Brennan v. Midwestern United Life Insurance Company

• Decision Date: 26 June 1968
• Docket Number: Civ. No. 1716.
• Citation: 286 F. Supp. 702
• Parties: Tora C. BRENNAN, Plaintiff, v. MIDWESTERN UNITED LIFE INSURANCE COMPANY, a Corporation, Defendant.
• Court: U.S. District Court — Northern District of Indiana

286 F. Supp. 702

Tora C. BRENNAN, Plaintiff, v. MIDWESTERN UNITED LIFE INSURANCE COMPANY, a Corporation, Defendant.

Civ. No. 1716.

United States District Court N. D. Indiana, Fort Wayne Division.

June 26, 1968.

Charles B. Feibleman and Sidney Mishkin of Bamberger & Feibleman, Indianapolis, Ind., Robert L. Kaag of Congdon & Kaag, Fort Wayne, Ind., for plaintiff.

G. R. Redding and John L. Woolling of Baker & Daniels, Indianapolis, Ind., Gilmore S. Haynie of Livingston, Dildine, Haynie & Yoder, Fort Wayne, Ind., for defendant.

MEMORANDUM OF DECISION AND JUDGMENT

ESCHBACH, District Judge.

This is a class action in which the plaintiff and members of her class seek damages against the defendant corporation for allegedly aiding, abetting, and assisting a securities dealer in the alleged violation by the securities dealer of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and of Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5. This court has jurisdiction under Section 27 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78aa.

In an order entered September 23, 1966, which is reported at 259 F.Supp. 673, this court denied, inter alia, the defendant's motion to dismiss plaintiff's complaint for failure to state a claim upon which relief could be granted. No good purpose would be served by repeating in detail here the matters discussed in that order. At that time the court, considering only the complaint and motion to dismiss, held, first, that it could not be said that civil liability could never under any circumstances be imposed upon persons who do no more than aid and abet a violation of Section 10(b) and Rule 10b-5. The court held, second, that there might be circumstances under which a person or corporation may, by merely failing to take action, give the requisite assistance or encouragement to a wrongdoer so as to constitute an aiding and abetting. The court then held that the pleadings presented to the court contained a sufficient basis to permit evidence that might establish conduct which under the circumstances would constitute an aiding and abetting. The principles discussed in that order are applicable to the facts disclosed by the evidence, and, to the extent they are relevant, they are incorporated herein by reference.

A trial was held to the court, without the intervention of a jury, beginning January 3, 1968. The court has concluded, after full consideration, that the plaintiffs have shown conduct on the part of Dobich Securities Corporation which constituted a flagrant violation of Section 10(b) and Rule 10b-5. The court has also concluded that the plaintiffs have shown affirmative conduct on the part of the defendant which, under the facts and circumstances of this case, constituted an aiding and abetting of Dobich's violation for the purpose of obtaining a benefit for the defendant. This aiding and abetting caused the losses sustained by the named plaintiff and those members of her class who purchased shares of stock in the defendant corporation on or after December 1, 1964 from Dobich Securities Corporation and did not receive delivery of the shares.

In its order denying defendant's motion to dismiss, this court said in part:

"This is not to hold that silence and inaction under all circumstances, or even under the circumstances which may be developed from the evidence in this case, constitutes aiding and abetting. This is merely to find a sufficient basis in the pleadings to permit evidence that may establish conduct which under the particular circumstances does constitute aiding and abetting. * * *" 259 F.Supp. at 682.

The correctness of that holding is now clear, because the evidence discloses affirmative conduct on the part of the defendant which constituted an aiding and abetting of Dobich's violation of the Securities Exchange Act of 1934. Therefore, it has not been necessary to the holding of the court to decide whether mere "silence and inaction" under the unusual circumstances of this case constituted aiding and abetting which caused the alleged damages. However, since under the evidence and the law the defendant's failure to report would constitute an independent basis of recovery and the parties have extensively briefed this question, it has been given consideration in this opinion.

Prior to the trial of this case, the parties entered into extensive discovery and voluminous stipulations. When the trial commenced, both sides were well aware of the evidence upon which each side has based its claims or defenses. If in any respect the pleadings do not strictly conform to the evidence, no prejudice to either side could have resulted therefrom.

