Equitable Remedies in SEC Enforcement Actions, Exams of Remedies

Download Equitable Remedies in SEC Enforcement Actions and more Exams Remedies in PDF only on Docsity! COMMENT EQUITABLE REMEDIES IN SEC ENFORCEMENT ACTIONS I. INTRODUCTION A. The Power to Fashion Equitable Remedies Section 21(e) of the Securities Exchange Act of 1934 au- thorizes the Securities and Exchange Commission (SEC) to bring an action to enjoin any person who "is engaged or about to engage in any acts or practices which constitute or will constitute a violation of [these] provisions . . . ."I Section 27 of this Act confers exclusive jurisdiction on the federal courts to hear "all suits in equity.., brought to enforce any liability or duty created by [the Act.]"'2 Pursuant to the equitable power conferred by these sections and analogous provisions of the Securities Act of 1933, 3 the courts, at the behest of the SEC, have fashioned a broad range of remedies, often ancillary to the issuance of an injunction, to aid in rectifying fraud and to protect against fu- ture violations. Remedies imposed in enforcement actions have become increasingly varied, 4 falling basically into three cate- gories: (a) the remedying of past abuses through the grant of monetary relief;5 (b) the prevention of future fraud by requiring the adoption of special corporate procedures; 6 and (c) the tem- porary appointment of special agents in cases of gross misman- agement requiring unusual control or wholesale replacement of existing management.7 The power of the courts to grant SEC requests for relief beyond a simple injunction against further wrongdoing appears 1 15 U.S.C. § 78u(e) (1970). 2 15 U.S.C. § 78aa (1970). 3 15 U.S.C. § 77(t), (v) (1970). For an extensive review of various types of ancillary relief, see Mathews, SEC Civil Injunctive Actions-II, 5 REv. SEc. REG. 949 (1972). 5 Text accompanying notes 40-50 infra. The Commission is not empowered to seek relief on behalf of private parties. In the context of this Comment, monetary relief refers to remedies which require defendants to give up money which they have obtained unlaw- fully; compensation to individual private parties is incidental to the thrust of the en- forcement action. 6 Text accompanying notes 51-65 inf'a. 7 Text accompanying notes 66-146 inyra. EQUITABLE REMEDIES well-established. The statutory grant of equitable power to the courts includes all power necessary to make effective the decree rendered by the court. The SEC has no express statutory authority to seek re- scission, restitution, or other forms of equitable monet- ary relief. The Commission, however, may institute an action for injunctive relief and, once the equity jurisdic- tion of the district court has been properly invoked, the court has power to grant all equitable relief necessary under the circumstances.... Ancillary relief contributes to effective enforcement of the securities laws by depriv- ing defendants of gains made through violations, by deterring future violations, and by increasing the over- all efficiency of Rule 1Ob-5 and similar actions.8 The power to effectuate the equitable decree is part of the court's ancillary jurisdiction9 and exists in all cases absent a specific statutory denial. 10 It is the necessary means to protect the authority of the court by assuring that its decrees are meaningful." To the extent that the remedies requested by the SEC serve specifically to effectuate the terms of the injunction, that is, to prevent future wrongdoing, they are surely well within the ancillary power of the court. A somewhat broader basis for the exercise of judicial power has emerged in the wake of the successful imposition of the disgorgement-of-profits remedy in SEC v. Texas Gulf Sulphur Co.'2 Initially there was some doubt whether a remedy which was not truly ancillary to the injunction could be imposed in an en- forcement action.' 3 Thus, in Texas Gulf Sulphur the relief re- quested was purely compensatory and remedial and could not, in a formal sense, be considered necessary to effectuate the pro- visions of the injunction, which was directed at the abatement of future wrongdoing. The court there nonetheless refused to read 8 Chris-Craft Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 390-91 (2d Cir.), cert. denied, 414 U.S. 910 (1973). ' See I J. POMEROY, EQUITY JURISPRUDENCE § 171(1) (5th ed. 1941). 10 See Morrow v. District of Columbia, 417 F.2d 728, 737-38 (D.C. Cir.1969). 11 Id. (power to order expungement of an arrest record properly ancillary to the court's power to declare the innocence of a defendant in a criminal case). 12 446 F.2d 1301 (2d Cir.), cert. denied, 404 U.S. 1005 (1971). " See, e.g., Note, Ancillary Relief in SEC Injunction Suits fordViolation of Rule lOb-5, 79 HARv. L. REv. 656 (1966); Comment, SEC Enforcement of the Rule lOb-5 Duty to Disclose Material Information-Remedies and the Texas Gulf Sulphur Case, 65 MICH. L. Rev. 944 (1967); cf. SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1307 (2d Cir.), cert. denied, 404 U.S. 1005 (1971). 