the indictment dismissed due to government misconduct. Defendant Abraham Salaman has moved to suppress, and to dismiss the indictment, claiming that his statements to the SEC were "coerced" since they were made in an attempt to achieve a civil settlement. Furthermore, Salaman claims that he also was granted an informal or implied immunity. Defendants Myron Freeman and Jack Silbiger have moved to suppress their testimony before the SEC on the grounds that they did not receive appointed counsel to advise them during those civil sessions.
The Court has held hearings on most of these matters in open court. The evidence presented at those hearings, together with transcripts and affidavits submitted by counsel, have all been considered in arriving upon the Court's ruling. After examining the briefs and hearing oral argument, the Court has decided to deny the pending motions. The Court has included its findings of facts and conclusions of law in narrative form below.
Search and Seizure
Defendants Cronin and Street were employees in the Washington office of Hornblower and Weeks, Hemphill-Noyes, Inc. in 1972. Because of customers' complaints, it came to the firm's attention that the two might be involved in some serious wrong-doing, including unauthorized purchases. In November of 1972 they were terminated and were not allowed to clear their desks out. After they left the office, a Hornblower supervisor searched their desks and confiscated what evidence might be pertinent to the allegations. At the time of termination, Hornblower notified the National Association of Securities Dealers (NASD), as it did for all such actions. In January, 1973, the NASD notified Hornblower that it was beginning an investigation into Cronin and Street because of the terminations. Sometime in February or March of 1973, the NASD requested that Hornblower provide it with any relevant information in Hornblower's possession. Hornblower turned over its file to the NASD, including copies of the items removed from the desks. In June of 1973, the SEC requested information from the NASD and was given the copies of the products of the Hornblower desk search.
Cronin and Street now claim that the Hornblower search violated their Fourth Amendment rights, in that it was "government motivated" and done in pursuance of governmental and quasi-governmental regulations. Also, they argue that stolen evidence should be suppressed as improper. Evidence must be excluded if it is seized in connection with the activities of government agents, but the Fourth Amendment protections do not extend to searches by private parties. Burdeau v. McDowell, 256 U.S. 465, 65 L. Ed. 1048, 41 S. Ct. 574 (1920); United States v. Goldberg, 330 F.2d 30 (3d Cir. 1964), cert. den. 377 U.S. 953, 12 L. Ed. 2d 497, 84 S. Ct. 1630 (1964). Goldberg held that where business associates of the defendant took his records and turned them over to the police without his knowledge, the evidence was admissible. Most courts allow evidence stolen by private citizens to be admitted, Philadelphia Resistance v. Mitchell, 58 FRD 139 (E.D. Pa. 1972); Arrington v. United States, 350 F. Supp. 710 (E.D.Pa. 1972). It is of no consequence therefore that Cronin and Street did not consent to the search.
However, any evidence taken by individuals must be free of any implication of government complicity in its acquisition. The timing of the search by a private citizen is critical in determining whether the government was motivating the search. If the government is already involved in the investigation and has contacted the private individual, some government encouragement may be presumed, unless there are facts rebutting this. In United States v. Stein, 322 F. Supp. 346 (N.D. Ill. 1971), the court suppressed evidence obtained by a private person who feared his own possible indictment. The court found that the evidence was produced on a number of occasions during the process of interrogation sessions with the individual. The court there felt that he perceived that he was under pressure to seize evidence on behalf of the government or face his own indictment. Where the evidence was produced because of governmental encouragement, even if subtle, "it cannot be said that the government was totally divorced from the situation under which he came into possession of these records." 322 F. Supp. at 348. However, in United States v. Mekjian, 505 F.2d 1320 (5th Cir. 1974), evidence of Medicare fraud was obtained by a nurse employee, who sent copies to Blue Shield for many months before the matter was investigated by the FBI. The court had no problems in admitting all evidence she obtained prior to her contact with the FBI in January. At that time, the FBI agents told her to stop copying the evidence, but she persisted without the agency's knowledge. The court there admitted all the post-January evidence as well, finding that there was no government knowledge, actual or implicit, involved in the continued searches, since the agents had encouraged her not to obtain the evidence on her own.
In the instant case, Hornblower acted on its own information to search for evidence of wrong-doing in 1971, prior to the 1972 investigations by the NASD and SEC. It is admitted that there was no contact with outside agencies prior to the search and seizure. There is no way that the defendants can argue that any government agent tacitly or implicitly encouraged this search. Since the search was made by a private individual and voluntarily turned over to other authorities,
it is no different than Goldberg. Being devoid of any government agent's actions, the evidence thus obtained is admissible.
