Arthur Young & Co. v. Reves
| Decision Date | 02 December 1988 |
| Docket Number | 87-1803 and 87-2533,Nos. 87-1726,87-1727,88-1014,s. 87-1726 |
| Parties | Blue Sky L. Rep. P 72,904, Blue Sky L. Rep. P 72,972, Fed. Sec. L. Rep. P 94,004, Fed. Sec. L. Rep. P 94,113 ARTHUR YOUNG & CO., Appellant, v. Bob REVES; Robert H. Gibbs; & Frances Graham, Appellees. Thomas E. ROBERTSON, Jr., As Trustee of the Farmer's Co-Op of Arkansas and Oklahoma, Inc., and as representative of a class of members, depositors, and equity security holders, who are similarly situated to him; Bob Reves; Frances Graham; Robert H. Gibbs, individually; Robert H. Gibbs, as natural guardian of his minor children, Thomas A. Gibbs and Robert H. Gibbs, Jr.; and Robert H. Gibbs, as Trustee of the Muskogee Internal Medicine Group Profit Sharing Funds, Appellants, v. ARTHUR YOUNG & CO., Appellee. Thomas E. ROBERTSON, Jr., etc., et al. v. Jack WHITE, et al. Robert R. CLOAR, Class Counsel, Appellant, v. Bob REVES, Appellee. Thomas E. ROBERTSON, Jr., As Trustee of the Farmer's Co-Op of Arkansas and Oklahoma, Inc., and as representatives of a class of members, depositors, and equity security holders, who are similarly situated to him, Appellees, v. ARTHUR YOUNG & CO., Appellant. Thomas E. ROBERTSON, Jr., etc., et al. v. Jack WHITE, et al. Thomas E. ROBERTSON, Jr., As Trustee of the Farmer's Co-Op of Arkansas and Oklahoma, Inc., and as representative of a class of members, depositors, and equity security holders, who are similarly situated to him; Bob Reves; Frances Graham; Robert H. Gibbs, individually; Robert H. Gibbs, as natural guardian of his minor children, Thomas A. Gibbs and Robert H. Gibbs, Jr.; and Robert H. Gibbs, as Trustee of the Muskogee Internal Medicine Group Profit Sharing Funds, Appellees, v. ARTHUR YOUNG & CO., Appellant. |
| Court | U.S. Court of Appeals — Eighth Circuit |
John Matson, New York City, for appellant.
Robert R. Cloar, Ft. Smith, Ark., for Renes et al.
Gary M. Elden, Chicago, Ill., for appellee.
Before FAGG and MAGILL, Circuit Judges, and SNEED, * Senior Circuit Judge.
This case arose out of the bankruptcy of the Farmer's Cooperative of Arkansas and Oklahoma, Inc. (Co-op). A class comprised of the holders of demand notes (Class) issued by the Co-op obtained a $6.1 million judgment against the Co-op's independent auditors, Arthur Young & Co. (Arthur Young). 1 The judgment followed a jury verdict that Arthur Young violated section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) (Federal Act) and section 67-1256 of the Arkansas Securities Act, Ark.Stat.Ann. Sec. 67-1256 (Arkansas Act) (recodified at Ark.Code Ann. Sec. 23-42-106 (1987)), in connection with the sale of demand notes by the Co-op.
Arthur Young appeals the district court's (1) denial of its motion for a new trial or judgment n.o.v.; (2) award of costs to the Trustee and the Class; (3) award of attorney's fees to Class counsel; (4) calculation of pre- and post-judgment interest; and (5) denial of its petition for costs against the Trustee and the Class.
The Class cross-appeals, claiming that the district court erred in crediting settlement proceeds against the jury verdict against Arthur Young, and in granting summary judgment in favor of Arthur Young on the Class' claim under the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. Secs. 1961-1968.
The Trustee cross-appeals the dismissal of his breach of contract claim.
Because we believe that the demand notes at issue are not "securities" for purposes of either the federal or Arkansas security acts, we reverse the denial of Arthur Young's motion for j.n.o.v. Furthermore, we deny the Class' and Trustee's cross-appeals.
In light of our disposition, only a brief recitation of the facts is necessary. Prior to retaining the services of Arthur Young in 1981, the Co-op had, for the most part, operated a traditional farmer's cooperative in northwest Arkansas and northeast Oklahoma. One of its financing methods, however, was not traditional, and it provides the focus for this lawsuit.
