Appendix — Custer Channel Wing Corp. v. United States

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APPENDIX A

‘UNITED STATES COURT OF APPEALS

FOR THE FOUBTH CIRCUIT ==

No. 10, 399. :

‘Untrep Staves OF AMERICA, Appellee,

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~~ Cusrse CHANNEL W1No Corporation and .

Wriaep.R. Custer, Appellants.

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- Appeal from the United States District.Court for the

District of Maryland, at Baltimore.

Harrison L. Winter, District Judge.

(Argued February 8, 1967. Decided April 3, 1967.)

Before SoseLorr, Borneman and Bryay, Circuit Judges.

Vincent L. Gingerich (Keith L. Seegmiller on brief) for.

Appellants, and Richard M. Phillips, Special Assistant

_ United States Attorney, (Thomas J. Kenney, United.

States Attorney, and Roy Nerenberg and Clarence FE. .

Beaver, Attorneys, Securities and Exchange ‘Commis-

sion, on brief) for Appellee.” ah,

Sosztorr, Circuit J nudge:

Appellants, Custer Channel. Wing Corporation and

Willard R. Custer, its president, were convicted of criminal

contempt for violating an injunction issued by the District

Court, permanently enjoining them from engaging in acts

or practices that would constitute a violation of section5of _—

eS

On’

the Securities Act of. 1933, 15 U. S.C. gg 77e(a) ona 1d 77e(c) Se

(1958). This Act forbids the use of any. means of interstate

‘commerce or of the mails to séll or offer to\sell securities

. without having first filed a registration statement with

- the Securities and Exchange Commission. Exempt from the .

registration requirement, and hence from the injunction, are

_certain types of transactions listed under section 4(1) of the .

. . Securities Act of 1933, 15 U.S.C. §77d(1) (1958), as ©

| amended, 15 U.S.C. § 77d(2) (1964), among them a

actions * an issuer not involving any public offering.’’

Appellants admitted: having sold unregistered shares of —

Channel Wing stock, but maintained that the sales were a

private offering within the section 4(1) exemption. They

further contended that even if it was a public offering,

- there was no evidence of ‘‘willful’’ violation of the court’s

' injunctive order, as required for a finding of criminal

contempt.

- The District Court-decided both contentions against. the

appellants and fined the corporate defendant $5,000 plus

one-half of the costs, and sentenced the individual defend-

ant to serve 183 days in prison and to pay one-half of the

costs. | : :

After the issuance of the injunction on May 25, 1962, the

appellants sold 1,579,590 shares of Channel Wing Class B

- Common Stock, none of which was registered. with the

_ Securities and Exchange Commission. Well over half of the

shares were issued to three ‘‘ Associates’’ set up by appel-

lants, and the remainder were ‘issued and sold to various .

individuals, at least nineteen in number. The manner in.

which the ‘‘ Associate’’ device operated is explained in

detail in the opinion of the District Court,’ which found

that the ‘‘ Associates’’ were not corporations, partnerships,

or associations, but merely names used as conduits for the

sale of stock to some 136 individuals.

247 F. Supp. 481, 486 (D. Md. 1965). .

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The question whether the sale of Channel Wing stock

was a public offering, required to be registered with the .

Securities and Exchange Commission, or a private offering -

exempted from registration by section 4(1), is controlled by

the Supreme Court’s decision in SEC vy: Ralston Purina Co.,

346 U.S. 119 (1953). There, the Securities and Exchange

Commission sought to enjoin Ralston Purina’ Company’s

; offerings of unregistered stock to its employees, and the

problem before the Court was to determine the scope of the

private offering exemption of section 4(1). Since ‘‘ public

offering’’ is not defined in the Securities Act, the Court

looked to the purpose of the Act, which it declared was ‘‘to |

protect investors. by promoting full disclosure of informa-

tion thought necessary to informed investment decisions.’?

346 U.S. at 124. Interpreting the section 4( 1), exemption

in the light of this statutory purpose, therefore, the Court.

expressed the view that a transaction is exempt when the.

particular class of offerees had ‘‘access to the same kind of

information that the Act would make available in the form

of a registration statement.’’ Id. at 125-26. The Court

thus made it clear that only where. an offering is ‘‘to those

' who are shown to be able to fend for themselves”? may the

transaction be deemed a private offering.

In the present case the District Court found that none of

‘the purchasers of Channel Wing stock had access to the kind

of information that would have become available to them

through a registration statement. Applying the Ralston

Purina test to the sale of Channel Wing securities, it is

evident that the transaction was a public offering.

. Appellants argue that the District Court erred in finding

that the individual purchasers were not able ‘‘to fend for

themselves,’’ noting that they were ‘sophisticated in-

vestors’’ and ‘‘businessmen of mature experience.’’ But .

-. “sophistication” is not a substitute for ‘‘access to the kind

of information which registration would disclose.’’ 364

SAIS ON EEG IS A. CO OPIN o~s SOPRA Hee PIES AY’ .

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U.S. at 127. Schedule A of the Securities Act, 15 US.C.

§77aa (1958), lists 32 categories of information that -

should be included in a registration statement.? This type

of information is designed to protect ‘the investor by

furnishing him with detailed knowledge of the company

and its* affairs to make possible an informed investment

- decision. A purchaser of unregistered stock must be shown

to have been in a sqaty to — similar information

about the issuer. .

- Since section 5 is 5 for the protection of the public, the |

terms of the exemption must be strictly construed against: .

the one claiming it, and the burden of establishing the ~

exempt character of the transaction rests on him who claims

the exemption.’ It is evident that appellants failed to meet

this burden since the District Court found, with full support

in the record, that most of the individual purchasers ‘‘were —

not furnished, nor did they have, anything more than the

' vaguest information about the financial affairs of Channel

Wing.’’ -.247 F. Supp. at 487. Even the few purchasers

shown by the evidence to have gained access to the pertinent

information when they later became directors of the corpo-

2 Some of these categories are: the nature and general character

of the issuer’s business; its capital structure; the remuneration to

be paid to the issuer’s ‘directors and to its officers and other em-

ployees, and the nature and extent of their interest in any prop-

erty acquired; an estiinate of the net ‘proceeds: to be derived from

the security offered; amounts, itemized in ‘‘reasonable’’ detail, of

‘ expenses incurred in connection with the\sale of the security; a

detailed balance sheet of the assets and liabilities\ of the issuer

certified by an independent publie or certified accountant ; a profit

and loss statement of the issuer showing earnings and income ; the

names and addresses and a copy of the opinions of counsel ‘who

have passed on the legality of the issue; and a copy of the i issuer ’s

articles of incorporation and of its by-laws. aN \

SSEC v. Ralston Purina Co., 346 U.S. 119 (1958) ; SEC v.

Culpepper, 270 F. 2d 241 (24 Cir. 1959) ; Gilligan, Will & Co. v.

SEC, 267 F. 2d 461 (2d Cir. 1959); United States v. Attaway,

’ 211 F. Supp. 682 (W.D. La. 1962) ; SEC v. sees Con.

' Min. Co., he OF Supp. 248 id Utah 1958).

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sels: lacked such access at the itn they ‘purchased most

of their stock. Furthermore, since the District Court found -

that the ‘‘ Associates’’ were not ‘‘legal entities,’’ but merely ~

_ conduits for the sale of stock to numerous individuals, none

' of whom had any connection with Channel Wing, it is clear

- that these 136 investors also were without access to the type

of information required by Schedule A.‘ ©

_ A farther contention advanced by the appellants i is that

‘Ralston Purina does not apply where the securities are held.

__ for investment, where resale is restricted, and where the |

| number df, transferees is Jimited, since in that case the com-

‘on pany offered its stock to hundreds of ‘‘key employees’’

without imposing any restriction on immediate resale.

Channel Wing and its president required each prospective .

purchaser to sign an investment letter acknowledging that

he knew that the ‘stock was not registered and that the

- corporation had been. enjoined from certain stock sales, |

and included an agreement that the purchaser would not

resell the stock for a period of 13 months.’ Appellants also

\ _ caused a- legend to be imprinted on the face of each

\ certificate restricting transfer. They assert that these

steps having been taken, the transactions were a S pasate,

offering.

We think that the sindihaiee’ misconceive the function of

these meastres. Although such precautions: are ‘taken by

issuers relying on the exemption of section 4(1) to ensure

that their purchasers shall not in turn distribute securities.

to others who might not have ‘‘access to the kind of in-

formation which registration would disclose,” even though

the initial purchasers possessed such information, ‘‘these

are only precautions [to prevent illegal distributions] and

*The evidence disclosed that not even the three ‘‘ Associates”

were given or had access to the kind of information that would ~

have been available to them in a registration state.

SA copy of the investment letter used by the commis is

set out in footnote 2 of the District Coert’ 8 —. 247 F. Supp. '

at =.

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are not to be regarded as a basis for exemption from

registration.’’?* The signing of an investment letter and |

' the imprinting of a legend on the stock certificates are not |

sufficient to constitute the Channel Wing offering a private

|. one-in the absence of proof that the purchasers actually

- had access to the kind of information that a registration ;

statement would have disclosed.

Appellants’ ‘contention. that the number of thinabecess

must be considered in determining whether an offering |

is public or private, and that Ralston Purina is distinguish- -

able from the present case by the fact that Ralston

‘Purina’s offering was made to hundreds of its employees

scattered over a large part of the country, is refuted by

the Court’s opinion in that very case, which declared that

‘the statute would seem: to apply to a ‘public offering’

whether to few or many. 7 346 U.S. at 125. (Emphasis

* Non-Public Offering”Exemption, SEC Securities Act Release

No, 4552; Nov. 6, 1962. .

TIn Gilligan, Will & Co. v. SEC, 267 F. 2d 461 (24 Cir. 1959)

it was argued that an exception to the standard announced in

Ralston Purina should be made for cases in which the number of —

offerees or. purchasers is small; in Gilligan there were on four -

purchasers. Judge Lumbard, speaking for the court in igan,

defined the Ralston Purina standard as follows:

‘‘[T]he governing fact is whether the persons to whom the

offering is made are in such a position with respect to the

‘issuer that they either actually have such information as a

registration [sic] would have van arta or have access to .

such information.”’

267 F. 2d at 466, He noted that in adopting this test for detér

mining whether an issue is a public offering, ‘‘the Ralston Purina

case clearly rejected a quantity limit on the construction of the

. statutory term.” Id. at 467. (Emphasis supplied.)

As early as 1935, the Commission stated that :

“‘in no sense is the question [what constitutes a public offer-

ing] to. be determined exclusively by the number of prospective

offerees.

- SEC Securities Act Release No. 285, Jan. 24, 1935.

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" gupplied.) Mieeevia, since the District Court justifiably

found. that the ‘‘ Associates” could not be considered ‘‘legal ©

entities,’’ the gale’ of shares was in fact not restricted to.

a limited group.” The total number of purchasers was more. -

than 150 and the government’s: exhibits indicate that, .

Channel Wing stock was. offered to at nent seventy others

— ‘the same period." :

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. Both in-the District Court and here the appellants have

vigorously insisted that.for them to be adjudged in criminal

contempt, it is not enough to show that they intentionally

committed the acts constituting the violation. with. full

knowledge -of all relevant circumstances; ¢here must, it is -

argued, also. be proof beyond a reasonable doubt of ‘‘evil

purpose or bad motive on their part,’’ that is, ‘proof of

. specific intent to violate the injunction.’’

Section 5 of the Securities Act of 1933, 15 U.S.C. § 770

(1958), provides that it is unlawful to utilize any means of

interstate commerce or the mails to sell or offer to sell un-

‘registered securities. Section 24 of the Act, 15 U.S.C. § 7x

(1958), makes it a-crime ‘‘willfully”’ to violate section 5.°

The Supreme Court has said that the word ‘‘willfully”’ does :

not necessarily mean done with a bad. purpose, but may be

« *temployed to characterize a thing.done without ground

for believing it. is lawful, * * * or conduct marked by

8‘ [The number of offerees]. does not mean the number of actual -

purchasers, but the number of persons to whom the security in ques-.

tion is offered for sale. The word ‘offering’ in this sense should

not be limited to those cases wherein a fo? proposal for a

firm commitment is submitted. Any attempt to dispose of a

security should be regarded as an offer.” _ \

SEC Securities Act Release No, 285, Jan. 24, 1985. See SEC v. | .

