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        Theodore Sonde, Bobby C. Lawyer, Richard O. Patterson, Edward B. Horahan, III, Washington, D. C., for Securities and Exchange Commission.

        Sherwin J. Markman, Jean S. Moore, Peter Raven-Hansen, Hogan & Hartson, Washington, D. C., for Lord, Bissell & Brook, Max E. Meyer and Louis F. Schauer.

        David Ginsburg, Lee R. Marks, Martha Jane Shay, Ginsburg, Feldman & Bress, Washington, D. C., for Cameron Brown.

        BARRINGTON D. PARKER, District Judge:

        This opinion covers the final act in a civil proceeding brought by the Securities and Exchange Commission (Commission or SEC) seeking injunctive sanctions against numerous defendants as a result of their participation in alleged securities laws violations relating to the National Student Marketing Corporation (NSMC) securities fraud scheme.¹ The original defendants included the corporation and certain of its officers and directors; the accounting firm of Peat, Marwick, Mitchell & Co. (Peat Marwick) and two of its partners; several officers and directors of Interstate National Corporation (Interstate); the law firm of White & Case and one of its partners; and the law

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firm of Lord, Bissell & Brook (LBB) and two of its partners. The majority of these defendants are not now before the Court. As discovery progressed during the pre-trial stages of this litigation, NSMC and other principal defendants consented to the entry of final judgments of permanent injunction or otherwise reached a resolution of the charges against them.² The only defendants remaining are Lord, Bissell & Brook; its two partners, Max E. Meyer and Louis F. Schauer; and Cameron Brown, a former president and director of Interstate, and presently a director of and consultant to NSMC.

        The focal point of the Commission's charges against these defendants is the corporate merger of Interstate with NSMC on October 31, 1969. The principal question presented is whether the defendants violated or aided and abetted the violation of the anti-fraud provisions of the federal securities laws in two instances: (1) consummation of the NSMC merger; and (2) the immediately following sale of newly acquired NSMC stock by former Interstate principals, including certain of the defendants. These transactions are alleged to have occurred despite the prior receipt by the defendants of information which revealed that NSMC's interim financial statements, used in securing shareholder approval of the merger and available to the investing public generally, were grossly inaccurate and failed to show the true condition of the corporation. The information was included in a comfort letter prepared by NSMC's accounts. The Commission contends that these violations demonstrate a reasonable likelihood of future misconduct by the defendants, thereby justifying the requested permanent injunctive relief.

        The matter was tried without a jury. After reviewing the extensive record in this case, the Court concludes, for the reasons stated below, that while each of the defendants violated the securities laws in specific instances, the Commission has not fulfilled its obligation of demonstrating a reasonable likelihood that they will do so in the future. Accordingly, the Commission's request for injunctive relief must be denied.

        This opinion contains the findings of fact and conclusions of law required by Rule 52 of the Federal Rules of Civil Procedure. Initially it will present the background events of this proceeding, including details of the October 31 merger of Interstate and NSMC, and the stock sales by Interstate principals. The Court then will review the Commission's allegations against the defendants in light of the applicable legal principles. Finally, the Court will address the factors involved in its determination that injunctive relief is not warranted in this instance.

        National Student Marketing Corporation was incorporated in the District of Columbia in 1966. The company enjoyed early prosperity; it grew rapidly and experienced a steady increase in assets, sales and earnings. Its common stock, which was registered with the SEC and traded on the over-the-counter market, rose from an initial public offering of $6 per share in the spring of 1968 to a high of $144 per share in mid-December 1969.³ The financial community held the company and its potential in high regard, and in anticipation of continued

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high market performance, it was seen as a good "buy" prospect. Its management was considered aggressive, imaginative and capable; if there was a question of its integrity and honesty, it did not surface in the public arena until a later period. During this period, White & Case served as its outside legal counsel, with Marion J. Epley, III, as the partner immediately in charge of the firm's representation. Peat Marwick served as its outside accountant.

        Interstate National Corporation, a Nevada corporation, was an insurance holding company. Its principal assets were several wholly-owned subsidiary insurance companies. The company's common stock was traded on the over-the-counter market and owned by approximately 1200 shareholders. Cameron Brown was president, chief executive officer, principal shareholder and a director of the company.⁴ Other Interstate principals and directors included Robert P. Tate, chairman of the board; William J. Bach, general counsel; Paul E. Allison, secretary; Louis W. Biegler; and Max E. Meyer. Between board meetings, all management authority was delegated to an executive committee composed of Brown, Tate, Bach, Allison and Biegler. Max E. Meyer, a director and shareholder, was a partner in the Chicago law firm of Lord, Bissell & Brook, which had long represented Interstate and served as its outside legal counsel in all matters relating to the merger of the corporation with NSMC. Meyer, a personal friend and legal advisor to Cameron Brown, served as the contact partner for the Interstate account and was otherwise in overall charge of his firm's representation.⁵ Another partner of the firm, Louis F. Schauer, was also involved in the merger transaction due to his experience in corporate and securities law. Peat Marwick served as Interstate's outside accountant during the period in question.

        National Student Marketing Corporation developed a reputation for having a unique and successful marketing network for selling its own and other products to college and high school students. Commencing in 1969, it undertook a highly active program to acquire companies specializing in selling goods and services to students. It was in this connection that NSMC first approached representatives of Interstate.

        Initially, NSMC discussed the possibility of acquiring an Interstate subsidiary that specialized in selling insurance to students. After Interstate indicated an unwillingness to dispose of a single subsidiary, NSMC expressed interest in acquiring its entire insurance holding company operation. Cortes W. Randell, NSMC's president and chief executive officer, proposed a merger of the two corporations, offering one share of NSMC stock for every two shares of Interstate stock.

        On June 10, 1969, NSMC representatives, including Randell and James F. Joy, a senior vice president and finance committee member, were invited before the Interstate directors to make a presentation concerning the proposed merger. The directors were provided with NSMC's 1968 annual report and its financial report for the first half of 1969. Randell discussed the company's acquisition program, reviewed several pending corporate acquisition commitments, and made certain earnings predictions for the fiscal year ending August 31, 1969. He also increased the earlier offer to two shares of NSMC common for every three shares of Interstate common. When certain Interstate directors expressed a desire to sell a portion of the NSMC stock which they expected to acquire in the merger, Randell responded that a registered public offering was planned for the fall of 1969, at which time the former Interstate shareholders

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could sell up to 25 percent of their shares.⁶ Very few questions were asked by Randell or Joy about the business and financial affairs of Interstate, an aspect of the meeting which surprised several of Interstate's representatives.

        This meeting resulted in an agreement in principle for the merger. Essentially identical press releases were then issued by the companies, announcing the agreed upon stock exchange ratio, the estimated value of the transaction as $37 million based on the current market value of NSMC stock, and the fact that the transaction represented approximately a 100 percent premium for the Interstate shares based on their market value at the time.⁷ Representations were also made in the releases as to NSMC's earnings for the first six months of fiscal 1969, which ended February 28, 1969.

        The two corporations' efforts to finalize the merger agreement were not uneventful. The initial proof of the Merger Agreement, prepared by NSMC's outside counsel, failed to provide for parallel rights and obligations of the parties. In fact, as to such matters as warranties and representations, a comfort letter from independent accountants, and counsel opinion letters on legal aspects of the merger, far more was required of Interstate than of NSMC. After insistence by Interstate, however, there was agreement to substantially parallel and mutual provisions covering those matters. On August 12, the Interstate directors met to review the final version of the agreement. A copy of a report from White, Weld & Co. (White Weld), a stock brokerage and investment consultant firm retained by Interstate to prepare an in-depth study of NSMC and the proposed merger, was made available to each director. A White Weld representative explained various aspects of the report, answered questions about NSMC's accounting procedures, and recommended the merger. Following that presentation, Louis F. Schauer, who had broad experience in corporate and securities law, reviewed and explained the agreement. A proof copy of the NSMC proxy statement was also available and examined by the directors then present. Although prepared for use in connection with the merger, that statement contained no entries in the spaces for NSMC's unaudited consolidated income statement for the nine-month period ending May 31, 1969. Because of the omission, Interstate's board chairman, Tate, refused to sign the agreement. After numerous efforts at attempting to obtain the missing proxy statement data and satisfactory answers to questions concerning the omitted data, the information was finally received by telephone. The remaining directors, including Tate, then signed the merger agreement on August 15. The added information, however, was not then analyzed or reviewed to any extent by any Interstate representative.

