Appendix — Kalmanovitz v. Securities & Exchange Commission

Supreme Court, U

‘ , S.

FILED

80-481 ie pele

ICHAEL RODAK, JR., CLERK

IN THE *

SUPREME COURT OF THE UNITED STATES

October Term 1980

NO.

PAUL KALMANOVITZ,

Petitioner,

vs

SECURITIES AND EXCHANGE COMMISSION,

Respondent.

APPENDIX

THEODORE F. SCHWARTZ

BARRY S. GINSBURG

7701 Forsyth, Suite 560

Clayton, Missouri 63105

(314) 863-4654

Attorneys for Petitioner

APPENDIX

TABLE OF CONTENTS

Findings of Fact and Conclusions

of Law, United States District

Court, District of Columbia

Opinion, United States Court of

Appeals, District of Columbia

Statutes

UNITED STATES DISTRICT COURT

DISTRICT OF COLUMBIA

SECURITIES AND EXCHANGE COMMISSION, )

PLAINTIFF, )

VS )

FALSTAFF BREWING CORPORATICN, )

DEFENDANT. )

No. 77-894

PRELIMINARY STATEMENT

On August 1, 1977, this Court on

motion of the Securities and Exchange

Comission, granted a preliminary

injunction restraining the defendants

Falstaff Brewing Corporation and Paul

Kalmanovitz from engaging in activities

deemed to be in violation of the

securities laws of the United States and

regulations promulgated thereunder.

Rie . Uae ette

A hearing on the merits was held

March 13-17, 1978. In addition to the

live testimony adduced at that hearing,

other testimony taken by deposition or in

related proceedings, and numerous

exhibits pertinent thereto, were made a

part of the record.

On the basis of the whole record the

Court, by Judgment annexed hereto,

permanently enjoins Falstaff and its

officers and agents from engaging in

activities deemed to be violative of the

securities laws of the United States and

regulations promulgated thereunder.

In support of that Judgment, and

pursuant to the requirements of Rule 52

Fed. R. Civ. P. the Court sets out

hereinafter its Findings of Fact and

Conclusions of Law.

FINDINGS OF FACT

Part I - BACKGROUND

1. Defendant, Falstaff Brewing

Corporation ("Falstaff" or "Company") is

a Delaware corporation with its principal

place of business at 470 10th Street, San

Francisco, California. At all times

prior to July 1975, the common stock of

Falstaff was traded on the New York Stock

Exchange, Falstaff's common stock is

currently traded in the over the counter

market. Falstaff has aprpoximately 4.5

million shares of common stock

outstanding which are held by

approximately 15,000 persons and 100,000

shares of Class A convertible preferred

stock which are all beneficially owned by

defendant Paul Kalmanovitz ("Kalmano-

vitz"). The common stock of Falstaff is

registered with the plaintiff Securities

and Exchange Commission ("Commission")

pursuant to section 12 of the Securities

Exchange Act of 1934 (15 U.S.C.

§781) [Exchange Act]. Falstaff files

various reports and proxy soliciting

materials with the Commission pursuant to

the Exchange Act at the Commissions's

offices in Washington D.C.1l

2. Since April 28, 1975-with the

exception of a brief period in

1976-Kalmanovitz has been and is

presently chief executive officer and

Chairman of the board of Falstaff. On

April 28, 1975, Kalmanovitz became the

beneficial owner of 100% of Falstaff's

Class A preferred stock; and at all times

Since then Kalmanovitz's beneficial

ownership of Falstaff's preferred stock

has entitled him to 52% of the voting

rights of Falstaff.2

1 Answers of Falstaff Brewing Corp. and

Paul Kalmanovitz ("Answers") 410 of

plaintiff's Complaint ("Complaint").

2 Answers 413, admitting 4 of Complaint

in relevant part.

3. Ferdinand J. Gutting ("Gutting")

was Chairman of the board, president and

chief executive officer of Falstaff prior

to April 28, 1975. 3

4. James S. McClellan

("McClellan")was, prior to April 28,

1975, a director of Falstaff, a member of

the executive committee of the board of

directors and outside legal counsel to

Falstaff.4

5. Gutting and McClellan were named

as defendants in the instant lawsuit.

They each consented to the entry by this

court of orders of permanent injunction

at the time that the complaint in this

action was filed.

6. For the year ending December 31,

1974, Falstaff reported losses in its

3 Answers 412 admitting 412 of the

Complaint in relevant part.

4 Answers 411 admitting 411 of Complaint

in relevant part; McClellan, Reporter's

Transcript of Trial Testimony ("RT") 23

s*

Annual Report on Form 10-K ("Annual

Report") in the amount of $3.8 million,

and for the year ending December 31,

1975, Falstaff reported losses in its

annual report in the amount of $8.5

million. 6

6A. The means and instrumentalities

of interstate commerce were used in

connection with the activities alleged in

the Complaint. 6A

Part II. THE 1975 PROXY STATEMENT

A. Introduction

7. Falstaff and Kalmanovitz entered

into an agreement as of March 10, 1975,

whereby Kalmanovitz agreed to buy, for

$10 million, 100,000 shares of a new

class of convertible preferred stock to

be issued by Falstaff. Each share of

this "Class A" preferred carried

sufficient voting rights so that if the

transaction was approved by Falstaff's

shareholders. Kalmanovitz would control

52 percent of the voting rights of the

company. Shareholder approval was

required to authorize the new class of

preferred and the March 10 agreement so

provided. 7

8. The transaction was submitted to

Falstaff's shareholders in Falstaff's

1975 Proxy Statement, which was mailed on

March 31, 1975 and which scheduled the

annual shareholders meeting for April 28,

1975. 8

9. At the shareholders meeting the

agreement with Kalmanovitz, which had

been favorably recommended by management,

was approved, and stock was issued, and

Kalmanovitz effectively took over

Falstaff's corporate reins. 9

7 PX, 56; McClellan RT

68(4)-69(2),77(16)-78(4).

8 PX l.

9 PXl; McClellan RT 89 (21)-90(2).

B. The Continental Can Company

Transaction.

10. A precondition to Kalmanovitz's

investment in Falstaff ws the generation

of sufficient capital to pay off all of

the high interest (one and one-half

percent over prime, or approximately 11

percent in early 1975) bank debt owed by

Falstaff, which amounted to $16.5

million. He viewed this interest rate as

a “cancer” and insisted that the debt be

retired in advance of its normal

maturity. 10

10 Gutting RT 201(17-21) 206(13-19);

Hoover Deposition ("Hoover") 22(19-23);

Kalmanovitz Investigative Deposition

("Invest") 113(8-9); Kalmanovitz

Deposition in Falstaff v. New York Life

Ins. Co. et al. U.S.D.C. N.D. Cal. No.

C75-1560 CFP ("NYL") (III) 50(27-26);

51(9-11); Kalmanovitz nYL (VIII) 327(26)

328(8) Tonna 118(15-25); Kalmanovitz RET

543 (16-20); Kalmanovitz RT J 543(16-20);

543(25) 544(5); 459 (2) 644(24) 645(5)

646(8-11).

ll. Initially, Kalmanovitz agreed

to invest $5 million in Falstaff

preferred stock if Falstaff's suppliers

would put up an additional $15 million.

lla This would have resulted in a total

influx of $20 milion in cash-enough to

pay off the high interest bank debt and

leave a little for working capital.

Kalmanovitz insisted on obtaining voting

control of Falstaff as a term of his

investment. llb

lla McClellan RT 46(2)-47(18), 53(7)

-54(15)3 Tonna 36(19) 37(9), 39(22) -

40(6), 42(11) - 43(15); Gutting Rt 201

(17-21); 203(11-19); PX 36; PX 39; Hoover

23(3-6), 26(21) - 27(21); PK RT p.

547(2-14).

llb McClellan RT 55(6-17); 60(4-9);

Gutting RT 206(1-13), 211(8) - 212(6);

Kalmanovitz Deposition in Calhoun v.

Falstaff, et. al., U.S.D.C. E.D. Mo. No.

76-246C(c) ("Calhoun")I 60(4-20);

Kalmanovitz (invest.) 73(22) -74(5);

Tonna 51(7-17); Hoover 33(11-15);

34(17-20); 36(3) -37(4).

12. Kalmanovitz could only interest

one supplier in participating in any

major way, and that one-Continental

Can-refused to buy stock or to loan money

outright. 12a Rather, at a meeting on

March 8, 1975, Fred Hoover, a

Vice-President of Continental, proposed

on behalf of Continental, to extend

Falstaff approximately $10 million in

credit, in the form of deferrals on can

payments, the balance to be put on a long

term note personally guaranteed by

Kalmanovitz and his wite. 12b while

Hoover did not have final authority on

March 8th to commit Continental to this

proposal, he told Kalmanovitz that

Continental's management probably would

approve it. 12c As a result,

Kalmanovitz reasonably believed that

12 a Hoover 38(2-5); Tonna 139(2-6).

12 b Hoover 37(1) - 91(20); Kalmanovitz RT

555(21) 556 (2).

12 c Hoover 91(4-11).

7".

Continental would extend $10 million in

credit to Falstaff on the terms

discussed. 12d

13. Accordingly, on Mareh 9, 1975,

Kalmanovitz agreed to increase his own

investment in falstaff to $10 million, so

that in the end there would still be $20

million capital infusion needed to pay

off the high-interest bank debt. l3a At

a meeting held on March 22, 1975, the

mechanics of the Continental extension of

credit were worked out. By the end of

the March 22nd meeting both Hoover 13b

and Kalmanovitz l13c were of the opinion

that an agreement had been reached

12d Kalmanovitz RT 556(3-14, 22-25).

l3a Gutting RT 213(15) -214(17);

McClellan RT 62(19) -46(15) -67(3-11);

McLaughlin 8(9-14); 9(19-23) Percy

34(3-19); PX 49; 36(7-14); Tonna 100(1) -

102(10); 108(17) - 109(6); 137(10) -

138(1); Kalmanovitz RT 557(1) - 558(1);

558 (24) - 559(5); 677(20) - 678(4);

678(14-16).

13b Hoover 121(8-18); 125(14-24);

127(25) 129(2) - 131(217).

13c Kalmanovitz RT 568(11) 570(11).

whereby Continental would extend up to

$10 million in credit to Falstaff payable

in two years subject to Kalmanovitz's

assumption of control of Falstaff. The

Continental credit was thus an essential

element of Kalmanovitz's investment in

Falstaff and he so viewed it. 13d

14. However, because the

Continental credit would only generate

case as Falstaff let can bills build up

over a four-month period, Kalmanovitz did

not have, up front, $20 million in cash

to buy 200,000 shares of $100 par value

preferred stock, as had been contemplated

in earlier drafts of his agreement with

: Falstaff. 14a But he still insisted on

having numerical voting control of the

company. 14b This could be done by

13d Kalmanovitz(Calhoun) I 186(15) -

187(24); 192(7-17); Kalmanovitz (NYL) VII

‘ 223(24) - 224(2); Kalmanovitz RT

646(8-11).

l4a PX 42; McClellan RT 57(6) - 59(5);

59 (13-19); 62 (5-18); Kalmanovitz RT 553

14b McClellan RT 64(18) 65(3); Tonna

101(7) - 102(16).

SESS

doubling both the voting rights and the

conversion ration on the $100 preferred,

so that buying only 100,000 shares would

give Kalmanovitz control. However, this

was not a practical solution, as it would

result in valuing Falstaff's common stock

at $2.25 per share, half the price

Falstaff believed would be "fair." 14 c

15. To resolve the dilemma,

Falstaff agreed to double the voting

rights on the preferred but left the

conversion ratio unchanged. 15a

Kalmanovitz was to buy 100,000 shares of

this "Class A" preferred for $10 million

in cash. In addition, Kalmanovitz was to

get an option to buy 100,000 shares of a

l4c McClellan RT 58(8-17); 59 (20-25);

Gutting RT 211(12-15); 212 (3-9).

15a Gutting RT 215 (2-8); McClellan RT

64(18)- 65(3); PX 46.

non-voting “Class B" preferred (carrying

the same conversion ratio as the "Class

A") for an additional $10 million. As

consideration for this option,

Kalmanovitz agreed to guarantee up to $10

million of Falstaff's accounts payable.

This guarantee was separate and distinct

from his guarantee of the Continental

credit and would not result in any cash

flowing into the Company. 15b

16. The net result of the foregoing

was that Kalmanovitz and Falstaff were in

the same position, vis-a-vis control, as

if Continental had agreed to make a $10

million equity investment in the company,

and Kalmanovitz had the $20 million he

wanted to prepay the high interest bank

debt. However he would have to wait

until mid-summer of 1975 to complete

15b McClellan RT 65(22) - 66(9); PX 46.

the pre-payments as the cash generated by

the Continental credit built up to the

necessary levels. 16

17. The existence of the

Continental extension of credit was not

disclosed in the 1975 Proxy Statement.

17a. Kalmanovitz advanced $3

million towards the purchase price on

March 13, 1975 and on March 18, 1975,

agreed to subordinate this money, at the

lenders request, to Falstaff's

outstanding debt. 17a

18. During the period from April

through August, 1975, pursuant to the

Kalmanovitz-Continental agreement,

Falstaff did not pay current Continental

invoices for can shipments. These def-

16 Gutting RT 220(24) - 221(11),

406(3-10); Hoover 198 (8-13); 199(4-18);

PX 48.

17a Gutting RT 217(17); 218(17), 219(22)

— 220(8).

erred invoices totalled approximately

$11.6 million on or about August 16,

1975. 18a On or about August 16, 1975,

Kalmanovitz, on behalf of Falstaff,

signed a two year note with Continental

for approximately $11.6 million. This

note was pesonally guaranteed by

Kalmanovitz and his wife. Within five

months of its signing, by the end of

December 1975, Kalmanovitz and Falstaff

prepaid all of the Continental note. 18b

C. Loan Prepayment Restrictions

19. Kalmanovitz consistently was

determined throughout his negotations

with Falstaff, to prepay the

19a

high-interest bank debt. Both the March

18a Answers, 452, admitting 452 of

Complaint in relevant part.

18b Kalmanovitz RT 588(3-25).

19a Tonna 118(15-18); Gutting RT 406(3-10);

McClennan RT 55(20); 56(5); Percy 36(7-14);

991-18); PX 54; Falstaff Memorandum in Oppo-

Sition to Preliminary Injunction ("Falstaff

Opposition Memo") at p. 63.

10 Agreement 19b and the 1975 Proxy

Statement 19c disclosed that the proceeds

of the Kalmanovitz investment would be

used to pay the bank loans. At the time,

Falstaff owed additionaliy some $12.5

million to insurance companies. It was

low-interest debt (6%) which Kalmanovitz

considered an asset and hence had no

desire to pay off. 19d

20. As of January 20, 1975, the

banks and insurance companies to which

Falstaff was indebted entered a so-called

"Collateral Agency Agreement." The

agreement provided that all prepayments

by Falstaff on any of its loans would be

shared by all of the lenders on a pro

rata basis. 20

19b PX 46.

19c PX il.

19d Tonna 118(15-25); 181(16-22);

Kalmanovitz (NYL) 11 46 (1-5);

Kalmanovitz (Antitrust) 782 (18-19); PX

54.

20. PX 33, Section 2].

21. Although Falstaff was not a

signatory to the Collateral Agency

Agreement, the Falstaff Board of

Directors approved it on January 27,

1975. 21

22. Between 1970 and 1974 Falstaff,

on numerous occasions, had been in

default on its loan agreements. It was

in default on its loan agreements. It

was in default on these agreements on

September 30, 1974. 22a Accordingly

Falstaff agreed in November, 1974 in

order to obtain waivers of the defaults,

to grant security - i.e. mortgages~- to

its lenders on all of its fixed assets,

excluding cash and receivables. 22b

21 PX 34.

22a Answers 418, admitting 418 of

Complaint; PX 21; Gutting RT 194(9-22);

PX 25; PX27.

22b Answers 9419 admitting 419 of

Complaint in relevant part; McClellan RT

33(2-12):; 34(16-25); 39(14) 40(18);

Gutting RT 194(23) - 195(8); 196(16);

198(12-16); 207(6-8); PX 28; PX30; Tonna

31(9) 32(15); 35(15) 36(4); Answers

q's 20,21 admitting 420,21 of Complaint

in relevant part.

OO ee eee

23. Before renewing the waivers of

defaults which had expired on March 15,

1975, Falstaff's insurance lenders made

the pro rata payment restrictions

contained in the Collateral Agency

Agreement applicable to Falstaff by

expressly requiring Falstaff to agree

that no funds of Falstaff or any third

party would be applied to the payment,

purchase, or acquisition of any existing

debt owed by Falstaff to any of the

parties of the Collateral Agency

Agreement except in equal pro rata

proportion to such indebtedness. The

insurance lenders further erguired

Falstaff to agree to their right to call

their loans should the pro rata

provision be violated. 23

24. Faicraff agreed to the

conditions on the “march waivers" on

March 31, 1975, including the pro rata

PX50; PX51; Gutting RT 393(12) 394(19)

provision. 24

25. Kalmanovitz knew about the pro

rata prepayment restriction in the

Collateral Agency Agreement 25a and the

mortgages 25b by March 10, 1975.

26. Kalmanovitz told Curtis Palmer,

a friend and advisor, about the pro rata

payment restrictions in the Collateral

Agency agreement on March 13, 1975. 26

27. Kalmanovitz knew bout the pro

rata prepayment restriction in the March

waivers by April 4, 1975. 27

24 Gutting RT 396(15-2;); 480 (6-13).

25a Palmer 15(5-28); 16(11-13); 16(20);

17(3)3 31(15-25); 32(7-14); 35(7-17);

39(13-18); Kalmanovitz (SEC) 89(26)

91(15); 92(10-17); 94(8-12); 112(28)

113(1); McLaughlin 18(8) 20(8); Tonna

181(1-12); 181(23) 182(14).

25b McClellan RT 41(19) 42(2) 54(16-24);

67(12); 68(3); McLaughlin 13(11-19);

14(22) 15(3)3; 15(6-17); Tonna 37(13)

38(11); 39(8-21); 134(10-19); Gutting RT

201(15-17); 207(6-8); 271(4-16);

440(7-13).

