Adalman v. Baker, Watts & Co.

Decision Date31 October 1986
Docket NumberB-W,Nos. 85-1964,s. 85-1964
Citation807 F.2d 359
PartiesFed. Sec. L. Rep. P 92,987, 21 Fed. R. Evid. Serv. 1283 Silvia L. ADALMAN; George S. Allen; Bernard Ansher; Irene B. Ansher; Laurence Banyas; J. Frank Belford, Jr.; Grace C. Belford; Juan M. Cameron; Nora L. Cameron; Dale Ann Cooke; Dennis D. Donahue; Gretchen J. Donahue; Stanley H. Engle; Marilyn J. Engle; Harry Feinberg; Douglas S. Goodwin; John F. Griffin; Ridgway M. Hall, Jr.; Anne Harken Hall; Donald V. Kane; Lois Jean Kane; Samuel J. Floyd, Jr.; Malcolm R. Lovell, Jr.; Celia C. Lovell; Warren L. Miller; O/G Recovery Partners, a Maryland Partnership; Richard A. Slifer; Kristine R. Slifer; Gifford Weary and Robert K. Weary, Jr., Appellees, and Gerald J. Bowes and Luther C. Dilatush, Plaintiffs, v. BAKER, WATTS & CO., a Maryland Partnership, Appellant. Edgar M. BOYD; N. Clark Moran; Paul Berghaus;Resources, Inc., a Maryland Corporation and Scott W. Williams, Defendants, v. JULIA M. WALSH & SONS, INC.; Henry T. Donaldson; Thomas D. Walsh; Douglas R. Bevers and Elkins & Co., a Division of Prudential Bache Securities, Inc., Third-Party Defendants. Silvia L. ADALMAN; George S. Allen; Bernard Ansher; Irene B. Ansher; Laurence Banyas; J. Frank Belford, Jr.; Grace C. Belford; Juan M. Cameron; Nora L. Cameron; Dale Ann Cooke; Dennis D. Donahue; Gretchen J. Donahue; Stanley H. Engle; Marilyn J. Engle; Harry Feinberg; Douglas S. Goodwin; John F. Griffin; Ridgway M. Hall, Jr.; Anne Harken Hall; Donald V. Kane; Lois Jean Kane; Samuel J. Floyd, Jr.; Malcolm R. Lovell, Jr.; Celia C. Lovell; Warren L. Miller; O/G Recovery Partners, a Maryland Partnership; Richard A. Slifer; Kristine R. Slifer; Gifford Weary and Robert K. Weary, Jr., Plaintiffs, and Gerald J. Bowes and Luther C. Dilatush, Appellants, v. BAKER, WATTS & CO., a Maryland Partnership, Appellee. Edgar M. BOYD; N. Clark Moran; Paul Berghaus;Resources, Inc., a Maryland Corporation and Scott W. Williams, Defendants, v. JULIA M. WALSH & SONS, INC.; Henry T. Donaldson; Thomas D. Walsh; Douglas R. Bevers and Elkins & Co., a
CourtU.S. Court of Appeals — Fourth Circuit

John Henry Lewin, Jr. (Thomas F. O'Neil, III, Geoffrey R. Garinther, Venable, Baetjer & Howard, Baltimore, Md., David S. Cupps, Joseph D. Lonardo, Vorys, Sater, Seymour & Pease, Columbus, Ohio on brief), for Baker, Watts & Co.

Gerson B. Mehlman (Wilbur D. Preston, Jr., John M. Belferman, Whiteford, Taylor & Preston, Baltimore, Md., on brief), for Gerald J. Bowes and Luther C. Dilatush.

David Machanic (John A. Ritchie, Joan L. Loizeaux, Pierson, Ball & Dowd, Washington, D.C., on brief), for Appellees.

Before HALL and SPROUSE, Circuit Judges, and MICHAEL, United States District Judge for the Western District of Virginia, sitting by designation.

MICHAEL, District Judge.

This case presents for resolution several issues which have arisen out of the use of the so-called "tax shelter".

I. FACTS

The controversies evolved from the relationships between Baker, Watts & Company, a Maryland investment banking partnership (hereinafter Baker, Watts), and Superior Petroleum, Inc. (hereinafter Superior), a closely-held Ohio corporation engaged in drilling for gas and oil in Ohio. In early 1981, certain partners, employees and counsel for Baker, Watts bought one-third of the outstanding stock of Superior, and two of the Baker, Watts personnel became members of the five-member board of directors of Superior. At that time, Baker, Watts was also the largest contributor of funds to finance Superior's drilling activities.

