Petition — United States v. Naftalin

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MICHAEL ROBAK, JR_CLERK |

Gu the Supreme Court of the UniteStaths ~

OCTOBER TERM, 1978

78-561

UNITED STATES OF AMERICA, PETITIONER

e.

NEIL T. NAFTALIN

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR

THE EIGHTH CIRCUIT

WADE H. MCCREE, JR.

Solicitor General

STEPHEN M. SHAPIRO

Assistant to the Solicitor General

Department of Justice

Washington, D.C. 20530

DAVID FERBER

Solicitor to the Commission

JAMES H. SCHROPP

Assistant General Counsel

LARRY R. LAVOIE

Attorney

Securities and Exchange Commission

Washington, D.C. 20549

INDEX

Page

Opinions below ta tet pd Saat Seal 1

STR oh 1

SE tenella SA ae 2

Statutory provisions involved ee Ee 2

Statement , 3

Reasons for granting the petition ______ Sosa 5

Conclusion 13

CITATIONS

Cases:

A. T. Brod & Co. v. Perlow, 375 F.2d 393_ 9

Blue Chip Stamps v. Manor Drug Stores,

i Su 12

Ernst & Ernst v. Hochfelder, 425 US.

185 7,8,9

Farrell v. United States, 321 F.2d 409___. 8-9

Hamling v. United States, 418 U.S. 87__ 5

Naftalin & Co. v. Merrill Lynch, Pierce,

Fenner & Smith, Inc., 469 F.2d 1166. 3-4

Piper v. Chris-Craft Industries, Inc., 430

Oe ph ae oe ort et eae eR ‘ 12

Sante Fe Industries, Inc. v. Green, 430

4 SS eee Se Se 7

Scarborough v. United States, 431 US.

563 9

Securities and Exchange Commission v.

C. M. Joiner Leasing Corp., 320 U.S.

Securities and Exchange Commission v.

Capital Gains Research Bureau, Inc.,

375 U.S. 180 8

II

Cases—Continued Page

Securities and Exchange Commission v.

National Securities, Inc., 393 U.S. 453. 7,8

United States v. Brown, 555 F.2d 336____.6, 9, 10

United States v. Culbert, No. 77-142

(March 28, 1978) 7,9

Statutes and regulations:

Securities Act of 1933, 15 U.S.C. 77a

et seq.:

Section 2(3), 15 U.S.C. 77b(3) _ 2,7

Section 17(a) (1), 15 U.S.C. 77q(a)

8) SSE a ia el ee 2, 4, 5, 6, 7, 9, 11, 12

Section 24, 15 U.S.C. 77x 12

Securities Act of 1934, 15 U.S.C. 78a et

seq.:

Section 2, 15 U.S.C. 78b _ SAE 8

Section 10(b), 15 U.S.C. 78j(b) Be 11

Section 15, 15 U.S.C. 780 et seg. _____. 13

Section 17A, 15 U.S.C. 78q-1 et seq... 13

15 U.S.C. 80b-1 et seq. _ ae 13

12 C.F.R. 220.8(d) EES 3

17 C.F.R. 240.10a-1 (d) Aa taebiciie gles 3

17 C.F.R. 240.10a-2(a) ———_______ 4,10

17 C.F.R. 240.10b-5 Piae: 9

Miscellaneous:

42d SEC Ann. Rep. (1976) 12

H. R. Conf. Rep. No. 94-229, 94th Cong.,

See TO ASO 12

1 L. Loss, Securities Regulation (2d ed.

1961) 7

2 L. Loss, Securities Regulation (2d ed.

1961) 4

Iu the Supreme Court of the United States

OCTOBER TERM, 1978

No.

UNITED STATES OF AMERICA, PETITIONER

Vv.

NEIL T. NAFTALIN

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR

THE EIGHTH CIRCUIT

The Solicitor General, on behalf of the United

States, petitions for a writ of certiorari to review

the judgment of the United States Court of Appeals

for the Eighth Circuit in this case.

OPINIONS BELOW

The opinion of the court of appeals (App. A,

infra, la-lla) is reported at 579 F.2d 444. The

opinion of the district court (App. D, infra, 15a-

20a) is not reported.

JURISDICTION

The judgment of the court of appeals (App. B,

infra, 12a-13a) was entered on June 13, 1978. A

timely petition for rehearing was denied on August

(1)

2

4, 1978 (App. C, infra, 14a). On August 31, 1978,

Mr. Justice Blackmun extended the time for filing a

petition for writ of certiorari to and including Oc-

tober 3, 1978. The jurisdiction of this Court is in-

voked under 28 U.S.C. 1254(1).

QUESTION PRESENTED

Whether Section 17(a)(1) of the Securities Act

of 1933 prohibits fraudulent practices that injure

brokers who serve as intermediaries in securities

transactions but who are not themselves investors.

STATUTORY PROVISIONS INVOLVED

1. Section 17(a) (1) of the Securities Act of 1933,

15 U.S.C. 77q(a) (1), provides in part:

It shall be unlawful for any person in the offer

or sale of any securities by the use of any means

or instruments of transportation or communica-

tion in interstate commerce or by the use of the

mails, directly or indirectly—

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

to defraud * * *

2. Section 2(3) of the Securities Act of 1933, 15

U.S.C. 77b(3), provides in part:

The term * * * “offer” shall include every at-

tempt or offer to dispose of, or solicitation of

an offer to buy, a security or interest in a se-

curity, for value.