26 Palmer 15(5-28); 16(11-13); 16(20)

17(3), 31(15-25); 32(7-14); 35(7-17);

39(13-18); Kalmanovitz (SEC) 89(26)

91(15) 92(10-17); 94(8-12); 112(28)

113(1); Mee

28. Despite the existence of the

pro rata prepayment restriction in the

Collateral Agency Agreement and the March

waivers, and his knowledge thereof,

Kalmanovitz did not alter his plan to

prepay the high interest bank debt. 28

29. Omitted.

30. The 1975 Proxy Statement did

not disclose the prepayment restrictions

contained in the Collateral Agency

Agreement or the March waivers, the fact

that Falstaff's assets were mortgaged, or

the fact that Kalmanovitz planned to

ignore the restrictions and prepay the

bank loans anyway.

31. Despite his knowledge of the

27 PX 79; Gutting RT 398(18) 399(4);

400(21) 401(9); 405(2-4); Kalmanovitz RT

§90(22) 591(6); McClellan RT 70 (10) 71

(22); McLaughlin 20(9) 23(16); Tonna 287

(3) 289(19).

28. PX 54; Kalmanovitz RT 6748(7-11)

Gutting RT 478(15-25); Percy 38(24)

39(10); 99 (1-21); Palmer 32(7-14).

prepayment restraints and the mortgages,

in June 1975 Kalmanovitz informed

Palste*f's lead bank that he intended to

prepay the bank loans in full and that

Falstaff would not make pro rata

prepayments to the insurance lenders.

3la By August 1975 Falstaff and

Kalmanovitz prepaid the bank ioans in

full. 3lb These prepayments contravened

the express terms of the March Waivers.

3lc.

32. By letters of July 25 and July

30, 1975, both of Falstaff's insurance

lenders declared defaults on their loans

and demanded immediate payment of the

entire principa]

3la PX 86.

3lb Kalmanovitz RT 623( 23-24)

3lc PX 33; PX 50; PX 5l.

7.

amounting to over $12.5 million in the

aggregate. The prepayment of the bank

loans was listed as an event of default

by both insurance lenders. 32

D. Misrepresentations and

Omissions in the 1975 Proxy Statement

1. As to the March 10 Agreement

33. ‘The 1975 Proxy Statement made

the following disclosure concerning the

March 10 Agreement between Kalmanovitz

and Falstaff:

ISSUANCE OF PREFERRED SHARES:

REASONS THEREFORE: Pursuant to an

agreement entered into as of March 10,

1975, and subject to approval of the

holders of a majority of the issued and

outstanding shares of comon stock, the

Company has agreed to issue and sell to

Paul Kalmanovitz of San Francisco,

California, 100,000 shares of the New A

Preferred stock at a price equal to the

32 PX 96; PX 97.

aggregate par value thereof, namely,

$10,000.000. Mr. Kalmanovitz has agreed

to purchase these shares and has further

agreed to guarantee the payment of up to

$10,000,00 of the Company's accounts

payable. In return, the Company has

agreed to grant him the option to

purchase 100,000 shares of the B

Preferred for $10,000,000 during a five

year period. The guaranty will expire

upon exercise of the option or at the

date of its termination, whichever shall

first occur. 33a

Three additional relevant facts were

disclosed, viz., (a) that each share of

preferred carried 45 votes, 33b(b) that

there were 4,496,625 voting shares of

Falstaff outstanding 35c and; (c) that if

the stock purchases were approved,

Kalmanovitz would have the right to name

a majority of the Falstaff Board of

33a PX 1, Section 9, P.8.

33b ID., Section 8, P.7.

33c ID., Section 4, P.4.

Directors.

34. The 1975 Proxy Statement did

not disclose:

(a) The Kalmanovitz had arranged a

$10 million extension of credit by

Continental to Falstaff which he and his

wife would personally guarantee;

(b) That the Continental extension

of credit was a material part of

Kalmanovitz's agreement with Falstaff;

(c) That Kalmanovitz had promised

additional Falstaff can business to

Continental as part of his agreement with

Continental. 34

35. The proxy also failed to

disclose in a clear and informative

manner:

(a) That, if the sale of preferred

to Kalmanovitz was approved, Kalmanovitz

would be in control of the corporation

and would become Chairman of the board

34 Tonna 55(19) 56(6) 97(7-8); 206(1-6);

Hoover 92(2-9)

of directors;

(b) That Kalmanovitz would receive

voting rights representing 52 percent of

the voting rights of the outstanding

Falstaff stock;

(c) The extent and amount of

dilution of common stock voting rights.

36. The 1975 Proxy Statement did

disclose that the proceeds from the

Kalmanovitz transaction would, to the

extent not required as working capital,

be applied to the payment and discharge

of Falstarff's bank loans. The 1975

Proxy Statement did not, however,

disclose that:

(a) by the terms of the March

Waivers, Falstaff would be prohibited

from making such prepayments on the bank

loans without pro rata prepayments on

tits insurance loans;

(b) there was a substantial risk

that the insurance lenders would declare

a default on the approximately $12.5

million in insurance loan indebtedness,

call their loans and seek to foreclose on

Falstaff if Falstaff made non pro rata

prepayments on the bank loans; and

(c) that Kalmanovitz intended to

make non pro rata payments on the bank

loans regardless of the risk.

37. The 1975 Proxy Statement did

disclose that Falstafff had had

difficulty in complying with certain

conditions in its loan agreements and had

been forced to request waivers thereof.

37a It did not disclose, however, that

the company had been in default on its

loan agreements since September 1974, and

had been forced to seek a series of

waivers from lenders since that time, all

of which were expressly conditoned on

Falstaff's agreement .o pledge all of

37a PXl, Section 9, page 8.

Ss

its real and personal property to its

lender as security for their loans; nor

was the pledge itself disclosed.

Further, the 1975 Proxy Statement did

not disclose that the March Waivers-which

Falstaff had signed-contained conditions

which required, in part, that none of the

bank loans, be paid down except on a pro

rata basis; that no new extraordinary

indebtedness, including the Continental

credit, be incurred; and that the

preferred stock to be sold to Kalmanovitz

not be issued without the consent of the

insurance lenders. 37b

2. Financial Statements Appended

to the 1975 Proxy.

38. The 1975 Proxy Statement did

not disclose the fact that General

Brewing Company which was owned and cont-

rolled by Kalmanovitz, a nominee director

of Falstaff, had entered into a product-

37b PX50; PX5l.

ion agreement with Falstaff and had

purchased Falstaff's San Francisco

brwerey in October, 1974. 38

3. Financial Statements Appended to

the 1975 Proxy.

39. Included in the 1975 Proxy

Statement were financial statements for

the year ended December 31, 1974. These

financials:

(a) stated that violations of the

covenants in Falstaff's loan agreements

had been waived by the lenders; 39a but

did not disclose the existence or terms

of the conditions on said wai ers.

(b) did not disclose that Falstaff

had pledged all of its real and personal

property to the lenders.

38 Answers 423, admitting 423 of Complaint

in relevant part.

38a PXl, page 20, footnote 6.

(c) did not disclose the existence

of the Collateral Agency Agreement or the

requirement contained in the March

Waivers of pro rata prepayments of

Falstaff's bank and insurance loans.

(d) did not disclose that the $2.5

million note receivable from General

Brewing Corporation for the sale of

Falstaff's San Francisco brewery was a

non-recourse note with limited sources of

payment or that the note represented an

indebtedness from a company owned by

Kalmanovitz a nominee director of

Falstaff. 39b

E. Kalmanovitz's Knowledge Regarding

the 1975 Proxy Statement.

40. Kalmanovitz had a draft of the

1975 Proxy Statement in his possession as

early as March 22, 1975, and on that date

showed it to a Continental representative

who reviewed it. 40a Prior to that meet-

39b Answers 423, admitting 423 of the Complaint

in relevant part; Tonna 12(16) (23).

40a Hoover 132(22) 133(11); 133(19-25).

ing, Kalmanovitz and Continental had

expressly agreed not to publicize their

agreement. 40b

41. In addition, Kalmanovitz

received a copy of the final Proxy

Statement shortly after March 31% He

read it, thought it was fraudulent, but

“kept his mouth shut" because he had

already put up his $3 million advance.4l

42. Thus, Kalmanovitz, in advance

of the annual shareholders meeting at

which he was to obtain control of

Falstaff, knew about mis-statements and

omissions in the 1975 Proxy Statement

regarding Continental and the lenders,

was a nominee director therein, and had

nominated three other proposed

directors.42

40b Hoover 197(4-20); Tonna 264(15) 266(23).

41 Kalmanovitz (Antitrust) VII 582(24-28); 533

(3-26) 584 (14-22); 585 (7-16); (19-23);

Kal manovitz RT 652 (4-9); 658 (2-24); PXl, page l

42 PX1l, Section 4, page 4.

PART III. FALSE MISLEADING AND UNTIMELY

REPORTS FILED WITH THE COMMISSION BY

FALSTAFF AND KALMANOVITZ AFTER APRIL,

1975.

43. During the period from April

1975 to the present, Falstaff has filed

with the Commission at its offices in

Washington, D.C. numerous annual and

periodic reports pursuant to Section

13(a) of the Exchange Act and Rules

l3a-l1, 13a-11 and 13a-13 promulgated

thereunder, including Annual Reports on

Form 1L0-K, Quarterly Reports on Form 10-Q

and Current Reports on Form 8-K. 43

44. During the period from April

1975 to the present, Falstaff has filed

with the Commission proxy soliciting

materials, in connection with annual and

other meetings of shareholders of

Falstaff, pursuant to Section 14(a) of

the Exchange Act and the rules and regul-

43 Answers 462.

lations promulgated thereunder. 44

45. After the Kalmanovitz

take-over, Falstaff continued to file

false and misleading reports with the

Commission and failed to submit other

required reports thus continuing to

deprive the shareholders and the

investing public of full and fair

disclosure concerning the corporation.

46. Barry Murphy acted as corporate

counsel for Falstaff From the summer of

1975 until his departure from Falstaff in

August 1977 with the exception of a few

months in early 1976. He was member of

the board of directors of Falstaff from

September 1975 to July 1976 and acted as

secretary to the corporation during

approximately the same period. Murphy

o participated in the drafting of the

majority of reports filed with the

Commission by Falstaff during the two

year period he was at Falstaff. However,

during this two year period Murphy was

a 44 Answers 463.

never on Falstaff's payroll-he was also

serving as corporate counsel for General

Brewing and was an employee of General

Brewing, hence of Kalmanovitz. 46

47. Robert Sievers is a certified

public accountant. He became treasurer

of Falstaff and was appointed to the

Board of Directors in August, 1976. From

the beginning of nis employment in March,

1976 to the time of his departure in

November 1977, Sievers participated in

the preparation of Falstaff's filings

with the S.E.C. 47

48. Daryl McCurry is presently the

controller for Falstaff. Since July 1976

McCurry has also had responsibility with

respect to SEC filings by Falstaff. 48

A. ‘Current Reports on Forms 8-K

49. Falstaff failed to file a Form

8-K disclosing the prepayments of the

bank loans during the summer of 1975, nor

46 Murphy 237(1) 288(10) 240(1) 241(4)

Answers to Interrogatories 41 and Exhibit A.

47 Sievers RT 265(12-15) 266 (1-24) 268 (4-6)

271 (2-9). |

did Falstaff disclose that these payments

violated terms of the March Waivers

Agreement between Falstaff and its

lenders.

49a. Falstaff failed to file a Form

8-K for July 1975 disclosing the fact

that the insurance companies had declared

over $12.5 million in loans in default

and that the prepayments to the bank

lenders had precipitated the declaration

of defaults.

49b. Falstaff failed to file a

Form 8-K to report that Palstaff had

entered into a two year note with

Continental for $11.6 million in August

1975.

49c. Falstaff failed to file a Porm

8-K disclosing the reduction in long term

indebtedness during October, November,

and December, 1975, resulting from

Falstaff's payments on the Continental

note.

50. On August 29, 1975, McClellan

sent a letter to a lawyer working for

Kalmanovitz, with copies to Kalmanovitz

and Murphy, in which he expressed concern

about Falstaff's compliance with the

reporting requirements of the securities

laws. He pointed out specifically that

the loan defaults should be disclosed on

a Form 8-K. 50

51. On November 10, 1975, Falstaff

filed a Form 8-K for the month of

October, but failed to disclose any of

the events described in 4's 49-49(c)

above including the declaration of

defaults by the lenders, the acceleration

of $12.5 million in principal payments,

the bank loan prepayments, or the $11.6

million long-term Continental note. 51

52. The October 8-K wsa prompted by

SPSS i a a

50 PX 107; McClellan RT 108(7-15), 109(1-2)

113(7-19).

51. PX 7; Murphy 403(8) 405(28).

by Haskins & Sells in which Haskins &

Sells resigned as independent auditors

and informed Falstaff that it would have

to report the resignation in a Form 8-K.

Kalmanovitz told Murphy to draft the

October 8-K in response to Haskins &

Sell's letter. 52

53. During the drafting of the

October 8-K, Murphy discussed the items

which should be included therein with

Kalmanovitz and reviewed drafts with him.

Although Murphy indicated that the rules

required disclosure of loan defaults,

they jointly determined not to disclose

the defaults specifically because it was

Falstaff's position that it had not

defaulted on the loan agreements. They

decided, instead, to disclose the

defaults by describing lender related

litigation. 53

53a. However, the October 8-K did

52 Murpjy 360(13) 361(14), 362(8-12) PX 7,

attached letter of 10/24/75.

53 PX 7; Murphy 364(2-1 2) 367(1-9), 385(25)

— Bite 5= 27) 392(10) 393(14) 394(11-24).

not describe the litigation; it only set

forth the case by name and number and

indicated the case related to

"financing". It gave no information

about the alleged defaults or any other

problems with the lenders. 53a

54. At the time the litigation

record was compiled for inclusion in the

8-K, Murphy and Kalmanovitz knew that the

Form 8-k rules required that Falstaff

give a description of the significant

items of litigation. 54

55. In response to comments by the

SEC, Murphy prepared and filed another

Form 8-K for January 1976. The January

8-K described the lender litigation and

Stated that when Falstaff made the

prepayments on the bank loans the

insurance companies threatened suit

"based on Falstaff's failure to permit

the insurance companies to share in these

53a PX 7.

54 Murphy 385(25) 387(14).

Same prepayments according to prearranged

terms set by the same companies. 55

55a. The 8-K did not disclose that

Falstaff had agreed to the pro rata

prepayment provisions contained in the

March waivers, nor did it disclose the

existence of the Collateral Agency

Agreement, or the pro rata prepayment

provisions which had been incorporated

therein. The January 8-K further did not

disclose that the foregoing agreements

existed before the shareholders approved

the sale to Kalmanovitz (which sale

required that the proceeds be used to pay

off the banks), and that Falstaff and

Kalmanovitz made the prepayments to the

banks with full knowledge that there was

a substantial risk that default would be

declared on th insurance loans.

Kalmanovitz participated in the drafting

of this specific disclosure. 55a

55 ‘urphy 413(11) 414(12); PX 9

55a Murphy 431(16-28)

B. The November 1975 Shareholders'

Letter

56. In November, 1975, Kalmanovitz

sent to Falstaff's shareholders a letter

drafted by himself and Murphy which was

false and misleading. The letter

disclosed that Falstaff had prepaid the

bank debt and stated the insurance

lenders threatened Falstaff with a

lawsuit based on "an agreement which the

lenders had made between themselves".

The letter did not disclose that the

lenders had declared $12.5 million in

indebtedness in default and immediately

due and owing. Nor did the letter

disclose that the “agreement" referred to

(the Collateral Agency Agreement) was

approved by Falstaff's Board of

Directors. Of greater significance is

that the letter omitted reference to the

March Waivers wherein Falstaff had speci-

56 Murphy 399(2-22), 399(27) 400(7) 430 (10-19)

PX120; Kalmanovitz SEC 276(16-25), 278(7-9),

PX 50 & 51 (para.3).

fically agreed inter alia not to pay any

Signatory of the Collateral Agency

Agreement other than on a pro rata basis.

56

C. The Annual Reports on Forms

10-K

57. In its annual report on Form

10-K for fiscal year 1975, Falstaff

disclosed in the description of

litigation that Falstaff's lenders were

"claiming default under covenants of the

Original lending agreements and also a

default resulting from an agreement dated

March 25, 1975 requiring the company to

pay off its long term lenders on a pro

rata basis."

57a. The 10-K did not disclose that

Falstaff's prepayments of its bank loans

precipitated the declaratoin of defaults

by the insurance lenders.

58. No attempt was made to correct

this misleading disclosure in succeeding

reports-the Falstaff Form 10-K for 1976

contains the same disclosure regarding

Falstaff's lender litigation as did the

1975 Form 10-K. 58

59. At the time that Falstaff was

making its reports to the Commission and

to the shareholders, Kalmanovitz

considered that the pro rata prepayment

restrictions, (which he considered to be

unenforceable) would be a considerable

threat to the financial stability of the

company if ultimately found to be

enforceable. 59

D. Adoption of False and Misleading

Statements

60. Since April 1975 Falstaff and

Kalmanovitz have failed to correct many

of the misleading disclosures in the 1975

Proxy Statement, and have adopted the

false and misleading disclosures therein.

58 PX 10, Item 5.

59 PX 114; PX 108 at pages 13-14, Kalmano-

vitz (SEC) 271 (28) 272(11); 273 (12-15)

EE

|

61. In various reports filed with

the Commission subsequent to the 1975

Proxy Statement, there have been

discussions of the sale of Falstaff

preferred stock to Kalmanovitz. Some of

these reports make explicit cross

reference to that portion of the original

1975 Proxy material dealing with

increases in outstanding securities. Yet

nowhere has Falstaff corrected the

misstatements and omissions noted in

435(a)-(c) above concerning the effect of

those share increases. 61

62. Moreover, as described below

((63b), Kalmanovitz adopted the language

of the 1975 Proxy Statement in describing

his purchase of Falstaff preferred stock

in his own personal filing of a Schedule

13D more than one year after the 1975

Proxy Statement was disseminated.

E. Kalmanovitz's Schedule 13D

61 Murphy 434 (18-28), 437(19) 438(7); PX 6,

Item C; PX 8, Item 6; PX ll, Section entitled

"Election of Directors"; PX 10, Footnote

No. 8 to the financial statements.

