Ambrosino v. Rodman & Renshaw, Inc.

• Decision Date: 11 August 1992
• Docket Number: Nos. 90-3769,91-1441,s. 90-3769
• Citation: 972 F.2d 776
• Parties: Fed. Sec. L. Rep. P 96,969 Dan AMBROSINO, Stephen J. Burns, and Steve R. Chura, et al., Plaintiffs-Appellants, v. RODMAN & RENSHAW, INCORPORATED; Rodman Properties, Limited, formerly known as Rodman Capital Group, Limited; and Richard E. Rice; et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 776

972 F.2d 776

Fed. Sec. L. Rep. P 96,969

Dan AMBROSINO, Stephen J. Burns, and Steve R. Chura, et al Plaintiffs-Appellants, v. RODMAN & RENSHAW, INCORPORATED; Rodman Properties, Limited formerly known as Rodman Capital Group, Limited and Richard E. Rice; et al Defendants-Appellees.

Nos. 90-3769, 91-1441.

United States Court of Appeals, Seventh Circuit.

Argued Dec. 13, 1991.

Decided Aug. 11, 1992.

James S. Barber, Allen B. Witz, Arvey, Hodes, Costello & Burman; John J. Enright, Horvath, Lieber & Quilici; and David A. Novoselsky (argued), Novoselsky & Associates, Chicago, Ill., for plaintiffs-appellants.

Ira Gould, Victoria Zielinski, Holleb & Coff; Brian J. Wanca, Robert Bell, Jr., John W. Emerson, Johnson & Bell; Robert D. Glick, Ira S. Kolb, Franklin S. Schwerin (argued), Schwartz, Cooper, Kolb & Gaynor; and John J. Harte, Chicago, Ill., for defendants-appellees.

Before CUMMINGS, WOOD, Jr., ^* and KANNE, Circuit Judges.

HARLINGTON WOOD, Jr., Circuit Judge.

This case is about oil-and-gas investors in 1981 and 1982, the plaintiffs-appellants here, who are not satisfied with the tax benefits their investment of $2,340,000 procured; it is about alleged violations of federal and state securities laws; and it is about money. It is about a promoter, defendant Richard Berry, ¹ who, according to the district court, failed to reveal a material fact that a reasonable investor would consider important and, thus, was held liable for $1,840,000. It is also about a securities dealer, Rodman & Renshaw, Inc., and some of its employees (collectively, the "Rodman defendants") ² that, according to the district court, are free of liability because in selling three oil-and-gas, limited partnerships they either did not fail to disclose The early 1980s in the oil fields: they were the best of times, they were the worst of times. ³ Everyone knew the price of oil and gas had increased many times over in just a few years, and many believed it would continue to do so, to the betterment of some and the detriment of others. Many also believed that drilling activity, which had similarly mushroomed, would continue to do likewise. But there was concern among some petroleum experts that domestic reserves would steadily decline while both production and the cost of exploration steadily increased. ⁴ Experienced oilfield workers were making and spending more than some corporate executives. Recent college graduates who could claim to be geologists, geophysicists, or petroleum engineers were making more, commonly much more than the professors who taught them. Price controls, divestiture, deregulation, where to drill, and where not to drill were hotly debated topics. The northern and eastern regions of the country, particularly, suffered brown-outs, shortages of natural gas and home heating oil, and severe restrictions on energy consumption.

                material facts, did not make material misrepresentations, or exercised due diligence although failing to discover a material fact.   Because the district court did not misunderstand the applicable law, was not clearly erroneous in its findings of fact, and did not abuse its discretion, we affirm its judgment
                

No one suspected that a major financial player, Penn Square Bank, in Oklahoma City would go under--July 5, 1982--or that the associated ripple, which for some was more a tidal wave, would ravage the financial and petroleum industries alike, nearly sinking Continental Illinois National Bank & Trust Co. of Chicago and putting many banks and savings and loan associations, as well as numerous oil and oil-support companies, out of business. ⁵ Nor did anyone anticipate that in just a few years the price of a barrel of oil would drop precipitously, as would both the number of active drilling-rigs and the number of wells drilled.

