Alvarado Partners, LP v. Mehta

• Decision Date: 15 September 1989
• Docket Number: Civ. A. No. 88-B-781.
• Citation: 723 F. Supp. 540
• Court: U.S. District Court — District of Colorado
• Parties: ALVARADO PARTNERS, L.P., on Behalf of Itself and All Others Similarly Situated, Plaintiff, v. Rajiv P. MEHTA, John A. Hoxmeier, James E. Brownhill, Robert A. Rademacher, Charles F. Smith, and 3CI Incorporated; and Hanifen Imhoff Inc., Individually and as Representative of a Defendant Class, Defendants. HANIFEN IMHOFF, INC., Third-Party Plaintiff, v. DELOITTE, HASKINS & SELLS, Third-Party Defendant.

723 F. Supp. 540

ALVARADO PARTNERS, L.P., on Behalf of Itself and All Others Similarly Situated, Plaintiff, v. Rajiv P. MEHTA, John A. Hoxmeier, James E. Brownhill, Robert A. Rademacher, Charles F. Smith, and 3CI Incorporated; and Hanifen Imhoff Inc., Individually and as Representative of a Defendant Class, Defendants.

HANIFEN IMHOFF, INC., Third-Party Plaintiff, v. DELOITTE, HASKINS & SELLS, Third-Party Defendant.

Civ. A. No. 88-B-781.

United States District Court, D. Colorado.

September 15, 1989.

COPYRIGHT MATERIAL OMITTED

John E. Grasberger, Frederic F. Nagel III, Milberg Weiss Bershad Specthrie & Lerach, San Diego, Cal., Jay S. Horowitz, Horowitz & Berrett, P.C., Denver, Colo., for plaintiff.

Robert F. Hill, Hill & Robinson, P.C., Denver, Colo., Gary Bendinger, Giauque, William, Wilcox & Bendinger, Salt Lake City, Utah, for Deloitte, Haskins & Sells.

David Palmer, Gregory J. Kerwin, Gibson, Dunn & Crutcher, Denver, Colo., for Mehta, Hoxmeier and 3CI.

David J. Richman, Coghill & Goodspeed, P.C., Denver, Colo., for Hanifen Imhoff, Inc.

Miles C. Cortez, Jr., Cortez & Friedman, P.C., Denver, Colo., for Brownhill, Rademacher and Smith.

MEMORANDUM OPINION AND ORDER

BABCOCK, District Judge.

In this federal securities class action, hearing was held on August 15, 1989 on plaintiff's, Alvarado Partners, L.P. (Alvarado) and defendants' Rajiv P. Mehta, John Hoxmeier, James E. Brownhill, Robert A. Rademacher, Charles F. Smith, and 3CI Incorporated (3CI) (collectively known as settling defendants) motions for 1) entry of a good faith order pursuant to Fed.R.Civ.P. 23(e) and 2) orders approving partial settlement and plan for distribution.

The motions present, inter alia, the issue, previously unaddressed in the 10th Circuit, of whether, and under what circumstances, a settlement between plaintiff and fewer than all defendants (partial settlement) may operate to bar the non-settling defendants' express and implied rights of contribution under the federal securities laws and if so, the form of the bar. In ruling on the motions, I determine that:

1. this is a proper case for conditional certification of a settlement class;

2. pursuant to Fed.R.Civ.P. 23(e), the settlement is fair, adequate, and in the best interests of the plaintiff class;

3. there is no right to indemnification in a federal securities action;

4. there is an express right to contribution under § 11 of the 1933 Securities Act;

5. under the 1934 Exchange Act there is an implied right to contribution under § 10(b) and Securities and Exchange Commission Rule 10b-5;

6. a bar to contribution is available under federal law; and

7. the offset under the settlement contribution bar is determined by applying the proportionate rule.

JURISDICTION AND VENUE

Alvarado brings this action pursuant to Sections 11, 12(2), and 15 of the Securities Act of 1933 (Securities Act) 15 U.S.C. §§ 77k, 77l(2), 77o, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (Exchange Act) 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5 promulgated thereunder by the United States Securities and Exchange Commission (SEC). Jurisdiction exists pursuant to Section 22 of the 1933 Act 15 U.S.C. § 77v and Section 27 of the 1934 Act 15 U.S.C. § 78aa.

PROCEDURAL AND FACTUAL BACKGROUND

This multi-party securities violation class action is brought by purchasers of stock in 3CI Incorporation, a company which designs, develops, and markets computer software. For the purpose of this ruling only, I glean from the parties' pleadings the following facts.

3CI is a public corporation which, as of February 1987, had approximately 1.1 million shares outstanding that were traded in the national over-the-counter market. Hanifen Imhoff, Inc. (Hanifen), a registered broker-dealer under the Exchange Act, was the principal and managing underwriter for the March 1987 offering. As lead underwriter, Hanifen conducted "due diligence" investigations into the business operations, internal accounting, operation, and management systems of 3CI. As 3CI's auditors and accountants, Deloitte, Haskins & Sells (DHS) reviewed audited and unaudited financial statements prepared by 3CI.

