Lewelling v. First California Co.

• Decision Date: 21 November 1977
• Docket Number: No. 75-2759,75-2759
• Citation: 564 F.2d 1277
• Parties: Fed. Sec. L. Rep. P 96,264 Asa L. LEWELLING, Plaintiff-Appellee, v. FIRST CALIFORNIA COMPANY, a California Corporation (Appellant), Harold F. Smither and M. J. Coen (Appellant), Defendants-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1277

564 F.2d 1277

Fed. Sec. L. Rep. P 96,264

Asa L. LEWELLING, Plaintiff-Appellee, v. FIRST CALIFORNIA COMPANY, a California Corporation (Appellant), Harold F. Smither and M. J. Coen (Appellant), Defendants-Appellants.

No. 75-2759.

United States Court of Appeals Ninth Circuit.

Nov. 21, 1977.

John R. Faust, Jr. (argued), Portland, Or., for defendants-appellants.

Clifford N. Carlsen, Jr. (argued), Miller, Anderson, Nash, Yerke & Wiener, Portland, Or., for plaintiff-appellee.

Appeal from the United States District Court for the District of Oregon.

Before DUNIWAY, ELY and CHOY, Circuit Judges.

CHOY, Circuit Judge:

This controversy arises out of a scheme to enable insiders to bail out of various corporations which were failing. Plaintiff, Asa L. Lewelling, brought a private suit for fraud under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); SEC Rule 10b-5, 17 C.F.R. § 240.10b-5; and the Oregon securities act and common law. ¹ From the adverse judgment of the district court, defendants First California Company (FCC), a brokerage firm, and its principal owner, M. J. Coen, appeal. We affirm.

Lewelling, a private investor, dealt with FCC through an employee, Harold F. Smither. ² In the last two years of their relationship, Smither handled Lewelling's account by purchasing securities without his knowledge, then forwarding confirmation slips regarding the transactions. When Lewelling received a confirmation slip, he would immediately telephone Smither for an explanation. Smither would then present justifications for his unilateral decision to purchase. Lewelling never tried to overturn a purchase. There was no written agreement between Lewelling and Smither.

The securities in question had been owned by Coen or C. Arnholdt Smith, or sources related to them, and were passed through a series of brokerage houses controlled by them before coming to FCC and then to Lewelling. The trial court found that the several transfers were all part of a scheme to "launder" the securities in order to conceal the underlying "bail outs" by the insiders. The gravamen of Lewelling's complaint was that, in selling him the securities, defendants failed to disclose the insider source of the securities or the sellers' reasons for disposing of them.

Materiality

The materiality of omissions is measured by an objective standard: whether " 'a fact's existence or nonexistence is a matter to which a reasonable man would attach importance in determining his choice of action in the transaction in question.' " Northwest Paper Corp. v. Thompson, 421 F.2d 137, 138 (9th Cir. 1970), quoting Restatement of Torts § 538(2)(a) (1938) (emphasis supplied). ³ Because of the trial court's finding that the sales were part of a larger plot to unload "bad" stock, its conclusion that the omissions were material is certainly not clearly erroneous. Fed.R.Civ.P. 52(a). See Ryan v. Foster & Marshall, Inc., 556 F.2d 460, 463 (9th Cir. 1977); Butler v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 528 F.2d 1390, 1391 (9th Cir. 1975).

Defendants argue, however, that there was insufficient evidence to warrant the trial court's findings that insiders were in fact bailing out of failing corporations. We need not reach their contentions, however, for the district court apparently felt that the routing of the securities through the various brokerage firms in which Coen had an interest was itself a material fact which should have been disclosed. The reason for this "laundering" attempt may not be as significant to an investor as the fact that the investment house with which he was dealing was engaging in the practice.

"In Connection With"

Defendants next contend that the purported omissions did not occur "in connection with" the purchase or sale of a security as required by Rule 10b-5 because Lewelling and Smither communicated only after the confirmation slips had been sent. They argue that Rule 10b-5 requires both that the fraud occur in connection with the transaction, see Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971), and that the plaintiff be a purchaser or seller, see Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975). If the purchases were consummated before the fraudulent nondisclosures, they reason, Lewelling is merely an "aborted seller" who was induced to retain the securities through the defendants' fraud, rather than to purchase them in the first instance, and is therefore barred from recovery under the teachings of Blue Chip, supra at 737-38, 95 S.Ct. 1917. ⁴

Precisely when the transactions were finalized is a question of intent for the finder of fact. See Reliance Finance Corp. v. Miller, 557 F.2d 674, 677-78 (9th Cir. 1977); Smith v. Onyx Oil & Chem. Co., 218 F.2d 104, 108 (3d Cir. 1955). The trial court found that Lewelling had the power to reject any of the purchases and that no transaction was complete until Lewelling had had the opportunity to exercise his veto and had failed to do so. In deciding whether or not to call off the purchases, Lewelling was guided only by the information given him by Smither. In this respect, the omissions had a direct effect on the disposition of the transactions. Thus, the failures to disclose did not come after the sales had been finalized, and Lewelling therefore cannot be characterized as an aborted seller.

