## Facts

- The SEC brought a civil enforcement action seeking injunctive and equitable relief for alleged securities fraud connected to the NSMC–Interstate merger and immediate post-merger insider stock sales.
- By the time of decision, most defendants had settled; the remaining defendants were the law firm Lord, Bissell & Brook (LBB), its partners Max E. Meyer and Louis F. Schauer, and Cameron Brown (a former Interstate president/director who later became an NSMC director/consultant).
- Interstate shareholder proxy materials for the merger included NSMC’s 1968 financial statements and an interim statement for the first nine months of fiscal 1969 reporting approximately $700,000 in earnings.
- The merger agreement required “comfort letters” from each company’s independent accountants stating no material adverse change from the interim statement date through closing.
- Shortly before closing, NSMC’s auditor (Peat Marwick) determined it could not provide the expected comfort letter because NSMC’s interim financial statement was materially misleading and required adjustments converting the reported profit into a loss.
- Meyer, Schauer, and Brown learned of the auditor’s reservations and information indicating the interim financials likely should have shown a net loss rather than a profit.
- Despite this knowledge, the merger closed on October 31, 1969 without corrective disclosure to Interstate shareholders or the investing public and without renegotiating the transaction terms.
- After the merger, former Interstate insiders, including Brown, allegedly sold newly acquired NSMC stock soon after closing without disclosing the adverse, material financial information.
- NSMC’s stock later fell sharply after information leaked that the merged company had misstated its financial condition.

## Issues

1. Whether a primary violation of the federal securities antifraud provisions occurred through the use of materially misleading interim financial statements in obtaining merger approval and closing the merger without correcting known misstatements.
2. Whether transactional counsel (Meyer and Schauer, and their firm) aided and abetted the antifraud violations through silence and inaction at closing after learning of the misleading financials.
3. Whether Cameron Brown aided and abetted the antifraud violations by permitting the merger to close with undisclosed adverse information and by participating in immediate post-merger stock sales while aware of material nonpublic facts.
4. What scienter standard applies to aiding-and-abetting liability in an SEC civil enforcement action, and whether recklessness suffices.

## Decision

- The court found that a primary antifraud violation existed based on materially misleading interim financial statements used in the proxy process and the failure to correct them when later information revealed they were false.
- The court held Meyer and Schauer (and LBB) aided and abetted the antifraud violations by proceeding with the closing despite knowledge, or at least reckless disregard, of the obvious materiality of the undisclosed adverse financial information.
- The court held Brown aided and abetted the antifraud violations through his involvement in allowing the merger to close without disclosure and through his participation in immediate post-merger stock sales while in possession of material nonpublic information.
- The court granted injunctive relief against the remaining defendants prohibiting future violations of the federal securities laws.

## Legal Principles

- Aiding-and-abetting liability in an SEC enforcement action requires: (1) a primary securities-law violation, (2) knowledge or reckless disregard by the aider and abettor of the violation, and (3) substantial assistance to the violation.
- Recklessness—ignoring the obvious materiality of undisclosed facts—can satisfy the scienter requirement for aiding and abetting in a civil SEC action.
- Transactional lawyers may provide substantial assistance through silence and inaction where they have a central role in a closing and knowingly (or recklessly) permit a transaction to proceed on the basis of materially misleading disclosures.
- Failure to insist on delaying closing or making corrective disclosure, when counsel knows that financial information used to obtain shareholder approval is materially false, can support injunctive liability for aiding and abetting.
- Corporate insiders who possess material nonpublic information may not trade without disclosure; participation in insider sales in that context can constitute substantial assistance to an antifraud scheme.

## Conclusion

The court imposed injunctive sanctions on transactional lawyers and a corporate insider for aiding and abetting securities fraud where they proceeded with a merger closing and related insider sales despite knowledge, or reckless disregard, that key financial disclosures used to secure shareholder approval were materially misleading and had not been corrected.


SEC v. Nat’l Student Mktg. Corp., 457 F. Supp. 682 (D.D.C. 1978)