63. By reason of his purchase of

the Falstaff preferred stock in April

1975, Kalmanovitz was required by Section

13(d) of the Exchange Act to file a

Schedule 13D setting forth specific

information about his purchase within 10

days of his purchase.

63a. Kalmanovitz filed the required

Schedule 13D over one year late, in May

1976. 63a

63b. The disclosure of

Kalmanovitz's transaction with Falstaff

in the Schedule duplicates word for word

the description in the 1975 Proxy

Statement concerning Kalmanovitz's

purchase and thereby adopts the

misleading disclosure of the 1975 Proxy

Statement. 63b

64. In addition, the Schedule 13D

failed to disclose, as required, certain

63a Answers 448.

63b PX 1, items 8, 9; PX 15, Item 4.

funds for the purchase.

65. Kalmanovitz filed the Schedule

13D only after a lawsuit was brought by a

minority shareholder of Falstaff,

alleging in part his failure to comply

with the requirements of Section 13(d).

65

66. In his letter to the SEC

enclosing the Schedule 13D, Kalmanovitz

Stated that his delay in filing the

Schedule was caused by the fact that he

was not familiar with the SEC

requirements for such disclosure. 66

66a. However, Kalmanovitz had

previously signed and filed a Schedule

13D with the SEC when he acquired control

of General Brewing Corporation in

October, 1971. 66a

Part IV. THE 1977 PROXY STATEMENT

67. On or about April 29, 1977,

Falstaff filed with the Commission and

65 Kalmanovitz RT 627 (17-23) 663(13-16)

66 PX 131; See also Answers 448

66a PX 183.

mailed to shareholders of Falstaff, a

proxy statement ("1977 Proxy Statement")

pursuant to Section 14(a) of the Exchange

Act and the rules and regulations

thereunder, with respect to an annual

meeting of shareholders of Falstaff to be

held on June 7, 1977. 67

68. The 1977 Proxy Statement

solicited proxies from the shareholders

for the election of directors, including

the re-election of Kalmanovitz, and for

an amendment to the character of Falstaff

which would permit Falstaff to pay

Kalmanovitz dividends on his preferred

stock in the form of common stock of

Falstaff instead of cash. The preferred

stock in question is the stock which was

purchased by Kalmanovitz by means of the

1975 Proxy Statement. The proposed stock

dividend had to be approved by a majority

vote of both Falstaff preferred and

67 Answers 457.

common shareholders voting as separate

classes. 68

69. The 1977 Proxy Statement states

the following concerning the proposed

charter amendment:

PROPOSED AMENDMENT TO THE CERTI-

FICATE Of INCORPORATION: On March 14,

1977 the Board of Directors approved an

amendment of the Corporation's

Certificate of Incorporation to permit

the payment of common stock dividends on

Class A and Class B preferred stock in

lieu of cash dividends. Adoption of this

proposed amendment requires the separate

approval of each class of stock

outstanding. Approval requires that a

majority of the votes entitled to be cast

by each class be voted in favor of such

amendment. The purpose of this amendment

is to allow the Corporation to provide

68 PX3; Answers 458.

their investment without draining the

working capital of the company. The

Certification of Incorporation

presently provides only for cash

dividends to be paid to the preferred

shareholders. As amended, the Certific-

ate of Incorporation would permit the

Corporation upon decision of the

Shareholders, to declare common stock

dividends in lieu of cash dividends on

the Class A and Class B preferres stock.

The effect of the payment of such

dividends, payable in common stock to the

preferred shareholders, would be some

dilution in ownership for the holders of

common stock. It is the opinion of

management that the adoption of this

amendinent will be highly advantageous to

the company since it will allow the

company to conserve its cash and working

capital and maintain a stronyer financial

position. Management highly recommends a

vote in favor of this amendment. It is

intended that shares represented by

proxies in the accompanying form will be

voted in favor of this amendment provided

such proxies are not voted to the

contrary.

The 1977 Proxy Statement also states

that Kalmanovitz is the holder of 100

percent of the Class A Preferred stock

and therefore has a direct interest in

the proposed stock dividend. 69

70. The 1977 Proxy Statement failed

to disclose the following:

(a) the beneficial ownership by

Kalmanovitz of 52 percent of the voting

rights of Falstaff;

(b) that Kalmanovitz controlled the

company and the Board of Directors and

therefore could dictate the Board of

Directors' action on the granting of the

69 PX 3.

stock dividend;

(c) that while Falstaff "highly"

recommended the amendment, there was a

potential conflict of interest between

Kalmanovitz and Falstaff concerning the

transaction, in that Kalmanovitz's

control of Falstaff might be

Significantly enhanced thereby;

(d) the intentions of the Board, if

any, with respect to declaring the stock

dividend in the current and succeeding

years;

(e) the fact that there were

existing restrictions on the payment of

cash dividends (contained in the March 10

agreement) and whether they would apply

to potential current or future stock

dividends;

(£) the number and percentage of

shares of common stock which Kalmanovitz

would receive if the charter amendment

were adopted (at the approximate market

price prevailing in April 1977, the stock

dividend proposed would amount to 240,000

shares of Falstaff common or five (5)

percent of the outstanding shares of

common stock;

(g) a quantification of the

dilution of Falstaff's common stock

resulting from the proposed amendment;

(h) the value which would be

assigned to the comon stock to be used as

dividends and the current market value of

the common stock (approximately $2.50 per

share);

(i) the source of the common stock

which would be used for the

dividends-i.e. whether it would be

purchased on the market, taken from

treasury stock or taken from unissued

stock of the corporation;

(j) the dollar amount ($600,000)

which would be paid to Kalmanovitz for

the cash dividends on his preferred

stock;

(k) pertinent financial data

regarding Falstaff's cash and working

capital showing that Falstaff's cash and

cash equivalents as of December 31, 1976

were $15.6 million, although the stock

dividend is recommended as being needed

by the company to conserve cash and

working capital;

(1) the facts concerning the

transaction in 1975 between Falstaff and

Kalmanovitz, the facts relating to the

conflict with the lenders, and

continental transaction and the

consequences to Falstaff therefrom; and

(m) that the “audit committee" of

Falstaff's Board, whose existence and

membership was disclosed therein, had

never functioned, and, indeed, had never

even met. 70

71. The 1977 Proxy Statement was

primarily drafted by Sievers, McCurry and

Murphy. McCurry, the primary draftsman,

had never drafted a proxy statement

before, was not confident of his ability

to do so, and characterized his role as

that of a “pencil pusher”. He relied on

Murphy for the adequacy of the

disclosures. Both Sievers and Murphy

reviewed drafts and commented thereon,

although Murphy states that he never

reviewed the proxy statement for SEC

compliance because he was never asked to

do so. 71

72. Kalmanovitz also received

copies of the drafts of the 1977 Proxy

Statement and suggested changes. 72

73. %In the process of preparing the

proxy statement, Falstaff considered

disclosure of many of the significant

70 PX 3, page 5. See discussion bbéow at 4142

re the audit committee.

71 McCurry 38(14) 29(6); 60(9) 61(11)

Murphy 227(9-20), 229(5~18), 235(18), 236(4)

276 (11-17) Sievers RT 277(5-14).

omitted facts discussed above but decided

to withhold them from the proxy

Statement. Thus, although the amendment

to Falstaff's charter which had been

approved by the Board of Directors

contained information concerning the

method of valuation of the stock dividend

and a description of the existing

restrictions on FalstafE€'s ability to

issue cash dividends, a specific decision

was reached at Falstaff not to disclose

all the information contained in the

amendment. 73a So, too, consideration

was given to disclosing (i) that

Kalmanovitz owned 52% of voting rights of

Falstaff 73b and (ii) that Falstaff had

in excess of $15 million in working

capital 73c and (iii) the diluting effect

the proposed stock dividend would have

upon the outstanding common stock. 73d

In each instance, the information was

72 Sievers RT 277(5-18), 279(10) 280(11)

336(5-11), 337(9-16).

73a McCurry 33(5), 34(16-25) 35(1-4)

41(13-24), 42(11-19); Murphy 231(9-15),

232(4), 233(18), PX203, pagse 12

withheld despite the fact that, with

respect to the dilution question, Sievers

knew that the regulations specifically

required disclosure of the dilution

impact and McCurry thought that the

dilution disclosure was not adequate and

so argued. 73e

74. During the drafting of the

Proxy Statement, McCurry became concerned

about the qualifications of the Falstaff

people to make required SEC disclosure.

Accordingly, he suggested to Sievers and

Murphy several times that someone more

familiar with the SEC rules -i.e.,

qualified counsel-be brought in to review

the 1977 Proxy Statement. His suggestion

was rejected. 74

75. McCurry remained concerned that

Falstaff personnel were not qualified to

73b McCurry 53 (23) 54(3)

74c McCurry 46(3-16), 49(6-18)

73d McCurry 30(9-13), 31(4-23), 32(5-22)

3395-10), (16-27)

73e McCurry 51(71-5), PX 156, page 3, Item #18

determine that the regulations had been

complied with. The “only comfort" which

he and Sievers thought they could find

for the fact tha Falstaff did not have

qualified legal counsel to review the

proxy statement was that they thought it

would be reviewed by the commission for

defects when it was filed. 75

76. The 1977 Proxy Statement was

filed with the Commission in preliminary

form on or about March 28, 1977.

Falstaff was advised on April 6 that the

Commission would not give informal

comnents but that the proxy materials

were materially deficient, and that if

Falstaff disseminated it, it would be at

its own risk.

McCurry 35(15) 20(21) 61(12) 62(19)

62(25) 63(8) 63(11-16).

75 McCurry 64/.-19); Sievers RT 282(6-24)

76 Murphy 281(2-14) 287(190 288(16) Dowd RT

527(8) 528(2) 528(;0-20); PX152; PX158

PX214

77. Commission regulations provide

that the comment procedure is informal

and that the Commission will not issue

comments:

Where the deficiencies appear to

stem from careless disregard of the

Statute and rules or a deliberate attempt

to conceal or mislead or where the

Commission deems formal proceedings

necessary in the public interest. 77

78. In response to the SEC

objections, Falstaff added the following

Statenent (the "Rider") to the 1977 Proxy

Statement:

In accordance with the rules and

regulations of the United States

Securities and Exchanye Commission, this

Notice of annual Meeting of Shareholders

and Proxy Statement was submitted to the

SEC in advance of mailing. The SEC has

taken a_‘'no comment' position relative to

oennnneeneenenentatinesttinensttitientiinensdt=iientitieedt

77:17 CWF.R. 202.3(a)

this proxy statement. The Company, in

the interest of its shareholders, has

proceeded with the mailing of this Proxy

Statement without having received any

formal comments from the SEC. In the

event that the SEC later objects to any

item or items to be voted upon, the votes

as tabulated by the Company respecting

any such item or items will not become

effective until such time as such

objections have been resolved.

The Rider does not disclose that the

Commission had informed Falstaff that the

proxy statement was materially deficient

and that it would be sent only at

Falstaff's peril. 78

79. The Rider was added at the

express insistence of Kalmanovitz, who

participated in its drafting, approved

its final wording and directed that the

proxy statement, as worded, be sent to

78 Murphy 281(2-14), 284(7), 286(2), 286

13-22), 287(19) 288(16); Answers 461; PX 162,

page 2 44.

Falstaff's shareholders. Sievers and

McCurry were concerned that the

Commission might still object to the form

of the proxy statement after the Rider

was included, but concluded they had been

directed to issue the proxy statement in

that Form. 79

80. Falstaff mailed the 1977 Proxy

Statement on or about April 29, 1977,

more than three weeks after the

Commission informed Falstaf& that the

Proxy Statement was materially deficient.

During that time, Falstaff made no

revisions to the originally drafted

disclosure in the proxy statement, other

than adding the Rider and changing the

annual meeting date. No outside advice

was sought by FalstafE as to the problems

with the proxy statement and no attempt

was made to redraft the proxy statement

79 Murphy 284(7) 286(2), 505(9-20); McCurry

72(5) 73(2) 73(7) 73(23); Sievers RT

283(10-19), Kalmanovitz (SEC) 178(3)

179(4); Kalmanovitz RT 659(21) 660(2).

argues that at least one misleading

statement in the 1977 Proxy Statement is

simply a “grammatical error" not even

this error was corrected before the final

proxy statement was mailed. 80

81. On May 10, 1977, the staff of

the Commission advised Falstaff that the

Commission had authorized the filing of a

complaint against Falstaff. Nonetheless,

Falstaff continued to go forward with the

1977 annual Shareholders Meeting

scheduled for June 7, 1977 and solicited

proxies ‘Sy means of the 1977 Proxy

Statement uatil the commission filed a

motion for preliminary relief on May 27,

1977. Falstaff then entered into a

Sstipulatoin dated June 1, 1977 with the

Commission the terms of which required

FalstafE to postpone its annaul meeting

and all solicitation of proxies until

80 Murphy 282(6-14) 282(20) 283(2); Sievers

RT 282(25) 283(2) 283(5-9); Answers 457.

Falstaff memorandum in opposition to prelimin-

ary relief, page 55; Kalmanovitz (SEC)

180(15-22).

motion for preliminary relief. The Court

entered a preliminary injunction against

Falstaff on August 1, 1977. 81

PART V FORMS 3 and 4

82. Section 16(a) of the Securities

Exchange Act of 1934 and the rules and

regulations thereunder required all

officers and/or directors of Falstaff to

file a "Form 3" (Initial Statement of

Beneficial Ownership of Securities)

within ten days of their election

disclosing whether or not they held

Falstaff stock. It also required that

changes in beneficial ownership be

reported on Form 4 within 10 days

following the end of the month in which

the change occurred.

83. Kalmanovitz, who was elected a

dicector of Falstaff on April 23, 1975,

failed to file either a Form 3 or Form 4

until July, 1977. None of Falstaff's

81 McCurry 74(1-4); PX 162; Murphy 297(12)

298(5).

directors elected at the August 6, 1976

shareholders meeting filed a Form 3 or

Form 4 until after July, 1977. 83

84. In the period between August

1976 and May 1977, Kalmanovitz purchased,

beneficially, approximately 250,000

shares of Falstaf€ common stock, and

transferred record ownership of his

100,000 shares of Falstaf& preferred

stock to his private companies, all

without reporting the transactions to the

Commission on a current basis. 84

85. At the time of their election

to Falstaff's board in August 1976,

several directors owned stock in

Falstaff. Falstaff knew about the

directors' stock ownership in 1976 but

no review was made to determine whether

the directors were required to make

reports. 85

86. In July through September 1977,

after the institution of this lawsuit on

May 26, 1977, Sievers prepared and filed

83 PX 18; McCurry 74(15) 75(12)

84 Id.

— E£_—

Forms 3 and 4 on behalf of Kalmanovitz

and all the other Falstaff directors

covering the entire period that they had

been directors. 86

PART VI. DISREGARD OF DISCLOSURE

RESPONSIBILITIES UNDER THE SECURITY LAWS

87. Since the Kalmanovitz

take-over, Falstaff and Kalmanovitz have

disregarded their responsibilities under

the federal securities laws. In addition

to the materially false and misleading

reports and failures to report discussed

above, the following factors fucther

support the conclusion that without

injunctive restraint there exists a

reasonable likelihood that Falstaff and

Kalmanovitz will continue to ignore and

disobey the requirements of the

securities laws.

A. Adequacy of Counsel

85 Murphy 457(7) 458(8) 464(9) PX 128;

Hutton 160(15) 156(8); Sievers RT 300(1-12)

311(19) 312(16) 337(21) 338(3) PX 18.

86 PX 18, PX 169 and PX 173.

Falstaff has not made an adequate attempt

to assure full and fair disclosure under

the securities laws. For example, prior

to this lawsuit, Falstaff did not have

experienced securities counsel to review

its reports or disclosure requirements.

Moreover, the counsel at Falstaff,

Murphy, told Kalmanovitz he was not

qualified to monitor SEC compliance and

that qualified counsel should be

retained. This was not done, and Murphy

continued to work on SEC filings in 1976

and 1977. 88

B. Adequacy of Accounting

89. In October, 1975, Kalmanovitz

who was then disputing the accuracy of

Falstaff's previous financial statements,

represented in a letter to the SEC that

FalstafE had hired new indepe.wient

accountants to audit Falstaff's books and

thereby enable Falstaff to file accurate

88 Murphy 348(14) 250(19) 440(5-26) 455(14)

446(11), 467(5) 468(1) Kalmanovitz (SEC)

183(22) 184(25) 186(2-28) Answer to

Interrogatorires 45.

reports. In fact, Falstaff had not hired

new independent accountants at that time.

90. At the urging of Sievers, an

audit committee was appointed at the

board of Directors meeting of September

29, 1976. The stated purpose of the

audit committee was to review and approve

the work of Falstaff's auditors. 90

91. Sievers believed the audit

committee should be composed of outside

directors. Although the minutes of the

September Board meeting reflect that the

audit committee consisted of "outside"

directors, the directors chosen were

Sievers, Garman and Nicholas Schleifer.

Garinan and Schleifer were employees of

General Brewing which is 99% owned by

Kalmanovitz. Kalmanovitz, Sievers and

Murphy had discussed whether Schliefer

and Garman were “independent" directors

and had concluded they were. Clearly,

90 Sievers RT 313(15) 314(9); PX 201 Page 2 at

q5-6.

Clearly, they are not. 91

92. Although the minutes of a

subsequent Falstaff Board meeting state

that the Board reviewed and approved "the

activities" of Falstaff's audit

committee, the audit committee in fact

never met, never became operational, and

had had no “acitvities" to review or

approve. 92

93. Accordingly, Falstaff's

statement in its 197/ Proxy Statement

that it had an audit committee was

misleading in that the committee existed

in name only. 93

CONCLUSIONS OF LAW

I. Applicable Legal Principles

1. The Commission seeks to enjoin

91 PX 201 Page 2 at 45-6; PX 1l, page 3

Kalmanovitz affidavit at 4101; Murphy 156(16)

158(2) 160(4-10).

92 PX 203 Page 3 at 4; Sievers RT 316(4-9)

320 (2-22); Garman 47(14) 48(3) 49(23)

50(19).

93 PX 3, page 5; Sievers himself couldn't

remember who the members of the audit commi-

tt ‘ee were and made a note to look them up

for disclosure in the proxy statement

(PX 156, Page 3, Iten 17).