STATEMENT

1. Respondent, the principal of a registered broker-

dealer firm and a sophisticated professional investor,

engaged in a “short selling” scheme. Respondent se-

lected stocks that, in his judgment, had peaked in

price and were entering into a period of market de-

cline. He then placed with brokers orders to sell

shares of these stocks, although he did not own the

shares he purported to sell (App. D, infra, 16a-18a).

Gambling that the price of securities would decline

substantially before he was required to deliver them,’

respondent planned to make offsetting purchases

through other brokers at lower prices and to take as

profit the difference between the price at which he

sold and the price at which he covered. Respondent

falsely represented that he owned the shares he

“sold;” he knew that the brokers who executed the

sell orders would not have accepted them had they

known that he did not own the securities (id. at

17a).?

1A broker may immediately execute an order to sell a cus-

tomer’s shares if it “is informed that the seller owns the

security ordered to be sold and, as soon as is possible without

undue inconvenience or expense, will deliver the security

** *” 17 C.F.R. 240.10a-1(d).

2 By misrepresenting his ownership of the shares, respond-

‘ent avoided the requirement that “short” sellers (that is,

persons who sell a promise to produce shares in the future)

make a substantial “margin” deposit with the brokers. See

Regulation T, 12 C.F.R. 220.8(d). Brokers executing short

sales are protected by such deposits against market fluctua-

tions. Respondent’s scheme, known colloquially as “free rid-

ing,” is also described in Naftalin & Co. v. Merrill Lynch,

4

The market prices of the securities that respondent

“sold” rose sharply prior to the settlement date. He

was unable to make covering purchases, and he never

delivered the securities (App. D, infra, 18a). The

five brokers with whom respondent had placed the

sell orders had in turn promised to deliver the shares

to investors at the prices prevailing when respondent

began his scheme. In order to keep their delivery

promises, the brokers purchased the stock on the open

market, a process known as “buying-in,” at an ag-

gregate loss to themselves of more than $1,000,000.°

2. After making the findings described above, the

district court found petitioner guilty on eight counts

of employing a scheme or artifice to defraud in the

sale of securities, in violation of Section 17(a) (1)

of the Securities Act of 1933, 15 U.S.C. 77q(a) (1).

See App. D, infra, 15a-20a. Although the court of

appeals thought the evidence sufficient to establish

that respondent committed fraud (App. A, infra, 5a),

it reversed his convictions. Reasoning that the pur-

pose of Section 17(a) (1) is to “protect investors from

fraudulent practices in the sale of securities” (App.

A, infra, 6a-7a), the court concluded that “the gov-

Pierce, Fenner & Smith, Inc., 469 F.2d 1166, 1171-1172 (8th

Cir. 1972), which found that he had engaged in “obvious and

calculated wrongdoing.”

® When a sell order is executed, and the seller fails to make

delivery when due, the broker normally must “buy-in” substi-

tute securities for the purchasers. See 17 C.F.R. 240.10a-2(a).

See also 2 L. Loss, Securities Regulation 122$-1235 (2d ed.

1961). This “buy-in” procedure serves as a form of insurance

for investors who purchase securities.

a

5

ernment must prove some impact of the scheme on

an investor” (id. at 8a). Because respondent’s fraud

injured brokers rather than investors, the court held,

respondent’s acts did not violate Section 17(a) (1).

The court reversed the conviction on the sixth count

of the indictment even though that count involved

fraud on a broker who traded for his own account

as an investor (App. D, infra, 17a). The court rea-

soned that “the indictment did not allege that [the

defrauded broker] was a purchaser and * * * [re-

spondent] could not be tried on charges that were not

made” (App. A, infra, 10a).* Judge Ross dissented

from the court’s disposition of Count 6 of the in-

dictment (id. at 1la).

REASONS FOR GRANTING THE PETITION

The decision of the court of appeals, which limits

the coverage of Section 17(a) (1) to fraudulent prac-

tices injuring “investors,” effectively removes federal

criminal prohibitions against fraudulent securities

* We believe that the court’s disposition of Count 6 is im-

proper even assuming, for this purpose, that Section 17 (a) (1)

applies only to fraud on “investors.” Ordinarily an indictment

is sufficient if it sets out the language of the statute and the

essential facts of the offense. Hamling v. United States, 418

U.S. 87, 117 (1974). Count 6 unquestionably is sufficient

‘under the standard of Hamling. But because the court’s treat-

ment of Count 6 appears to involve only the (mis) application

of settled principles to particular facts, we do not present

it as a separate question for this Court’s review. Of course,

if the Court should accept our construction of Section 17 (a)

(1), it would follow that the convictions on all counts should

be reinstated.

6

schemes in which the fraudulent statements are made

to financial institutions serving as intermediaries in

securities transactions. But the statute applies on its

face to all fraudulent practices in “the offer or sale

of any securities.” This language prohibits fraud

aimed at non-investor financial institutions. The Sec-

ond Circuit has applied Section 17(a)(1) at face

value, squarely rejecting the “investor” limitation

adopted by the court below. See United States v.

Brown, 555 F.2d 336, 338-399 (2d Cir. 1977).°

The decision in this case deprives the United States

and the Securities and Exchange Commission of power

to protect the principal participants in the nation’s

securities markets under Section 17(a)(1). Because

protection of such participants from fraudulent

schemes is essential to the integrity of the securities

marketplace, this Court should review the court of

appeals’ decision and resolve the conflict among the

circuits.

*’ Brown was prosecuted under Section 17(a) (1) for sub-

mitting counterfeit stock certificates to a transfer agent and

obtaining genuine certificates in smaller denominations in

exchange. Brown contended that his scheme was designed

to defraud the transfer agent rather than any investor. The

court of appeals, noting that Section 17(a) (1) “broadly con-

demns the employment of “any device, scheme, or artifice to

defraud’” (id. at 339), stated that “there is no doubt that

Congress in the broad language employed in [Section 17(a)

(1)] was intent upon protecting the integrity of the market-

place in which securities are traded” (ibid.).