While the trial court's analysis reaches the correct result, we feel that there is a more direct route to the same conclusion. Rule 10b-5 requires that those in possession of material information which is not generally available to the other party disclose before selling, or refrain from dealing. See L. Loss, Securities Regulation 3572-73, 3588-90 (Supp. ed. 1969); 2 A. Bromberg, Securities Law: Fraud § 7.4(6)(a) (1975). Complete silence in the face of this duty is actionable. See List v. Fashion Park, Inc., 340 F.2d 457, 461-62 (2d Cir.), cert. denied sub nom. List v. Lerner, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 (1965); Loss, supra at 3575-76. ⁵ And Rule 10b-5 covers totally impersonal security transactions such as those consummated over the exchanges as well as more personal face-to-face or telephone encounters. See id. at 1456 (2d ed. 1961); id. at 3573 (Supp. ed. 1969). See generally United States v. Charnay, 537 F.2d 341, 348-50 (9th Cir.), cert. denied, 429 U.S. 1000, 97 S.Ct. 528, 50 L.Ed.2d 610 (1976); Fridrich v. Bradford, 542 F.2d 307, 318 (6th Cir. 1976), cert. denied, 429 U.S. 1053, 97 S.Ct. 767, 50 L.Ed.2d 769 (1977); Dasho v. Susquehanna Corp., 461 F.2d 11, 32 & n. 49 (7th Cir.), cert. denied, 408 U.S. 925, 92 S.Ct. 2496, 33 L.Ed.2d 336 (1972); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968); cert. denied sub nom. Coates v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969).

It is established that the defendants failed to disclose the insider source of the securities and the sellers' reasons for disposing of them. We feel that the trial court's concern about the exact date on which the purchases were completed is unnecessary when analyzing the defendants' omission because the facts which underlie the fraud occurred well before either the "purchase" by Smither or the "ratification" by Lewelling. If the transaction were complete when Smither "purchased" the securities, the omission of the material information would be actionable. Even if Smither lacked the ability to complete the transaction and only Lewelling's "ratification" made it complete, the omission would still be actionable. In either event, the transaction was complete before disclosure of the material information, making the omission precisely the type of fraudulent practice which the securities laws guard against.

Therefore, since it is clear from the trial court's findings that the entire series of transactions with Lewelling was undertaken with the material information already in hand, defendants violated Rule 10b-5 in not disclosing that information to Lewelling before selling to him. ⁶

Pendent State Claims

Finally, Lewelling also brought a pendent state claim under the Oregon securities law, asserting that defendants improperly sold him unregistered stock in Olix Industries in violation of Or.Rev.Stat. § 59.055. Defendants appeal the trial court's finding that the stock sales were not exempt from the Oregon registration provisions.

Under Oregon law, the burden is on defendants to show that such sales were exempt from registration. See Or.Rev.Stat. § 59.275; Tarsia v. Nick's Laundry & Linen Supply Co., 239 Or. 562, 566, 399 P.2d 28, 30 (1965). In order to do so, they must demonstrate, among other things, that the prices at which they sold the stock were "reasonably related to the current market price(s) thereof at the time of (the) sale(s). . . ." Or.Rev.Stat. § 59.035(9)(a). The trial court found that defendants did not meet this burden. Once again, on the basis of the record before us, we cannot say that the decision of the trial court was clearly erroneous.

AFFIRMED.

ELY, Circuit Judge (concurring):

I concur in the result reached by my Brothers.

I am inclined to the view, however, that the majority needlessly complicates the analysis by concentrating on when the transactions in question were completed in an effort to deal with the appellants' argument that Lewelling was no more than an "aborted seller."

The District Court found that Lewelling had the power to reject any of the "purchases" made by Smither and that Lewelling's subsequent oral approvals by telephone constituted "ratifications." This, I believe, comports with the realities of the arrangement. Accordingly, I would hold that Smither's representations and failure to reveal the insider source of the securities were "connected" with the various purchases, despite the fact that such events postdated in a calendar sense, the "purchases" by Smither. This would obviate the need to engage in unnecessary and...