has been an affirmative statement that will be rendered materially misleading by the failure to provide the necessary additional information. See 15 U.S.C. § 77q(a)(2); 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. Indeed, once Yeaman and Capital General made an affirmative statement with respect to this proceeding, they had a duty to disclose all material facts so as to not make their previous disclosures misleading.
Additionally, the disclosure in the annual 10-K reports for U.S. Card and Omega did not reveal the outcome of the state proceeding. The disclosure in the annual report for these two companies implies, if not states, that Yeaman and Capital General were unjustly fined and ordered to cease and desist simply for making a no-action request. In reality, they were fined and subjected to such an order because Yeaman and Capital General had violated state securities laws by making false and misleading statements to the state regulatory agency in connection with their request. (Govt's Resp. at Ex. 4). There is a vast difference between the two versions. Clearly, the disclosure provided was hardly enough.
Further, the disclosure provided also failed to satisfy the standard of Rule 12b-20 of the Exchange Act. 17 C.F.R. § 240.12b-20. This rule provides that once disclosure has been made, the issuer must be sure to add all other and further material information needed to insure that the disclosures, which have been made, are not materially misleading. Rule 12b-20 applies to all "required statements," which encompasses the statements required by Regulation S-K. As stated above, the statements with respect to the Oregon proceeding were misleading, thus Yeaman and Capital General had a duty to add all other and further material information to insure that their previous disclosures were not materially misleading. As previously mentioned, Yeaman and Capital General failed to make such additional disclosures. Thus, they violated the duty of disclosure mandated by Rule 12b-20.
The Court, however, rejects the government's argument that Yeaman and Capital were required to disclose every other instance in which they were the subject of a state or federal proceeding. The government claims that the annual reports were materially misleading without such information. The government contends that the disclosures made tended to negate any inference or implication that Yeaman or Capital General had ever previously been the subject of any federal or state securities law proceedings. However, a fair reading of the disclosures made by Yeaman and Capital General lead this Court to conclude that such disclosures did not imply that Yeaman and/or Capital General had ever previously been the subject of any federal or state securities law proceedings.
Therefore, Yeaman and Capital General were not obligated to make additional disclosures.
Yeaman argues that the government exceeds the scope of the indictment in arguing that the disclosures of the 1988 Oregon proceeding were inadequate. Yeaman contends that paragraph 6(o)(2) merely charges a failure to disclose, not inadequate disclosure. This argument is without merit. Yeaman's argument, if accepted, would stand the disclosure requirements of the federal securities laws on their head. If Yeaman's argument is correct, no person could ever be prosecuted for failing to disclose past securities laws violations if that person made some disclosure, no matter how woefully inadequate that disclosure was. This Court rightfully refuses to accept such a proposition.
Yeaman next argues that Rule 12b-20 cannot require him to make additional disclosures beyond those contained in Regulation S-K because such a requirement would deprive him of his right to due process. Yeaman vigorously contends that a person of ordinary intelligence reading Regulation S-K would believe that it governs matters to be disclosed with respect to certain legal proceedings. Yeaman submits that Regulation S-K does not state that, in addition to the disclosure found therein, Rule 12b-20 also must be complied with in order to stay within the bounds of law. Yeaman states that the government cannot seek to impose a greater duty to disclose, then that which is imposed by Regulation S-K, by reference to a general catchall regulation because to do so would violate due process since he was not given fair notice of the standard by which he should judge his conduct.
However, Yeaman's argument misses the mark.
Yeaman fails to understand when and under what circumstances Rule 12b-20 of the Exchange Act applies. This rule comes into play in the case of affirmative misrepresentations. In this case, Rule 12b-20 required Yeaman to provide additional and further disclosures where he made partial but incomplete disclosures about certain proceedings, for example, as was true of his incomplete and materially misleading disclosure in the annual reports about the Oregon proceeding.
Yeaman's due process rights are not violated by imposing upon him the disclosure requirements of Rule 12b-20. Importantly, there is no conflict between what is required to be disclosed under either Regulation S-K and Rule 12b-20. In the first instance, Regulation S-K requires a person to make disclosures with respect to certain legal proceedings. This Regulation is unambiguous and provides Yeaman with fair notice of what is required of him. Rule 12b-20 merely supplements Regulation S-K by requiring a person who has provided such information in "a statement or report . . . [to] add such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading." Rule 12b-20 clearly provides a person with fair notice as to what the law requires of him. In this case, Regulation S-K required Yeaman to make such disclosure with respect to certain legal proceedings. However, Yeaman was required to supplement his initial disclosure with such further material information as was necessary to make this disclosure not misleading because his initial disclosure pursuant to Regulation S-K was inadequate in that it was misleading. Yeaman's due process rights are not violated by the imposition of the clear and unambiguous requirements of Rule 12b-20, which surely gave him fair notice as to what the law required him to do.