7

1. “‘Thestarting point in every case involving con-

struction of a statute is the language itself.’”*° Sec-

tion 17(a) (1) forbids “any person in the offer * * *

of any securities * * * directly or indirectly * * * to

employ any device, scheme, or artifice to defraud.”

Section 2(3) defines “offer” to include “every attempt

or offer to dispose of * * * a security * * * for

value.”* Respondent placed “sell” orders for value

with various brokers, and he employed a scheme to

defraud in the course of placing those orders. The

statute unambiguously proscribes respondent’s con-

duct.

“Nothing on the face of the statute suggests a

congressional intent to limit its coverage” (United

States v. Culbert, No. 77-142 (March 28, 1978), slip

op. 2) to fraud practiced on investors. Just as it was

improper to restrict the scope of the Hobbs Act “by

reference to an undefined category of conduct termed

‘racketeering’ ” (id. at 9), so it was improper for the

court of appeals to restrict the scope of Section 17

(a) (1) to “the species of fraud” aimed at “investors”

(App. A, infra, 5a). Here, as in Culbert, the broad

¢ Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976);

Santa Fe Industries, Inc. Vv. Green, 430 U.S. 462, 472 (1977).

“The definition of ‘offer’ is obviously much broader than

the common law concept.” 1 L. Loss, Securities Regulation 512

n.163 (2d ed. 1961). See also Securities and Exchange Com-

mission V. National Securities, Inc., 393 U.S. 453, 467 n.8

(1969).

8

words of the statute “do not lend themselves to [such

a] restrictive interpretation.” *

We do not doubt that investor protection is an

essential purpose of the Securities Act of 1933, just

as the prevention of “racketeering” is an essential

purpose of the Hobbs Act. But statutes commonly

have more than one purpose and strike at more than

one evil. So it is with the Securities Act of 1933.

This Court summarized the general objectives of the

statute in Ernst & Ernst v. Hochfelder, 425 U.S. 185,

195 (1976) (emphasis added) :

The Securities Act of 1933 * * * was designed

to provide investors with full disclosure of mate-

rial information concerning public offerings of

securities in commerce, to protect investors

against fraud and, through the imposition of

specified civil liabilities, to promote ethical stand-

ards of honesty and fair dealing.

A principal purpose of the federal securities laws is

“to insure the maintenance of fair and honest mar-

kets.” 15 U.S.C. 78b.° Conduct that defrauds finan-

* This Court has often held that the securities laws should

be interpreted broadly to effectuate their remedial purposes

in government enforcement actions. See Securities and Ex-

change Commission V. Capital Gains Research Bureau, Inc.,

375 U.S. 180, 195 (1963); Securities and Exchange Commis-

sion V. National Securities, Inc., 393 U.S. 458, 467 (1969);

Securities and Exchange Commission Vv. C. M. Joiner Leasing

Corp., 320 U.S. 344, 350-351 (1943).

®* Consistent with this purpose, it is “well settled” in the

lower courts “that in a prosecution [under Section 17 (a) (1) ]

the government is not required to prove that anyone was de-

frauded or that any investor sustained loss.” Farrell v. United

on ee

9

cial intermediaries such as brokers strikes at the

heart of the securities markets.”

There was therefore no reason for the court of

appeals to invoke the “rule of lenity” to narrow the

literal application of Section 17(a)(1). As this

Court observed in United States v. Culbert, supra,

slip op. 8-9: “It is true that ‘ambiguity concerning

the ambit of criminal statutes should be resolved in

favor of lenity’. * * * But here Congress has con-

veyed its purpose clearly, and we decline to manu-

facture ambiguity where none exists.” See also Scar-

borough v. United States, 431 U.S. 563, 577 (1977).

Because Section 17(a) (1) is literally applicable here,

there is no ambiguity and no necessity to resort to

rules of construction intended to resolve statutory

uncertainties. See Securities and Exchange Commis-

sion v. C. M. Joiner Leasing Corp., 320 U.S. 344,

354-355 (1943).

States, 321 F.2d 409, 419 (9th Cir. 1963) (collecting cases).

See also United States v. Brown, supra.

1 Tt has long been recognized that Rule 10b-5, 17 C.F.R.

240.10b-5, which was based on Section 17(a) (see Ernst &

Ernst v. Hochfelder, supra, 425 U.S. at 213 n.32), prohibits

fraud practiced on “brokers.” See A. T. Brod & Co. v. Perlow,

375 F.2d 393, 396-397 (2d Cir. 1967): “Neither § 10(b) nor

Rule 10b-5 * * * speaks in terms of limiting the nature of the

violation to one involving fraud on ‘investors’; nor is there any

‘justification for reading such an additional requirement into

the act. * * * We believe that § 10(b) and Rule 10b-5 prohibit

all fraudulent schemes in connection with the purchase or sale

of securities, wehther the artifices employed involve garden

type variety of fraud, or present a unique form of deception.

Novel or atypical methods should not provide immunity from

the securities laws.”

10

2. Even if it were correct to conclude that tne

.1933 Act protects investors only, it would not follow

that frauds practiced on brokers are beyond the cov-

erage of the statute. A broker usually acts as the

agent of buyers and sellers. If the seller does not

have the promised shares, they cannot be delivered

to the buyer, and the buyer may suffer loss as a re-

sult. That loss is averted in cases like the present

one by the requirement (see 17 C.F.R. 240.10a-2(a) )

that the broker “buy in” real shares to deliver to the

buyer of the phantom shares. This, like insurance,

transfers the buyer’s loss to a financial intermediary.

