II. SECTION 17(a):
Section 17(a) of the Securities Act of 1933, by contrast, reaches only fraud "in the offer or sale" of securities. Quite clearly, the omission of the words "in connection with" makes the scope of § 17(a) narrower than that of § 10(b) in that the former requires a closer relationship between the fraud and the securities transaction. We would not go so far, however, as to accept the defendants' contention and the court's conclusion in Financial Programs, Inc. v. Falcon Financial Services, Inc., 371 F. Supp. 770, 775 (D.Ore. 1974), that only "sellers of securities" (i.e., those personally involved in the sales) come within the ambit of § 17(a), at least insofar as SEC enforcement proceedings are concerned. The facts regarding the extent of the defendants' involvement in the offer or sale of securities, beyond the fact that they did not personally sell securities, are both sketchy and disputed at this point. Furthermore, we know of no controlling case imparting to us a clear standard of the relationship required under § 17(a) between the fraud and the securities transaction.
We consequently will deny the defendants' motion for summary judgment as to the allegation of violations of § 17(a). We are disposed to do so particularly in light of the fact that granting the motion as to § 17(a) in no way would diminish the scope of the trial or the eventual liability or relief in this case, so long as the § 10(b)-based claim remained.
The balance of this opinion deals with the issues raised by defendants' motions for summary judgment and for reconsideration under the more fully developed law of § 10(b) and Rule 10b-5, which we perceive as the heart of this case, with the caveat that much of the authority dealing with these issues blurs the distinctions between § 17(a) and § 10(b), and understandably so. We must emphasize, however, that the plaintiff will have to demonstrate at trial a more direct involvement in the offer or sale of securities to make out a § 17(a) violation than is necessary to establish a violation of § 10(b) and Rule 10b-5. See 1 A. Bromberg, Securities Law, Fraud, SEC Rule 10b-5 § 2.3(300), at 24 (1971 Supp.).
Defendants contend that the relief sought by plaintiff, an injunction including the disgorgement of payments received from the corporations as a result of the scheme to inflate reported profits, cannot be granted on the grounds, inter alia, that various causal connections between these payments and securities transactions are not alleged. What these arguments fail to perceive is that determining the scope of the equitable remedy of disgorgement entails an analysis separate from assessing whether the SEC has stated a cause of action in an SEC enforcement case. Should we determine that any defendant violated § 17(a) or § 10(b), we have the discretion to fashion whatever equitable relief we deem necessary to deprive defendants of all gains flowing from the wrong. J.I. Case Co. v. Borak, 377 U.S. 426, 433, 12 L. Ed. 2d 423, 84 S. Ct. 1555 (1964); SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir.), cert. denied, 404 U.S. 1005, 30 L. Ed. 2d 558, 92 S. Ct. 561 (1971); SEC v. Golconda Mining Co., 327 F. Supp. 257, 259-60 (S.D.N.Y. 1971). That remedy can include disgorgement of proceeds from the wrongful conduct, SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1104 (2d Cir. 1972).
The amount to be disgorged is not limited as a matter of law to the damages inflicted upon purchasers and sellers. The SEC does not stand in the shoes of the purchasers and sellers who it asserts were defrauded. While we know of no case going so far as to require disgorgement of compensation to corporate officers and directors, neither have we found any case in which the facts revealed such compensation to be the result of fraud violating the securities law as directly as those alleged here. As the facts are alleged, the excesses in compensation sought by plaintiff seem indeed to have "flowed" from the wrong. We are unable, consequently, to say at this point that none of the compensation was part of defendant's wrongful gain. We find the case for restitution under the alleged facts to be more compelling than in SEC v. Galaxy Foods, Inc., 417 F. Supp. 1225 (E.D.N.Y. 1976), for example, in which the court held that a corporation and its executives violated the securities laws in the sales of franchises from which they received salary overrides. With respect to one violator, the court deemed it inequitable "under the circumstances" to make him disgorge his full salary but required disgorgement of the value of a franchise he had been given free of charge. Id. at 1249. We are ill equipped without knowledge of the circumstances in this case to determine what is equitable under them, and therefore we must reserve judgment until trial as to the proper relief.
Defendants contend that plaintiff has failed to allege scienter as an element of the cause of action under § 10(b) and Rule 10b-5 and that scienter is a necessary element of an enforcement action by the SEC.
We disagree with the first part of defendants' assertion and reserve judgment as to the second. It is true that the amended complaint does not allege in a single terse statement that defendants caused the misrepresentations to be made with an "intent to deceive, manipulate or defraud," which allegation is required in private damage actions under § 10(b) and Rule 10b-5, Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976). The Amended Complaint does track, however, the language of § 10(b) and Rule 10b-5 by alleging that defendants employed "devices, schemes and artifices to defraud" and has engaged in practices which have operated as a "fraud and deceit" upon purchasers of Penn Central Transportation Company securities. Amended Complaint at para. 61. It further alleges that defendants engaged in a "scheme" to misrepresent and conceal Penn Central's financial condition in various ways, id. at PP 62-63, and that the compensation agreements with one corporation provided the "incentive" for the scheme. Id. at P 63.