        The Merger Agreement set forth fully the terms and conditions of the understanding between the two corporations. Among other things, both corporations represented and warranted that the information "contained in Interstate's and NSMC's Proxy Statements relating to the transactions contemplated by this Agreement will be accurate and correct and will not omit to state a material fact necessary to make such information not misleading,"⁸ and that the financial statements included among the provisions "are true and correct and have been prepared in accordance with generally accepted accounting principles

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consistently followed throughout the periods involved."⁹ NSMC specifically referred to its 1968 year-end and May 31, 1969, nine-month financial statements and represented that those statements:

        fairly present the results of the operations of NSMC and its subsidiaries for the periods indicated, subject in the case of the nine month statements to year-end audit adjustments.¹⁰

        The Agreement also provided several conditions precedent to the obligations of the two corporations to consummate the merger. One required the receipt by NSMC of an opinion letter from Interstate's counsel LBB to the effect, inter alia, that Interstate had taken all actions and procedures required of it by law and that all transactions in connection with the merger had been duly and validly taken, to the best knowledge of counsel, in full compliance with applicable law; a similar opinion letter was required to be delivered from NSMC's counsel to Interstate.¹¹ Another condition was the receipt by each company of a "comfort letter" from the other's independent public accountants. Each letter was required to state: (1) that the accountants had no reason to believe that the unaudited interim financial statements for the company in question were not prepared in accordance with accounting principles and practices consistent with those used in the previous year-end audited financials; (2) that they had no reason to believe that any material adjustments in those financials were required in order fairly to present the results of operations of the company; and (3) that the company had experienced no material adverse change in its financial position or results of operations from the period covered by its interim financial statement up to five business days prior to the effective date of the merger.¹² Although setting forth these specific conditions to consummation of the merger, the final paragraph of the Agreement also provided that:

        Anything herein to the contrary notwithstanding and notwithstanding any stockholder vote of approval of this Agreement and the merger provided herein, this Agreement may be terminated and abandoned by mutual consent of the Boards of Directors of NSMC and Interstate at any time prior to the Effective Date and the Board of Directors of any party may waive any of the conditions to the obligations of such party under this Agreement.¹³

        Finally, the Agreement specified that "[t]he transactions contemplated herein shall have been consummated on or before November 28, 1969."¹⁴

        Both NSMC and Interstate utilized proxy statements and notices of special stockholder meetings to secure shareholder approval of the proposed merger. Interstate's materials included a copy of the Merger Agreement and NSMC's Proxy Statement; the latter contained NSMC's financial statements for the fiscal year ended August 31, 1968, and the nine-month interim financial statement for the period ending May 31, 1969. Interstate shareholders were urged to study the NSMC Proxy Statement:

        The NSMC Proxy Statement contains a description of each company, relevant financial statements, comparative per share data and other information important to your consideration of the proposed merger. You are urged to study the NSMC Proxy Statement, hereby incorporated as part of this Proxy Statement, prior to voting your shares.¹⁵

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        The boards of both companies recommended approval of the merger and at special shareholder meetings that approval was secured by large majorities.¹⁶

        In mid-October, Peat Marwick began drafting the comfort letter concerning NSMC's unaudited interim financials for the nine-month period ended May 31, 1969. As issued by NSMC, those financials had reflected a profit of approximately $700,000.

        Soon after beginning work on the comfort letter, Peat Marwick representatives determined that certain adjustments were required with respect to the interim financials. Specifically, the accountants proposed that a $500,000 adjustment to deferred costs, a $300,000 write-off of unbilled receivables, and an $84,000 adjustment to paid-in capital be made retroactive to May 31 and be reflected in the comfort letter delivered to Interstate. Such adjustments would have caused NSMC to show a loss for the nine-month period ended May 31, 1969, and the company as it existed on May 31 would have broken even for fiscal 1969. Although Peat Marwick discussed the proposed adjustments with representatives of NSMC, neither the accountants nor NSMC informed Interstate of the adjustments prior to the closing.¹⁷ A draft of the comfort letter, with the adjustments, was completed on October 30 and on the next day, the morning of the closing, it was discussed among senior partners of Peat Marwick.

        The closing meeting for the merger was scheduled at 2 p.m. on Friday, October 31, at the New York offices of White & Case. Brown, Meyer and Schauer were present in addition to Interstate directors Bach, Allison and Tate. The representatives of NSMC included Randell, Joy, John G. Davies, their attorney Epley and other White & Case associates.

        Although Schauer had had an opportunity to review most of the merger documents at White & Case on the previous day, the comfort letter had not been delivered. When he arrived at White & Case on the morning of the merger, the letter was still not available, but he was informed by a representative of the firm that it was expected to arrive at any moment.

        The meeting proceeded. When the letter had not arrived by approximately 2:15 p. m., Epley telephoned Peat Marwick's Washington office to inquire about it. Anthony M. Natelli, the partner in charge, thereupon dictated to Epley's secretary a letter which provided in part:

        [N]othing has come to our attention which caused us to believe that:

        1. The National Student Marketing Corporation's unaudited consolidated financial statements as of and for the nine months ended May 31, 1969:

        a. Were not prepared in accordance with accounting principles and practices consistent in all material respects with those followed in the preparation of the audited consolidated financial statements which are covered by our report dated November 14, 1968;

        b. Would require any material adjustments for a fair and reasonable presentation of the information shown except

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with respect to consolidated financial statements of National Student Marketing Corporation and consolidated subsidiaries as they existed at May 31, 1969 and for the nine months then ended, our examination in connection with the year ended August 31, 1969 which is still in process, disclosed the following significant adjustments which in our opinion should be reflected retroactive to May 31, 1969:

        1. In adjusting the amortization of deferred costs at May 31, 1969, to eliminate therefrom all costs for programs substantially completed or which commenced 12 months or more prior, an adjustment of $500,000 was required. Upon analysis of the retroactive effect of this adjustment, it appears that the entire amount could be determined applicable to the period prior to May 31, 1969.

        2. In August 1969 management wrote off receivables in amounts of $300,000. It appears that the uncollectibility of these receivables could have been determined at May 31, 1969 and such charge off should have been reflected as of that date.

        3. Acquisition costs in the amount of $84,000 for proposed acquisitions which the Company decided not to pursue were transferred from additional paid-in capital to general and administrative expenses. In our opinion, these should have been so transferred as of May 31, 1969.

        2. During the period from May 31, 1969 to October 28, 1969 there has been no material adverse change in the consolidated financial position of National Student Marketing Corporation and its consolidated subsidiaries, or any material adverse change in results of operations of National Student Marketing Corporation and its consolidated subsidiaries as compared with the nine month period ended May 31, 1969 after giving retroactive effect at May 31, 1969 of the adjustments disclosed above.¹⁸

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Epley delivered one copy of the typed letter to the conference room where the closing was taking place. Epley then returned to his office.

        Schauer was the first to read the unsigned letter. He then handed it to Cameron Brown, advising him to read it. Although there is some dispute as to which of the Interstate representatives actually read the letter, at least Brown and Meyer did so after Schauer. They asked Randell and Joy a number of questions relating to the nature and effect of the adjustments. The NSMC officers gave assurances that the adjustments would have no significant effect on the predicted year-end earnings of NSMC and that a substantial portion of the $500,000 adjustments to deferred costs would be recovered. Moreover, they indicated that NSMC's year-end audit for fiscal 1969 had been completed by Peat Marwick, would be published in a couple of weeks, and would demonstrate that NSMC itself had made each of the adjustments for its fourth quarter. The comfort letter, they explained, simply determined that those adjustments should be reflected in the third quarter ended May 31, 1969, rather than the final quarter of NSMC's fiscal year. Randell and Joy indicated that while NSMC disagreed with what they felt was a tightening up of its accounting practices, everything requested by Peat Marwick to "clean up" its books had been undertaken.^18A

        At the conclusion of this discussion, certain of the Interstate representatives, including at least Brown, Schauer and Meyer, conferred privately to consider their alternatives in light of the apparent nonconformity of the comfort letter with the requirements

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of the Merger Agreement.¹⁹ Although they considered the letter a serious matter and the adjustments as significant and important, they were nonetheless under some pressure to determine a course of action promptly since there was a 4 p.m. filing deadline if the closing were to be consummated as scheduled on October 31.²⁰ Among the alternatives considered were: (1) delaying or postponing the closing, either to secure more information or to resolicit the shareholders with corrected financials; (2) closing the merger; or (3) calling it off completely.