Like insurance, it has a cost; in the long run it raises

the brokerage fees paid by investors. And if, in some

cases, brokers should be financially incapable of “buy-

ing in” to protect investors from loss, then investors

would bear the loss directly.

It is not logical to conclude that the “species of

fraud” practiced by respondent was beyond the scope

of the securities laws simply because the investors

were “insured” by the brokers’ “buy in” of shares.

As the Second Circuit pointed out in United States

v. Brown, supra, 555 F.2d at 339, “[o]ne might as

well argue that if Brown stole [some person’s] fully

insured automobile, he was never the victim of a lar-

ceny.” The court continued (ibid.) :

The fact that the Uniform Commercial Code

might ultimately shift the monetary loss from

Smith and ultimate investors hardly serves to

exculpate Brown and his group of fellow thieves,

counterfeiters and forgers from criminal respon-

11

sibility. This was not of course the garden vari-

ety of security fraud—its long planned execution

* * * constituted a massive assault upon innocent

investors and brokerage houses and their normal

business procedures which we -cannot construe

the statute to countenance.

Fraud practiced on brokers results in greater losses

to them, or perhaps in costly precautions to avoid

loss. The costs of loss or precautions are ultimately

borne by persons who use the services of brokers—

the investing public. The decision below removes an

important deterrent to fraud practiced against bro-

kers, and, in the end, must serve to render brokerage

services more costly or more cumbersome, to the

detriment of all traders in securities.

8. At all events, the decision of the court of ap-

peals seriously impairs the ability of the United

States and the Securities and Exchange Commission

to enforce the securities laws in cases involving fraud

practiced on the largest participants in the national

securities markets." Brokers are integral parts of

the securities exchange process, handling sales and

11 The reasoning of the court below—that the “purpose” of

the statute was to protect investors, and that mere agents

are therefore beyond protection—would seem to apply equally

under Section 10(b) of the 1934 Act, 15 U.S.C. 78] (b), as well

as Section 17(a) of the 19383 Act. Indeed, the court placed

principal reliance on authorities construing Section 10(b)

(see App. A, infra, 7a). Thus, the decision of the court of

appeals may mean, as a practical matter, that government

enforcement actions under Section 10(b) will also be fore-

closed in the Eighth Circuit in cases involving fraud on brokers

and other securities professionals.

12

consummating purchases for customers throughout

the nation. The amount of money involved in such

transactions is enormous. In 1975 brokers partici-

pated in securities transactions on national exchanges

with a dollar volume of $166.9 billion. See 42d SEC

Ann. Rep. 192 (1976). Because Section 17(a) au-

thorizes not only criminal prosecutions but also civil

remedies, the effect of the decision here is to abol-

ish one of the government’s most effective weapons

against the most serious forms of securities fraud

practiced on members of the brokrage industry.”

The decision of the court of appeals also would bar

government enforcement actions in cases where other

financial institutions—including transfer agents, in-

vestment advisers, and commercial bank trust de-

partments—have been defrauded. In each case it

could be argued, with equal logic, that the defrauded

financial intermediary was not an actual “investor”

or “purchaser” of securities, and thus was beyond the

scope of statutory protection.

12“The securities markets of the United States are indis-

pensable to the growth and health of this country’s and the

world’s economy. In order to raise the enormous sums of

investment capital that will be needed in the years ahead and

to assure that capital is properly allocated among competing

uses, these markets must continue to operate fairly and

efficiently.” H.R. Conf. Rep. No. 94-229, 94th Cong., 1st Sess.

91 (1975).

18 There is no question in this case of enforcing a private

implied right of action or of conferring “standing to sue.” See

Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975);

Piper Vv. Chris-Craft Industries, Inc., 480 U.S. 1 (1977). This

criminal prosecution is squarely predicated on Congressional

grants of jurisdiction. See 15 U.S.C. 77q(a), 77x.

13

Brokers, transfer agents and investment advisers

are subject to pervasive regulation under the federal

securities laws. See 15 U.S.C. 780 et seq., 15 U.S.C.

78q-1 et seg., 15 U.S.C. 80b-1 et seg. Congress has

not demonstrated any intent to impose the burdens

of the securities laws on these financial institutions

without conferring the protections of the securities

laws, and those protections therefore should be avail-

able where, as here, they are literally applicable.

CONCLUSION

The petition for a writ of certiorari should be

granted.

Respectfully submitted.

WADE H. McCCREE, JR.

Solicitor General

STEPHEN M. SHAPIRO

Assistant to the Solicitor General

DAVID FERBER

Solicitor to the Commission

JAMES H. SCHROPP

Assistant General Counsel

LARRY R. LAVOIE

Attorney

Securities and Exchange Commission

' OcTOBER 1978

la

APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

No. 77-1290

UNITED STATES OF AMERICA, APPELLEE

Vv.

NEIL T. NAFTALIN, APPELLANT

Appeal from the United States District Court

for the District of Minnesota

Submitted: August 30, 1977

Filed: June 13, 1978

Before BRIGHT, ROSS and HENLEY, Circuit Judges

HENLEY, Circuit Judge.

Neil T. Naftalin, appellant here and defendant in

the district court, was indicted on eight counts of

employing a scheme to defraud in the offer or sale

2a

of securities, in violation of §17(a)(1) of the Se

curities Act, 15 U.S.C. § 77q(a)(1). Appellant was

tried without a jury in the United States District

Court for the District of Minnesota and found guilty

on all eight counts. He was sentenced to five years

imprisonment on each of the eight counts, to be served

concurrently. This court has jurisdiction on appeal

under 28 U.S.C. § 1291.

