Akin v. Q-L Investments, Inc.

• Decision Date: 15 April 1992
• Docket Number: Q-L,No. 89-1643,89-1643
• Citation: 959 F.2d 521
• Parties: Fed. Sec. L. Rep. P 96,641, RICO Bus.Disp.Guide 8013 W.O. AKIN, et al., Plaintiffs-Appellants, v.INVESTMENTS, INC., etc., et al., Defendants, Laventhol & Horwath, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 521

959 F.2d 521

Fed. Sec. L. Rep. P 96,641, RICO Bus.Disp.Guide 8013

W.O. AKIN, et al., Plaintiffs-Appellants, v. Q-L INVESTMENTS, INC., etc., et al., Defendants Laventhol & Horwath, Defendant-Appellee.

No. 89-1643.

United States Court of Appeals Fifth Circuit.

April 15, 1992.

Samuel L. Boyd, Boyd & Adams, Wayne Swift, Dallas, Tex., for plaintiffs-appellants.

Eric R. Cromartie, John J. Little, David H. Roberts, Hughes & Luce, Dallas, Tex., for defendant-appellee.

Appeal From the United States District Court for the Northern District of Texas.

Before KING, JOHNSON, and HIGGINBOTHAM, Circuit Judges.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

This is a suit alleging violations of state and federal securities laws and RICO by accountants who audited financial statements included in private placement memoranda. Plaintiffs appeal a summary judgment and a sanction. We reverse.

I.

Plaintiffs are 127 investors who invested in a number of tax-oriented limited partnerships syndicated between 1973 and 1985 by a group of companies known as the Quinn-L group. The Quinn-L group included four companies that served as general partners of these limited partnerships: Quinn-L Investments, Inc., SML, Inc., Quinn-L Corporation, and Quinn-L Equities, Inc. The group also included other companies that performed various functions for the partnerships such as management and leasing of partnership properties (Quinn-L Management Corp.), mortgage financing (Quinn-L Mortgage Co.), lending of working capital funds (Quinn-L Capital Co.), and construction of improvements on properties, (Braxton Co.). Virtually all of the companies in the Quinn-L group were owned entirely by S. Mark Lovell.

The defendant, Laventhol & Horwath, is a national accounting firm retained by the Quinn-L group in connection with the sale of thirteen of these limited partnerships in the early 1980's. L & H furnished reports on financial statements, some of which were included in the Private Placement Memoranda (PPMs) used in marketing the partnership investments. L & H prepared reports on three kinds of financial statements included in the PPMs: (1) Start-up Balance Sheets, showing initial capitalization of the partnerships as either $100 or $1,000; (2) Historical Financials, reporting prior period performance for two of the partnerships being acquired by the Quinn-L Group; and (3) Corporate Balance Sheets, reporting financial statements of some of the syndicating companies. Preparation of these reports was L & H's sole involvement with the offerings.

The partnerships were primarily involved in real estate--the construction, ownership, and management of apartment complexes and office buildings throughout the southeast. There was a common cash management program among the various entities in the Quinn-L group through which the general partners borrowed money from individual partnerships for use within the overall structure as needed. The partnerships were projected to have operating losses for the first five to eight years of operation, which would generate tax deductions for the limited partners. Profitable operation would follow, if all went according to plan. Success depended largely on the general partners' ability to refinance the partnerships, sell them for more than their debt, or resyndicate them. With the passage of the Tax Reform Act of 1986 and the general collapse of the real estate market in the late 1980s, approximately forty of the forty-five limited partnerships ultimately went into bankruptcy or had their properties foreclosed upon.

In 1987 and 1988, plaintiffs filed twenty-six separate lawsuits alleging violations of federal and state securities laws and RICO in the sale of the limited partnerships. L & H is a defendant in thirteen of these suits. The plaintiffs contended that L & H aided and abetted the Quinn-L partnerships in securities violations by omitting material facts from the financial reports they prepared, thereby misleading investors as to the finances of partnerships in which they were investing. The plaintiffs alleged: (1) that L & H failed to disclose that the Quinn-L group had to syndicate additional partnerships in order to survive; (2) that L & H failed to disclose that the partnerships were "integrated" in nature--that "affiliate" or "interrelated" transactions among the individual partnerships were so numerous that the financial success of each partnership depended on the others; (3) that L & H failed to disclose certain contingent liabilities and the uncollectability of certain inter-company receivables, thereby distorting the companies' true net worth; (4) that L & H falsely represented that it complied with generally accepted accounting principles and auditing standards; and (5) that L & H materially aided the Quinn-L Group in the illegal sale of unregistered securities.

