Alter v. DBLKM, INC., Civ. A. No. 90-M-1981.

• Decision Date: 20 December 1993
• Docket Number: Civ. A. No. 90-M-1981.
• Citation: 840 F. Supp. 799
• Parties: Thomas ALTER, individually and as assignee, Lee Schlessman, as assignee, and Bank of Denver, Plaintiffs, v. DBLKM, INC., f/k/a Kirchner, Moore & Company, Kutak, Rock & Campbell, Colorado Springs-Stetson Hills Public Building Authority, Amwest Development I Limited Partnership, Amwest Development Corporation, Gregory D. Timm, and one or more John and/or Jane Doe(s) and/or Doe Entity(ies), Defendants.
• Court: U.S. Court of Appeals — Seventh Circuit

840 F. Supp. 799

Thomas ALTER, individually and as assignee, Lee Schlessman, as assignee, and Bank of Denver, Plaintiffs, v. DBLKM, INC., f/k/a Kirchner, Moore & Company, Kutak, Rock & Campbell, Colorado Springs-Stetson Hills Public Building Authority, Amwest Development I Limited Partnership, Amwest Development Corporation, Gregory D. Timm, and one or more John and/or Jane Doe(s) and/or Doe Entity(ies), Defendants.

Civ. A. No. 90-M-1981.

United States District Court, D. Colorado.

December 20, 1993.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Kenneth C. Groves, John S. Butcher, Kenneth C. Groves, P.C., Denver, CO, Rodney R. Patula, Pryor, Carney & Johnson, P.C., Englewood, CO, for plaintiffs.

Jeffrey A. Chase, Edwin P. Aro, Holme Roberts & Owen, Denver, CO, James C. Ruh, John V. McDermott, Byrne Ruh & McDermott, P.C., Denver, CO, for defendants.

MEMORANDUM OPINION AND ORDER

MATSCH, Judge.

Defendants DBLKM, Inc. ("DBLKM"), Kutak, Rock & Campbell ("Kutak"), AmWest Development I Limited Partnership ("AmWest I") and AmWest Development Corporation ("AmWest Corp.") moved pursuant to F.R.Civ.P. 12(b)(6) to dismiss plaintiffs' second amended complaint alleging claims for relief under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5, the civil liability provisions of the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1961-68, the Colorado Organized Crime Control Act (COCCA), C.R.S. §§ 18-17-101 to -109, and Colorado common law fraud and civil conspiracy. This court has jurisdiction over the federal claims pursuant to 28 U.S.C. § 1331, and has supplemental jurisdiction over the state statutory and common law claims under 28 U.S.C. § 1367(a).

The plaintiffs' second amended complaint sets out the following factual basis for their claims. The Colorado Springs-Stetson Hills Public Building Authority, (the "Authority"), issued Series 1986A bonds ("1986 bonds") to raise $15,000,000 to finance improvements in the 2,200 acre Stetson Hills subdivision in Colorado Springs, Colorado. The Authority issued Series 1988A bonds (1988 bonds) to raise an additional $11,000,000. The 1986 and 1988 bonds were part of the first phase of a three-phase plan to raise a total of $45,000,000 to develop Stetson Hills over 10 to 15 years. The Authority was managed by a limited partnership, AmWest I, the developer and owner of Stetson Hills. The general partner in AmWest I was AmWest Corp., Gregory Timm ("Timm") served as a director of the Authority, director and president of AmWest Corp., as well as general counsel for both AmWest Corp. and AmWest I. Dain Bosworth, Inc. was the lead underwriter for the 1986 bonds. Smith Barney Harris Upham & Co., Inc., and DBLKM, then known as Kirchner, Moore & Company, also underwrote the 1986 bonds. DBLKM was the lead underwriter for the 1988 bonds. Central Bank of Denver served as trustee for both series of bonds. Kutak served as bond counsel for the 1986 issue, and bond and special disclosure counsel for the 1988 issue. Neither series of bonds was rated and they were not traded on any exchange.

Payment on principal and interest was to be from assessments against land within Stetson Hills — totalling approximately 250 acres for the 1986 bonds and 273 acres for the 1988 bonds. The indenture between the trustee and the Authority, an assessment and lien agreement between the Authority and AmWest I, and a development agreement between AmWest I and the trustee defined the obligations of the parties involved in the bonds' issuance. Two principal covenants are material here: The "110% test" required the Authority to maintain assessment charges against the land equal to or greater than 110% of the outstanding bond principal. The second covenant, called the "160% test," required AmWest I to maintain an assessment lien against property with a discounted bulk sale value equal to 160% of the outstanding principal of the bonds. AmWest I was required annually to provide an appraisal to the trustee as evidence of compliance with these covenants. The covenants provided that if the 160% test was not being met, AmWest I would subject additional land in Stetson Hills to the assessment lien.

