Brief for Respondent — Supt. of Insurance v. Bankers Life & Cas. Co.

4

without prejudice to. the prosecution by Petitioner of his

pending New York Supreme Court action. (App., p. 90a) —

Similarly, the Court of Appeals in affirming the judg-

ments of the District Court stated that it did “not decide

that theicreditors of Manhattan do not have any remedy

_ under general state tort law for the fraud practiced on their

‘debtor, but only that the federal Securities Acts have not

_ provided a federal forum for its enforcement.” (App., p.

107a) :

Questions Presented \

1.. Does a misappropriation of corporate funds which

may be traced in part to the proceeds from the sale of cor-

_ porate securities constitute a fraud in connection with the

sale of those securities i in violation of the federal securities

laws?

2. Cah A soeporate seller of securities recover under

the federal securities laws when its sole stockholder au-

thorizes and approves the hems fraudulent sale of its ©

securities?

-8. Do ereditors of a corporation have standing under

the federal securities laws to obtain judicial review of

' securities transactionsyof that corporation and decisions:

of the corporation’s madagement with respect thereto?

Suiamary Statement of the Case

This summary statement of the case contains the most -

significant events claimed by Petitioner to describe a viola-—

tion of the federal securities laws. In ‘the Complaint

hereip, in his complaint in the New York State action,

in his ‘answers to interrogatories and in the many

briefs he has filed in this action, Petitioner has depicted

4)

numerous—and occasionally inconsistent—incidents which

allegedly caused $5,500,000 damage to Manhattan. This

_Summary statement does not attempt to include all such

details, but merely outlines those alleged facts which Peti-

tioner claims support the legal theories on which he now

- relies. A more complete statement of the facts with cita-

tions is set forth as Attachment A to this brief.

The events leading to this action commenced in late 1961

whén Begole negotiated with Bankers Life for the acquisi-

tion of its wholly-owned subsidiary, Manhattan. * Begole

contracted to purchase Manhattan on January 24, 1962 for

$5,000,000. Financing for Begole’s purchase was arranged

by Bourne, who enlisted the assistance of ary, a partner

in Garvin, Bantel.

On January 24, 1962, at the request of Gari, C. Joseph |

Gunter (“Gunter”), an Assistant Secretary of Irving, drew

a $5,000,000 Irving check payable to Bankers Life. At the

closing of the sale of Manhattan, the check was delivered

to Bankers Life in payment for Begole’s pynene of all of

the Manhattan capital stock.

Immediately after acquiring Manhattan, Begole installed

a new Board of Directors, including himself as Chairman.

The new Board then elected Begole’s nominees as officers— _

including Sweeny as President—and authorized the sale of

Manhattan’s Treasury bonds and -the purchase of a —

$5,000,000 certificate of deposit from Belgian Trust.

Later on January 24, 1962, Gunter received the Manhat- .

tan Treasury bonds which were sold through Garvin; Bantel

and delivered to the purchaser, Second Disfrict Securities

Co., Inc. Fair value in the amount of $4,854,552.67 was

paid by the purchaser for the bonds. Gunter credited the

$4,854,552.67 to.an account of Manhattan at Irving and

also credited to that account $150,000 received by check

from Manhattan.

rear

SCG OTF. Pos,

6 e

Also on J anuary 24, 1962, Gunter, pursuant to instruc-

tions from Garvin, drew a $5,000,000 Irving check payable

to Belgian Trust and delivered it to Sweeny at the Belgian

American Banks. Sweeny deposited the check with Belgian |

Trust which issued a six month $5,000,000 certificate of

deposit to Manhattan. Both Sweeny, as President of Man-

hattan, and Manhattan’s Assistant Treasurer endorsed the

certificate of deposit to New England. Sweeny gave the

CD to Bourne, President of New England, who in turn

endorsed it to Belgian Banking. Thereupon Belgian Bank-

~ ing loaned $5,000,000 to New England and for collateral

took possession of the Belgian Trust CD which had been

endorsed by Sweeny and Bourne. The proceeds of this .

loan were paid in the form of a $5,000,000 Belgian Banking

check payable to Irving for. the account of New England

which was delivered to Gunter. At the same time Belgian

Banking made another loan to New. England of $250,000

which was secured by the outstanding shares of Manhattan | .

which had been assigned by Begole. to New England.

_ On July’ 24, 1962, Belgian Trust’s six month certificate

. of deposit payable to Manhattan matured and the loans by

‘Belgian Banking to New England became due. At that

time certain new, arrangements were effectuated. Belgian

_ Trust credited Manhattan’s account with $74,383.56 inter-

est, on the Manhattan CD, and the principal amount of the

CD which had been endorsed on behalf of Manhattan by

Sweeny was used to purchase a new six-month $5,000,000

Belgian Trust CD .for Manhattan.” This new CD was

delivered to Sweeny, as President of Manhattan, and kept.

by him in his possession. Belgian Banking’s loans to New

England were extended to January 24,1963.

. In August, 1962, Sweeny returned the certificate of de-

_ posit he had been holding to Belgian Trust, and Manhattan

was issued a negotiable six month $5,000,000 CD, also dated

July 24, 1962. Sweeny endorsed this new CD on behalf of

7

Manhattan and delivered it to Belgian Trust together’with

instructions to deposit its proceeds upon maturity in Man-

hattan’s account at Belgian Trust. In addition, he deliv-

_ ered a $500,000 CD of the First National Bank of Boston,

which was also owned by Manhattan, to Belgian Trust.

_ Both CDs were delivered on the assurance of a letter from

- Belgian Trust stating that they would be held in trast for

. Manhattan.

On January 25, 1963, adaiGioun transactions occurred

_ which Petitioner claims, were part. of the conspiracy to

defraud Manhattan. Belgian Trust ¢redited Manhattan’s

‘account with $5,590,977.62. -$5,000,000 of this sum .repre-

sented principal of the Belgian Trust CD issued to Man-

hattan in August of 1962 ; $75,616.44 represented interest on

that CD; $500,000 represented principal of the First —

National Bank of’Boston CD which had. been‘ delivered to

Belgian Trust; and $15,361.18 represented meiner on the

First National Bank of Boston CD. ,

Also on January 25, 1963, Belgian Trust issued a

_ $5,500,000 check payable to Irving and charged it against _

the Manhattan account which had theretofore been

eredited with $5,590,977.62. Irving, pursuant to instruc-

tions from -Garvin, issued a $5,250,000 check payable |

to Belgian Banking. The Belgian Trust check to Irving

and Irving’s check fo Belgian Banking were exchanged on

. January 25, 1963 at the Belgian American Banks. The

-Irving check was used by Belgian Banking to repay its

$5,250,000 loans to New England. Pursuant to instructions

from Garvin, the $5,500, 000 Belgian Trust. check payable to

Irving was credited to the Garvin, Bantel account at Irving

and the $5,250,000 Irving check payable to Belgian Banking

was debited to the Garvin, Bantel account. The net effect

of these alleged transactions was to apply funds in the Man-

hattan account, at.Belgian: Trust to the repayment of the

meeae Banking loans to New England.

8

As a consequence of the foregoing -transactions, Peti-

a ae

tioner suing in Manhattan’s behalf alleges that Manhattan ~

was defrauded of $5,500,000 in violation of the federal secu-

rities laws. Petitioner has suggested two alternative

times at_which Manhattan funds may have.been misappro-

priated. Under Petitioner’s first theory, Manhattan was

injured on January 94, 1962, when $5,000,000 of

$5,004,552.67 (consisting of $4,854,552.67 deposit of pro-

ceeds of securities plus $150,000 cash deposit) in the Man-

hattan account at Irving were diverted by Begole to pay for

the check to Bankers Life used for-the purchase of the Man-

hattan stock.’ Under Petitioner’s second theory, Manhat-

tan was injured on January 25, 1963, when $5,500,000 of ©

funds in its account at Belgian Trust were misappropriated ;

$5,250,000 of which was used to repay the Belgian Banking

loans to New England, and $250,000 of which was diverted

by Begole and Sweeny. Under the second theory, the

$5,000,000 Irving check to Bankers Life was-paid for by the

ad

$5,000,000 Belgian, Banking check payable to Irving for the —

account of New England whicl? represented the proceeds of

one of the Belgian Banking loans to New England.

