schell, who initially maintained the financial records of the company, testified that he was told not to expect any revenue from the AIG and Market Data relationships.

 

 Following his June 1999 meeting with Schell, Cannon met briefly with Lee and Baker.  Shortly thereafter Cannon distributed proposed employment agreements to Schell, Lee and Baker.  The terms of the employment agreements had been negotiated by Cannon and Schell at the June 1999 meeting.  Schell, Lee and Baker accepted employment and began working for ESI in August 1999.  Schell's title was executive vice president and head of engineering;  Lee and Baker were vice presidents.  They worked in an independent division of ESI called the Secure Systems Solutions division.

 

 In August of 1999, Cannon contacted Solomon regarding the chief executive position with ESI. Solomon was recommended to Cannon by Jeffrey Moritz, treasurer and director of ESI at that time, with whom Solomon was acquainted. Cannon invited Solomon to New York and they met at the Waldorf Astoria Hotel in early September.  At that meeting, Cannon identified himself as the senior management consultant to ESI and told Solomon that he had past problems that prohibited him from being an officer or director.  Cannon then briefly described the business of ESI. Solomon, in turn, described his background, including the fact that his prior company, CEA, had gone into bankruptcy.  He then stated his compensation terms:  a three year contract, salary of $200,000 per year with the possibility of raises up to $500,000, stock in the company, profit sharing of up to 7% and a credit line of up to $750,000.  Cannon approved of these terms and told Solomon that if the company did well, the board would not deny him anything.  Following this meeting, Solomon had brief telephone conversations with Wayne Kight and Moritz.  He *570 was then notified that he had been hired.  Solomon rejected the first contract, which did not provide for the $750,000 line of credit.  Shortly after, Kight sent him a new contract that contained the line of credit provision.  That contract was executed on September 15, 1999.

 

 When Solomon joined ESI, the company had $328 in revenue and assets of approximately $30,000.  Solomon worked out of his residence in Massachusetts. Wayne Kight, who then held the position of vice president of operations and was in charge of the company's finances, operated out of Boca Raton, Florida.  The engineering department, headed by Schell, was in Monterey, California.  The Board of Directors consisted of Wayne Kight, Jeffrey Moritz and Nina Cannon Anthony, Cannon's daughter.  Solomon testified that he was not aware that Anthony was Cannon's daughter until sometime later.  The company had no source of revenue and paid salaries and expenses through the sale of stock and loans from stockholders.  Company records at that time showed loans to ESI, arranged by Cannon, from Rowen House, HSC Consulting, Effingham, Ltd., all companies owned or controlled by Cannon, and Omega Funding, a company owned by Nina Cannon Anthony.

 

 After Solomon was hired, he took several steps to demonstrate his authority.  Schell testified that, in late September 1999, Solomon circulated a memorandum in which he stated that he was at the top of the chain of command. In December 1999, Solomon called an "all hands meeting," which Cannon attended.  At the meeting, Solomon addressed the staff and reaffirmed that he was running the company, and Cannon agreed.  On February 7, 2000, Solomon presented an organizational plan to the Board of Directors, which identified Solomon as the person to whom everyone was to report and did not include Cannon in the company hierarchy.

 

 Notwithstanding the formal declarations that Solomon was in charge, the Commission presented substantial evidence that Cannon controlled the company. Milch testified that Cannon made it absolutely clear that he was the one running the company. [FN3]  Cannon said that he could not be an officer or director of the company because of "SEC issues," and he agreed that he would be a "red flag" to investors.  Instead, he put his daughter on the Board to look after his interest.  Cannon further said to Milch that he had hired Solomon and understood that as the company grew he might have to replace him.  In addition, Schell testified that, on three occasions, Cannon paid ESI's expenses with his own credit card.  Solomon testified that he forwarded a draft of the Registration Statement to Cannon on at least one occasion.  The Commission also presented an email from Solomon to an ESI attorney that contained Cannon's comments and suggestions for the Registration Statement.  In addition, board minutes and corporate resolutions indicate that Cannon negotiated loans for the company, arranged for sales of stock to investors and negotiated the proposed acquisition of Gemini.  When asked at his deposition whether he controlled ESI, Cannon invoked the Fifth Amendment privilege against self-incrimination.