        The consensus of the directors was that there was no need to delay the closing. The comfort letter contained all relevant information and in light of the explanations given by Randell and Joy, they already had sufficient information upon which to make a decision. Any delay for the purpose of resoliciting the shareholders was considered impractical because it would require the use of year-end figures instead of the stale nine-month interim financials. Such a requirement would make it impossible to resolicit shareholder approval before the merger upset date of November 28, 1969, and would cause either the complete abandonment of the merger or its renegotiation on terms possibly far less favorable to Interstate. The directors also recognized that delay or abandonment of the merger would result in a decline in the stock of both companies, thereby harming the shareholders and possibly subjecting the directors to lawsuits based on their failure to close the merger. The Interstate representatives decided to proceed with the closing. They did, however, solicit and receive further assurances from the NSMC representatives that the stated adjustments were the only ones to be made to the company's financial statements and that 1969 earnings would be as predicted. When asked by Brown whether the closing could proceed on the basis of an unsigned comfort letter, Meyer responded that if a White & Case partner assured them that this was in fact the comfort letter and that a signed copy would be forthcoming from Peat Marwick, they could close. Epley gave this assurance. Meyer then announced that Interstate was prepared to proceed, the closing was consummated, and a previously arranged telephone call was made which resulted in the filing of the Articles of Merger at the Office of the Recorder of Deeds of the District of Columbia.²¹ Large packets of merger documents, including the required counsel opinion letters, were exchanged.²² The closing was

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solemnized with a toast of warm champagne.

        Unknown to the Interstate group, several telephone conversations relating to the substance of the comfort letter occurred on the afternoon of the closing between Peat Marwick representatives and Epley. The accountants were concerned with the propriety of proceeding with the closing in light of the adjustments to NSMC's nine-month financials. One such conversation occurred after Epley delivered the unsigned letter to the Interstate participants but before the merger had been consummated. At that time Epley was told that an additional paragraph would be added in order to characterize the adjustments. The paragraph recited that with the noted adjustments properly made, NSMC's unaudited consolidated statement for the nine-month period would not reflect a profit as had been indicated but rather a net loss, and the consolidated operations of NSMC as they existed on May 31, 1969, would show a break-even as to net earnings for the year ended August 31, 1969. Epley had the additional paragraph typed out, but failed to inform or disclose this change to Interstate. In a second conversation, after the closing was completed and the Interstate representatives had departed, Epley was informed of still another proposed addition, namely, a paragraph urging resolicitation of both companies' shareholders and disclosure of NSMC's corrected nine-month financials prior to closing. To this, he responded that the deal was closed and the letter was not needed. Peat Marwick nonetheless advised Epley that the letter would be delivered and that its counsel was considering whether further action should be taken by the firm.

        The final written draft of the comfort letter arrived at White & Case late that afternoon. Peat Marwick believed that Interstate had been informed and was aware of the conversations between its representatives and Epley and of its concern about the adjustments.²³ Because of this belief and especially since the merger had been closed without benefit of the completed letter, Peat Marwick's counsel perceived no obligation to do anything further about the merger. Nonetheless, a signed copy of the final letter was sent to each board member of the two companies, presumably in an effort to underline the accountants' concern about consummation of the merger without shareholder resolicitation.

        The signed comfort letter was delivered to the Interstate offices on Monday, November 3. It was first seen and read by Donald Jeffers, Interstate's chief financial officer. He had not been present at the October 31 closing or informed of the adjustments to the interim financials. Concerned, he contacted Brown immediately and read the letter to him. Since a meeting with other Interstate principals was scheduled for the next morning the letter was added to the other matters to be discussed.

        The signed letter was virtually identical to the unsigned version delivered at the closing, except for the addition of the following two paragraphs:

        Your attention is called, however, to the fact that if the aforementioned adjustments had been made at May 31, 1969 the unaudited consolidated statement of earnings of National Student Marketing Corporation would have shown a net loss of approximately $80,000. It is presently estimated that the consolidated operations

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of the company as it existed at May 31, 1969 will be approximately a break-even as to net earnings for the year ended August 31, 1969.

        In view of the above mentioned facts, we believe the companies should consider submitting corrected interim unaudited financial information to the shareholders prior to proceeding with the closing.²⁴

        The only other change was the reduction in the write-off to receivables from $300,000 to $200,000, making total negative adjustments to NSMC's nine-month financials in the amount of $784,000.

        At the meeting the following day, the matter was fully discussed by the former Interstate principals. Of particular concern were the additional "break-even" and "resolicitation" paragraphs.²⁵ Brown explained what had occurred at the closing and the reasons for the decision to consummate the merger. He called Meyer at LBB, who by that time was also aware of the letter. After some discussion, it was decided that more information was needed. Brown and Jeffers agreed to contact Peat Marwick and Meyer agreed that his firm would contact Epley at White & Case.

        On that afternoon, Schauer contacted Epley by telephone. Epley stated that he had not known of the additional paragraphs until after the closing. He added that in any case the additions did not expand upon the contents of the earlier unsigned letter; the "break-even" paragraph simply reflected the results of an arithmetic computation of the effects of the adjustments, and the "resolicitation" paragraph was gratuitous and a matter for lawyers, not accountants. While Schauer disagreed, Epley again responded that the additional paragraphs made no difference and that NSMC regarded the deal as closed.

        Brown and Jeffers fared no better with Peat Marwick. That company's representative, Cormick L. Breslin, met briefly with several Interstate representatives on November 4. He could give no information concerning the matter other than that he had not seen a similar letter before and thought it was rather unusual.²⁶ Later, when contacted again by Brown, Breslin stated that the letter would have to speak for itself and his company would provide no additional information, comment or advice.

        Over the next several days the Interstate directors continued their discussion of the matter, consulting frequently with their counsel, Meyer and Schauer. As they viewed it, the available options were to attempt to undo the merger, either permanently or until the shareholders could be resolicited, or to leave things as they were. The attorneys indicated that rescission would be impractical, if not impossible, since Interstate no longer existed and NSMC had indicated that it would oppose any effort to undo the merger. Meanwhile, the market value of NSMC stock continued to increase, and the directors noted that any action on their part to undo the merger would most likely adversely affect its price. By the end of the week, the decision was made to abstain from any action. Thereafter, Brown issued a memorandum to all Interstate employees announcing completion of the merger. No effort was ever made by any of the defendants to disclose

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the contents of the comfort letter to the former shareholders of Interstate, the SEC or to the public in general.

        Early in the negotiations the principal Interstate shareholders understood that they would be able to sell a portion of the NSMC stock received in the merger through a public offering planned for the fall of 1969. Various shareholders, including Brown, Tate, Allison, Bach and Meyer, intended to profit by this opportunity and sell up to 25 percent of their newly acquired stock. The opportunity did not materialize, however, because within several days of the merger the NSMC operating committee decided to postpone the registration. Brown was advised that the shareholders could still sell up to 25 percent of their shares in a private placement under SEC Rule 133.²⁷ If they so decided, he was urged to have all use the same broker to avoid upsetting the market for the stock.

        Brown then contacted Henry Meers, a personal friend and a partner in the White Weld brokerage firm, advised him of their desire to sell and inquired as to whether he could handle the transaction. Meers reported back that his firm could proceed. Brown then received the necessary authorization from the other shareholders and agreed with Meers that the sale would take place on the day of the merger closing. Meers indicated that the sale price could only be determined the day before the closing due to price fluctuations and, on October 30, the two agreed on a price of $49.50 per share.²⁸

        Two matters of significance to the stock sales occurred on the day of the closing. First, certain of the Interstate principals, including Brown, were informed that the amount of NSMC shares they could sell following the merger was limited due to a restriction on their Interstate stock. As a result, Brown was limited to selling only about seven percent of his newly acquired NSMC stock instead of the 25 percent previously planned.²⁹ Second, NSMC's inhouse

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counsel Davies told Schauer that NSMC wanted an opinion from LBB in connection with the stock sales. As outlined in a memorandum prepared by White & Case for NSMC, the requested opinion was to state that LBB had made initial factual determinations as to whether the sales comported with the requirements of Rule 133(d).³⁰ White & Case would then consult with NSMC and prepare its own final opinion letter as to the validity of the sales under the rule. After discussing the matter with Davies, Schauer indicated that there would be no problem delivering the letter in the form and language requested.