The suits were consolidated for discovery and trial. After nearly two years of discovery, the district court granted L & H's motions for summary judgment on the state and federal securities and RICO claims and sanctioned plaintiffs' counsel for bad faith submission of false and misleading form affidavits.

II.

We ask "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). This rule "mandates the entry of summary judgment, after adequate time for discovery and upon motion, against a party who fails to make a showing sufficient to establish the existence of an element essential to the party's case, and on which the party will bear the burden of proof at trial." Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986).

A. Federal Securities Claims

Congress and the SEC have constructed an elaborate regimen for the securities markets. Its central premise of disclosure finds expression, in part, by defined roles for players in the complex endeavor of issuing new securities, including underwriters, lawyers, and accountants. Rule 10b-5 was at its conception a carefully crafted piece for the disclosure and enforcement apparatus. Of course that limited assignment changed dramatically with recognition that Rule 10b-5 was enforceable by a private right of action. The relevant point is that judicial acceptance of private enforcement of Rule 10b-5 by an implied right of action came when the courts were far more hospitable to such ventures. This implied right brought with it an expansive judicial enterprise of developing a supporting common law.

The implication of such private rights of enforcement is no longer favored. Moreover, it is now apparent that open-ended readings of the duty stated by Rule 10b-5 threaten to rearrange the congressional scheme. The added layer of liability not for directly violating Rule 10b-5 but for aiding and abetting such violation is particularly problematic. Imposing liability upon traditional participants in the securities markets by resort to this theory presents greater risks of frustrating the congressional scheme of securities regulation than direct enforcement of the rule. There is a powerful argument that these risks are such that aider and abettor liability should not be enforceable by private parties pursuing an implied right of action. We must accept the law of this circuit acquiescing as it does in such suits. There are formidable arguments, however, against recognizing this cause of action--arguments that have grown with judicial insistence that Congress legislate; that is, with increasing judicial reluctance to undertake legislative tasks. We should be exacting in determining whether aider and abettor liability can be demonstrated.

Plaintiffs argue that L & H aided and abetted violation of Rule 10b-5 ¹ by preparing false and misleading reports on financial statements. There are three routes by which an accountant may be held liable under the rule. First, an accountant is directly liable for intentional or reckless ² misrepresentations if he knows his statements will be communicated to third parties. See, e.g., Fine v. American Solar King Corp., 919 F.2d 290, 298 (5th Cir.1990); Admiralty Fund v. Hugh Johnson & Co., 677 F.2d 1301, 1312 (9th Cir.1982); Chemical Bank v. Arthur Andersen & Co., 552 F.Supp. 439, 454-55 (S.D.N.Y.1982), rev'd on other grounds, 726 F.2d 930 (2d Cir.1984). Here the labels "aiding and abetting" and "secondary liability" are really misnomers, since § 10(b) prohibits any person from making false or misleading statements "in connection with" the purchase or sale of a security, even if the person plays an auxiliary role in the transaction.

Second, an accountant may be held liable for knowingly joining and substantially assisting in the misrepresentations of another, regardless of whether he makes any false statements of his own. Although the Supreme Court has twice reserved decision on liability for aiding and abetting a violation of Rule 10b-5, see Herman & MacLean v. Huddleston, 459 U.S. 375, 379 n. 5, 103 S.Ct. 683, 685 n. 5, 74 L.Ed.2d 548 (1983); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 191-92 n. 7, 96 S.Ct. 1375, 1380 n. 7, 47 L.Ed.2d 668 (1976), this Circuit, in common with other courts of appeals, has consistently recognized the validity of this theory. Abell v. Potomac Insurance Co., 858 F.2d 1104, 1115 (5th Cir.1988), vacated in part on other grounds sub nom. Abell v. Wright, Lindsey & Jennings, 492 U.S. 918, 109 S.Ct. 3242, 106 L.Ed.2d 589 (1989); Bane v. Sigmundr Exploration Corp., 848 F.2d 579 (5th Cir.1988); Woodward v. Metro Bank, 522 F.2d 84 (5th Cir.1975). Like any conspiracy to defraud, this route generally requires knowledge of the fraud and intent to join in it.

This court has cleared a third path more circuitous than the other two. By this route, an accountant may be held liable for recklessly aiding and abetting a...