Howey Co., 328 U.S. 293, 301 (1946). A ais

°77x. Penalties —

““* Any person who wi y violates any of the provisions of

this subchapter, * * * upon conviction be fined not more

than $5,000 or imprisoned not more than five years, or both.’’

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careless disregard ee or not one has the right so

to act * bs 99 ,

United States v. Murdock, 290 U.S. 389, 394-395 (1933).

A number of courts have indicated that in criminal

prosecutions for violation of section 5, it is not necessary |

to prove specific intent to violate the law. All that need °

_ be shown to sustain a conviction is that the defendant has

intentionally sold or offered to sell unregistered securities

through the mails or in interstate commerce.” It has also

been held that an aii alate may be granted-for a violation

of section 5

- “even though it is not demonstrated that the violations

_ or threatened. violations furnishing its basis are wilful

- .in-the special sense of being fraudulent, in bad faith or

with deliberate intent to violate known requirements of

law. * * * [E]ven though violations fall short of those

that would be wilful in a criminal sense, the Court

may infer from.a wanton or even careless willing-

- Tn Kistner v. United States, 332 F. 24 978 (8th Cir. 1964),

it was pointed out that to sustain a conviction under section 5

‘‘the Government must prove only-that the defendant caused

to be carried in the mails a security —e with the

Security and Exchange Commission, ’’:

: distinguishing this from the proof required under section 17 of the

Act, 15 U.S.C. § 77q: that ‘‘the defendant with intent committed

a fraud.’ Id. at 981.: (Emphasis. supplied.) See also Estep v. ~

United States, 223 F. 2d 19 (5th Cir.), cert. denied 361 U.S: 896 -

(1955) ; Stone v. United States, 113 F. 2d 70 (6th Cir. 1940). A

district court in the’ Third Circuit has ruled even more explicitly

that

“it was sufficient to establish that the defendants willfully

and intentionally sold or delivered unregistered securities by

use of the mails. * *.* [I] do not now conceive an element of

the crime charged * * * [violation of section 5]~to be actual

ee that a security was being cold i in violatien of the

“” l

United States v. dinitatte. 37 F. Supp. 294, 296 (E.D. Pa. 1941).

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ness to take a chance on the legality of questionable

transactions that a defendant is about to similarly

violate the Act’ if afforded an opportnnity to do so

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SEC v. Mono-Kearsarge Con. Min. Co., 167 F. Supp. 248,

261 (D. Utah 1958). See 16 U.S.C. $77 (1958). Clearly, °

if in a direct criminal prosecution or in a proceeding for

injunctive relief, it is sufficient to show that the act of

selling unregistered stock was willful and intentional, with-

out the necessity of showing evil purposé or bad motive

with specific intent to violate the law, no more stringent

test of guilt should be required in a proceeding for

criminal contempt for violation of an order enjoining the

defendant from engaging in acts forbidden by the statute.”

Appellants argue, however, that other cases, while not

expressly requiring a showing of evil motive with specific

11 Similar rulings have been made in respect .to violations of in- ©

‘junctions involving other federal -regulatory statutes. See United

States v. Schlicksup Drug Co., 206 F. Supp. 801 (S.D. IIL 1962),

holding that in a proceeding for criminal contempt for violating

an injunction restraining defendant from delivering into interstate

commerce adulterated drugs in violation of the Federal Food, Drug,

and Cosmetic Act, § 301(a), 21 U.S.C. § 331(a) (1958), the govern-

“ment need not prove specific intent to violate the injunction. The

court reasoned that there is an ‘‘interrelationship between the

criminal rerelial provisions of the Act and a contempt proceeding

growing out #f the violation of a remedial order based upon the

Act.’’? Id. at 805. Since adulteration’of drugs could be enjoined -

without proving any specific intent, it would be ‘‘anomalous’’ to

require proof of specific intent in continued violations of the Act,

and in violation of an injunction. The court distinguishes United

States ex rel. Porter v. Kroger Grocery Baking Co., 163 F. 2d

168 (7th Cir. 1947), which required proof of specific intent in a

contempt proceeding for violation of an injunction issued pursuant

to provisions of the Emergency Price Control Act, on the ground

that specific intent had been held to be an essential element of the

_-eriminal sanctions imposed by that statute and that ‘‘the contempt

'- proceeding partook of the character of the substantive crimes

created by the statute.’’ 206 F. Supp. at 806.

PE AE EIN: Deg mA te tere Be Pee ap oka,

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intent to violate section 5 before a “willful? whehotien may

be found, can be read to imply such a requirement. They

cite in particular United States v. Crosby, 294,F. 2d 928.

(2d Cir. 1961). This was an appeal by a stock brokerage

firm and seven individuals who were found guilty of

fraud and conspiracy on a 50-count indictment, in which

some of the defendants were charged with willfully and

knowingly using. the mails to sell stock admittedly un-

registered. They contended that there was not the ‘‘neces-

- sary knowledge’’ to support the element of willfulness. In |

discussing this question, the court stated that ‘‘there was

no evidence that the brokers knew or should have known

_ they were ‘underwritgs’ in terms of the Securities Act.”’

(Emphasis supplied.) This language implies that the

court was concerned with the sufficiency of the proof of

knowledge, rather than with the nature of the intent re-

quired by the word ‘‘willful.’’

_ The later’case of United States v. Dardi, 330 F, 2d 316

_ (2d Cir. 1964), supports the view that Crosby’ was de-

cided on the basis of insufficient proof of knowledge.

’ Furthermore, the Dardi opinion does not discuss the need -

‘for proof of specific intent, but says that ‘‘the crucial

‘issue as to the broker-dealers’ guilt is whether they knew

that they were selling for a ‘control’ group.’’ Id. at 325.

(Emphasis supplied.) Thus, again, the concern appears

to be with the necessary knowledge and not with an evil

motive or specific intent to violate the law. We think,

therefore, that these cases do not cut against those dis-

cussed above which indicate that ‘iene intent is not —

a requisite element of the offense.

At common law, the fundamental concept of crime em-

braced an element of evil intent, and in the-absence of

| -legislative instructions to the contrary, statutory crimes

were interpreted as requiring a similar element. United

States v. Carll, 105'U.S. 611 (1881). With the advent of

modern economic, industrial, and urban conditions, how-

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ever,. new statutory crimes—‘‘public welfare offenses’’—

‘were created which did not depend en any intent as a

necessary element, although in the case of certain public

' welfare offenses, Congress deemed it desirable to make

some form of intent an element of the offense. Justice —

Jackson’s opinion in Morissette v. United States, 342 US.

246 (1952),. contains a philosophic discussion of the basic

element of mens rea or evil purpose, and an analysis of

the development of a less stringent rule for public wel-

fare offenses. He declined, however,:to undertake

‘‘to delineate a precise line or set forth comprehensive

criteria for distinguishing between crimes that require

- a mental element and crimes that do not. We at-

tempt no closed definition, for the law on the sub-

ject is neither settled not static. =

342 U.S. at 260.

12 A number of regulatory statutes require a ‘‘willful’”’ violation

to sustain a criminal conviction. This ag speaking through

_ Judge Parker, has held that in a prosecution for a violation of the

Elkins Act, 49 U.S.C. §41 (Supp. 1951), where the maximum -

penalty i is two years’ imprisonment or a fine of $20,000, or both,

‘the use in the act of the word ‘wilful’ does not require that

there be an evil intent to commit the offense, but that it is

sufficient if the act was done knowingly.’’

Powell v. United States, 112 F. 2d 764, 767 (4th Cir. 1940). See.

Armour Packing Co. v. United States, 209 U.S..56 (1908), quoted

extensively by Judge Parker in the Powell case. See also United

' States v. Gris, 247 F. 2d 860 (2d Cir. 1957) [violation of proscrip-

tion against wiretapping, Sections 501 and 605 of the Communica-

tions Act of 1934, 47 U.S.C. §§ 501, 605 (1958)]; United States v..

Keegan, 331 FP. 2d 257 (7th Cir. 1964) [Section 302 of the Labor

Management Relations Act, 29 U.S.C. _ (1964)]. In Gris,

. the. court held: that

‘*it matters not whether appellant realized his conduct was

unlawful. He knew exactly.what he was doing; and what he

did was a violation of the Federal Communications Act. He

intended to do what he did, and that is sufficient.’’

247 F. 2d at 864.

FOP Re Poe teemntonee nr a seers

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Nor is it within the scope of this opinion to lay down

a broad rule identifying the laws that make specific evil

intent indispensable to the imposition of criminal sanc-

fions. It is sufficient for the present purpose to speak

more restrictively. The appellants had already. breached

the law and had been enjoined not to do so again; yet

they knowingly repeated the selfsame forbidden acts. It

is not consonant with reason, in these circumstances,: to

demand a more explicit demonstration of an evil mind in

order to sustain the conviction for criminal contempt.

See D: H. Roe v. United States, 316 F. 2d 617, 623 (5th

Cir. 1963), a prosecution for violation of section 5, holding

that the ‘‘best proof’? of.the requisite willfulness ‘‘would

be a prior eonviction [defined by the court to include

_ “other significant judicial actions such as an injunction’’]

of the very same defendant for acts substantially identi-

cal.’’

The facts cannot possibly be fitted into the pattern of

an innocent stumbling into an unintended transgression.

The injunction pointedly brought to the defendants’ at-

tention their past infraction of the Securities Act and /

laid down a specific admonitory prescription to guide -

-their future course. As the District Court noted, ap-

pellants, thus warned, should have been more than nor-

mally careful i in their behavior not to repeat. the offense. _.

There is no occasion to adduce further proof of evil .

intent here for it is immaterial. Even if material, the

factual background supplies the proof. The District Court

found that the evidence demonstrated beyond a reasonable -

‘doubt that appellants had full knowledge’ of the acts con- —

stituting the violations and participated’ in such acts in-

tentionally. The appellants knew that the individuals

purchasing directly from them, as well as those making

their purchases through the ‘‘ Associates, ”’ had no access —

to. the type of information concerning the corporation

that.a registration statement would have disclosed. Al-

though the defendant Custer introduced testimony designed

to show unawareness on his part that the purported sales

LEE NODE LAI LR A ABI OO © “en COLES GPA OS Dew Hal

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to the ‘Associates’? were in fact sales to individuals

. having no contact with the corporation, the. District Court

found this testimony ‘‘totally unworthy of belief.’’ We

agree with the District Judge that the documentary evi-

dence, fortified by additional testimonial evidence, clearly —

permits the finding.” | }

" Defendant Ouster seihedete’* the further contention that

a conviction is barred by his alleged reliance on the ad- —

vice of the corporation’s lawyer, his now deceased brother,

that the sale of Channel Wing stock was not a public:

offering. Elsewhere we have held that reliance on legal

‘counsel may be considered in determining the question of

good faith, but does not always constitute a complete de-

fense. Linden v. United States, 254 F.2d 560, 568. (4th

Cir. 1958).* Good faith is a relevant consideration on

. % The hollowness of the defense may be illustrated by one ex-

ample from many in the voluminous correspondence offered in

evidence, indicating the nature of the arrangement for sales to

the ‘‘ Associates.’’ A letter to Custer from Bruce Wallace, one of

the three ‘‘ Associates,’’ transmitting checks totaling $63,550 for

the. purchase of 154,000 shares of stock, named nineteen persons ,

in whose names certificates should be issued, and designated the

denominations of the certificates. Custer, in replying, returned

some of the checks, referring to them as the checks ‘‘I talked

with you about * * * which cannot be accepted by this Corpora-

tion.’’ Custer went on to instruct Wallace to ‘‘Please handle this

matter of the enclosed check as per our phone conversation, along

with any additional friends who become part of the Bruce Wallace

Associates in one personal check.’’ This evide.«°s Custer’s knowl-

edge of the acts constituting a violation. Tie vistrict Court was

warranted in concluding that appellants realize. that if they sold

directly to individuals, instead of through the ‘‘ Associate,’’ the

violation would become manifest, and that the-‘‘ Associate’’ device

was a bald attempt to evade the injunction.