The class of plaintiffs in this action, of which the plaintiff Tora C. Brennan is a member, claim to have purchased from Dobich Securities Corporation, and to have paid for, shares of common stock of the defendant, Midwestern United Life Insurance Company (hereinafter MULIC). The purchases involved in this action were in the secondary market for MULIC shares; that is, the market for shares already issued and outstanding. Throughout the period of time which is involved in this lawsuit, MULIC acted as its own transfer agent. The plaintiffs in this action claim that they never received from Dobich the shares of MULIC stock which they purchased and paid for. The Dobich Securities Corporation filed a petition in bankruptcy July 14, 1965. The bankrupt's insolvent estate is worth but a small fraction of the value of the shares in MULIC which Dobich sold but failed to deliver. The claims involved in this lawsuit are alleged to involve 419 individuals who claim losses totaling $2,104,904.75. However, as previously indicated, only a portion of plaintiff's class will be entitled to recover—those who purchased on or after December 1, 1964.

The Dobich Securities Corporation was formed October 16, 1963, as successor to a sole proprietorship run by one Michael Dobich and known as the Dobich Securities Company. ("Dobich" as hereinafter used will refer to either or both Michael Dobich and Dobich Securities Corporation.) The Corporation was registered as a broker-dealer with the Indiana Securities Commission, but not with the United States Securities and Exchange Commission.

The method of operation of the Dobich Securities Corporation and its predecessor was to concentrate its sales efforts in the secondary market for the common shares of one particular life insurance company. Thus, the corporation or its predecessor concentrated first in the stock of Bankers Life Insurance Company, then Wabash Life Insurance Company, then First United Life Insurance Company, and finally, beginning in the spring of 1964, MULIC. The general procedure followed by the corporation was to solicit orders for a particular stock through a staff of salesmen and to accept payment for these shares, either in cash or in the form of other securities, before actually purchasing the shares for delivery. This pattern of selling a share which the corporation did not yet own is known as a "short sale." Delivery of shares pursuant to these orders was made in numerous instances, after varying periods of delay, by purchasing the shares in the over-the-counter market.

The funds which Dobich Securities Corporation acquired through these "short sales" were applied predominantly in three ways: Payment of operating expenses, speculation in corporate securities for Dobich's own account and in his own name and speculation in commodities, also for Dobich's own account. The results were disastrous. Between January 1, 1964 and July 14, 1965, the corporation paid approximately $615,000 in commissions, plus a salary and "officer's commission" to Michael Dobich totaling $167,000. Operating expenses as a whole totaled $992,000. Speculations in corporate securities during this period for Dobich's own account produced a net excess of losses over gains of at least $465,000. Speculations in commodities during this period, with the funds of Dobich's customers but for Dobich's own account, produced a loss of $224,000. In addition, the short sale transactions in the stock of the various life insurance companies in which Dobich specialized also produced substantial losses—$140,000 in Wabash Life, $189,000 in First United Life, and $109,000 on the 48,409 shares of MULIC which Dobich actually did deliver. Dobich Securities Corporation produced during its short lifetime actual estimated liabilities of $2,700,000 and assets, other than insurance proceeds, of only $228,942. In all, Dobich failed to make delivery on short sales of approximately 36,000 shares of MULIC, for which customers paid Dobich approximately $2,900,000.

Even if all the assets of the Dobich Securities Corporation are accepted at the values given on the corporation's financial statements, the corporation was insolvent in the sense that its liabilities exceeded its assets as early as March 31, 1964. On that date it had a deficit net worth of $92,000. By August 31, 1964, the deficit had grown to $479,000, again assuming that all the assets stated on the balance sheet were worth what the statement claimed them to be worth. By December 31, 1964, the deficit net worth was $1,600,000. By July 14, 1965, the deficit was approximately $2,500,000. Growth in the balance of short sales (that is, sales of securities the corporation had not yet purchased) was equally spectacular. Short sales grew from $303,245 on January 1, 1964 to $875,985 on March 31, to $2,246,320 on August 31, to $2,529,710 on December 31, and finally to $3,142,842 on July 14, 1965.

To summarize, the Dobich Securities Corporation was in deep financial difficulties as early as March 31, 1964, and possibly much earlier. In what appears now to have been a desperate effort to recover, Dobich made short sales of MULIC stock in enormous quantities and used the proceeds in stock and commodity speculations for his own account, which only...