’ ARGUMENT

I.

MISAPPROPRIATION OF CORPORATE FUNDS WHICH

MAY BE TRACEABLE IN PART TO THE PROCEEDS

FROM A SALE OF CORPORATE SECURITIES DOES NOT

CONSTITUTE A FRAUD IN CONNECTION WITH THAT

. SALE IN VIOLATION OF THE FEDERAL SECURITIES

, ° -LAWS. . .

Petitioner claims that Manhattan was defrauded of .

$5,500,000 us a result of an alleged fraud in connection with

the sale of securities in violation of Section 10(b) of the

1934 Act. The alleged fraud consists of a misappropriation

of corporate funds which may be traceable in part to a

- A

i ae

corporate securities transaction. Upon analysis, however,

such a misappropriaion does not constitute a fraud in’con-

: nection with a securities transaction and was not tended

by Congress to constitute such a fraud. To hold otherwise _— -

would result in federal preemphon of a major part of state

corporate law,

A. There is a distinction betwecn a fraud in con-

nection with a security transaction and the

effectuation of a security transaction as an-

incident to the perpetration of a fraud.

“This case involves the proper interpretation of the statu-

tory. phrase “in connection with the purchase or sale of any

security”. The Second Circuit recently reaffirmed its inter-

pretation given to that phrase herein by stating: .

“$10(b) liability arises only when the alleged fraud

between the parties and/or [the ] alleged market

manipulation or deception is intrinsic to the seéuri-

ties transaction itself.” [ Footnotes omitted] Drach-

man Vv. Harvey, Docket No. 35077, CCH Fed. See. L.

Rep. 193, 129 at 91, 100, 91, 101 (2d Cir. July 21,

1971).

' Thus, it is not sufficient for a plaintiff merely to allege

both a fraud and a security transaction. As Judge Herlands

stated in dismissing the Complaint herein:

“A ‘federal claim is not pleaded by allegations that,

in the course of a scheme to loot a corporation of its’

assets, certain security transactions occurred, when

these transactions—though contaminated by the

_ overriding evil intent to accomplish the ultimate

- looting—did.not involve fraud or.deceit in connection.

_with the sale or purchase of a security.” App., P.

83a. |

. For.a fraud to occur in connection with the purchase or

sale. of a security, that fraud must materially affect the

purity of the security transaction or the purity of the secu:

rity trading poe The wrongdoing may involve, among

10 °

. other things, the terms of salé,? ‘dishonesty by a broker;*

' _ manipulation of a market,‘ ‘or failure to provide accurate

_ information to the investing public.’ But wherever. the

fraud occurs in the securities exchange process, it must

affect a part of that process to be subject to fey federal

securities laws.

In this ‘case, no injury is alleged to have occurred at any

. point in the securities exchange process. No participant

in any securities market. is alleged to have acted dis-

- honestly; no market for any security is alleged to havé been

manipulated; and no security_is alleged to have been sold

for other than its fair value. Manhattan’s Treasury bonds

were delivered by Chemical Bank to Irving; they were sold

through Garvin, Bantel to Second District Securities Co.,

‘Ine., & leading dealer’ in the government bond market; and

the procneds of $4,854,552.67 paid by Second District were

eredited by Irving to Manhattan’s account. The alleged

wrong was not in the security transaction but rather in the

later misappropriation of $5,500,000 of Manhattan’s “funds,

$4,854,552.67 of which may be traceable to the’ proceeds of

sale of the bonds.

Petitioner has suggested two alternative times at which -

Manhattan funds may have been misappropriated. Unde

_ « Petitioner’s first theory, Manhattan was injured on Japu-

ary 24, 1962, when -$5,000,000 of $5,004,552.67 (consisting

of © $4,854,552.67. deposit of ‘proceeds of securities plus

$150,000. cash deposit) in the Manhattan account at Irving

were diverted by Begole to, pay for the check to Bankers .

_ Life used for the purchase of the Manhattan stock. This

‘2. Schoenbaum v. Firstbrook, 405 F.2d 200; rev'd en banc on

other grounds, 405 F.2d 215 (1968), cert. denied sub nom. Manley

v. Schoenbatm, 395 U.S. 906 -( 1969).

3. SEC v. Lawson, 24 F. Supp. 360 (D. Md. 1938). .

4. Pettit v. American Stock Exchang e, 217 F. Supp. 21 ( S.D.N.Y.

1963). : &

.5. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968),

cert. denied sub nom. nan VOEG, 394 U.S. 976 (1969).

: PORPS POG IAS BUR ating AEN! Mpa Ey ite ct Narn POPS een IS TM Paes

ie ress teks et

econ wi be

ae.

1 oo

theory has the advantage of simplicity but is inconsistent

with Petitioner’s second theory and certain facts admitted

by Petitigner. :

Under Petitioner’s second theory, Manhattan was injured

_on January 25, 1963 when $5,500,000 of funds in its account

at Belgian Trust were misappropriated; $5,250,000 of

which was used to repay the Belgian Banking loans to New

England and $250,000 of which was diverted by Begole ~

and Sweeny. Under this theory, the $5,000,000 Irving

check to Bankers Life was paid for by the $5,000,000 Bel-

gian Banking check payable to Irving for the account of

New England which represented the proceeds of one of the

Belgian’ ‘Banking loans to New England.

Also under this theory, $5,000,000 of the funds in the

Manhattan account at Irving onFanuary 24, 1962 were ~

used by Manhatian~to purchase the $5,000,000 Belgian

Trust certificate ‘of deposit issued to Manhatan on that

date. The proceeds of this certificate of deposit wergeused

on July 24, 1962 to pay for a second six-month $5,900,000 .

Belgian Trust certificate of deposit. Also on July 24, 1962,

Manhattan’s account at Belgian Trust was credited With

$74,383.56 interest’ on the maturing certificate deposit.

In August of 1962, the Belgian Trust certificate of deposit

which had been issued on July 24, 1962 was exchanged for -

a new negotiable Belgian Trust certificate of deposit in

the same amount in the name of Manhattan, and the néw

certificate of deposit was: delivered to Belgian Trust’

together with a $500,000 certificate of ‘deposit of the First

National Bank of Boston also owned by Manhattan. Both

certificates of deposit were delivered on the assurance of

a letter from Belgian Trust stating that they would be

held in trust for Skee cea and that the proceeds. would

_ be credited to Manhatfan’s account on maturity. Petitioner

alleges that the #5,590,9) 977. 62 prineipal and interest of those

e

» " ras “ : ré .- ” ry =

OSE LILLE LEESON LE LED EXTOL LOOT IE 2 POLLS GE LOO RID

)

Bo

two CDs wore wsdited to a Manhattan account at Belgian

‘Trust on January 25, 1963. He further claims that there-

after Manhattan was injured when $5,250,000 of those

_ funds were misappropriated to repay the Belgian Banking

~ loans té Néw England and $250; ” were e div erted by Begole

‘and Sweeny.

Under either theory Petitioner has alleged no more ‘than

a complicated scheme of common law fraud in which the

- diverted funds may be traced in part to a securities trans-

action. Under his first theor y, the proceeds of the Marihat-

tan Treasury bonds may be. baeee to.a misappropriation

which allegedly ocenrred on the same day as their sale.

Under his second theory, the proceeds of the honds may be

traced to the. purchase” of the Belgian Trust CDs .whose

proceeds were eventually’ misappropriated. However,

‘neither effort to. trace the proceeds of Manhattan’s

Treasury bonds describes a fraud in connection with their -

~ sale within the meaning:of the federal securities acts. The.

iy sas o,e ‘. 4

possibility that Petitioner may trace some of the converted.

funds to the bond proceeds does not taint the non-

fraudulent sale of the bonds and eause that sale to have :

been “in connection with” the subsequent misappropriation

within the meaning of Section 10(b).

The essence of the fraud in this ease’ is a conversion of

corporate assets. (App., pp. 84a, 89a) No fraud oecurre 3

in-eonnection with the sale of the bonds, and thus no f _

occurred in violation of the federal. securities laws.