Falstaff and Kalmanovitz from future

violations of the federal securities

laws. It seeks this relief pursuant to

Section 21(4) of the Exchange Act [15

U.S.C. §78u(d)] which provides that the

court shall grant a permanent or

temporary injunction or restraining order

upon a “proper showing" by the

Commission. This test is satisfied where

there is a showing that defendants" past

conduct indicates a resonable Likelihood

of future violations by the defendants.

(D.C. Cir. , July 14, 1978) at 36.

2. In an action involving

"remedial" statutes such as the Exchange

Act, a district court has broad

discretion to enjoin possible future or

present violations of law where past

violations have been shown. SEC v. Kor-

acorp Industries, Inc., 575 F. 2d 692,

701 (9th Cir. 1978); SEC v. Manor Nursing

Centers, Inc., 458 F. 2d 1082, 1100 (2d

Cir. 1972).

3. The standards governing the

issuance of an injunction sought by the

government for the protection of the

' public are necesarily broad and Free froin

the more restrictive concepts employed in

private litigation. When a federal court

exercises its eo a issuing a

Statutory restraining order or

injunction, it is guided by the primary

objectives of the statute involved, using

the public interest as its guide post,

rather than the requirements of private

litigation. Superintendent of Insurance

v. Bankers Life & Casualty, 404 U.S. 6,

321, 331 (1944). As the Supreme Court

held in SEC v. Capital Gains Research

Bureau, Inc. 375 U.S. 180 (1963), the

"mild prophylactic" relief of an

injunction under the federal securities

laws is not to be circumscribed by the

more rigid standards which prevail at

common law. Thus, it is not necessary

for the Commission to show irreparable

harm, or the inadequacy of other remedies

or to post bond upon the granting of an

injunction. SEC v. Management Dynamics,

515 F. 2d 801 (2d. Cir. 1975); SEC v. Tax

Service, Inc., 357 F 2d 143, 145 (4th.

Cir. 1966); But C.F. SEC v. Commonwealth

Chemical Securities, Inc., 574 F. 2d 90,

99 (2d Cir. 1978).

4. The findings of fact demonstrate

there have been violations of Sections

10(6), 13(a) and 14(a) of the Exchange

Act [15 U.S.C. §§78j3(b), 78m(a) and

78n(a)] and Rules 10b-5, l3a-1, 1l3a-1l,

13a-13, 14a-3 and 14a-9 [17 C.F.R. §§240

10b-5 240 l3a-1, 240.13a-11, 240.13a-13,

240 14a-3 and 240.14a-9] thereunder, and

Rule 12b-20 [17 C.F.R. §240.12b-20] by

both Kalmanovitz and Falstaff and of

Section 13(d) of the Exchange Act [15

U.S.C. §78m(d)] and Rule 13d-1 [17 C.F.R.

§240.14d] thereunder by Kalmanovitz

himself.

A The Commission has made a proper

showing that there exists a reasonable

likelihood that Kalmanovitz and Falstaff,

unless enjoined and restrained, will

violate the federal securities laws in

the future.

6. In light of the showing made by

the Commission of repeated past

violations and of a reasonable likelihood

of future violations by the defendants,

the Court concludes that both Kalmanovitz

and Falstaff should be enjoined from

future violations of the anti-fraud,

reporting and proxy provisions of the

Exchange Act.

II. VIOLATIONS OF SECTION 14(a)

7. Material facts necessary to be

disclosed in a proxy statement are facts

about which: .. . there is a substanti-1l

likelihood that a reasonable shareholder

would consider it important .. . What

the standard does contemplate is a

showing of a substantial likelihood that,

under all the circumstances, the ...

fact would have assumed actual

significance in the deliberations of the

reasonable shareholder. Put anotehr way,

there must be a substantial likelihood

that the disclosure of the... fact

would have been viewed by the reasonable

investor as having significantly altered

the “total mix" of information made

available. TSC Industries v. Northway,

Inc., 426 U.S. 438, 449 (1976).

8. Failure to disclose material

information specifically required to be

disclosed under Schedule 14A [17 C.F.R.

§240.14a101 et seg.] violates Section

14(a) of the Exchange Act and Rule 14a-3

thereunder SEC v Kalvex, Inc., 425 F.

Supp 310 (S.D.N.Y. 1975); SEC v. General

Refractories Co., 400 F. Supp. 1248, 1257

(D.D.C. 1975).

9. The Commission has made a proper

showing that proxy materials filed with

the Commission pursuant to Section 14(a)

of the Exchange Act and disseminated to

Falstaff's shareholders were materially

false and misleading and omitted to state

material information required to be

stated therein under the applicable rules

and regulations of the Commission.

A. The 1975 Proxy Statement

10. Falstaff's transactions with

Kalmanovitz, Kalmanovitz's control of

Falstaff and potential conflicts of

interest with respect thereto, the

Continental credit, and Falstaff's

difficulties with its lenders, are all

material facts which should have been

but were not disclosed in Falstaff's 1975

Proxy Statement and which were necessary

to enable stockholders to appraise their

corporation and its management and vote

their shares intelligently. The failure

to disclose these facts rendered

FalstaEE's 1975 Proxy Statement

materially false and misleading.

ll. Item 7(£) of Schedule 14A

required that the 1975 Proxy Statement

disclose the Continental extension of

credit and Kalmanovitz's and his wife's

personal interest therein and the fact

that the Continental extension of credit

was a mterial part of Kalmanovitz's

nveataent in Falstaff. The failure of

the 1975 Proxy Statemetn to do so

rendered it materially false and

misleading.

12. Item 5(f) of Schedule 14A

required that the 1975 Proxy Statement

disclose the material fact that

Kalimanovitz would be in control of

Falstaf€ if the sale of preferred stock

was approved. The failure of the 1975

Proxy Statment to do so, clearly and

unambiguously rendered it materially

false and misleading.

12a. The disclosure contained in

the 1975 Proxy Statement concerning

Kalmanovitz's control of Falstaff,

requiring a shareholder to search out

three critical facts which were set forth

in separate sections and on various pages

of the proxy statement, and to make

mathmatical calculations in order to

conclude that Kalmanyvoitz would have

numerical voting control of Falstaff, was

not adequate to inform the shareholders

of Kalmanovitz's control position. Buried

disclosure is not adequate jisclosre

Feit v. Leasco Data Processing Equipment

Corp., 332 F. Supp. 544, 545 (E.D.N.Y.

1971); Gould v. American Hawaiian

Steamship Co., 331 F. Supp. 981, 988-989

(D.Del. 1971) aff'd in relevant part, 535

F. 24 761, 774 (3d Cir. 1976).

13. Item 12(d) of Schedule 14A

required that the 1975 Proxy Statement

disclose the material dilution effect on

Falstaff's existing shareholders of the

sale of stock to Kalmanovitz. The

failure of the 1975 Proxy Statement to do

so rendered it materially false and

misleading.

14. The failure of the 1975 Proxy

Statement to disclose the serious

financial straits of Falstaff, including

the facts that there had been a

continuing default on the loan agreements

and that Falstaff obtained waivers of the

defaults by mortgaging its assets, made

the 1975 Proxy Statment materially false

and misleading. This informatin was

particularly material in light of the

Kalmanovitz plan to prepay the bank

loans.

15. The failure to disclose the pro

rata prepayment restrictions regarding

Falstaff's bank loans was also a mterial

omission in that Kalmanovitz's prepayment

plan put in jeopardy over $12.5 million

in insurance loans, risked foreclosure on

Falstaff's assets, and made possible

lengthy, expensive and uncertain

litigation with Falstaff's lenders.

Falstaff and Kalmanovitz contend that the

pro rata prepayment restrictions in the

Collateral Agency Agreement and March

Waivers did not have to be disclosed

because they (1) violated the antitrust

laws, (2) were improperly executed and,

(3) in any event did not preclude

prepayment. Even if these contentions

were true, 15 they would not excuse the

failure to disclose the existence of

15 On March 3, 1978 the District Court fort

the Northern District of California entered

summary judgment ayainst Falstaff on

these contentions. See Falstaff Brewing

Co. v. New York Life Insurance Co. No. C-

*

these restrictions and the terms thereof.

The relevance of the restrictions were

not their validity, but rather their

existence and terms. It was the risk

attendant to Kalmanovitz's plan to ignore

these restrictions that had to be

disclosed. In deciding whether to

approve the sale of control to

Kalmanovitz, Falstaff's shareholders were

entitled to know the substantial downside

risks inherent in Kalmanovitz's proposed

infusion of capital into the company.

15a. Item 7(f£) of Schedule l4a

required that the 1975 Proxy Statement

disclose the material October 1974

agreements between Falstaff and General

Brewing. The failure of the 1975 Proxy

Statement to do so rendered it materially

false and misleading.

B. KALMANOVITZ'S LIABILITY UNDER

SECTION 14(a) FOR THE 1975 PROXY

STATEMENT.

16. To hold Kalmanovitz personally

liable under §14(a) for the misstatements

and omissions contained in the 1975

Proxy Statement is must be demonstrated

that he either "solicited" or "permitted"

the use of his name to solicit the

proxy". The SEC has claimed to have

established Kalmanovitz's personal

liability under §14(a) under two separate

theories.

l6a. First, the SEC asserts that

Kalmanovitz is liable as a principal in

that he permitted the use of his name to

solicit the 1975 proxy. Accordingly, we

are required to face the rather novel

question of whether the reach of §14(a)

can be extended beyond the directors and

officers of a company to the prospective

buyer, when the solicitor of the proxy is

the company itself.

16b. To hold a person liable under

§14(a) for the use of his name in

soliciting a proxy, it must be demon-

Strated at the very least that a

substantial connection between the use of

the person's name and the solicitation

effort existed. Yamamoto v. Omiya, 564

F. 24 1319, 1323 (9th. Cir. 1977). The

SEC points to the following factors to

demonstrate such a connection: (a)

Kalmanovitz was a director-nominee, (b)

he was nominating three other directors

and, (c) he was the sole beneficiary of

the proposal in that it would yield him

control of Falstaff. Kalmanovitz

coccectly points out that, at lesat as to

the last factor, the mere appearance of

one's name as the beneficiary of a proxy

proposal, without more, does not

constitute the use of his name to

"solicit". Yamamoto, supra; Lewis v.

1975).

l6c. However, in addition to being

beneficiary of the proposals, Kalmanovitz

was also a director-nominee and was

nominating three other directors. Hence,

he had at least some duty to determine

for himself the validity of the proxy

materials submitted and to correct

Statements and facts which he knew or

should have known were erroneous or

misleading. Cf. Chris Craft Industries

v. Independent Stock Committee, 354 F.

Supp 895, 913 (D. Del. 1973). Further,

the details of the Continental

transaction, which was a material part of

the proposal contained in the Proxy

Statement as well as the details of the

planned prepayment of the high interest

debt was information which rested

primarily with Kalmanovitz. Under such

circumstances we find the necessary

"substantial connection" between the use

of Kalmanovitz's name and the

solicitation effort to hold hiim indivi-

dually liable for violation of §14(a) and

Rule 14a-9. 1l6c

C. The 1977 Proxy Statement

17. The many failures in the 1977

Proxy Staement to disclose material

information including, among other

things, Kalmanovitz's control of

Falstaff, the terms and conditions of the

proposed stock dividend, the significant

enhancement of Kalmanovitz's control of

Falstaff which could flow from the

dividend and the potential conflict of

interest position held by Kalmanovitz (in

that he was the sole beneficiary of a

plan which management, under his control,

had recommended), rendered the 1977 Proxy

Statement materially false and

misleading.

16c The second theory under which the SEC asserts Kal-

manovitz's individual liability under 814(a) is as an

aider and abettor. To sustain this charge, the SEC must

establish: (a) the doing of a wrongful act (b) Kalman-

ovitz's knowledge of it and (c) his knowledge and "'sub-

stantial participation" in the wrongdoing. Gould v.

American Hawaiian S.S. Co., 535 F2d 761, 779 (3d Cir.

1976). Our prior factual findings fulfill the first two

of these elements. With respect to the third element,

we view the circumstances discussed supra which lead to

our conclusion that the use of Kalmanovitz's name had a

misleading.

20. Items 12 and 13 of Schedule 14A

required that the 1977 Proxy Statement disclose

the following material facts in connection

with the proposed charter amendment: the

number, percentage and value of shares of

common stock Kalmanovitz would receive, the

source of the common stock dividend; the amount

of cash dividends payable to Kalmanovitz; and

information necessary to make the statement

that the stock dividend would allow conser-

vatoinof cash and working capital not mis-

leading. The failure of the 1977 Proxy

Statement to do so rendered it materially

false and misleading.

< 21. The statement inthe 1977 Proxy

Statement regarding the existence of an audit

committee of Falstaff's Board of Directors

was materially false and misleading, in that

the audit committee never met or functioned.

The proxy statement thus falsely conveyed to

Falstaff's shareholders the impression that

effective oversight of their company's account-

ing functions was being exercised by the

rrr esse

Board of Directors.

22. The Rider to the 1977 Proxy State-

ment by disclosing only that "the SEC has

taken a 'no comment' position relative to

this proxy statement" omits to state the

material facts that the SEC advised Falstaff

that the Proxy Statement was materially def-

icient and that if sent in its then present

form to shareholders, Falstaff would be doing so

at its own risk. Falstaff's shareholders

were thus deprived of the information that

the Committee considered the proxy statement

false and misleading in its then present

form. *2 This material omission rendered

the 1977 Proxy Statement materially false

and misleading.

22 The Rider which Falstaff attached to the 1977

Proxy Statement before mailing it to the

shareholders does not prove its good faith.

Indeed, the Rider undermines Falstaff's repre-

sentations that it intends to comply with the

federal securities laws in the future. Thus, the

Rider has exacerbated the deficiencies already

noted in the 1977 Proxy Statement. Rule 14a-4(e)

requires that shares solicited by proxy be voted,

subject to specified reasonable conditions. by

conditioning the voting of proxies on highly

speculative future events, the Rider to Falstaff's

1977 Proxy Statement violates Rule 14-a4(e) further

demonstrating Falstaff's inability to comply on its

own initiative with the requirements of the federal

securities laws.

III. VIOLATIONS OF SECTION 13(a)

23. Section 13(a) of the Exchange Act

(15 U.S. C. 878m(a)) is violated when a

report required to be filed thereunder is mat-

erially false and misleading. SEC v. Great

American Industries, Inc., 407 F. 2d 453, 457

(2d Cir. 1968) cert. denied, 359 U.S. 920

(1969); SEC v. Kalvex, Inc., supra at 316;

SEC v. General Refractories Co., 400 F.

Supp. 1248, 1257 (D.DC. 1975).

24. Pursuant to Rule 13a-1 under the

Exchange Act, Falstaff is required to file

an Annual Report on Form 10-K.

25. Pursuant to Rule 13a-11 under the

Exchange Act, Falstaff is required to file

Current Reports on Form 8-K.

26. Pursuant to Rule 13a-13 under the

Exchange Act, Falstaff is required to file

Quarterly Reports on Form 10-Q.

27. The Commission has proven that

Annual, Quarterly and Current reports filed

with the Commission and disseminated to

Falstaff's shareholders subsequent to April

1975 were materially false and misleading

and did not contain material information

required to be contained therein. This is

so with respect to Falstaff's indebtedness

before and after the 1975 sale of stock to

Kalmanovitz, the prepayments of the bank

loans, the declaration of defaults by the

insurance lenders; the conversion of the

Continental credit into long-term debt

and the paydown thereof, and the material

facts concerning the litigation between

Falstaff and the lenders. Nor did the

report correct the false and misleading

disclosures in the 1975 Proxy Statement.

28. Items 8 of Form 8-K required that

a Form 8-K be filed by Falstaff in 1975

disclosing the prepayment of the bank loans

and the consequent possible violation of

the express terms of the Collateral

Agency Agreement as they were incorporated

in the March Waivers. The failure to

file a Form 8-K disclosing these material

facts constituted a violation of Section

13(a) of the Exchange Act, and Rules 13a-11

and 12b-20 thereunder.

29. Item 6 of Form 8-K required that a Form

8-K be filed by Falstaff in 1975 disclosing

the declaration of default by the insurance

lenders of $12.5 million in loans. The

failure to file a Form 8-K disclosing this

material fact constituted a violation of

Section 13(a) of the Exchange Act and Rules

13a-11 and 12b-20 thereunder.

29a. Items 7 and 8 of Form 8-K required

a Form 8-K be filed by Falstaff in 1975

disclosing both the entry by Falstaff

into a two year $11.6 million note with

Continental and the note's reduction by

payment during October, November and

December 1975. The failure to file such

a Form 8-K constituted a violation of

Section 13(a) of the Exchange Act and Rules

13a-11 and 12b-20 thereunder.

30. Items 3 of Form 8-K and Rule 12b-

20 required that Falstaffs Form 8-K for

October 1975 disclose material information

regarding legal proceedings between

Falstaff and its lenders. The failure of

Falstaff's Form 8-K for October 1975 to

adequately describe this litigation

rendered it materially false and misleading.

31. Rule 12b-20 required that Falstaff's

form 8-K for January 1976, which disclosed

the existence of litigation between Falstaff

and its lenders, also disclose the material

facts (1) that Falstaff had agreed to the

prepayment restrictions in the March

Waivers: (2) the Collateral Agency Agree-

ment andits pro rata prepayment restriction;

and (3) that Falstaff's prepayments to the

banks, made with knowledge of the prohi-

bitions against them, precipitated the len-

ders' declaration of defaults. The failure

of the Form 8-K for January 1976 to do

so rendered it materially false and mis-

leading.

32. Falstaff's Annual Reports on Form

10-K for fiscal year 1975 and 1976 violated

Rule 12b-20 by omitting to state material

facts regarding; (a) Falstaff's relations

with the lenders; (b) the litigation with them;

(c) the prepayment restirctions on the

loans; (d) prepaymentof the bank loans;

(e) declaration of defaults by the insurance

lenders, and ; (f) the Continental trans-

action.

33. Rule 12b-20 required that the

filings made by Falstaff with the Commission

subsequent to the 1975 Proxy Statement

correct the materially false and misleading

disclosures contained in the 1975 Proxy

statement of provide the necessary addi-

tional disclosure to make the 1975 Proxy

Statement not materially false and mis-

leading. The failure of those filings

to do so rendered them materially false

and misleading.