        White Weld began processing the sales on the afternoon of October 31. It subsequently sold a total of 59,500 shares of NSMC stock. The gross received was slightly less than $3 million. Brown received approximately $500,000 for his shares and Meyer received approximately $86,000 for the shares he held, including $10,000 for shares he owned and the balance for shares he held in trust for the benefit of Brown and Brown's family. White Weld was never informed of the comfort letter adjustments before it undertook the sale as agents for the Interstate principals.

        Later that week a letter from Brown to NSMC and an opinion letter from LBB to NSMC, both of which addressed the Rule 133 matters, were drafted and delivered to NSMC.³¹ Though prepared sometime during

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the week of November 3, the papers were dated October 31.

        Following the acquisition of Interstate and several other companies NSMC stock rose steadily in price, reaching a peak in mid-December. However, in early 1970, after several newspaper and magazine articles appeared questioning NSMC's financial health, the value of the stock decreased drastically. Several private lawsuits were filed and the SEC initiated a wide-ranging investigation which led to the filing of this action.

        The Court has jurisdiction of this proceeding under § 22(a) of the Securities Act of 1933 (1933 Act)³² and § 27 of the Securities Exchange Act of 1934 (1934 Act).³³ In seeking injunctive relief against the defendants, the Securities and Exchange Commission relies upon § 21(e) of the 1934 Act which in relevant part provides:

        Whenever it shall appear to the Commission that any person is engaged or is about to engage in acts or practices constituting a violation of any provision of this chapter [or] the rules or regulations thereunder, . . . it may in its discretion bring an action . . . to enjoin such acts or practices, and upon a proper showing a permanent or temporary injunction or restraining order shall be granted . . ..³⁴

        Section 20(b) of the 1933 Act, also relied upon by the Commission, is to the same effect.³⁵ Each statutory provision requires the Commission to make a "proper showing" that an injunction is warranted, a showing that the Commission attempts to make in this case by proving two instances of past violations by the defendants from which future violations can be inferred and injunctive relief justified.³⁶ Specifically, the Commission alleges that the defendants, both as principals and as aiders and abettors, violated § 10(b) of the 1934 Act,³⁷ Rule 10b-5 promulgated thereunder,³⁸ and

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§ 17(a) of the 1933 Act,³⁹ through their participation in the Interstate/NSMC merger and subsequent stock sales by Interstate principals, in each instance without disclosing the material information revealed by the Peat Marwick comfort letter.⁴⁰

        The Commission, in what appears to be typical fashion, SEC v. Barraco, 438 F.2d 97, 99-100 (10th Cir. 1971), makes little effort to distinguish between principals and aiders and abettors in its charges against the defendants. Although the significance of the distinction between primary and secondary liability may be dwindling in light of recent developments, see Note, Rule 10b-5 Liability after Hochfelder: Abandoning the Concept of Aiding and Abetting, 45 U.Chi.L.Rev. 218 (1977), the distinction nonetheless provides a means by which the violations can be specified and the defendants' conduct qualified. Thus, the Court will attempt to sort through the SEC allegations and delineate which charge principal violations of the antifraud provisions and which charge aiding and abetting.

        The Commission charges Brown and Meyer with responsibility for proceeding with the merger of Interstate and NSMC. Since shareholder approval of the merger was secured in part on the basis of the nine-month financials which the comfort letter indicated were inaccurate, the SEC contends that Brown and Meyer should have refused to close until the shareholders could be resolicited with corrected financials. The Commission also charges the two directors with effecting the sale of NSMC stock following the merger, without first disclosing the information contained in the comfort letter. These allegations clearly constitute charges of principal violations of the antifraud provisions. See 3 A. Bromberg, Securities Law: Fraud § 8.5 (515) (1970). In addition, Brown is specifically charged with aiding and abetting sales of NSMC stock by Interstate principals through his issuance, with Schauer's assistance, of the Rule 133 letter to NSMC.

        Numerous charges, all of which appear to allege secondary liability, are leveled against the attorney defendants. Schauer is charged with "participating in the merger between Interstate and NSMC,"⁴¹ apparently referring to his failure to interfere with the closing of the merger after receipt of the comfort letter. Such inaction, when alleged to facilitate a transaction, falls under the rubric of aiding and abetting. See Kerbs v. Fall River Industries, Inc., 502 F.2d 731, 739-40 (10th Cir. 1974). Both Schauer and Meyer are charged with issuing false opinions in connection with the merger and stock sales, thereby facilitating each transaction, and with acquiescence in the merger after learning the contents of the signed comfort letter. The Commission contends that the attorneys should have refused to issue the opinions in view of the adjustments revealed by the unsigned comfort letter, and after receipt of the signed version, they should have withdrawn their

Page 701

opinion with regard to the merger and demanded resolicitation of the Interstate shareholders. If the Interstate directors refused, the attorneys should have withdrawn from the representation and informed the shareholders or the Commission. The SEC specifically characterizes the attorneys' conduct in issuing the Rule 133 opinion as aiding and abetting, and because their alleged misconduct with regard to the merger also appears sufficiently removed from the center of that transaction, it too will be considered under a charge of secondary liability. See SEC v. Coven, 581 F.2d 1020 (2d Cir. 1978); SEC v. Spectrum, Ltd., 489 F.2d 535, 541 (2d Cir. 1973); 3 A. Bromberg, supra. And finally, LBB is charged with vicarious liability for the actions of Meyer and Schauer with respect to the attorneys' activities on behalf of the firm.⁴²

        Since any liability of the alleged aiders and abettors depends on a finding of a primary violation of the antifraud provisions, the Court will first address the issues relating to the Commission's charges against the principals. If the evidence presented demonstrates that there was a violation in either instance the Court will then proceed to discuss whether the conduct of the various defendants also constituted aiding and abetting. In determining whether the Commission has shown violations of the securities laws by the defendants, the Court will employ a preponderance of the evidence standard of proof.⁴³

        The antifraud provisions effectuate the federal securities laws' purpose of full disclosure and prevention of unfair practices by proscribing the sale or purchase of any security through fraud, or through the use of materially false or misleading statements or omissions. If the requisite level of culpability is demonstrated, any material misstatement or omission with a sufficient nexus to the transfer of a

Page 702

security constitutes a violation.⁴⁴ Each of these principal elements will be examined separately in the context of the allegations made by the Commission. The requirement that there be a nexus between the defendants' conduct and a sale of a security will be discussed first, followed by consideration of materiality and scienter.

        For the SEC to prove a violation of the antifraud provisions, it must demonstrate that the alleged misconduct was "in the offer or sale" of a security under § 17(a) or "in connection with the purchase or sale" of a security under § 10(b) and Rule 10b-5. The Commission has made the requisite showing for each of the provisions with respect to the defendants' activities leading to the closing of the merger. SEC v. National Securities, Inc., 393 U.S. 453, 467, 89 S.Ct. 564, 21 L.Ed.2d 668 (1969); SEC v. Savoy Industries, Inc., 190 U.S.App.D.C. ___, at ___, 587 F.2d 1149, at 1171 (1978). However, the defendants⁴⁵ contest the SEC's evidence with respect to the nexus between the defendants' conduct and the stock sales by Interstate principals, and between the defendants' conduct during the week of November 3 and either of the "sales" alleged by the Commission.