1975] UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 tion, though one was sought.25 Such an award is not without precedent. In United States v. Moore,26 the Supreme Court granted restitution for rental payments made in violation of simi- larly worded rent control provisions of the Housing and Rent Act of 194727 although no injunction could issue in that situation because the property in question had been decontrolled. It is clear that both the courts and the SEC are becoming increasingly aware of this "quasi-legislative" power to impose flexible and creative remedies to fit the violation charged.2 8 As a practical matter, however, in some cases this power has de- veloped with little formal judicial check on the SEC's discretion, because a number of these newer remedies have emerged as a result of negotiated consent decrees. B. The Consent Decree Process Consent decrees as a method of concluding litigation are viewed as a necessity for the Commission, which has neither the time nor the resources to litigate each case. 29 They are also a speedy and efficient means by which to secure the immediate cessation of illegal conduct and to impose the desired relief.30 For the targets of the proceeding, there are many reasons to agree to a settlement. Early settlements limit the extent of ad- verse publicity, avoid more detailed elaboration of the proof un- derlying the charge (which would be presented, for example, in support of a preliminary injunction), may provide the opportun- ity to negotiate who is named in the injunctive decree, and pre- clude any possible collateral estoppel effects of the proceeding in future private actions. 31 Additionally, because an unsuccessful defense is not reimbursable from corporate funds, 32 the targets have an incentive to avoid costly litigation. 2- Id. at 392. Similarly, in SEC v. Manor Nursing Centers, Inc., 340 F. Supp. 913 (S.D.N.Y. 1971), modified, 458 F.2d 1082 (2d Cir. 1972), certain defendants were ordered to return proceeds made in a fraudulent public offering of stock although no injunction was granted against them. Id. at 936. 26 340 U.S. 616 (1951). 27 Ch. 163, § 206(b), 61 Stat. 193. The provision under which the Administrator was suing provided, "Whenever... any person has engaged or is about to engage in any act or practice which constitutes or will constitute'a violation of subsection (a) of this section, [the Administrator] may make application . . . for an order enjoining such act ... or for an order enforcing compliance with such subsection .... " 2 ' See, e.g., Sporkin, SEC Developments in Litigation and the Molding of Remedies, 29 Bus. LAW. 121 (1974). 29 Cf. Gapay, When the SEC Slaps Your Wrist, Wall St. J., Nov. 27, 1973, at 24, cols. 4-6; Mathews, supra note 4, at 955. 3 Cf. United States v. Carter Prods., Inc., 211 F. Supp. 144 (S.D.N.Y. 1962). 31 Mathews, supra note 4, at 955. 2 See SEC v. Capital Counsellors, Inc., [1973-1974 Transfer Binder] CCH FED. SEC. L. REP. 94,572 (S.D.N.Y. 1974) (legal fees for unsuccessfully resisting a SEC action for EQUITABLE REMEDIES Although the decision to enter into a consent decree is an administrative act,33 the entry of the decree itself is an exercise of judicial power.3 4 "By approving the consent judgment, the court is adjudicating the plaintiff's right to relief and its extent, both of which are essential elements of any judgment. '35 The court must be satisfied that the decree is equitable, 36 that it af- fords relief in the public interest, and that the violation will, in fact, be remedied. Once there is consent to a decree, it can be attacked on appeal only on the grounds of fraud, lack of actual consent, or lack of subject matter jurisdiction in the court enter- ing the decree. That a remedy could not be imposed if the case were litigated is not ground for appeal.38 Finally, it is extremely difficult for the defendant to secure modification of the decree once it is entered.3 9 Out of this process recently have come several new remedies which are largely the creations of the SEC. Among these are model corporate procedures, the appointment of special counsel, and the appointment of interim directors. Although it is clear that these new remedies are within the power of the SEC to an injunction and appointment of a receiver not reimbursible out of the receivership estate). 33 United States v. Automobile Mfrs. Ass'n, 307.F. Supp. 617, 620 (C.D. Cal. 1969), affd mem. sub nora., City of New York v. United States 397 U.S. 248 (1970). '4 United States v. Carter Prods., Inc., 211 F. Supp. 144, 147 (S.D.N.Y. 1962). 3- SEC v. Thermodynamics, Inc., 319 F. Supp. 1380, 1382 (D. Colo. 1970), aff'd, 464 F.2d 457 (10th Cir. 1972), cert. denied, 410 U.S. 927 (1973). 3' United States v. Ling-Temco-Vought, Inc., 315 F. Supp. 1301 (W.D. Pa. 1970). 37 See, e.g., Swift & Co. v. United States, 276 U.S. 311, 324 (1928); SEC v. Dennett, 429 F.2d 1303 (10th Cir. 1970). 38 In Walling v. Miller, 138 F.2d 629 (8th Cir. 1943), cert. denied, 321 U.S. 784 (1944), an action brought by the Administrator of the Wages and Hours Division, the court refused to vacate a consent decree ordering restitution for back wages in an action under the Fair Labor Standards Act of 1938, 29 U.S.C. § 201 (1970), even though this remedy had not been established as one which the administrator was empowered to bring. Assuming, but not deciding, that the administrator is not authorized in the first place to maintain a suit for restitution and that only the employees may do so, the inclusion of the order for restitution in the consent decree did not go to the jurisdiction or power of the court but to the merits only. Id. at 631. Compare Communication Workers v. NLRB, 362 U.S. 479 (1960) (per curiam), modifying 266 F.2d 823 (6th Cir. 1959), with NLRB v. Brandman Iron Co., 368 U.S. 399 (1962), rer'g 281 F.2d 797 (6th Cir. 1960). In the former, a litigated case, the Court modified, as too broad, the injunction which had issued. In the latter case, equivalent language was reinstated by the Court when the injunction had issued as a result of a consent decree. Cf. Flynn, Consent Decrees in Antitrust Enforcement: Some Thoughts and Proposals, 53 IOWA L. REV. 983, 985 (1968): "[P]rovisions of the decree based upon erroneous factual or legal conclusions, provisions which enjoin intrastate activities, provi- sions which are vague and general, and provisions which go beyond the scope of the antitrust laws are barred from attack on appeal because of the defendant's consent to the decree." But cJ. Cascade Natural Gas Corp. v. El Paso Natural Gas Co., 386 U.S. 129 (1967); Orth v. Transit Inv. Corp., 132 F.2d 938 (3d Cir. 1942). 