IV. VIOLATIONS OF SECTION 10(b)

34. Falstaff's false and misleading

disclosures in the 1975 Proxy Statement

in Annual, Quarterly and Current Reports

required them to be filed with the Comn-

ission subsequent thereto, in the November

1975 shareholders’ letter, and in the

1977 Proxy Statement violated Section 10(b)

of the Exchange Act and Rule 10b-5 there-

under by concealing material facts from

Falstaff's shareholders and the investing

public with respect to the matters set forth

above. Material facts within the meaning

of Rule 10b-5 are those about which there

is a substantial likelihood that a reasonable

investor would consider important in the

making of an investment decision. TSC

Industries v. Northway, Inc., supra at

449; Affiliated UTE Citizens v. United

States, 406 U.S. 128, 153-154 (1972).

A. Necessity of a Finding of Scienter

35. The Supreme Court in Ernst &

Ernst v. Hochfelder, 425 U.S. 185 (1976)

held that a private cause of action will not

lie under 610(b) and Rule 10b-5 without

an allegation of scienter. However, it

specifically declined to address the question

of whether scienter is a required element

in injunctive actions brought by the

Commission. Id. at 194 n. 12.

36. Subsequently the Court in SEC

v. Bausch & Lomb, Inc., 420 F. Supp. 1226

(S.D.N.Y. 1976) attempted to abandon the

long standing Second Circuit rule that

proof of past negligence will suffice to

sustain an SEC injunction action 36a by

holding inter alia that Hochfelder required

36b

a showing of scienter in such cases.

However, rm affirming the district court,

the Second Circuit expressly declined to

adopt that holding, basing its affirmance

instead on the independent finding by the

lower court that there was no likelihood

of future violations, SEC v. Bausch &

Lomb, Inc., 565 F. 2d 8, 14 (2d Cir. 1977).

B. Requisite Scienter Established

37. Like the Second Circuit, we too

can leave for another day the resolution

of the difficult question of whether

scienter is a required element in SEC

injunctive actions. For the evidence

in this record amply establishes that

Falstaff and Kalmanovitz filed reports

with the Commission with such knowledge

of the facts or reckless disregard for the

truth that scienter, however that term

may be defined by the cases, see, e.g.

36a

See e.g. SEC v. ig eee SEES Ri

Inc. 515 F.2d Cir.

SEC v. Texas Gulf. Sulfur Co., 401 F. 2d 833,

854-855 (2d Cir. 1968).

36b In SEC v. American Realty Trust, 1977-

78 CCH Fed. Sec. L. Rptr. p. (E.D.

Va. 1977), the Court also found scienter

was required in such actions. This case

is currently on appeal to the Fourth Circuit.

SEC v. American Realty Trust, CCH Fed SEc

L. Rptr (77-78 Transfer Binder) p. 96,275

(2d Cir. 1977) at 92,772 has been amply

demonstrated on the part of both Kalmanovitz

and Falstaff.

38. Thus, Falstaff and Kalmanovitz

knew of the existence of the misstatements

and omissions of-material facts in the 1975

Proxy Statement set forth in paragraphs 11

through 15A of these Conclusions of Law.

38a. Falstaff and Kalmanovitz also

knew of the existence of misstatements in

the 1977 Proxy Statement set forth at

Pavagraphs 17 through 22 of these Conclusions

of Law.

V. KALMANOVITZ'S SCHEDULE 13D

39. The Commission has proved that

Kalmanovitz violated Section 13(d) and

Rules 13d-1 and 12b-20 by filing a Schedule

13D containing omissions of material fact

required to be stated therein.

40. Kalmanovitz filed a Schedule 13D

(17 CFR $240.13d-101) regarding his

purchase of Falstaff preferred stock

pursuant to Section 13(d) of the Exchange

Act and Rule 13d-1 thereunder on or

about May 13, 1976.

41. Kalmanovitz's 13D violated Rule

13d-1, as it was filed more than one year

after it was due.

42. Section 13(d)(1)B and E of the

Exchange Act, Items 3, 5 and 6 of Schedule

13D and Rule 12b-20, required that Kal-

manovitz's 13D disclose the material facts

concerning the transaction with Continental.

The failure of Kalmanovitz's 13D to do so

rendered it materially false and misleading.

43. Section 13(d)(1)C, Item 4 of

Schedule 13D and Rule 12b-20 required that

Kalmanovitz's 13D disclose the material

fact that he would acquire control of

Falstaff as a result of his purchase of

Falstaff stock. The failure of Kalmanovitz's

13D to do so rendered it materially false

and misleading.

44, Item 6 of Schedule 13D and Rule

12b-20 required that Kalmanovitz's 13D

disclose the material facts concerning

the pro rata prepayment restrictions of

the Collateral Agency Agreement and

March Waivers; Kalmanovitz's intentions

to prepay the bank loans despite these

restrictions and the substantial risk

that the insurance lenders would declare

a default on their loans and accelerate

the payment of principal thereon if

prepayments were made. The failure of

Kalmanovitz's 13D to do so rendered it

materially false and misleading. 44

44 It is obvious that a number of the

disclosures required by Item 6 had already

occurred by the time Kalmanovitz late filed

his Schedule 13D on May 13, 1976. For

instance, the bank loans had already been

prepaid and the insurance lenders had already

declared a default on their loans. However,

Kalmanovitz should have recorded this

information in a form which would have

been accurate if he had filed Schedule

13D in a timely manner.

45. item 3 of Schedule 13D and Rule

12b-20 required that Kalmanovitz's 13D

disclose the material facts concerning

the source of funds used by Kalmanovitz

in making the purchase of Falstaff's

stock. The failure of Kalmanovitz's 13D

to do so rendered it materially false

and misleading.

45a. Kalmanovitz knew the facts

which were omitted from his 13D.

VI. REASONABLE LIKELIHOOD OF FUTURE

VIOLATIONS.

46. The standard to be applied in

determining whether to issue injunctive

relief is whether there is a reasonable

likelihood of future violations. United

States v. W.T. Grant Co., 345 U.S. 629,

633 (1953); SEC v. Aminex Resources Corp.

supra, SEC v. Penn Central Co., 425 F.

Supp. 593, 596 (E.D. Pa. 1976).

47. As noted by the Court in SEC v.

National Student Marketing Corp., 360 F.

Supp. 284, 297 (D. DC. 1973).

“%

The case law identifies several factors

which are deemed relevant to the probability

of recurrent violations. The character

of thepast violations, the effectiveness

of the discontinuance and the bona fides

of the expressed intent to comply are

considered. The number and duration of

past wrongs, the time which has elapsed

since the last violation, the opportunity

to commit further illegal acts, the novelty

of the violation, and the harmful impact

of the innunction on the defendant are

objective factors which the courts have

examined. Subjective inquiries into the

willfulness or bad faith in a defendant's

prior conduct and the sincerity of his rep-

resentations not to violate the law are

also pertinent. (cites omitted)

48. Regarding the number, duration

and character of defendants' past violations,

our discussion supra of these factors

indicate that they have not been isolated

4

or random, but have rather been part of

a chronic pattern of violations, which has

continued up to the present time. As a

result, neither of the defendants can

take solace from cases which appear to

suggest that isolated violations of

the law may not warrant a finding of reasonable

likelihood of future violations. See,

e.g. SEC v. Commonwealth Chemical Securities,

Inc., supra; SEC v. Bausch & Lomb, Inc.,

supra.

49. As for the subjective inquiry into

the willfulness of defendants, prior

conduct, we view the following factors as

suggestive of a reasonable likelihood of

future violations:

(a) The fact that Kalmanovitz and

Falstaff continued to solicit proxies for

the 1977 annual meeting even after being

put on notice of the Commission's suit

challenging the solicitation of proxies

by means of the fraudulent 1977 Proxy

Statement, demonstrates the egregiousness

of the defendants' violations and disregard

for the federal securities laws.

(b) The fact that Falstaff sent out

its 1977 Proxy Statement to shareholders

in spite of (1) the warning by the

Commission of the inadequacy of the proxy

statement and the risks to Falstaff of

its mailing, and (2) the concern expressed

ee

the proxy statement, provides ample proof

by Falstaff's own employees charged with

preparing filings as to the adequacy of

of Falstaff's lack of regard for compliance

with the securities laws.

(c) None of the directors of Falstaff's

board, including Kalmanovitz, who have

served under his chairmanship, filed the

reports (Forms 3 and 4) required by Section

16(a) (15 U.S.C. 878p(a)) of the Exchange

Act and the rules thereunder (17 CFR 8240.

l6a-l et seq.) regarding their ownership

and transactions in Falstaff stock until

after this suit was brought - these required

forms were thus filed between one and two

years late. While this has not been

charged by the Commission as a substantive

violation, it is compelling support for

the reasonable likelihood of future vio-

lations, especially in light of the fact

that those forms were not filed during

a time when, if from no other source,

Kalmanovitz and the directors should have

become sensitized to the requirements of

the federal securities laws from the

existence of the Commission's investigation.

(d) Kalmanovitz's false representation

to the SEC in a letter of October 15,

1975 that Falstaff had hired new inde-

pendent auditors to rectify purported

inadequacies in Falstaff's June 1975 Form

10-Q is particularly probative of reasonable

likelihood, as this false statement was

made to the agency enforcing the laws

which Kalmanovitz seeks to assure the

Court he will comply with in the future.

(e) Kalmanovitz sent Falstaff's

shareholders a false and misleading letter

in November 1975, well after he took control

of Falstaff which concealed from the

shareholders: (1) the facts that Falstaff

had approved the Collateral Agency Agreement

and signed the March Waivers, (2) that

the insurance lenders had declared defaults on

their loans, and which, (3) misrepresented

to shareholders the circumstances surrounding

the dispute between Falstaff and its lenders

the cause of which dispute was the very risk

which went undisclosed in the 1975 Proxy

Statement.

(f) The 1977 Proxy Statement informed

shareholders of the existence of an audit

committee of Falstaff's Board of Directors

and of that committee's membership despite

the fact that the committee never met and

contrary to the impression conveyed to

the shareholders, exercised no oversight

function.

(g) Falstaff falsely represented to

this Court, in a July 1, 1977 letter,

that the initiation of the Commission's

suit against it caused the cancellation

of its brewer's bond.

(h) The failure by Falstaff under

Kalmanovitz's stewardship to inquire further

into, review in greater detail, or take

affirmative steps to comply with the

disclosure requirements of the securities

laws, even when faced on two separate

occasions with the discovery of previously

unknown requirements or deficiencies, does

not inspire confidence that serious efforts

to comply with the laws will be made in

the future.

VII. NECESSITY OF COMMISSION COMMENTS.

50. Falstaff contends that the

misleading statements and material omissions

in the 1977 Proxy Statement resulted from

the failure of the Commission to comment

on the Proxy Statement. These arguments

are without merit. The defendants do

not have the right to rely on the Comm-

ission's assistance to tell them how to

comply with the securities laws, nor

can they successfully assert the absence

of such assistance as a defense. SEC

v. Guaranty Bond and Securities Corp.,

CCH Fed. Sec. L. Rep. ('70-'71 Transfer

Binder) p.92,928 (M.D.Tenn. 1971). It

is clear, in the first instance, that the

staff expressly advised Falstaff that it

considered the 1977 proxy to be false and

misleading and that it would be forced to take

action if the proxy were sent to Falstaff's

shareholders in its then present form.

Despite this advisement, Falstaff's mana-

gement mailed the proxy as is, without

even making correction of errors previously

argued by Falstaff to be "grammatical" in

nature, adding only the Rider, which

itself violated the proxy rules. Falstaff

has shown no reason for such precipitate

action and has no demonstrated that

degree of good faith which has led some

courts to deny injunctive relief despite a

finding of past violations of the secu-

rities laws. See SEC v. Harwyn, 326

F. Supp. 943 (S.D.N.Y. 1971).

51. Falstaff was not entitled to

receive comments from the Commission's

staff with respect to its deficient

filings, 17 CFR 8202.3(a), and, as

McCurry testified, it knew this. The

obligation to file accurate reports is

entirely the registrant's and this

obligation cannot be shifted to the

Commission or its staff under any cir-

cumstances. SEC v. Great American Ind-

ustries, 407 F. 2d 453, 457 (2d. Cir.

1968); See Boruski v. Division of

Corporation Finance of the U.S. Securjties

and Exchange Commission, 321 F. Supp. 1273,

1276 (S.D.N.Y. 1971); cf. Section 26 of

the Exchange Act, 15 U.S.C. 878z.

52. With respect to a proxy statement,

review by the Commission is neither

necessary nor tantamount to a determination

that that document is not false and

misleading. Rule 14a-9(b)(17 C.F.R. 240.

14a-9(b)).

VIII. FURTHER EQUITABLE RELIEF

53. The Commission has requested, as

further equitable relief, the appointment of

additional independent directors to the

Board of Directors and the appointment of

an audit committee fo Falstaff's Board

of Directors to be composed of independent

persons.

54. It is true that once equity

jurisdiction has been properly invoked by

a showing of securities law violations, the

Court possesses considerable latitude to

fashion an appropriate remedy. See SEC

v. Manor Nursing Centers, Inc., supra at

1103. However, in formulating such

remedies, the Court should not, without

considerable justification, impose a

remedy which would in effect regulate

areas traditionally left to internal

corporate management. Cf. Superintendent

of Insurance v. Bankers Life and Casualty

Co., 404 U.S. 6, 12 (1971). Our review

of the evidence leads us to conclude

that Falstaff's internal corporate struc-

ture has not deteriorated to the point

where a remedy such as that proposed by

the Commission is warranted.

JUDGMENT

In light of the foregoing, the Court

is granting permanent injunctive relief

as set forth in the "JUDGMENT OF PERMANENT

INJUNCTION AS TO DEFENDANT FALSTAFF

BREWING CORPORATION" filed herewith.

JUDGMENT OF PERMANENT INJUNCTION.

Plaintiff Securities and Exchange

Commission ("Commission") having filed

a complaint for injunctive and other

relief (the "Complaint") and the Court

having considered the pleadings. and papers

filed herein and having heard the trial

of this matter and upon the findings of

fact and conclusions of law reached by

this Court and issued this date, the Court

being fully advised in the premises:

I

IT IS HEREBY ORDERED, ADJUDGED AND DECREED

that Falstaff Brewing Corporation ("Fal-

staff") its officers, agents, servants,

employees and attorneys, and those persons in

active concert or participation with them,

and each of them be, and they are hereby,

permanently enjoined from, directly or

indirectly in connection with the offer,

purchase or sale of the securities of

Falstaff, its subsidiaries and affiliates,

or of any other issuer, by the use of

any means or instrumentality of interstate

commerce, or of the mails or of any

facility of any national securities

exchange:

A. Employing any device, scheme,

or artifice to defraud; or

B. Making any untrue statement of

a material fact or omitting to state a

material fact necessary in order to make

the statements made, in light of the

circumstances under which they were made,

not misleading, concerning, but not

limited to:

(1) The financial condition of

Falstaff or any other issuer;

(2) The business operations of

Falstaff or any other issuer;

(3) The present and prospective

value of the securities of Falstaff or

any Other issuers;

(4) The ownership and voting rights

of the securities of Falstaff or any other

issuer;

(5) The acquisition of any securities

of Falstaff or any other issuer; and

(6) The dissemination of information

with respect to Falstaff or any other

issuer; or

C. Engaging in any act, practice or

course of business which operates or

would operate as a fraud or deceit upon

any person in violation of Section 10(b)

of the Securities Exchange Act of 1934

(15 U.S.C. 678j(b)) ("Exchange Act") and

Rule 10b-5 (17 C.F.R. 8240.10b-5) there-

under; it is

II

FURTHER ORDERED, ADJUDGED AND DECREED

that Falstaff, its officers, agents,

servants, employees and attorneys, and

those persons acting in active concert

or participation with them, and each of

them be, and they are hereby, permanently

enjoined from filing or causing to be filed

with the Commission annual, current or other

periodic reports with respect to Falstaff,

its subsidiaries and affiliates, or any

other issuer, which contain any untrue

statement of material fact or omit

to state any material fact necessary in

order to make the statements made, in

light of the circumstances under which

they were made, not misleading or which omit

any material fact required to be contained

therein, in violation of Section 13(a)

of the Exchange Act (15 U.S.C. 878m(a))

and Rules 12b-20, 13a-1, 13a-11 and 13a-

13 (17 C.F.R. 88240.12b-20, 240.13a-1,

240.13a-11 and 240.13a-13 thereunder; it

is

III

FURTHER ORDERED, ADJUDGED AND DECREED

that Falstaff, its officers, agents,

servants, employees and attorneys, and

those persons in active concert or

participation with them, and each of them

be and they are hereby, permanently

enjoined from, directly or indirectly

with respect to securities of Falstaff,

its subsidiaries and affiliates or any

other issuer, by the use of the mails or

by any means or instrumentality of inter-

state commerce, or of any facility of

a national securities exchange, or

otherwise:

A. Soliciting or permitting the use of

the name of Falstaff to solicit, any

proxy or consent or authorization with

respect to any class of voting securities

of Falstaff, unless each person solicited

is concurrently furnished or has previously

been furnished with a written proxy

statement conctaining the information

specified in Schedule 14A (17 C.F.R.

§240.14a-101); or

B. Using a proxy statement, infor-

mation statement, form of proxy, notice

of meeting or other communication,

written or oral, containing any statement

which, at the time and in the light of

the circumstances under which it is made,

is false or misleading with respect to

any material fact, or which omits to state

any material fact necessary in order to

make the statements therein not false or

misleading or necessary to correct any

statement in any earlier communication in

connection with the same meeting or subject

matter which has become false or misleading,

in violation of Section 14(a) of the

Exchange Act (15 y.S.c. 878m(a)) and

Rules 14a-3 and 14a-9 (17 C.F.R. 88

240.14a-3 and 240.14a-9) thereunder, it

is

IV

FURTHER ORDERED, ADJUDGED AND DECREED

that Falstaff within one hundred twenty

(120) days after the entry of this Order

or such later time as the Commission

may permit, shall make such amendments

and supplements to its existing filings

with the Commission, as may be necessary

or appropriate in order that such filings

not contain any untrue statements of mat-

erial fact or omit te state any material

fact requird to be stated therein or

necessary to make any statement made in

such filings not false or misleading in

light of the circumstances under which

they were made; and it is

V

_ FURTHER ORDERED ADJUDGED AND DECREED

that the Court shall retain jurisdiction

of this action to implement and carry

out the terms of this judgment.

