Appeal from the Circuit Court of Cook county; the Hon. FRANK
LEONARD, Judge, presiding. Judgment reversed.
PRESIDING JUSTICE MCCORMICK DELIVERED THE OPINION OF THE COURT.
Rehearing denied January 5, 1959.
The plaintiff under the provisions of the Illinois Securities Law of 1953 (Ill. Rev. Stat. 1955, chap. 121 1/2, §§ 137.1-137.19) filed an application with the office of the Secretary of State for the registration of 21 classes of investment fund shares including two classes of shares known as the General Bond Fund and the Fully Administered Fund. A hearing was held to determine whether the application for the registration of shares of the General Bond Fund and the Fully Administered Fund should be allowed. After the hearing the Secretary of State issued his findings and decision and an order of denial of the said application for registration.
The plaintiff under the Administrative Review Act (Ill. Rev. Stat. 1955, chap. 110, §§ 264-279) filed a complaint to review the administrative decision and order issued by the defendant with respect to the investment fund shares. The trial court entered a judgment reversing and setting aside the findings, decision, and order of the Secretary of State, and from such judgment this appeal is taken.
The appeal was first taken to the Supreme Court of Illinois which, in Group Securities, Inc. v. Carpentier, 13 Ill.2d 41, held that the court did not have jurisdiction of the appeal because the constitutional questions raised were not passed on in the trial court, and the case was transferred here for determination.
Group Securities, Inc., hereafter referred to as the plaintiff, is an open-end investment company which offers for sale to the public 21 classes of investment fund shares. All of the plaintiff's investment fund shares are sold through investment dealers by the underwriter, Distributors Group, Inc. Upon the sale of the securities to the public the issuer, the plaintiff, receives 91 1/2% of the initial offering price, and the underwriter, Distributors Group, Inc., receives 8 1/2% as a distribution charge, selling charge, sales commission or sales load. Out of the sum received by the underwriter the dealer gets 6%. The remaining 2 1/2% is retained by the underwriter.
With respect to the securities involved in this appeal (the shares of the Fully Administered Fund and the General Bond Fund), the plaintiff entered into "Dealers' Continuing Compensation Contracts" with dealers whose clients hold these shares. These contracts provide for compensation to the dealer at the rate of one-fourth of 1% of the asset value of such shares which have been sold by the dealer and which are outstanding and registered on the books of the plaintiff. Such payments are made after the time of sale and are charged against current income of the two funds in question. These contracts recite that it is recognized that the dealer is a vital and continuing point of contact between the plaintiff and the dealer's customers, holders of the shares, and that the dealer is called upon to follow with diligence the progress of the plaintiff's affairs in the interest of his client and to supply counsel and information of various accounts to the said client during the said period that these shares are held by him. The additional payments to the dealers, paid annually, under these contracts are computed monthly based on the average daily asset value of the shares outstanding on the books of the corporation throughout the preceding month, and no payments shall be made for any month in which the average daily asset value of all such shares outstanding, sold by the dealer prior to the beginning of the month, is less than $25,000.
The contract provides for automatic termination if the dealer ceases to be qualified as a securities dealer under Federal or State laws. The plaintiff has interpreted this clause as meaning that this would be true even if the former dealer continues to act as an investment adviser and renders to his clients counsel and advice concerning the securities and further that the dealer does not actually have to perform services to enable him to collect.
The evidence shows that the amounts paid under these contracts for the Fully Administered Fund during 1952, 1953, and 1954 were $12,628, $12,373, and $12,675 respectively, and for the same periods the amounts paid under the General Bond Fund were $8,862, $7,789, $7,021. The Fully Administered Fund and the General Bond Fund are more permanent or longer-range investments than the other 19 classes of shares of the plaintiff.
Shares of the Fully Administered Fund and the General Bond Fund were originally registered and qualified for sale in Illinois on March 15, 1939 and October 4, 1943 respectively, and the shares of these two funds continued to be qualified for sale in Illinois until September 14, 1955. The dealer's continuing compensation contracts have been in existence only since the initial offering of the two funds.
On September 21, 1955 the Secretary of State of Illinois, hereafter referred to as the defendant, notified the plaintiff of an administrative hearing to be held to determine whether registration of securities of these two funds should be denied. The reasons specified were that the continuing compensation contracts were inequitable and tended to work a fraud and deceit, were violative of Section 7D of the Illinois Securities Act, and that the prospectus proposed for the sale of these securities failed to disclose material facts in connection with these contracts. Hearing was had on October 11, 1955 before an Assistant Secretary of State, and on December 22, 1955 the defendant issued his written findings, decision and order denying the application for registration. He found that the continuing compensation contracts violated Section 7D of the Illinois Securities Act in that such payments constitute sales commissions, sales distribution compensation, sales charges, sales expenses or distributing charges paid in connection with the sales of the said shares; that such payments exceed 10% of the offering price of the securities and are not paid at the time of sale; that the prospectus failed to disclose material facts concerning the continuing compensation contracts and payments made thereunder; that the offering and sale of the shares of the said securities are inequitable because there is paid in connection with the sale and distribution of such shares certain continuing compensation payments which tend to prejudice the judgment and advice to his customers by a dealer because of such dealer's contingent financial interest in the sale of such shares and the continued effectiveness thereof. He further found that the contract imposed on the purchasers of such securities a charge for services which are ordinarily performed by dealers for their customers without charge and that it made no provision to insure that the purchasers would receive any such services, and that such contract necessarily influences the dealer to sacrifice the interests of his customers whenever such customer's interests conflict with those of the plaintiff.
The plaintiff contends that the interpretation by the defendant of Section 7D of the Securities Act is erroneous inasmuch as such section does not restrict or limit payments such as are here provided for, and that it limits only the relationship of the offering price of shares at the time of sale to the asset value that is received and invested by the issuer; that the findings of the defendant are against the manifest weight of the evidence; that the plaintiff was denied a full hearing before the defendant; that there is no statutory sanction for a denial of, or a hearing on, an application for a renewal of registration filed in full compliance with Section 7I of the Illinois Securities Law.
The defendant contends that the plaintiff had violated Section 7D of the Illinois Securities Act of 1953 (Ill. Rev. Stat. 1955, chap. 121 1/2, § 137.7D), which provides in part that no investment fund shares shall be registered unless the formula for determining the offering price is such that at the time of sale the market value of the unpledged underlying securities and other assets, after deducting all accrued liabilities and established reserve accounts, is at least 90% of such price. Upon the sale to the public of the two classes of shares herein involved the plaintiff received 91 1/2% of the initial offering price. The Distributors Group, Inc. and the dealer received 8 1/2% of the offering price. If this constituted the only sales charge or commission paid for the sale of such securities the plaintiff would receive a sum in excess of 91% of the total offering price of all such shares sold, and there would be no violation of the statute. The defendant, however, objected to the continuing compensation agreement and on the hearing held that such an agreement is an additional sales load or sales charge. Diligence of counsel has failed to provide, nor have we been able to find, any decision dealing with the specific question here involved. The only case cited which even remotely approaches the problem is Anchor Life and Accident Ins. Co. v. Taylor, 163 N.E. 631, 29 Ohio App. 428 (1928). This was a case involving an organization of an insurance company. The statute provided that the promotion and organization expenses of such companies shall not exceed 15% of the amount actually raised upon stock subscriptions. The insurance company in that case had filed articles of incorporation and before it was licensed stock was sold and an agreement was entered into under which all proceeds of the ...