3"See, e.g., United States v. Swift & Co., 286 U.S. 106 (1932). 19751 UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 negotiate and the courts to approve, they nonetheless present problems which should be examined. The appointment of interim directors is a drastic remedy in that, like the equity receivership, it temporarily suspends the power of a company's shareholders to choose its managers. It is very different from that traditional remedy in that such direc- tors, unlike equity receivers, have broad power to manage the firm-power that appears to be coextensive with that of elected directors; this increased power, however, seems to be subject to substantially less supervision by the court entering the decree authorizing appointed management. Moreover, provisions in consent decrees themselves seem to give the SEC a voice in the internal management of the company, as well as in the selection of these appointed managers. Although it is clear that the SEC as presently composed is one of the most effective and trusted fed- eral agencies, it is equally clear that this may not always be the case. It seems a wise precaution to establish proper standards for the imposition of extensive new forms of relief before the failure to have articulated standards leads to abuses of power. The finality of the consent judgment, the private nature of the negotiation process, and the lack of discussion by courts im- posing many of the SEC's newer remedies combine to create relationships among shareholders, appointed management, the SEC, and the courts that need to be fully described and analyzed. II. REMEDIES THAT Do NOT DISPLACE ELECTED MANAGEMENT A. Monetary Relief Since Texas Gulf Sulphur, disgorgement of profits derived from illegal insider trading has become a "regular" in the arsenal of enforcement remedies. 40 (A recent variation of this remedy, requested in SEC v. Penn Central Co.,4 1 seeks disgorgement of profits, unrelated to insider trading, made through improper diversion of corporate funds and improper corporate agreements.) 42 The rationale for the imposition of this remedy is that it promotes the statutory goals of the securities acts by en- 4 0 See, e.g., SEC v. Shapiro, 349 F. Supp. 46 (S.D.N.Y. 1972, aff'd, 494 F.2d 1301 (2d Cir. 1974); SEC v. Golconda Mining Co., [1969-1970 Transfer Binder] CCH FED. SEC. L. REP. 92,504 (S.D.N.Y. 1969). 41 [1973-1974 Transfer Binder] CCH FED. SEC. L. REP. 94,527 (E.D. Pa. 1974). 42 Cf the recent consent decrees in the illegal political contribution cases wherein the targets agreed to reimburse the company for illegal payments which they caused the company to make. Notes 60-62 infra & accompanying text. EQUITABLE REMEDIES to enforce against brokerage firms 5 4 and was specifically tailored to protect the public in its dealings with Goldman Sachs. The SEC has not hesitated to mandate special procedures for companies other than broker-dealers. Teleprompter Corpo- ration, an operator of cable television systems, recently con- sented to an injunction against issuing false and misleading press releases and annual reports.55 Apparently satisfied that the company's failure to disclose that it was reducing its construction program was caused by inadequate "internal financial controls and procedures," rather than by intentional fraud, 56 the SEC accepted new financial monitoring and reporting techniques as part of the consent decree. These new procedures required the preparation of operating and capital budget forecasts on a reasonably current basis; they also included the safeguard of furnishing the SEC with an affidavit describing the procedures accompanied by a letter from the auditor confirming that such procedures had in fact been implemented.57 This settlement was clearly aimed at the specific problem of identifying anticipated cutbacks in capital expansion programs at an early stage and assuring full disclosure to the public. This specific failure to disclose was the precise problem for which Teleprompter had been cited. The consent decree in SEC v. Lums, Inc. 58 went one step further than the Teleprompter order, in that it actually man- dated the disclosures which had to be made in any subsequent registration or proxy statement issued in connection with the future acquisition of any gambling casino. Included among the required disclosures were who controlled the acquired business and the material consideration, in addition to the purchase price, to be paid for the acquired business. These disclosures were supplemented by a proscription against the inclusion of unau- dited financials of the acquired company unless assurances of their fairness were received from independent auditors. 59 This order was an attempt to assure the accuracy of proxy and regist- ration statements issued by Lums in connection with future ac- quisitions. " See, e.g., In re Alexander Reid & Co., [1961-1964 Transfer Binder] CCH FED. SEC. L. REP. 76,823 (SEC 1962); cf. Kahn v. SEC, 297 F.2d 112 (2d Cir. 1961) (Clark, J,. concurring). SEC %'. Teleprompter Corp., 262 BNA SEC. REG. & L. REP. A-22 (S.D.N.Y. 1974). 5 Wall St. J., July 16, 1974, at 7, cols. 2-3. 17 SEC v. Teleprompter Corp., 262 BNA SEC. REG. & L. REP. A-22 (S.D.N.Y. 1974). " (1973-1974 Transfer Binder] CCH FED. SEC. L. REP. 1 94,504 (S.D.N.Y. 1974). 59 Id. 1975] 1197 UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 Companies that have filed false financial reports to cover up their illegal campaign contributions may become targets of en- forcement actions in the future.60 In the first such campaign contribution case, the Commission negotiated a consent decree with American Ship Building Company in which the corporation agreed to disclose the illegality and to set up a special review committee made up of two independent directors and a chair- man, unaffiliated with the company, to study the company's books to determine the extent of misused corporate funds, and to remedy these violations. 