The Co-op was a membership organization for the farmers it served; it charged only a nominal membership fee. The Co-op obtained some of its operating funds not from traditional borrowing sources such as banks, but rather from the sale of promissory notes (demand notes) to its members. The practice involved the payment of money to the Co-op by a member in exchange for a promissory note payable on demand, at a rate of interest higher than could be obtained from area banks or savings and loans. The rate of interest changed periodically, based on market conditions, and those changes were announced in the Co-op's newsletter. The sale of the demand notes was an ongoing activity, and no financial information regarding the Co-op was disclosed to the members at the time of sale except for a statement of the Co-op's total assets, which was released by the Co-op periodically. All members of the Class held demand notes.
Arthur Young was engaged by the Co-op to audit and report on its 1981 and 1982 financial statements. Neither the Co-op's management nor its board of directors disseminated the audited financial statements to either the Co-op's members or its demand noteholders. The only dissemination of financial information by the Co-op occurred at its annual meetings. Its management created condensed financial statements, and these were distributed to the approximately 350 members, a small fraction of the total Co-op membership, who attended the meetings.
At both the 1982 and 1983 meetings, Arthur Young representatives spoke briefly. They informed the members that the full audited financial statements, together with Arthur Young's report on them, were available at the Co-op's office. They also made a presentation of approximately ten minutes describing the general financial status of the Co-op.
The Class argued that Arthur Young deliberately failed to follow generally accepted accounting principles and, specifically, intentionally failed to follow Accounting Principles Board Opinion 16 with respect to its valuation of one of the Co-op's major assets, a gasohol plant. The Class maintained that had Arthur Young properly treated the gasohol plant, the Co-op's insolvency would have been readily apparent. The Class contended that Arthur Young avoided the correct accounting treatment and lied about its reasons for so doing, in order to inflate the assets and net worth of the Co-op. The Class asserted that Arthur Prior to trial, the district court granted summary judgment to Arthur Young on the Class' RICO claim and dismissed the Trustee's breach of contract claim. The jury found in favor of Arthur Young on the Trustee's fraud and negligence claims and in favor of the Class on the securities claims. This appeal and cross-appeal followed.
Young "originated" fraudulent statements and omissions, and that the demand notes were purchased in reliance upon these statements and omissions.
The first issue is whether the demand notes are securities within the meaning of the Federal Act. While the Federal Act defines a security as "any note," 15 U.S.C. Sec. 78c(a)(10), it is nevertheless well settled that these definitional sections are not to be read literally because "Congress intended the application of [the federal securities acts] to turn on the economic realities underlying a transaction and not on the name appended thereto," United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 849, 95 S.Ct. 2051, 2059, 44 L.Ed.2d 621 (1975), and an instrument which seems to fall within the broad sweep of the federal acts is not to be considered a security "if the context otherwise requires." Marine Bank v. Weaver, 455 U.S. 551, 556, 102 S.Ct. 1220, 1223, 71 L.Ed.2d 409 (1982); see Smith International, Inc. v. Texas Commerce Bank, 844 F.2d 1193, 1199 n. 4 (5th Cir.1988); cf., Landreth Timber Co. v. Landreth, 471 U.S. 681, 105 S.Ct. 2297, 85 L.Ed.2d 692 (1985). 2 Thus, "the wide-ranging definition of a security found in the [Federal] Act is limited by congressional intent not to provide a broad federal remedy for all fraud and by the Supreme Court's practical approach to interpreting the federal securities laws." Union National Bank of Little Rock v. Farmers Bank, 786 F.2d 881, 884 (8th Cir.1986) (footnote omitted).
For the demand notes at issue to be considered securities under the Federal Act, they must satisfy the elements of the test developed in SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946); see Farmers Bank, 786 F.2d at 884; Kansas State Bank v. Citizens Bank, 737 F.2d 1490, 1494-95 (8th Cir.1984). Even if the Supreme Court should determine it inappropriate to apply the Howey test to an instrument which bears both the name "note" and the usual characteristics of a security, see supra n. 2, it is no bar in this case because the instrument at issue, while possessing the name, lacks the characteristics.
The demand nature of the notes is very uncharacteristic of a security. "A demand or short-term note is almost ipso facto not a security unless payment is dependent upon the success of a risky enterprise or the parties contemplate indefinite extension of the note or perhaps conversion to stock." Great Western Bank & Trust v. Kotz, 532 F.2d 1252, 1257-58 (9th Cir.1976); see Kansas State Bank, 737 F.2d at 1494. Neither of the conditions is present here. Because the demand notes are uncharacteristic of a security, we look to the economic reality of the transaction to determine their status. See Howey, 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946).
The Howey test defines a security as (1) an investment; (2) in a common enterprise; (3) with a reasonable expectation of profits; (4) to be derived from the entrepreneurial or managerial efforts of others. Id. at 301, 66 S.Ct. at 1104.
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