        The defendants' principal argument is directed to the alleged nexus between their conduct and the stock sales. They contend there is no nexus between their actions and the stock sales since the Interstate principals committed themselves to sell the NSMC stock before receiving the unsigned comfort letter on October 31. Because the time of commitment is the "sale" for purposes of the antifraud provisions, they assert that their failure to disclose after-acquired information does not fall within the statutory proscription. Their second contention, that there was no connection between their conduct during the week following the merger and the merger or stock sales, is similar. Their position is that both "sales" occurred prior to their actions or inaction during that week, and therefore could not be affected by their alleged misconduct at that time.⁴⁶

        The Commission's response is primarily directed to the first of the defendants' contentions. It argues that no valid commitment could have been made with respect to the stock sales since White Weld was not a purchaser of the NSMC stock, but only an agent for the defendants. Further, even if a commitment could have been made with their agent, the defendants could not and did not make such a commitment prior to the time they received the unsigned Peat Marwick comfort letter at the closing. The Court finds the latter argument persuasive.⁴⁷

Page 703

        In the seminal case of SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969), the Second Circuit held that liability for insider trading violations of Rule 10b-5 attaches at the time the commitment to buy or sell is made and not when the transaction is ultimately consummated. 401 F.2d at 853 n. 17. The rationale for using the moment of commitment as the critical point in time derives from the underlying purpose of the antifraud provisions to protect the investment decision from inadequate disclosure and misrepresentations. Once the decision is made and the parties are irrevocably committed to the transaction, there is little justification for penalizing alleged omissions or misstatements which occur thereafter and which have no effect on the decision.

        A party does not, within the intendment of Rule 10b-5, use material inside information unfairly when he fulfills contractual commitments which were incurred by him previous to his acquisition of that information, for . . . the Rule imposes "no obligation to pull back from a commitment previously made by the buyer and accepted by the seller because of after acquired knowledge." The goal of fundamental fairness in the securities marketplace is achieved by such a determination.

        Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 891 (2d Cir. 1972). Accord, Pittsburgh Coke & Chem. Co. v. Bollo, 421 F.Supp. 908, 923 (E.D.N.Y.1976) (dicta), aff'd on other grounds, 560 F.2d 1089 (2d Cir. 1977); Goodman v. Poland, 395 F.Supp. 660, 689-91 (D.Md.1975).

        In view of this authority the Court must focus its attention on the point in time, relative to receipt of the unsigned comfort letter, when the Interstate principals committed themselves to sell their NSMC stock.⁴⁸ This commitment has been defined as "the point at which, in the classical contractual sense, there was a meeting of the minds of the parties . . .." Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d at 891.

        The defendants urge that the "meeting of the minds" occurred prior to the receipt of the comfort letter, specifically on October 30 when Brown and Meers agreed on the price to be paid for the stock. As support they point to the price paid for the stock $49.50 per share⁴⁹ and a telephone conversation between Brown and Tate on November 3, during which Brown stated that he expected Tate to abide by the commitment made on October 30.⁵⁰ The Commission, on the other hand, argues that no valid commitment could have been made until the merger was consummated and the defendants had received their NSMC stock. In addition, it relies on the testimony of the defendants, that they did not intend to sell NSMC stock unless the merger took place, as support for the lack of a commitment as a factual matter. Under these circumstances,

Page 704

asserts the Commission, no commitment was made by the defendants until the merger was consummated and they had received their NSMC stock.⁵¹

        The Commission's position is persuasive and indeed the evidence supports that conclusion. While the defendants may have felt committed on October 30 to the price and number of shares to be sold following the merger, the evidence clearly shows that they had no expectation or duty to proceed with the sales if the merger was aborted.⁵² Such a conditional commitment is not what the courts had in mind when setting the time of commitment as the critical point for antifraud analysis. It is not some magical incantation of "commitment" that sets the point at which disclosure is no longer mandated, but rather the nature of the commitment. In order to prevent the unfair use of material inside information, the commitment must irrevocably bind the parties to their agreement, without regard to further action or inaction on their part. See Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d at 890-91; SEC v. Texas Gulf Sulphur Co., 401 F.2d at 853 n. 17.

        Goodman v. Poland, supra, illustrates the type of commitment required to terminate the duty to disclose material information. The defendants in that case had entered into oral stock purchase agreements with various stockholders during the period from February 28 through March 5. Each of the agreements was subject to certain conditions, with the last being expressly conditioned on all minority stockholders agreeing to sell their securities. Specific terms of a final agreement were left to be worked out by counsel. Although the defendants signed the completed agreement on March 15, it was not until March 25 that all parties had signed, and not until April 15 that the signed agreements were exchanged and the securities delivered. The court, following the reasoning of Radiation Dynamics, first concluded that the duty to disclose terminated on the date of commitment. It then looked to the relevant dates to determine which one met the requirements of a commitment:

        While it is true that the [defendants] had entered into oral agreements with certain of the plaintiffs herein, those agreements were contingent upon a certain number, or upon all, of the dissident minority stockholders agreeing to sell their securities. That condition was repeatedly emphasized by the [defendants], and the written Agreement of March 15, 1968 itself provided that it would not be binding until all the minority stockholders had signed. This Court, therefore, finds that the parties were not committed to one another until March 25, 1968, when all of the dissident minority stockholders had signed the written Agreement of Purchase and Sale.

        395 F.Supp. at 691.

        The circumstances here are virtually identical. Although Brown, Meyer and the other Interstate principals had agreed to certain aspects of the stock sale prior to receipt of the comfort letter, they had no intention or obligation to proceed with the sale absent the consummation of the merger of the two companies.⁵³ The Merger Agreement specifically stated that the obligation of either company to proceed with the merger was subject to the performance of certain conditions. Those conditions, and the recognition by the defendants that the stock sale would not occur unless the merger was consummated, barred the existence of a binding, irrevocable commitment. The earliest point at which such a commitment could have been made was after the closing

Page 705

on October 31, when the merger had been completed and the conditions removed.

        This conclusion is particularly justified here, where the defendants themselves played a significant role with respect to fulfilling the conditions for the merger and stock sale. Antifraud liability should not be foreclosed under such circumstances; otherwise, an insider could remain silent upon receiving material information, secure in the knowledge that he is free either to let the merger and sale proceed or to cancel them both by exercising his control over previously set conditions, whichever course appears financially more beneficial. It is this opportunity for unfair advantage that the securities laws prohibit. See Radiation Dynamics, Inc. v. Goldmuntz, supra; SEC v. Texas Gulf Sulphur Co., supra. The defendants having received the unsigned comfort letter prior to the "sale" of NSMC stock by the Interstate principals, their initial contention that the failure to disclose did not have a sufficient nexus with the transactions must be rejected.

        Their second argument, however, concerning the lack of a causal relationship between the events of the week of November 3 and either of the "sales" alleged by the Commission, presents a different situation. The SEC has limited its charges against the present defendants to alleged violations with respect to the merger and the sale of NSMC stock by the Interstate principals.⁵⁴ Each of these "sales" occurred on October 31, immediately following the consummation of the merger. The events of the following week could not have had any effect on either of the transactions and thus fail to meet the nexus requirement. Nevertheless, they may be considered on a limited basis as "relevant to showing non-disclosure or fraud with respect to events before that date." Goodman v. Poland, 395 F.Supp. at 691.

        Also essential to an alleged violation of the antifraud provisions is that the omission or misstatement be material. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976), the Supreme Court articulated the legal standard of materiality with respect to misleading proxy statements.⁵⁵ The Court emphasized that "[t]he question of materiality . . . is an objective one, involving the significance of an omitted or misrepresented fact to a reasonable investor." 426 U.S. at 445, 96 S.Ct. at 2130. Elaborating further, the Court stated:

        An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. This standard is fully consistent with Mills' [Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970)] general description of materiality as a requirement that "the defect have a significant propensity to affect the voting process." It does not require proof of a substantial

Page 706

likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.

        426 U.S. at 449, 96 S.Ct. at 2132 (footnote omitted). Thus, the trier of fact must consider all the circumstances surrounding the transaction and then objectively must assess the inferences a reasonable shareholder would draw from the omitted or misrepresented facts and the significance of those inferences to him in his investment decision.

        In the present case, the alleged misstatement or omission is the failure to disclose, either to the Interstate shareholders or to the purchasers of the NSMC stock sold by Interstate principals following the merger, the adjustments contained in the unsigned comfort letter delivered at the October 31 closing.⁵⁶ Although the defendants contend that the adjustments were not material, and make several arguments in support of that position, the Court concludes that the defendants have misconceived the legal standard of materiality and that the evidence presented clearly demonstrates that the comfort letter adjustments would have assumed "actual significance in the deliberations of the reasonable shareholder" or investor, and were therefore material.