14‘ Ag a-general rule, reliance on the erroneous advice of com-

petent counsel will not relieve an individual of his responsi-

- bility for acting in accordance with court orders, and will not

enable him to escape conviction and somes for enema

if he disregards the orders.’’

Note, Reliance on Aavies of Counsel, 70 Yale L.J. 978, 992 (1961).

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an issue of specific intent where a pertinent inquiry would

be whether defendant acted with bad motives. Bisno'v. -

United States, 299 F.2d 711, 719 (9th Cir. 1962); Licavoli

_v. United States, 294 F.2d 207 (D.C. Cir. 1961). See

also SEC v. Culpepper, 270 F.2d 241 (2d Cir. 1959).

In any event, the District Court in our case found as

a fact that the defendants did not in good faith rely

upon the advice of counsel, for they sold and issued stock

to persons far in excess of the maximum number cautiously

advised by the lawyer."®

It has been asserted, ‘and we assume, that in this in-

stance the stock sales were undertaken without intent

' to defraud the purchasers, but in a desperate endeavor

’ to save a business from failing for*lack of sufficient cap-

ital. Doubtless this is a proper consideration in assessing

the penalty; it constitutes no defense.

The judgment of the District Court is 7

| < Affirmed —

. 15°*The first prerequisite to successful invocation of the defense

of advice of counsel is that the advisee must follow the advice

of his attorney without variation.’’

Note,-Reliance on Advice of Counsel, 70 Yale L.J. 978, 979 (1961).

. In oral argument, it was pointed out that if despite the-defend-

ants’ past experience as violators of §5 and the consequent in-

junction, they still entertained a good faith doubt as to the appli- -

cation of the registration requirements to their activities, they

could have obtained an advisory optain: letter from the Commis-

sion. They made no onenys to do so.

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Judgment of Circuit Court of Appeals

(Caption omitted) —

JUDGMENT

AppraL From the United States District Court for the

District of Maryland. °

Tus Cause came on to be heard on the record from the

United States District Court for the District of sad atin

and was argued by counsel.

On ConsweRaTiOn WHEREOF, It is now here caaieda and

adjudged by this Court that the judgment of the said Dis-

- trict Court appealed from, in this tause, be, and the same

is is hereby affirmed.

‘/3/ Smon E. Sosotorr

| United States Circuit Judge

Filed April 3, 1967 re,

Maovrice S. Dean, Clerk

APPENDIX B

UNITED STATES DISTRICT COURT

D. MABYLAND

Unsrrep Srares or America, Plaintiff

caine v.- }

Custer CHANNEL Wixa Corporation

and 7

Wuarp R. Custer, Defendants

Mise. A. No. 399

Nov. 12, 1965.

[Filed November 12, 1965]

Miscellaneous Action No. 399

Tomas J. Kuwney, Esa. United States. Attorney, Roser:

W. Kernan, Esq. Assistant United States Attorney, and

Cuarence BE. Beaver, Esq. Attorneys for Plaintiff. Vixoent

s Siehe sien mented cla i iste aia ten it cand ena daaae ced nt Dek EL oe ee aT a ante

16a

L. Grncerica, Esq. and Kerrs L. SEEGMILLER, Ese. ‘Attor-

neys for Defendants. * ae

Winter, District Judge:

By final judgment in Civil No. 13500, entered May 25,

1962, defendants, Custer Channel Wing Corporation (here-

after called ‘‘Channel Wing’’) and Willard R. Custor

(hereafter called ‘‘Custer’’), were permanently restrained

and enjoined from directly or indirectly making use of any —

means or instruments of transportation or communication

in interstate commerce, or of the mails, to offer to sell or

- gell the capital stock-of Channel Wing unless and until a

_ registration statement had been filed with the Securities |

and Exchange Cémmission in regard thereto. Excepted

- from this main command were any securities exempted by

'§$4(1) of the Securities Act of 1933, as amended, 15

U.S.C.A. § 77d(1), from the necessity of registration. Thus,

defendants were enjoined from using the means of inter-

state commerce and from using the mails to sell stock of

_ Channel Wing as part of a public offering, but were not so

prohibited if such sales were part of a private offering.

On April 14, 1965 the United States of America, acting —

at the instance of the United States Attorney for the Dis-

_ trict of Maryland and the:Securities and Exchange Com-

mission, filed an application to institute contempt proceed-

ings against the defendants. On the basis of allegations

showing reasonable cause to believe that the injunction may

have been violated, an order to show: cause was entered.

_ Defendants responded, alleging that they had sold no

securities in violation of the May 25, 1962 injunction, since

all sales had been made for investment only, at private

sale and under circumstances not involving any public

offering. The matter was set down for hearing. “Exten-

sive testimony on behalf of plaintiff and on behalf of -

- defendants has been heard and numerous exhibits. on behalf

_ of both parties were admitted. The case ne been _argued

and submitted for decision.

Since May 25, 1962 to and including February 16, 1965, a

1,579,590" shares of Class B common stock of Channel Wing —

2

x 17a

_ have been issued and sold. Channel Wing realized a sum in

excess of $400, 000 as a result thereof. No registration

statement was in effect during any portion of this period.

Of total sales, 225,567 shares, in the aggregate, were

issued from time to time to ‘‘J. Ben Parent Associates,”’

397,581 shares, in the aggregate, were issued from time to

time to ‘‘Bruce Wallace Associates,’’. and 163,294 shares,

in the aggregate, were issued from time to time to ‘“Ward —

Brooks Associates.’’. The balance of the stock was issued -

and sold to various individuals." The issuance of all of

om - Number of

LE AE AL LIE! INCE EF! SAY EGE LEI LOVEE ES LOIN IES

Date Shares | P Name in Which Issued |

6/ 4/63 _ %7,000 Edward L. and Juanita L. Mortimer

‘ 6/ 4/63 1,000 . Juanita L. Mortimer, custodian for

. Edward L. Mortimer, Jr.

6/.4/63 1,000 Juanita L. Mortimer, custodian for

’ Dona Anne Mortimer

6/ 4/63 1,000 Juanita L. Mortimer, custodian for

eet Denny Lee Mortimer

10/ 8/63 20,000 John M. Hickey

10/ 8/63 21,370 Guy D. Clarke and Lorraine L. Clark

10/ 8/63 © 200,000 Wayman Cornelson A

10/ 8/63 29,720 Earl P:and Mary Grace Zepp

10/ 8/63 . 45,000 Roy Bishop and Phyrne Bishop :

8/10/64 42,000 Harold Sabol and Irene Sabol - ~

6/ 2/64 10,000 Harold Sabol and Irene‘Sabol

6/18/64 . 60,000 - U.I.Smith \.

6/25/64 - 20,000 ° Wayman Cornelson

7/ 7/64 “20,000 Charles A. Myers

7/28/64 . 10,000 Harold Sabol

7/30/64 36,758 ‘Donovan Beachley ~

8/ 6/64 — 38,000 Leroy Bishop and Phyrne‘Bishop

10/ 2/64 32,000 -. Robert L. Chamberlin, Jr.

10/29/64 4,000 Robert L. Chamberlin, Jr:\

10/29/64 = 4,000 Harold Sabol and Irene Sabol

12/28/64 30,000 _ Leo W. Morris”

1/11/65 - . 30,000. Charles.L. Loomis A

1/27/65 30,000 Donald L. Martins and Walter A

Bartel \

2/16/65 30,000 Edward W. Kliewer x

18a

_ these shares was approved in writing by Custer, whose

written authorization was directed to The Corporation

Trust Company, transfer agent for Channel Wing; the

stock was issued with the restrictive legend, ‘‘Resale or

distribution of this stock is restricted. Details available

_at the office of the issuer,’’ and with regard to most (but |

not all) of the stock, an investment letter was signed in

substantially the form set forth in the margin? prior to issu-

ance of the stock. ee

2“T have this day purchased from the Custer Channel Wing

Corporation .......... shares of its Class-B Common Stock at

25¢ per share, and paid $........ *,. in cash therefor. I under-

stand that no registration ‘statement is on file with the Securities

and Exchange Commission with respect to this stock, and that

the Corporation now has no stock with respect to which a registra-

tion statement is on file with said commission. This sale was

initiated by my application.to the Corporation and the Corporation

_ agreed to sell me the stock only upon condition that I become

informed to the extent I desire to do so about the Corporation in all

and every aspect of its activities, including its litigation during |

the past few years, part of which I understand has resulted in an

order of the Federal Court of Maryland, enjoining the Corporation

from certain sales of stock. I am also aware that a Regulation

A’ Filing by the Corporation was stispended by the Securities ~~

' and Exchange Commission in December, 1960.

‘‘The Corporation has allowed me unlimited access to all its

books, records, files, plant and personnel to obtain all information

‘about its affairs which I-desire. I have made such inquiry as I

believe to_he desirable for my purpose, and I have obtained all.

_ information \ regard necessary for my decision to purchase the

Rt ee shares of k that I have this day purchased.

' “In consideration of the sale of said stock to me, I hereby

undertake and agree that I will not sell any of said stock within

‘ thirteen months from this date.

DATED: HAGERSTOWN, MARYLAND

Piialsacsilesactnadinnseeds , 196...

comer eeeer eee eeeeeeeeseeweeeeeeeseses

19a

Further explanation of sales to ‘‘J. Ben Parent Asso-

ciates,’’ ‘*Bruce Wallace Associates,’’ and ‘‘Ward Brooks

Associates’? is required. J. Ben Parent, Bruce Wallace

‘ and Ward Brooks are individuals interested in the ‘finan-

cial success of Channel Wing, and the certification and

marketing of the aircraft embodying the principles set

forth in a patent issued to Custer. J. Ben Parent has

never had any formal association with Channel Wing other

than that of an investor who was interested in its financial

welfare. The same may be said concerning Ward Brooks.

Bruce Wallace initially occupied.a similar position, but on

' March 9, 1964, some months after purchases of Channel

Wing stock had been made in the name of Bruce Wallace

- Associates, he became a director of Channel Wing and

thereafter participated actively as a director in the man-

agement ofits affairs. J. Ben Parent Associates, Bruce’

Wallace Associates and Ward Brooks Associates, respec-

tively, are not corporations, partnerships or associations; —

they are simply names, devised probably at the. instance of

a certain Cecil Custer (now deceased), who was a brother

of Custer and. one of counsel to Custer and Channel Wing.

These names were used as conduits for the sale of stock’

to other individuals, viz;:In the names of J. Ben- Parent

Associates, Bruce Wallace Associates and Ward Brooks

_. Associates bank accounts were opened and maintained’ .

under the direction and control of the individual permitting

the use of his name. J. Ben Parent, Bruce Wallace and

Ward Brooks actively solicited their friends, ‘neighbors

and business acquaintances to purchase ‘Channel Wing: :

stock. Bruce Wallace was aided in his solicitation by Way-

man Cornelson, who also later became a director of Chan- .

nel Wing on March 9, 1964, and Samuel Stoner who had

been a director sirice December 26, 1959. Persons desiring

to purchase original issuance stock of Channel Wing would

subscribe for their stock by indicating the number of shares

they desire to purchase and making a check therefor. pay-

able to the ‘‘ Associate’? through whom they desired to.

purchase (usually at the price of 25 cents-per share). The

Associate would then undertake to subscribe to stock .of

Channel Wing, sign an investment letter therefor, obtain

a group of certificates in the denominations for which in-

dividual subscriptions had been accepted, endorse the cer-

tificate (which bore the restriction on transfer above re-

cited), in blank, and, except in the case of Ward Brooks

Associates, deliver the certificates to thé persons who sub-

scribed for the stock. By-these means J. Ben Parent As-

sociates obtained 29 stock certificates and delivered them °

to the individual purchasers thereof; Bruce Wallace. As-

sociates obtained 89 stock certificates and delivered them -

~ to the purchasers thereof; and Ward Brooks Associates

Obtained 18 stock certificates. but, although they were en-

dorsed in blank, did not deliver them’ to the purchasers —

thereof... J?-Ben Parent resides in Lake Park, Florida;

Bruce Wallace resides in Enid, Oklahoma; and Ward

Brooks resides in Garberville, California. The mails and

instruments of interstate transportation and communica-

tion were freely used in effecting the issuance of stock to

the individuals named in footnote 1, the ‘‘ Associates’’ and —

persons subscribing through the “Associates” as described

above.

