Carpenter v. Harris, Upham & Co., Inc.

Decision Date13 March 1979
Docket Number77-2182,HARRIS-UPHAM,77-2181,77-2052,Nos. 77-2051,s. 77-2051
CourtU.S. Court of Appeals — Fourth Circuit
PartiesFed. Sec. L. Rep. P 96,803 Thomas S. CARPENTER and Elliott Taylor, Appellants, v. HARRIS, UPHAM & COMPANY, INC., Appellee. Joseph WARREN, III, Mark B. Edwards, and Edwards & Warren, Professional Association, Appellants, v.AND COMPANY, Appellee. Eldo GROGAN, William Mills, and Gene Patton, Appellants, v. HARRIS, UPHAM & COMPANY, INC., Appellee. Michael B. ALLRAN, Edward R. Anderson, A. J. Beall, Jr., Anne C. Hawley, Barbara Morgan, Robert S. Morgan, G. F. Parker, Samuel White, R. W. Cannon, Dominic Capelli, Pauline Capelli, Frank W. Cayce, John Gaylord, Jr., John A. Jenks, Frank Manship, Appellants, v. HARRIS, UPHAM & COMPANY, INC., Appellee.

Harry C. Hewson, Charlotte, N. C. (Jones, Hewson & Woolard, Charlotte, N. C., on brief), for appellants in No. 77-2051.

William E. Underwood, Jr., Charlotte, N. C. (Caudle, Underwood & Kinsey, Charlotte, N. C., on brief), for appellants in No. 77-2052.

J. Douglas Stewart, Gainesville, Ga. (Telford, Stewart & Stephens, Gainesville, Ga., on brief), for appellants in No. 77-2181.

Robert G. McClure, Jr., Asheville, N. C. (Long, McClure & Dodd, Asheville, N. C., on brief), for appellants in No. 77-2182.

James H. Abrams, Jr., Charlotte, N. C. (William K. Diehl, Jr., James, McElroy & Diehl, Charlotte, N. C., on brief), for appellee in Nos. 77-2051, 77-2052, 77-2181 and 77-2182.

Before WIDENER and HALL, Circuit Judges, and HOFFMAN, * Senior District Judge.

WALTER E. HOFFMAN, Senior District Judge:

These cases are appeals from summary judgment granted in favor of Harris, Upham & Company, Inc. (Harris, Upham), a securities brokerage firm. The appellants sought to hold Harris, Upham liable for losses appellants incurred as purchasers of unregistered securities. The scheme involved investment in cattle and grain contracts purchased from companies operated by Wallace McKinney, a Kansas rancher. A central figure in the sale of the contracts was Gresham Northcott, a commodities broker employed by Harris, Upham's Charlotte, North Carolina, office until February 1, 1974. The losses which appellants sought to recoup were suffered on contracts purchased After Northcott left the employ of Harris, Upham. Appellants attempted to establish that the brokerage firm was a "controlling person" under Section 15 of the Securities Act of 1933 (15 U.S.C. § 77(L and O )) and/or Section 20 of the Securities Exchange Act of 1934, (15 U.S.C. § 78 (j and t)). Following extensive discovery, the district court granted summary judgment, holding that there was no theory which would support a judgment against Harris, Upham based on actions taken by Northcott after he left the firm's employ. 1 We affirm.

Many actions arose from losses suffered from investment in the McKinney operation and were consolidated for trial. Appellants (plaintiffs below) in Nos. 77-2051, 77-2181 and 77-2182 were purchasers of cattle or grain contracts. Appellants in No. 77-2052 (defendants and third-party plaintiffs below) sought indemnity and contribution from Harris, Upham for any liability which they or their law firm might suffer as a result of Northcott's actions. Since we hold that Harris, Upham could not have been liable as a controlling person under the facts of this case, summary judgment is affirmed as to all appellants.

The McKinney Cattle Company was engaged in feeding cattle prior to selling them to packing houses. In 1972 Northcott, while employed as a commodities broker for Harris, Upham, met McKinney in Kansas and solicited commodities business from him. McKinney became a customer of Harris, Upham, with Northcott as his registered representative. 2 Sometime in late summer or early fall of 1972, McKinney and Northcott began feeding cattle by means of subchapter-S corporations. 3 Three such corporations were formed. Those persons who became shareholders in these three corporations invested no cash, but instead filed financial statements with a Kansas bank showing a net worth of sufficient amount to allow the bank to loan the money which funded the corporations. Investors hoped to receive an immediate personal income tax deduction for the value of the grain purchased to feed the cattle, and anticipated converting ordinary income into capital gains upon liquidating the corporations within two years. Claude L. Ives, Jr., office manager for the Harris, Upham office in Charlotte, became a shareholder in one of the subchapter-S corporations, along with Northcott. There is no evidence that this was ever more than a private investment for Ives, or that he ever recommended similar investments to Harris, Upham customers or anyone else.

