Colonial Bank & Trust Co. v. American Bankshares Corp.
| Decision Date | 07 November 1977 |
| Docket Number | No. 75-C-638.,75-C-638. |
| Citation | 439 F. Supp. 797 |
| Court | U.S. District Court — Eastern District of Wisconsin |
| Parties | COLONIAL BANK & TRUST COMPANY, an Illinois Banking Corporation, Plaintiff, v. AMERICAN BANKSHARES CORPORATION, a Wisconsin Corporation, Federal Deposit Insurance Corp., as Receiver for American City Bank & Trust Co., N.A., a National Banking Corporation, Raymond L. Callen, Peter Wegmann, Harold L. Erickson, Walter F. Benz, William George Bruce, III, John D. Cahill, Gerald S. Colburn, John De Belak, Albert M. Deshur, Bernard D. Heifetz, Edward A. Korpady, Henry S. Lauterbach, Nicholas J. Lesselyoung, Harold F. Lichtsinn, W. Stanley Pearce, Clement J. Schwingle, Robert J. Trecker, Richard D. Wright, James W. Sullivan, and Ernst and Ernst, a Partnership, Defendants. |
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Reuben W. Peterson, Jr., Borgelt, Powell, Peterson & Frauen, S.C., Milwaukee, Wis., James S. Gordon, Chicago, Ill., for plaintiff.
Clay R. Williams, Robert J. Loots and William J. French, Gibbs, Roper, Loots & Williams, Milwaukee, Wis., Elwin J. Zarwell, Thomas J. Donnelly and Ronald L. Wallenfang, Quarles & Brady, Milwaukee, Wis., Walter S. Davis, David E. Leichtfuss and Clifford B. Buelow, Davis, Kuelthau, Vergeront, Stover & Leichtfuss, S.C., Milwaukee, Wis., David J. Cannon, Lee J. Geronime, Glenn A. Buse, Michael, Best & Friedrich, Milwaukee, Wis., Gregory J. Harrold, Milwaukee, Wis., William H. Alverson, Godfrey & Kahn, S.C., Milwaukee, Wis., John C. Carlson, Richard L. Cates, Lawton & Cates, Madison, Wis., Howard A. Schoenfeld, Russell R. Stepke, Milwaukee, Wis., Robert E. Hackett, Jr., Milwaukee, Wis., James W. Sullivan, Excelsior, Minn., for defendants.
There are several motions pending in this action which are fully briefed and ready for resolution. Because of the number of defendants in this action and the multiplicity of claims, crossclaims and third party actions, the Court will segregate the motions according to the pertinent claim.
The 10 defendants represented by the law firm of Quarles & Brady (the Quarles Group), defendants Erickson and Trecker and the partnership of Ernst & Ernst along with the two named partners of the firm have all moved to dismiss the complaint.
The defendants attack count I of the complaint contending that it fails to adequately allege scienter as required by Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976).
Count I of the complaint asserts an action arising under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission. The plaintiff contends that it made loans to certain individuals, taking stock as security for the loans in reliance and upon representations made to it by the defendants. The complaint alleges that the representations were false and contained omissions of material fact. The plaintiff has alleged that it was relying on the representations made to it concerning the book value of the stock being pledged and that the defendants knew of this reliance. Subsequent allegations state that the defendants "knew or should have known, but concealed from the plaintiff" that the representations were false and incomplete. It is the "knew or should have known" language which is attacked by the defendants.
The plaintiff, by employing the alternative language of "knew or should have known," has alleged different theories of recovery. Insofar as the complaint alleges that the defendants made representations to the plaintiff to induce it to make the loans taking the stock as security therefor knowing the representations were false and incomplete and knowing that the defendant would rely on the representations, the allegations clearly are sufficient to plead the requisite scienter of § 10(b). The knowing conduct alleged is the equivalent of an allegation of intentional deceit. The real issue before the Court is whether the alternative allegations of "should have known" are also sufficient under § 10(b).