The alleged schemes to defraud consisted of appel-

lant ordering five different brokers in eight separate

transactions to sell stock listed on the New York

Stock Exchange that appellant did not own at the

time of the orders, either without disclosing that he

did not own the stock or by affirmatively misrepre-

senting that he did own the stock. Counts I-V, VII

and VIII of the indictment arose out of sell orders

placed with various broker-dealers whereby the bro-

kers became appellant’s agents for the purpose of

finding buyers for the stock and transferring the

stock to the third party purchasers. Count VI, pres-

ently to be discussed separately, differs from the

other counts in that the evidence adduced in support

thereof shows that on August 28, 1969 H. S. Kipnis

and Co., the brokerage house involved, purchased the

securities mentioned in that count as a principal

rather than acting as appellant’s agent for the sale

of the securities to third parties.

Appellant was the president and controlling share-

holder of Naftalin and Co., Inc. (Company), a cor-

poration registered as a securities dealer under fed-

eral and Minnesota securities laws. Prior to 1963,

=.

the Company operated a public business as a broker-

dealer. After 1963, and at the time of the transac-

tions involved in this case, the Company had ceased

doing business with the public and was operated

essentially as a one-man business with appellant con-

ducting all of its affairs.

From 1966 until the time of the transactions in-

volved in this case, appellant had been trading for

the Company’s account in a number of stocks. The

pattern of trading which appellant established during

this period, and particularly in the summer of 1969,

was to place large sell orders in the Company’s name

with various broker-dealers for listed stocks. Deliv-

ery of the securities for these transactions was often

made weeks or months after the settlement dates set

forth in the confirmation slips prepared and mailed

to the Company by the brokers.*

Naftalin was, and is, a knowledgeable and sophis-

ticated professional investor. It is possible that such

a person can sell securities that he does not own

without at the time disclosing he does not own them

or representing falsely that he does own them. If

before delivery of the securities is required the mar-

ket price declines the seller can buy in the securities

at a lower price and pocket the difference. Of course,

_if the market advances the seller suffers loss, and if

1A good description of Naftalin’s over-ali “short-selling”

or “free-riding” mode of operation during the indictment

period may be found in Naftalin & Co. v. Merrill Lynch,

Pierce, Fenner & Smith, Inc., 469 F.2d 1166, 1170 (8th Cir.

1972). See also United States v. Naftalin, 534 F.2d 770 (8th

Cir.), cert. denied, 429 U.S. 827 (1976).

4a

he does not deliver the securities the broker through

whom he sells suffers loss. To be sure, a seller law-

fully may sell stock he does not own “short” if he

discloses at time of sale that he is short and if he

maintains appropriate brokerage accounts and other-

wise trades according to prescribed procedures. How-

ever, the government charges in essence that undis-

closed short sales misrepresented as sales of stock

owned by the seller, 7.e., “long” with intent to deceive

the broker and take a free ride on the broker’s money

or credit are made unlawful by §17(a)(1) of the

Securities Act, 15 U.S.C. § 77q(a) (1).?

Appellant never delivered any of the stock which

he had agreed to deliver pursuant to the sell orders

included in this case. With regard to Counts I-V,

VII and VIII, when appellant failed to deliver the

stock involved, the brokers ultimately purchased stock

2 Securities Act of 1933, 15 U.S.C. § 77q(a):

Sec. 17(a). It shall be unlawful for any person in

the offer or sale of any securities by the use of any means

or instruments of transportation or communication in

interstate commerce or by the use of the mails, directly

or indirectly—

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

defraud, or

(2) To obtain money or property by means of

any untrue statement of a material fact or any omis-

sion to state a material fact necessary in order to

make the statements made, in light of the circum-

stances under which they were made, not misleading,

or

(3) To engage in any transaction, practice, or

course of business which operates or would operate

as a fraud or deceit upon the purchaser.

5a

sufficient to cover the sales which they had arranged

with third party purchasers. With perhaps one ex-

ception, the indictment transactions resulted in loss

to the brokers. There is no evidence that any of the

third party purchasers were deceived or defrauded

in any way.

Appellant urges on appeal that the evidence ad-

duced at trial was insufficient as a matter of law to

support the district court’s finding of fraud. While

we are convinced there is no merit to that claim we

pretermit further discussion of it and the factual

details of the fraudulent acts at this juncture because

we are not persuaded that the provision of § 77q(a)

(1) under which appellant was put to trial is vio-

lated by the species of fraud practiced against the

defrauded brokers who were not purchasers, and for

that reason we reverse on all counts other than Count

VI"

With respect to the counts now under considera-

tion, the government argues that the issue is whether

the government alleged and proved a device, scheme

or artifice to defraud in the offer or sale of a security.

And the government insists that 15 U.S.C. § 77q(a)

(1) does not require that the purchaser be defrauded,

8 Other issues raised on appeal are (1) that the district

’ court had no jurisdiction with regard to Counts I—V because

of a lack of proof of use of the mails by appellant; (2) that

sentencing on eight counts was improper since the proof

showed only a single scheme to defraud; and (3) that appel-

lant was exposed to double jeopardy due to prior disciplinary

action which had been taken by the Securities and Exchange

Commission in connection with the same stock transactions.

6a

so long as someone is defrauded in the offer or sale

of securities.