Besides failing to fully disclose all material information with respect to the Oregon proceeding, it appears, contingent upon the government offering proof at trial, that Yeaman failed to disclose proceedings 6, 7 and 9.
Yeaman argues that he was not required to disclose such proceedings because he was not "the subject of" these proceedings. Item 401(f)(3)-(4) of Regulation S-K require registrants to disclose if any of their directors or officers were "the subject of" certain legal proceedings. 17 C.F.R. § 229.401(f)(3)-(4). Yeaman contends that these provisions only refer to persons who were "named" in the proceedings. Yeaman's argument, however, is without merit. Although Item 401(f)(2) refers to "named subject," Item 401(f)(3) and (4) merely refer to "the subject of," which connotes a broader meaning then "named subject." Surely, if (f)(3) and (f)(4) meant only "named subject," the SEC could have explicitly stated so, as it did in (f)(2). Thus, Yeaman had a duty to disclose proceedings 6, 7 and 9, if he was "the subject of" those proceedings.
The government alleges that it possesses evidence that will show that, at the time of proceedings 6, 7 and 9, Yeaman and Peterson were the directors of Capital General and respectively held the offices of president and vice president. Moreover, the government contends that it will prove that in 1990, Yeaman owned more than 90% of the stock of Capital General by virtue of his ownership interest and through Yeaman Enterprises, a family corporation owned by his children and his mother. Further, the government alleges that Yeaman also owns and controls NST through Capital General, and Yeaman, who was still president at the time of the proceeding against NST in 1988, already was or became a director of NST.
Additionally, the government alleges that NST can be deemed an affiliate of Capital General through Yeaman. An "affiliate" is defined in Rule 405 of the Securities Act as follows:
An "affiliate" of, or person "affiliated" with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified.
17 C.F.R. § 230.405. The government alleges that it possesses evidence that NST and Capital General are "affiliates" because Capital General through stock ownership controls NST and Yeaman is a director of NST. If the government can produce such evidence at trial, then it would appear that NST and Capital General would be affiliates.
Thus, if the government at trial can prove these allegations with respect to Yeaman's relationship with the above-mentioned entities, then there would be no question that Yeaman was the "subject of" proceedings 6, 7 and 9 either as a named party or through corporations he controlled or with which he was affiliated. Thus, contingent on evidence being produced at trial, the Court concludes that Yeaman failed to disclose proceedings 6, 7 and 9.
With respect to proceeding 11,
Yeaman also failed to comply with a specific duty to disclose. To begin, it is irrelevant that Regulation S-K and Item 103 may have not required disclosure of this proceeding.
Yeaman had a specific duty to disclose such further additional information to make his previous disclosures not misleading. Item 3, "Legal Proceedings," in the annual 10-K forms for both Omega and U.S Card states:
Other than described above, neither the Registrant nor any of its officers or directors, to their best knowledge, is a party to any material legal proceeding or litigation which would impact the operations of the Registrant, and such persons know of no material legal proceeding, judgments entered, legal actions or litigation contemplated or threatened which would impair operation of the Registrant in the future.
These statements are materially misleading. Indeed, at the time these statements were written in or about March 1990 for the period ending December 31, 1989, both Yeaman and Capital General had been the subject of an SEC investigation for over two years (since 1987). While the precise outcome of the litigation with the SEC may not have been known, there was a strong possibility in 1990 that, contrary to the statements in the annual reports, the SEC litigation could impact the operations of U.S. Card and Omega, companies on whose behalf the disclosures were being made.
Thus, Yeaman violated a specific duty to disclose by failing to disclose proceeding 11 in the annual 10-Ks.
With respect to proceedings 1, 2, and 3, Yeaman did not improperly fail to disclose these proceedings because he was under no specific duty to disclose. The government argues that Regulation S-K required these proceedings to be disclosed. The government, however, incorrectly relies on Regulation S-K.
The plain language of Item 401(f) of Regulation S-K explicitly requires the disclosure of specified legal proceedings that both occurred during the previous five years and are material.
It appears that the conjunctive language of Item 401(f) unambiguously shows that both materiality and temporal proximity are necessary in order for disclosure to be required. However, as the government correctly notes, Securities Act Releases numbers 5758 and 5949 indicate that Item 401 was intended only as a "guide," and that "events occurring outside this period may be material and should be disclosed." See Securities Act Release No. 5949, 1978 SEC LEXIS 1031, at *24 (July 28, 1978); Securities Act Release No. 5758, 1976 SEC LEXIS 484, at *4 (Nov. 2, 1976). From these SEC interpretations, the government argues that although the proceedings in dispute fall outside the five year period required by the specific language of Item 401(f), Yeaman was under a duty to disclose because such proceedings are material. The government's argument must fail for the following reasons.