There being no just reason for

delay, the clerk of the Court is hereby

directed to enter this Judgment forthwith.

Notice: This opinion is subject to formal revision before publication

in the Federal Reporter or U.S. App. D.C. Reports. Users are requested

to notify the Clerk of any formal errors in order that corrections may be

made before the bound volumes go to press.

United States Cmut of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

No. 79-1467

SECURITIES AND EXCHANGE COMMISSION

Vv.

FALSTAFF BREWING CORPORATION

AND PAUL KALMANOVITZ, APPELLANTS

Appeal from the United States District Court

for the District of Columbia

(D.C. Civil Action No. 77-0894)

Argued February 12, 1980

Decided May 29, 1980

Alfred H. Moses, with whom Jeffrey H. Howard was

on the brief, for appellants.

Rosalind C. Cohen, Special Counsel, Securities and

Exchange Commission, with whom Jacob H. Stillman, As-

sociate General Counsel, was on the brief, for appellee.

Bills of costs must be filed within 14 days after entry of judgment. The

court looks with disfavor upon motions to file bills of costs out of time.

2

Before MCGOWAN, TAMM, and Ross, Circuit Judges.

Opinion for the court filed by Circuit Judge TAMM.

TAMM, Circuit Judge: The Securities and Exchange

Commission filed this action seeking to have the United

States District Court for the District of Columbia en-

join the Falstaff Brewing Corporation and the chair-

man of its board and controlling stockholder, Paul Kal-

manovitz, from future violations of certain provisions of

the Securities Exchange Act of 1934 (Act), 15 U.S.C.

§§ 78a-78hh (1976). After considering oral testimony,

depositions, and documentary evidence, Judge Howard

F. Corcoran held that both Falstaff and Kalmanovitz had

violated the Act and issued the injunctions sought. See

SEC v. Falstaff Brewing Corp., [1978 Transfer Binder]

FED. SEc. L. REP. (CCH) {96,583 (D.D.C. 1978). Fal-

staff and Kalmanovitz appeal, and we affirm.

I. OVERVIEW

The facts of this case are intricate and will be devel-

oped more fully in discussing each challenge made to the

district court’s decision. For now, we shall summarize

the overall factual background, the district judge’s hold-

ing, and the grounds of appeal.

Falstaff, an independent, publicly owned brewer, suf-

fered severe financial losses for several years in the late

1960’s and early 1970’s. In 1974 Falstaff sold its San

Francisco brewery to the General Brewing Corporation,

a company beneficially owned by Paul Kalmanovitz, a

wealthy businessman active in the beer industry. General

Brewing would continue to produce oeer under the Fal-

staff name.

Following this transaction, Falstaff’s management de-

cided to probe Kalmanovitz to see if he was interested

in investing in Falstaff itself. On March 10, 1975, Kal-

3

manovitz entered into an agreement with Falstaff under

which he would invest $10 million in cash and personally

guarantee another $10 million in loans. In return, he

would receive preferred stock sufficient to give him a

majority voting interest in the company, together with

an option to purchase more. Falstaff sent a proxy state-

ment to the company’s shareholders, who approved the

transaction at an April 28 meeting.

After assuming control of Falstaff, Kalmanovitz failed

to report his stock acquisition to the Commission for

more than one year. In addition, Falstaff failed to file

certain required reports with the Commission and filed

others that the Commission believed were materially

misleading.

In 1977 Falstaff issued another proxy statement to its

shareholders, seeking approval to pay dividends on Kal-

manovitz’s preferred stock in common stock rather than

in cash. The Commission contends that this proxy state-

ment misstated certain material facts and omitted others.

The Commission instituted this action to block the 1977

shareholders’ meeting and to obtain a permanent injunc-

tion against Falstaff and Kalmanovitz ordering them not

to violate certain provisions of the Act in the future.

After reviewing the evidence, Judge Corcoran con-

cluded that Falstaff and Kalmanovitz committed the

following violations:

(1) The 1975 proxy statement was false and mis-

leading, a violation of section 14(a) of the Act,

15 U.S.C. §78n(a) (1976), and rules 14a-3

and 14a-9 thereunder, 17 C.F.R. §§ 240.14a-3,

-9 (1979). Both defendants now concede that the

1975 proxy statement was deficient, and Falstaff

admits its liability. Kalmanovitz, however, con-

tests the district court’s holding that he, too, is

liable for this violation.

(2)

(3)

(4)

(5)

4

Kalmanovitz failed to make a timely filing of

a Schedule 13D reporting his acquisition of

Falstaff stock and thus violated section 13(d)

of the Act, 15 U.S.C. §78m(d) (1976), and

rules 13d-1 and 12b-20 thereunder, 17 C.F.R.

§$§ 240.13d-1, .12b-20 (1979). Kalmanovitz does

not challenge this holding.

Falstaff failed to file or filed inaccurate reports

on Forms 8-K, 10-K, and 10-Q during 1975 and

1976, violations of section 13(a) of the Act, 15

U.S.C. § 78m(a) (1976), and rules 13a-1, 13a-

11, 18a-13, and 12b-20 thereunder, 17 C.F.R.

§§ 240.13a-1, -11, -18, .12b-20 (1979). The de-

fendants, though conceding that one report was

deficient, contend that they filed all other re-

quired reports and that all filings were ma-

terially correct. Kalmanovitz also argues that

the district judge made insufficient findings to

hold him liable for aiding and abetting Falstaff

in these violations.

The 1977 proxy statement was materially defi-

cient in several respects, a further violation of

section 14(a) and rules 14a-9 and 12b-20. Both

defendants raise challenges to particular state-

ments or omissions the court held were viola-

tions.

Both defendants violated section 10(b) of the

Act, 15 U.S.C. § 78j(b) (1976), and rule 10b-5

thereunder, 17 C.F.R. § 240.10b-5 (1979),

through their errors in the 1975 and the 1977

proxy statements and in the 1975 and 1976 re-

ports and through misstatements in a Novem-

ber 1975 letter that Kalmanovitz sent to Falstaff

shareholders. Both defendants argue that the

misstatements and omissions were immaterial

and that the district judge was required to find

that they acted with scienter.

—

5

On the basis of these and other findings, Judge Corcoran

concluded that there existed a reasonable likelihood that

the defendants would engage in further misconduct. He

therefore enjoined them from violating these sections and

rules in the future. Both defendants also challenge the

injunctions.

We shall discuss, in order, the violations with regard

to the 1975 proxy statement, the 1975 and 1976 reports,

the 1977 proxy statement, and the section 10(b) viola-

tions. We then shall turn to the reasonable likelihood of

further misconduct and the propriety of entering the

injunctions.

II. THE 1975 Proxy STATEMENT

Falstaff and Kalmanovitz concede that the proxy state-

ment mailed to shareholders in April of 1975 was ma-

terially false and misleading in several respects, and

Falstaff now admits its liability for these deficiencies.

Kalmanovitz, however, contests his liability. He argues

that because he was not yet a shareholder, an officer, or

a director of Falstaff, the district court should not have

held that he violated the Act and the relevant Commis-

sion rules. We nevertheless agree with Judge Corcoran

that Kalmanovitz, as well as Falstaff, is liable for the

misstatements.

A. The Facts

At the time Kalmanovitz and Falstaff opened their

negotiations early in 1975, Falstaff was in severe finan-

cial distress. It had lost $3.8 million in 1974. It owed

$12.5 million in low-interest loans to two insurance com-

panies and $16 million in notes and lines of credit to

three banks, interest at 142% above prime. In the fall

of 1974, these institutional lenders demanded that Fal-

staff pool all its assets, aside from accounts receivable

6

and inventories, to secure the $28.5 million debt. In

January 1975 the lenders executed a “Collateral Agency

Agreement,” under which they agreed among themselves

to share all of Falstaff’s payments on a pro rata basis.

Falstafi’s board of directors approved this arrangement

on January 27, 1975. Later, on March 31, Falstaff ac-

ceded to the insurance lenders’ demand that it acknowl-

edge any failure to repay pro rata would constitute a de-

fault and thus would entitle them to call their loans im-

mediately (the “March waivers’).

In the meantime, Kalmanovitz and Falstaff completed

arrangements for Kalmanovitz’s investment in Falstaff.

Kalmanovitz would purchase 100,000 shares of a new

Class A preferred stock for $10 million, giving him a

majority voting interest in Falstaff.1 Additionally, Con-

tinental Can Company, a major supplier of cans to the

brewery, had agreed to defer Falstaff’s payment of $10

million in can purchases, provided that Kalmanovitz

would personally guarantee the underlying note. Kal-

manovitz agreed. Finally, Kalmanovitz received an

option to purchase another 100,000 shares of a new non-

voting Class B preferred stock for $10 million in re-

turn for his guarantee on another $10 million in Falstaff

accounts payable.

On March 10, 1975, Falstaff and Kalmanovitz signed

an agreement reflecting these arrangements. The dis-

trict court found that, at this time, Kalmanovitz already

knew of the liens on Falstaff’s assets and the pro rata

restrictions in the Collateral Agency Agreement. He

also knew by April 4 that Falstaff had agreed to the

March waivers, including their provision that payment

other than on a pro rata basis would be deemed a default

1 Each of the 100,000 shares would have 45 votes. Because

there were slightly fewer than 4.5 million shares of common

stock outstanding, the transaction would leave Kalmanovitz

with 50.02% of the voting interest in Falstaff.

7

on the $12.5 million in insurance ioans. Kalmanovitz

nonetheless planned to use the $20 million raised by Fal-

staff in the transaction ($10 million from Kalmanovitz

and $10 million from deferral of payments to Continental

Can) to pay off the $16 million in high-interest bank

notes, even though doing so would violate the March

waiv rs and the Collateral Agency Agreement. Kalmano-

vitz believed that the bank loans, with their high interest

rate, were a “cancer” on the company.’

Falstaff’s directors approved the Kalmanovitz trans-

action on March 31, 1975, and called a shareholders’

meeting for April 28 to ratify the arrangement. In

early April, the directors mailed a proxy statement to

the shareholders. Kalmanovitz had seen a first draft of

the proxy statement on or before March 22 and read

the final version shortly after its distribution. After the

latter reading, he thought that the statement was fraudu-

lent but elected to say nothing about it.*

Judge Corcoran also concluded that the proxy state-

ment was materially deficient in several respects. First,

it failed to disclose two potential conflicts of interest:

(1) Kalmanovitz’s beneficial ownership of General Brew-

ing Corporation, which had purchased Falstaff’s San

Francisco brewery and was producing Falstaff beer, and

(2) Kalmanovitz’s agreement to guarantee the Conti-

2 Falstaff was paying approximately 11% on the bank loans

as opposed to 6% on the insurance loans.

* Kalmanovitz contests this finding. At oral argument,

counsel characterized Kalmanovitz’s remarks as meaning that

he thought the deal was fraudulent as to him, not as to the

existing Falstaff shareholders. We do not believe, after ex-

amining the record, that the district court’s finding was clearly

erroneous. Moreover, we have difficulty understanding how a

proxy statement could defraud a person who was not a

recipient of it and who had more information than the state-

ment contained.

8

nental Can credit. Second, the proxy statement, though

mentioning the loans from the banks and the insurance

companies, did not apprise the shareholders of the de-

faults and liens, the Collaterak Agency Agreement, the

March waivers, or Kalmanovitz’s plan to pay off the bank

loans despite these restrictions. Third, the proxy state-

ment failed to disclose with sufficient clarity that ap-

proval of the sale of stock to Kalmanovitz would give

him effective control of Falstaff and would dilute the

present shareholders’ control.*

Based on these facts, Judge Corcoran concluded that

both Falstaff and Kalmanovitz had failed to provide all

the information Schedule 14A requires for a proxy state-

*The defendants challenge as clearly erroneous the district

court’s finding that the proxy statement did not disclose

adequately Kalmanovitz’s control and the dilution of the exist-

ing shareholders’ interest. We disagree. Although on page 4

the proxy statement stated that Kalmanovitz would be entitled

to name a majority of Falstaff’s directors, see Joint Appendix

(J.A.) at 225, no mention of this result appeared in the dis-

cussion of the proposed charter amendments, see id. at 228-30.

Disclosures that Kalmanovitz would purchase 100,000 pre-

ferred shares, that each share would have 45 votes, and that

4,496,625 common shares with one vote each were outstanding

were spread over two pages of small print. See id. at 228-29.

Nowhere did the proxy statement tell the shareholder that a

vote to approve the transaction was a vote to transfer control

of his company to Kalmanovitz.

No one disputes that the transaction’s giving Kalmanovitz

majority control is a material fact. Although “corporations

are not required to address their stockholders as if they were

children in kindergarten,” Richland v. Crandall, 262 F. Supp.

538, 554 (S.D.N.Y. 1967), disclosure may not be buried in a

mass of information that, when pieced together, might give

the correct impression. A court is not clearly erroneous when

it finds inadequate a proxy statement that spreads over two

pages the data necessary to calculate the impact of a proposed

transaction on control of the company. See Gould v. American-

Hawaiian Steamship Co., 535 F.2d 761, 774 (3d Cir. 1976).

a 4

9

ment * and had made omissions that rendered the proxy

statement materially false and misleading. Therefore,

they had violated section 14(a) of the Act and rules

l4a-3 and 14a-9 thereunder.

B. Kalmanovitz's Liability

Kalmanovitz contests his liability under section 14(a)

of the Act. He argues that because he was not yet part

of Falstatf's management, which issued the statement,

and because he neither drafted the statement nor con-

trolled its contents, he was under no obligation to correct

any false or misleading information it contained. We

do not agree.

As the Supreme Court has said time and again, any

effort to construe a statute, including the securities laws,

must begin with the language of the statute itself. E.g.,

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

Accord, ¢.g., Lewis v. United States, 100 S. Ct. 915, 918

(1980). Section 14(a) of the Act forbids “any person

... to solicit or to permit the use of his name to solicit

any proxy” in violation of Commission rules. 15 U.S.C.

> -

‘

$78n(a) (1976).° By its express terms, section 14(a)

5’ The current version of Schedule 14A appears at 17 C.F.R.

$ 240.14a-101 (1979).

®In full, this subsection reads:

It shall be unlawful for any person, by the use of the

mails or by any means or instrumentality of interstate

commerce or of any facility of a national securities ex-

change or otherwise, 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, to solicit or to permit the use of his name to

solicit any proxy or consent or authorization in respect of

any security (other than an exempted security) regis-

tered pursuant to section 78! of this title [Act § 12].

15 U.S.C. § 78n(a) (1976).

Rule 14a-8 requires every proxy solicitation to conform to

Schedule 14A. In a solicitation by management for the annual

10

applies not only to one who himself solicits proxies but

also to anyone who “permit[s] the use of his name” in

the solicitation. Kalmanovitz’s name appeared eleven

times in the nine-page proxy statement, in three separate

items. He saw a first draft over a week before it was

issued and read the final version shortly after it was

mailed to the shareholders. Thus, under the literal lan-

guage of the statute, Kalmanovitz permitted his name

to be used in the proxy solicitation.

Of course, the simple appearance of one’s name in a

proxy statement does not trigger liability for any mis-

statement appearing therein. Instead, there must have

been “a substantial connection between the use of the

person’s name and the solicitation effort.” Yamamoto

v. Omiya, 564 F.2d 1319, 1823 (9th Cir. 1977). For ex-

ample, this substantial connection is present in the case

of director nominees listed in the proxy statement:

[NJominees h[o]ld out their names and reputations

to shareholders as evidence that the group backing

them [is] the proper choice to run the corporation.

shareholders’ meeting, the statement must be accompanied by

an annual report that complies with the specifications of

Form 10-K, with some additions. 17 C.F.R. § 240.14a-3 (a) -(b)

(1979). Rule 14a-9 provides in relevant part:

No solicitation subject to this regulation shall be made

by means of any proxy statement, form of proxy, notice

of meeting or other communication, written or oral, con-

taining any statement which, at the time and in the light

of the circumstances under which it is made, is false or

misleading with respect to any material fact, or which

omits to state any material fact necessary in order to

make the statements therein not false or misleading or

necessary to correct any statement in any earlier com-

munication with respect to the solicitation of a proxy for

the same meeting or subject matter which has become

false or misleading.

Id. § 240.14a-9 (a).

11

Having put their reputations in issue, the nominees

cannot divorce themselves from improper actions

taken in the proxy battle by the participants acting

under the banner of their names. Moreover, since

the major object of the proxy contest |is] to install

the nominees into positions where they would osten-

sibly control the corporation, all participants work-

ing for their election are in a sense agents of the

nominees, and thus the nominees must be expected

to assume some responsibility for the actions of their

agents.

Chris-Craft Industries, Inc. v. Independent Stockholders

Committee, 354 F. Supp. 895, 915 (D. Del. 1973).

We agree with the reasoning in Chris-Craft and be-

lieve it applies to the situation now before us.? Kalmano-

vitz’s reputation as a businessman, his plans for Fal-

staff, and his oth- dealings that could create conflicts

of interest were important to the existing shareholders,

who were being asked to transfer control of the company

to him. That the proxies nominally were sought by the

management is not dispositive; in reality, it was Kalman-

ovitz who was seeking the shareholders’ votes to approve

his taking control. His connection with the transaction

was more than substantial. It was pivotal. Thus, the

district court properly concluded that he could be held

liable for his failure to correct errors that he knew ap-

peared in the proxy statement issued on his behalf.*®

7 Kalmanovitz seeks to distinguish Chris-Craft because the

directors’ election there was contested. This difference in no

way affects our analysis. The absence of an organized opposi-

tion does not reduce the obligation of proxy solicitors to be

truthful and comprehensive in the material they distribute.

Indeed, with no group actively fighting the transaction, solici-

tors arguably are subject to a greater duty: no opposition is

presenting the other side.

8 Kalmanovitz relies on the facts in Yamamoto v. Omiya,

564 F.2d 1819 (9th Cir. 1977), which articulated the “sub-

12

Our conclusion comports with the policy behind the

regulation of proxy solicitations. In the words of Ferdi-

nand Pecora, counsel to the Senate Committee on Bank-

ing and Currency when it considered the Act:

I think [section 14(a)] mak[es] it possible for every

stockholder to learn in advance of his giving a proxy

what the proxy is sought for, whether the request

for the proxy comes from the management group or

whether it comes from a minority group who want

to use the proxy. It enables every stockholder to act

intelligently with regard to the giving of his proxy,

instead of putting him in a position where he gives

his proxy through the process of signing a blank

check.