While we agree with the government’s statement

of the issue in this case, we do not agree with the

government’s analysis of the requirements of 15

U.S.C. § 77q(a) (1). It is clear that as between ap-

pellant and the brokers, there was no offer or sale

of securities. Appellant made phone calls to the vari-

ous brokers, during which he allegedly made a num-

ber of fraudulent statements, but he did not propose

to sell any securities to the brokers alleged to have

been defrauded. Appellant did request that the bro-

kers find purchasers for appellant’s stock and did

authorize sales for his account. A stockbroker does

not become the purchaser of stock when an owner

requests that the broker sell certain of the owner’s

securities. The ordinary relationship of a stockbroker

to his customer is that of principal and agent. See

Galiger v. Jones, 129 U.S. 193 (1889); McMann v.

Securities and Exchange Commission, 87 F.2d 377

(2d Cir. 1937). And the facts here clearly indicate

that the stockbrokers were acting as agents of appel-

lant, with the limited authority to find persons will-

ing to purchase appellant’s stock and subsequently to

transfer the stock to the purchasers.

The third party purchasers to whom the brokers

sold were not deceived or defrauded in any way. They

received the securities from the brokers and paid the

price they had contracted to pay.

The legislative purpose in enacting 15 U.S.C. § 77q

(a)(1) was to protect investors from fraudulent

Ta

practices in the sale of securities. Ernst & Ernst v.

Hochfelder, 425 U.S. 185, 195 (1976) ; Securities and

Exchange Commission v. International Chem. Dev.

Corp., 469 F.2d 20, 26 (10th Cir. 1972); Superin-

tendent of Ins. of the State of New York v. Bankers

Life & Cas. Co., 300 F.Supp. 1088, 1094 (S.D. N.Y.),

affd, 480 F.2d 355 (2d Cir. 1970), rev’d on other

grounds, 404 U.S. 6 (1971); Dolgow v. Anderson,

43 F.R.D. 472, 482 (E.D. N.Y. 1968).

As Mr. Justice Powell noted in Ernst, supra, 425

U.S. at 194, federal regulation of transactions in

securities emerged as part of the aftermath of the

market crash in 1929. In the decade prior to 1933

the investing public suffered losses through invest-

ments in worthless securities estimated at twenty-

five billion dollars. S.Rep. No. 47, 73rd Cong., Ist

Sess., 2, to accompany S.875 (April 27, 1933). At

the time there was national concern with public sales

of worthless stock to persons who had no means of

adequate protection and emphasis upon protecting

the investing public from exploitation through sales

of unsound, fraudulent and worthless securities. In

a message to the Congress President Franklin D.

Roosevelt on March 29, 1933 said in part:

In spite of many State statutes the public in

the past has sustained severe losses through prac-

tices neither ethical nor honest on the part of

many persons and corporations selling securities.

Of course, the Federal Government cannot and

should not take any action which might be con-

strued as approving or guaranteeing that newly

issued securities are sound in the sense that their

8a

value will be maintained or that the properties

which they represent will earn profit.

There is, however, an obligation upon us to

insist that every issue of new securities to be

sold in interstate commerce shall be accompanied

by full publicity and information, and that no

essentially important element attending the is-

sue shall be concealed from the buying public.

This proposal adds to the ancient rule of

caveat emptor, the further doctrine ‘let the seller

also bevvare.’ It puts the burden of telling the

whole truth on the seller. It should give impetus

to honest dealing in securities and thereby bring

back public confidence.

The purpose of the legislation I suggest is to

protect the public with the least possible inter-

ference to honest business.

“Regulation of Security Issues,” Message from the

President of the United States, March 29, 1933.

House Document No. 12, 73rd Congress.

It was against this backdrop that the Securities

Act of 1933, including the section now codified as 15

U.S.C. § 77q(a) (1), was adopted. And it is against

this backdrop that we are constrained to hold that

the government must prove some impact of the scheme

on an investor. United States vy. Ashdown, 509 F.2d

793, 799 (5th Cir.), cert. denied, 423 U.S. 829

(1975), quoting United States v. Schaefer, 299 F.2d

625, 629-30 (7th Cir. 1962).

Our resolve is strengthened by reference to the

general principle that statutes creating crimes are to

be strictly construed in favor of the accused and be-

fore one may be punished it must appear that his

9a

case is plainly within the statute. United States v.

Harris, 544 F.2d 947, 949 (8th Cir. 1976); United

States v. Freeman, 473 F.2d 7, 9 (8th Cir. 1973);

Jacobs v. United States, 359 F.2d 960, 964 (8th Cir.

1966).

Moreover, the government has cited and our re-

search has uncovered no case in which 15 U.S.C.

§ 77q(a) (1) has been used to prosecute a defendant

for fraud in the sale of securities perpetrated upon

an agent-broker, where no investor has been deceived

or defrauded as a result of the fraud. We decline to

expand the scope of 15 U.S.C. § 77q(a) (1) to encom-

pass the facts of the present case.

Turning now to Count VI of the indictment, as

indicated it may be observed that the evidence shows

that on August 28, 1969 Naftalin called H. S. Kipnis

& Co. (Kipnis) to sell 1,000 shares of Fairchild

Camera (Fairchild). Kipnis, which both bought and

sold Fairchild for its own account, executed the order

by purchasing the shares.*

The evidence is somewhat conflicting as to repre-

sentations, if any, made by Naftalin in connection

with the sale and as to whether Naftalin was in fact

“short.” There are also facts including the fact of

a substantial post sale payment on the Kipnis account

by Naftalin in September, 1969 tending perhaps to

show lack of fraudulent intent never to deliver stock

or pay a debit balance.

* We are not advised as to whether Naftalin knew immedi-

ately that Kipnis was the purchaser; however, in due course

of business he learned the identity of the purchaser to whom

he had sold.

