Cleary v. Perfectune, Inc.

• Citation: 700 F.2d 774
• Decision Date: 28 February 1983
• Docket Number: No. 82-1250,82-1250
• Parties: Fed. Sec. L. Rep. P 99,111 Richard V. CLEARY, et al., Plaintiffs, Appellants, v. PERFECTUNE, INC., et al., Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

Page 774

700 F.2d 774

Fed. Sec. L. Rep. P 99,111

Richard V. CLEARY, et al., Plaintiffs, Appellants, v. PERFECTUNE, INC., et al., Defendants, Appellees.

No. 82-1250.

United States Court of Appeals First Circuit.

Argued Oct. 7, 1982.

Decided Feb. 28, 1983.

William M. O'Brien, Boston, Mass., with whom Paul G. Counihan, Boston, Mass., was on brief, for plaintiffs, appellants.

Christopher P. Sullivan, Boston, Mass., with whom Stephen G. Dietrick, Carolan & Sullivan, and John J. O'Brien, Boston, Mass., were on brief, for defendants, appellees.

Before PECK, ^* Senior Circuit Judge, CAMPBELL and BREYER, Circuit Judges.

JOHN W. PECK, Senior Circuit Judge.

Richard V. Cleary and Thomas J. Cleary ("plaintiffs") appeal the district court's grant of summary judgment to John Mitchell, William Sheskey, and James F. Higgins ("defendants") on plaintiffs' action to recover damages under Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), Securities and Exchange Commission Rule 10b-5, 17 C.F.R. Sec. 240.10b-5, and Sec. 17(a) of the Securities Act of 1933, 15 U.S.C. Sec. 77q(a). Plaintiffs alleged that the defendants were liable as aiders and abettors because they failed to inform the Securities and Exchange Commission, the Massachusetts authorities or the plaintiffs that they had not consented to be listed as directors of Perfectune, Inc. ("Perfectune") in the Offering Memorandum for Perfectune when they discovered they had been so listed. The district court granted summary judgment based on its holdings that Sec. 17(a) does not provide a private right of action and that plaintiffs failed to establish any basis for imposing aider and abettor liability under Sec. 10(b) or rule 10b-5 in this case. Although we do not reach the question of whether Sec. 17(a) affords a private right of action for damages, we affirm the judgment of the district court because we find that in this case there is no basis for imposing liability on the defendants as aiders and abettors under either Sec. 10(b) and rule 10b-5 or Sec. 17(a).

I

In January, 1976, John W. McHugh, the promoter of Perfectune, gave the plaintiffs an Offering Memorandum for Perfectune, a proposed chain of automobile tune-up centers. In March, 1976 plaintiffs purchased 550 shares of stock in Perfectune for $11,000.00.

In the Offering Memorandum, which was dated January 3, 1976, as well as in the Articles of Organization for Perfectune filed with the Commonwealth of Massachusetts, McHugh listed the defendants as directors of Perfectune without their knowledge or consent. None of the defendants signed the Offering Memorandum or participated in drafting, issuing or disseminating it. The defendants, however, were aware that McHugh was promoting Perfectune. In September, 1975, Sheskey and Higgins each made personal loans of $2,000.00 to McHugh. The debts later were converted into equity investments in Perfectune. Mitchell also provided $2,000.00 to McHugh to cover the initial costs of the Perfectune venture but he always treated this advance as an equity investment.

In January, 1976 each defendant received a copy of the Perfectune Offering Memorandum. At no time did any of the defendants object to being listed as a director. Moreover, no defendant informed the Securities and Exchange Commission, the Massachusetts authorities, or the plaintiffs that they had been listed as directors without their consent or knowledge. The defendants contend, and the district court implicitly found, that they assumed positions as outside directors of Perfectune. The plaintiffs deny that defendants ever became directors, although they concede that the defendants attended a Perfectune directors meeting that was held in July, 1976.

In September or October, 1976 a Perfectune tune-up center opened for business in Quincy, Massachusetts. The venture was not successful. In August, 1978 the Internal Revenue Service conducted a tax sale of Perfectune's assets.

In February, 1979 plaintiffs filed suit in the United States District Court for the District of Massachusetts to recover the purchase price of the Perfectune stock. The plaintiffs alleged that McHugh violated the securities laws by, among other things, preparing, issuing and disseminating a fraudulent Offering Memorandum. The plaintiffs also alleged that the defendants were liable as aiders and abettors of McHugh's violations. In the district court plaintiffs contended that the defendants had a duty to inform the Securities and Exchange Commission, the Massachusetts authorities or the plaintiffs that they were not directors of Perfectune and had not consented to be so listed in the Offering Memorandum. The plaintiffs then argued that as a result of the breach of this duty liability for aiding and abetting could be imposed on the defendants.