_ Based upon the facts stated and further facts to be .

found in connection with various points considered in this

opinion, plaintiff contends that Channel Wing and ‘Custer

have wilfully, in criminal contempt of this Court disobeyed’

and defied the injunction of May 25,.1962. Plaintiff prays

that they be adjudged in criminal contempt of this Court

and punished in: such manner as the Court may deem

proper. The basi¢ questions for determination are whether

the sales of stock under the circumstances outlined are in

violation of the injunction and, if. so whether defendants,

or either of them, wilfully participated in or carried out

activities in connection therewith such that they should be

adjadged in criminal contempt of court.

21a cae

oa:

The first “question | to be considered is whether the in-

junction has been violated, i.e., whether the sale of stock

to which reference has been. made was a public offering

for which §5 of the ‘Securities Act of 1933 required reg-

istration or whether it was a private offering exempt from

registration under §4(1). ‘The proof shows that except

for a Regulation A filing, long since revoked, none of Chan-.

nel Wing’s stock has been registered with the Securities

and Exchange Commission, either before or eacad entry of

the May 25, 1962 injunction.

The legal answer to what is and what is not a private

offering is found in Securities & Exchange Comm’n. v.

Ralston Purina Co., 346 U.S. 119 (1953). In that case the

issuer made treacury stock available for purchase be cer-

tain of its key employees. -Among those subscribing were

employees -with the duties of artist, bake shop foreman,

chow loading foreman, clerical assistant, copywriter, elec-

trician, stock clerk, mill office’ clerk, order credit trainee,

production trainee, stenographer and veterinarian. The

mails and other instrumentalities of interstate commerce

were employed to effect the sales. The issuer argued that

the transaction was a private offering, exempt from reg-

istration, because the offerees were limited to key

employees. :

After pointing out that the, Securities Act nowhere de-

fines the scope of the private offering exemption contained

in §4(1), and that the legislative history of the statute

sheds little light on what was meant, the Court adopted

as the test of what may be a private offering, ‘‘* * * the

need of the offerees for the protections afforded by reg-

istration.’”? Jd. at 127. The Court indicated that where

it appears that an offering is limited to those persons who

are able to fend for themselves, i.e.; have access to the

type of information that would be made: available by a

22a

registration statement, the offering. is exempt, as a private

offering. But except for this limited circumstance, the

offering is public and registration required. In-arriving —

at this result, the Court specifically rejected as the sole

test of what is a public offering the number of persons |

to whom stock was offered, the Court ‘saying, ‘‘* * *

nothing prevents the Commission, in enforcing the statute,

from using some kind of a numerical test in deciding when

to inyestigate particular exemption claims. But there is. .

no warrant for superimposing a quantity limit on private

offerings as a matter of ee interpretation.’’ Id. at

125.

Under the test of Ralston Purina, the sales of Channel -

Wing’s stock were manifestly a public offering. Among

the transferees named in footnote 1, Wayman Cornelson

is the only one who is shown by the evidence to have any

connection with the corporation. Mr. Cornelson became

' - a director on March 9, 1964 and, presumably, on and after

that date he would have had access to the same kind of

information concerning Channel Wing that would have

been available in the form of.a registration statement, but

even as to Mr. Cornelson the majority of the stock which

he purchased, namely, 200,000 shares, was brought four

months prior to the time that he became a director.. Among

those named in footnote 1, Mr. U. I. Smith and Mr. Harold

Sabol both testified in the proceedings. Although they

signed investment letters acknowledging that they had un-

limited access to all of the books, records, files, plant and

personnel of Channel Wing to cbtain all the information

about its affairs which they desired, and that they had

made inquiry and had obtained all information that they

regarded necessary for their decision to purchase shares.

of stock, their testimony was ¢lear that they were not

furnished, nor did they have, anything more than the

- vaguest information about the spaneitd affairs of Channel

—

23a

It is not: necessary, however, to rest the conclusion that

shares of Channel Wing were distributed by public offer-

ing solely upon the sales to the persons named in footnote

1. The sales to J. Ben Parent Associates, Bruce Wallace

Associates and Ward Brooks Associates were also sales

made as a part of a public offering, whether the sales be

treated as limited to the three associates in whose name

stock certificates were issued, or whether they be treated

‘as sales to the individuals who advanced money to the

various associates and who took from them (except from

Ward Brooks Associates) certificates of stock ‘endorsed

in blank, albeit they: bore a legend restricting transfer.

This conclusion follows because if J. Ben Parent Associates,

Bruce Wallace Associates and Ward Brooks Assaciates

are treated as legal entities, the proof does not show that

they had access to the same kind of information that the

Act would -make available in the form of a registration

. certificate. Mr. Parent never became a director of Channel

Wing and has no connection with Channel Wing except

as a stockholder. Ward Brooks never became .a director

of Channel Wing and had no connection with Channel

Wing except as a stockholder. Bruce’ Wallace became a

director on March 9, 1964, but substantial purchases of

stock by Bruce Wallace Associates occurred on October

8, 1963.

~ Moreover, J. Ben ‘Parent. Associates, Bruce Wallace As-

sociates and Ward Brooks Associates are not legal entities ;

they are only names. Hence, the conclusion is inescapable

that the sales purportedly to them were actually sales to

the individuals who subscribed in the name of one of the

Associates, and who furnished the consideration for the

share purportedly issued in the name of the Associate.

Many of these individuals testified at the contempt hear-

ing, and it appears that they had no connection with Chan-

nel Wing such as would give them access to information of

the type which the Act would make available in the form

he,

of a registration statement, and they were neither asked

to sign, nor did they sign, any investment letter? The

mere fact that the -certificates of stock ‘which they held

were issued in the name of the Associate through whom .

they had purchased it with a restrictive legend on trans-

fer does not render them any the less the equitable owner

thereof where they furnished the consideration for the

issuance of that certificate. Channel Wing and its transfer

agent seemed to be of this view, because the Assistant Vice

President of The Corporation Trust Company testified ~

that after May, 1962 transfer of restricted. stock was per- —

‘ mitted in one instance because it was a hardship case, i.e.,

someone badly needed money. | |

-Defendants_stress the comparatively limited number of

persons to whom stock was issued after entry of the in-

junction as a factor having significance to establish that

the offering after May 25, 1962 was a private one. Of

course, defendants treat the three Associates as single

entities in advancing this argument, but the .Court. has.

found that the Associates were mere conduits for a much |

larger number of individuals. Furthermore, the number

of offerees is significant only as it bears upon whether the

character of the group of offerees is private, 1.e., whether

the group was ‘‘* * * the requisite association with and

-knowledge of the issuer which make the exemption “te

able.’”? SEC Securities Act Release No. 4552 (1962). ;

is only one of many elements to be considered in ieiien

the factual determination that a public offering does or

does not exist. SEC Securities Act Release No. 285 (1935) ;

3 A representative group of purchasers through the ‘‘ Associates’’

testified. Their testimony, without exception, was that they were

- not asked to sign, nor did they sign, an investment letter. They

demonstrated a lack of knowledge of the financial affairs of Channel -

Wing, as well as the absence of a tender by defendants, or the

‘* Associates,’’ of such data. To restrict cumulative evidence, the

Court limited the number of such witnesses it would hear at the

behest of the plaintiff. Defendants offered no contrary proof.

20a 5

Loss, Securities Regulation 653-96 (2d ed. 1961). e.g.,

D. F. Berheimer & Co., SEC Securities Exchange Act Re- -

lease No. 7000 (1963) (sale of $175,000 of convertible

debentures to 18 of 22 offerees, most’ of whom were-stock-

holders of the issue, not shown to be entitled to an esemp-

tion as a private offering. ).

‘The argument that the number of offerees, whether ‘eseaie

or small, is determinative on the issue of public or private

; offering was specifically rejected in the Ralston Purina

case.’ Indeed, in that case the dictum of an English judge

to the effect that-a single person may be the public if he is

intended to. be the first of a series of subscribers, but

makes further proceedings needless by himself subscribing

the whole, is quoted with approval. The test adopted to

determine what is public and what is private is whether the

offeree is able to fend for himself and, if not able to fend

for himself so that the offering: becomes public, it makés

no difference whether the offerees are few or many.

Defendants also lay great stress on the investment let-

ter, the form of which is set forth in footnote 2,° Even

if the form of investment letter was signed by each of the

persons named in footnote 1, the investment letter is simply

evidence of what information was given them and what

information they obtained. Two of them, Messers. Smith

and Sabol, were offered little and obtained less. Again,

the form of investment letter was signed in the name of

the three Associates, bat the real purchasing public on

whose behalf the Associates acted were not aware of, nor

were they asked to sign, any investment letter. Even if

each offeree were voluntarily furnished the information

about the issuer which-would have been required | for reg-

istration, the offering might not then be exempt as private

because such a statutory. ‘‘* * * construction would give each

issuer the.choice of registering or making its own voluntary

disclosures without regard to the standards and sanctions

' of the Act,’’ and would make the Act’s effective enforce-

26a 4 |

ment nearly an administrative impossibility. SEC Se-

curities Act Release No. 4552, supra.

In order for an offering to fall within the exemption of —

§4(1) two conditions must be met. First, the offeree

‘must have such information as registration would have

disclosed or have access to such information and, seccondly,

the purchasers must take for investment. Loss, Securities

Regulation, supra, at 665-72. See Merger Mines Corp. v.

Grismer, 137 F.2d 335 (9 Cir. 1943), cert. denied, 320 U.S.

794 (1943) ; S.E.C. y. Mono-Kearsarge, 167 F. S. 248 (D.C.

Utah 1958). .The use of an investment letter, as well as

other devices, to insure that securities are purchased for

investment is discussed in Non-Public Offering Exemption,

SEC Securities Act Release No. 4552, supra. There it is

' pointed out that an important factor to be considered is

whether the securities offered remain in the hands of the

initial informed group or whether the initial purchasers are

_ merely conduits for a wider distribution. The distinction

is important to the seller because if the initial purchasers

acquire securities with a view to public distribution the

sellers assumés the risk of possible violation of §5 and

consequent civil liabilities. The release then states:

‘‘This has led to the practice whereby the issuer se-

cures from the initial purchasers representations that,

they have acquired the securities for investment.

Sometimes a legend to this effect is placed on the stock

certificates and stop-transfer instructions issued to the

transfer agent. However, a statement by the initial

_ purchaser, at the time of his acquisition, that the se-

_ curities are taken for investment and not for distribu-

- tion is necessarily self-serving and not conclusive as

to his actual intent. Mere acceptance at face value

‘of such assurances will not provide a. basis for re-

-liance on the exemption when inquiry would suggest

to a reasonable person that these assurances are formal

rather than real. The real additional precautions of

placing a legend orf the security and issuing /stop-trans-

fer orders have proved in many cases to be an effec-

tive means of preventing illegal distributions. Never-

27a

theless, these are only precautions and are not to be

regarded as a basis for exemption from_registration,

The nature of the purcha®ér’s past investment and

trading practices or thé character and scope of his

business may be inconsistent with the purchase of

large blocks of securities for investment. In particular,

purchases by persons engaged in the business of buy-

ing and selling securities. require careful scrutiny for

the purpose of determining whether. such person may

be acting as an underwriter for the issuer.’? .

It thus appears that a signed investment letter is some

evidence that a security is purchased for purpose of in-

vestment. Even conclusive evidence of a purehase for

purpose of investment, standing alone, however, is not

sufficient to render an offering a private one unless the oe

first condition for a private offering has been met, namely,

that the purchasers have, or have access to, the type of

information that would be disclosed in a registration state-

ment. The record here-is conclusive that the persons

named in footnote 1, the ‘‘Associates’’ as such, and the

persons purchasing through the Associates did not have -

such information or access to such information. Hence,

even if the investment letter with the restriction on stock

transfer is treated as conclusive proof of a purchase for

the purpose: of investment, the legal conclusion is inescap-

able that the transactions involving stock of Channel Wing

since the date of the injunction have been a ‘public offer-

ing in violation of the injunction.

