Zabriskie v. Lewis

Decision Date05 December 1974
Docket NumberNo. 74-1015,74-1015
PartiesFed. Sec. L. Rep. P 94,902 Donna V. ZABRISKIE, Plaintiff-Appellee, v. Reed D. LEWIS and William J. Rogers, Jr., Defendants-Appellants.
CourtU.S. Court of Appeals — Tenth Circuit

M. Richard Walker, Salt Lake City, Utah, for defendants-appellants.

Leonard W. Burningham, Salt Lake City, Utah, for plaintiff-appellee.

Before HILL, SETH and McWILLIAMS, Circuit Judges.

HILL, Circuit Judge.

This appeal stems from a judgment against defendants-appellants in which jurisdiction was based on 15 U.S.C. 78aa and pendent jurisdiction. Liability was predicated on violations of 17 C.F.R. 240.10b-5 (Rule 10b-5) and Utah Code Ann. 61-1-1 (1968).

Appellee Donna Zabriskie (now Beaman) engaged appellant Lewis to locate investment properties for her. Lewis was a real estate agent for Max Ingalls & Associates, Realtors. Appellant Rogers, broker for the firm and Lewis' immediate supervisor, requested that Lewis bring appellee into Rogers' office to allow Rogers to present to the appellee a proposal for loaning funds to one John Worthen. Lewis called appellee to set up the meeting; on February 1, 1971, Lewis transported appellee to Rogers' office. The proposal was that appellee loan $15,000 to Worthen and in exchange she would receive a promissory note signed by Worthen for.$17,250 including interest paid to April 1, 1971 (maturity was April 1 with an optional demand date of March 2 and a $16,500 payoff). For security, appellee would be given a stock certificate of 1,000,000 shares of Computer Parking Systems, Inc. (hereinafter Computer) issued to Albert P. Folsom, allegedly president of Computer, and a hypothecation agreement covering the shares. Appellee testified that Rogers told her the shares were worth approximately $100,000, that she was told the shares were negotiable, that Lewis told her Worthen was almost a genius and a good man to whom she could entrust her money, and that Rogers told her the funds were to be used to promote Dax Corporation (hereinafter Dax) '. . . which was to be one of the greatest stock developments that he had ever heard of . . ..' Appellee accepted the proposal. Lewis drove appellee to a bank where she obtained a $15,000 cashier's check and then transported her back to the office where she gave the check to Worthen and received the note, stock certificate, and hypothecation agreement.

Lewis subsequently contacted appellee to arrange a second meeting for February 10. Rogers, Lewis and Worthen were present at this meeting. 1 Appellee gave Worthen an additional $7,000 and received an $8400 promissory note from J.E.W. Inc., Worthen's closely-held corporation. The note, payable on or before April 10, 1971, was secured by the assignment of another note in the amount of $12,500 issued by Pacific Flight Support, Inc. (hereinafter called Pacific Flight) to J.E.W. Inc. Appellee testified that she was told the money was needed to promote Dax and that Rogers and Worthen said the Pacific Flight note was valuable.

On March 1, 1971, Rogers and Lewis obtained two drafts of $15,000 and $1,500 and delivered them to appellee at her home. 2 Appellee retained the $1,500 draft as interest and returned the $15,000 draft to the two men. Appellee testified Rogers and Lewis told her this reinvestiment was needed for thirty days for Dax's purposes.

The obligations were not paid in full when due; however, appellee did receive a total of $3,500. In July or August 1971, appellee received a warranty deed with Lewis as grantee and a special warranty deed with herself as grantee. These deeds covered 100 lots in Texas. In August appellee purchased shares of Dax and paid $1,382.50 for them. Appellee testified Lewis told her Dax was a very good investment.

Appellee hired an attorney to recover her funds. The efforts to realize money on the collateral were unsuccessful. The Computer stock was nonnegotiable; Pacific Flight could not be contacted and appellee testified, as of the trial date, the company was no longer in operation; appellee's attorney was unsuccessful in ascertaining the value of the Texas property. 3 Appellee testified Lewis discouraged her from contacting the Securities and Exchange Commission (SEC) about transferring the Computer stock because he did not want Dax investigated until it was promoted further; however, appellee contacted the SEC and was unsuccessful in her transfer attempt.