On February 24, 1987, 3CI, seeking an infusion of capital into the company, filed a preliminary prospectus for the sale of additional shares to the public. The preliminary prospectus allegedly contained false and misleading statements which operated to inflate artificially the price of the 3CI stock. These statements included representations that revenues and income from 3CI's principal product had consistently increased during the previous two years and nine months and that the number of licenses and contracts of 3CI's software packages was growing rapidly. The preliminary prospectus also represented that, pursuant to DHS's reviews, 3CI's financial statements were in conformity with generally accepted accounting principles and that 3CI's method of recognizing revenues was proper. The registration statement and prospectus containing the alleged false and misleading statements were filed with the SEC on March 18, 1987. Between the filing dates of the preliminary prospectus and the registration statement and prospectus, 3CI management and Hanifen made presentations to prospective investors based on these optimistic earnings statements and projections. Also, on March 18, 1987, DHS wrote to Hanifen a so-called "comfort letter" and amendment dated March 27, 1987. In it, DHS opined that 3CI's financial statements and accounting procedures were proper and that the registration statement complied as to form in all material respects with the accounting requirements of the Securities Act and Exchange Act and published rules and regulations thereunder.

Based on investor reaction to the positive information in the preliminary prospectus and the presentations, defendants were able to increase the number of shares to be registered in the public offering and to increase the per-share price by approximately $0.75 per share. At the time of the preliminary prospectus, the market price of 3CI's then outstanding stock was approximately $7.00 per share while the offering price was $7.75 per share.

The registration statement and prospectus became final on March 18, 1987. All of the newly-registered shares, 1.15 million shares plus an over-allotment of 172,500 shares, were then sold. Of the approximately 1.3 million shares sold, 1.1 million were sold by 3CI and 200,000 shares were sold by two inside directors, defendants Mehta and Hoxmeier. The shares sold for $7.75 each. This represented revenues of more than $10 million, of which approximately $8.6 million went to 3CI, $1.3 million to Mehta and $200,000 to Hoxmeier. Out of these amounts, Hanifen received fees of approximately $350,000 for marketing the issue. Following the public offering, Hanifen, pursuant to its undertakings in connection with the underwriting, supported the market for 3CI stock allegedly resulting in a loss of $500,000 to Hanifen.

Allegedly, not only were the projections of future revenues and earnings incorrect, but past revenues and income had been over-stated. In July, 1987 3CI announced that, notwithstanding the information in its prospectus, it expected to report a loss for the quarter ended March 31, 1987, and that it might report a loss for the entire fiscal year. Several days later, 3CI made other public disclosures, including that:

(a) according to its independent auditor, third-party defendant DHS, 3CI's financial statements had NOT been prepared in accordance with generally accepted accounting procedures; and

(b) not only would revenue and income not double each year, but for the fiscal year just ended, 3CI was reporting a loss of 19 cents per share, as compared to a profit of 34 cents per share the prior year.

After this news, the price of the 3CI stock plummeted. During the class period (February 24, 1987, the date of the preliminary prospectus, to July 30, 1987, the date of announcement of business problems), 3CI stock sold for $6 — $8 per share. After these unfavorable announcements, in one month the price of 3CI shares dropped to below $4 per share. By the end of July 1989, 3CI stock sold for less than $1 per share.

On May 23, 1988, Alvarado filed this action against settling defendants and Hanifen on behalf of all persons who purchased 3CI common stock during the class period. Hanifen answered and filed the following cross-claims:

1. contractual indemnity pursuant to its underwriting agreement against 3CI, Mehta and Hoxmeier;

2. breach of warranty and breach of contract against 3CI, Mehta, and Hoxmeier arising out of the parties' underwriting agreement;

3. contractual contribution against 3CI, Mehta, and Hoxmeier arising out of the underwriting agreement;

4. contribution under §§ 11(a) and 11(f) of the Securities Act and contribution under § 10(b) of the Exchange Act or Rule 10(b)(5) of the SEC regulations against all crossclaim defendants;

5. fraud against all crossclaim defendants;

6. negligent misrepresentation against all cross-claim defendants.

Thereafter, as third-party plaintiff, Hanifen filed a complaint against third-party defendant DHS.

On May 31, 1989 Alvarado entered into a settlement agreement with settling defendants. On June 1, 1989, Alvarado and settling defendants filed a joint motion requesting class certification for settlement purposes.

The terms of the proposed settlement include:

1. cash payment of $350,000 including $250,000 to be paid by 3CI and $100,000 to be paid by the inside directors Mehta and Hoxmeier;

2. issuance of $1.0 million worth of 3CI common stock, to be valued by averaging the closing price of the stock during a two-week period ending several days before distribution, with the maximum number of shares capped at 1.5 million;

3. reformation of Mehta's employment contract, reducing his salary from $125,000 to $90,000 and removing him from day-to-day management of 3CI;

4. full cooperation by 3CI and all of its

...