 

 

FN3. According to Milch, Cannon also said that ESI would be "a good stock play," and therefore Milch's investment in the company could be profitable even if the company were not successful.  The Milch testimony was received only with respect to Cannon.  See, supra, note 2.

 

 

 Cannon's services as a consultant were terminated by ESI on March 20, 2000, ten days before the Commission suspended trading of ESI stock.  This fact alone *571 does not rebut the substantial evidence presented by the Commission that Cannon controlled ESI. Moreover, there is contradictory evidence as to the reason for Cannon's termination.  The minutes of the March 20, 2000 Special Meeting of the ESI Board, at which the Board terminated Cannon, state that the consulting agreements with HSC Consulting were terminated "due to personal time constraints of HSC Consulting."  But Solomon testified that he fired Cannon because Cannon failed to meet certain objectives for which he was retained and that the board minutes were falsified at the request of Nina Cannon to protect her father's reputation.

 

 The Alleged Violations

 

 As of September 1999, ESI was listed on the National Association of Securities Dealers ("NASD") Over-The-Counter bulletin board ("OTC bulletin board") under the symbol EPSO. According to the monthly statements of the Gibraltar entities at Colin Winthrop and Wall Street Equities, ESI was trading at approximately $6 to $7 per share in September 1999.

 

 At about this time, the NASD instituted a rule that companies whose stock was traded on the bulletin board were required to file audited financial statements.  The NASD selected stocks alphabetically, and gave the selected companies 30 days to make the required filings.  The NASD indicated on the bulletin board that a company was selected and had 30 days to file by placing an "E" after the stock symbol.  If a company failed to comply it would be de- listed from the bulletin board, and shares of that company's stock could only be traded in the "pink sheets."  Prices of stocks in the pink sheets are not quoted to the public.  Consequently, shares of de-listed stock are more difficult to sell.

 

 In October 1999, Salvatore Cerruto, a broker at Wall Street Equities who handled the accounts of the Gibraltar entities, contacted Cannon and warned him that if ESI did not submit its audited financial statements, it would be de- listed.  Cannon told Cerruto that ESI's accountants had everything ready and were prepared to file with the NASD.

 

 In early November 1999, ESI was de-listed from the OTC bulletin board.  On November 18, ESI filed a Form 10-SB Registration Statement with the Commission in connection with its application to the NASD to be re-listed.  The preparation of that document by the law firm of Bondy & Schloss, ESI's attorneys, had begun prior to Solomon's employment with the company.  Solomon filled out a questionnaire, given to him by ESI's attorneys, that contained information about his business background, including business and personal bankruptcies.  He reviewed drafts of the Registration Statement and suggested changes.  Solomon signed the Registration Statement on behalf of the company. Cannon also reviewed a draft of the Registration Statement and suggested changes to it on at least one occasion.  The Registration Statement did not describe Cannon as either a promoter or control person of ESI. It contained no mention of Cannon.  The Registration Statement described Solomon's management experience with CEA, but did not disclose that CEA had gone into bankruptcy.

 

 Schell testified that toward the end of 1999, ESI's development activities were redirected.  He received a revised business plan, approved by the board of directors, that focused more on the short termsale of ESIGuard and less on the longer term development of products that Schell had envisioned.  While discussing the new business plan, Solomon told Schell that the old business plan was not "sellable" to investors.  The change of direction created tension between Schell and Solomon.  *572 Roughly a month after Solomon joined ESI, Schell was asked to give a presentation on the nature of ESI's business to AIG. Shortly before the presentation, Schell and Solomon had what Schell characterized as an "animated discussion" about the content of the presentation.  Schell said that he was trying to be technically accurate with respect to GemGuard, but Solomon told him that he needed to be more aggressive in presenting GemGuard as a product that could serve AIG's security needs.  On other occasions, Solomon pressured Schell to tell possible customers and investors that GemGuard was a "high assurance" or "bondable" product, but Schell was unwilling to make such statements because he believed that they were untrue.