. The critical issue presented here is whether ‘there is a

limit to the concept of a fraud in connection with the pur-

chase or sale of a security or whether, any relationship—

however indirect, attenuated or tangential—is sufficient to

establish federal jurisdiction. Both the Congressional in-

tent underlying the enactment of the 1934 Act and the

extensive preemption of traditional state law which would

result from a contrary holding compel Me conclusion that

iy)

13

there is a jurisdictional distinction between Section 10(b)

claims and non-federal anti-fraud claims. This distinction,

- as stated by Judge Herlands below, is that: “. ... . Rule

10(b)-5 requires the employment of fraud in connection

with a security transaction, which js essentially different

from the effeMuation of a security transaction in connec-

tion with a fraudulent activity.” (App.,’p. 84a) -

~

B. Congress did ok intend to regulate conduct which

’ does not in any way affect investment decisions or

the public interest in maintaining sound securities

~ markets. \ x -

Although Section 10(b) is perhaps the most litigated f

provision of the federal securities laws, its draftsmen seem

not to have anticipated its potential significance. It “was

one of the least controversial parts of the 1934 Act”, and

‘there is a “dearth of evidence” as to the Congressional

intent in enacting it. Bromberg, Securities Law: Fraud— id

SEC Rule 10b-5, Sec. 2.2. As a conseqtience, one can only

deduce the legislative purposes for its enactment from the ~

more abundant information available about other sections

of the statute. Cs .

From the background of the 1934 Act generally and in

view of the economic events which provoked its adoption,

it appears that “the anti-fraud ‘provisions were adopted to

protect the trading process in the securities marlets [foot-

notg omitted], not to provide a federal remedy for every

injury that might in any way be connected with a securities

fraud.” Boone and. McGowan, “Standing to. Sue under

SEC Rule 10b-5,” 49 Tex. L. Rev. 617, 662 (1971). As the

Court of Appeals for the Second Circuit recognized: -

“The dominant Congressional purposes underlying _

the Securities Exchange Act of 1934 were to promote “

free and open public securities’ markets and to pro-

tect the investing public from suffering inequities in

.

=

i}

aa

trading. . _ 2 SEC v. Texas Gulf Sulphur Co., 401

F.2d 833, 858. e08) cert. denied, ie US. 976

-(1969).

.. More specifically, the Fifth Circuit recently concluded

that: = “/

“By section 10(b) Congress meant to prevent man-

ipulation and control of the prices at which securities

are bought and sold and to enable buyers, sellers,

and traders. of securities to make a proper appraisal

of the. value of securities.” “Hergiich v. Wallace, 430 -

F.2d 792, 801 (: oth Cir. 1970).

N otwithstanding the paucity of information ag to Con-

gressional intent in enacting Section 46(b); both Petitioner

and the Securities and Exchange’ Commission {“SEC”), as .

~ gmicus, have contended that legislative historv sanctions

an.action such as-this. A complete examination of the

sources of legislative. history cited by Petitioner and the

SEC indicates that those sources do not.Support the propo-

sition that conduct such as that alleged herein should con-.

stitute a fraud in connection with a securities transaction.

The overriding purpose of Congress in enacting the

1934 Act was the regulation ef i issuers, exchanges, brokers —

and speculatgrs i in order to protect participants in invest-

ment transactions and to prevent the recurrence of an

economic. depression. As the Court of appease indicated

below: ,

“Although in the broadest sense the public interest .

is involved when a corporation whith is subject to

regulation by the state Superintendent of Insurance ..

is defrauded, the public interest cognizable by §10(b).

is limited to preserving the integrity of the securities

markets. ” “App., p. 107a.

“Gonpteas did not intend to scetontt investors in all of

“their business transactions, but rather to provide a federal

t

15

remedy. for them when they engage inva purchase or sale.

of securities. Congress intended to reduce the risks of

_ dealing in securities, but did not attempt to guard against

the risks of accumulating cash or owning bank accounts as’

a consequence of dealing in securities. Investors are af-

forded certain protection by Section 10(b) when they func-

tion as investors, but are not afforded this protection when

they are not functioning as investors.

The consequences of this distinction aré made clear in a

case such as this in which the “person” dealing in securities

is not an individual but rather a corporation which must

act through agents who may have interests contrary to its

‘own. When an individual purchgges or sells securities, the

federal courts look only to the integrity of the transaction

in which he participates. and to the market mechanisms and

institutions by means of which the transaction occurs. Pre-

sumably, the federal interest is no broader in the case of

corporations. When the individual investor disposes of a

security, the federal courts do not i inquire as to the use of

the proceeds. Presumably, there is no greater need for

_ federal review of the use of security proceeds by corporate

investors.

Although corporate insiders have opportunities to divert

for their own, benefit the Proceeds of corporate securities

transactions, those opportunities are no greater than, and

_ ho different from, the opportunities afforded those persons —

to misuse other corporate assets.. The mere fact that an

embezzlement or misappropriation of corporate funds can

be linked by some chain to a securities transaction does not

change the character ‘of that wrongful act from an embez- |

zlement or misappropriation to a federal fraud. The Con-

gressional purpose underlying the Securities Exchange

Act was to protect the corporate investor when it functioned

as such—that~is, when it availed itself of. brokers, ex-

changes, credit agencies « or other. instrumentalities of the

¢ | . 16 /

securities markets. The corporate assets resulting from

such participation were not the subject of federal

regulation.

'C. To find a federal wrong herein would result in fed-

eral preemption of State law governing corporate

‘mismanagement.

iat eens

The alleged wrong in this action was the misappropria- -

tion of Manhattan’s funds. Misappropriation of corporate

assets has long been held under state law to constitute

corparate waste, and state remedies are available against

officers; directors ‘and shareholders. guilty of such a breach

of fiduciary duty. In this case the Court myst decide

whether state law relating to corporate mismanagement

federal corporate law, a substantial increase in federal

-eourt litigation will result:

The lower federal courts. have’ concluded that such fed-

or the legislative history of the 1934. Act. See Birnbaum v.

Newport Steel Corp., 193 F.2d 461 (2a Cir.), cert. denied,

343 U.S. 956 (1952) ; Lester v. Preco Industries, Inc., CCH

Fed. See. L. Rep. 191,562 (S.D.N.Y. 19 5); and Kaminsky

v. Abrams, 281 F.Supp. 501 (S.D.N-Y. 1968). As the court

observed in Barnett v. Anaconda Co., 238 F.Supp. 766, 770

(S.D.N.Y. 1965), in dismissing a complaint brought under

both Section 10(b) and Section 17(a), the federal securities

acts have not “swallowed the whole body of state statutory

those who manage and control them.”

Absent clear legislative intent, such preemption of state

law and such increased burden upon the federal courts

should not.be sanctioned. The 1934 Act was not in-

will be preempted by judicially created federal law. If —

the as decides to preempt state law and to create a

‘eral preemption is not warranted by either the language —

-and common law covering the internal administration of |

the affairs of corporations and the fiduciary obligations of

tended to supérsede state law,* but rather to make avail.

6. State law was then, and is now, effectively coping with new -

. types of corp@%ate mismanagement. See, e:g., Diamond v. Oreamuno,

24 N.Y. 2d 494, 248 N.E. 24 910, 301 NYS 2d 78 (1969),

gee NATE nore gene RT som

eS

able new remedies applicable. to transactions in thé inter-

state securities market. As Professor Loss has: pointed

out: | |

“the implication of a private action under Rule 10b-5__

has already displaced and federalized a great deal of

state law, not only in the area of deceit but also

with respect to the duties of officers and directors

to the corporation and its stockholders. A District

Court has recently observed in another context that,

‘where effective state remedies for the conduct pro-

scribed by the federal statute are available through-

out fhe country, there is generally little reason to

imply a federal caus¢ of action.’ Olympic Capital

Corp. v. Newman, 276 F.Supp. 646, 657 (C.D. Cal.

