White v. Abrams

• Decision Date: 11 June 1974
• Docket Number: 71-2076,71-2077.,No. 71-2068,71-2069,71-2068
• Citation: 495 F.2d 724
• Parties: J. Arthur WHITE et al., Plaintiffs-Appellees, v. Paul ABRAMS, Defendant-Appellant. Robert HOFFMAN, Plaintiff-Appellee, v. Paul ABRAMS, Defendant-Appellant. Robert HOFFMAN, Plaintiff-Appellant, v. Paul ABRAMS, Defendant-Appellee. J. Arthur WHITE et al., Plaintiffs-Appellants, v. Paul ABRAMS, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

495 F.2d 724 (1974)

J. Arthur WHITE et al., Plaintiffs-Appellees, v. Paul ABRAMS, Defendant-Appellant.

Robert HOFFMAN, Plaintiff-Appellee, v. Paul ABRAMS, Defendant-Appellant.

Robert HOFFMAN, Plaintiff-Appellant, v. Paul ABRAMS, Defendant-Appellee.

J. Arthur WHITE et al., Plaintiffs-Appellants, v. Paul ABRAMS, Defendant-Appellee.

Nos. 71-2068, 71-2069, 71-2076, 71-2077.

United States Court of Appeals, Ninth Circuit.

March 15, 1974.

Petition for rehearing denied June 11, 1974.

COPYRIGHT MATERIAL OMITTED

Oliver F. Green, Jr. (argued) and Douglas C. Conroy, Paul, Hastings, Janofsky & Walker, Los Angeles, Cal., for appellant in 71-2068 and 71-2069 and for appellee in 71-2076 and 71-2077.

Thomas F. Call (argued), Adams, Duque & Hazeltine, Andrew S. Garb and Alfred I. Rothman, Los Angeles, Cal., for appellee in 71-2068 and 71-2069 and for appellant in 71-2076 and 71-2077.

Before BARNES and WALLACE, Circuit Judges, and TAYLOR,^* District Judge.

WALLACE, Circuit Judge:

Abrams appeals from a jury verdict awarding damages against him for violations of the federal securities laws. The case arises out of his actions in connection with investments that White and others who invested with or through White (White Group) made in corporations owned and controlled by Theodore Richmond, now deceased. Abrams raises six points on appeal. We agree with his first contention that the trial court erred in instructing the jury that defendant violated the federal securities laws if he made a material misrepresentation, even if he did not know the falsity of his statement. We reverse and remand.

I. FACTUAL BACKGROUND

After a long relationship as a trusted friend and advisor, during which White had made a number of successful investments through him, Abrams encouraged White to invest substantial sums of money in several of 26 corporations owned and controlled primarily by Theodore Richmond (Richmond Corporations).¹ Richmond operated bus lines in New York and New Jersey from 1948 until 1967 through a complex structure of corporations consisting of finance, real estate, bus leasing and bus operating corporations, all involved in one aspect or another, in operating the same bus lines. Early in their history, the Richmond Corporations began selling their own unsecured corporate promissory notes bearing interest at rates ranging from 12 to 20% per annum and generally maturing in three years. As the Richmond Corporations' loans increased to the point that the profits from the bus lines were insufficient to pay current interest and the principal on the matured loans, the corporations borrowed additional money to meet these obligations. At the time of bankruptcy the corporations owed approximately $58,000,000 to about 5,000 persons. In addition, the corporations owed over $9,000,000 to institutional lenders such as Chase Manhattan Bank, Talcott Factors and General Motors Acceptance Corporation. In 1966, the year prior to bankruptcy, the corporations paid $6,000,000 in interest and another $8,000,000 on principal.

In 1956 Abrams began soliciting loans from private lenders for the Richmond Corporations, receiving in some instances a commission as high as 4% per annum for each year the money was left with the corporations. At the time of bankruptcy, the Richmond Corporations owed in excess of $3,000,000 to persons who had made loans through Abrams. Abrams did not sell any stocks or promissory notes, but did make arrangements for their purchase from the Richmond Corporations. The majority of the White Group's loans were made to Manufacturers Credit Corporation, a holding company, which had as its sole asset the stock of the other 25 Richmond Corporations. The White Group had made loans, bearing interest at the rate of 12 to 14% per annum, to the Richmond Corporations over a period from 1959 until mid-1967 when the corporations filed for bankruptcy. The White Group also purchased stock, with an option in Richmond to repurchase at a price calculated at a fixed annual rate of return, approximately the same as the interest rate on the loans. At the time of bankruptcy, Mr. and Mrs. J. Arthur White and their daughter Margo, the largest investors of the White Group, held promissory notes in the total sum of $455,000 and stock in the sum of $260,000. They had been receiving interest continuously since 1959 on the promissory notes from Richmond that totalled $346,575.