        Initially, the sheer magnitude of the adjustments supports a finding that they were material. The interim financials issued by NSMC reflected a profit of $702,270 for the nine-month period ended May 31, 1969. Peat Marwick, NSMC's independent accountants, determined that significant negative adjustments were required to be made in those financials to make them not misleading.⁵⁷ Those adjustments, contained in the unsigned comfort letter and referred to therein as "significant", included a $500,000 adjustment to deferred costs, a $300,000 write-off of unbilled receivables, and an $84,000 adjustment to paid-in capital, all of which were retroactive to May 31, 1969.⁵⁸ The aggregate adjustments amounted to $884,000, thereby reducing the reported profit by 125 percent and resulting in a net loss for the nine-month period of approximately $180,000. Viewing these figures alone, it is difficult to imagine how the adjustments could not be material.⁵⁹

Page 707

        The defendants, however, disagree. Among other things, they argue that the comfort letter adjustments were not material to the merger transaction because they failed to reflect accurately the financial status of NSMC as it existed on October 31, the date of the closing and the time at which Brown, Meyer and the other Interstate principals were required to decide whether to proceed with the closing or to abandon the merger, at least on its existing terms.⁶⁰

        In making this argument, the defendants ignore the fact that the Interstate shareholders made their investment decision to approve the merger a few weeks before the date of the closing, and on the basis of information provided them at that time, largely consisting of the Interstate proxy materials. Therefore, in determining whether the comfort letter adjustments were material, consideration must be given to the information available to the shareholders at the time they approved the merger, not to whatever additional information was available to the Interstate representatives at the closing. See TSC Industries, Inc. v. Northway, Inc., supra; Mills v. Electric Auto-Lite Co., 396 U.S. 375, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970);⁶¹ SEC v. Texas Gulf Sulphur Co., 401 F.2d at 862.

        In a merger transaction such as that presented here, accurate financial information is necessary in order for a shareholder fairly to be able to vote. "Perhaps nothing is more relevant to a vote on whether or not to approve a merger than the earnings picture of the acquiring company, at least to the stockholder of the company being acquired." Republic Technology Fund, Inc. v. Lionel Corp., 483 F.2d 540, 547 (2d Cir. 1973), cert. denied, 415 U.S. 918, 94 S.Ct. 1416, 39 L.Ed.2d 472 (1974). "Accordingly, failure to convey these earnings accurately, if the discrepancy is at all substantial, has to be material to the person being misled." 483 F.2d at 551; Kaiser-Frazer Corp. v. Otis & Co., 195 F.2d 838, 840 (2d Cir.), cert. denied, 344 U.S. 856, 73 S.Ct. 89, 97 L.Ed. 664 (1952).

        The interim financials issued by NSMC for the nine-month period were included in the proxy materials sent to the shareholders of Interstate and NSMC. Although the shareholders were also sent audited year-end financials for 1968, the interim statements were NSMC's most current earnings statements available to the Interstate shareholders at the time they approved the merger. As such, they would clearly be of importance to the shareholders of the acquired company in deciding whether to approve the merger.

        Moreover, in this instance the Interstate shareholders were specifically informed of the importance of the NSMC financial statements by the proxy materials sent them in connection with the proposed merger. They were advised "to study the NSMC Proxy Statement, hereby incorporated as part of this Proxy Statement, prior to voting your shares," because the NSMC

Page 708

Proxy Statement contained, among other things, "relevant financial statements . . important to your consideration of the proposed merger."⁶² The proxy materials also contained copies of the Merger Agreement, which not only represented and warranted that the financial statements of NSMC were accurate and truthful, but in addition, provided a specific requirement of a comfort letter from NSMC's independent accountants to the effect that they had no reason to believe that the unaudited interim financial statements for the nine months ended May 31, 1969, were not prepared in accordance with generally accepted accounting principles or that any material adjustments were necessary to present accurately the results of NSMC's operations. These provisions effectively assured the Interstate shareholders that the financial statements would be accurate. The comfort letter requirement provided an extra measure of assurance, since its receipt by Interstate was a condition precedent to effectuation of the shareholders' investment decision.⁶³

        The defendants also urge that the conduct of Brown, Meyer and other Interstate representatives at the closing evidences the lack of materiality with respect to the comfort letter adjustments. Those actions, however, are not determinative of materiality since, as noted, that question "is an objective one, involving the significance of an omitted or misrepresented fact to a reasonable investor," TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 445, 96 S.Ct. at 2130 (emphasis added), not the significance of the information to various individual investors.⁶⁴

        In any event, even if their conduct and the information available to them at the time of the merger were determinative of materiality, the evidence presented reveals that though the Interstate representatives may not have considered the adjustments decisive to their decision to close the merger, they clearly considered them important and significant in other words, material. Upon receipt of the comfort letter, Schauer read it and immediately gave it to Brown, advising him to read it as well. Thereafter, the Interstate representatives questioned those present from NSMC concerning the meaning and effect of the adjustments. They then caucused privately to consider their course of action in light of the information in the letter. They discussed various options, including postponement or calling off the merger. Returning to the conference room, they asked further questions of the NSMC representatives

Page 709

about the adjustments. After receiving assurances as to the accuracy of the year-end earnings estimates and that the adjustments in the comfort letter were the only ones required to be made in the interim financials, the Interstate representatives decided to proceed with the closing. The fact that, after taking these various precautions, Brown, Meyer, and other Interstate representatives made a business judgment that the merger was still in the best interests of the Interstate shareholders does not mean that the adjustments were not material. Decisiveness is not equivalent to materiality.

        [Materiality] does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that . . . the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.

        TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 449, 96 S.Ct. at 2132; Mills v. Electric Auto-Lite Co., 396 U.S. at 384-85, 90 S.Ct. 616 (1970). Despite their business judgment to proceed, the conduct of the Interstate representatives clearly demonstrates that they considered the adjustments significant and important in their deliberations. The adjustments would be no less important in the deliberations of the reasonable investor. At the very least, the reasonable shareholder would likely have been disturbed by the adjustments, just as were the defendants, and therefore might have sought further explanation before deciding to approve the merger. Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281, 1302-03 (2d Cir. 1973).⁶⁵

        In summary, the Court concludes that the adjustments contained in the unsigned comfort letter would have altered the total mix of information available and would have assumed actual significance in the deliberations of the reasonable Interstate shareholder. Although it is arguable whether the better business decision under the circumstances was to proceed with the merger, the antifraud provisions prohibit such a course of action when a material misrepresentation or omission has occurred, regardless of the business justification for closing the merger. There is no doubt that the adjustments were material, and therefore Brown and Meyer should have refused to proceed with the merger absent disclosure to and resolicitation of the shareholders.

        The adjustments were equally material with respect to the decisions of those purchasing NSMC stock from the Interstate principals. Although the proxy materials were prepared in connection with the merger, they also provided the general investing public, including those purchasers, with the most current information as to the financial condition of NSMC. The revelations in the unsigned comfort letter that the nine-month financials were inaccurate and misleading clearly would have assumed actual significance in the deliberations of those purchasing the NSMC stock from Brown, Meyer and other Interstate principals. As such, Brown and Meyer were prohibited from selling their newly acquired NSMC shares without first disclosing the comfort letter information.