1967). The very lengths to which the 10b-5 develop-

ment has been carried inevitably arouse some doubt _

whether so marked a reform in important areas of.

essentially ‘private’ law, however, overdue it may

_ have been, can be justified on the basis of an eight-

line omnibus provision in a securities statute that

gives the enforcing agency a rule-making authority .

to deal with types of market “shenanigans” that the

draftsmen might not have dealt with specifically.”

6 Loss, Securities Regulation 3870 (1969 Supp. )

- In the context: of both effective state regulation and the

. ‘Coocresconal intent, expansion of Section 10(b) by judicial

; interpretation to include the misappropriation of corporate —

funds by corporate insiders is not justified. Such a broad

expansion of the statute should be left to Congress. As the

Fifth Circuit recently stated:

“If Congress | had intended that the federal courts .

inquire into every decision affecting the management

of corporations and then fashion: a new federal law

superseding state law on the fiduciary responsibili-

ties of corporate directors, officers, and controlling —

-persons, presumably so revolutionary a. federal

. intervention into an area traditionally handled by

the states would have been clearly expressed.”

Herpich v. Wallace, 430 F.2d 792, 809 (Sth Cir, ”

1970).

18

PETITIONER CANNOT RECOVER ON BEHALF OF MAN-

HATTAN UNDER THE FEDERAL SECURITIES LAWS

BECAUSE. MANHATTAN’S SOLE SHAREHOLDER

AUTHORIZED AND APPROVED THE SALE OF ITS

SECURITIES.

Petitioner alleges that he-is suing as Sapiiater of

Manhattan and that as Liquidator he is vested with all

rights of action of Manhattan. (Complaint 2; App., p. 4a;

Petitioner’s Brief p. 5) However, Petitioner cannot state

a claim under the federal securities laws on behalf of Man-

\ . hattan because Manhattan’s sole security holder, defendant:

Begole, authorized and approved all actions taken by Man-

hattan relating to the purchase or sale of securities. °

A corporation which sells securities cannot be injured, .

in its capacity as a seller, when its sole shareholder

authorizes, and is aware of all circumstances surrounding,

the sale transaction. All of the shareholders of a corpora-

tion constitute the corporation and consequently cannot

defraud themselves by’any corporate action which is rati-_.

fied by them. See Cunningham v. Jaffe, 251 F. Supp. 143

(D.S.C. 1966). In Schoenbaum v. Firstbrook, 405 F.2d 215

(2d Cir. 1968) (en banc), cert. denied sub nom. Manley v.

Schoenbaum, 395 U.S. 906 (1969), where a corporation was

alleged to have issued stock to its controlling shareholder

for an inadequate consideration, the Court of Appeals for

the Second Circuit recognized that a Section 10(b) action

could be brought on behalf of the corporation only because

minority shareholders of the issuer had been deceived in

connection with that sale. See 405 F.2d at 220; see also

the opinion of Hays, J., dissenting to the decision of the

_ panel in that case, at 405 F.2d 200, 215.

_. As the court-held in Field v. Lew, 184°F. Supp. 23, 27 °

(E.D.N.Y. 1960), af’d 296 F.2d 109 (2d Cir. 1964), cert.

dented, Field v. Bankers Trust Co., 369 U.S.°859 (1962):

* “A corporate officer who uses corporate funds for

his own purposes may be liable for conversioh to the

” ‘|

19

corporation and in bankruptcy to the trustee. Since

_ the officer had no title to the property, transferees

of the officer may be similarly liable. However, the

_ general rule of liability does not apply when . the

officer’s acts have been ratified by all the share-

holders of the corporation. In that case, the unau-

thorized acts of the individual become the authorized

acts of the corporation, the corporation loses its

right of action against the officer, and the corpora-

tion, having no right, the trustee in bankruptcy also

has no right. See Reif v. Equitable Life Assurance

Soc’y, 1935, 268 N.Y. 269, 197 N.E. 278, 100 A.L.R.

D9; Barr & Creelman Milk & Plumbing Supply Co. v.

Zeller (sic), 2 Cir., 1940, 109 F.2d 924; Quintal v.

Kellner, 1934, 264 N.Y. 32, 189 N.E. 770; Rosenfeld

v. Fairchild Engine & Aviation (sic) Corp., 1955,

309 N.Y. 168, 180, 128 N.E.2d 291, 51 A.L.R.2d 860

(dissenting opinion) ; Capitol Wine & Spirit Corp.

v. Pokrass, 1st Dept. 1950, 227 (sic) App. Div. 184,

98 N.Y.S. 2d 291; John William Bldg. Corp. v.

Union Trust Co., 4th Dep’t 1999, 256 App. Div. 885,

9 N.Y.S.2d 14; New ‘York Credit Men’s Adjustment

Bureau, Inc. v. Manhattan Life Ins. Co., City Ct.

N.Y. 1955, 149 N.Y.S.2d 778. Under the facts of the

instant case, the corporation would have no action

in conversion agaist Lew, any of his transferees,

or any. one participating in the transfer, because -

Lew as sole stockholder ratified: his own actions. _.

- As the Feld ease illustrates, it is important to dis-

tinguish the various capacities in which a corporate trus-

tee or liquidating agent may act. Each capacity may

provide the agent with standing to assert different causes

of action, but, of course, each separate cause of action will

be subject to its own defenses. The agent may bring a suit

in the right of the corporation,. but will-be subject to the

defenses and counterclaims to which the corporation would

be subject. On the other hand, the agent may have the

right to litigate on behalf of the creditors of the corpora-

tion as distinguished from the company itself. See, e I+

20

Bankruptcy Act §70e, 11 U.S.C. §110(e). In that situation, .

the agent would be free of defenses against the corporation

but might be subject to other objections not applicable to

the corporation.

In the .present case, Petitioner asserts that he is litigat-

ing on behalf of Manhattan, the corporation. In that capac-

ity he is subject to the defenses to which Manhattan

would be subject. In particular, he cannot claim that

Manhattan was a defrauded seJler when the sole share-

holder of the corporation was aware of, and in fact the

‘ planner of, the sale transaction. See Field v. Lew, supra,

and 13 Fletcher, Corporations §$5862 and 5866 (1970 ed.).

This is not to say that the conduct of a sole shareholder

in diverting to his personal-‘use corporate funds which

were generated by the sale of securities violates no law.

Such conduct may constitute the payment of an illegal divi-

dend or ‘may violate state laws respecting creditors’ rights.

See opinion of Judge Herlands below, App.,-p. 84a; see also

“New York Debtor and Creditor Law §§270-281 and New

York Business Corporation Law $§719, 720. But the mere

fact that such conduct may otherwise be unlawful doeg not

_ mean that it violates the federal securities laws. See

Iroquois Industries, Inc. v. Syracuse China Corporation,

417 F.2d 963, 969 (2d Cir..1969), cert. denied, 399 U.S.909

(1970), and Carliner v. Fair Lanes, Inc., 244 F. Supp. 25

(D. Md. 1965). Those statutes are atended to protect

persons who engage in.securities transactions. When the

sole shareholder of a-corporation authorizes the transaction

in ae no federal injury can occur to the corporate

“person”. | —

A recent decision of the Court of Appeals: for the Fifth

Cireuit, Batles v. Colonial Press, Inc., Docket No. 29048,

CCH Fed. See. L. Rep. 993,085 (5th Cir, June 15, 1971), |

may be in conflict with the reasoning set forth above. In

that case the court held that a federal trustee in bank-

~ * ruptey stated a claim on behalf of a corporation against

arr

21

_ corporate promoters under Section 10(b) of the Securities

Exchange Act of 1934, even though at the time of the

alleged fraud all of the shareholders, i.e., the promoters,

had approved of and participated in the corporate trans-

action. The court conceded that it was -acting without

. any direct precedent, and stated that if was reversing a

“well-reasoned” opinion of Judge Allgood that no claim

could be stated under the 1934 Act. (The opinion of Judge

_ Allgood appears as an appendix to the Bailes decision at

- CCH Fed. Séc. L. Rep. 193,085 at 90,989.) As-the Bailes

case involved the liability of promoters of a newly organ-

ized corporation, it is also in- direct conflict with the holding

of this Court in Old Dominion Mining and Smelting Co. v.

| Lewisohn, 210 U. S. 206 (1908). In Old Dominion, the Court

held that under federal common law a corporation has no

cause of action against its promoters for an injury incurred |

in connection with the sale of its stock to the promoters

when all of the shareholders participate in and ratify such

sale. In short, there is no precedent for the Bailes decision

under the federal securities laws and it would appear to be

iQ conflict with Old Dominion insofar as federal common law

is concerned.’ |

The error of the decision, in Bailes that a corporate seller

may recover notwithstanding ratification of the sale trans-

action by all shareholders is that it misinterprets the pur-

7. The Old Dominion decision was rendered prior to Erie R. Co.

v. Tompkins, 304 U.S. 64 (1938). It was distinguished in McCand-

less v. Furlaud, -296 U.S. 140 (1935), where the Court held that

an equity receiver suing on behalf of creditors of a corporation could -

assert a claim against promoters. However, the Court did. not state

‘that the corporation itself or the receiver suing on behalf of the cor-

* poration could bring such an action.