The White Group charges Abrams with violations of section 17(a) of the Securities Act of 1933 15 U.S.C. § 77q(a),² section 10(b) of the Securities Exchange Act of 1934 15 U.S.C. § 78j(b), rule 10b-5 17 C.F.R. § 240.10b-5 and with common law fraud and seeks rescission and punitive damages. The jury found no liability under the charge of common law fraud. The White Group complains that Abrams misrepresented to them (1) that he had investigated Richmond and his corporations, examined the corporations' financial statements and found the corporations and Richmond to be financially sound, (2) that Richmond would use the borrowed money to purchase new franchises, bus lines and additional bus equipment and (3) that the Richmond Corporations had large earnings and were well able to pay the high interest on the loans. They further complain that Abrams failed to disclose (1) that he was receiving a large commission on each investment made through him in the Richmond Corporations, (2) that he sold similar securities and loans to other persons at higher rates of return, in some instances up to 20% per annum and (3) that Manufacturers Credit Corporation owned no assets other than the stock in other Richmond Corporations. They also allege that Abrams conspired with Richmond to use unrecorded "second mortgages," "registered notes" containing misleading language and other "lures" as a scheme, device or artifice to defraud.

After seven weeks of trial the case was submitted to the jury, which found in favor of the plaintiffs and awarded compensatory damages in the total amount of $1,101,982. Punitive damages were not allowed. The court subsequently decided it had erroneously allowed prejudgment interest and decreased the total award to $867,200. This resulted in a cross-appeal by the White Group.

II. ABSOLUTE LIABILITY JURY INSTRUCTION

Abrams argues that the trial court improperly instructed the jury as to the scope of duty imposed by clause (b) of rule 10b-5 which makes it unlawful for any person in connection with the sale or purchase of securities "to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading . . . ." SEC Rule 10b-5(b), 17 C.F.R. § 240.10b-5(b). The trial court instructed on the question of material misrepresentations as follows:

If you find that defendant made a material misrepresentation to plaintiffs in connection with the sale to plaintiffs of a promissory note or share of stock, the law is that defendant has violated the Federal securities laws even if you find that defendant did not know the falsity of the misrepresentation he made to plaintiffs. (Emphasis added.)

The court's instruction would impose upon Abrams a duty to insure the truthfulness and reliability of the representations he has made. We reject such a broad construction since there is no indication that Congress, in passing section 10(b) of the Securities Exchange Act of 1934, or that the Securities and Exchange Commission, in issuing rule 10b-5 thereunder, intended that "anyone should be an insurer against false or misleading statements made non-negligently or in good faith." Kohn v. American Metal Climax, Inc., 458 F.2d 255, 280 (3d Cir. 1972) (Adams, J., concurring and dissenting). See List v. Fashion Park, Inc., 340 F.2d 457, 463 (2d Cir.), cert. denied, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 (1965) (purpose of rule 10b-5 is to qualify the rule of caveat emptor — not to establish a scheme of investors' insurance). The instruction proposed by the White Group, objected to by Abrams and given by the trial court, imposes a liability without fault which we find to be contrary to the basic thrust of the statute and rule.

III. PRIOR NINTH CIRCUIT DECISIONS

In attempting to define the broad duty imposed under the rule, the courts have traditionally focused upon the defendant's state of mind, generally utilizing the catchword "scienter."³ The question of what state of mind should be required before a court will impose liability has been a source of controversy in federal securities law since the Second Circuit said in Fischman v. Raytheon Mfg. Co., 188 F.2d 783, 786 (2d Cir. 1951), that "proof of fraud is required in suits under § 10(b) of the 1934 Act and Rule X-10 B-5. . . ." Early in this controversy we rejected the notion that common law fraud or scienter must be proven in order to recover under rule 10b-5. In Ellis v. Carter, 291 F.2d 270, 274 (9th Cir. 1961), we were urged by the appellees to hold that genuine fraud, as opposed to "a mere misstatement or omission," must be alleged and proved on the ground that proscribing material misstatements and half-truths without using fraud or scienter language would not be a permissible implementation of section 10(b). We disagreed and said:

Section 10(b) speaks in terms of the use of "any manipulative device or contrivance . . . ." Had Congress intended to proscribe common-law fraud, it would probably have said so. We see no reason to go beyond the plain meaning of the word "any", indicating that the use of manipulative or deceptive devices or contrivances of whatever kind may be forbidden, to construe the statute as if it read "any fraudulent" devices.

In Ellis we were concerned primarily with whether rule 10b-5 gave a private remedy to a buyer as well as a seller of securities. We held on the pleadings that a buyer did have a private remedy under the rule and rejected the defendants' additional challenge that plaintif...