        Finally, there must be proof that Brown and Meyer acted with the requisite degree of culpability. Unfortunately, the level of culpability required in an SEC injunctive

Page 710

action is far from certain. Negligence or the lack of due diligence was previously considered sufficient. E.g., SEC v. Spectrum, Ltd., 489 F.2d 535, 541 (2d Cir. 1973); SEC v. Pearson, 426 F.2d 1339, 1343 (10th Cir. 1970); SEC v. Texas Gulf Sulphur Co., 401 F.2d at 854-55, 866-68 (concurring opinion); but see, e.g., SEC v. Coffey, 493 F.2d 1304, 1314 (6th Cir. 1974), cert. denied, 420 U.S. 908, 95 S.Ct. 826, 42 L.Ed.2d 837 (1975). However, that position has been significantly eroded by Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), where the Supreme Court held that scienter, defined as a "mental state embracing intent to deceive, manipulate, or defraud," 425 U.S. at 193-94 n. 12, 96 S.Ct. at 1381, was a necessary element in a private damage action under § 10(b) and Rule 10b-5. While the Court expressly refused to consider whether scienter was also required in an injunctive action alleging violations of § 10(b) and Rule 10b-5, its analysis of the language of the statutory provision strongly suggests that proof of scienter is required in all actions under § 10(b), regardless of the identity of the parties involved. See 425 U.S. at 217-18, 96 S.Ct. 1375 (Blackmun, J., dissenting). Nevertheless, courts have still failed to reach a consensus on the issue. Compare SEC v. Southwest Coal & Energy Co., 439 F.Supp. 820, 825 (W.D.La.1977); SEC v. American Realty Trust, 429 F.Supp. 1148, 1171 (E.D.Va.1977); and SEC v. Bausch & Lomb, Inc., 420 F.Supp. 1226, 1240-41 (S.D. N.Y.1976) (scienter required), aff'd on other grounds, 565 F.2d 8 (2d Cir. 1977) with SEC v. World Radio Mission, Inc., 544 F.2d 535, 540-41 (1st Cir. 1976); SEC v. Hart, No. 78-65 (D.D.C. May 26, 1978) (alternate holding); and SEC v. Goetek, 426 F.Supp. 715, 726 (N.D.Cal.1976) (scienter not required).⁶⁶

        Similar confusion prevails with respect to the role of scienter in an injunctive action involving alleged violations of § 17(a). Several courts have focused on the Supreme Court's suggestion in Hochfelder that the language of § 17(a) may be broader in scope than that of § 10(b), see 425 U.S. at 212-13 & n. 32, 96 S.Ct. 1375, and have concluded that § 17(a) encompasses both intentional and negligent misconduct, at least in actions brought by the SEC for injunctive relief. SEC v. Coven, 581 F.2d 1020, at 1027-1028 (2d Cir. 1978); SEC v. Southwest Coal & Energy Co., 439 F.Supp. at 826; see Comment, Scienter and SEC Injunction Suits, 90 Harv.L.Rev. 1018, 1021 n. 24 (1977). Other courts, however, have come to a contrary conclusion and have required scienter under § 17(a) as well as under § 10(b). SEC v. American Realty Trust, supra; SEC v. Cenco, Inc., 436 F.Supp. 193 (N.D.Ill.1977).

        Though these are important issues, the resolution of which would be welcome to the securities bar, the Court concludes that they need not be decided at this time, because the conduct of Brown and Meyer in this case meets the prevailing standard for scienter.

        After receiving the unsigned comfort letter at the closing, the Interstate representatives immediately expressed concern over the new information; they caucused privately and sought and received various oral assurances from the NSMC representatives. Moreover, the new information included adjustments which were far from insubstantial; they reduced the reported profit of NSMC by several hundreds of thousands of dollars and converted what had been a sizable profit into a net loss. Despite the obvious materiality of this information, especially as demonstrated by their conduct,

Page 711

they made a conscious decision not to disclose it. Such conduct has been found sufficient to meet the scienter requirement. McLean v. Alexander, 420 F.Supp. 1057, 1080-82 (D.Del.1976); Nassar & Co., Inc. v. SEC, 185 U.S.App.D.C. 125, 130 n. 3, 566 F.2d 790, 795 n. 3 (1977) (Leventhal, J., concurring); Lanza v. Drexel & Co., 479 F.2d 1277, 1305 (2d Cir. 1973).

        This knowing failure to disclose does not alone support a finding of scienter here. Also relevant are certain extrinsic factors, such as the presence of trading in the security during the period in question, actions taken by the defendant to remedy his prior actions, the pattern of the defendant's conduct, and any other similar conduct by the defendant. See SEC v. Bausch & Lomb, Inc., 420 F.Supp. at 1242. The Commission concedes that none of the defendants has been involved in other misconduct, either before or since the incidents alleged here. Further, the present actions took place within a short period of time, with some pressure on the participants to choose a course of action and proceed.

        Nevertheless, it cannot be ignored that Brown and Meyer expected to profit handsomely from the merger and the subsequent stock sales.⁶⁷ They were in no haste to disseminate the comfort letter information, and in fact they never revealed the adjustments, even after NSMC's year-end audit had been released and their fears of the adjustments being taken out of context should have been assuaged. Finally, although it is difficult to assess their concern with regard to the market value of NSMC stock it is apparent that a major reason for not disclosing the information was the protection of the investments made by Interstate shareholders, including themselves, by avoiding any action which could have a detrimental effect on the price of the stock. These circumstances provide strong additional support for an inference that the defendants acted with scienter.

        In any event, to the extent an inference of actual intent to deceive, manipulate, or defraud may be inappropriate, the defendants' actions here clearly constitute "the kind of recklessness that is equivalent to wilful fraud," SEC v. Texas Gulf Sulphur Co., 401 F.2d at 868 (concurring opinion), and which also satisfies the scienter requirement. Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 44-47 (2d Cir. 1978); Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1040, 1044 (7th Cir.), cert. denied, 434 U.S. 875, 98 S.Ct. 225, 54 L.Ed.2d 155 (1978); SEC v. Hart, supra; SEC v. American Realty Trust, 429 F.Supp. at 1171 n. 8; SEC v. Bausch & Lomb, Inc., 420 F.Supp. at 1243 n. 4; McLean v. Alexander, 420 F.Supp. at 1080-81. The failure to disclose the material information in this case was neither inadvertent, SEC v. Bausch & Lomb, Inc., 420 F.Supp. at 1242, nor the product of simple forgetfulness, Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d at 1045 n. 20,⁶⁸ but

Page 712

instead the result of a conscious decision made by the defendants. In view of the obviousness of the danger that investors would be misled by their failure to disclose the material information, such conduct must be considered reckless. Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d at 1047-48 (obvious danger of misleading investor, coupled with conscious decision not to disclose information, establishes recklessness as a matter of law).

        Accordingly, the Court finds that Brown and Meyer violated § 10(b), Rule 10b-5, and § 17(a) through their participation in the closing of the Interstate/NSMC merger and through their sales of NSMC stock immediately following the merger, in each instance without first disclosing the material information contained in the unsigned comfort letter.

        The Court must now turn to the Commission's charges that the defendants aided and abetted these two violations of the antifraud provisions. The violations themselves establish the first element of aiding and abetting liability, namely that another person has committed a securities law violation. Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d at 47; Woodward v. Metro Bank of Dallas, 522 F.2d 84, 95 (5th Cir. 1975); SEC v. Coffey, 493 F.2d at 1316. The remaining elements, though not set forth with any uniformity, are essentially that the alleged aider and abettor had a "general awareness that his role was part of an overall activity that is improper, and [that he] knowingly and substantially assisted the violation." SEC v. Coffey, supra. Accord, Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d at 47-48; Woodward v. Metro Bank of Dallas, 522 F.2d at 94-97. See generally, Ruder, Multiple Defendants in Securities Law Fraud Cases: Aiding and Abetting, Conspiracy, In Pari Delicto, Indemnification, and Contribution, 120 U.Pa. L.Rev. 597 (1972); 3 A. Bromberg, supra at § 8.5(530).

        The Commission's allegations of aiding and abetting by the defendants, specified at page 700 supra, seem to fall into four basic categories: (1) the failure of the attorney defendants to take any action to interfere in the consummation of the merger;⁶⁹ (2) the issuance by the attorneys of an opinion with respect to the merger; (3) the attorneys' subsequent failure to withdraw that opinion and inform the Interstate shareholders or the SEC of the inaccuracy of the nine-month financials; and (4) the issuance by the attorneys and Brown of an opinion and letter, respectively, concerning the validity of the stock sales under Rule 133. The SEC's position is that the defendants acted or failed to act with an awareness of the fraudulent conduct by the principals, and thereby substantially assisted the two violations. The Court concurs with regard to the attorneys' failure to interfere with the closing, but must conclude that the remaining actions or inaction alleged to constitute aiding and abetting did not substantially facilitate either the merger or the stock sales.