Even if the federal common law. were to the contrary, it would not.

avail Petitioner herein as he has commenced this action solely on the

basis of the federal securities laws. Petitioner’s common law rights

as a New York State liquidator are determined by the law of the

State of New York. Moreover, the causes of action set forth in the

‘federal Bankruptcy Act in favor of a trusteé in bankruptcy do not ©

apply to Petitioner as his ape does not derive from that statute.

99

pose of the federal securities laws. . Those statutes were

intended to govern the integrity of securities transactions

and the securities markets; they were not intended to create

_a new federal law of debtor and creflitor rights nor a néw

federal law encompassing the entire.area of corporate mis-

management.

The purpose of Section 10(b) can again be illustrated by

considering a sale of securities by an individual. When an

individual knowingly engages in a security transaction, he

cannot be defrauded ‘in connection with that transaction in

violation of the federal securities laws. Consequently, no

action te réview that transaction may be brought under the

1934 Act by him, by his successors in interest or by a cred-

itor or any other non-participant in the transaction. The

result should be the same when.all of the shareholder# of a

corporation knowingly ratify and affirm the eOrnoranon: S

participation in a security transaction.

“If the Court holds that a federal: claim can be stated on

‘behalf of a corporation notwithstanding ratification of the

corporate security transaction by all shareholders, there

will be no finality. to any security transaction. by a corpo-

ration or any entity other than ani individual. Since inter-

ests in corporations and_other entities are transferable,

any successor holder of any such interest might complain ._

of the validity of a transaction consummated while his

predecessor held his interest. Certainly as regards corpo-

rate shareholders, such a result would be contrary to the

federal policy set forth in Rule 23.1 of the Federal Rules of

Civil Procedure.

If this Court permits Petitioner to sue on behalf of Man-

hattan whose securities transactions were authorized by its

sole shareholder, it will overturn long standing principles

of corporation law and will intrude on state regulation of

- eorporate mismanagement and creditors’ rights. Moreover,

such a decision will bring into the federal courts new

~~.) a . 93

actions based on theories not contemplated by Congress and

extending far beyond the intended scope of the federal secu-

rifies laws.: Any such-creation of new rights should be left

to Congress and should not be undertaken by this Caprt in

the unusual circumstances presented herein. Consequently,

Petitioner should not. be permitted to bring an action under

the federal securities laws on behalf of Manhattan.

\

i || Ae

PETITIONER HAS NO STAN ING TO SUE ON BEHALF

OF MANHATTAN’S CREDITORS UNDER THE FEDERAL

SECURITIES LAWS FOR JUDICIAL REVIEW OF COR-|

PORATE SECURITIES ANSACTIONS.

Petitioner claims to be suing on behalf of. ‘Manhittan,

However, as established in Point II, supra, Petitioner,

suing on behalf of Manhattan as a corporate seller, cannot

reeover under the federal securities-laws-because defendant

Begole, its sole shareholder, authorized and participated i in

the corporate securities transactions.

In apparent recognition that Petitioner is foreclosed —

from suing on behalf of Manhattan, the SEC suggests that

Petitioner might have standing to maintain this action as

the representative of injured creditors and policyholders

of Manhattan (Amicus Brief, p..27). In making this

suggestion the SEC indicates an unfamiliarity with the -

record herein. First, the policyholders of ‘Manhattan were

reinsured at, the time of the liquidation. Second, Petitioner

does not claim any injury to: Any creditor of Manhattan. .

‘Third, Petitioner does not claim to be suing on. behalf

of Manhattan creditors. —~ a,

Assuming, arguendo, that a creditor of Manhattan was

injured, the SEC is mistaken in concluding that creditors

of a corporation—in addition to its security holders—have

24

standing to sue under the securities acts with respect to

security transactions of the debtor corporation. Contrary

to the position: taken by the SEC, there is nothing in the

legislative history of the federal securities laws to support

the proposition that creditors of a corporation have stand-

ing to sue under those statutes. Although the SEC’ ‘asserts

that Congress was concerned with the protection of corpo-

rate creditors and holders of insurance policies, reference

to the legislative history of the 1934 Act makes it clear that

such concern was directed toward conditions in the national

securities and credit markets and to. the fuhctioning of the

national sécurities exchanges. When read in context, the

_SEC’s citations to the legislative history do not support its

- position. See S. Rep. No. 1455, 73rd Cong., 2d Sess. .5

(1934) and 78 Cong. Ree. 7867-7869 (1934). = *

. Neither case cited by the SEC (Amicus Brief, p. 28)

- justifies extending to ‘ereditors standing ‘to sue under the °

-1934 Act. In Pepper v. Litton, 308 U.S..295 (1939), a bank-

ruptey case not. involving the federal securities laws, the

Court held that a trustee under the Bankruptcy Act could

enforce for the benefit of creditors the fiduciary obligations

_of a director or dominant sto¢kholder. .Hooper v. Mountam ©

States Securities Corp., 282 F.2d 195 (5th Cir. 1960), cert.

' denied, 365 U.S. 814 (1961), was an action by a trustee in

‘hankeipiey brought on behalf of a publicly- held corpora-

tion, and the trustee represented the corporation and its

public shareholders as well as its creditors. There could

be no claim that all of the shareholders therein had ratified

the corporate securities transactions. As Judge Herlands ©

indicated in distinguishing Hooper, the “scheme, [in that

ease] indneed an unfair‘sale of securities and it had as a ©

major purpose the spread of watered stock .to many in-

véstors.” (App, p. 87a)

"In support of its position that ereditors have standing’

to sue under the securities acts the SEC states that it

——

25 :

¢

has\long been recognized that controlling shareholders -

owe \a duty to’ corporate creditors. No citation in sup-

_ port “of this proposition is given, apparently because any

such citation would have to be to state law which provides

corporate creditors with ample remedies again dishonest

officers, directors and shareholders.? The absen effec- |

tive state remedies. for participants in the national. securi-

ties markets necessitated the enactment of the federal

securities laws; however, the existence of effective state

remedies made it lecessary for Congress to create new

-rights for creditors and make it unnecessary.for this Court .

to create such remedies under Section 10(b). -As the Court

of Appeals below indicated :

“(Whe do not decide that the creditors of Manhattan

_ do not have any remedy under general state tort law

for the fraud.practiced on their debtor, but only that

the federal Securities Acts have not provided a fed-

_ eral forum for its enforcement.” App., P. 107a.

Although the SEC asserts’ that this Court need not reach

the question of the validity of the limitation established in’

Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2nd Cir.),

cert. denied, 343 U.S. 956 (1952), thatzonly a purchaser |

or seller of securities may. maintain an action for damages —

under Section 10(b), it fails to recognize » that the validity of

the -purchaser-seller doctrine must be. -reviewed by the

Court if it considers the question of Petitioner’s standing

to sue on behalf-of Manhattan’s creditors. Bignbaum will -

be seriously eroded if Petitioner is permitted to maintain

this action on behalf of creditors, who were’ neither pur-

8. Ser e.g., New Yo ; Business Corporation Paw, Sections 719

and 720; New York Credit Men’s Adjustment Bureau, Inc.°v. W e1Ss,

305 N.Y. 1, 110 N.E. 2d 397 (1993); and New York Debtor and

Creditor Law, §§270-281.