— S

The next aspect of the case to be considered is whether

defendants, or either of them, wilfully participated in’ or

carried out activities in connection with the public offer-

ing such that they should be adjudged in criminal contempt

of court. While counsel for all parties agree that wilful-

ness is an element of the criminal. contempt charged here,

they disagree sharply as to what ‘is meant. The plaintiff

argues that wilfulness is established if it is shown that

the defendants had full knowledge of all of. the _essen-

.

28a

tial elements of the public offering. The defendants argue

that, additionally, there must be proof of evil purpose or

bad ‘motive on their part; in other words, proof of specific

intent to violate the injunction. For reasons which will

presently appear, the Court concludes that. proof of spe-

- cific intent is not required; it is enough if the evidence

demonstrates beyond a reasonable doubt that defendants,

_ or either of them, when performing some overt act, had

knowledge of all. the facts collectively eens criminal

contempt. ‘

_ There is little case law sities direct bearing on the

issue. In essence, the claim that defendants violated the

injunction is a claim that defendants violated §5 of the.

‘Act, 5 U.S.C.A. § 77e(a),* for which they could be pros-

ecuted under § 24 of the Act, 15 U.S.C.A. § 77x." First

*§77e. Prohibitions relating to interstate commerce and the

mails

(a), Unless a registration statement is in effect as to a

security, it shall be unlawful for any person, directly or in-

directly—

(1) to make use of any means or instruments of transpor-

. tation or communication in interstate commerce or of the

mails to sell such security through the use or medium of any

_ prospectus or otherwise; or ~

(2) to carry or cause to be carried through the mails or in |

interstate commerce, by any means or instruments of trans-

‘portation, any such security for the purpose of sale or for

delivery after sale.’’

5 “77x. Penalties

Any person who willfully violates any of the provisions of

this subchapter, or the rules and regulations promulgated by

the Commission under authority thereof, or any person who _

willfully, in a registration statement. filed under this sub-

chapter, es any untrue statement of a material fact or

omits to state any material fact required to be stated therein

- or at to make thé’ statements ‘therein not misleading,

shall upon conviction be fined not more than #5,000 or im- |

prisoned not more than five ‘years, or .both.’’ ‘

29a

to be considered will be the standard. of conduct which

must be shown to have been violated before the penal sanc-

tions of the Act may be applied. ace

_ Morissette v. United States, 342 U.S. 246 (1952), al-

though arising on facts quite dissimilar to thease of the

case at bar, is the modern bible of ‘the Sircumstances in -

which proof of criminal or specific intent is an essential

element in a successful prosecution. To’ generalize, the

- thesis of the case is that the necessity of proof of specific

intent_is ‘‘* * * as universal and. persistent in mature

systems of law as belief in freedom of the human will and ,

a consequent ability and duty of the normal. individual to

choose between good and evil.’’. Id. at 250. However, a

more recent development of the criminal law a

to call into existence new duties and crimes which dis-.

regard any ingredient of intent.’’ Jd. at 253. Examples

of the latter and the needs of society which require recogni-

tion of nonintentional criminal conduct are deseribed as

follows:

“‘The industrial revolution multiplied the number of

workmen exposed to injury from increasingly powerful

and complex mechanism, driven by freshly discovered

sources of energy, requiring higher precautions by em-

ployers. Traffic of velocities, volumes and varieties

unheard of, came to subject the wayfarer to intolerable

casualty risks if owners and drivers were not to ob-

Serve new cares and uniformities of conduct. Con-

gestion of cities and crowding of quarters called. for

health and welfare regulations undreamed of in sim-

pler times. Wide -distribution of goods became an

instrument of wide distribution of harm when those

who dispersed food, drink, drugs, ‘and even securities,

did not comply with reasonable standards of quality,

. integrity, disclosure and care. Such dangers have en-

gendered increasingly ‘numerous afd detailed regula-

tions which heighten the duties of those in control of

particular industries, trades, properties or activities

that affect public health, safety or welfare.’? Jd. at

253-54 (emphasis supplied) - :

as 80a

_ Aa to the latter statutes imposing criminal sanctions for

‘public welfare offenses,’ the Court added :: “9

\ ‘* * ® whatever the intent of the violater, the injury

. ig the same, and the consequences are injurious or not

\ according to fortuity. Hence, legislation applicable

\to such offenses, as a matter of policy, does not specify

intent as a necessary element. The accused, if he does”

not will the violation, usually. is in a position to prevent

it\ with no more care than society might reasonable

expect and no more exertion than it might reasonably

> exact from one who assumes his responsibilities. Also,

" penalties commonly are relatively small, and convic- .

tion does no grave damage to an offender’s reputa- -

tion. Under such considerations, courts have turned

to construing statutes and regulations which make no

mention of intent as dispensing with it and holding

9 the guilty act alone makes out the crime.’’ Id. at

‘

The Court nevertheless recognized that even in the |

area of ‘“public welfare offenses’? Congress may see fit ’

to make intent a decisive element of criminal conduct. In

this connection; it is significant that the Court, in footnote’

23 on page 264 of its opinion, referred to at least three

statutes in which use of the word ‘‘willfully’’ was con-

sidered to have this effect. Section 24 of the Securities Act

of 1933, 18 U.S.C.A. § 77x, under which a prosecution: of

the defendants for their alleged wrongful conduct in the

case at bar would proceed, employs the word ‘‘willfully.’’ *

Aside from the use of the word ‘‘willfully”’ in § 24 of

the Act, there is ample support ‘in the cases for treating

the Securities Act of 1933 as legislation having broad re-

medial purposes and thus in its criminal sanctions to create:

a class of ‘public welfare offenses.”” Securities & Exch.

-

—

© See text note 5, supra.

3la

Com. v. Joiner Leasing Corp., 320 U.S. 344 (1943).7 See

also, Securities é. Exchange Commission v. Ralston Purina

Co., supra, Wilko v. Swan, 346 US. 427 (1953) ; Berko v.

Seourities and .Exchange Comm’n., 316 F.2d 137 (2 Cir. —

1963) ; Creswell-Keith, Inc. v. Willingham, 264 F.2d 76 (8

~ Cir. 1959) ; Otis é Co. v. Securities and Exchange Comm’n.,”

(106 F.2d 579 (6 Cir. 1939). There is also support in the

congressional history of the Securities Act for the conelu-

- sion that Congress intended the Act to be remedial and

intended to, protect an unsuspecting public from ‘the ir-

responsibility which had been demonstrated in the distribu-

. tion of securities prior to the Act’s passage in 1933. :

Rep. No. 85, 73d Cong., Ist Sess. 1-5 (1933); S. BOP. No.

47, 73d Cong., 1st Sess. 1-2 (1933).

United States v. Sussman, 37 F. S. 294 (ED. Pa. 1941),

is apparently the only case which has passed specifically on .

the issue of what proof of intent is needed to sustain a -

criminal prosecution for violation of:§5 of the Act. In —

ie oe that case, in ruling on a motion for a new trial, the trial

Fa judge remarked, ‘‘I did not then and do not now conceive

an element of the crime * * * to-be actual knowledge that a

security was being, sold in violation of the law.’’ Id. at 296.

It should be noted that there was no discussion of the

statement, no citation of authority was referred to in sup- |

port of it and, moreover, the statement ‘was made in a

criminal prosecution: under the Act as possibly distin-

o. guishable from proceedings for a determination of criminal

‘ contempt of court.

* A decision of the Fighth Circuit, ie v. "United

States, 332 F.2d 978 (8 Cir. 1964), lends support to the

conclusion that a successful. prosecution for failure to com-

7 Since Mr: J ustice Jackson was the author of the opinion of

, . the Court in this case, it would appear that he had this case in

mind when, subsequently .writing for the Court in, Morssette: v..

f ‘United States, supra, he employed the italicized phrase ‘‘and even -

securities” cited in the text. ;

"320

ply with §5 of the Act does not require proof of specific

intent. In this case, which arose as a motion filed under 28

U.S.C.A. § 2255, a defendant who had been convicted first

of violating §5 of the Act, 15 U.S.C.A. §77e (a)(2), and

later of violating $17, 15 U:®.C.A. §77q(a) (fraudulent

- interstate transactions) as a result of his activities in the

‘game. transaction, claimed that he had been subjected to

double jeopardy. Assuming for the purpose of the deci-

sion that the question of double jeopardy could be reached

‘on such a motion, the Court concluded that defendant was ~

not twice placed in jeopardy. The Court stated that. it was

- bound to apply the ‘‘same evidence’’ test and, in applica-

tion of that test, made the following statement:

“As spelled out in United States v. Attaway, 211.F.

‘Supp. 682, 684 (W.D. La. 1962), the essential facts

constituting a crime under § 77e(a) (2) are that ‘(1) a

‘security’ was carried through the mails or in inter-

state commerce,-(2) for the purpose of a sale or deliv-

ery after a sale, and (3) that no registration statement

was in effect as to such security at the time thereof

* * * (emphasis supplied.) Whereas, the sine qua

_ non of the crime under § 77q(a) is not the interstate

. transportation of an ‘unregistered security, but_ the.

perpetration of a,fraudulent scheme upon a‘duped in-

vestor, federal jurisdiction of which is acquired from

the incidental utilization of the channels of interstate

commerce to transport the. misrepresented securities.

- United States v. Cashin, 281 F.2d 669 (2nd Cir., 1960) ;

United States v. Attaway, supra; United States v.

-Greenberg, 30 F.R.D. 164 (S.D.N.Y. 1962). Therefore,

under the first indictment, the Government must prove

only that the defendant caused fo be carried in the

_ mails a security unregistered with. the Securities and °

_. Exchange Commission to sustain a conviction within

the meaning of § 77e(a) (2); while proof of a violation

of § 77q(a), as charged in the second indictment, de-

mands the quite different evidence that the defendant

with intent committed a fraud upon the purchaser of a

security by means of an untrue or omitted statement

of a material fact or engaged in a course of business

designed to deceive the purchaser.’’ Id. at 980-81.

(33a -

The significance of this statement is that intent was not

mentioned as an element of the crime under § 77e(a) (2),

but was an essential element of the crime under § 77q(a).

These cases, however, should be compared with three ap-'

pellate decisions of the Second Circuit, which touch upon

the concept of wilfulness in prosecutions under the Securi-_.

ties Act. of 1933. The first, United States v. Crosby, 294

F.2d 928 (2-Cir. 1961), arose under complicated and per-

haps unique facts. A: brokerage firm and its three stock-

holders were convicted of violating § 5 of the, Act, but on

appeal their convictions were reversed. Proof showed that

the issuer of the securities had given 2,000,000 shares for

prospecting permits. Many of these shares were returned to

the brokerage firm and sold through it. The defendants

knew that the stock was not registered, but they had opin-

ion letters from counsel that registration was not required.

. By construction of § 4(1) of the Act, the Court concluded

‘that the close question of whether registration was required _

should be decided adversely to the defendants, but the Court

also concluded that, because of lack of clarity in the regula-

tory scheme, the defendants did not know, nor should they

have known, that registration was. required. While this

conclusion’ was contrary to the opinion of counsel under

which the defendants acted, the Court concluded that coun-

sel’s opinion was not so patently erroneous as to permit the

jury to speculate on the defendants’ good faith.

In the course of its-opinion on the aspect of the case with

which we are concerned (294 F.2d at 938-43), the. Court

employed a number of phrases from which it could be

argued that its concept of wilfulness required proof beyond /

a reasonable doubt of evil purpose on the part of the de-

fendants, i.e., a specific intent to violate the Act, but a care-

ful reading of the opinion leads this Court to the conclusion

that the-case is not direct.authority for that rule. In the

. first place, in the portion of the opinion relevant here, the

. Court was discussing simultaneously a conspiracy count,

————————eaeaeeEeEeEeEeEeEeEeEeEeEeeeEeEeEeEeEeEeEeEeEeEeEeEeEeEewEweerrrrrr

TT” merrrrrerereeeor

as well as several substantive counts on which the defend-

ants were indicted, so that reference to guilty knowledge

and criminal intent may relate only to the conspiracy count,

in which guilty knowledge is‘an element of the crime.