61 The expectation of the Commission is that this special committee will remedy past improprieties and set up a system to prevent recurrence of such illegality.6 2 Further, the SEC has indicated that corporations that have failed to disclose illegal campaign contributions may adopt the proce- dures mandated in the American Ship Building Company court order and thereby SEC action against them.6 3 The provisions mandated by each of these consent decrees are attempts by the Commission to establish ongoing procedures which will ensure corporate compliance with federally created obligations. That enforcement of the securities laws is creating a federal law of substantive corporate duties and responsibilities which supplements and often exceeds the requirements of state law is well-documented.6 4 Mandating special corporate proce- dures by court order contributes to this already substantial body of federal law in several ways. The immediate effect of this kind of remedy is to restructure certain aspects of corporate proce- dure on pain of contempt. The larger result is that the SEC is building up a body of approved model corporate procedures (including special committees to oversee various aspects of the 60 See Wall St. J., Oct. 7, 1974, at 13, col. 1. 6 Id. In addition, the company chairman agreed to repay any illegally contributed funds. " See Wall St.J., Feb. 3, 1975, at 4, col. 1, reporting a consent decree negotiated with the Minnesota Mining & Manufacturing Company enjoining the company, its chairman, and two former officers from using-corporate funds for illegal campaign purposes, from filing false reports with the SEC, and from establishing secret funds. The company agreed to the appointment of a special agent, approved by the Commission, to "investi- gate and report on any other instances in which the company disguised the real use of corporate funds." 63 The order ... spells out the actions other illegal corporate contributors should take if they want to avoid SEC action. SEC officials have said that any company convicted of making illegal gifts should disclose the wrongdoing, set tip procedures to make sure it doesn't happen again and require the repayment of any corporate funds. Wall St. J., Oct. 7, 1974, at 13, col. 1. 64 See, e.g., Fleischer, "Federal Corporation Law": An Assessment, 78 HARV. L. REV. 1146 (1965). 1198 EQUITABLE REMEDIES business, approved statements of policy, and approved items for inclusion in proxy or registration statements) which can be taken as guides to all companies in their efforts to meet federal law. The SEC has not gone uncriticized for having fostered the creation of an unreasonably high level of corporate re- sponsibility.6 5 Mandating model procedures is a creative way for the SEC to show that these expectations are not unrealistic. These "approved" procedures could have the effect of shifting the burden of proof in subsequent private actions against target companies that had failed to comply with the court orders against them. Alternatively, the institution of and compliance with these model procedures in a non-target company might provide evidence of having complied with the duty of due care. The remedies discussed in this section are well within the statutory grant of authority to the SEC and the courts "to en- force any liability or duty" created by the securities acts. The special procedures have been specifically designed to remedy the precise violation charged. If the SEC has the power to request injunctions against future violations, surely its ancillary power should include the ability to mandate procedures to ensure fu- ture compliance. Management that has failed to set up proce- dures which successfully ensure compliance with the law may appropriately be ordered to implement changes which will pro- tect the public in dealing with its securities. III. REMEDIES THAT DISPLACE ELECTED MANAGEMENT Another type of remedy which the SEC has successfully re- quested is the appointment of a variety of special agents en- dowed with power to redress past violations, to bring the com- pany into compliance with applicable law, and to prevent future wrongdoing. In this category are receivers, and, it will be ar- gued, what are essentially variations of this remedy-special counsel and interim directors. The appointment of a receiver is a traditional tool of equity courts. 66 The Commission staff maintains that its success in ob- taining equity receiverships in appropriate cases indicates that its power must extend as well to less extreme forms of relief, namely the appointment of special counsel and interim directors. 67 In imposing remedies short of receivership, the 6" For a discussion of the major criticisms in this area, see id. 1172-73. 66 See generally 1 R. CLARK, THE LAW AND PRACTICE OF RECEIVERS §§ 1-10 (3d ed. 1959). 67 Sporkin, supra note 28, at 123. 1975] UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 section 22(a) . . . specified courts are given jurisdiction "of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter." The power to enforce implies the power to make effec- tive the right of recovery afforded by the Act. And the power to make the right of recovery effective implies the power to utilize any of the procedures or actions normally available to the litigant according to the ex- igencies of the particular case.8 7 The cited language is equally applicable to actions instituted by the Commission "to enforce any liability or duty created" by the Securities Acts. If present management cannot be trusted to comply with an injunction, the appointment of a receiver be- comes necessary to make effective the injunctive decree and to bring a company into compliance with applicable law. In such a case the SEC may appropriately request the remedy and