On September 5, 1972, appellee filed an action in the United States District Court for the District of Utah. Appellee's four basic claims, as distilled in the pretrial order, were (1) a violation of 10(b) of the Securities & Exchange Act of 1934, in that the defendants fraudulently induced the plaintiff to loan money to J.E.W. Inc., through misrepresentations, and as a result of a scheme and artifices to defraud, and through practices which did operate as a fraud and deceit upon the plaintiff, (2) substantially the same allegation under Title 61 of the Utah Code Annotated; 4 (3) common law fraud in that defendants made substantial misrepresentations, and (4) a claim under the terms and provisions of a secured note.

Following a trial to the court, judgment was entered for appellee against Rogers and Lewis, jointly and severally, in the amount of $26,373.39, including $3,500 attorneys fees. 5

The court concluded 'the acts, practices, scheme, course of business, false and misleading statements and omissions, and artifice to defraud perpetrated by the defendants on the plaintiff . . .' violated Rule 10b-5 and Utah Code Ann. 61-1-1. An order granting sale of the collateral and awarding judgment of any deficiency after sale was made.

Appellants attack the trial court's determination initially on two legal grounds: (1) the promissory note 6 involved here is not a security and (2) even if the promissory note is a security, no purchase or sale occurred.

These challenges attack both the court's jurisdiction and the existence of a prima facie case.

It is, of course, the law that the burden is upon the plaintiff to establish jurisdiction, and coincidentally make out a case under the statute and rule (15 U.S.C. 78j and Rule 10b-5), and to do so he must prove: (1) Use of the mails or instrumentalities of interstate commerce; (2) the purchase or sale of a security; and (3) the use of a manipulative or deceptive device. Stevens v. Vowell, 343 F.2d 374, 378 (10th Cir. 1965).

Title 15 U.S.C. 77b(1) (Securities Act) defines security as including 'any note . . . (or) evidence of indebtedness . . ..' 7 Title15 U.S.C. 78c(a) (10) (Securities Exchange Act) defines security as 'any note . . . but shall not include . . . any note . . . which has a maturity at the time of issuance of not exceeding nine months . . ..' These definitions of security have been held to be virtually identical. Tcherepnin v. Knight,389 U.S. 332, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967). Appellants argue the notes in question are not securities because of the maturity date exception. Although the stated maturities of these notes would appear to place them within the statutory exclusion, that exception is not applicable to the type of notes involved here. Numerous courts, interpreting that exception, have agreed with the Securities Exchange Commission (Securities Act Rel. No. 4412, 26 Fed.Reg. 9158 (1961)) and limited that exception to '. . . only . . . prime quality negotiable (commercial) paper of a type not ordinarily purchased by the general public, that is, paper used to facilitate well recognized types of current operational business requirements and of a type eligible for discounting by Federal Reserve banks.' Bellah v. First Nat'l Bank, 495 F.2d 1109 (5th Cir. 1974); Zeller v. Bogue Elec. Mfg. Corp., 476 F.2d 795 (2d Cir. 1973), cert. den'd 414 U.S. 908, 94 S.Ct. 217, 38 L.Ed.2d 146; Sanders v. John Nuveen & Co., 463 F.2d 1075 (7th Cir. 1972), cert. den'd, 409 U.S. 1009, 93 S.Ct. 443, 34 L.Ed.2d 302; Anderson v. Francis I. duPont & Co., 291 F.Supp. 705 (D.Minn. 1968). The notes involved here certainly were not prime quality negotiable commercial paper.

A more difficult question is raised by appellants' assertion that these notes are not within the definition of security because they are not the type of notes Congress intended federal securities law to regulate. Appellee admits that not all notes are meant to be reached by the federal securities law. Although this statement seems to be contrary to the clear language 'any note', the 'unless the context otherwise requires' language of 15 U.S.C. 77b and 78c(a) and the Supreme Court's indication that we are dealing with a flexible concept, SEC v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), have been held to compel limitation concerning notes to be considered within the definition. But see Sanders v. John Nuveen & Co., supra at 1978. Thus, not all notes are included within the protection of the anti-fraud provisions. McClure v. First Nat'l Bank, 497 F.2d 490 (5th Cir. 1974); Lino v. City Investing Co., 487 F.2d 689 (3d Cir. 1973); Zeller v. Bogue Elec. Mfg. Co., supra at 800.

This Circuit has not determined what tests should be applied in determining which notes come within the definition of security. The Supreme Court in dealing with an investment contract said of the definition of security that it embodied

a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits. SEC v. W. J. Howey Co., supra.

This Court has stated

whether a particular investment constitutes a security depends upon the facts and circumstances of the case . . .. Substance is exalted over form and emphasis is placed on economic reality. Vincent v. Moench, 473 F.2d 430 (10th Cir. 1973).

At least three circuits have adopted a test placing those notes of commercial character outside the definition...

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