Although the district court denied McHugh's motion for summary judgment, it granted summary judgment for the defendants in an order on November 19, 1981. The district court held that the defendants were not liable to the plaintiffs as aiders and abettors under Sec. 10(b) and rule 10b-5 because the plaintiffs failed to raise genuine questions of material fact concerning the elements of such liability. The district court also held that aiding and abetting liability could not be imposed under Sec. 17(a) on the ground that no private right of action for damages exists under Sec. 17(a). McHugh has been adjudged a bankrupt and discharged. Perfectune, which was defaulted, has no assets. On appeal the plaintiffs contend that both holdings of the district court with respect to the defendants were erroneous.

II

Plaintiffs contend that the defendants are liable as aiders and abettors under Sec. 10(b) and rule 10b-5 because the defendants, who as investors stood to benefit from additional investment from third parties, failed to inform the Securities and Exchange Commission, the Massachusetts authorities or the plaintiffs that they were not directors at the time the Offering Memorandum for Perfectune was prepared, issued and disseminated. The inaction and silence of the defendants is the sole basis on which the plaintiffs attempt to ground the defendants' aiding and abetting liability.

The test to be applied to determine whether a defendant is liable as an aider and abettor of a violation of Sec. 10(b) or rule 10b-5 is now well-settled. To establish liability a plaintiff must prove:

(1) the commission of a violation of Sec. 10(b) or rule 10b-5 by the primary party;

(2) the defendant's general awareness that his role was part of an overall activity that is improper; and

(3) knowing and substantial assistance of the primary violation by the defendant.

Harmsen v. Smith, 693 F.2d 932, 943 (9th Cir.1982); IIT v. Cornfeld, 619 F.2d 909, 922 (2d Cir.1980); Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94-97 (5th Cir.1975); SEC v. Coffey, 493 F.2d 1304, 1316 (6th Cir.1974), cert. denied, 420 U.S. 908, 95 S.Ct. 826, 42 L.Ed.2d 837 (1975); Landy v. Federal Deposit Insurance Corp., 486 F.2d 139, 162-63 (3d Cir.1973), cert. denied, 416 U.S. 960, 94 S.Ct. 1979, 40 L.Ed.2d 312 (1974). See generally Ruder, Multiple Defendants in Securities Law Fraud Cases: Aiding and Abetting, Conspiracy, In Pari Delicto, Indemnification, and Contribution, 120 U.Pa.L.Rev. 597, 627-38 (1972). Application of the above-stated tripartite test to this case confirms the correctness of the district court's holding that liability cannot be imposed on the defendants for aiding and abetting violations of Sec. 10(b) or rule 10b-5.

Primary Violations

The plaintiffs alleged that McHugh committed a variety of violations of Sec. 10(b) and rule 10b-5. The alleged misrepresentation of the defendants as directors of Perfectune in the Offering Memorandum is the sole link between the defendants and McHugh's violations. Whether the listing of the defendants as directors in the Offering Memorandum by McHugh violated Sec. 10(b) and rule 10b-5 is a question that is contested by the affidavits filed in this case. The plaintiffs' affidavit has raised as genuine questions whether the listing was a misrepresentation; whether it was material; whether it was in connection with the sale of securities; and whether the plaintiffs relied on the misrepresentation, and if so, what was the extent of that reliance. Because genuine questions of material fact were raised by the plaintiffs concerning the commission of a violation of Sec. 10(b) and rule 10b-5, we must turn to the remaining elements of the test.

Awareness of Role in an Improper Activity

Courts generally have held that in the absence of a duty of disclosure, a defendant should be held liable as an aider and abettor only if the plaintiff proves that the defendant had actual knowledge of the improper activity of the primary violator and of his role in that activity. Woodward v. Metro Bank of Dallas, 522 F.2d at 96; SEC v. Coffey, 493 F.2d at 1316-17; IIT v. Cornfeld, 619 F.2d at 923; Ruder, supra, at 630-31. Where the defendant has a duty to disclose the primary violations, however, courts have been willing to impose liability on the basis of a recklessness standard, Edwards & Hanly v. Wells Fargo Securities Clearance Corp., 602 F.2d 478, 484 (2d Cir.1979), cert. denied, 444 U.S. 1045, 100 S.Ct. 734, 62 L.Ed.2d 731 (1980), or on a lesser showing of actual awareness than is otherwise required, SEC v. Washington County Utility District, 676 F.2d 218, 226 (6th Cir.1982).

Among the situations in which a duty to disclose may arise are where the defendant possesses insider information, SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848-49 (2d Cir.1968) (en banc), cert. denied sub nom. Coates v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969); where a controlling person consents to and approves of the fraudulent practices, Strong v. France, 474 F.2d 747, 752 (9th Cir.1973); or where the law imposes special obligations, as for accountants and brokers, Woodward v. Metro Bank of Dallas, 522 F.2d at...