As a general rule, courts "defer to an agency's consistent interpretation of its own regulation unless it is 'plainly erroneous or inconsistent with the regulation.'" Sekula v. FDIC, 39 F.3d 448, 453 (3d Cir. 1994) (quoting Bowles v. Seminole Rock and Sand Co., 325 U.S. 410, 414, 89 L. Ed. 1700, 65 S. Ct. 1215 (1945)). Nonetheless, "this deference does not permit us to defer to an 'interpretation' . . . that strains 'the plain and natural meaning of words . . ." Director, Office of Workers' Compensation Programs v. Mangifest, 826 F.2d 1318, 1324 (3d Cir. 1987), and is "tempered by our duty to independently insure that the agency's interpretation comports with the language it has adopted." Director, Office of Workers' Compensation Programs v. Gardner, 882 F.2d 67, 70 (3d Cir. 1989). In sum, a court "cannot accord more deference to the . . . interpretation of the regulation than to the actual regulation." Director, Office of Workers' Compensation Programs v. Eastern Associated Coal Corp., 54 F.3d 141, 149 (3d Cir. 1995).
With these principles in mind, the Court rejects the SEC's interpretation as inconsistent with the plain language of Regulation S-K itself, reaching this conclusion is not difficult. The plain language of Regulation S-K, without ambiguity, explicitly states that the specified legal proceedings must both have occurred within the previous five years and be material in order for disclosure to be required. Release numbers 5949 and 5758, however, suggest the direct opposite of what the plain language of the regulation require. Such an interpretation is inconsistent with the plain meaning of the language of Item 401(f), which the Court finds to be an unambiguous item.
Additionally, the fact that the SEC interpreted Item 401(f) twenty years ago when promulgating it does not make deference to the interpretation appropriate. The Third Circuit stated in Eastern Associated Coal that:
although the Director claims that she consistently has applied the same policy for twenty years, she is not permitted to imply language that simply does not exist. . . . Her interpretation strains the "plain and natural meaning" of the text. To reach such a result would require consideration of factors far beyond the actual regulation.
54 F.3d at 149 (citation omitted). The reasoning from Eastern Associate Coal is instructive for this case. Although the SEC has consistently interpreted Item 401(f) to require disclosure beyond five years, this interpretation strains the plain and natural meaning of the text. Thus, this interpretation is entitled to no deference, and as such, there is no disclosure required by Item 401(f) which reaches beyond the five years explicitly stated in the text.
Consequently, Yeaman had not duty to disclose proceedings 1-3 because they were outside the five-year period.
The Court also notes that a reading of Item 401(f) which requires disclosure beyond five years imposes considerable constitutional problems in a criminal prosecution. The Fifth Amendment to the United States Constitution provides that "no person shall . . . be deprived of life, liberty, or property, without due process of law." U.S. Const. amend. V. A person is deprived of due process if he is prosecuted without having been given fair notice that his conduct was forbidden. United States v. Harriss, 347 U.S. 612, 617, 98 L. Ed. 989, 74 S. Ct. 808 (1954). There are considerable doubts as to whether Item 401(f) with its attendant Releases give a person fair notice that his conduct is forbidden by statute.
In United States v. Matthews, 787 F.2d 38 (2d Cir. 1986), the government prosecuted a defendant for proxy violations for failing to disclose in proxy materials information not explicitly required by Schedule 14A. The Second Circuit, however, reversed the defendant's conviction, holding that "at least so long as [the information at issue] is not required to be disclosed by any rule lawfully promulgated by the SEC, nondisclosure of such [information] cannot be the basis of a criminal prosecution." Id. at 49. It rested this holding in part on "the obvious due process implications that would arise from permitting a conviction to stand in the absence of clearer notice as to what disclosures are required" in the area of qualitative management conduct. Id.
In this case, even if certain Releases suggest that specified legal proceedings beyond five years old are required to be disclosed, they are not required to be disclosed by any rule lawfully promulgated by the SEC. Indeed, the imposition of such a disclosure requirement, despite the lack of such a requirement in a rule, would surely violate Yeaman's right to due process. Regulation S-K does not give fair notice to an individual that they could be prosecuted for failing to disclose all material proceedings beyond five years.
Therefore, these additional due process considerations direct the Court to conclude that Yeaman did not have a duty to disclose proceedings 1-3.
With respect to proceedings 4, 5 and 10, Yeaman did not have a duty to disclose. The government primarily argues that Yeaman had a duty to disclose these proceedings because they were material. As stated previously, there is no general duty to disclose all material information. Thus, Yeaman would not have had to disclose proceedings 4, 5 and 10 merely because they were material. Moreover, the government cannot demonstrate that Yeaman was under some specific duty to disclose these proceedings. The Court thus finds that Yeaman cannot be prosecuted for failing to disclose proceedings 4, 5 and 10.