The plaintiffs and their assignors purchased 1986 bonds at prices at or near par value in the secondary market concurrent with, or just after, the initial offering of the 1988 bonds. Plaintiff Thomas Alter ("Alter") purchased 1986 bonds with a face value of $100,000 on June 8, 1988. Alter is also the assignee from 34 other secondary market purchasers of the 1986 bonds. Plaintiff Lee Schlessman ("Schlessman") is the assignee of two bondholders who purchased 1986 bonds with a face value of $40,000 in January and February 1989. Plaintiff Bank of Denver purchased 1986 bonds with a face value of $120,000 in July and August of 1988 and January of 1989. The trustee gave notice on March 15, 1989 that a technical default had occurred on the 1986 bonds and that the Authority had failed to provide an updated appraisal of the property securing the bonds. After that notice of default, the secondary market for the 1986 bonds has collapsed.

Plaintiffs allege that these purchases of 1986 bonds resulted from a fraudulent scheme involving all of the defendants. In essence, the plaintiffs contend that if adequate disclosure concerning the status of the 1986 bonds had been made in 1988, the 1988 bonds could not have been issued and there would not have been a secondary market for the 1986 bonds. The plaintiffs also contend that DBLKM manipulated the market by buying 1986 bonds at or near par value and then reselling them through other brokers. Plaintiffs contend these prices were artificially inflated because in June and December 1987 the trustee had to invade the reserve fund to make interest payments and the Authority failed to submit the required appraisal for the trustee to verify compliance with the "160% test."

The official statement for the 1988 bonds, dated May 20, 1988, was nearly identical to the 1986 statement. Plaintiffs, however, allege that it left out material information, including: that AmWest I was going to use $2,000,000 from the 1988 bonds to purchase more land so that the 1986 bonds would remain secured; that the Authority was in default on the 1986 bond covenants; that the value of the land securing the 1986 bonds had been questioned by the trustee; that Dain and the trustee had questioned the reliability of the appraisals done to comply with the 1986 bond covenants; that the trustee had requested an independent review of the appraisal; and that Kutak and AmWest I decided to delay the independent appraisal review until after the initial marketing of the 1988 bonds.

Plaintiffs allege DBLKM also omitted these material facts in a May 5, 1988 presentation to bond professionals and in subsequent solicitations of bond brokers and potential purchasers. Plaintiffs allege they relied on the information dispensed in relation to the 1988 bonds in making their respective decisions to purchase the 1986 bonds. Plaintiffs also claim to have relied on the market price of the 1986 bonds being close to par value as evidence that the bonds were a secure investment. Plaintiffs claim the misinformation and concealment in the 1988 official statement contributed to the artificial inflation of the market price of the 1986 bonds.

The defendants' motions to dismiss assert that the plaintiffs are unable to show reliance on the 1988 bond issue in the purchase of the 1986 bonds in the secondary market.

I. 15 U.S.C. § 78j(b) and Rule 10b-5

Rule 10b-5 reads:

It shall be unlawful for any person ...

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5. Reliance is an essential element of a Rule 10b-5 cause of action. Basic, Inc. v. Levinson, 485 U.S. 224, 243, 108 S.Ct. 978, 989, 99 L.Ed.2d 194 (1988). The plaintiffs contend that reliance is not a problem in this case because they are entitled to a presumption under one or more theories advanced by them. The courts have recognized that certain circumstances will support a presumption or inference of reliance without direct evidence.

Two of plaintiffs' asserted theories of reliance are not applicable. Neither the "fraud-on-the-market," nor the "fraud-created-the-market" theories of reliance are supported by the allegations in this case.

The fraud-on-the-market theory is based on the premise that the price of a security in an open, developed and efficient market is determined by the use of all available public information regarding the issuer by all who are involved in the market. Accordingly, any fraudulent representation or omission will taint the price to the damage of buyers or sellers regardless of their personal knowledge or reliance. Basic, 485 U.S. at 241-242, 108 S.Ct. at 988-89. The fraud-on-the-market theory requires showing that the security was traded in large volume during the time period at issue, that a significant number of securities' analysts followed and reported on the security and that the price changed in relation to public statements or reports about the activities of the issuer. Cammer v. Bloom, 711 F.Supp. 1264, 1286-87 87 (D.N.J.1989).

Plaintiffs have made no such allegations here. To the contrary, they and their assignors purchased the 1986 bonds in a thin, undeveloped secondary market. The second amended complaint makes one conclusory allegation as to the market being "open, developed and sufficiently efficient to be responsive to the truth...