United States v. Naftalin, 441 U.S. 768 (1979)

United States v. Naftalin

No. 78-561
Argued March 26, 1979
Decided May 21, 1979
441 U.S. 768

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

Syllabus

Respondent engaged in a fraudulent "short selling" scheme, by placing orders with brokers to sell certain shares of stock which he believed had peaked in price and which he falsely represented that he owned. Gambling that the price would decline substantially before he was required to deliver the securities, he planned to make offsetting purchases through other brokers at lower prices. But the market price rose sharply before the delivery date, so that respondent was unable to make covering purchases and never delivered the securities. Consequently, the brokers were unable to deliver the securities to the investor purchasers, and were forced to borrow stock to make the delivery. In order to return the borrowed stock, the brokers had to purchase replacement shares on the open market at the now higher prices, a process known as "buying in." While the investors were thereby shielded from direct injury, the brokers suffered substantial financial losses. The District Court found respondent guilty of employing "a scheme and artifice to defraud" in the sale of securities in violation of § 17(a)(1) of the Securities Act of 1933, which makes it unlawful "for any person in the offer or sale of any securities . . . directly or indirectly . . . to employ any device, scheme, or artifice to defraud." The Court of Appeals, while finding the evidence sufficient to establish that respondent had committed fraud, vacated the conviction on the ground that the purpose of the Securities Act was to protect investors from fraudulent practices in the sale of securities, and that, since respondent’s fraud injured only brokers, and not investors, respondent did not violate § 17(a)(1).

Held: Section 17(a)(1) prohibits frauds against brokers as well as investors. Pp. 771-779.

(a) Nothing on the face of § 17(a)(1) indicates that it applies solely to frauds directed against investors. Rather, its language requires only that the fraud occur "in" an "offer or sale" of securities. Here, an offer and sale clearly occurred within the meaning of the terms as defined in § 2(3) of the Securities Act. And the fraud occurred "in" the "offer" and "sale," as the statute does not require that the fraud occur in any particular phase of the selling transaction. Pp. 772-773.

(b) The fat that § 17(a)(3) makes it unlawful for any person in the offer or sale of any securities to engage in any transaction, practice, or course of business which operates as a fraud or deceit "upon the purchaser" does not mean that this latter phrase should be read into § 17(a)(1), since each subsection of § 17(a) proscribes a distinct category of misconduct. Pp. 773-774.

(c) Neither this Court nor Congress has ever suggested that investor protection was the sole purpose of the Securities Act. While prevention of fraud against investors was a key part of the purpose of the Act, so was the effort "to achieve a high standard of business ethics . . . in every facet of the securities industry," SEC v. Capital Gains Bureau, 375 U.S. 180, 186-187, and this conclusion is amply supported by the legislative history. Pp. 774-776.

(d) Moreover, frauds against brokers may well redound to the detriment of investors. Although the investors in this case suffered no immediate financial injury, the indirect impact upon investors in such a situation can be substantial. And direct injury to investors is also possible. Had the brokers in this case been insolvent or unable to borrow, the investors might have failed to receive their promised shares. Placing brokers outside the aegis of § 17(a)(1) would create a loophole in the statute that Congress did not intend. Pp. 776-777.

(e) Although the Securities Act was primarily concerned with the regulation of new offerings of securities, the antifraud prohibition of § 17(a) was meant as a major departure from that limitation, and was intended to cover any fraudulent scheme in an offer or sale of securities, whether in the course of an initial distribution or in the course of ordinary market trading. Accordingly, the fact that respondent’s fraud did not involve a new offering does not render § 17(a)(1) inapplicable to that fraud. Pp. 777-778.

(f) Since the words of § 17(a)(1) "plainly impose" a penalty for the acts committed in this case, it would be inappropriate to apply the rule that ambiguity as to the scope of a criminal statute should be resolved in favor of lenity. Pp. 778-779.

579 F.2d 444, reversed.

BRENNAN, J., delivered the opinion of the Court, in which all other Members joined except POWELL, J., who took no part in the consideration or decision of the case.