_ More importantly, an analysis of the Court’s opinion in-

dicates that its holding was that the government had failed

to prove beyond a reasonable doubt knowledge on the part

of the defendants of a fact essential to constitute the com-

mission of the substantive offense on their part. In the

case the brokers were claiming an exemption from § 5 on -

- the theory that under § 4(1) they were not underwriters.

On an aspect of this contention, the Court.found:

‘‘It is key here that the government nowhere showed

that the brokers [defendants] knew the details of the

alleged transfer from Gully to Castagna—or that they

knew the latter’s relation to and probable domination

by McCarthy. Thus there was no evidence that the

brokers knew. or should have known that they were

—— in terms of the Securities Act.’’ - Id. at,

42, |

It was in the context of this finding, then, that the Court,

earlier in its opinion, expressed its holding: —

‘‘The proof is clear that no Texas-Adams stock -was

ever registered—and that defendants knew that the .

particular certificates involved in Counts 46-8 were not’

registered. There were, however, opinion letters claim-

ing the shares to be exempt from registration. Two

basic elements thus remain: Were the shares exempt?

‘If not, does the record adequately prove the necessary |

knowledge on the part of these defendants to support

the element of wilfulness? We hold that, while the

shares have heen registered, there was insufficient proof .

from which the jury legitimately could have inferred

wilfulness and criminal intent.’’ ‘Id. at 938-39.

It is not clear from the Crosby opinion whether the Court

would require specific intent to violate the statute and was

holding that such specific intent is impossible without knowl-

° 35a

edge of. the factors which constitute the violation, or

whether it would conclude that only intent to do the act

knowing of the factors which constitute the violation, was

required. This Court thus understands United States v.

Crosby, supra, not to decide. the threshold question consid-

ered in this case, although it did decide at least that knowl- -

edge of the factors constituting the violation was required

before a wilful violation can be found. .

United States v. Robertson, 298 F.2d 739 (2 Cir. . )

dealers knew that they were selling for a “‘control’’ case a

conviction on two counts of using the mails or instruments

of transportation or communication in interstate commerce «|

to sell unregistered certificates was also reversed. The

Court, citing United States v. Crosby, supra, stated that

the parties did not appear seriously to contest the claimed

insufficiency of the charge to the jury on these counts as to

wilfulness judged by the test established in the Crosby case,

but the opinion fails to disclose what was the charge and,

hence, it cannot be determined by this Court that the ques-

_ tion facing it was there decided.

United States v. Crosby, supra, has also been cited in

United States v. Dardi, 330 F.2d 316 (2 Cir. 1964). Again,

broker-dealers were convicted of unlawful sales of unregis-

tered stock. They did not dispute that they sold the ‘stock,

_, or that it was not registered, but they claimed they were

_ . ignorant that registration was required. The key to this

question was found by the. Court to: rest in the crucial issue

as to whether the broker-dealers knew that they were sell-

ing for a ‘‘control’”’ group. Overall, the Court concluded

that there was sufficient evidence from which the jury could

conclude beyond a reasonable doubt that the broker-dealers

knew that they were acting for a control group and, hence,

the judgments entered on their convictions were affirmed.

In arriving at. this result, the Court stated, ‘‘in United

States v. Crosby, supra, this Court found that there was

_ insufficient evidence that'the broker-dealers ‘knew or should

have known that they were ‘‘underwriters”’ in the terms of

.

36a

the Securities Act.’ The evidentiary problem here is

whether the link missing in Crosby has been supplied.’

Id. at 325-26. An analysis of the evidence led the Court to

conclude’that each of the three broker-dealers could prob-

ably have been found by the jury to know that the. sellers

were.*‘control’’? persons, so that the broker-dealers were

‘‘underwriters” and registration was required.

United States v. Dardt, supra, thus reinforces this Court’s

initial reaction that Crosby was.decided on the basis of in-

sufficient proof of knowledge. More importantly, Dardt

takes the next step and seems to indicate that specific intent

need not be proved beyond a reasonable doubt to sustain a

successful prosecution.

This conclusion that United States —

vy. Dardi has this effect stems from the Court’s limiting its

consideration ‘to the question of knowledge on the part of

the broker-dealers of the fact that registration was required ,

and not considering or

discussing the need for proof of

specific intent.® Consequently, it appears to this Court that

- what Dardt requires, and all -that Dardi requires, to con-

stitute a wilful violation of § 5 of the Securities Act is in-

tentional activity in violation of § 5 with knowledge of all

the factors constituting

the violation, but not proof of evil

purpose. The Court adopts this rule as the proper one in

a prosecution for violation of § 5 of the Act. *

This conclusion is in harmony with the cases previously

cited and discussed. Under this conclusion, actual knowl-

edge that the sale is in

violation of the law, the standard -

rejected in United States v. Sussman, supra, is not required.

8 Dardi could ‘be read as saying that the issue of whether the

brokers knew they were selling for a ‘‘eontrol’’ group was crucial

because once that fact was established, the brokers, who were in =

-. the business of handling securities, would have actually known, or

would have been bound to know; that. they were acting in violation

of the statute and thus specific intent to violate the Act would be

-. implied. This is an unlikely reading, however, because in affirming

- the convictions the Second Cireuit did not say that it was implying

"intent.

37a

- All that is required is knowledge of all the facts which con-

stitute the violation. This conclusion does no violence to

_ Kistner v. United States, supra; because that case did not

even reach the question of whether knowledge of facts which

would make a registration statement required was a pre-

requisite to establishing a criminal violation of § 5. As

previously noted, United States v. Crosby, supra, and

United States v. Robertson, supra, do not foreclose the

question at issue in this case.

The conclusion reached promotes the remedial purposes

of § 5 of the Act. It should be noted that, under § 12 of the

Act, 15 U.S.C.A. § 77(L), civil penalties may attach to a

person who violates § 5, regardless of his intent or knowl- -

edge. Such a statutory scheme is in keeping with the re-

medial purpose of the Act, which is broadly designed to

protect the public. A requirement of something less than -

‘specific intent or evil purpose to show a criminal violation

of the Act is also in harmony with the Act’s remedial pur-

pose. At the same time, the conclusion gives meaning to

the language in § 24, which requires a wilful violation be-

fore penal sanctions may be imposed, A requirement of

intent oni the part of the accused deliberately ‘to do an act

constituting part of the intent with knowledge of all of the

other factors constituting the violation distinguishes § 24

from some of the public welfare offenses discussed in Moris-

sette v. United States, supra, where the mere act may con-

stitute a crime regardless of intent, if it.is prohibited by |

statute and Congress has not included any language such

as “wilful”? -in the penal provisions. e.g. 21 U.S.C.A.:

§ 333(a) (Food, Drug. & Cosmetic Act).

oO = enue

The authorities discussed to this point are all cases in

which there was a direct prosecution for violation of the

Act. The case at bar, however, is a prosecution fora vio- -

lation of the injunction, and so there must be considered »

the correlation, if any, between the need for proof of spe-

38a

a) ar

cific intent, if any, to shgw a substantive violation of the

Act to the need for proof of specific intent, if any, to show

a criminal contempt in violation of an injunction. Here

- again, as with the need to prove specific intent to prosecute

successfully under the Act, the decided cases are not con-

clusive. . “ be

In the unreported case of United States v. Wilson-Wil-

liams,-Inc., No. 149-6 (S.D.N.Y. 1961), it was said, by way -

of dictum, that proof of specific intent was not an essential

element of the proof upon a charge of criminal contempt

- for the violation of-an injunction against misbranding un-

- der the Food, Drug & Cosmetic Act because that Act does

not require such proof in a dirdct prosecution, and it would

be an anomaly to require proof of specific intent in the con-

tempt situation when no such requirement was necessary to

prove a criminal violation. Cire 5

. United States v. Schlicksup Drug Co., 206 F.S. 801 (S.D.

Ill. 1962), achieved a similar result but on slightly differ-

ent reasoning. There again, the issue-was whether defend-

ant was guilty of criminal contempt in violating an injunc-.

tion against adulteration of articles of drugs proscribed by

the Act. The Court found that defendant had specific in-

tent to violate the injunction, but nevertheless discussed in

some detail the necessity of proof of that element. The

Court pointed out that in United States v. Dotterweich, 320

U.S. 277 (1943), it had been held that proof of specific in-

tent under that Act was unnecessary to sustain a prosecu-

tion, and that, also under that Act, injunctive relief was

available for the purpose of enforcement, as well as crim-

inal sanctions. If injunctive relief were sought, proof of

specific intent was not required. The Court stressed the

substantial interrelationship between the criminal remedial

provisions of the Act and a contempt proceeding arising

from the violation of a remedial order based upon the Act.

Thus, Chief Judge Mercer concluded, at 805: |

‘¢It would be anomalous, indeed, therefore, to require |

proof of specific intent in continued violations of the

ie rani et

39a

Act, and in violation of an injunction, before the court

which issued the injunction could enforce it by a con-

_ tempt proceeding. Such a result would not only defeat

the purposes of the Act, but it might also sterilize the

court’s power to compel obedience to its orders.”?

Possibly United States ex rel. Porter vy. Kroger Grocery

¢& Baking Co., 163 F.2d 168 (7 Cir. 1947), is a contrary au-

thority. That case was a criminal contempt proceeding for

violation of an injunction issued under the Emergency

Price Control Act. In clear and unmistakable language,

specific intent was an essential element of criminal sanc-

tions imposed by -the Act, and the government’s petition

for a citation for contempt charged knowing, flagrant arid’

wilful disobedience of the injunction. Proof of specific in-

tent was held to be an essential element to sustain a convic-

tion of criminal contempt. The case does recognize, how-

ever, as was pointed out in United States v. Ford, 9 F.2d

990 (D. Mont. 1925), and Morissette v. United States, supra,

that even when specific intent is, required, specific intent

may be inferred from forgetfulness, neglect or failure of or

indifference to duty or consequences, -

The power to punish for violation of an injunction en-

joining transgression of § 5 of the Act should ‘not be less °

than the power to enforce § 5 of the Act by criminal sanc-

tions. Both have'the same ultimate objective—protection

of the investing public—so that a greater quantum of proof

or additional elements of proof should not be required in

_ one proceeding as contrasted to the other. The fact that if |

criminal contempt is found the Court has a relatively un-—

limited power to punish (18 U.S.C.A. § 401), or that de-

fendants may not be entitled to a jury trial where as here

the original injunction was obtained by the United States

(18 U.S.C.A. § 3691),\do not require a different conclusion.

These considerations are outweighed by other factors. An

injunction like’ the original injunction here is granted only

because there is a showing, inter alia, of more than a re-

mote possibility of future harm. The person enjoined is

40a

put on notice that his past acts have violated the law, and, .

that there is a substantial likelihood of future violation.

No concept of basic fairness is violated by requiring a per-

son in this position to be more than normally careful in his

future conduct. Moreover, the Court’s power to do justice

by granting injunctive relief would be seriously embar-_

rassed, if not destroyed, by a requirement of greater proof

to show a violation of the injunction than to shqw a viola-

tion of the statute incorporated into its order. —

Indeed, reason would support the application of a rule

' which permits a lesser showing to‘prove criminal contempt

than to show a criminal violation of the Act in the first.

instance. Like the Pure Food, Drug & Cosmetic Act, the

Securities Act of 1933 authorizes entry of the injunction

. which defendants are charged with violating, without regard

to the factor of intent.? Sueh an order, when entered, must —

. be respected.. When, as here, the acts constituting an in-

fringement of the injunction, if considered alone, would sup-

port the entry of an injunction, the necessity of creating

.

respect for its own order may well lead to the conclusion

that a court should not require as much proof to show

criminal contempt as to show a basis for original injunctive

relief.. Ordinarily;\the creation of a remedy to redress

private wrongs pt from a violation of an injunction

is the object of a proceeding for civil contempt. Under

the facts here neither defendant is in a financial position

®§77t. Injunctions and prosecution of offenses

; , e* -@ oe!