        As noted, the first element of aiding and abetting liability has been established by the finding that Brown and Meyer committed primary violations of the securities laws. Support for the second element, that the defendants were generally aware of the fraudulent activity, is provided by the previous discussion concerning scienter. With the exception of LBB, which is charged with vicarious liability, each of the defendants was actually present at the closing of the merger when the comfort letter was delivered and the adjustments to the nine-month financials were revealed. Each was

Page 713

present at the Interstate caucus and the subsequent questioning of the NSMC representatives; each knew of the importance attributed to the adjustments by those present. They knew that the Interstate shareholders and the investing public were unaware of the adjustments and the inaccuracy of the financials. Despite the obvious materiality of the information, see section III-B supra, each knew that it had not been disclosed prior to the merger and stock sale transactions. Thus, this is not a situation where the aider and abettor merely failed to discover the fraud, Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d at 52 (Mansfield, J., dissenting), or reasonably believed that the victims were already aware of the withheld information, Hirsch v. du Pont, 553 F.2d 750, 759 (2d Cir. 1977). The record amply demonstrates the "knowledge of the fraud, and not merely the undisclosed material facts," Hirsch v. du Pont, supra, that is required to meet this element of secondary liability. See Ruder, supra at 630-31.

        The final requirement for aiding and abetting liability is that the conduct provide knowing, substantial assistance to the violation. In addressing this issue, the Court will consider each of the SEC's allegations separately. The major problem arising with regard to the Commission's contention that the attorneys failed to interfere in the closing of the merger is whether inaction or silence constitutes substantial assistance. While there is no definitive answer to this question, courts have been willing to consider inaction as a form of substantial assistance when the accused aider and abettor had a duty to disclose. Woodward v. Metro Bank of Dallas, 522 F.2d at 97; Kerbs v. Fall River Industries, Inc., 502 F.2d at 740; Brennan v. Midwestern United Life Ins. Co., 417 F.2d 147, 154 (7th Cir. 1969), cert. denied, 397 U.S. 989, 90 S.Ct. 1122, 25 L.Ed.2d 397 (1970). Although the duty to disclose in those cases is somewhat distinguishable, in that they contemplate disclosure to an opposing party and not to one's client, they are sufficiently analogous to provide support for a duty here.

        Upon receipt of the unsigned comfort letter, it became clear that the merger had been approved by the Interstate shareholders on the basis of materially misleading information. In view of the obvious materiality of the information, especially to attorneys learned in securities law, the attorneys' responsibilities to their corporate client required them to take steps to ensure that the information would be disclosed to the shareholders. However, it is unnecessary to determine the precise extent of their obligations here, since it is undisputed that they took no steps whatsoever to delay the closing pending disclosure to and resolicitation of the Interstate shareholders. But, at the very least, they were required to speak out at the closing concerning the obvious materiality of the information and the concomitant requirement that the merger not be closed until the adjustments were disclosed and approval of the merger was again obtained from the Interstate shareholders. Their silence was not only a breach of this duty to speak, but in addition lent the appearance of legitimacy to the closing, see Kerbs v. Fall River Industries, Inc., supra. The combination of these factors clearly provided substantial assistance to the closing of the merger.

        Contrary to the attorney defendants' contention, imposition of such a duty will not require lawyers to go beyond their accepted role in securities transactions, nor will it compel them to "err on the side of conservatism, . . . thereby inhibiting clients' business judgments and candid attorney-client communications."⁷⁰ Courts will not lightly overrule an attorney's determination of materiality and the need for disclosure. However, where, as here, the significance of the information clearly removes any doubt concerning the materiality of the information, attorneys cannot rest on asserted "business judgments" as justification for their failure to make a legal decision

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pursuant to their fiduciary responsibilities to client shareholders.

        The Commission also asserts that the attorneys substantially assisted the merger violation through the issuance of an opinion that was false and misleading due to its omission of the receipt of the comfort letter and of the completion of the merger on the basis of the false and misleading nine-month financials.⁷¹ The defendants contend that a technical reading of the opinion demonstrates that it is not false and misleading, and that it provides accurate opinions as to Interstate's compliance with certain corporate formalities. Of concern to the Court, however, is not the truth or falsity of the opinion, but whether it substantially assisted the violation. Upon consideration of all the circumstances, Woodward v. Metro Bank of Dallas, 522 F.2d at 97, the Court concludes that it did not.

        Contrary to the implication made by the SEC, the opinion issued by the attorneys at the closing did not play a large part in the consummation of the merger. Instead, it was simply one of many conditions to the obligation of NSMC to complete the merger. It addressed a number of corporate formalities required of Interstate by the Merger Agreement, only a few of which could possibly involve compliance with the antifraud provisions of the securities laws.⁷² Moreover, the opinion was explicitly for the benefit of NSMC, which was already well aware of the adjustments contained in the comfort letter. Thus, this is is not a case where an opinion of counsel addresses a specific issue and is undeniably relied on in completing the transaction. Compare SEC v. Coven, 581 F.2d 1020, at 1028; SEC v. Spectrum, Ltd., 489 F.2d 535 (2d Cir. 1973). Under these circumstances, it is unreasonable to suggest that the opinion provided substantial assistance to the merger.

        The SEC's contention with regard to counsel's alleged acquiescence in the merger transaction raises significant questions concerning the responsibility of counsel. The basis for the charge appears to be counsel's failure, after the merger, to withdraw their opinion, to demand resolicitation of the shareholders, to advise their clients concerning rights of rescission of the merger, and ultimately, to inform the Interstate shareholders or the SEC of the completion of the merger based on materially false and misleading financial statements. The defendants counter with the argument that their actions following the merger are not subject to the coverage of the securities laws.

        The filing of the complaint in this proceeding generated significant interest and an almost overwhelming amount of comment within the legal profession on the scope of a securities lawyer's obligations to his client and to the investing public.⁷³ The very initiation of this action, therefore, has provided a necessary and worthwhile impetus for the profession's recognition and assessment of its responsibilities in this area. The Court's examination, however, must be more limited. Although the complaint alleges varying instances of misconduct on the part of several attorneys and firms, the Court must narrow its focus to the present defendants and the charges against them.

        Meyer, Schauer and Lord, Bissell & Brook are, in essence, here charged with failing to take any action to "undo" the merger. The Court has already concluded that counsel had a duty to the Interstate shareholders to delay the closing of the merger pending disclosure and resolicitation with corrected financials, and that the breach of that duty constituted a violation of the antifraud provisions through aiding and abetting the merger transaction. The Commission's charge, however, concerns the period following that transaction. Even if the attorneys' fiduciary responsibilities to the Interstate shareholders continued beyond

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the merger, the breach of such a duty would not have the requisite relationship to a securities transaction, since the merger had already been completed.⁷⁴ It is equally obvious that such subsequent action or inaction by the attorneys could not substantially assist the merger.

        The final contention of the SEC concerns the issuance by the attorneys and Brown of the Rule 133 opinion and letter, respectively. Little discussion is necessary with respect to this charge, for the Commission has clearly failed to show that these documents substantially assisted the stock sales. Neither of the documents were required by the Merger Agreement, but were requested by NSMC at the closing of the merger. The documents were not intended for the investing public, but for the sole use of NSMC and its counsel in preparing a formal, independent opinion concerning the validity of the sales under Rule 133. Further, the documents were limited to primarily factual issues relevant to the requirements of the Rule, and in no way indicated that they could be relied upon with regard to compliance with the antifraud provisions. Under the circumstances, the Court concludes that the Rule 133 documents issued by the attorneys and Brown did not substantially assist the stock sales by Interstate principals, specifically Brown and Meyer.

        Thus, the Court finds that the attorney defendants aided and abetted the violation of § 10(b), Rule 10b-5, and § 17(a) through their participation in the closing of the merger.

        Although the Commission has proved past violations by the defendants, that does not end the Court's inquiry. Proof of a past violation is not a prerequisite to the grant of injunctive relief, United States v. W. T. Grant Co., 345 U.S. 629, 633, 73 S.Ct. 894, 97 L.Ed. 1303 (1953), nor by itself necessarily sufficient to justify such relief, SEC v. Bausch & Lomb, Inc., 565 F.2d 8 (2d Cir. 1977); SEC v. Management Dynamics, Inc., 515 F.2d 801, 807 (2d Cir. 1975), but it may, in combination with other factors, warrant an inference of future misconduct by the charged party, SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1100 (2d Cir. 1972). The crucial question, though, remains not whether a violation has occurred, but whether there exists a reasonable likelihood of future illegal conduct by the defendant, "something more than the mere possibility which serves to keep the case alive." United States v. W. T. Grant Co., supra. Thus, the SEC must "go beyond the mere facts of past violations and demonstrate a realistic likelihood of recurrence." SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 100 (2d Cir. 1