the court has the power and discretion to grant it. Despite its well-established power to obtain receiverships in appropriate cases, the Commission is often reluctant to enforce this remedy.8 8 One reason, mentioned above as a consequence of the requirement, that he represent all interests in the receiver- ship estate, is the inability of the receiver to operate the company aggressively. The principal drawback of this remedy, however, is the negative public reaction consequent to its institution. The appointment of a receiver is often a sharp blow to customer and investor confidence. Courts are not unmindful of the public- relations impact of this remedy. In Los Angeles Trust Deed & Mortgage Exchange v. SEC,s 9 in which a receiver was appointed at the request of the SEC, the court said: "It is appreciated that the conservator type of receivership which we have insisted upon is not well adapted to a business the very essence of which is prom- otion and, apparently, depends on a constant inflow of new business." 90 Again, in SEC v. Bowler,9' the court conceded: We do not question the strength of defendants' ar- guments that some plan of reorganization of the corpo- rate defendants is probably preferable to the appoint- ment of a receiver. The latter carries connotations which may be ruinous in an industry where ready access 87 Id. at 287-88 (emphasis in original). 88 See generally Sporkin, supra note 28. s' 285 F.2d 162 (9th Cir. 1960), cert. denied, 366 U.S. 919 (1961). 90 Id. at 182. 91 427 F.2d 190 (4th Cir. 1970). EQUITABLE REMEDIES to borrowed funds is a condition precedent to profitable operation and where prompt payment of receivables is essential. 92 The effect of this remedy on creditors, alluded to in Bowler, may be even more direct. A provision found in many loan agreements provides that the appointment of a receiver will con- stitute a condition of default and thus cause the loan to fall due.93 Such a triggering of any substantial loan may, of course, be ruinous to a business. Courts have struggled with this problem in private actions, attempting to structure relief to accomplish the goals of protec- tion of investors or creditors from further wasting of assets with- out totally destroying the ongoing business in the process. In Adelman v. CGS Scientific Corp., an action for rescission of a sale of one corporation to another which was alleged to have been fraudulently induced, the court appointed a "custodian" who was authorized to hold the assets of the company for fifty-nine days; this avoided a condition in a loan agreement which pro- vided that the appointment of a receiver for sixty consecutive days would be a ground for acceleration of the loan.95 And in Roach v. Margulies,96 the trial court appointed a fiscal agent " 'with full power and authority to check the propriety of all disbursements to be made or proposed to be made or proposed to be made by the corporation.' ,,97 If the agent questioned any disbursement he was to report to the parties who could then apply to the court for relief. The appellate court sustained this remedy as an ingenious device "contrived to avoid more string- ent measures" and thus "to avoid injuring the business in its relations with the public and its large number of subscribers. 98 Thus, courts have long been willing to mold their decrees in private actions to minimize the possibility of harm when the goals of protection could be adequately served through means less drastic than the appointment of a receiver. Recently, in en- forcement actions, the SEC has been attempting to construct 92 Id. at 196. 93 See generally Sporkin, supra note 28. 91 332 F. Supp. 137 (E.D. Pa. 1971). 95 Id. at 151-52. 96 42 N.J. Super. 243, 126 A.2d 45 (App. Div. 1956). 97 Id. at 245, 126 A.2d at 46. 98 Id. at 246, 126 A.2d at 47. Cf. SEC v. Koenig, 469 F.2d 198 (2d Cir. 1972) (appointing a "limited receiver" inter alia to supervise public disclosures, to investigate and make a public report on certain secret securities transactions, and to make prepara- tion for and hold a shareholders' meeting to elect new directors). 1975] UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 remedies which avoid the inflexibility and adverse connotations which are inherent in the traditional remedy of receivership. B. Directors Appointed or Approved by the Court 1. Use of the Remedy in Practice Recent consent decrees in enforcement actions have in- cluded, in various forms, the appointment of independent direc- tors who are satisfactory to the SEC and approved by the court. This remedy, like the receivership, temporarily suspends the traditional power of the stockholders (at least with respect to these directors) to choose the management of their company. SEC v. Mattel, Inc. 99 is one example of the way in which this remedy has been imposed. On August 5, 1974, Mattel consented to an order permanently enjoining it from securities fraud viola- tions. As part of this order, it agreed to add to its board two court-approved directors, unaffiliated with Mattel and satisfac- tory to the Commission, and to set up two special committees composed in part of these new directors to review accounting procedures, to supervise the accuracy of financial disclosures and reports issued from the company, and to study the possibil- ity of legal action against past or present officers of the company.'0 0 On November 26, 1974, the court, at the behest of the SEC, amended the order to require that Mattel name a ma- jority of independent, SEC-approved directors to its board; these additional directors were ordered to appoint a special counsel satisfactory to the SEC, and approved by the court. 101 The amendment was prompted by additional disclosures to the SEC indicating that overstatement of profits and understatement of losses had occurred at least since 1971 (rather than for only the 1973 fiscal year, as originally thought), and that the company might be vulnerable to private class action litigation already insti- tuted alleging fraud in the sale of securities. 