Weil v. Investment/Indicators, Research and Management, Inc.

• Citation: 647 F.2d 18
• Decision Date: 28 August 1981
• Docket Number: No. 77-2754,77-2754
• Parties: Fed. Sec. L. Rep. P 98,023, 8 Fed. R. Evid. Serv. 475 Pauline WEIL and Emanuel J. Weil, on Behalf of Themselves and all Others Similarly Situated, Plaintiffs-Appellants, v. INVESTMENT/INDICATORS, RESEARCH AND MANAGEMENT, INC., Desmond W. Mitchell, Charles R. Schwab, Robert Birkie, John Hossfeld, Marjorie A. Wegner and Laurel Brook Farms, Inc., Defendants-Appellees. CA
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

Page 18

647 F.2d 18

Fed. Sec. L. Rep. P 98,023, 8 Fed. R. Evid. Serv. 475

Pauline WEIL and Emanuel J. Weil, on Behalf of Themselves and all Others Similarly Situated, Plaintiffs-Appellants, v. INVESTMENT/INDICATORS, RESEARCH AND MANAGEMENT, INC. Desmond W. Mitchell, Charles R. Schwab, Robert Birkie, John Hossfeld, Marjorie A Wegner and Laurel Brook Farms Inc., Defendants-Appellees.

CA No. 77-2754.

United States Court of Appeals Ninth Circuit.

Argued and Submitted March 12, 1980.

Decided June 1, 1981.

Rehearing and Rehearing En Banc Denied Aug. 28, 1981.

Arthur W. Friedman, Devoe, Shadur & Krupp, Chicago, Ill., for plaintiffs-appellants.

Reed H. Bement, George M. Carr, Carr, Smulyan & Hartman, John B. Bates, Jr., San Francisco, Cal., for defendants-appellees.

Appeal from the United States District Court for the Northern District of California.

Before TRASK and WALLACE, Circuit Judges, and EAST, ^* District Judge.

TRASK, Circuit Judge:

This case is before us on appeal from the district court's dismissal of appellant Weil's complaint because she failed to post a $40,000 undertaking ordered by the court pursuant to section 11(e) of the Securities Act of 1933 (the '33 Act), 15 U.S.C. § 77k(e). Weil contends that issuance of this order was an abuse of discretion. She also contends that the court erred in refusing to certify her case as a class action, in denying a motion for summary judgment on the issue of liability, and in ordering that she pay one defendant's attorneys fees on appeal as a condition to the court's substituting such defendant's legal representative as a party-defendant. Finally, Weil assigns error to the court's refusal to require that appellee Investment Indicators Fund (the Fund) answer certain questions asked by Weil during discovery proceedings. This court has jurisdiction pursuant to 28 U.S.C. § 1291. ¹

I

The Fund is an "open-end, no-load" ² mutual fund registered with the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940 and the '33 Act. The Fund's only significant asset is its portfolio of stock, which is managed by Investment/Indicators Research and Management, Inc. (IIRM). Fund shares are marketed through various brokers who recommend the Fund to their customers in return for the privilege of handling a share of the Fund's portfolio transactions.

Beginning in the summer of 1968, various brokers started offering and selling Fund shares to persons residing in states where the Fund had not registered its shares pursuant to applicable Blue Sky laws. Although aware of these sales efforts, ³ the Fund did not register its shares in most states. ⁴ This failure to register the shares was not disclosed in either the Fund's prospectus of November 5, 1968 (the '68 prospectus), or that of October 29, 1969 (the '69 prospectus).

Weil purchased 443.185 shares of the Fund over a period extending from December 19, 1968 to November 26, 1969. ⁵ These purchases were made after Weil received an unsolicited letter from Nardone, a broker who handled some of the Fund's portfolio transactions. Nardone had enclosed the '68 prospectus with the letter, and had highly recommended that Weil purchase Fund shares. Weil redeemed these shares in mid-1970 at a substantial loss per share.

In late 1970, the Texas Securities Commission suspended sales of Fund shares to Texas residents because the Fund had failed to register its shares as required by that state's Blue Sky law. Fearing that it had exposed itself to significant liability by failing to register its shares in Texas and other states, the Fund sought an SEC order suspending redemption of Fund shares. The order was issued on December 22, 1970, and remained in effect for about eight months.

Alleging violations of numerous federal securities laws, ⁶ Weil filed suit in the district court against the Fund, IIRM, Nardone and his employer, Charles H. Plohn & Co., and various officers, directors, and alleged control persons of the Fund and IIRM. The suit was filed as a class action on behalf of all persons who acquired shares of the Fund after November 12, 1968 (the effective date of the '68 prospectus), including those who were unable to sell their shares because of the eight-month SEC suspension of Fund share redemption, and those who had not yet sold their shares.

