On Petition for Review of an Order of the Securities and Exchange Commission
Before: Henderson, Randolph, and Rogers, Circuit
The opinion of the court was delivered by: Randolph, Circuit Judge
Opinion concurring in the judgment filed by Circuit Judge HENDERSON.
Nicholas P. Howard petitions for review of a Securities and Exchange Commission order imposing sanctions on him for aiding and abetting alleged securities laws violations committed in the course of closing two private placement offerings of common stock in 1991 and 1992. The SEC's opinion holding Howard liable is confused and confusing. The SEC first held that "awareness of wrongdoing" is a necessary element of aiding and abetting, but it marshaled no evidence to show that Howard had any such awareness. The SEC then stated - inconsistently - that alleged aiders and abettors who act "recklessly" may be liable, but it never explained what it thought "recklessly" meant in this context; it disregarded evidence tending to show that Howard did not act recklessly as this court has defined the term; and it wound up applying a "should have known" negligence standard that we have rejected. Under a correct scienter standard the evidence is insufficient to sustain most of the charges against Howard. The record is unclear with respect to two others, which we remand to the SEC for reconsideration.
In the early 1990's Howard served as a senior vice president of James Capel, Inc. ("JCI"), a registered broker-dealer based in New York. JCI was a subsidiary of James Capel & Company, Ltd., a securities brokerage firm in London, which together with another affiliate, made up the Capel Group. Howard's job was to market European equity securities to American and Canadian institutional investors. In 1990, his customers became interested in investment opportunities created by the fall of communism in Eastern Europe. Howard believed there would be demand for new hotels in the region, an idea that ultimately resulted in New Europe Hotels, N.V., a Netherlands Antilles corporation incorporated on December 20, 1990, for the purpose of developing hotel properties in Eastern and Central Europe. Howard became a director of the new company. Before its formation, he consulted with IDG Development Corporation, a real estate development company; executives from the Capel Group and its affiliates; and JCI's corporate finance department, headed by Joel Matcovsky - a former SEC lawyer. JCI accepted the project, and its corporate finance department took steps to initiate a stock offering.
The initial offering of 5,000,000 shares of common stock occurred in late 1990 and early 1991. JCI was the exclusive marketer of New Europe Hotels stock in the United States; its affiliates were the underwriters overseas. The law firm of Rogers & Wells prepared the offering documents for use in this country. Rogers & Wells began drafting the documents in the fall of 1990. Howard was not involved in the drafting process although he was apprised of developments. Matcovsky and the corporate finance department served as the liaison between JCI and Rogers & Wells.
The final placement documents - which Howard skimmed through but did not read closely - offered the stock on a "best efforts, part or none" basis. Under SEC Rule 10b-9, 17 C.F.R. § 240.10b-9, a part-or-none offering requires prompt refunds to investors if the minimum number of shares set forth in the offering is not sold, or full payment is not received, by the date specified. The first offering made closing contingent on the sale of at least 2,000,000 shares at 20 Deutsche Marks per share by January 2, 1991.
JCI began marketing the United States placement in late 1990. Howard headed the marketing effort here, telephoning potential investors and arranging road shows. Sales were not up to expectations. With concern growing that the minimum might not be met by the deadline, three transactions were undertaken, each of which eventually led to an alleged violation of the securities laws.
On December 20, 1990, the Capel Group - at the behest of its co-chairmen - obtained for itself enough shares to close the offering. It did this by taking 100,000 shares in lieu of the fee it would have received for serving as the worldwide selling agent and by purchasing an additional 55,650 shares. Howard told the subscribers in this country, and potential investors, that the Capel Group had purchased these shares, viewing this as a "marketing plus." In making this representation, he did not say whether the shares would count toward the subscription minimum. Howard did not believe there were any legal problems with the Capel Group's purchases because he understood that Matcovsky had cleared the transactions with Rogers & Wells. Howard was on vacation during the week of the closing and played no role in determining which shares would be counted toward the minimum.
The next questioned transaction was a purchase by JCI. During the offering period Howard received an indication of interest for 30,000 New Europe Hotels shares from Julius Baer Securities on behalf of the European Warrant Fund, a closed-end investment company that Howard participated in creating. Baer served as the fund's investment adviser, and JCI served as a "subadviser." Howard was aware of these relationships. In the days before the closing, Howard was unable to reach Baer for confirmation. Howard checked with his supervisor, JCI's president Mark Green, who told him that JCI should itself purchase the stock. Before the closing, JCI did this and held the shares in a JCI-controlled account. JCI's 30,000 shares were counted toward the minimum. On January 4, 1991, two days after the closing, JCI sold the shares to the European Warrant Fund.
The third transaction involved the real estate developer, IDG Development Corporation. As disclosed in offering documents, IDG was to receive 75,000 shares free of charge as "founders shares" and had agreed to purchase another 75,000 shares on its own. The offer of free shares was rescinded after another investor objected. Unhappy with losing the free shares, IDG asked if New Europe Hotels would advance IDG's managerial fees to ease a cash flow burden. Although a director of New Europe Hotels, Howard was on vacation at the time and did not participate in these discussions. In his absence, New Europe Hotels' board of directors approved a plan whereby the company would deposit an amount equal to IDG's fees in a bank that in turn would use the deposit as collateral for a loan to IDG. Matcovsky, who was also a director and participated in the meetings, called Howard, told him of the board's resolution, and represented that Rogers & Wells had been consulted and approved the transaction. Only then did Howard vote in favor of the plan. New Europe Hotels thus assisted IDG in obtaining two loans, which IDG used to buy the shares it was originally supposed to receive free of charge. These shares were counted toward the minimum.
Although the closing took place on January 2, 1991, it was not until several weeks later that full payment was made for up to a third of the shares, including those sold to IDG Development Corporation. In part this was due to conflicting instructions about where to wire payment. Howard learned of these problems when he returned from vacation on January 4 and assisted JCI's efforts to account for and collect the missing funds.
JCI initiated a second private placement offering of NEH securities in October and November 1991. As with the first offering, the corporate finance department coordinated the drafting of documents by Rogers & Wells. Howard relied on its work product and believed the offering materials contained all the necessary disclosures. The second offering closed on November 27, 1991.
The SEC charged Howard with willfully aiding and abetting and causing the securities violations committed by JCI and New Europe Hotels. In the SEC's view, the minimum subscription of 2,000,000 shares in the part-or-none offering was reached by improperly counting (1) shares the Capel Group purchased for itself, (2) shares JCI purchased for an aftermarket sale to the European Warrant Fund, and (3) shares IDG purchased with bank loans using as collateral the fees New Europe Hotels advanced. These transactions were not, according to the SEC, "bona fide" under Rule 10b-9.*fn1 In addition, the SEC determined that antifraud violations occurred when the first offering closed despite the fact that payment had not been received for a third of the shares. JCI and New Europe Hotels thus violated § 10(b) of the Securities Exchange Act, and Rules 10b-5 and 10b-9 thereunder, and § 17(a) of the Securities Act.*fn2 The violation of Rule 10b- 9 consisted of improperly closing the initial offering rather than returning the proceeds of the sales to the investors. The violations of Rule 10b-5 were the failure to disclose in the first offering that these purchases ...