Arnold v. Dirrim

• Decision Date: 19 December 1979
• Docket Number: No. 3-677A142,3-677A142
• Citation: 398 N.E.2d 426
• Parties: Esta George ARNOLD and Gale Reiling Harris, Defendants-Appellants, National Guaranty Corp., Kenneth L. Jackson, Bill C. Smith, Edward George Weiss, Martin Stewart Schlissberg, Chris Stauffer, Harry W. Creely, Arthur D. Story, Richard D. Keating, Steven Bruce Sias, Non-Appealing Defendants, v. Kenneth DIRRIM and Wynell Dirrim, Individually and as Representatives of a Class, Plaintiffs-Appellees.
• Court: Indiana Appellate Court

Page 426

398 N.E.2d 426

Esta George ARNOLD and Gale Reiling Harris, Defendants-Appellants,

National Guaranty Corp., Kenneth L. Jackson, Bill C. Smith,

Edward George Weiss, Martin Stewart Schlissberg, Chris

Stauffer, Harry W. Creely, Arthur D. Story, Richard D.

Keating, Steven Bruce Sias, Non-Appealing Defendants, v. Kenneth DIRRIM and Wynell Dirrim, Individually and as

Representatives of a Class, Plaintiffs-Appellees.

No. 3-677A142.

Court of Appeals of Indiana, Third District.

Dec. 19, 1979.

Vincent J. Heiny and Sherrill W. Colvin, Snouffer, Haller & Colvin, Fort Wayne, for defendants-appellants.

Martin T. Fletcher, Rothberg, Gallmeyer, Fruechtenicht & Logan, Fort Wayne, for plaintiffs-appellees.

HOFFMAN, Judge.

On July 21, 1972 plaintiffs-appellees Kenneth and Wynell Dirrim initiated an action against National Guaranty Corporation (NGC) and Kenneth Jackson, its president, to recover their investment in NGC. Dirrims alleged that they purchased 1,000 shares of NGC stock in July 1970 for $10,000 and another 500 shares in April 1971 for $5,000 pursuant to a false and misleading prospectus. On April 13, 1973 Dirrims filed an amended complaint adding as defendants the nine individuals who were officers and/or directors of NGC including defendant-appellant Esta G. Arnold. In addition to seeking permission to bring their suit as a class action on behalf of all purchasers of NGC stock after October 15, 1969, Dirrims alleged that the actions of NGC in selling its securities were violative of the Indiana Securities Act, IC 1971, 23-2-1-1 to 23-2-1-25 (Burns Code Ed.) because (1) all sales after October 15, 1969 were made pursuant to a false, misleading and inadequate prospectus, IC 1971, 23-2-1-19(a), and (2) all stock sold after October 15, 1970 when the prospectus expired was unregistered. IC 1971, 23-2-1-3. The trial court found Arnold liable under IC 1971, 23-2-1-19(b), ¹ the derivative liability section of the Securities Act, for NGC's sales during these two periods.

Arnold has posited sixteen issues for consideration on appeal. For the sake of clarity and convenience, these questions have been restated and rearranged as follows:

(1) whether the trial court erred in finding that the prospectus was inadequate and otherwise failed to disclose material facts;

(2) whether the trial court erred in finding Arnold liable without determining that he materially aided in the sales of securities;

(3) whether the trial court erred in finding that Arnold failed to prove the special statutory defense in IC 1971, 23-2-1-19(b) (4) whether reliance is an element of a purchaser's claim under IC 1971, 23-2-1-19(a) for rescission of stock purchases;

(5) whether the trial court abused its discretion in denying Arnold's motion for a separate trial;

(6) whether the trial court erred in permitting Dirrims' action to proceed as a class action;

(7) whether the trial court abused its discretion in failing to require each member of the class to file a proof of claim;

(8) whether the trial court abused its discretion in allowing Dirrims to file an amended complaint;

(9) whether the class was barred by estoppel, estoppel by laches or laches;

(10) whether the trial court erred in denying Arnold a right to trial by jury;

(11) whether the filing of the amended complaint constituted a filing by all persons who were subsequently found to be members of the class;

(12) whether the burden of proof was on Arnold to prove his statute of limitations defense;

(13) whether the trial court applied an erroneous rule of law regarding when the securities violations were discovered;

(14) whether the award of attorney fees was contrary to the evidence;

(15) whether the hearing on attorney fees was held without sufficient notice; and

(16) whether Arnold was denied a fair trial.

Arnold maintains the trial court erred in finding that the prospectus failed to contain facts required by IC 1971, 23-2-1-5(b)(1) or otherwise omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. He also insists that any alleged omissions would not have materially affected any purchaser's decision to acquire the stock.

In the case of registered securities, IC 1971, 23-2-1-5(d) imposes certain minimum requirements on the contents of a prospectus to be used in connection with a stock offering. This statute provides in pertinent part:

"The commissioner shall require as a condition of registration of any security under this section 204 (23-2-1-5) that an adequate prospectus be sent or given to each person to whom an offer is made or from whom an offer to buy is solicited(.)