9. The SEC concedes that’ the Court does not have to’ review

the Birnbaum. rule in determining Petitioner’s standing to sue in

connection with the sale of Manhattan’s “ae stock. Amicus Brief,

p. 7, in. 6. : g

(a

26 ae

chasers nor sellers of any of the securities involved 3 in this

action. | 7

The Birnbaum holding has been ‘uniformly and repeatedly

followed by every Circuit’ considering the issué. See Green-

- stein vse Paul, 400 F.2d 580 (2d Cir. 1968); 7 erpioh v. Wal-

lace, 430.F.2d 792 (5th Cir: 1970) ; Mader v. Armel, 402 F.2d

158 (6th Cir: 1968), cert. denied sub. nom. Young v. Mader,

394 U.S. 930 (1969) ; Dasho vy. Susquehanna\Corp., 380 F.2d

262 (7th Cir.), ert. denied sub nom. Bard, v. Dasho, 389.

U.S. 977 (1967) ; The Greater Iowa Corp v. McLendon, 378

* F.2d 783 (8th Cif. 1967); and Erling v. Powel} 429 F.2d

\795 (8th Cir. 1970)... \

-In :1969, the Court of Appeals for the Second - ‘Circuit

reviewed ayd reaffirmed the purchaser- seller reqhirement i in

; Iroquois Industries, Inc. v, Syracuse China Corp., 417 }

963 (2d Cir. 1969), cert.tdenied, 399° " S.. 909 (1970) :

«the Birnbaum rule espace thes, pulley of Con-

gress. in enacting Section 10(b) and of tHe Commis- -

_ sion inadopting Rule 10b-5, namely, the protection of

- defrauded purchasers and sellers. It is not the prov-

ince of the courts to extend Section 10(b) to apply

to transactions not intended to be covered by Con-

gress. We do well to heed the words of Mr. J ustice -

_ Black, writing for the Court in a case about an-

other section of the 1934 Act, Blau v. Lehman, 368

US. -403, 413, 82.8. Ct. 451, 457, 7 L. Ed. ‘ed 403

(1962) :

‘Congress can and might amend [the Act] if the |

Commission would ‘present to it the policy argu: --

ments it has presented to us, but we think that

: Congress, is the proper ageney to change an_inter-

» .pretatior® of the Act unbroken since its passage,

if the change is to be made. ad AIT F.2d at 969.

. In the context of a judicially created cause of action, and

th

e a clear Congressional intent, a doctrine as

~

|

’ ‘

um

~

“Ns

me OF

A

long established as Birnbaum should not be overruled in’

- order to give ereditors or their representatives standing to

sue under Section 10(b).

-. The legislative history of the securities laws, the de- ©

_ cigions | rendered thereunder and. the adequate remedies

available to creditors under state law all support the propo-

sition that a creditor who is. not a security holder of his

debtor should not havg standing to obtain review of corpo-

a transaétions. Dramatic practical canse-

qu s would follow if this Court were to hold to the

contrary. If Petitioner is permitted to maintain this action —

on behalf of creditors, then any ¢reditor-: will have standing

under the federal sécurities acts to object to any security

tfansaction of its debtor. In the case of a corporate debtor,

any creditor might challenge any decision of management

to issue, purchfise: or sell any security. Even the _most .

routine corporate transaction would be subject to the’ scru- |

tiny of the federal courts at ,the request of a litigious

creditor. Indeed, creditor actions might be brought not-

“withstanding :the decisice br interests of the corporatipn’s

shareholders. Such a ir incursion upon state law

governing the management of corporations and the’ rela-

tionship of creditor (debtor should tot result in the

absence of dear © gressional intent. ‘It certainly should .

not arike from the judicial creation of a private remedy.

by inference. from the very general anti-fraud provisions

of Section {0(b). e@

—"

‘

~ eed

— 28

/ CONCLUSION |

The judgment of the Court of Appeals should be

_ affirmed. | |

| ye St, Respectfully submitted,

Wuuium W. Karatz

Counsel for Respondent

. . 0) Irving Trust Company

a _ 40 Wall Street

ma +e New York, New York 10005

Joun B. Danis, fo

Wiuam C, F. Kurz,

_ _ Wiytsrop, Stimson, ©

; Putnam & -RoBerts, |

a Counsel.

| Dated: 1: August 30, 1971

. pit. >

29°

_ ATTACHMENT. A

STATEMENT OF FACT s

The courts’ below considered the motions to dismiss the

Complaint, the final.resolution of which is now on review

before this Court, not only on the basis of the allegations of.

the Complaint but also with’ regard to additional claims. set

forth by Petitioner in his briefs and in oral argument. Inen

~ attempt to give the Court as clear a picture as possible of

what Petitioner has claimed throughout the course of this

litigation, this “Statement of Facts” also refers to claims

made by Petitioner which do not appear in the Complaint.”

It should be understood that a reference in this brief to any

assertion by Petitioner does not mean that the Respondent

Irving admits that any such claim is true.

_ Petitioner alleges that as of the autumn of 1961, Man-

hattan was wholly-owned by defendant Bankers Life. (C.

17; App., p. 7a) At that time Bankers Life made ‘two deci-

sions which led to the events of this case. It released defen- |

dant Sweeny as President of Manhattan (CAB, p. 5), and’

it determined to sell its interest in that company. After his

discharge, Sweeny introduced the defendants Bourne and

Begole, prospective purchasers of Manhattan, to James W.

: Bourland, a Vice-President of Bankers Life charged with

arranging the sale of Manhattan. (App., p.-52a). Although

it is not alleged in the Complaint, Judge Herlands assumed

that at this ‘time Sweeny came to an agreement with Begole _

10. For purposes of this Attachment, the following abbreviations

are used in references to the Record: “€”__Complaint i in this action;

“DCB”—Petitioner’s Brief to the District Court for the Southern

District of New York; “CAB”—Petitioner’s Brief to the Court of

Appeals for the Second Circuit; “Pet.”—the Petition for a Writ of

Certiorari; “P.B. ”Petitioner’s Brief to-this Court on the merits;

and “St. C. ”—Complaint in Petitioner’s action in the Supreme Court :

of New York County. For the full names of persons ‘and entities

referred to herein, see pp. 1 and 2, supra.

30

and Bourne that he would be reinstated as President of

‘Manhattan when, and if, they acquired control of the com-

. —patiy. (App., 52a; see CAB, p: 5) Negotiations which com- —

menced in November of 1961 led to a contract for the pur-

‘chase and sale of the Manhattan shares which was executed

by Bankers Life and Begole on J anuary 19, 1962. (C. 719,

20; Avp., p. 7a; DCB, p. 8) Begole agreed to deliver to

‘Basiors Life, at a closing to be held on January 24, 1962, a

bank check or certified. check in the amount of $5,000;000.

(C..20; App., p. 7a) The Complaint dees not charge any -

misrepresentation, deceit or non-disclosure in connection

with this contract of purchase and sale.

Some time after January 19, 1962, but prior to the clos-

ing date, Bourne informed Begole that he would obtain fi-

-nancing for the stock acquisition. (C. 21; App., p. 8a)

Bourne contacted defendant Garvin, a partner in the

_ defendant brokerage firm Garvin, Bantel, and asked Garvin

to arrange with a bank to‘issue a $5,000,000 certificate of |

deposit and to grant a loan in the same amount secured by. .

that certificate. (C. 121, 22; App., p. 8a; see DCB, pp. 7-9)

Acting upon Bourne’s request, Garvin: arranged for Bel-

gian Trust to issue a $5,000,000 certificate of deposit in the

name of Manhattan. (C. 723; App. p. 8a) Garvin also

asked Belgian Banking to loan $5,000,000 to the defendant.