Stock Exchange Practices: Hearings Before the Sen.

Comm. on Banking & Currency, 73d Cong., 1st Sess. (pt.

stantial connection” standard, see p. 10 supra, to support his

position. We do not believe that case is apposite here. In

Yamamoto, the Court of Appeals for the Ninth Circuit refused

to hold the purchaser of a building liable for errors in a proxy

statement sent to the seller’s shareholders seeking their

approval of the sale. The court reasoned that the purchaser

had no control over the statement’s contents and that the

identity of the purchaser probably did not induce sharehol¢ rs

vo vote for the sale. See id. at 1823. In the case before us now,

Kalmanovitz was seeking to take control of the company

itself, and information about him and his plans certainly was

material to the shareholder deciding whether to give his proxy

to persons supporting the transaction.

Kalmanovitz also argues that the district court erred in

remarking that the information relating to the Continental

Can transaction and the plans to retire the high-interest debt,

which the proxy statement failed to disclose, ‘‘was information

which rested primarily with Kalmanovitz.” SEC v. Falstaff

Brewing Corp., [1978 Transfer Binder] FEp. Sec. L. REp.

(CCH) {| 96,583, at 94,469 (D.D.C. 1978). We do not believe,

however, that Kalmanovitz’s relative knowledge is important;

rather, what is relevant is Kalmanovitz’s awareness of this

information and his failure to disclose it when he concluded

that the proxy statemeat was fraudulent.

13

16) 7716 (1934). Falstaff shareholders in effect were

asked to sign just such a blank check when they received

a proxy statement, nominally from the management, that

failed to disclose material information needed for them

to cast an intelligent vote. Permitting Kalmanovitz to

escape liability would mean that anyone attempting to

take control of a corporation could mislead the existing

shareholders with impunity simply by finding a nominal

solicitor willing to violate the law. The Supreme Court

has written that “Congress intended securities legisla-

tion enacted for the purpose of avoiding frauds to be

construed ‘not technically and restrictively, but flexibly to

effectuate its remedial purposes.’” Affiliated Ute Citizens

v. United States, 406 U.S. 128, 151 (1972) (quoting

SEC v. Capital Gains Research Bureau, Inc., 375 US.

180, 195 (1963)). Kalmanovitz’s conduct falls within

the purpose, as well as the literal language, of a statute

designed to give shareholders complete and accurate in-

formation when voting on corporate policy. We there-

fore conclude that Judge Corcoran properly held him

liable under section 14(a) and the Commission’s rules

thereunder.

III. VIOLATIONS OF SECTION 13(a)

The district court also held Falstaff and Kalmanovitz

liable for failing to file required reports and for filing

inaccurate reports with the Commission. Specifically,

Falstaff did not file a Form 8-K when Kalmanovitz went

forward with his plans and prepaid the bank loans, when

the insurance lenders thereafter declared a default under

the March waivers, or when Falstaff issued a note to

Continental Can for the payment deferrals. A Form

8-K filed in January of 1976 noted the litigation with the

insurance lenders but, in the district court’s view, did not

reveal adequately the basis of the action and thus was

materially false and misleading. In addition, at no time

14

did Falstaff or Kalmanovitz correct the errors made in

the 1975 proxy statement. Falstaff and Kalmanovitz

challenge these conclusions and some of the facts under-

lying them. Kalmanovitz in addition asserts that Judge

Coreoran’s failure to make an explicit finding that he

aided and abetted Falstaff’s violations precludes any

finding of personal liability on his part.”

A. Current Reports on Form 8-K

Section 13(a) requires all issuers subject to the Act’s

registration requirements to submit periodic reports to

the Commission containing such information as the Com-

mission may direct through its rules. 15 U.S.C. § 78m

(a) (1976).%° The Commission, pursuant to this au-

® The district court also held that the defendants had vio-

lated rule 13a-13, 17 C.F.R. § 240.13a-138 (1979), and rule

12b-20, id. § 240.12b-20, with regard to Falstaff’s filings of

quarterly reports on Form 10-Q. We have discovered no find-

ings of fact concerning the filing of Form 10-Q’s, but the

defendants have not challenged this absence. Therefore, we

decline to comment on the correctness of this holding. We

do note, however, that all Form 10-Q requires is a statement

that the registrant has made all necessary reports during the

past 12 months and has been subject ‘. the reporting require-

ments for the past 90 days. SEC Form 10-Q, reprinted in

4 Fep. Sec. L. Rep. (CCH) {31,081 (1979). Any misstate-

ment on this form thus would be cumulative of the errors

and omissions found on Forms 8-K and 10-K.

” This subsection provides:

Every issuer of a security registered pursuant to sec-

tion 781 of this title [Act § 12] shall file with the Com-

mission, in accordance with such rules and regulations

as the Commission may prescribe as necessary or appro-

priate for the proper protection of investors and to insure

fair dealing in the security—

(1) such information and documents (and such

copies thereof) as the Commission shall require to

keep reasonably current the information and docu-

ments required to be included in or filed with an

15

thority, has directed every registrant to notify it on a

Form 8-K of large acquisitions and dispositions of as-

sets, declarations of bankruptcies or receiverships, di-

rector resignations, and other major corporate events

whenever these events occur; other information must be

reported annually on a Form 10-K. See 17 C.F.R.

$$ 240.138a-1, -11 (1979).'' Under rule 12b-20, a com-

pany filing a report must include such additional infor-

mation as will make the filing not misleading under the

surrounding circumstances. /d. § 240.12b-20.""

application or registration statement filed pursuant

to section 78/1 of this title, except that the Commis-

sion may not require the filing of any material con-

tract wholly executed before July 1, 1962.

(2) such annual reports (and such copies there-

of), certified if required by the rules and regulations

of the Commission by independent public account-

ants, and such quarterly reports (and such copies

thereof), as the Commission may prescribe.

Every issuer of a security registered on a national

securities exchange shall also file a duplicate original

of such information, documents, and reports with the

exchange.

15 U.S.C. § 78m(a) (1976).

" Rule 13a-1 requires a registrant to file an annual report

on Form 10-K. Rule 18a-11 requires a Form 8-K whenever

certain events listed in the form’s instructions transpire. See

text. For the current versions of these forms, see 4 FED. SKC.

L. Rep. (CCH) ‘'{[31,001-04 (1979) (Form 8-K); id.

"7 31,101-08 (1980) (Form 10-K).

'2 As a preliminary matter, we note that the defendants

concede a Form 8-K filed in October of 1975 did not adequately

discuss pending litigation between Falstaff and the insurance

lenders and thus violated rule 12b-20. This Form 8-K men-

tioned that the company was the plaintiff in an antitrust and

fraud action brought against the insurance lenders. It did

not state, however, that Falstaff had filed this action to have

16

In January of 1976, Falstaff filed a Form 8-K stating

that it had paid off the bank loans and had entered

court seeking a declaration of the rights of the various

parties to the insurance loans.’* Judge Corcoran con-

the court declare the Collateral Agency Agreement, the March

waivers, and the lenders’ declarations of default invalid.

In addition, we declive to rule on the defendants’ conten-

tion that the bank and the insurance loans and the Continental

Can credit were not securities and thus Form 8-K as it then

read did not oblige Falstaff to report the payment of the

bank loans, the insurance lenders’ declaration of default, and

the issuance and payment of the note to Continental Can.

(Form 8-K at the time required reports only on changes and

defaults on “‘securities.”) The defendants, in their objections

before the district court to the Commission’s proposed con-

clusions of law, did not raise the issue of whether the loans

and notes were securities. See J.A. at 187 (arguing only

overtechnicality, immateriality, and ultimate disclosure). We

will not permit them to embark on this theory for the first

time on appeal. Judge Corcoran’s ruling must stand.

18 The Form 8-K read, in relevant part:

Falstaff paid off all its outstanding bank loans during

the summer of 1975, thereby eliminating more than

$16,000,000 in high-interest indebtedness. Once Falstaff

had made these payments, New York Life Insurance

Company and Mutual Life Insurance Company of New

York threatened suit based on Falstaff’s failure to permit

the insurance companies to share in these pre-payments

according to pre-arranged terms set by these same com-

panies. Falstaff had never been in default on its payment

obligation to these insurance companies.

In August, 1975, Falstaff filed an action for a declara-

tory judgment against the four banks and two insurance

companies, asking the Court to determine the rights and

duties of the parties under the various contracts relating

to the Falstaff loans. Both the New York Life Insurance

Company and the Mutual Life Insurance Company of

New York responded by filing counter-claims against

Falstaff. The suit alleges that Falstaff was in default

under the terms of its promissory notes with the insur-

17

cluded that this statement violated rule 12b-20 because

it failed to disclose that Falstaff had agreed to the pro

rata repayment on March 81, 1975, and that Falstaff’s

prepayment of the bank loans was what triggered the

insurance lenders to declare their loans in default. Fal-

staff and Kalmanovitz, however, believed that this in-

formation was obvious from the language of the com-

pleted form.

We believe Judge Corcoran properly found that the

January 1976 Form 8-K failed to disclose needed in-

formation. The Form 8-K nowhere mentions that Fal-

staff itself had agreed to pro rata repayment. Instead,

it states flatly that Falstaff “had never been in default”

and then reports that the insurance lenders alleged Fal-

staff was in default. Joint Appendix (J.A.) at 340,

quoted in note 13 supra. The omission of any descrip-

tion of the March waivers executed by Falstaff makes

the Form 8-K misleading. Only by a painstaking reading

could one perhaps infer that the prepayment was the

ground of the default, thus making the suit more than a

vexatious action brought by one group of lenders dis-

satisfied that another group had been prepaid. By fail-

ing to disclose in the Form 8-K material information

necessary to make the statements in it not misleading,

Falstaff and Kajmanovitz violated rule 12b-20.

B. Annual Reports on Form 10-K

In a description of its antitrust action against the

insurance company lenders, Falstaff’s 1975 Form 10-K

stated:

Current lenders are claiming default by the Regis-

trant under convenants [sic] of the original lending

ance companies, and demands acceleration of the repay-

ment of all outstanding principal under said notes.

J.A. at 840 (emphasis added).

18

agreements and also a default resulting from an

agreement dated March 25, 1975 requiring the Regis-

trant to payoff its long-term lenders on a pro-rata

basis, and are demanding acceleration of the repay-

ment of all principal outstanding under said Notes.

J.A. at 285. The district court found this passage mis-

leading because it did not disclose that Falstaff’s pre-

payment of the bank loans had led the insurance lenders

to declare a default. The court then concluded that the

Form 10-K’s violated rule 12b-20 by failing to describe

adequately Falstaff’s relations with its lenders, the litiga-

tion with them, the pro rata restrictions, the bank loans,

and the subsequent declarations of default.

Again, we do not believe that Judge Corcoran’s finding

was clearly erroneous. The Form 10-K states only in the

most general of terms the basis of the lenders’ case, i.e.,

Falstaff’s alleged violation of the March waivers and

the Collateral Agency Agreement; it does not discuss the

nature of the violations or the events underlying the

claimed breaches. Failure even to mention facts as material

as Falstaff’s own agreement to repay the loans pro rata

misleads investors and shareholders by denying them

critical information about major litigation and, indi-

rectly, about the performance of the company’s manage-

ment. With the disclosure presented in a materially mis-

leading way, we affirm the district court’s holding that

this Form 10-K violated rule 12b-20."

14The defendants assert that the omission of the Con-

tinental Can transaction was immaterial because Falstaff

regularly purchased cans from Continental and the arrange-

ment simply deferred payment. We disagree. The amount of

the note ($11.6 million) and its term (two years) suggest that

it was more than a routine payment scheme. We do not be-

lieve Judge Corcoran’s finding was clearly erroneous.

The defendants also argue that failure to include the Con-

tinental Can transaction on the 1976 Form 10-K was imma-

terial because the loan was repaid fully in 1975. The district

19

C. Kalmanovitz’s Liability

Kalmanovitz argues vociferously that even if the Form

8-K’s and 10-K’s violated the Act and the relevant Com-

mission rules, the district court did not expressly make

the findings of fact and conclusions of law necessary to

render him liable as an aider and abettor.’® To hold that

a defendant aided and abetted another’s violation, a court

must conclude that a wrongful act occurred, that the

defendant was aware of it, and that he knowingly and

substantially participated in it. Gould v. American-

Hawatian Steamship Co., 5385 F.2d 761, 779 (8d Cir.

1976). Our previous discussion amply confirms that a

variety of violations of the reporting requirements did

indeed occur. The district court also found Kalmanovitz’s

participation in this wrongdoing to have been both know-

ing and substantial. Thus, we conclude he may be held

liable despite the absence of an express conclusion of law

in the district court’s opinion.

In discussing the facts surrounding the filing of the

Form 8-K’s and 10-K’s, the district court several times

court’s opinion is somewhat vague on this point. It nowhere

expressly finds that this omission was material, but it lists

the Continental Can transaction among several deficiencies

that apply to both the 1975 and the 1976 Form 10-K’s. See

SEC v. Falstaff Brewing Corp., [1978 Transfer Binder] Fen.

Sec. L. REP. (CCH) {| 96,588, at 94,462, 94,471 (D.D.C. 1978).

Because this error is merely cumulative of the other defi-

ciencies found in the 1976 Form 10-K, we do not believe it

necessary to determine precisely what the district court held,

for even if its conclusion were improper, remand on this

point would be unnecessary.

15 Kalmanovitz also raised the possibility that the district

court may have been acting under § 20 of the Act, 15 U.S.C.

§ 78t (1976), which provides liability for controlling persons.

The Commission has not pursued this alternative basis for

liability before us, so we do not discuss it.

20

found Kalmanovitz to have been a knowing and active

participant. First, on August 29, 1975, outside coun-

sel to Falstaff sent Kalmanovitz a copy of a letter that

expressed concern over Falstaff’s compliance with the

securities laws. The letter explicitly recommended filing

a Form 8-K regarding the declarations of default. Sec-

ond, Kalmanovitz directly participated in the decision not

to include a description of the loan defaults in the 1975

Form 10-K but instead to mention them in the disclosure

relating to the antitrust litigation. Third, Kalmanovitz

knew that Form 8-K required a disclosure of all signifi-

cant litigation. Fourth, Kalmanovitz participated in the

drafting of the January 1976 Form 8-K with its in-

sufficient description of the litigation. Fifth, Kalmanovitz

at the time considered the acceleration of the insurance

company loans, if enforceable, to be a substantial threat

to Falstaff’s financial future. Kalmanovitz does not

claim that any of these findings is clearly erroneous."*

Despite these express findings of fact, Kalmanovitz

argues that the district court could not hold him liable

under section 13(a) without explicitly stating that he

was an aider and abettor. Having reviewed Judge Cor-

coran’s opinion thoroughly, we disagree. We do not be-

lieve that when a judge makes ample and unambiguous

findings of fact, his conclusion that the defendant vio-

lated the law must be overturned simply because he did

not state the theory he obviously was using in haec verba.

The Commission charged Kalmanovitz in part on an

aiding-and-abetting theory. See J.A. at 1 (complaint).

The opinion of the district court laid all the necessary

predicates for Kalmanovitz’s liability under such a theory

and then expressly concluded that he was liable. That

it neglected to state explicitly one link in the chain is

regrettable, but this omission does not undermine the

16 We also note that Kalmanovitz signed all the forms

actually filed.

21

chain, the validity of the link clearly implied, or the

strength of the ultimate conclusion. We therefore affirm

Kalmanovitz’s liability under section 13(a) and rules

13a-1, 13a-11, and 12b-20.

Interpolating facts and legal theories from insufficiently

thorough opinions is not an exact science, but this ob-

servation does not mean we cannot make inferences when

the route to them is short and safe. We strongly believe

that district courts should lay out their findings and con-

clusions clearly, and we will remand for illumination

when we are left in the dark. Nevertheless, we may

proceed when the light, though slightly dimmed, is none-

theless amply bright to guide us in our review. See SEC

v. Savoy Industries, Inc., 587 F.2d 1149, 1168 (D.C. Cir.

1978), cert. denied, 440 U.S. 913 (1979) .”

17 Kalmanovitz cites Savoy in support of his position. We

believe, however, that the situation that confronted us in

Savoy differs markedly from the one before us now. The

district court in Savoy had found that certain filings had been

deficient and then had held the defendant liable, stating

simply that the defendant’s group had been in control. On

appeal, we noted the absence of any findings of fact concern-

ing the defendant’s personal participation. 587 F.2d at 1170.

We also described the absence of any findings of facts or con-

clusions of law pertaining to a good-faith defense under

§20(b) of the Act, 15 U.S.C. §20t(b) (1976). 587 F.2d

1170-71. Our decision to remand rested on our inability to

infer exactly what formed the basis of the district court’s

holding. Indeed, on another issue in the case, we held, “The

absence of an express finding on the probability of future

violations by the district court does not impair our ability

to sustain the district court’s injunction where the necessary

factors are so obviously present.” Jd. at 1168.

Judge Corcoran’s opinion contains explicit findings on

Kalmanovitz’s participation in and knowledge oi the § 13 (a)

violations. No good-faith defense exists under that section.

As we note in the text, findings are present on all the ele-

ments of aiding and abetting, followed by the ultimate con-

clusion of liability. All that is missing is a statement that

22

IV. THE1977 Proxy STATEMENT

In April of 1977, Falstaff sent to its shareholders a

proxy statement for its upcoming annual meeting.** The

statement solicited proxies for the election of directors,

including the reelection of Kalmanovitz, and for an

amendment to the corporation’s charter that would permit

it to pay Kalmanovitz the dividends due on his preferred

stock in common stock rather than cash. ‘this transac-

tion would increase Kalmanovitz’s voting interest in

Falstaff.

The district court found the 1977 proxy statement

materially deficient in several respects. First, it did not

disclose Kalmanovitz’s voting control of Falstaff. Second,

it did not detail (1) the number of common shares

Kalmanovitz would receive under the proposed transac-

tion, (2) the source of the common stock, (3) the amount

payable to Kalmanovitz under the existing terms of the

preferred stock, or (4) background information explain-

ing how the proposal would conserve Falstaff’s cash re-

sources. Third, the statement referred to an audit com-

mittee that in fact never met. Fourth, it stated that the

Commission had “no comment” on the proxy statement

when, in fact, the Commission had informed Falstaff

that it regarded the statement to be materially deficient.”

