Levine v. Diamanthuset, Inc.

• Decision Date: 19 December 1991
• Docket Number: No. 89-15790,89-15790
• Citation: 950 F.2d 1478
• Parties: Fed. Sec. L. Rep. P 96,456 Louis H. LEVINE; Robert E. Asher, Plaintiffs-Appellants, v. DIAMANTHUSET, INC., Defendant, and Security Pacific National Bank; Wilmington Trust Company; Bank of Delaware, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1478

950 F.2d 1478

Fed. Sec. L. Rep. P 96,456

Louis H. LEVINE; Robert E. Asher, Plaintiffs-Appellants, v. DIAMANTHUSET, INC., Defendant, and Security Pacific National Bank; Wilmington Trust Company;

Bank of Delaware, Defendants-Appellees.

No. 89-15790.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted July 19, 1990.

Decided Dec. 19, 1991.

Elizabeth Joan Cabraser, Daniel C. Girard, and Karen E. Karpen, Lieff, Cabraser & Heimann, San Francisco, Cal., for plaintiffs-appellants.

Robert Cross, and Michael Stokes, Broad, Schulz, Larson & Wineberg, San Francisco, Cal., for defendant-appellee Security Pacific.

Walter Allan, James Kirkham, and Ellyn Freed, Pillsbury, Madison & Sutro, San Francisco, Cal., for defendant-appellee Wilmington Trust Co.

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

Before TANG and NOONAN, Circuit Judges, and HATTER ^*, District Judge.

TANG, Circuit Judge:

Lewis Levine and others ("Levine") brought a class action for purported violations of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5 (collectively "Rule 10b-5"), as well as other federal and state laws. The complaint named the following defendants: Diamanthuset, a corporation to which we will refer by its more recent name, "Investia"; various individuals associated with Investia; the Wilmington Trust Company ("Wilmington") and the Bank of Delaware, both Delaware corporations; and Security Pacific National Bank ("Security Pacific"), a California corporation. The two Delaware corporations and Security Pacific eventually moved to dismiss the claims against them for failure to state a cause of action. The district court granted the motion, 722 F.Supp. 579 (N.D.Cal.1989), and subsequently entered judgment as to these defendants pursuant to Fed.R.Civ.P. 54(b). Having settled with the Bank of Delaware, Levine now appeals the dismissal of the Rule 10b-5 claims against Wilmington and Security Pacific. We reverse and remand for further proceedings.

I

Levine alleged the following: Beginning in June 1979, Investia marketed to the public a guaranteed return on an investment in diamonds. Investia offered a contract linking a purchase by the investor of diamonds represented to have a certain value with an undertaking on the part of Investia to obtain for the investor a subsequent buyer who would pay a higher price for the diamonds. Investia designed its representations to deceive investors into believing that their principal investment was secured by diamonds with a fair market value equivalent to what was paid by the investor. Investia's sales pitch also led prospective investors to believe that an independent third party would serve as a depository for the investor, acknowledging the receipt of diamonds having the value indicated and certifying the value to the investor. Furthermore, Investia stated that it would advance the amount of guaranteed appreciation in the diamonds' value to an account with an independent bank where it would be held in trust for the investor.

The diamonds sold by Investia were small diamonds, known in the jewelry trade as melee, with a weight of seven to fourteen percent of one carat. Investia highly overvalued the diamonds by regularly reporting to investors that the diamonds' value had appreciated after the purchase, when in fact no appreciation had occurred.

Investia persuaded investors to have the diamonds they purchased shipped to a depository in Delaware. Wilmington began service as a depository for Investia in December 1984. After an investor had purchased diamonds from Investia they were packed in a "cassette" that was then sealed and shipped to Wilmington, which would acknowledge receipt of a cassette in the following terms:

Dear ____:

Investia has recently deposited the cassettes listed on the attached sheet having the indicated insured value with our precious metals depository, subject to its order.

Investia has indicated these cassettes were acquired on your behalf and has requested we send you this advice.

These letters were signed by a banking officer in the precious metals division of Wilmington and, pursuant to agreement with Investia, mailed directly to the investors.