New England, a company controlled by Bourne, upon the

+ security of the Belgian Trust certificate of deposit to be |

issued in the name of Manhattan. (C. 123; App., p. 8a) On

January 23, 1962, in final preparation for the closing, Gar-

vin asked Gunter, an Assistant Secretary of defendant Irv-

ing, to appear at-his office the next morning with an Irving

check for $5,000,000 payable to Bankers Life. Garvin in-

formed Gunter that the check would be paid for by the deliv-

ery of securities from Chemical Bank New York-Trust Com-

pany. (C. 9124; App., p. 8a) . 7

31°

Events of January 24, 1962

On the. morning of January 24, 1962, Bourne, Sweeny,

. Begole and Gunter assembled at Garvin’s office. Begole

then executed two notes totaling $5,250,000 payable to New

England. At the same time, Begole assigned to New Eng-

land the shares of the Manhattan capital stock that he was

to receive from Bankers Life. (C 925; App., p. 8a)

Later that same morning, Sweeny, Begole, Garvin and

Gunter went to the ‘offices of Manhattan for the closing of

the sale of the Manhattan stock. There, Gunter delivered

~ a $5,000,000 Irving check to Leo Lehane, an Executive Vice-

President of Bankers Life. (C. 126; App., p. 9a; Pet., p. 6;

DCB, p. 9; CAB, p. 9) Although the Complaint does not

so state, Judge Herlands assumed that Begole did obtain

_ possession of the Manhattan stock. (App., p. 55a; see C. -

28, 38; App., pp. 9a-10a, 12a)

Following the closing, Begole, the new is shareholder

of Manhattan, installeda new Board of Directors for the

‘company. (CAB, p. 18) All previous ‘officers resigned or

were removed, and the new Board unanimously elected a °

new slate of officers which ineluded Begole as Chairman of

the Board ‘and Sweeny as both President and Treasurer.

(Bankers Life Exhibit 7-H: see ‘CAB, p. 5; Pet., p. 8 and

P.B., p.7) The new. Board then adopted resolutions (App.,

p. 122a; Bankers Life Exhibit 7- H) “which authorized:

1. President to open. beak accounts of his .

choosing, including accounts at Irving;

2. Appropriate officers to be signatories on such

accounts ; ie

3. President and. Secretary - take all necessary .

acts to effectuate intent of the above resolutions;

4. Sale of. Manhattan’ s) portfolio ss Treasury

securities; and

5. Purchase of a $5,000 000 certificate of deposit |

from Belgian Trust.

32

All of the above resolutions were submitted to the Board by

Begole, and, as no dissenting votes are indicated, must have

been passed unanimously. (See App., p. 122a; Bankers

Life Exhibit 7-H) |

Subsequent to the Directors’ meeting, United States gov-_

ernment securities were delivered from Chemical Bank to

Irving. (CAB, p. 26) The securities were sold by Garvin,

Bantel for the account of Manhattan to Secorid District

Securities. Co., Inc. The securities were delivered to the

‘purchaser, and Irving credited the $4,854,552.67 proceeds .

of sale to Manhattan’s account at Irving. (C. 27; App.,

p. 9a) Irving also received a $150,000 check of Manhattan

for deposit to Manhattan’s account. (CAB, p. 27) The

Manhattan account at Irving allegedly was ont openéd

es until the afternoon of January 24, 1962. (C..980; DCB,

p. 10; CAB, p. 10;/Pet., p. 9; P.B., p. 8)

Also on January 24, 1962, at the request of Garvin, Gun-

ter brought to the offices of Belgian Trust an Irving check-

payable to. Belgian Trust in the amount of $5,000,000. Gun-

ter gave this check to Sweeny who in turn deliv ered it to

Belgian Trust on behalf of Manhattan. Pursuant to Gar-

vin’s prior discussion with the bank, Belgian Trust then .

issued a six month $5,000, 000 certificate of deposit in the —

name of Manhattan and accepted the Irving check in pay- *

ment for it. Both Sweeny, as President-of Manhattan, and

Manhattan’s Assistant Treasurer endorsed the certificate

of deposit to New. England. ‘Bourne, as President of New

England, accepted the certificate of deposit from Sweeny,

and, in turn, endorsed it to Belgian Banking. (C. 1128; St.

C. 27; App., pp. 9a, 129a-130a; DCB, pp. 9-10; CAB, p.

10; Pet., p. 8; P.B., pp. 7-8; Plaintiff’s Exhibit 10-A)

Belgian Banking then extended two loans to New Eng-

land aggregating $5,250,000. One loan was for $5,000,000,

and as collateral for this loan Belgian Banking took posses-

sion of the Belgian Trust certificate of deposit which had

| ; 4 |

:: ne

been endorsed by Manhattan and then by New England.

The second loan was for $250,000, and as collateral Belgian

Banking took possession of the outstanding Manhattan

‘stock which had been assigned to New England by, Begole:

In payment of the first loan, Belgian Banking: ‘drew a

$5,000,000 check payable to Irving for the account of New

England and delivered it to Gunter. The $250,000 proceeds —

of the second loan were deposited by New England in an

account at Belgian Trust and were distributed, in part, as

follows: to. Garvin, Bantel—$25,000; to Begole—$50,000;

to Bourne—$50,000; and to Belgian Banking—$100,000.

(C. 1928, 29; App., pp. 9a-10a; DCB, p. 10; CAB, p. 10;

Pet., pp. 8-9;-P.B., pp. 7-8) These various payments ag-

gregate $5,225,000, and neither the Complaint nor any of —

Petitioner’s briefs contain any allegation as to the disposi-

tion of the final $25, 000 of the Belgian Banking loans to

New England. _

Later Events of 1962 7

By January 29, 1962, Irving is alleged to have made cer-

tain misleading entries on its own books, and Garvin is

accused of obtaining backdated letters signed by Bourne.

(C.N 31, 32; “App., p. 10a; DCB, p: 10; CAB, P. 10; | Pete,

— ~p. 9; P.B., p. 8)

On J ate 24, 1962, the various six-month arrangements

‘entered on J. anuary 24 expired. The Belgian Trust certifi-

cate of-deposit’ matured; the loans by Belgian Banking to

New England became cain: and the loans by New Eng-

land to Begole were due. (DCB, p. 10; Pet. p: 9; P.B., p. 8;

St.C. 131; App., Pp. 13la). The ‘Complaint and Potiiiones’s

. briefs have alleged that the response of Begole, Bourne,

Garvin, Bantel, Belgian Trust and Belgian Bank-

ing was to renew these arrangements. (C. 133; App., pp.

10a-11a; St.C. 131; App., p. 11a; Pet., p. 9; P.B,, pp.'8-9)

$74,383.56 interest ‘on the Belgian Trust CD was credited

to Manhattan’s account at Belgian Trust (See Plaintiff’s

Exhibit 179- and Exhibit D to Brief of Irving. to Second

Circuit), and the proceeds of that CD ‘were used to pur-.

‘ . chase a new Belgian Trust $5,000,000 CD for: Manhattan.

(C. 733; App., p. 10a-1la; DCB, p. 10; CAB, pp. 10 and

46; Pet., p. 9; P.B., p.9) This-certificate was delivered to

Sweeny and was kept in his own physical possession. (CAB,

p.-46; Pet.; p. 10; P.B. ,p.9) Finally, the Belgian Banking

loans to New England were. ecbnded to January 24, 1963,

and New England’s loan§ to Begole were continued to Jan- -

uary 24, 1963.. (C. 133; App., p. 10a- 11a; CAB, p. 47; Pet.,

p. 9; P.B., pp. 8-9)

In August of 1962, Sweeny allegedly returned to Belgian

Trust the CD he had been holding, and was issued a second

CD also in the name of Manhattan. (Pet., p. 10; P.B., pp.

9-10) Sweeny endorsed this. new negotiable certificate on

behalf of Manhattan, and delivered it to Belgian Trust to-

gether with instructions to deposit its proceeds upon ma-

turity.in Manhattan’s ‘account at Belgian Trust. (C. 134;

App., p. lla) Sweeny delivered that CD on the assurance

of a letter stating that it would-be held in trust for Man-

hattan. (CAB, p,47; Pet., p. 10; P.B., pp. 9-10) Belgian‘

Trust allegedly had issued that letter because Belgian ~

-Banking had received a separate letter fromm Begole author-

izing it to treat the new CD, once endorsed by Sweeny, as.”

collateral for the Belgian Banking loans to New England.