““hiiding and abetting is the theory underlying the conclusion.

“Thijs omission is a far cry from the multitude of missing

findings and conclusions in Savoy.

18 The meeting was not held. On May 10, the Commission

staff notified Falstaff that it was authorized to institute this

action. The Commission filed a motion for preliminary relief

to block the meeting on May 27. By stipulation entered June 1,

Falstaff agreed not to hold the meeting or solicit proxies for

it until the district court ruled on the granting of interim

relief.

1* Falstaff filed a preliminary copy of the proxy statement

with the Commission about March 28, 1977. See 17 C.F.R.

23

Falstaff and Kalmanovitz argue that the proxy state-

ment adequately disclosed Kalmanovitz’s control and po-

tential conflicts of interest and that the references to the

audit committee were not false and misleading. They

contend any omissions were trivial items of little concern

to investors.” We disagree and affirm Judge Corcoran’s

§ 240.14a-6(a) (1979). The Commission advised Falstaff on

April 6 that the statement was materially deficient and that

any dissemination of it would be at Falstaff’s own risk. J.A.

at 776 (letter from Falstaff’s general counsel acknowledging

receipt of this message and asking for information on the

specific nature of the deficiencies). The Commission declined

to give detailed comments. See id. § 202.3(a) (Commission

ordinarily does not give comments “when the deficiencies

appear to stem from careless disregard of the statutes and

rules or a deliberate attempt to conceal or mislead”). In-

stead of reporting that the Commission believed the statement

was materially deficient, Falstaff simply added the following

rider to the statement, which it then mailed:

In accordance with the rules and regulations of the

United States Securities and Exchange Commission, this

Notice of Annual Meeting of Shareholders and Proxy

Statement was submitted to the SEC in advance of mail-

ing. The SEC has taken a “no comment” position relative

to this proxy statement. The Company, in the interest

of its shareholders, has proceeded with the mailing of

this Proxy Statement without having received any formal

comments from the SEC. In the event that the SEC later

objects to any item or items to be voted upon, the votes

as tabulated by the Company respecting any such item

or items will not become effective until such time as such

objections have been resolved.

J.A. at 253 (emphasis added). Obviously, this remark sub-

stantially misrepresented the Commission’s position. The de-

fendants do not appear to challenge the district court’s find-

ing that this passage was false and misleading.

20 The district court also held that Falstaff violated § 14(a)

and the relevant rules by failing to correct in the 1977 proxy

statement the errors made in the 1975 proxy statement. The

defendants argue that the rules do not require correction of

24

findings and his conclusion that the omissions violated

section 14(a) and rules 14a-9 and 12b-20.

A. Kalmanovitz's Control

The district court held that the 1977 proxy statement

was materially false and misleading, in part because

it did not disclose adequately that Kalmanovitz con-

trolled Falstaff and its board. The court believed that

a clear statement of his control was needed to place the

board’s recommendation of a stock dividend to Kalmano-

vitz in perspective: shareholders then could vote on the

proposal knowing not only that Kalmanovitz had a vital

interest in the approval of the stock dividend but also

that he controlled the board that ultimately would vote

on it.

The 1977 proxy statement said only: “Mr. Paul Kal-

manovitz, who is Chariman of the Board of the Company,

has a direct interest in this matter as a result of his

beneficial ownership of 100% of the Class A Preferred

Stock outstanding.” J.A. at 258. This passage does not

suggest that he also held a majority voting control, could

name a majority of the directors, and in fact was in

command of the company and its board. Thus share-

holders might not know Kalmanovitz controlled the very

management that was recommending approval and so-

liciting the common stockholders’ proxies. We therefore

agree that Falstaff’s failure to make this potential con-

flict clear rendered its comments on the conflict of in-

all misstatements and omissions made in earlier solicitation

materials. We need not reach this difficult question, however.

The 1977 proxy statement contained ample mistakes for the

district court to support its conclusion that it violated the Act

and the rules. Failure to correct the 1975 errors, if a violation,

is purely cumulative. Thus, even if we were to reverse this

holding, multiple violations with regard to the 1977 proxy

statement and other areas would remain. A reasonable likeli-

hood of future violations still would be present.

‘>

ry

25

terest misleading. The defendants thereby violated sec-

tion 14(a) and rules 14a-9 and 12b-20."

B. The Audit Committee

The 1977 proxy statement also referred to an audit

committee consisting of Kalmanovitz and two other di-

rectors. Judge Corcoran found that in fact this com-

mittee never met or functioned. He concluded that men-

tioning this nonexistent committee created the false im-

pression that the board of directors was exercising care-

ful oversight of the company’s finances; the statement,

therefore, was false and misleading.

The defendants attempt to undermine this finding by

submitting that even if not functioning as a formal com-

mittee, the named individuals were overseeing the com-

pany’s finances and thus the statement was not false.

We ‘nevertheless believe that the district court’s finding

was not clearly erroneous. The existence of a committee

implies a structured investigation and analysis of a com-

pany’s fiscal welfare. Informal procedures may be ade-

quate, but formal entities such as committees create at

least the impression of great care and precision through

detailed review and oversight. Stating that an audit

committee, with its implication of careful oversight, ex-

isted when it did not thus is misleading, particularly

when the proxies are being sought for a meeting at

which directors will be selected; 7.e., when one major

21 The district court also held that the failure to disclose

Falstaff’s control violated item 5 of Schedule 14A, 17 C.F.R.

§ 240.14a-101 (1979). The defendants argue that the rule

governs only changes in control since the beginning of the

last fiscal year. See id. (item 5(f)). Because we have con-

cluded that the failure to describe Kalmanovitz’s control vio-

lated the Act and rules 14a-9 and 12b-20, we need not decide

whether this omission also violated Schedule 14A. The

Schedule 14A violation would be simply a different characteri-

zation of the same underlying misconduct.

26

issue before the shareholders is whether to retain the

current management. Therefore, we agree that this state-

ment in the 1977 proxy materials was false and mis-

leading and that its inclusion violated the Act and the

relevant rules.

V. SECTION 10(b) AND RULE 10b-5

The district court also held that Falstaff and Kalmano-

vitz had violated section 10(b) of the Act, 15 U.S.C.

§ 78} (1976), and rule 10b-5 thereunder, 17 C.F.R.

§ 240.10b-5 (1979).** These provisions prohibit manipu-

22 This section reads, in relevant part:

It shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality of

interstate commerce or of the mails, or of any facility

of any national securities exchange—

(b) 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 manipu-

lative or deceptive device or contrivance in contravention

of such rules and regulations as the Commission may

prescribe as necessary or appropriate in the public inter-

est or for the protection of investors.

15 U.S.C. § 78j (1976).

28 This rule reads:

It shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality of

interstate commerce, or of the mails or of any facility

of any national securities exchange,

(a) To employ any device, scheme, or artifice to de-

fraud,

(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 circum-

stances under which they wcre made, not misleading, or

[Continued]

27

lative and deceptive practices in the purchase and sale of

securities. The district court found that Falstaff and

Kalmanovitz engaged in such practices in submitting a

misleading proxy statement to shareholders in 1975, in

failing to file or filing inaccurate reports, in misleading

Falstaff shareholders in a 1975 letter,*' and in distribut-

“3 [Continued]

(c) To engage in any act, practice, or course of busi-

ness 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 (1979).

*4 This letter, sent over Kalmanovitz’s signature as the new

chairman of Falstaff’s board, stated in part:

For your information, Falstaff paid off all its outstand-

ing bank loans in full during the summer of this year,

thereby eliminating more than $16,000,000 in high inter-

est indebtedness. When Falstaff made these payments,

New York Life Insurance Company and Mutual Life

Insurance Company of New York threatened Falstaff

with a lawsuit because we did not permit the insurance

companies to share in these prepayments according to

the terms of an agreement which the lenders had made

between themselves. However, Falstaff had never been in

default of its payment obligations to these insurance

companies, and never will be.

Falstaff has been advised by its attorney, Mr. Joseph

L. Alioto of San Francisco, that the agreement between

the insurance companics and the banks to share any loan

prepayments constituted a clear violation of the antitrust

laws, threatening the financial stability of Falstaff. Based

upon this advice, Falstaff is now in the process of filing

an antitrust lawsuit against the New York Life Insur-

ance Company, the Mutual Life Insurance Company of

New York, and four major banks, alleging that these

lenders agreed among themselves to allocate lending op-

portunities, to pool their interests in certain lending

agreements with Falstaff, and to pool any prepayments

by Falstaff under those lending agreements, all to the

financial detriment of Falstaff. Your management has

28

ing another misleading proxy statement in 1977.% The

defendants challenge the materiality of the omissions and

errors and also contend that the district court did not

make a proper finding of scienter, which, they argue, is

a prerequisite to liability in a Commission enforcement

action. We affirm the district court’s determinations in

all respects.

A. Materiality

We need pause but briefly on the defendants’ argu-

ments that the misstatements and omissions were im-

material. Materiality is a question of fact, and informa-

tion is material if “there is a substantial likelihood that

a reasonable shareholder would consider [information]

important in deciding how to vote.” 7'SC Industries, Inc.

v. Northway, Inc., 426 U.S. 438, 449 (1976). Our dis-

cussions of the violations of sections 13(a) and 14(a)

and the rules thereunder amply demonstrate that Fal-

staff and Kalmanovitz indeed made false and misleading

statements and omitted information necessary to make

instructed its attorneys to prosecute these matters vig-

orously to the full extent of the law.

J.A. at 772. The district court found that these remarks

were misleading in failing to disclose Falstaff’s acquiescence

to the Collateral Agency Agreement or its execution of the

March waivers. We do not believe this finding is clearly

erroneous.

25 On three occasions, we have declined to resolve the de-

fendants’ challenges to specific findings because the district

court’s decisions that violations occurred in these instances

were simply cumulative of other findings that we have

affirmed. See notes 14, 20 & 21 supra. Liability under § 10(b)

and rule 10b-5 depends in part, at least arguably, upon these

violations. Nevertheless, there remain ample other violations

that we have affirmed or that the defendants have conceded

underlying the §10(b) and rule 10b-5 liability, and any

error regarding these three violations would be harmless.

29

other remarks not false or misleading. Their attempt

to contest materiality here is meritless.

B. Scienter

The Supreme Court has held that in private actions

under rule 10b-5, the plaintiff must prove that the de-

fendant acted with scienter, ie., “intent to deceive,

manipulate, or defraud.” Ernst & Ernst v. Hochfelder,

425 U.S. 185, 198 & n.12 (1976). The Court has not

yet decided whether the Commission must prove scienter

in an administrative enforcement proceeding. See id. at

193 n.12.** Judge Corcoran declined to decide this ques-

tion, for he found that the Commission had proved

scienter on the facts before him.

Falstaff apparently does not challenge the finding of

scienter on its part. Kalmanovitz, however, argues that

the district court could not find that he acted with

scienter. We disagree. In discussing scienter, the dis-

trict court specifically restated its earlier conclusion that

Kalmanovitz had known of the material omissions and

misstatements in the 1975 proxy statement, a conclusion

that we have affirmed, see pp. 9-13 supra. It also re-

iterated that Kalmanovitz had known of the errors in

the 1977 proxy statement. Moreover, in conjunction with

the violations of section 18(a), the district court con-

cluded that Kalmanovitz had known of the omissions and

failures to file. See pp. 19-20 supra.

Kalmanovitz contends that scienter requires an in-

quiry into “the defendant’s state of mind—his subjective

belief as to the legality of his action... .” Brief of

Appellants at 41. We strongly disagree. Knowledge

means awareness of the underlying facts, not the labels

26 This issue is presently before the Court in Aaron v. SEC,

48 U.S.L.W. 3568 (U.S. No. 79-66) (argued Feb. 25, 1980),

on cert. to 605 F.2d 612 (2d Cir. 1979).

80

that the law places on those facts. Except in very rare

instances, no area of the law—not even the criminal law

—demands that a defendant have thought his actions

were illegal. A knowledge of what one is doing and the

consequences of those actions suffices. We therefore hold

that because Kalmanovitz knew the nature and conse-

quences of his actions, he acted with scienter.”’

VI. THE INJUNCTIONS

The district court entered orders enjoining Faltaff and

Kalmanovitz, their agents, and their employees from com-

mitting further violations of the securities laws. Because

prospective relief is designed to prevent future miscon-

duct rather than to compensate for or to punish past

violations, see Hecht Co. v. Bowles, 321 U.S. 321, 329

(1944), cited in SEC v. Savoy Industries, Inc., 587 F.2d

1149, 1169 (D.C. Cir. 1978), cert. denied, 440 U.S. 913

(1979), the court must determine “ ‘whether the defend-

ant’s past conduct indicates ... that there is a reason-

able likelihood of further violation[s] in the future.’ ”

27 Several courts of appeals have held that a reckless dis-

regard for the consequences of one’s actions is enough to

demonstrate scienter in an action under rule 10b-5. See, e.g.,

Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 88, 46 (2d

Cir.), cert. denied, 489 U.S. 1089 (1978) ; Coleco Industries,

Inc. v. Berman, 567 F.2d 569, 574 (8d Cir. 1977), cert. denied,

4389 U.S. 8380 (1978); First Va. Bankshares v. Benson, 559

F.2d 1807, 1814 (5th Cir. 1977), cert. denied, 485 U.S. 952

(1978) ; Sanders v. John Nuveen & Co., 554 F.2d 790, 792

(7th Cir. 1977). Accord, Nassar & Co. v. SEC, 566 F.2d 790,

794-95 (D.C. Cir. 1977) (Leventhal, J., concurring). Cf.

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 198 n.12 (reserv-

ing question of whether scienter includes recklessness). We

need not decide whether recklessness alone suffices, for we

have held that Kalmanovitz acted knowingly. Of course, be-

cause knowledge embraces recklessness, our conclusion that

Kalmanovitz acted knowingly a fortiori includes a conclusion

that he acted at least recklessly.

81

SEC v. Savoy Industries, Inc., 587 F.2d at 1168 (quot-

ing SEC v. Commonwealth Chemical Securities, Inc., 574

F.2d 90, 99 (2d Cir. 1978) (emphasis in original) ).

Falstaff and Kalmanovitz challenge the injunctions by

reiterating earlier assertions of incorrect analysis of the

evidence, by raising new objections to certain additional

findings of fact, and by arguing that the Commission did

not demonstrate a reasonable likelihood of further viola-

tions. We conclude that Judge Corcoran acted properly.

A. Factual Basis of the Injunctions

In addition to the violations discussed above,** the

court relied on additional factors in deciding whether to

issue the injunctions. Specifically, it found that Falstaff

had continued to seek proxies under the 1977 statement

despite warnings from the Commission and Falstaff’s

employees of the statement’s serious inadequacies. More-

over, Falstaff board members failed to file certain dis-

closure forms under the Act, and Falstaff had falsely

represented to the court that its brewer’s bond had been

cancelled on account of the litigation in this case. The

defendants contend that these findings by the district

court could not support the injunctions. We disagree.

28 Our decision not to reach three issues because the vio-

lations involved would simply be cumulative, see notes 14, 20,

21 & 25 supra, also does not hamper our upholding the in-

junctions. Because they are cumulative, we do not believe

that these particular violations were the proverbial straws

that broke the camel’s back, and the absence of an express

finding that the remaining violations would have been enough

does not undermine the reasonable likelihood of future mis-

conduct. See SEC v. Savoy Indus., 587 F.2d 1149, 1168 (D.C.

Cir. 1978) (“absence of an express finding on the probability

of future violations by the district court does not impair our

ability to sustain the district court’s injunction where the

necessary factors are so obviously present”), cert. denied, 440

U.S. 918 (1979).

32

1. Disregard of Warnings

The defendants do not dispute the district court’s find-

ing that they continued to solicit proxies with the 1977

statement even after the Commission informed the com-

pany that it regarded the document as being materially

deficient. Instead, they argue that a judge may not take

this conduct into account in evaluating the likelihood

of future violations. They believe that a court may not

fault a party for persisting in its belief that its conduct

is lawful and acting on that behalf, at least until a

court holds the party in violation of some legal duty.

In the present context, we believe that the district

court could consider Falstaff’s proceeding with the 1977

proxy statement. That document, we have concluded,

was indeed deficient. The Commission so warned Fal-

staff. The company’s own employees questioned the ade-

quacy of the disclosures. Failure to follow Commission—

and internal—advice may not be a violation itself, but it

surely suggests that in the future, apprised again of

potential violations, Falstaff might proceed undeterred

as it did in 1977. Ignoring warnings of possible viola-

tions is relevant to the particular task facing a judge

in ruling whether to grant an injunction; namely, as-

sessing the likelihood that a defendant will violate the

law again.

2. Reports by Directors

Falstaff also maintains that the failure of certain ex-

ecutives to file reports under section 16(a) of the Act,

15 U.S.C. § 78p(a) (1976),2° does not demonstrate a

2°This provision requires officers, directors, and persons

having a beneficial ownership totalling 10% or more of any

class of equity securities to file reports on any acquisitions or

changes in outstanding amounts of those securities. 15 U.S.C.

§ 78p(a) (1976). The report is filed on Commission Form

8 or 4. See 17 C.F.R. § 240.16a-1 (1979).

3d

propensity for Falstaff to violate the Act in the future.

Falstaff characterizes the violations as overly technical

and not probative. Again, we must conclude that Judge

Corcoran could consider this information and decide that

it indicated a likelinood of future misconduct. Whether

due to ignorance, neglect, or conscious decision, noncom-

pliance with section 16(a) does evince a disregard of the

securities laws that may manifest itself in noncompliance

elsewhere. Moreover, these violations involved several

members of Falstaff’s board other than Kalmanovitz.

Misconduct by multiple directors surely suggests that

Falstaff might continue shirking its legal duties.

3. Brewer’s Bond

Falstaff, in a letter from counsel dated July 1, 1977,

informed the district court that “the bond which is

required of every brewery by federal law to ensure pay-

ment of taxes has been cancelled by Falstaff’s bonding

company as a result of this suit.” J.A. at 817. The

district court found that this representation was false

and used it as further evidence pointing to a likelihood

of future violations.

The defendant

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