DCD Programs, Ltd. v. Leighton

• Decision Date: 24 July 1996
• Docket Number: No. 94-55776,94-55776
• Citation: 90 F.3d 1442
• Parties: Fed. Sec. L. Rep. P 99,280, 96 Cal. Daily Op. Serv. 5449, 96 Daily Journal D.A.R. 8891 DCD PROGRAMS, LTD.; JKB Alpha Programs, Ltd.; Technimatics Five, Ltd.; Lord Hill Investors; Pack Programmers; Uxbridge Management; Integrated Commodity Systems, Ltd., Plaintiffs-Appellants, v. Michael W. LEIGHTON, Defendant, and Jacob Y. Terner, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1442

90 F.3d 1442

Fed. Sec. L. Rep. P 99,280, 96 Cal. Daily Op. Serv. 5449,

96 Daily Journal D.A.R. 8891

DCD PROGRAMS, LTD.; JKB Alpha Programs, Ltd.; Technimatics Five, Ltd.; Lord Hill Investors; Pack Programmers; Uxbridge Management Integrated Commodity Systems Ltd., Plaintiffs-Appellants, v. Michael W. LEIGHTON, Defendant and Jacob Y. Terner, Defendant-Appellee.

No. 94-55776.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Oct. 17, 1995.

Decided July 24, 1996.

Rick M. Stein, Palm Springs, California, for plaintiffs-appellants.

James H. Lehr, Beverly Hills, California, for defendant-appellee.

Appeal from the United States District Court for the Central District of California, Richard A. Gadbois, Jr., District Judge, Presiding. D.C. No. CV-85-01040-RG.

Before: POOLE and O'SCANNLAIN, Circuit Judges; MARQUEZ, ^* District Judge.

O'SCANNLAIN, Circuit Judge.

May investors who purchased limited partnership interests in certain "tax shelters" recover as damages, in a federal securities fraud suit, back taxes and interest paid to the Internal Revenue Service?

I

This complex and seemingly interminable securities fraud action was initially filed in 1985. ¹ The plaintiffs consist primarily of two groups of California limited partnerships. The partnerships in the first group (the "1982 R & D Partnerships") ² were allegedly established in 1982 by the defendants to research and to develop state-of-the-art technical trading systems for use in the commodity futures trading market. The second set of partnerships (the "1983 CTA Partnerships") ³ were also allegedly established by the defendants and were designed to serve as commodity trading advisors for licensees of the programs to be developed by the 1982 R & D Partnerships.

The plaintiffs' complaint alleged that the defendants sold certain investment contracts to the partnerships in derogation of the registration and anti-fraud provisions of the Securities Act of 1933, 15 U.S.C. § 77a et seq., section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5. The complaint also alleged various violations of state law and of 18 U.S.C. § 1962(c), a section of the Racketeer Influenced and Corrupt Organizations Act ("RICO").

During the course of the litigation, the plaintiffs settled with two of the defendants (not including the present appellee, Dr. Jacob Y. Terner) for a total of $1,360,000. In addition, the district court also entered default judgments against a number of the other defendants (not including Terner) in the amount of $6,845,976 (representing $2,281,992 trebled under RICO). ⁴

According to the plaintiffs' appellate brief, the defendants who sold the investment contracts to the partnerships also sold limited partnership interests in those partnerships to the individual partners. The defendants allegedly marketed these partnership interests as "tax shelters," telling the partners that because the partnerships would be highly leveraged and would incur significant research and development ("R & D") expenses, the partners would be entitled to substantial federal tax deductions from ordinary income under then-existing federal tax law. However, none of the R & D expenditures were made, and the Internal Revenue Service ("IRS") subsequently disallowed the deductions. As a result, in July 1991, partners of two of the 1982 R & D Partnerships ⁵ were forced to pay $1,385,669 to the IRS in settlement of back taxes and interest. (No penalties were assessed by the IRS.) In addition, the partners spent $70,000 for the services of a certified public accountant ("CPA") who negotiated their settlement with the IRS.