0 2 It was the opinion of the SEC, and the court agreed, that Mattel should be con- trolled by new, independent management. The Mattel case is an excellent example of the flexibility of this new remedy, which allows the courts to institute a specific 11 264 BNA SEc. REG. & L. REP. A- 11, 12 (D.D.C. Aug. 5, 1974). 1 00 Id. 101 Civil No. 74-2958 (C.D. Cal., Nov. 26, 1974). The case was transferred from the District of Columbia to the Central District of California after the entry of an amended order on October 2, 1974, which embodied essentially the same relief as the order of November 26. Wall St. J., Oct. 3, 1974, at 4, cols. 2-4. 102 Wall St. J., Oct. 3, 1974, at 4, cols. 2-4. 1204 EQUITABLE REMEDIES quire assets, negotiate with creditors, and, in short, do what is necessary to manage the "business and affairs" of the company. 114 They may do all this, presumably, without applying to the court for direction. To substitute for the cloak of protec- tion which court approval provides for the receiver, 115 the order prescribes a "gross negligence" standard of care to which these directors will be held accountable. Because there is continuing jurisdiction in the court to oversee various provisions of the decree," 6 and because it has been held, in connection with a receivership proceeding, that the SEC remains a party and may apply to the court to enforce compliance with the decree or to bring evidence of misbehavior to the court's attention," 7 the shareholder will still be protected. What has changed, of course, is that given the gross negligence standard, effective protection now lies in the court or the SEC rather than in the shareholder's own private legal action. The result, then, of the institution of interim directorships is that, as in a receivership, the existing management is ousted or effectively precluded from further control;" 8 there is continuing surveillance by the SEC and the court of the operation of the business; and the company continues to function, vis-A-vis the public, subject to the provisions of applicable law. Unlike a re- ceivership, however, the interim board has broad and flexible powers to manage the company without going to the court for approval. C. Special Counsel Another agent, whose appointment the SEC has been secur- ing with some regularity, is special counsel." 9 His designation 114 Cf. DEL. CODE ANN. tit. 8, § 141 (Supp. 1971). 115 Text accompanying notes 75-78 supra. "6 See, e.g., Memorandum of Terms of Settlement 18, SEC v. Clinton Oil Co., Civil No. W-5020 (D. Kan., Mar. 8, 1973): "[T]he Court shall retain jurisdiction with respect to all matters relating to the implementation, accomplishment and enforcement of the acts to be done pursuant to the terms of the settlement agreement and to make such orders as may be necessary and appropriate in connection therewith ... 117 East v. Crowdus, 302 F.2d 645, 647 (8th Cir. 1962). The interest of the [SEC] in such an action [appointment of a receiver] does not terminate upon the appointment of a receiver therein. Under Section 78u of the 1934 Act... the Commission is authorized to apply to the Federal Courts in aid of enforcement of the powers vested in it .... Certainly, if ... the Commission should learn of any unconscionable malfeasance or neglect on the part of the receiver, no court would hold that the Commission was without standing to bring such matters to the appointing court's attention .... 118 Cf. Youngstown Sheet & Tube Co. v. Patterson-Emerson-Comstock of Ind., 227 F. Supp. 208, 216-17 (N.D. Ind. 1963). "9 See, e.g., SEC v. Holiday Magic, Inc., Civil No. C 73 1095 (N.D. Cal., Apr. 2, 1974); 1975] UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 often accompanies the court appointment of interim directors, and his role in reordering the enterprise is essentially to investi- gate the financial affairs of the company, 120 to oversee a full accounting of all the transactions, 12 1 and to take any legal actions warranted by the results of these investigations. 11 2 Special counsel appointed for the International Controls Corporation (ICC) has brought one such action pursuant to his mandate in SEC v. Vesco.' 23 ICC is part of the beleaguered finan- cial enterprise of the now-famous Robert Vesco. Special counsel brought suit against forty-two individual and corporate defen- dants who had allegedly aided Vesco in his scheme to defraud a number of Vesco-controlled companies, including ICC, resulting in the defendants' control of "over $200 million deposited in banks located in countries ranging geographically from Luxem- bourg to Costa Rica."' 2 4 In that suit, ICC secured a preliminary injunction against the disposition of certain assets claimed by ICC-including a pleasure yacht used exclusively by Vesco and his family, an astonishingly well-equipped Boeing 707 aircraft, and over 800,000 shares of ICC stock transferred by Vesco and his family to an alter ego, Vesco and Co.' 2 5 The incredible complexity of the fraud alleged in the Vesco case, and the obvious need for rapid action to protect ICC and the public from further diversion of corporate assets beyond the borders of this country, provide an excellent example of the need for a special agent to investigate the company's affairs and to take quick legal action. Indeed, the International Controls Corp. v. Vesco suit was instituted within three months of ICC's consent to the injunction and appointment of special counsel.' 26 This power to bring suit on behalf of a corporation for fraud or waste is normally vested in the board of directors of the company itself, or, if the board will not act, in the stockholders by way of a derivative suit. Empowering a special agent to bring SEC v. Clinton Oil Co., Civil No. W-5020 (D. Kan., Mar. 16, 1973); SEC v. Vesco, 72 Civ. 5001 (S.D.N.Y., Mar. 16, 1973). 