In 1973 McKinney began to offer other modes of investment in cattle feeding. Investors began purchasing cattle on an oral basis from McKinney. Later in 1973 such purchases were transacted in the form of letter agreements. Finally, McKinney began using form contracts which had been revised by the lawyer defendants involved in this appeal. All of the above transactions were represented to be purchases of specific lots of cattle, ostensibly avoiding the registration requirements of the securities laws. Each contract would provide for the purchase of a given number of cattle, which were represented to have been presold to packing houses at a prearranged price. Each investor's profit on the transaction was thus "guaranteed". However, by the spring of 1974 the basic plan had changed from one where McKinney actually held cattle for feeding to one where he attempted to cover contracts by buying and selling on the commodities market. New investor money was used to pay off existing investor contracts which had become due during the summer of 1974. This variation of the "Ponzi" scheme collapsed under its own weight in December, 1974, when McKinney was no longer able to pay contracts as they became due. According to McKinney's deposition, investors were never informed of the change in operation. 4 Investors discovered in November or December, 1974, that McKinney did not have enough cattle to meet the requirements of the outstanding contracts.

In February, 1973, Ives had noticed that margin calls had been made on hedging accounts for some of Harris, Upham's customers. He inquired of Northcott if those people were buying cattle from McKinney. Northcott admitted that he had referred to McKinney any customers who inquired about buying cattle, but stated that he was not receiving any compensation for such referrals. Ives testified in his deposition that he directed Northcott to stop making such referrals; Northcott denied that he was ever given such instructions. In large part appellants' suits are based on Northcott's allegations that Ives must have been aware that Northcott was continuing to refer individuals to McKinney because of Northcott's activities in the office and because of correspondence which Northcott received at the office. 5 However, Northcott admitted that he never discussed the referrals with Ives, that he never showed the contracts to anyone at Harris, Upham, and that he never sought an opinion from Ives or the compliance department regarding the legality of the contracts. 6 Only one piece of correspondence was received by Northcott at the office prior to November, 1973. 7

During 1973 Northcott was out of the office quite often and his production as a commodities broker declined sharply. When Ives brought this to his attention, Northcott attributed the decline to unfavorable conditions in the commodities market, and stated that he was attempting to obtain new accounts. It is now apparent that Northcott had begun to devote a large portion of his efforts to soliciting investors for McKinney. In early December Ives learned from a chance comment by a customer that Northcott had recommended that the customer consider investing in cattle. Ives immediately confronted Northcott, learned that he was still referring people to McKinney, and ordered him to stop making such referrals and to produce a list of those whom he had already introduced to McKinney. Ives then wrote to Robert Q. Jones, a vice president of Harris, Upham and Ives' immediate superior, and stated that he intended to terminate Northcott because of his poor production and because his outside activities were interfering with his performance as a broker. At Northcott's request, Jones, Ives and Northcott met to discuss the matter. Northcott again stated that he had merely introduced people to McKinney, that he had received no commissions from the referrals, and that he had made it clear to the people he referred that Harris, Upham had nothing to do with the cattle feeding program. 8 Northcott agreed to produce a list of those whom he had referred to McKinney.

Two weeks later, on January 17, 1974, Northcott returned to the Harris, Upham office and voluntarily submitted his resignation effective February 1, 1974. He parted on generally amicable terms. When asked by Ives if he had prepared a list of referrals, Northcott stated that the information was not available. 9

On January 21, after receipt of Northcott's letter of resignation, Jones wrote to Ronald Veith, compliance director for Harris, Upham. Included in the letter was a summary of what Jones had learned from Ives and Northcott concerning the reasons for Northcott's termination. Based on the information in Jones' letter, Veith recommended that Northcott be given a clean release. Thereafter an RE-4 form was submitted to the New York Stock Exchange which contained no negative comments concerning Northcott. 10

Following Northcott's termination, Harris, Upham personnel had very little contact with Northcott or McKinney. Early in 1974 one broker at the Harris, Upham office received several checks from BeTex Corporation, the entity through which Northcott began operating upon leaving the brokerage firm. The...

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