Finally, the Court addresses whether Yeaman failed to comply with the specific disclosure requirements of Rule 15c2-11. Form 2-11, required by Rule 15c2-11 of the Exchange Act, 17 C.F.R. § 240.15c2-11, is filed with NASD for the purpose of obtaining approval for "listing" and trading of stock either in the "pink sheets" or on the OTC Bulletin Board. The information provided on these forms constitute the basis for commencing a trading market and assessing the price at which the stocks will be traded. When seeking to establish trading markets in the stocks of U.S. Card, Omega and AFS, it is alleged that Yeaman prepared or caused to be prepared for those companies Form 2-11.
The government alleges that Yeaman violated the anti-fraud provisions of the federal securities laws by failing to disclose in these Forms 2-11 the following information. With respect to Forms 2-11 for U.S Card and Omega, the government alleges that these forms failed to identify Yeaman as a control person and failed to disclose his prior securities laws violations for the past 20 years. With respect to Form 2-11 for AFS, the government asserts that this form, and disclosure packages provided to market makers, failed to disclose Yeaman's disciplinary history. The government claims that these were material omissions, and thus actionable under the general anti-fraud provisions. Yeaman contends that U.S. Card, Omega and AFS did not breach a duty to disclose information about him because they fully complied with the disclosure requirements of Rule 15c2-11(a)(5).
The Court finds, agreeing with Yeaman, that U.S. Card, Omega and AFS did not breach any duty to disclose. Importantly, the government does not refute Yeaman's contention that U.S. Card, Omega and AFS complied with Rule 15c2-11(a)(5). The government probably does not refute this contention because it appears that these companies did comply with the specific requirements of Rule 15c2-11.
The government instead relies on the reasoning of In re New Allied Development Corp., Exchange Act Release No. 37990, 1996 WL 683705 (Nov. 26, 1996), for its argument that AFS, U.S. Card and Omega were required to disclose that Yeaman was a control person and that Yeaman had an extensive history of securities laws violations. In New Allied Development, it was alleged that there were material omissions in Forms 2-11 because these forms failed to indicate that one of the parties, Grady Sanders, maintained a control position in New Allied and failed to set forth his prior disciplinary history. The SEC, in its opinion, found that these omissions in the disclosure statements to market makers were material, false and misleading. Accordingly, the SEC held that Sanders had wilfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act.
The government's reliance on New Allied is misplaced. Although the SEC in New Allied concluded that the disclosure requirements of Rule 15c2-11 were violated, nowhere in its opinion does the SEC cite to a specific provision which was violated. Instead, it appears that the SEC summarily concluded that Rule 15c2-11 was violated because such information was material. Indeed, it appears that the SEC relied on a standard of disclosure that requires the disclosure of all material information, rather then relying on the specific requirements of Rule 15c2-11. However, as stated above, there is no general duty to disclose all material information. Therefore, to the extent that New Allied relies on a general duty to disclose all material information, this Court rejects New Allied's reasoning and result.
New Allied is also strikingly inapposite to this case in that it was merely an administrative action. In this case, Yeaman is being criminally prosecuted for allegedly violating securities laws. Due process considerations are implicated here because the government is not arguing that particular provisions of Rule 15c2-11 were violated; instead, the government is arguing that Yeaman failed to satisfy his duty to disclose by failing to disclose all material information in the Forms 2-11. Under the government's standard, the problem of fair notice arises because Yeaman did not have fair notice as to what conduct was prohibited by law. Indeed, Yeaman complied with Rule 15c2-11(a)(5), and as stated previously, there is no general duty to disclose all material information. The government cannot now attempt to prosecute Yeaman for failing to comply with some ambiguous duty to disclose all material information. Surely, such a prosecution would violate the fair notice requirement of due process.
Since U.S. Card, Omega and AFS did comply with Rule 15c2-11(a)(5) and the government cannot point to any other specific duty to disclose, the Court concludes that these companies did not breach any duty to disclose any information about David Yeaman.
Accordingly, based on the foregoing reasons, Yeaman's motion to strike language is dismissed. The government has demonstrated that Yeaman failed to disclose certain information for which he had a duty to disclose. Therefore, the language in paragraph 6(o)(2) is relevant to the charges in the indictment and is information which the government hopes to properly prove at trial, and thus cannot be considered surplusage under Rule 7(d) of the Federal Rules of Criminal Procedure.
AND IT IS SO ORDERED.
Clarence C. Newcomer, J.
AND NOW, this 10th day of March, 1997, upon consideration of defendant David Rex Yeaman's Motion to Strike Language, and the government's response thereto, and Yeaman's reply thereto, and the parties' supplemental memoranda thereto, it is hereby ORDERED that said Motion is DENIED.
AND IT IS SO ORDERED.
Clarence C. Newcomer, J.