10a

On the other hand, there is strong evidence tend-

ing to support a finding of guilt.

Nevertheless, the conviction under Count VI must

be reviewed precisely as the other counts were re-

viewed even though a sale to Kipnis was in evidence.

In passing upon pretrial motions the district court

ruled that the entire indictment was not subject to

dismissal on the ground that it did not charge Nafta-

lin with having defrauded “purchasers,” and rejected

the government’s argument that it could satisfy the

purchaser requirement by proving that certain shares

were sold to Kipnis.

In rejecting the government’s argument, the trial

court noted the indictment did not allege that Kipnis

was a purchaser and observed that the defendant

could not be tried on charges that were not made.

Accordingly, the trial court concluded this portion of

its reasoning by announcing that the government

would be limited at trial to proof of violations of § 17

(a) (1). Under the statutory construction applied by

the trial court this meant, of course, that proof of

the fact of purchase by Kipnis was not to be con-

sidered essential at trial. Indeed, as the government

concedes with commendable candor, fraud on the pur-

chaser as purchaser was not charged.

Thus we have an anomolous situation in which we

have held that the theory and facts upon which the

case went to trial do not permit conviction, but in

which we perhaps could sustain a conviction had the

defendant been put to trial upon another basis.

lla

In the circumstances, we must vacate the convic-

tion on Count VI also.

The judgments of conviction are vacated and the

indictment shall be dismissed.

Ross, Circuit Judge, Concurring and Dissenting.

I concur in the disposition of all of the counts ex-

cept Count VI. I would affirm the conviction as to

Count VI.

A true copy.

Attest:

Clerk, U. S. Court of Appeals,

Eighth Circuit

12a

APPENDIX B

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

SEPTEMBER TERM, 1977

No. 77-1290

[Filed June 13, 1978]

THE UNITED STATES, APPELLEE

v8.

NEIL T. NAFTALIN, APPELLANT

Appeal from the United States District Court

for the District of Minnesota

JUDGMENT

THIS CAUSE came on to be heard on the desig-

nated record of the United States District Court for

the District of Minnesota and was argued by counsel.

ON CONSIDERATION WHEREOF, it is now

here ordered and adjudged by this Court, that the

judgment and sentence of the said District Court as

to Counts I-V, VII and VIII be and is hereby re-

versed.

And it is further ordered by this Court that this

cause as to Count VI be and is hereby vacated and

13a

the indictment shall be dismissed in accordance with

the majority opinion of this Court.

June 13, 1978

[SEAL]

A true copy:

Attest:

/s/ Robert C. Tucker

Clerk, U. S. Court of Appeals,

8th Circuit

l4a

APPENDIX C

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

SEPTEMBER TERM, 1977

No. 77-1290

[Filed August 4, 1978]

THE UNITED STATES, APPELLEE

v8.

NEIL T. NAFTALIN, APPELLANT

Appeal from the United States District Court

for the District of Minnesota

The Court having considered petition for rehearing

en banc filed by counsel for appellee and, being fully

advised in the premises, it is ordered that the peti-

tion for rehearing en banc be, and it is hereby, de-

nied.

Considering the petition for rehearing en banc as

a petition for rehearing, it is ordered that the peti-

tion for rehearing also be, and it is hereby, denied.

August 4, 1978

/s/ Robert C. Tucker

Clerk, U. S. Court of Appeals,

8th Circuit

15a

APPENDIX D

UNITED STATES DISTRICT COURT

DISTRICT OF MINNESOTA

FOURTH DIVISION

Cr. No. 4-74-73

UNITED STATES OF AMERICA

Vv.

NEIL T. NAFTALIN

FINDINGS OF FACT, CONCLUSIONS OF LAW

AND VERDICT

The above-entitled criminal matter came on for

trial December 14, 1976, before the Court (a jury

having been waived) on an eight-count indictment,

each count charging Neil T. Naftalin with a viola-

tion of Title 15, United States Code, Section 77(q)

(a).

Upon all of the evidence presented at trial, the

Court finds as follows:

1. From on or about February 10, 1960, and con-

tinuing thereafter up to and including the present,

Naftalin & Co., Inc., a corporation duly organized

under and by virtue of the laws of the State of Min-

‘nesota, maintains its principal offices in Minneapolis,

Minnesota. Since February 25, 1960 and continuous

thereafter up to May 17, 1973, Naftalin & Co., Inc.,

was registered with the Securities and Exchange

Commission pursuant to Section 15(b) of the Securi-

16a

ties Exchange Act, Title 15, United States Code,

Section 780(b). Naftalin & Co., Inc., was also a

member of the National Association of Securities

Dealers, Inc., a national securities association regis-

tered pursuant to Section 15A of the Securities Ex-

change Act, Title 15, United States Code, Section

780-3, since 1960. From the time of its registration

in 1960 through approximately the end of 1962, Naf-

talin & Co., Inc., conducted a general securities busi-

ness in the over-the-counter market from its offices

in Minneapolis, Minnesota. Since 1963 through De-

cember, 1969, except for a few isolated transactions,

Naftalin & Co. did not conduct a public business, but

rather traded for its own account through various

broker/dealers.

2. At all times since its incorporation, Neil T.

Naftalin, defendant herein, was President, principal

executive officer, and majority shareholder of Nafta-

lin & Co., Inc. Neil T. Naftalin was an experienced,

knowledgeable and sophisticated investor and was

familiar with the customs and terminology used in

the trade.