The substance of the complaint is that the Fund's failure to register its shares pursuant to the Blue Sky laws of most states was a material fact which should have been disclosed in the '68 and '69 prospectuses. ⁷ Weil alleges that the failure to register subjected the Fund to large, contingent liabilities which, if realized, would have substantially reduced the value of Fund shares. Weil further alleges that failure to disclose this contingent liability was a material omission, and that disclosure would have deterred her and other members of the alleged class from purchasing Fund shares in the first place. ⁸

The district court declined to certify Weil's suit as a class action, directing that the case proceed through discovery as an individual action "unless and until further developments should make proper the court's redetermination of the class." At one point in the discovery proceedings, the defendants refused to answer certain of Weil's questions and discovery requests, claiming that they required disclosure of privileged information. These questions and requests related to communications between officers of the Fund and the Fund's Blue Sky counsel.

After three years of discovery, Weil moved for summary judgment on the issue of liability, and asked the court to reconsider its earlier denial of class certification. Both motions were denied. The defendants to the suit (appellees on this appeal) then moved for an order pursuant to section 11(e) to require Weil to post an undertaking in the amount of $40,000 for their costs and attorneys fees. Weil opposed this motion, and renewed her earlier motion for the court's reconsideration of its denial of class certification. In the alternative, she moved for certification of an interlocutory appeal to this court on the class certification issue. She also moved the court to substitute a deceased defendant's attorney as a party-defendant. The district court granted defendants' motion and denied the first two of Weil's motions. It granted Weil's substitution motion on the condition that Weil pay the legal representative's attorneys fees on appeal if such appeal were unsuccessful. When Weil failed to post the undertaking as ordered, the court ordered her complaint dismissed with prejudice as to all defendants. Weil appeals from this order of dismissal.

II

Weil's complaint was dismissed when she failed to post an undertaking ordered pursuant to section 11(e) of the '33 Act. Accordingly, we consider first whether the district court properly ordered Weil to post such an undertaking.

Section 11(e) gives the district court discretion to require a party to post security sufficient to cover the costs and attorneys fees of opposing parties. 15 U.S.C. § 77k(e). The section provides that costs and fees may be awarded to such parties in the event they prevail in the action and the court finds the claim or defense maintained by the losing party to have been without merit. Although section 11(e) requires that the court make an explicit finding of lack of merit before fees may be awarded, the section has been read as permitting the awarding of fees in a broader range of cases than is permissible under the district court's equitable power to award such fees for claims or defenses maintained in bad faith. See Nemeroff v. Abelson, 620 F.2d 339, 349-50 (2d Cir. 1980).

The appropriate standard for determining whether an undertaking should be required is whether "the defendants (have) show(n) that the plaintiff has commenced her suit in bad faith or that her claim borders on the frivolous." Straus v. Holiday Inns, Inc., 460 F.Supp. 729, 732-33 (S.D.N.Y.1978); accord Can-Am Petroleum Co. v. Beck, 331 F.2d 371, 374 (10th Cir. 1964); Linchuck v. Cooper, 43 F.R.D. 382, 384 (S.D.N.Y.1967). Nevertheless, an order requiring an undertaking need not be based on a formal, factual finding that the claim or defense is obviously without merit or is asserted in bad faith; such a finding is premature and inappropriate at the time when the decision whether to require an undertaking must be rendered. Linchuck v. Cooper, supra, at 384; Dabney v. Alleghany Corp., 164 F.Supp. 28, 33 (S.D.N.Y.1958); see Straus v. Holiday Inns, Inc., supra, at 733-34 & n.3. It is only required that an eventual finding of bad faith or obvious lack of merit appear likely to the district court in view of the evidence before it. See Dabney v. Alleghany Corp., supra, at 33.

Thus, whether the district court erred in requiring that Weil post an undertaking depends on whether there is sufficient evidence in the record that her complaint was likely to be found obviously without merit or to have been brought or prosecuted in bad faith. However, any conclusion by us that the record contains the necessary quantum of evidence to enable us to affirm the district court would be seriously undermined were we also to conclude that the Fund was not entitled to a claim of privilege in refusing to respond to some of Weil's questions and discovery requests; responses might have provided or led to convincing evidence of the merits of Weil's allegations. Therefore, we now consider whether the district court properly refused to order appellees to answer Weil's disputed questions and requests. Only after resolution of this issue do we reach the question whether the undertaking was properly ordered.

A

Weil challenges the Fund's right to invoke the attorney-client privilege in refusing to respond to discovery questions and requests relating to advice given to the Fund by outside counsel regarding registration of Fund shares pursuant to state Blue Sky laws. It is well established that a...