But no one saw the approaching storm or paid any heed to those who said they did; money continued to flow freely. Investors were everywhere, throwing money at anyone who claimed to be an oil or gas promoter, whether he or she had been in the business for decades or days. Many promoters were both knowledgeable and honest, earning a living, albeit a very comfortable one, by developing legitimate oil and gas prospects, using their own and investors' money. Sometimes these prospects were extremely successful with everyone's investment multiplying many times over in less than a year or so. Sometimes the payout was less or took longer, but still the investment was pleasingly profitable. Sometimes the prospect, through no one's fault or fraud, was a bust; still there were handsome tax benefits. But there was another type of promoter, too. ⁶ These promoters sold mostly illusory dreams; their prospects, if drilled at all, produced mostly salt water--a product for which the market was severely depressed--and tax benefits, a not entirely unwelcome result. Investors and the securities dealers who marketed the investments were hard pressed to distinguish honest promoters from the others, the legitimate prospects from the fraudulent ones, and the prospects that failed This is a securities case; it is not about oil or gas other than as the stage upon which the drama unfolds. Nonetheless, to understand the materiality of many of the facts raised by the plaintiffs-appellants as evidencing violation of the securities laws it is necessary to know a bit about both the geology of oil and gas and the petroleum industry.

fairly from those that were foreordained to fail.

Almost all of the world's economically recoverable oil and gas occurs in sedimentary rocks, mostly in sandstones and limestones. ⁷ These rocks originally formed as pods, or stringers, or ribbons, or finite sheets of sediment, deposited more or less in horizontal layers that upon lithification became the sedimentary strata we see exposed, for example, in many roadcuts and the Grand Canyon. These strata are not uniform in composition, texture, thickness, or extent, and certainly not in the amount and type of cement or other lithification products that bind the sedimentary grains together. Furthermore, upon burial and as the result of tectonic movements, the strata become deformed: they may be tilted, folded and faulted. Consequently, inhomogeneity is the rule, not the exception. It is this inhomogeneity that both traps oil and gas and limits its occurrence to rather unique settings. ⁸

Oil and gas, if generated in the first place and if present at all, occur in pores in the strata, in holes or fractures of one sort or another mostly smaller than the naked eye can distinguish. The more porous a rock is, the more oil and gas it can contain. But to get the oil or gas out, the rock must be permeable; fluids must be able to flow from the strata into the well. The natural inhomogeneity of sedimentary strata means no single stratum is uniformly porous and permeable, nor, if oil- or gas-bearing, will it be uniformly oil- or gas-bearing. Nonetheless, earth scientists have developed techniques and an ability to identify likely locations for the presence of oil and gas, albeit with far less than perfect accuracy. The earth holds many surprises for even the most honest and insightful earth scientist.

Perhaps in spite of or, perhaps, because of the nature and occurrence of its product, the petroleum industry has become a mainstay of the modern world's economy. It is an integrated industry, comprising five basic functions: exploration, production, refining, transportation, and marketing. ⁹ Our concern is mostly with exploration and, to a lesser extent, production. Transcending these two functions is development. It is a subset of both exploration and production and occurs only after discovery (successful exploration). While preceding most production, it also often accompanies at least the early stages of production.

Pure exploration is a risky venture. ¹⁰ The rank, or newfield, wildcat is the riskiest of the legitimate exploration ventures, constituting an attempt to discover petroleum in a potentially possible site in a region where none has been produced but where its absence is not foreordained. The ordinary wildcat is somewhat less risky with an industry-wide success ratio of about 1 in 9 or 10 for finding petroleum, whether economically producible or not; it tests an unproven but possible location in a region known or reasonably thought to contain petroleum. The least risky but still uncertain exploration venture is the step-out, an attempt to discover a new, nearby oil- or Once oil or gas is discovered, the field or pool must be developed if hydrocarbons are to be produced in economically meaningful amounts. Development involves both drilling to determine the external limits of the occurrence and drilling to establish a pattern of wells that will maximize ultimate recovery. ¹¹ The former, sometimes referred to as outpost or extension drilling, is dominantly an exploration function; whereas, the latter is mostly a production function. Neither is without risk: the former, however, is generally riskier than the latter. Some holes drilled to test the limits of an occurrence must necessarily fall outside the area of producible hydrocarbons or lose production before achieving payout. In-field drilling may encounter impermeable or low-porosity zones from which oil or gas cannot be produced, possibly because of differential cementation or a facies change; unanticipated faults may have disadvantageously displaced the producing interval; or the producing interval may unexpectedly pinch-out beneath or onto an unconformity. Uncertainty is always present. ¹²

gas-pool or to examine a previously untested horizon above or below a producing or formerly producing interval.

Lastly, production is generally quite predictable but not entirely so. Essentially all oil wells, once they are on-line, are most productive very early on: generally, this is during their first few weeks or, at most, months of operation. ¹³ Production rates...