 

 In January 2000, during the period in which ESI was de-listed from the OTC bulletin board, its stock price fell to as low as $2 per share.  It was re- listed sometime in February and began trading at approximately $6 to $7 again. On February 24, 2000, shortly after being re-listed, ESI entered into an agreement with Global Financial Group, Inc., a Minneapolis-based brokerage firm, pursuant to which ESI engaged Global to be its non-exclusive investment banker.  For the first 30 days following its re-listing, Global Financial Group was the only broker authorized to sell ESI stock on the OTC bulletin board.  By mid-March, however, other firms had entered the market and were selling ESI stock.

 

 On March 14, ESI issued a press release announcing that "the first of its bondable products, ESIGuard, is scheduled for release in April 2000."  Solomon testified that he believed, based on discussions with insurance companies, that ESIGuard was bondable.  Schell, who wrote the engineering plan which first used the term, testified that ESIGuard was not bondable.  I find that the description of ESIGuard as "bondable" was false.  Schell also testified that the term "bondable" does not have a precise definition in the industry, and was largely invented by him in the engineering plan.  The March 14 press release also used the phrases "high assurance," "high integrity" and "strong assurance" to describe the security properties of ESIGuard.  Based on Schell's testimony, I find that these descriptions overstated the level of security ESIGuard would provide.  Schell testified that ESIGuard was not certified and rated by the federal government, and without government certification there was no reason to believe that the product would be secure.  He also testified that within the company "there had been substantial discussion about the security properties or lack thereof of the GEMGuard."

 

 On March 28, ESI issued another press release announcing that "its Internet and Data Transfer Security Products have been granted Export approval by the U.S. Government."  ESI did not apply for export approval for ESIGuard, ESI's only product.  Gemini, however, obtained export approval for GemGuard.

 

 At about this time, Solomon arranged for an ESI web site to be posted on the Internet.  In the "About Us" portion of the web site, the company made the following representations:

Enterprise Solutions Inc. developed a suite of products and solutions for Internet security along with great network support--a combination that can't be beat!

Through our commitment, experience, and expertise Enterprise Solutions Inc. has established a business relationship with our customers that will last a lifetime!

  Solomon testified that he did not prepare the content of the site, but he did review it.  *573 He admitted that ESI had not, in fact, developed a suite of products.  He testified that certain products were under development, and the web site representation was an inadvertent mistake.  Solomon also admitted that the company had not sold any products.  Schell testified that he discussed the website with Solomon and raised his concern that it overstated the degree of development the company had achieved.  Solomon asked Schell to put his concerns in writing, and Schell did so.

 

 During late March, ESI's stock price rose sharply, with a high of $23 per share. [FN4]  On March 30, the Commission issued an order suspending the trading of ESI stock.

 

 

FN4. Skidell, a broker at Colin Winthrop, testified that there was a general increase in the price of technology stocks during February and March of 2000.  Defendants argue that the price increase occurred as a result of the general market trend.  It is undisputed, however, that the significant increase in the market price of ESI stock occurred in mid to late March, at the same time that ESI stock began being sold freely on the bulletin board, and ESI published the press releases and posted its web site.

 

 

    DISCUSSION

 

 **********************************************************************************

 

 Remedies

 

 The Commission seeks injunctive relief and imposition of statutory penalties against Cannon and Solomon, as well as an order of disgorgement against Cannon.

