Hoffman v. Estabrook & Co., Inc.
| Citation | 587 F.2d 509 |
| Decision Date | 26 October 1978 |
| Docket Number | No. 78-1034,78-1034 |
| Parties | Fed. Sec. L. Rep. P 96,587 Murray HOFFMAN et al., Plaintiffs-Appellants-Appellees, v. ESTABROOK & CO., INC., et al., Defendants-Appellees, James F. Laura and Albert Eng, Defendants-Appellants. |
| Court | United States Courts of Appeals. United States Court of Appeals (1st Circuit) |
John P. Birmingham, Jr., Boston, Mass., with whom Mintz, Levin, Cohn, Glovsky & Popeo, Boston, Mass., was on brief, for plaintiffs-appellants-appellees.
George C. Caner, Jr., Boston, Mass., with whom R. K. Gad, III, and Ropes & Gray, Boston, Mass., were on brief, for Estabrook & Co., Inc., defendants-appellees.
Steven M. Brody, Boston, Mass., with whom Fleming & Brody, Boston, Mass., was on brief, for defendants-appellees-appellants, James F. Laura and Albert Eng.
Before COFFIN, Chief Judge, CAMPBELL and BOWNES, Circuit Judges.
These are appeals from findings and rulings in a nonjury securities fraud case. Plaintiffs, unassociated purchasers of convertible debentures on January 28, 1970, 1 of a new company called Foto-Mem, Inc., brought action against its two principal officers, its directors and the underwriters pursuant to sections 12(2) and 17(a) of the Securities Act of 1933, 15 U.S.C. §§ 77L (2), 77q(a), and section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5. At the time the action was instituted, January 28, 1972, the company was in a Chapter XI bankruptcy proceeding.
The defendant officers, James F. Laura and Albert Eng, appeal the findings of liability under section 10(b) and Rule 10b-5. Plaintiffs-appellants appeal the finding of no liability as to the defendant underwriters, Estabrook & Co., Inc., under sections 12(2) and 10(b) of their respective Acts. The district court also made a finding of nonliability as to the directors of Foto-Mem, Inc., but this has not been appealed.
The trial and the consequent findings and rulings focused on alleged misrepresentations and omissions as to the production stage of the two main products of the company.
Foto-Mem, Inc., was formed by defendant Laura on May 5, 1967. Laura had conceived an idea for coping with the "information explosion" through the development of a high capacity, high speed photo-optical storing and retrieval system which would interface with contemporary computers. Initial funds of approximately $100,000 were obtained by private investors, mainly through the efforts of Laura. Defendant Eng, who had extensive experience in computer technology and related fields, joined the company in January of 1968. Laura, who described himself as a financial consultant, did have some experience with computers, but it was Eng who had the engineering expertise and knowledge.
On January 8, 1969, the company made a public offering and its stock was traded in a range of from $181/2 to $54 a share until the fall of 1969 when Foto-Mem, Inc., concentrated its financial efforts towards the sale of the debentures which led to this law suit. The prospectus prepared for this offering described its products as being in the development stage. 2
Two machines were built and displayed at computer shows in Las Vegas and Boston to demonstrate the new storing and retrieval systems. The FM 390 was intended to store and retrieve digital information (computer readable) and to operate in conjunction with, and as a supplemental memory bank for, a computer. The memory bank consisted of plastic photodata cards on which information was stored and subsequently read by the use of a laser beam. Conventional computer memory banks used magnetic The Risar, which was an extension of the FM 390, was designed to combine a computer capacity for index and calling up (positioning for transmission of information) the photodata card with television transmission of the information sought so that the cards did not have to be physically removed from the file and so that two or more interrogators could obtain information from the same card simultaneously.
tape or magnetic cards. The advantage of the laser imprinted photodata cards was that each card could contain a great deal more information at far less cost than magnetic tapes or cards. 3
The machines used as demonstrators at the two shows were hand assembled and contained within finished cabinets. The laser beam for the FM 390 was hand adjusted as required and the part of the Risar system used to store and call up the photodata cards was manufactured by another company, Mosler. The Mosler selectriever was capable of storing up to two hundred thousand microfilm cards and calling up any one of them automatically.