3. From July 22, 1969 through August 28, 1969,

Neil T. Naftalin knowingly employed a scheme and

artifice to defraud Paine, Webber, Jackson and Cur-

tis, Piper, Jaffray and Hopwood, Inc., Dain, Kalman

and Quail, Inc., Merrill Lynch, Pierce, Fenner and

Smith, Inc., and H. S. Kipnis & Co., Inc.

As a part of said scheme and artifice to defraud

the above firms, Neil T. Naftalin placed sell orders

with the above firms for the cash account of Naftalin

17a

& Co., Inc., for the stocks of American Research and

Development, Avon Products, Inc., Burroughs Corpo-

ration, Control Data Corporation, and Fairchild

Camera and Instrument. In each instance defendant

Naftalin represented Naftalin & Co. to be “long” in

the stock, either by direct statement to that effect or

by using words and phrases in placing the sell order

which would be understood in the trade as a repre-

sentation that Naftalin & Co. was “long” in the

stock. In each instance Naftalin & Co. was “short”

the stock involved. Neil T. Naftalin knew that each

of the firms would not have accepted the sell orders,

except that giving rise to Count 6 of the indictment,

had they known that Naftalin & Co. was “short” the

stock. They either would not have taken the sell

order at all or would have required a margin deposit.

As to Count 6, the short sale of 1000 shares of Fair-

child Camera through H. S. Kipnis & Co., Kipnis

would not have required margin because it dealt in

that stock as a principal, but, as Neil T. Naftalin

knew, it would have refused to complete the transac-

tion had it known that Naftalin & Co. was not in a

position to deliver the stock as represented by Neil

T. Naftalin.

As a part of the scheme and artifice to defraud the

above firms in the sell orders placed with respect to

‘the above stocks, Neil T. Naftalin lulled the above

firms into believing Naftalin & Co. was long in the

stocks by responding to the firms’ demands for deliv-

ery of the stock with assertions that Naftalin & Co.

was “long” and the stock was on its way to Naftalin

18a

& Co. from other brokers, banks, or transfer agents.

None of the securities sold by Naftalin & Co. in the

transactions alleged in the indictment were delivered

by Naftalin & Co. Each broker had to buy the securi-

ties in (and in all but one case, said buy ins were at

a loss).

4, With respect to Count One, Neil T. Naftalin

employed the scheme to defraud, described in para-

graph 8 herein, by placing a sell order for 500 shares

of American Research and Development with Paine,

Webber, Jackson and Curtis on July 22, 1969, and

caused said firm to send and deliver by United States

mail an envelope addressed to Naftalin & Co. contain-

ing a written confirmation of that sale.

5. With respect to Count 2, Neil T. Naftalin em-

ployed the scheme to defraud described in paragraph

3 hereby placing a sell order for 1000 shares of Bur-

roughs Corporation with Paine, Webber, Jackson and

Curtis on August 5, 1969, and caused said firm to

send and deliver by United States mail an envelope

addressed to Naftalin & Co. containing a written

confirmation of that sale.

6. With respect to Count 3, Neil T. Naftalin

employed the scheme to defraud described in para-

graph 8 herein by placing a sell order for 1000 shares

of Burroughs Corporation with Piper, Jaffray &

Hopwood, Inc., on August 7, 1969, and caused said

firm to send and deliver by United States mail an

envelope addressed to Naftalin & Co. containing a

written confirmation of that sale.

19a

7. With respect to Count 4, Neil T. Naftalin

employed the scheme to defraud described in para-

graph 3 herein by placing a sell order for 1000 shares

of Control Data Corporation with Dain, Kalman and

Quail, Inc., on August 8, 1969, and caused said firm

to send and deliver by United States mail an envelope

addressed to Naftalin & Co. containing a written

confirmation of that sale.

8. With respect to Count 5, Neil T. Naftalin

employed the scheme to defraud described in para-

graph 3 herein by placing a sell order for 500 shares

of American Research and Development with Merrill

Lynch, Pierce, Fenner and Smith, Inc., on August 20,

1969, and caused said firm to send and deliver by

United States mail an envelope addressed to Naftalin

& Co. containing a written confirmation of that sale.

9. With respect to Count 6, Neil T. Naftalin

employed the scheme to defraud described in para-

graph 3 herein by placing a sell order for 1000 shares

of Fairchild Camera and Instrument Corporation

with H. S. Kipnis & Co. on August 28, 1976, and in

placing such sell order the defendant used a com-

munication in interstate commerce, that is, a tele-

phone call from Minnesota to Illinois.

10. With respect to Count 7, Neil T. Naftalin

employed the scheme to defraud described in para-

graph 3 herein by placing a sell order for 500 shares

of American Research and Development with H. S.

Kipnis & Co. on August 4, 1969, and in placing such

sell order the defendant used a communication in

interstate commerce, that is, a telephone call from

Minnesota to Illinois.

20a

11. With respect to Count 8, Neil T. Naftalin em-

ployed the scheme to defraud described in paragraph

3 herein by placing a sell order for 1000 shares of

Avon Products, Inc., with H. S. Kipnis & Co. on

August 1, 1969, and in placing such sell order the

defendant used a communication in interstate com-

merce, that is, a telephone call from Minnesota to

Illinois.

From the above facts, the Court finds that as to

each count the government has proven beyond a rea-

sonable doubt that Neil T. Naftalin employed a

scheme or artifice to defraud in the sale of securities

and has used the mails or a communication in inter-

state commerce in said scheme.

As to each count of the indictment, the Court finds

that the defendant acted as charged in the count

wilfully and knowingly.

The Court finds the defendant guilty of each count

in the indictment.

/s/ Earl R. Larson

United States District Judge

Dated: February 1, 1977.

W sou. s. covernment printine orrice; 1978 274154 127

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