We have stated in the past our conviction that complaints should be construed liberally when faced with challenges to their specificity, in light of the notice-pleading mandate of F.R.Civ.P. 8, Denny v. Carey, 72 F.R.D. 574, 578-79 (E.D.Pa. 1976). In light of that conviction and the provision of F.R.Civ.P. 9(b) that "intent, knowledge, and other conditions of mind may be averred generally", we believe the allegations noted above amount to an allegation of the intent required under Hochfelder -- that is, either the "intent to say something, that is expected to be relied on, that is not believed to be true, or, if strictly true, is hoped will be understood in an untruthful sense," SEC v. World Radio Mission, Inc., 544 F.2d 535, 540 (1st Cir. 1976), or recklessness, Coleco Industries, Inc. v. Berman 567 F.2d 569, [1977-78 Transfer Binder]Fed.Sec.L.Rep. (CCH) P 96, 253 (3d Cir. 1977).
To say that defendants had an incentive to scheme and in accordance with that incentive schemed to misrepresent and conceal seems to us tantamount to averring they had such an intent.
Since there is a factual issue as to whether defendants had the scienter required under Rule 10b-5, we cannot grant summary judgment on this ground.
The issue of whether scienter is required at all in an SEC enforcement action explicitly was left unresolved by the Supreme Court in Hochfelder, 425 U.S. at 193 n.12. We note that the division of authority on this issue has survived that decision. Some courts have concluded that the Hochfelder rationale ought to be applied in this context, e.g., SEC v. Cenco Inc., 436 F. Supp. 193 (N.D.Ill. 1977); SEC v. American Realty Trust, 429 F. Supp. 1148 (E.D.Va. 1977); SEC v. Bausch & Lomb, Inc., 420 F. Supp. 1226 (S.D.N.Y. 1976). Others have held scienter unnecessary upon determining that the policy of public protection underlying SEC enforcement actions differentiates these cases from private damage suits and distinguishes Hochfelder, e.g., SEC v. Universal Major Industries Corp., 546 F.2d 1044 (2d Cir. 1976), cert. denied sub nom. Homans v. SEC, 434 U.S. 834, 98 S. Ct. 120, 54 L. Ed. 2d 95 (1977); SEC v. World Radio Mission, Inc., 544 F.2d 535 (1st Cir. 1976); SEC v. Shiell, [1977-78 Transfer Binder] Fed.Sec.L.Rep. (CCH) P 96, 190 (N.D.Fla. 1977). See also Comment, Scienter and SEC Injunction Suits, 90 Harv.L.Rev. 1018, 1223-25 (1977). Our determination that scienter has been alleged and survives as a genuine issue of fact in this case makes it unnecessary for us to decide whether it must be proved at this point: notwithstanding the SEC's legal contention that scienter is unnecessary, we assume that showing the intent as defined in Hochfelder, World Radio Mission and Coleco will be a part of plaintiff's case since it has been alleged. Moreover, we deem it unwise, as did Judge Gesell in SEC v. Wills, to issue an advisory opinion as to this issue at this stage of the litigation. Given the volatile nature of this area of securities law and the suddenness with which the judicial tide might turn in either direction, we ought not bind ourselves now by deciding the consequence of the SEC's failure to establish scienter at trial.
For the same reason, we do not now decide precisely what degree of scienter, if any, is necessary for plaintiff to prevail in an enforcement action. In particular, it is possible that the plaintiff will demonstrate that one or both defendants intentionally misrepresented facts to the corporations in order to enhance their compensation, which misrepresentations in turn caused material misrepresentations to be made to purchasers and sellers of securities with neither the intent nor recklessness of defendants. These facts would present a situation standing between the categories of negligence and scienter as Hochfelder presents them, and we shall not issue an advisory opinion as to the legal consequences of a hypothetical fact pattern.
V. INTERLOCUTORY APPEAL:
Defendants request that we certify for interlocutory appeal pursuant to 28 U.S.C. § 1292(b) our denial of their motions. That statute permits us to certify the appeal of an order if (1) it involves a controlling question of law, (2) there is substantial ground for difference of opinion and (3) immediate appeal may materially speed termination of the litigation. The sole legal issue in this case which we perceive as satisfying the difference of opinion criterion of § 1292(b) is the degree of scienter, if any, required in an SEC enforcement action under § 17(a), § 10(b) and Rule 10b-5. As we have noted, however, resolution of that question could not terminate the action in this court, nor would it significantly hasten its end, since scienter has been alleged and trial would still be necessary to determine the factual issues of what knowledge and intent were present. To put it another way, we lack the "background of determined and immutable facts" necessary for certification under § 1292(b). 9 Moore's Federal Practice § [110.222], at 261 (2d ed. 1975).