120 Final Judgment of Permanent Injunction and Appointment of Special Counsel and Directors 3(a), SEC v. Vesco, 72 Civ. 5001 (S.D.N.Y., Mar. 16, 1973). 121 See, e.g., Memorandum of Terms of Settlement 10(a), SEC v. Clinton Oil Co., Civil No. W-5020 (D. Kan., Mar. 8, 1973). 122 Id. at 110(b). 123 International Controls Corp. v. Vesco, 490 F.2d 1334 (2d Cir.), cert. denied, 417 U.S. 932 (1974).124 1d. at 1338-39. 125 Id. at 1338. 126 Entry of the injunction was March 16, 1973, and the subsequent suit was in- stituted June 7, 1973, id. at 1340. 1208 EQUITABLE REMEDIES such suits represents a significant departure from the traditional scheme created by state law. The orders appointing these agents give them full power to institute all legal proceedings subject only to notification of or consultation with the board of directors with respect to their intentions, 27 or in one case, subject to a prior demand on directors. 128 In essence, this power is no different from the power often given to equity receivers in enforcement actions to aid them in the marshaling and preservation of assets.' 29 To the extent that special counsel acts as a receiver under the court's supervi- sion, the remedy is simply a modified form of an equity receivership. 130 There is, however, an extremely important way in which this remedy differs from a receivership order. Although the board of directors has relatively little power to prevent special counsel from prosecuting claims, the SEC has significant power in this regard. The court order in SEC v. Vesco provides that special counsel "shall neither decline to pursue any claim ... , nor settle any claims, against the recommendation of plaintiff Commission and without the approval of this Court .... "131 The order appointing special counsel in SEC v. Holiday Magic, Inc. provides that "[t]he Commission retains the right to oppose the pursuit of any claim where it believes investors' in- terests would not be served by the pursuance of such claim."' 3 2 These provisions give the SEC broad power to control the deci- 127 Memorandum of Terms of Settlement 10(c), SEC v. Clinton Oil Co., Civil No. W-5020 (D. Kan., Mar. 8, 1973). 128 Consent Judgment of Permanent Injunction and Appointment of Special Coun- sel Ill-B, SEC v. Holiday Magic, Inc., Civil No. C 73 1095 (N.D. Cal., Apr. 2, 1974). Special Counsel shall, after consulting with corporate counsel of the Corporate Defendants, request the board of directors of the appropriate companies to authorize and direct management to institute the suit. If the board of directors fails to honor the Special Counsel's request within 15 days of the request or if management or its counsel fails to institute the suit expeditiously, the Special Counsel shall be authorized to institute and pursue the suit on behalf of the company. 129 See text accompanying note 136 infra. 130 It should be noted that special counsel has been given the same immunity from liability, except for actions which are grossly negligent, as that discussed in connection with the appointment of interim directors. Text accompanying notes 110-117 supra. In the case of special counsel, however, the need for flexibility and freedom from court supervision is not as compelling as in the case of temporary directors, and this provision seems to be an unnecessary dilution of accountability. Realistically, it is likely that in both cases the provision is included as an inducement to get well-qualified people to serve in often difficult situations. 13 Final Judgment of Permanent Injunction and Appointment of Special Counsel and Directors 3(b), SEC v. Vesco, 72 Civ. 5001 (S.D.N.Y., Mar. 16, 1973). 132 Consent Judgment of Permanent Injunction and Appointment of Special Coun- sel Il-B, SEC v. Holiday Magic, Inc., Civil No. C 73 1095 (N.D. Cal., Apr. 2, 1974). 1975] UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 operation of a company. It is apparently felt that the imposition of something called a receivership will cause creditors and inves- tors far more alarm than the appointment of agents with more familiar names-temporary directors and special counsel. There are, in fact, many kinds of receivers. 137 A receiver may be appointed to preserve property during the course of litigation or in aid of a final decree. He may be directed to take charge of some of the assets of a corporation or of the corpora- tion itself. A receiver may be directed to liquidate a company or to preserve assets pending some future action, and, perhaps most significant in the present context, a receiver may be ap- pointed pursuant to a statute or by the inherent equity power of the court. Very often the appointment of receivers pursuant to a statutory procedure may either herald the initiation of a federal bankruptcy proceeding wherein debts will be canceled or an ar- rangement confirmed, 138 or indicate that a dissolution proce- dure has been initiated under state law.' 39 The appointment of a receiver in these cases is often dependent on some showing of insolvency. It usually indicates to the creditor that his property is going to be dealt with in a way that is beyond his control and to the investing public that the corporate entity may be on the verge of bankruptcy or liquidation. The appointment of an equity receiver in an SEC enforcement action, however, does not necessarily signal the need for or institution of a bankruptcy proceeding. It is precisely this failure to distinguish among the various types of receivers in the covenants of loan agreements that has forced the SEC to seek similar remedies with new names.' 