In September of 1969, Foto-Mem, Inc., began discussions with Estabrook, which culminated in an underwriting contract. Estabrook was to undertake the private placement of Foto-Mem debentures in return for options to purchase a part of them at a favorable price and was to be reimbursed for expenses, including sales commissions. Estabrook, of course, had the right to review the confidential memorandum which was to be distributed to potential debenture purchasers.
The district court found that the confidential memorandum contained material misrepresentations and omitted material facts. It was drafted mainly by the company lawyers, Stephen Honig and Jerome Gotkin, and Laura and Eng. A lot of time and energy was devoted to this memorandum; seven drafts were drawn up before the offering circular was finalized. Estabrook's representative in direct charge of the offering, John M. Plukas, spent one day a week at the plant. He saw several of the drafts, but there is no evidence that he took part in any of the actual writing and formulation of the memorandum. The final draft was dated October 31, 1969, and circulated to prospective debenture purchasers immediately thereafter. Sale of debentures closed on January 30, 1970. The two other purchasers of debentures, American Suez Company and the Mellon Bank of Pittsburgh, did not receive the memorandum and are not parties to this suit.
With the exception of Eduard F. Catalono, all of the plaintiff who testified stated that they read the confidential memorandum and relied on it. 4
Shortly after the closing of the debenture sales, Foto-Mem received an order from the New York Times to purchase a Risar which the paper intended to use to replace its "morgue." 5 The company from then on concentrated its efforts and time on meeting this order to the exclusion of further work on the FM 390. Mosler, the owner and producer of the card selection system, which had been used by Foto-Mem in its demonstration model of the Risar, had also been bidding for the Times contract. When it learned that Foto-Mem had been awarded the contract, it refused to sell it a selectriever, Foto-Mem, therefore, had to design and fabricate its own card selection system for the Risar ordered by the Times. There was testimony by Eng that the Mosler selectriever was not adequate anyway because it used different card sizes and that he had determined to build his own system in 1969. A unit with a Foto-Mem built card selectriever was finally delivered to the Times in August of 1970, but it failed to work properly because of the inadequacies of the card selection system. 6 Despite intensive It became apparent to Laura and Eng, as well as others, in the late spring of 1970 that Foto-Mem was running out of money. A meeting was, therefore, scheduled for July 15 to which all debenture holders were invited in the hope that they would be persuaded to invest additional funds. The hopes for a cash infusion were not realized. Laura left the meeting abruptly when the debenture holders began to ask hard questions about the financial condition of the company. The reason given for the arid cash condition was poor management which, of course, covers a multitude of sins. After failing to meet the second interest installment on the debentures, due January 30, 1971, Chapter XI bankruptcy proceedings were commenced.
work for several months by Foto-Mem's engineers and technicians, the Risar was never able to meet the Times' requirements.
We begin our analysis of the evidence with a statement of the obvious, that the district court's findings of fact must be upheld unless clearly erroneous. The district court found that Laura and Eng had committed fraud in the preparation of the confidential memorandum:
I find actual intent to deceive by Eng and Laura in informing, and not informing, the other defendants, as well as many plaintiffs individually, and I find they knowingly, and intentionally, and as a matter of proximate cause, were responsible for the found material misstatements and omissions in the Memo. 7
Rule 10b-5 fleshes out section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). It provides:
(2) 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 the light of the circumstances under which they were made, not misleading, or
(3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
The Supreme Court in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), defined the scienter necessary, at least absent extraordinary circumstances, for liability under 10b-5 as "a mental state embracing intent to deceive, manipulate or defraud."
It is clear that the district court's finding of fraud came within the ambit of the rule and the Supreme Court's definition. We turn...
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