However, Cronin and Street argue that the requirements for self-policing imposed both by the NASD and SEC transformed Hornblower's search into one by the government. After studying the law, the Court concludes that this is in error. In United States v. Burton, 341 F. Supp. 302 (W.D. Mo. 1972), the defendant claimed that searches by airline employees for weapons were "government action" because they were prompted by statutes and FAA regulations banning guns from interstate flights. He argued that the airlines' searches were made to comply with the law, and therefore were "caused" by the government so as to trigger constitutional protections. At that time, there were no FAA regulations specifically requiring airlines to search customers and their baggage. The defendant's bag was searched after a ticket agent became suspicious due to its unusual weight. The court concluded that, in light of the recent hijackings and bombings, the ticket agent's search was serving the purposes of his employer and not the government. This circuit's appellate court extended this even farther in United States v. Valen, 479 F.2d 467 (3d Cir. 1973). In that case, an airline employee who had in the past been paid by narcotics agents for finding contraband in air freight, reported his suspicions regarding a particular suitcase to a federal agent. In fact, the airline employee had already opened it himself and discovered a large cache of marijuana. Judge Aldisert held that the search was conducted by a private party whose airline job was to report suspicious parcels, in order to protect himself and his employer. The judge said there were no sufficient minimal contacts to show the employee's governmental agency.
The Court concludes here that Hornblower made the search of the desks to protect itself. Under the securities laws, the firm can suffer administrative penalties and face extensive civil liabilities if its employees have been engaged in wrong-doing due to lax supervision. When the possibility of illegalities by Cronin and Street became known to their employers, the supervisors took swift moves to find out the extent of the trouble and to protect the firm from any future liability. Since, as in Burton, no statute or regulation directly commanded Hornblower to perform the search and as in Valen, the searches protected the employer as well as aiding in law enforcement, the Court finds that the government did not influence these searches.
Cronin and Street argue that the particularly heavy burden of self-policing imposed by securities regulation requires private employers to act in lieu of the government and therefore entitle persons to constitutional protection from their employers. This argument was clearly rejected by Judge Friendly in United States v. Solomon, 509 F.2d 863 (2d Cir. 1975). In that case, Judge Friendly considered the question of whether statements coerced by the stock exchanges under threat of expulsion were protected by the Fifth Amendment. He held that since the stock exchange was not a public actor, it could not violate such constitutional rights. He acknowledged that many statutes require severe self-policing that may encourage employers to take drastic and coercive acts, which if performed by the government would be unconstitutional. However, he stated that it is necessary for proper economic regulation, and does not bring constitutional dimensions to regular employer actions. For example, he cited the Elkins Act, 49 U.S.C. § 41(2), which imposes criminal liability on a railroad employer for acts of its employees. Its purpose "was surely to enlist the aid of the carriers and shippers in policing their employees . . . There would be a complete breakdown in the regulation of many areas of business if employers did not carry most of the load of keeping their employees in line . . ." 509 F.2d at 870. Judge Friendly held that a private actor, in accordance with controlling employees' illegal activities, may impose sanctions preventing exercise of Fifth Amendment rights. The Court feels that Solomon's rationale is equally applicable to this Fourth Amendment claim. The ability of a brokerage firm to regulate its own employees and to monitor their business activity cannot be unnecessarily hamstrung or that increased regulatory burden will be placed back on the government. The laws and regulations do not specify the means for accomplishing brokerage self-policing; they only require that it be done. Since Hornblower chose on its own to search for and seize the evidence in question, that was a purely non-governmental act. Therefore, the motion to suppress must be denied.
Defendants Cronin and Street have argued that the indictment against them should be dismissed, or their SEC testimony suppressed, because of "government misconduct." Three portions of their argument will be considered here: 1) that the SEC violated their due process rights by the informal procedure of referral for prosecution; 2) that the SEC was misusing the civil proceeding to conceal a criminal investigation; and 3) that an SEC attorney intentionally led them to believe that they were safe from prosecution by telling a third party that they were not targets. The fourth claim, of use of illegally obtained evidence, has previously been discussed.
Regarding the use of the informal reference procedure, Judge Haight dealt with that issue in some detail in United States v. Fields, Cr. 76 Cr. 1022-CSH (S.D.N.Y., June 2, 1977). After reviewing that decision, and the SEC amicus brief presented to the court of appeals in Fields' appeal, the Court agrees with Judge Haight's reasoning and adopts it. The principle of informal reference does not in itself offend any constitutional guarantees. Cronin and Street have not demonstrated any way in which informal reference harmed them. The reference was made by Dennis Taylor, the primary SEC attorney investigating Magic Marker, in 1975. This date was long after Street and Cronin testified before the SEC and they consented to NASD sanctions. This is not a situation, such as Fields, where the criminal reference was concealed to mislead defendants into a civil settlement. Here, the SEC did not even undertake any civil action against Cronin and Street. Since the informal reference here did not work any demonstrable harm, the Court finds that it was not improper.