"The prospectus shall be adequate if it contains all of the information specified in section 204(b)(1) (subsection (b)(1) of this section.)"

A prospectus which does not include the information required by section 204(b) (1) (23-2-1-5(b)(1)) is therefore inadequate. The sale of a security through the use of an inadequate prospectus is a specified basis for civil liability under IC 1971, 23-2-1-19(a)(1).

"Any person who offers or sells a security in violation of sections 201(23-2-1-3), 204(d) (subsection (d) of 23-2-1-5) . . . is liable to the person buying the security from him." (Emphasis added.)

In general, the trial court found the prospectus was inadequate because it failed to disclose: material transactions between NGC and Guaranty Management Corporation (GMC); control of GMC by NGC's directors; facts surrounding GMC's acquisition, control and resale of NGC stock; the fact that GMC had created the $10 market price for NGC stock; the transactions between NGC and the Pyramid Corporation of Michigan (Pyramid); and the indirect ownership of NGC shares by its directors through GMC, Pyramid and other entities. ²

Arnold claims that both the GMC and Pyramid transactions were disclosed. The sole reference to GMC in the prospectus is at Note 2 of NGC's 6/30-69 financial statement. It reads:

"Note 2: On July 1, 1969, a 6% Note, due July 1, 1970, was executed in the aggregate amount of $101,782.56 to consolidate the principal and interest owing to Guaranty Management Corp. as of June 30, 1969."

The only statements in the prospectus about Pyramid showed that Pyramid held 172,000 shares of Class B common stock in NGC and that NGC directors Edward Weiss, Martin Schlissberg and Richard Keating were also officers and/or directors of Pyramid.

Among the facts which must be contained in a prospectus are the amount and kind of consideration for which the issuer has issued any of its securities within the two years preceding the registration date. IC 1971, 23-2-1-5(b)(1)(G). The trial court found that the prospectus failed to disclose that on July 16, 1968, the directors of NGC unanimously voted to issue 3,000 shares of its common stock to GMC for services rendered even though GMC was not incorporated at that time. The prospectus also omitted to state that on December 4, 1968, NGC sold 10,000 shares of its common stock to GMC at $5 per share. Furthermore, the prospectus failed to show that on September 8, 1969, NGC issued 8,000 shares to Pyramid which paid nothing for them. Each of these issuances was required by law to be disclosed. Hence the trial court properly held that the prospectus violated IC 1971, 23-2-1-5(b)(1)(G).

A prospectus is also required to include any material interest of any officer or director in any material transaction with the issuer or any affiliated corporation within three years of the registration date, IC 1971, 23-2-1-5(b) (1)(B), and every material contract made within two years prior to registration. IC 1971, 23-2-1-5(b)(1)(K). Moreover, a prospectus must contain all material information not expressly required that is necessary under the circumstances to make the statements made not misleading. IC 1971, 23-2-1-5(b)(1)(P); Ind.Admin.Rules & Regs. (23-2-1-5)-2 (Burns Code Ed.).

The trial court found that the prospectus failed to disclose that NGC directors Harris, Jackson, Sias, Stauffer and Arnold were also directors and principal shareholders of GMC. Nor did it reveal that GMC's officers were the same as NGC or that its books and records were maintained by NGC officers and employees. It also omitted to state that the function of GMC was to operate as a holding company through which its principals would loan funds to NGC which in turn would channel the money to National Guaranty Mutual Life Insurance Company (NGMLI) for the purpose of providing the necessary minimum capitalization for the creation of a mutual insurance company in Indiana. As soon as NGMLI was functioning, NGC would provide managerial and agency services to it and receive fees and commissions which would then be used by NGC to repay GMC. Additionally, the prospectus did not show that GMC acquired a total of 14,856 shares of NGC stock at price ranging from $2 to $5 per share between July 16, 1968 and October 15, 1969. Furthermore, the prospectus omitted to state that the $101,000 which GMC loaned to NGC was obtained by borrowing from its officers and directors, primarily Messrs. Sias, Harris, Stauffer or Arnold.

It also omitted to reveal that GMC had been selling its stock only from July 25, 1969 through October 15, 1969 at $10 per share or that the $10 market price for NGC stock was established by GMC's sales of NGC stock to various persons. The trial court further found that the prospectus failed to reflect an accurate percentage of the ownership of NGC stock held directly or indirectly by its directors. The prospectus did state that NGC's directors held as of October 1, 1969, 18,726 shares as a group or 21% Of NGC's total shares. These shares, however, were only of shares held directly in the names of NGC's directors and their wives. Considering an additional 19,004 shares held indirectly, the true percentage of ownership would be 42%.

Regarding the Pyramid transaction, the trial court found that the...