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United States v. Louis E. Wolfson and Elkin B. Gerbert

Court of Appeals for the Second Circuit
405 F.2d 779 (1969)
ELI5:

Rule of Law:

A person who directly or indirectly controls a company is considered an 'issuer' under Section 2(11) of the Securities Act of 1933. Consequently, their sale of a substantial amount of unregistered stock to the public through a broker constitutes a non-exempt transaction by an 'underwriter', in violation of Section 5 of the Act.


Facts:

  • Louis E. Wolfson, along with his immediate family and associate Elkin B. Gerbert, owned in excess of 40% of the 2,510,000 outstanding shares of Continental Enterprises, Inc.
  • The remaining stock was held by approximately 5,000 outside shareholders.
  • Although Wolfson was not an officer or director, he was the 'guiding spirit' of Continental, with corporate officers being subject to his direction and control.
  • Gerbert was a director of the corporation.
  • Between August 1, 1960, and January 31, 1962, Wolfson, Gerbert, and the Wolfson family sold over 633,000 shares of their unregistered Continental stock to the public through multiple brokerage houses.
  • The stock sold represented approximately 25% of the total outstanding shares of Continental.
  • No registration statement was in effect for the Continental stock, which was traded over-the-counter.

Procedural Posture:

  • Louis E. Wolfson and Elkin B. Gerbert were indicted in the United States District Court for the Southern District of New York for violating federal securities laws.
  • The defendants filed a pre-trial motion to dismiss the indictment, which the district court denied.
  • The defendants also filed a motion for a change of venue, which the district court also denied.
  • After a trial, a jury found the defendants guilty on all counts.
  • The defendants (appellants) appealed their convictions to the United States Court of Appeals for the Second Circuit.

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Issue:

Does a controlling shareholder of a corporation, by selling a large quantity of the corporation's unregistered stock to the public through brokerage houses, become an 'issuer' for the purposes of Section 2(11) of the Securities Act of 1933, thereby making the transactions ones by 'underwriters' that are not exempt from the registration requirements of Section 5?


Opinions:

Majority - Woodbury, Senior Circuit Judge

Yes. A controlling shareholder is deemed an 'issuer' under the Securities Act's expanded definition, making brokers who sell their stock 'underwriters' and rendering the transaction ineligible for the exemption from registration requirements. The court reasoned that while Section 4(1) of the Act exempts transactions by any person other than an issuer, underwriter, or dealer, this exemption does not apply here. Section 2(11) defines an 'underwriter' as someone who participates in a distribution for an issuer. Crucially, Section 2(11) explicitly expands the definition of 'issuer' for this purpose to include 'any person directly or indirectly controlling' the actual issuer. Because Wolfson admitted he controlled Continental, he was an 'issuer' within this definition. Therefore, the brokers who sold his large block of shares were facilitating a distribution from an 'issuer' and became 'underwriters,' making the transaction unlawful under Section 5 because no registration was filed. The defendants' professed ignorance of the law was not a defense.



Analysis:

This case is a landmark decision that solidifies the 'control person' liability doctrine under the Securities Act of 1933. It clarifies that the registration requirements are not limited to the company itself but extend to individuals who exercise control over the company. The ruling effectively closes a major loophole that would have allowed powerful insiders to distribute vast quantities of unregistered stock to the public, thereby circumventing the disclosure protections the Act was designed to provide. As a result, this decision imposes a significant due diligence obligation on brokers to ascertain whether a large block of stock comes from a controlling person before executing the sale.

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