40 The intent of the covenants is usually to call loans only when the company is nearing insolvency. A receivership, requested by the SEC and imposed by the courts, is traditionally available only in cases of massive fraud, where allowing existing management to remain would be highly detrimental to the investors and cre- ditors alike. It is instituted to protect the public and often to put I See generally 16 W. FLETCHER, supra note 74, § 7666. 1"I 11 U.S.C. § ll(a)(3) (1970). 'See, e.g., DEL. CODE ANN. tit. 8, §§ 291-303 (Supp. 1971). 140 Confusion surrounds the definition of "receiver" in other areas as well. In re Blair & Co., 471 F.2d 178 (2d Cir. 1972), vacated, 414 U.S. 212 (1973), dismissed as moot, 495 F.2d 299 (2d Cir. 1974), concerned whether a liquidator appointed pursuant to New York Stock Exchange rules was a receiver within the contemplation of the Bankruptcy Act (11 U.S.C. § 21(a)(5) (1970)), which deems an act of bankruptcy the appointment of a receiver of an insolvent's property. 1212 EQUITABLE REMEDIES the company back in a position of viability. It would seem unten- able for a creditor to argue that he is in a worse position after the imposition of this remedy than before, assuming that no other conditions of default have occurred. In Ferguson v. Tabah,'14 a derivative suit in which massive fraud, waste, and mismanagement were alleged, the court sus- tained the appointment of a receiver, saying: [T]he factors usually militating against the appointment of a receiver are not so strong in this case. [Defendant's] credit position has been severely jolted over the last de- cade by the apparent repeated raids by its management .... [I]t is not unreasonable to hope for even a com- paratively favorable response from financial and credit institutions because of the appointment of the receiver.1 42 A realistic approach to the needs of the company and a specific molding of the decree appointing a receiver to fit those needs are far more important than the label "receiver."'143 As has been argued, the imposition of an interim board or the appointment of special counsel may be an unwarranted in- terference with the power of shareholders to determine the di- rection of the corporation, vesting it solely, if temporarily, in the SEC and the federal courts. Shareholder elections are suspended144 and any attack on the imposition of these remedies is subject to being enjoined by the federal court as an attack on its judgment. 45 Although a receivership also has this effect, it is established in the minds of the public and the courts as a drastic remedy. The grounds for its institution and its duration are established by settled legal traditions. It is the SEC staff's position that the imposition of interim directors and special counsel is an alternative to a receivership and will be requested most often in cases where there are grounds for the appointment of a receiver. However, the failure to identify these remedies adequately as modified forms of re- ceivership (for fear that the label will invoke a procession of 141 288 F.2d 665 (2d Cir. 1961). 142 Id. at 674-75. 143 In those cases in which the SEC has obtained receivers, mismanagement and friaud have been so extensive that other covenants of outstanding loan agreements prob- ably have already been breached. 144 Text accompanying note 109 supra. 145 See, e.g., International Controls Corp. v. Vesco, 490 F.2d 1334, 1352 (2d Cir.), cert. denied, 417 U.S. 932 (1974). 19751 UNIVERSITY OF PENNSYLVANIA LAW REVIEW [Vol. 123:1188 horribles) gives them the appearance of normalcy which is pre- cisely te appearance the Commission and often the defendant corporation are seeking. But this failure obscures the facts that flexible alternatives to the receivership should be instituted only in extreme cases where management has effectively forfeited its right to control the corporation, 146 and that they are unusual and temporary measures designed only to bring the corporation back into compliance with applicable law, to ascertain the current state of affairs, and to make required disclosures. If they serve any further purpose, such as allowing the SEC or the courts to influence the policies of the business or the substantive nature or character of the organization itself, these remedies are inappropriate for the Commission to request and the courts to grant. The restructuring of companies so that sub- stantive business decisions, placed by state law in the hands of shareholders and their managers, become subject to scrutiny by the SEC is not properly ancillary to the Commission's power to obtain injunctions to enforce compliance with the securities laws, nor does it seem to be a traditional and appropriate way to further the statutory purposes. IV. CONCLUSION The imposition of an equity receivership, though a drastic remedy which temporarily alters the basically state-created power relationship between stockholders and management, is a traditional remedy which is imposed only as a last resort, in accordance with established standards when compliance with federal law can be assured through no less drastic means. The grounds for the imposition of special counsel and interim direc- tors, however, have not been articulated, the nature of the re- medies themselves is not clear, and the reasons for increased oversight by the Commission of substantive business decisions have not been explained. Responsibility for the exploration and ultimate resolution of these concerns rests with the courts because their powers are invoked to give force to the consent decrees which incorporate these remedies. Following the model of the recently enacted Antitrust Procedures and Penalties Act, 1 4 7 which encourages in- creased judicial scrutiny of antitrust consent decrees, courts in the SEC enforcement area should determine that a consent de- 146 Cf. Mintzer v. Arthur L. Wright & Co., 263 F.2d 823 (3d Cir. 1959). 147 Pub. L. No. 93-528, (Dec. 21, 1974), in 1974 U.S. CODE CONG. & AD. NEWs 6666.