 

Disgorgement of Cannon's Profits

 

 [21] "In the exercise of its equity powers, a district court may order the disgorgement of profits acquired through securities fraud."  S.E.C. v. Patel, 61 F.3d 137, 139 (2d Cir.1995).  Through the Gibraltar entities, Cannon sold hundreds of thousands of shares of ESI stock in March of 2000 before the Commission suspended trading of the stock.  On March 30 and 31, Cannon's Montville account with Wall Street Equities was credited with over $2.2 million as proceeds of the sale of 152,000 shares of ESI stock.  The evidence does not allow for an exact calculation of Cannon's profits.  However, the amount of disgorgement "need only be a reasonable approximation of profits causally connected to the violation," Patel, 61 F.3d at 139.  The average purchase price of the shares in the Rowen House and Montville accounts for which there is evidence of a purchase price is $7.79 per share.  Assuming a comparable purchase price for the ESI shares sold by Cannon in late March 2000, I find that Cannon's profits from the sale of ESI stock were at least $1 million. Accordingly, I order Cannon to disgorge $1 million.

 

Injunctive Relief

 

 [22][23][24] A permanent injunction prohibiting defendants from committing further violations is appropriate where "there is a likelihood that, unless enjoined, the violations will continue."  First Jersey, 101 F.3d at 1477 (quoting Commodity Futures Trading Commission v. American Board of Trade, Inc., 803 F.2d 1242, 1250-51 (2d Cir.1986)).  The Second Circuit has identified several considerations that warrant imposition of injunctive relief, including a history of past violations, whether the present violation was "founded on systematic wrongdoing, rather than an isolated occurrence," the degree of culpability of *579 defendants, and whether defendants have admitted wrongdoing.  Id. (quoting United States v. Carson, 52 F.3d 1173, 1184 (2d Cir.1995)).

 

 After consideration of these factors, I permanently enjoin defendant Cannon from further violating the securities laws in connection with ESI. Cannon has an extensive history of criminal and regulatory violations, including securities fraud.  He was the principal architect of the scheme to conceal his involvement with ESI. Further, Cannon still has the ability to affect the activities of ESI through his ownership interest in the Gibraltar entities, which continue to own hundreds of thousands of shares of ESI stock.  Pursuant to the October 12, 2000, Consent Judgment, ESI disclosed Cannon's role as a promoter in subsequent SEC filings, but Cannon continues to deny any ownership interest in the Gibraltar entities.  These circumstances suggest a substantial likelihood of further violations and warrant injunctive relief.

 

 Solomon has no history of criminal violations, fraud or other misconduct and this is his first experience running a public company. The Commission has not demonstrated that Solomon is likely to commit further violations.  Accordingly, a permanent injunction against Solomon is not warranted.

 

Statutory Penalties

 

 The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the  "Remedies Act"), 15 U.S.C. §  78u(d)(3), prescribes three tiers of penalties for violations of the securities laws.  The second tier provides for a maximum penalty of $50,000, if the violation "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement."  15 U.S.C. §  78u(d)(3)(B)(ii).  The third tier provides for a maximum of $100,000, if, in addition, the violation "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons."  Id., §  78u(d)(3)(B)(iii).

 

 [25] The Commission has established that defendants' 10(b) violations involved fraud and deceit, and, as to Cannon, that his violations resulted in substantial losses to other persons.  Second tier statutory penalties are warranted against Solomon, and third tier against Cannon.  Accordingly, Cannon is directed to pay a statutory penalty of $100,000, and Solomon is directed to pay a statutory penalty of $10,000.

 

CONCLUSION

 

 The foregoing shall constitute my findings of fact and conclusions of law pursuant to Fed.R.Civ.P. 52(a).  The Clerk of the Court shall enter judgment in favor of the Commission and against defendants John Solomon and Herbert Cannon.  Cannon is permanently enjoined from committing further violations of the securities laws in connection with ESI, and is ordered to disgorge $1,000,000 in illicit profits and to pay a statutory penalty of $100,000.  Solomon is ordered to pay a statutory penalty of $10,000.

 

END OF DOCUMENT