(b) Whenever it shall appear to the Commission that any

person is engaged or about to engage in any acts or practices

_ which constitute or will constitute a violation of the provisions

of this subchapter, or of any rule or regulation prescribed

under authority thereof, it may in its discretion, bring an

action in any district court of the United States or United

States court of any Territory, to enjoin such acts or practices,

and upon a proper showing a permanent or temporary injunc-

tion or restraining order shall be granted without bond.”’

Nae

isan capac

\we

ee ee eh ee ‘ —_

: r

4la |

to restore the purchasers of 1,579,590 shares of stock to

their former status. Remedial action, if any, can be .ob-

tained solely from the deterrent effect of criminal sanctions.

This is a second factor which would point to the correctness

' . of not requiring as much proof to show criminal contempt

as is required to show a substantive violation.

In any event, the Court does not: deem it necessary to

decide whether criminal contempt may be shown by proof

‘which fails to show a criminal violation of § 5 of: the Act,

because an analysis of the proof which will follow leads.

the Court to conclude that defendants. actually or vicari-

ously had knowledge of each of the acts constituting a con-

tempt and-participated in fhem wilfully in the sense that

they did so intentionally and not inadvertently or acciden-.

tally. Thus, the Court concludes that the proof would be

. Sufficient to sustain a prosecuti@n for violation of §5 of

the Act, irrespective of whethergan injunction against such

violation had been previously entered.

Iv.

In support of this conclusion, the Court now turns to the

proof to show, the extent of defendants’ knowledge and par-

ticipation in the public sale of 1,579,590 shares of Channel

. , \ ’

Defendants in their response to the petition to an order

Wing’s Class B common stock. ;

| adjudging them in criminal contempt admit knowledge of

entry of the May 25, 1962 injunction and that thereafter

Channel Wing’s common stock was not registered with the

Securities and Exchange Commission. The extent of de-

fendants’ other knowledge must be considered in three sepa-

rate steps. Defendants pitch their whole defense on lack

of knowledge that sales to the ‘‘Associates’’ were in fact

sales to persons who subscribed to Channel Wing stock

through an Associate. But the extent of defendants’ alleged

contempt is not so limited by the facts.. The Court has

already concluded that there was a public offering of Chan-

2

| 42a

nel Wing’s stock subsequent to the injunction in at least |

three separate respects, viz., (1) sales to the persons named

in footnote 1, (2). sales to the ‘‘ Associates,’’ and (3) sales

to persons for whom the ‘‘ Associates’’ were conduits. De-

fendants’ knowledge and participation in, each of these

_ groups of transactions must be separately considered.

Defendant Custer, as President of Channel Wing, au-

' thorized and “directed The Corporation Trust Company to

issue the shares of stock sold to the persons named in foot-

note 1. Thus ~he; individually and acting on behalf of

* Channel Wing, was bound to know that the shares had been

sold and were being issued.- Indeed, in connection with

direction and authorization to issue the shares, he certified

the consideration therefor, a fact significant to the transfer

‘agent since it was thus able to determine what stock transfer

taxes were payable. Subsequently, in each instance, the —

certificates issued by The Corporation Trust Company were

sent to defendant Custer in his capacity as President df

Channel Wing. It may be inferred that delivery was then,

made to the alternate purchasers. Defendant Custer and

Channel Wing knew, or had knowledge of facts from which

‘they are presumed to have known, at the fime of each

transaction that the person to whom the shares were issued

and sold was not a person who had actual intimate knowl-

edge of the affairs of Channel Wing or a person who had ©

access to the information that a ‘registration statement

would disclose. These persons were manifestly not so

closely associated with Channel Wing that they either had

- intimate knowledge of the corporation’s affairs or could

command access to information which could give them such

knowledge. As a.matter of fact, they were not even fur-

nished such information voluntarily. :

The same is true with respect to sales to the Associates,

except that Bruce Wallace became a director on March 9,

1964, and thereafter may be presumed to have had access

to the requisite knowledge of the corporation. As has been

4 : aj - |

Vv

>

, : a

etslaltiemienaiatiaatae eee

~ attempt to refresh their recollection are not to be tre

previously mentioned, however, substantial sales to Bruce .

Wallace Associates were made on or about October 8, 1963.

There remains to be considered the extent to which, if at

all, both. defendants had knowledge ‘that the Associates

were in fact conduits for a substantial number of fndi

closed purchasers who subscribed through the Associates,’

Defendant Custer in his testimony denied flatly that he

knew ‘that: standing behind the Associates were 4 large

number of people from whom originated the cash considera-

tion for the sales of stock to the Associates. In this respect

his testimony was. corroborated by the testimony of

Wayman Cornelson, who assisted in the solicitation of sub-

scriptions for B ‘Wallace Associates and Bruce E.

Wallace. Ward Brooks and J. Ben Parent offered. some

corroboration also. - But the record shows that each of the |

four named witnesses had testified under oath in an admin- .

istrative proceeding before a Securities and Exchange

Commission examiner to the effect that there had been free

and frank discussion between them and defendant Custer

about the operation of the ‘Associate’ with which each

was connected. (Each conveniently forgot, or unconvine-

ingly explained &way, such testimony when he appeared

before this Court. Méssrs. Brooks ‘and Parent were less

successful in exhibiting convenient memories, and more dis-

posed to be truthful witnesses than Messrs. Cornelson and

Wallace, because Mr. Brooks did acknowledge some of his

testimony in the administrative proceedings to be true, and

Parent Associates. with defendant Custer. !

In making this observation ‘about the credibility of these

four witnesses, the Court is aware that the portions of their

testimony before the S.E.C. examiner which it permitted to

be read to them at the instance of the government in an |

.

3

e

-

as affirmative evidence.” To the extent that the readings

of the prior transcripts adversely affect the credibility of

these witnesses, the fact remains that the witnesses were

called as government’s witnesses to assist the government

' in meeting its burden of proof beyond a reasonable doubt,

and impeachment has the effect only of discrediting them

but does not convert.their testimony into affirmative proof. ~

However, as alibi witnesses for defendants, they are totally

unworthy of belief.

Notwithstanding Mr. Custer’s denials, and notelihstand-

_ ing the denials of ‘his four close Associates, other evidence

establishes beyond a reasonable doubt that defendant

Custer, and through him Channel Wing, knew that pur-

ported sales to the Associates were in fact sales to an undis-

closed number of individuals having no connection with .

Channel Wing, other than as investors. A large part of

this evidence is documentary; some consists of testimony.

‘By way of general background, it should: be stated that —

Channel Wing was attempting to’manufacture an aeroplane

embodying certain concepts. of aerodynamics. developed by »

defendant Custer and for which a patent had. been issued.

“The accomplishment. of the objective required substantial -

vamounts of cash and substantial investment, and, to state

the matter succinctly, Channel Wing was in desperate

‘financial straits, particularly after the injunction entered

- 10"The government did not’ attempt either to authenticate and

offer the transcripts of administrative proceedings, or to press

upon the Court the evidentiary rule adopted in. the Second Circuit. -

See United States v. DeSisto, 329 F. 2d 929 (2 Cir. 1964) ; United

States v. Corsi, 65 F. 2d 564 (2 Cir. 1933), overruled in Bridges v.

Wizon, 326 U.S. 135 (1945) ; DiCarlo v. United States, 6 F. 2d 364

(2 Cir. 1925) ; McCormick, Evidence § 39 (1954) ; 3 Wigmore, Evi-

dence § 1018 (3d ed. 1940). Contra, United States v. Rainwater, —

+ 283 F. 2d 386 (8 Cir. 1960) ; Ellis v. United States, 138 F. 2d 612

(8, Cir. 1943); McCracken v. Richmond, Fredericksburg and

Potomac R. Co., 240 F. 2d 484 (4 Cir. 1957) ; Sykes v. O’Hearne,

181 F. Supp. 368 (D. Md. 1960). “oy

D,

May 25, 1962. Channel Wing’s need for cash to complete —

engineering studies and to obtain a certification of its air-

craft by federal aviation authorities was the subject $f con-'

tinuous discussion: after May 25, 1962. In August, 1962,

defendant Custer discussed the money needs of Channel

Wing with J. Ben Parent. Tentative agreement to sell

100,000 shares in the aggregate of Channel Wing stock to

residents of Palm Beach, Florida was made. The shares

"were to’ be sold in blocks of 20,000 at a consideration of

$5,000.00 per block. This plan, however, was not successful .

because: purchasers for stock in this fips were ~ to be

found.

Thereadter, the device of J. Ben Parent pee nem was

hit upon. Probably the concept originated with Cecil. .

Custer (now deceased), a brother of defendant Custer, and

one of counsel for Channel Wing. Once the device had been

conceived and put into operation, the proof shows that

defendant Custer knew precisely what was’ going on. }

First and foremost, among the evidence indicating know]l-

edge on the part of defendant Custer, and through him on

the part of Channel Wing,.ig the great bulk of correspond-

ence indicating the mechanics by which the stock was issued.

Xn regard to all sales of stock, including ‘sales to J.. Ben

Parent Associates, defendant Custer, as President of Chan-

nel Wing, having an office in Hagerstown, Maryland, would

write to The Corporation Trust Company, in Jersey City,

New Jersey, authorizing and directing the latter to issue

shares as indicated in the letter. In each instance of a sale

' to J. Ben Parent Associates, or either of the other two

Associates when they were established, defendant Custer

would designate the number of certificates and denomina-

tions thereof to be prepared. Defendant Custer would also

certify the sales price for the stock. Typical of such trans-

actions is the first such letter, dated October 16, 1962, in

. which defendant Custer directs the issuance of 34,000-shares |

_ to J. Ben Parent Associates, and specifies ‘‘8 certificates of

46a ; |

4,000 esich—one ‘certificate of 2,000 shares.” Additionally,

by letter of January 21, 1963 defendant Custer directed the

issuance of: 16,000 shares to J. Ben Parent Associates,

' eonsisting of ‘16 certificates of 1,000 shares each';?? by ©

~ Jetter dated September 27, 1963 defendant Custer directed

the issuance inter alia, of 84,900 shares to J, Ben Parent

Associates, consisting of ‘‘34 certificates of 2,000 each—16

certificates of 1,000 each—9 certificates of 100 each,” 38,000.

shares to Ward Brooks Associates, consisting of ‘‘4 certifi-

- esites of 1,000 each—one certificate of 4,000 each, 3 certifi-

cates of 10,000 each,’’ and 123,600 shares to Bruce, Wallace .

Associates, consisting of 2 certificates of 20,000 shares, one

certificate of 8,000 shares, 6 certificates of 5,000 shares, one

certificate of 4,100 shares, 4 certificates of 4,000 shares, one

certificate of 3,000 shares, 3° certificates of 2,000 shares, 2

" certificates of 1,500 shares, one certificate of 1,200 shares,

9 certificates of 1,000 shares, one certificate of 600 shares,

one certificate of 500 shares, four certificates of 400 shares,

two certificates of 200'shares, and 2 certificates of 100

shares. Twenty-two letters of similar vein were written, ~

‘the details of which will not be recited. gy

“This proof, standing alone, would seem inescapably

to indicate that defendant Custer knew that the ‘‘Associ- ~

ates’? were not ultimate purchasers of Channel Wing

stock, but were conduits for distribution to others. But

the record shows even more specific proof in this regard,

namely, the letters to defendant Ouster ‘and Channel Wing |

concerning the issuancé of stock. :

_ In connection with his operation of J. Ben Parent As- |

gociates, which was the first of the ‘‘ Associates’ to be-

~ gin the distribution of stock, Mr. Parent wrote defendant

- Quster under date of October 18, 1963, sending a check ©

for the issuance of 1,000 shares of stock. He stated that ©

he had had nine certificates in denominations of 100 shares

‘but it was not enough,’’ and he requested defendant

Custer to send ten 100 share certificates.- Significantly -

Pek RENTED IT. AIRES ILE RA PRI LEESON AE A TRC

~

Ta

he added, ay ‘had sane more. that ‘auaied stock, but

they can buy; it through the brokers at a lower price. -.