The Supreme Court in Hochfelder held that mere negligent conduct was insufficient to establish a § 10(b) violation. The question of whether reckless conduct could provide the necessary scienter was left unanswered. The Seventh Circuit has since resolved this issue for this circuit and has stated that reckless conduct can form the basis of a violation. Sanders v. John Nuveen & Co., Inc., 554 F.2d 790 (7th Cir. 1977); Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977); Bailey v. Meister Brau, Inc., 535 F.2d 982 (7th Cir. 1976); Stern v. American Bankshares Corp., 429 F.Supp. 818 (E.D.Wis.1977).
The Seventh Circuit in Sundstrand, supra, defined recklessness in the context of omissions. It quoted from Franke v. Midwestern Oklahoma Development Authority, 428 F.Supp. 719 (W.D.Okl.1976):
"reckless conduct may be defined as a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." 553 F.2d at 1045.
The Court went on to explain that:
under this definition, the danger of misleading buyers must be actually known or so obvious that any reasonable man would be legally bound as knowing, and the omission must derive from something more egregious than even "white heart/empty head" good faith. While this definition might not be the conceptual equivalent of intent as a matter of general philosophy, it does serve as a proper legally functional equivalent for intent, because it measures conduct against an external standard which, under the circumstances of a given case, results in the conclusion that the reckless man should bear the risk of his omissions. Id.
The Court characterized the requirement that the defendant be aware of the danger or legally bound as being aware of the danger as an objective test. Id. at 1045 n. 19. The latter requirement of the omission deriving from something more than even "white heart/empty head" good faith was characterized as a subjective test which requires something more than the "inexcusable negligence" found in Hochfelder. Id. at 1045 n. 20.
Applying this definition to the allegations of the complaint, the Court finds the complaint sufficient. The complaint may be viewed as alleging both misrepresentations and omissions of material facts.
As to the omissions, the two tests listed in Sundstrand are met. The complaint alleges that the defendants knew that the plaintiff was relying on the representations made by the defendants. This allegation clearly meets the objective test of Sundstrand, i. e., knew or legally bound as knowing the danger of misleading the buyers. The subjective test is met by the allegation that the defendants knew or should have known that the representations were incomplete. The "should have known" language is sufficient in this Court's opinion to allow proof of reckless conduct in this regard. If the plaintiff can establish that the defendants were reckless in adequately informing themselves of the accuracy and completeness of the representations made coupled with their knowledge of the plaintiff's reliance, it will have established the scienter requirement for liability under § 10(b). These allegations, which must be taken as true in dealing with the instant motions, are in the Court's estimation a proper legally functional equivalent for intent.
Applying the concepts of recklessness stated in Sundstrand, a case of omission, to this case of misrepresentation, the Court finds the allegations sufficient. The functional equivalent of intent was found in Sundstrand where the defendant was cognizant of the danger of misleading the plaintiff or the danger was obvious, but nevertheless, acted recklessly or recklessly failed to act in his dealings with plaintiff. The complaint in this case alleges that the defendants knew of the plaintiff's reliance on the representations made by the defendants and that they knew the representations were false or should have known them to be such. As stated above, the Court finds the allegation of "should have known" sufficient to allow proof of reckless conduct. If the plaintiff can establish that the defendants acted recklessly in ascertaining the truth or falsity of their representations while cognizant of the plaintiff's reliance, it will have established the functional equivalent of intent.
For the reasons stated above, the Court finds that the motions to dismiss count I of the complaint for failure to allege the requisite scienter must be denied.
The Ernst & Ernst defendants have also moved to dismiss count II of the complaint for lack of subject matter jurisdiction. Having found a valid cause of action arising under the federal securities laws in count I, the Court may and does assume pendent jurisdiction over the related state claims.
The motion to dismiss count II is, therefore, denied.
The above disposition renders moot the plaintiff's motion to amend.
The FDIC and defendants Callen and Erickson have moved to dismiss the crossclaim asserted against them by defendant Benz. Three grounds are asserted: (1) the crossclaim does not arise out of the transaction or occurrence which is the subject matter of the original complaint; (2) that the statute of limitations bars the claim; and (3) that the crossclaim fails to state a claim against the FDIC.
This Court has previously ruled in this case that crossclaims and third-party actions of defendants other than defendant Benz were properly assertable in this action since they arose out of the transaction or occurrence which is the subject matter of a counterclaim properly filed in this action. The instant crossclaim of defendant Benz relates to this same...
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