(Pet., p. 10; P.B., p: 10; St.C. 131; App., p. 131a)

At the same time Manhattan also transmitted a $500,000 °

First, National Bank of Boston certificate of deposit to Bel-

' gian Trast.. This CD was delivered pursuant to the

‘same letter from Belgian Trust which stated that it would

hold the certificates in trust. (C. 134; App., p. lla; St. C.-

169; App.vp. 139a; he 10; PB. pp. 9-10) . .

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35 .

Events of 1963

In January of 1963, Belgian Banking allegedly indicated

that it would not renew its loans to New England which

fell due on January 24, 1963. (C. 135; App., p. lla; DCB,

- p.1l; ; CAB, p-11) In response to this information, Bourne

and Begule initiated another series of transactions. (App,

p. 60a) ‘

: oe

First Transaction of January, 1963

On January 21, 1963, Begole, at the request of Bourne

and*Garvi in, instructed Irving to issue $5,500,000 in bearer

certificates of deposit for the account of Manhattan ‘and

directéd that they be delivered against payment to Garvin,

_Bantel. On January 22, 1963, Marine Midland Trust Com- '

pany of New York loaned Garvin, Bantel $5,500,000 on the |

security of the Irving bearer CDs, and the proceeds of this.

loan’ were delivered to Irving in payment: for those bearer

CDs. (St. C. 134; App. p. 132a) The Irving certificates of

deposit were delivered to Marine Midland and were held

as collateral for the loan to Garvin, Bantel. (Pet., p. 12;

P.B., p. 11). The- effect of. this transaction was to create a

$5,500,000 Manhattan deposit on the books of Irving. How-

ever, the negotiable certificates of deposit underlying this

deposit were pledged to Marine Midland as security for its

loan to Garvin, Bantel, which loan had been used to effec-

tuate payment for the certificates of deposit.

Second Transaction of January, 1963

On January 23, 1968, Sweeny, Begole, Garvin. and. an.

officer of Belgian Américan agreed that the proceeds of

Manhattan’s $5,000,000 Belgian Trust CD. and $500,000

First National Bank of Boston CD would be used to repay -

the New England Joans at Belgian Banking. Sats - 735;

App. ”? 132a)

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36 -

On J anuary 25, 1963, Belgian Trust credited Manhattan’s

account with 990,977.62: $5,075,616.44 of which repre-

sented the principal of and interest on the $5,000,000 Bel-

gian Trust certificate of’ deposit, and $515,361.18 of which

‘represented the principal of and interest on -the $500,000

First National Bank of Boston certificate. (C. 137; DCB,

p. 11; CAB, p. 11) Then, Belgian Trust issued a

$5,500,000 check“ payable to Irving and charged this

check against Manhattan’s account. (C. 37, DCB, p.

11; CAB, p. 11; Pet., p. 12; P.B.,,p. 11) Irving, at the diree-

tion of Garvin, Bantel, issued its check to Belgian Banking

in the sum of. $5,250,000. The $5,500,000 Belgian Trust

‘check . payable to Irving and the $5,250,000 Irving check

payable to Belgian Banking were exchanged at Belgian

American on January 25, 1963. Belgian Banking applied

the Irving check in payment of its $5,250,000 loans to New

England. (C. 137; App., p. 12a; St.C. 136; App., p. 132a)

At the direction of Garvin,’ Bantel, Irving credited the

$5,500,000 check payable to it to the account of Garvin,

Bantel at Irving and slebited its $5,250,000 check payable to ~

Belgian Banking to the same account. (St. C. 1365 App. ‘

p. 132a; Pet. p.12;P.B., pp.11-12)

Later, Garvin drew a check for $250,000 enecand lias the

difference between the credit and debit to the Garvin,

_ Bantel account at Irving and sent it to the Belgian Ameri-

ean Banks. There Begole and Sweeny opened a special sus-

pense account to hide those funds. (CAB, p. 49) Although

Petitioner fails to disclose the fact in the Complaint or any

‘of his briefs, Belgian American delivered ‘those funds to

Petitioner after — had been placed in liquidation.

Final Transactions of 1963 | , og _

The Complaint alleges that two additional tinipiglions

occurred before the alleged fraud was discovered. First,

on April 18, 1963,. _— Banking returned to ~— and

Ws

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a | 87 < |

Sweeny the shares of Manhattan stock’ which it had re-

ceived as collateral for its loans to New England. (C. 138;

App., p, 12a) Secondly, for thé purpose of concealing the

reduction in Manhattan’s assets, Irving allegedly certified.‘

to the New York State Insurance Department on May ib,

1963, that Manhattan had on deposit at Irving the-sum of

$5,500,000. as ‘evidenced by certificates of deposit issued on

January 21, 1963. The certification included a statement

that the certificates of deposit were free of all liens, claims,

or encumbrances and werdnot held as security for ~~ loan.

(C..139; App., pp. 12a-13a) .

On or‘ about August 22, 1963, Marine Midland Trust

Company applied the proceeds of the $5,500,000 Irving CDs, -

which had been issued on January “91, 1963, to the repay-

ment of its $5,500,000 loan to Garvin, Bantel secured by

those CDs. (St.C> 139 ; App. p. 133a) .

- Conclusion . ; . /

_ The alleged consequence of these seemingly disparate

. transactions which occurred during’ an eighteen month —

period was that the purchase of Manhattan was financed.

By its own assets. Petitioner has suggested two’ alternative *

times at which Manhattan funds may have been misappro-

priated. Under Petitioner’s first theory, Manhattap was

injured on January 24, 1962, when $5, 000,000 of $5,604,-:

552.67 (consisting of $4,;854,552:67 deposit of proceeds of

securities plus $150,000 cash deposit) in the Manhattan ac- * )

count at Irving were diverted by Begole to pay for the’

_ check to Bankers Life used for the purchase of the Manhat-

- tan stock. This theory has the advantage of stmplicity but

is incénsistent with Pétitioner’s cia theory and « certain

facts admitted by Petitioner. Ri

. Under Petitioner’s second theory, Manhattan was tajuved

- on January 25, 1963, when $5,500,000 of funds in its account

- =

-

at Belgian Trust were miproprinted: $5,250, 000 of which -

was used to repay the Belgian Banking loans to New Eng,

land and $250,000 of which was diverted by Begole and

Sweeny. Under this theory, the $5,000,000 Irving check to

Bankers Life was paid for by the $5,000,000 Belgian Bank-

ing check pra

which represente

loan to New England. _

Also under tiis theory $5,000,000 of the fonds 3 in the

Manhattan account at Irving on January 24, 1962 were |

used by Manhattan to purchase the $5,000,000 Belgian Trist

certificate of deposit issued to Manhattan on fiat date. The

proceeds of this certificate of deposit were used on July

24, 1962 to pay for a second six-month $5,000,000 Belgian -

Trust certificate of deposit. On the same day Man-

hattan’s account at Belgian Trust was credited with °

$74,383.56 interest on the. maturing certificate of deposit.

In August of 1962, the Belgian Trust certificate of deposit

which had been issued on July 24, 1962 was exchanged for

a new negotiable Belgian ‘Trust certificate of deposit in

the’same amount, and the new certificate of deposit was

delivered to Belgian Trust together with a $500,000 certifi-

edte of deposit of the First National Bank of Bostow. also

owned by’:Manhattan. Both certificates of deposit were

delivered on the assurance of a letter from Belgian Trust

- stating that they would be held in trust for Manhattan

_ and that the-proceeds would be credited to Manhattan’s

account ‘on maturity. Petitioner alleges that the -

$5,590, 977.62 principal and interest of those two CDs were

~ eredited to a Manhattan account at Belgian Trust on Janu-

_ ary 25, 1963. He further claims that thereafter $5,250, 000

of those funds were misappropriated fo repay the Belgian: |

Banking loans ay a England erry) injuring Manhattan.

»

a-

Irving for the account of New England

the proceeds of the Belgian Banking 7

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