Three days before, Mr. Parent had transmitted a check

and ordered 8,000 shares of stock. After directing that. .

it be made out the.same way as ‘‘the other Stock that I

have purchased,’’ he added ‘‘there may be additional pur- °

chases, if there is still some of this Stock for sale.’’: In .

a similar letter under date of June 26, 1963, Mr. Parent

-made the comment, ‘‘I expect several more Checks to

come in very soon. I will forward them as ‘they come

in.’’ In another.similar letter dated September 24, 1963,

in which Mr. Parent directed that 12,800 shares of stock

for which the consideration was enclosed be issued in 16

certificates of varying denominations, Mr.- Parent com-

mented ‘‘I am expecting-more-Checks-before-the-middle

of next week.’? On August 25, 1964, when Mr. Parent

transmitted a check for 3,667 shares of stock, he stated

' _ that it was his understanding that that amount “‘cleans. up

*. the total Balance’’ of all of the stock ‘‘that I. have been

gelling to myself as well as.-my good friends. “és

When Bruce Wallace Associates was devised as a means

for selling stock, Mr. Wallace initialfy did not under-

stand how Bruce Wallace Associates should operate. By

letter dated June 22, 1963 Mr. Wallace transmitted checks

totaling $63,550.00 for the purchase of 154,000 shares of

stock. From the tenor of the letter, the Court finds that

the .checks transmitted were thosé given him by the ul-

timate purchasers and were not checks of Bruce Wallace

Associates. Mr. Wallace in his letter specified that the

stock certificates were to be issued as follows, and. he

then named nineteen individuals, including himself, as

the persons in whose: names certificates should be issued,

and stated the denomination of the certificate for each.

He also stated in his letter ‘fon the strength of these

subscriptions, think we could have sold another 100 000 -

_Shares.’? Defendant Custer replied to this letter undér

‘date of June %6, 1963. He returned checks ee

oe i

to $10,050.00, describing them as the checks ‘‘I talked with

you about *** which cannot be accepted by this Corpor-

ation.?? Defgndant Custer stated that he was retaining -

Mr. Wallace’s personal check in the amount of $3,500.00

and'a check of Mr. Cornelson which had been transmitted

in the Juné 22 letter in the amount of $25,000.00: Fol-

lowing these statements, he then instructed Mr. Wallace. |

‘Please handle this matter of the enclosed check as -per

our phone conversation, along with any additional friends

who become part of the Bruce ‘Wallacé Associates in one

personal check.’’ + _ ;

Other proof conclusively demonstrates that Mr. Cor-

__nélson_was one who helped Bruce- Wallace solicit sub-—C—CS~S

scriptions placed in the name of Bruce Wallace Associ-

ates, It is not without significance, therefore, that un-

‘der dates of August 10, 1964 and September. 9, 1964 de-

fendant Custer wrote to Mr. Cornelson complaining in

the letter of August.10, 1964, that when Mr. Cornelson

left Hagerstown, defendant Custer had been ‘under the

impression’ that he was going to supply funds to meet. _

- the numerous bills coming due-for engineering services

~for the aircraft, but that Mr. Cornelson had not produced

any funds and, further complaining, in we letter of Sep-

_ tember 9, 1964, that at the directors meeting held August

_ 21, 1964, everyone agreed that defendant Custer should ~

proceed with expenditures to get the aircraft certificated,

‘but that money to meet obligations falling due was not

forthcoming. Apparently, the difficulties defendant Custer

had with raising money were continuous, because, in an

undated memorandum to all directors, which referred to

a previous letter under date of April 6, 1964, defendant

Custer had written at length about his need for money

to continue the program of development of the aircraft,

and concluded by saying, ‘‘I hope all of you realize this

is not a request for any Director to put up any money,

it is an urgent appeal for my Directors, as well as myself,

|

.

0s tainty Ske anti Daa ine nsdn geen Delite telllleddiaeiinangn

. .

49a

to find someone with -this money, that will invest with . .

us to help carry this project to a conclusion.”

After his letter of June 22, 1963, Mr. ‘Wallace continued

to write defendant Custer in terms which unquestionably .

would make clear to him that Bruce Wallace Associates,

was a conduit through which stock was purchased by

‘outsiders. Under date of April 6, 1964, Mr. Wallace

wrote to transmit an investment letter for 63 ,800 shares

of stock. He stated that he would like to have ‘‘several

_. of these certificates for 500 shares each, as I have a few

‘investors who have put in-only-$150.00. each.” By letter

__ dated June 4,. 1964 he referred to ‘‘the Checks I have sent

_ recently for which no stock has been issued’? and sug-

gested that the stock be issued .in 1,000 share certifi-.

cates ‘‘with 2 at $100 each for which a man purchased

_ for his 2 sons.” In an apparent reference to the total

_ number of shares which were to be forwarded. to him:

_ @s a result of the transactions set out in the letter, Mr.

Wallace concluded by saying, ‘‘with Waymans and my

stock on hand we can use that to give to our customers

without waiting for a couple of months to get et di

(emphasis supplied).

. Defendant Custer, and through him Channel Wing, was

as much ‘on‘notice of the true modes of operation of Ward

Brooks Associates as the documentary proof shows was the ©

fact in regard to J. Ben Parent Associates and Bruce

Wallace Associates. Thus, when defendant Custer wrote.

Mr. Brooks under date of October 3, 1963 to advise him

'. that stock was authorized to be issued, defendant Custer

stated all materials were furnished at The Corporation

Trust Company and ‘‘*** the’ stock certificates for all

your friends ‘should be coming to you. in ~ than ten

days. sea emphasis supplied). |

Should the documentary proof admit of any doubt pe

(which the Court firids it does not) that defendant Custer

knew the true nature of the activities of the Associates,

an

.

é‘ 50a : = ; 4

there was evidence that defendant Custer referred at

least two purchasers to Bruce Wallace Associates to ok-

_tain stock. 0

epee Charles” R. Lancaster, a resident of Sarasota, Florida,

appeared as a witness and testified that he met defendant

' Custer in Hagerstown, Maryland in 1961, and again in

1964, On the latter occasion Lancaster inquired if stock

was available, and defendant Custer told him that Bruce

Wallace. would know if stock was available. Defendant

Custer gave Mr. Lancaster Mr. Wallace’s address: Young-.

- blood Hotel, Enid, Oklahoma. By letter dated September

9, 1964 Mr. Lancaster wrote and asked if he could obtain

stock through Bruce Wallace Associates as. suggested to

him at a recent meeting with defendant Custer in Hagers-

\town, Maryland. Magnanimously, Mr. Wallace responded

that stock could be obtained, that the price had recently

: . been raised to 35 cents per share, but that since Mr. Lan-

_easter had talked to Mr. Custer prior to the raise ‘‘wg are

. still going to give you the old price of 25.cents per share.”’

Mr. Wallace also added: that the company was making

rapid progress and would have complete certification of the

aircraft early in 1965, at which time stock would be listed

on the ‘‘board’? at $3.00 per share.

Mr. T. B, Holliday, of Elmhurst, Wtiknats, al cles titel.

He had been employed as a consultant for Channel Wing

in connection with the interest evidenced by the United

States Air Force in obtaining information about the plane

that Channel Wing hoped to manufacture. Late. in 1963,

Mr. Holliday inquired of defendant Custer if the former

could obtain Channel ‘Wing stock. Mr. Custer ‘‘carefully

+ emphasized thgt-he~ couldnt have anything to do with

stock’’ but gave Mr. Holliday the name of Mr. Sam Stoner

and Bruce Wallace Associates. Under date of December

30, 1963, Mr. Holliday wrote to Mr. Stoner asking if he

a could convert a fee due him from Channel Wing into stock,

as well as purchase some additional stock for a-check for

$200.00 enclosed in his letter. Mr. Stoner replied promptly,

\

gerdeunintes

x

Bla”

Mr. Stoner indicated that a certificate for the stock would

x

Other than defendant Custer’s denial of his Knowledge —

-of essential facts constituting a violation of the injuti¢-

tion in regard to sales to the “‘Associates,”? which the ;

Court finds neither convincing nor sufficient to raise a

reasonable doubt of the fact of defendant Custer’s actual

knowledge. in this regard, defendant Custer asserts, as

a defense, that he was advised by counsel that the over-

all sales which were made did not. amount to a public

stricted, and sales of stock limited to approximately fifteen

to twenty people, there would -be no public offering of

Custer’s brother died, and was succeeded in the r

the sale and no violation of the injunction. ‘Def. ei

ole of\_

_ vised to limit the number of persons subscribing to stock

through J. Ben Parent Associates to six to fifteen in num.

ber. From the evidentiary basis, defendant Custer asserts

that he acted 6n-advice of counsel in good faith.

- adviser to defendant Custer and Channel Wing by Keith ~~

52a |

- There are at least two answers to this alleged defense. .

“The first is that, as a factual matter,even treating repeated |

- gales to the ‘‘ Associates’? as no more than sales to three ~

entities and repeated sales to the same individuals as only

one sale, defendant Custer did not stay within the advice

given him by his brother with regard to the number of

purchasers. Rather, with this method of computation, he.

expressly authorized the sale and issuance of stock to

twenty-two persons. The precise date on which defendant

Custer was first.advised by Mr. Seegmiller is not disclosed .

in the record, 40 that it may well be that. defendant: Custer

" had authorized sales to persons in number exceeding the —

- maximum advised by Mr. Seegmiller by the time that Mr.

Seegmiller first gave such advice, but the record shows that

‘ three sales were made in-1965, and it seems clear from the

record that defendant Custer had the advice of Mr. Seeg- -

miller at or shortly after a directors’ meeting held in No-

vember, 1964. As a fact, the Court finds that defendant ©

Custer, and’ through him Channel Wing, did not rely in |

good faith upon any advice of counsel.

The second answer to the alleged defense is that the

Court has already found that in the case at bar wilfulness

may be proved by showing knowledge of each of the essen-

- tial elements of the violation and does not require proof of. —

specific intent.. Any defense of good faith reliance on ad-

vice of counsel has bearing upon only specific intent, and —

not general intent. Linden v. United States; 254° F.2d

560 (4 Cir. 1958); Miller v. United States, 277 F. 721 (4

"Gir, 1991); Bisno v. United States, 299 F.2d 711 (9 Cir.

’ - 1961). In a proper case, good faith, or good faith reliance —

_on advice of counsel, is a factor to be considered in mitigat-

__ing of punishment, Lustgarten.v. Felt.é Turrant Mfg. Co,.

92 F.2d 277 (3 Cir. 1987) ; In re LaVarre, 48 F.2d 216 (S.D.

_.. ‘For-the reasons stated, the Court finds each of the defend-

ants guilty of criminal contempt as charged.

‘United States District Judge

_— PEFR POLAR I EEA DY LIED ow 0

Anat “

.

rv ost

: Criminal Contempt, it is

Fae © Che:

_ «@

| o 53a

[Filed November 12, 1965] ae

F o | ‘i

ie OrderofCourt ~ =. . ||

‘This cause having come on for ing on Apr

T ' _on for hearing on. ica-

tion of the United: States of America, for ntiehor Mean

" ing Defendants to show cause. why they should not be

adjudged in Criminal Contempt of this Court for failure —

- to comply with the Final J udgment dated May 25, 1962

a >. ’

filed:in Civil Action No. 13500, and; the matter >* “ ‘minal

__ Contempt having been tried before the Cour: sel

for all ‘parties havin an

rtie g been heard, and th irt ;

i filed an Opinion, containing its findings of fac den 7

sions of law, and, finding both Defendants uilty’’ of

ORDERED, by the United States District Court for the

Custer is hereby committed to the custody of the Attorney

_ General or his authorized representative for imprisonment’ _

for a period of One Hundred Eighty-three days (183), and ~

PJ

.. to pay % United States costs of case; service of sentence

this Judgment and Commi | ,

_ dndgme : tment to the Uni :

ee or other qualified officer and that agen po

as the commitment of the. Defendant, Willard R Dna

} /3/ Hanarson L. Wires :

: United States District Judge. .

Yy