Subsequently, in the spring of 1981, Baker, Watts undertook to serve as the dealer-manager for a private offering of limited partnership interests in a tax shelter investment which was denominated "Superior Drilling Partners No. 81" (hereinafter the Partnership), in which Superior was a general partner. Under the agreement, Baker, Watts would offer and sell in interstate commerce, on a best-efforts basis, limited partnership interests in the partnership. In its capacity as a dealer-manager, Baker, Watts entered into soliciting dealer agreements with two securities dealers, Julia M. Walsh & Sons (hereinafter Walsh) and Elkins & Co. (hereinafter Elkins), in which both agreed to use their "best efforts" to find investors to purchase the limited partnership interests.

In preparation for the selling effort, Baker, Watts prepared a lengthy Confidential Offering Memorandum, which served essentially as a prospectus for the offering. The document was furnished to all investors, either directly from Baker, Watts, or through the soliciting dealers. Baker, Watts stringently required Walsh and Elkins to use only the Offering Memorandum in soliciting investors. Walsh and Elkins were directed to make no representations of any sort concerning the offering other than those representations contained in the Offering Memorandum. The Memorandum contained a number of references to Baker, Watts as an "affiliate" of the general partner, Superior. The Memorandum provided that each limited partnership interest would be sold for $75,000, half to be paid in cash, and the other half in the form of promissory notes secured by letters of credit. This permitted the investors to defer payment of half the purchase price while realizing immediately income tax deductions permitted for this type of investment.

Thirty-one investors purchased interests worth a total of $1,702,500 during the course of the private offering, which opened on March 9, 1981, and closed on June 1, 1981. Nineteen of these investors purchased their interests through the soliciting dealers, Walsh and Elkins, and ten investors purchased their interests through Baker, Watts. Unfortunately for the rosy expectations of the parties, Superior ran into financial difficulties in the spring of 1982, and these problems were magnified by the untimely death of Superior's president in June of 1982. These events brought the Partnership into receivership in June of 1982, and the Clinton Oil Company took over operation of the Partnership, though it ultimately proved to be unprofitable. The letters of credit of the various investors were called in December 1982, thus effectively terminating the Partnership and resolving the matter of payment for the interests which had been purchased by the investors.

In April of 1983, the investors as a group filed suit against Baker, Watts and several others, alleging violations of numerous state and federal securities laws, and seeking rescission of the original investment contracts and restitution. All counts were eventually dismissed by stipulation, except those counts which charged violations of Sec. 12(2) of the Securities Act of 1933, 15 U.S.C. Sec. 77l(2), and Maryland Corporations and Associations Code Sec. 11-703(a)(1)(ii). The core of these remaining counts focused on the allegation that those persons listed in the Offering Memorandum as being "associated" with Baker, Watts negotiated with, and eventually sold their stock in Superior, to Anthony Biondi, Superior's president, such negotiation being carried on during the offering period, with the sale to Biondi occurring shortly after the close of the offering period. This information was never disclosed to any of the individual investors or to the soliciting dealers at any time before the offering was closed. In fact, an employee at Baker, Watts who was responsible for the Partnership's gas and oil investments and who handled negotiations for the sellers of Superior stock, Hugh Grady, stated at trial that he had not revealed the negotiations between the "affiliates" and Superior because he felt that disclosure of this information would have an adverse, and likely fatal, effect on the offering.

II. ISSUES PRESENTED

The issues presented for resolution on appeal are as follows:

1. Did the District Court err in instructing the jury that Baker, Watts was a "seller" as to all plaintiffs within the meaning of Sec. 12(2) of the Securities Act of 1933?

2. Did the District Court err in refusing Baker, Watts permission to call an expert witness to testify concerning the Superior stock sale, under the circumstances of this case?

3. Did the District Court err in its determination of the plaintiff's damages by disregarding the tax benefits received by the plaintiffs as a result of their investment in the limited partnership?

4. Did the District Court err in its rulings and in its instructions to the jury on the issue of causation?

5. Did the District Court err in directing a verdict against two plaintiffs, Bowes and Dilatush?

III. DISCUSSION
A. The District Court's instruction that Baker, Watts was a "seller" within the meaning of Sec. 12(2)

The court below found as a matter of law that Baker, Watts was a seller within the meaning of Sec. 12(2) "with respect to all of the plaintiffs in this case, whether they purchased from Baker, Watts or through other broker/dealers." Section 12(2) of the Securities Act of 1933 reads in pertinent part as follows:

Any person who ... offers or sells a security ... by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statement, in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable to the person purchasing such security from him who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, less the amount of any...

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