Wilmington's involvement was a material factor in the investment decision of virtually all class members. Indeed, Levine claims the trust company's participation "was crucial to Defendants' plan to deceive investors regarding the value of the diamonds." Complaint at 24-25. Wilmington's acknowledgments stating the insured value of the diamonds constituted a representation that the diamonds had the value stated and were insured for that value. The trust company failed to indicate that it had made no independent evaluation of the diamonds, and omitted other material facts bearing on its responsibility for the diamonds, such as the nature of the indicated insurance. ¹

Wilmington's actions facilitated the fraudulent sale of securities by Investia in part because potential purchasers would check with current investors, whose names were provided by Investia. Current investors would confirm the representations of the trust company, including the issuance of the acknowledgments. Wilmington also served as a reference for Investia by appearing in Investia's written promotional materials and by responding to the telephone inquiries of potential investors. The effect was to deceive potential investors into believing that Wilmington had certified the value of the diamonds contained in the cassettes and was otherwise acting as trustee for the benefit of the investors. Furthermore, the deceptive nature of Investia's scheme was evident to Wilmington, in part because of the ever-increasing value of the diamonds. Wilmington had an independent interest in examining these values because its storage fee was based on a percentage of the diamond's value as declared by Investia. ²

Security Pacific's involvement in the Investia scheme was somewhat different. As part of its offering, Investia represented to investors that a Reserve Account would be created in an amount equal to twenty-five percent of each investment. This fund would be available to the investors in the event that Investia was unable to effect liquidation of their respective accounts. In promotional literature, Investia stated: "We totally secure your return through funds deposited in a bank trust account. So your profits are protected." Complaint at 26.

Each client's Reserve Account was part of an account opened by Investia with Security Pacific. The sole signatory on the account was Investia, and Investia alone was responsible for determining the amount of any client's reserve. In its deposit agreement with Investia, Security Pacific assumed no trust responsibilities. The contract provided that Security Pacific would distribute principal and income as directed by Investia.

Once an investor bought into the scheme, Investia would issue a "Client Reserve Certificate." This certificate misrepresented Investia's deposit agreement with Security Pacific by indicating that the funds in the client's Reserve Account, exclusive of interest and appreciation, would be distributed to the client in the event of Investia's insolvency. The implications of the Client Reserve Certificate were that the funds in the Various individuals who were considering investing contacted officers of Security Pacific to verify the status of the Reserve Account and confirm the role of Security Pacific as provided in Investia's promotional materials. Officers of Security Pacific assented to or made no objection to the portrayal of Security Pacific's role contained in the promotional materials. Furthermore, Security Pacific continued its participation even after newspaper articles, in which bank officials were interviewed concerning Investia, disclosed inconsistencies between the representations made in the Client Reserve Certificate and the actual terms of Investia's deposit agreement with Security Pacific. Upon Investia's demise, these inconsistencies became evident when investors failed to receive disbursements from the Reserve Account.

                Reserve Account were being held by Security Pacific as trustee with an obligation to the investors upon the occurrence of specified events.   The Reserve Account and the Client Reserve Certificates were designed to deceive investors into believing that the appreciation guaranteed to them by Investia had been paid to Security Pacific to be held in trust
                

According to Levine, Security Pacific was "a necessary and substantial participant in the Investia Scheme, with a pervasive presence in the offering." Complaint at 35. It served as a reference for Investia prior to sale. It permitted the defendants to issue a prospectus which was materially misleading in relation to the relative rights of Security Pacific, Investia, and the investor. The bank also provided financing and other banking services to Investia and its officers and lent credibility to Investia's sales offers.

Based on the foregoing allegations, Levine charges that Wilmington and Security Pacific were both principals and aiders and abettors of Investia's securities fraud.

II

In dismissing the Rule 10b-5 claims against Wilmington and Security Pacific, the district court held that neither Wilmington's "written confirmation" nor the Client Reserve Certificate referring to Investia's Reserve Account at Security Pacific were securities. 722 F.Supp. at 584-85. The district court also suggested as an alternative ground for dismissal Levine's inability to show that Wilmington's and Security Pacific's alleged wrongdoing was "in connection with a purchase or sale of a security." Id. at 584. The court, however, did not elaborate on this alternative basis for its ruling, except to say that Security Pacific's "titular inclusion in [the] Client Reserve Certificate[s] [issued by...