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Securities and Exchange Commission v. Advance Growth Capital Corp.

decided: November 13, 1972.


Duffy and Murrah,*fn* Senior Circuit Judges, and Juergens,*fn** District Judge.

Author: Murrah

MURRAH, Senior Circuit Judge.

This action is brought by the Securities and Exchange Commission (Commission) pursuant to Sections 36 and 42(e) of the Investment Company Act of 1940, 15 U.S.C. § 80a-35 and 41(e), against Advance Growth Capital Corporation, Peter D. Giachini, Chairman of Advance Growth's Board of Directors, and John J. Murphy, the company's president and director.

The Investment Company Act is a comprehensive regulatory scheme designed to prevent abusive practices by those in control of investment companies. As the Act declares:

". . . the national public interest and the interest of investors are adversely affected --

". . .

"(2) when investment companies are organized, operated, managed, or their portfolio securities are selected, in the interest of directors, officers, investment advisors, depositors, or other affiliated persons thereof, . . . rather than in the interest of all classes of such companies' security holders . . . ."

Section 17 of the Act, thus, prohibits "affiliated persons,"*fn1 including officers and directors, from taking part in certain transactions unless they bear the burden of proving in advance that such transactions are reasonable, fair and consistent with the purposes of the Act. Sections 36 and 42(e) empower the appropriate district courts, on petition of the Commission, to utilize traditional equity jurisdiction as a ready means of enforcing general compliance with the provisions of the Act.

The Commission's complaint in this case alleges generally that Sections 17(a), 17(d), 34(b) and 36 of the Act*fn2 have been violated as a result of certain transactions between Advance Growth and various affiliated persons of either Advance Growth or defendant Giachini, and because of a failure to disclose information regarding certain affiliated persons in annual reports submitted to the Commission. On the basis of these alleged violations the Commission sought: (1) to enjoin permanently Giachini and Murphy from violating the Investment Company Act and from serving as officers and/or directors of Advance Growth or any other regulated investment company; and, (2) the appointment of a receiver to conduct the affairs of Advance Growth.

Some 19 months after the conclusion of a lengthy trial, the District Court entered Findings of Fact and Conclusions of Law and a memorandum opinion. The essence of the decision was that while violations of Sections 17(a) and 17(d) of the Investment Company Act had occurred, they were inadvertent in nature and not disadvantageous to Advance Growth; the Commission's requests for a permanent injunction and appointment of a receiver were, therefore, denied. The court did enter an order, which expired March 31, 1972, directing the defendants to conform more strictly to the statute and to obtain the consent of the Commission before making any loan which might entail a conflict between the interests of Advance Growth and that of any of its officers, directors, or shareholders. The Commission appeals, claiming that the equitable remedies sought should have been granted on the basis of the violations clearly established at trial and recognized by the trial court's findings. We are in partial agreement with the Commission's arguments and reverse the trial court's order to that extent.

The basic facts are these. Advance Growth Capital is a small business investment company licensed by the Small Business Administration (S.B.A.) and registered with the Commission pursuant to the Investment Company Act, 15 U.S.C. § 80a-8. It has outstanding approximately 439,000 shares of common stock held by some 1,100 stockholders. Upon its organization in 1961, Advance Growth raised approximately $6,500,000 in capital by obtaining a loan from the S.B.A. and selling its stock to the public. It made several improvident investments with these funds resulting in large losses. As a consequence of these losses and some especially high operating expenses -- consisting primarily of management salaries, benefits, and expense account items -- the company soon found itself in the red.

Defendant Giachini, a practicing attorney and owner of a substantial amount of Advance Growth stock, was disturbed by the company's losses, which he justly considered to be the product of flagrant mismanagement. Because of this concern with management practices, Giachini formed a group of stockholders, including his law partner Murphy, for purposes of gaining control of the affairs of Advance Growth. Upon realization of this goal in 1963, Giachini and Murphy were named, respectively, as chairman of the board and president/director of the company.

The new management began its program to rejuvenate Advance Growth by eliminating directors' fees and officers' salaries and benefits. They also moved the offices from Chicago into less expensive quarters in the suburb of Maywood, Illinois.*fn3 All of the company's staff and office expenses were absorbed by the new officers' law firm. Giachini and Murphy also expended a great deal of time and effort traveling about the country attempting to salvage as much as possible from the unprofitable loans made by prior management. As a result of the dramatic cuts in operating expenses, coupled with a somewhat fluctuating increase in income since Giachini and Murphy gained control, Advance Growth has gradually reduced its large deficit and achieved some degree of financial stability -- especially in comparison with its condition under prior management. On the basis of these facts the trial court found that from the time they assumed office Giachini and Murphy worked arduously and without compensation to restore Advance Growth to a solvent and viable status.

Despite these efforts, the company's capital was severely impaired in 1965, and the S.B.A. filed suit seeking apointment of a receiver in dissolution. This impairment was subsequently cured by the sale of certain assets, and the S.B.A. suit was dismissed in 1966. Shortly thereafter, however, the Securities and Exchange Commission began an investigation of Advance Growth because of certain allegedly improper transactions with affiliated companies. That investigation culminated in the present action.

The tangled web of affiliations and the many transactions resulting in the alleged violations are involved and complex. Because of our inherent disagreement with the trial court's characterization and appraisal of the defendants' conduct, we find it necessary to treat the facts in some detail, not only for background purposes but also to indicate our own assessment of those facts which we find to be operative and controlling.

The Addison Industrial Land Transactions

In 1965, Giachini played the dominant role in forming Proviso Industrial Builders. Advance Growth owns 49% of Proviso's stock; the remaining 51% is owned by Mario Roselli and Mal Monbrod, experienced builders and real estate developers doing business as Roselli-Monbrod Builders. Proviso, as a controlled company of Advance Growth, is an affiliated person within the meaning of the Act. At the urging of Giachini, Proviso purchased a one-third interest in 45 acres of land in Addison, Illinois. The other two-thirds interest was owned by Hardy Realty Company, also an affiliated person of Advance Growth.*fn4 Proviso and Hardy formed Addison Industrial Land, a partnership devoted to development of the 45 acre tract for use as industrial plant sites. Actual development of the tract was carried out by Roselli and Monbrod. As compensation for these services they received a share of Proviso's ...

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