The two were investigated by the NASD and ultimately consented to a bar from practice by that organization. Because much of their argument of "government misconduct" involves the actions of the NASD officials, it is important in this section of the memorandum to decide whether or not the actions of the private self-regulatory group bind the government. Defendants argue that since the NASD's existence is allowed by statute, its rules are subject to SEC approval and its sanctions may be appealed to the SEC, it is in fact an arm of the government. If that were so, its procedures would be subject to constitutional strictures and its officials could bind the SEC and other government agencies. Two recent decisions have examined the NASD, its authority and history in some detail and are instructive here.
In Lange v. H. Hentz & Co., 418 F. Supp. 1376 (N.D. Tex. 1976), the court was presented with the question of whether the NASD rules could serve as a federal jurisdictional basis for an implied right of action -- in effect, whether they were effectively federal regulations in the same sense as an SEC regulation would be. The court carefully examined the origins of the NASD as a part of "cooperative" regulation. The Court noted its statutory roots and its close association with and dependence on the SEC. "Yet despite owing its existence and in large measure its power and prestige to the SEC, NASD is still a private association governed by its own rules as developed and applied by its own members." 418 F. Supp. at 1379. The court concluded that although the rules would not support an implied right of action in themselves, they established a standard of care for the industry by which broker-dealers could be evaluated. This holding recognized the NASD as the professional association that is seeking to promote high standards and maintain a good reputation for the trade, no different from other trade or professional groups.
This description of the NASD is borne out by the evidence on the record here. The NASD is a national association, whose members comprise the great bulk of the brokerage firms in the country. It is funded solely by its members and its rules are made by the members. It is only controlled by the securities industry, as one witness testified. It conducts independent investigations, and monitors many actions by the firms, such as personnel terminations, of which the SEC is unaware. When its investigation reveals something egregious, this information is passed on to the SEC.
Judge Friendly, in United States v. Solomon, supra, considered the question of the status of self-regulatory groups in a criminal context. There, he considered the New York Stock Exchange, but his arguments have equal force here. As Frederick Englert, house counsel for Hornblower, recognized, the exchanges and the NASD are similar groups, all involving in self-policing but having back-up authority in the SEC. One of the primary reasons that Judge Friendly held that the exchange was not a government actor was the problem of immunity.
[To hold that the exchange was governmental] would mean that a large number of private bodies have been unwittingly endowed with a power to grant exactly such immunity . . . without any weighing of the need for evidence against the desirability of conferring an immunity which goes beyond the testimony or information itself, and without the supervision of the Attorney General to which even government agencies are subjected. 509 F.2d at 870.
Furthermore, as Judge Friendly noted, if the securities self-regulating bodies were to be deemed "governmental," it would be difficult to draw the line.
As he says, supra at 869: "This is but one of the many instances where government relies on self-policing by private organizations to effectuate the purposes underlying federal statutes."
The Court must conclude that the NASD is not part of the government and its actions cannot be imputed to it nor its agents to bind it. To hold otherwise would be to eliminate a bulwark of our economic regulatory scheme, for there would be no need for a NASD if it were in effect a lower level of the SEC. Although private, it plays an important role in the scheme of securities regulation. It allows the securities industry to keep its own house clean and holds back the seemingly overwhelming tide of government supervision. Therefore, the Court will not consider the acts of NASD officials or their comments to be imputed to the SEC.
Cronin and Street's second argument, that the SEC was using its civil investigation as a ruse to gather evidence for criminal prosecution, must fail when the facts are examined. Of course, there is no inherent unfairness in a system, such as securities regulation, which allows pursuit of both civil and criminal remedies. United States v. Kordel, 397 U.S. 1, 25 L. Ed. 2d 1, 90 S. Ct. 763 (1970). Where the same events might be either civil or criminal, "a rational decision whether to proceed criminally . .. may have to await consideration of a fuller record. . . It would stultify enforcement of federal law to require a governmental agency . . . invariably to choose either to forgo recommendation of a criminal prosecution once it seeks civil relief or to defer civil proceedings pending the ultimate outcome of a criminal trial." Kordel at 11. Of course, the possibility of unfairness exists when the civil and criminal proceedings are commingled. United States v. Fields, supra. In tax cases, a summons may be defeated if it can be shown that it really is for criminal investigatory purposes. However, as Chief Judge Seitz noted in United States v. McCarthy, 514 F.2d 368 (3d Cir. 1975), the mere fact of an investigation is not enough to show use for criminal purposes. Instead, it must be shown that the summons is issued in bad faith. Quoting United States v. Wall Corp., 154 U.S. App. D.C. 309, 475 F.2d 893 (1972), the Chief Judge set up a test to discern the true nature of an investigation:
"If it can be shown that the investigating agent had already formed in his mind a firm purpose to recommend criminal prosecution even though he has not as yet made a formal recommendation, issuance of the subpoena would presumably be in bad faith. Similarly, if the civil liability were already determined, the summons would appear to be solely for a criminal purpose." 514 F.2d at 374.