While it is not entirely clear from the extremely limited factual sections of the parties' briefs, it appears that during the course of the proceedings the plaintiff partnerships claimed that they were entitled to recover, as part of their damages, the taxes and interest paid by the individual partners to the IRS, as well as the funds paid to the CPA. ⁶ On April 26, 1994, the district court entered a final judgment which rejected this claim and ordered that the plaintiffs "take nothing" from Terner and defendant Richard Dougherty. The court noted that in an earlier 1993 order, it had held that "the payments to the IRS by the individual partners" and "the payments for CPA representation of the 1982 partnerships before the IRS are not potentially recoverable damages against defendant Dougherty in this litigation." In that earlier order, the court also noted that the amount the plaintiffs had received in settlement to date ($1,360,000) exceeded the partners' total capital investments in the partnerships ($1,062,796, representing $656,615 in initial capital outlays plus $406,181 in interest). Based on these calculations, the court held that the "plaintiffs have recovered by way of settlement all potential damages they could recover" from Dougherty. In its April 1994 order, the court stated that these conclusions applied equally well to Terner, and thus ordered that the plaintiffs "take nothing" from either defendant.

The plaintiffs timely appealed the court's order. ⁷ In this appeal, they argue that the district court's ruling was based on a finding that the payments of back taxes and interest to the IRS (and the payments to the CPA) are not potentially recoverable damages under sections 10(b) and 28(a) of the Exchange Act, and that this ruling was in error. ⁸

II

In analyzing the appellants' damages claims, we necessarily begin with Section 28(a) of the Exchange Act, 15 U.S.C. § 78bb(a). That provision states in relevant part that:

The rights and remedies provided by this chapter shall be in addition to any and all other rights and remedies that may exist at law or in equity; but no person permitted to maintain a suit for damages under the provisions of this chapter shall recover, through satisfaction of judgment in one or more actions, a total amount in excess of his actual damages on account of the act complained of.

15 U.S.C. § 78bb(a) (emphasis added).

In Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972) the Supreme Court "clearly interpreted § 28(a) as governing the measure of damages that are permissible under § 10(b)." Randall v. Loftsgaarden, 478 U.S. 647, 663, 106 S.Ct. 3143, 3153, 92 L.Ed.2d 525 (1986). However, "[i]n enacting § 28(a) Congress did not specify what was meant by 'actual damages.' " Id. at 662, 106 S.Ct. at 3152. In addition, neither section 10(b) nor Rule 10b-5 specifies an appropriate measure of damages, leading at least one observer to note that "[t]he question of damages under Rule 10b-5 is extremely open-ended." J. Cox et al., Securities Regulation: Cases and Materials 810 (1991); see also L. Loss & J. Seligman, Fundamentals of Securities Regulation 1060 (3d ed. 1995) ("Section 10(b) and Rule 10b-5 specify no damage or rescission standards, prompting the courts to take an ad hoc approach that often uses the common law out-of-pocket measure as an initial reference point and allows appellate courts to exercise the discretion traditionally left to the trial courts in finding damages appropriate to the facts of the case.") (citation, internal quotations omitted).

In Affiliated Ute, the Supreme Court suggested that the proper measure of damages under section 28(a) is ordinarily

the difference between the fair value of all that the ... seller received and the fair value of what he would have received had there been no fraudulent conduct ... except for the situation where the defendant received more than the seller's actual loss. In the latter case damages are the amount of the defendant's profit.

Affiliated Ute, 406 U.S. at 155, 92 S.Ct. at 1473 (citations omitted). The Court has since suggested that Affiliated Ute's tort-based "out-of-pocket" measure is generally the appropriate measure of damages to be applied in cases arising under sections 10(b) and 28(a). See Randall, 478 U.S. at 661-62, 106 S.Ct. at 3151-52; id. at 668, 106 S.Ct. at 3155-56 (Blackmun, J., concurring) ("Normally ... the proper measure of damages in a § 10(b) case is an investor's out-of-pocket loss...."). While also noting that the issue of whether rescissory damages may be recovered under section 10(b) is "an unsettled one," id. at 661, 106 S.Ct. at 3151-52, the Court noted that there is authority for allowing a section 10(b) plaintiff, at least in some circumstances, to elect either an out-of-pocket or rescissory measure of damages. Id. at 662, 106 S.Ct. at 3152 (citation omitted).

This court, following Randall and Affiliated Ute, has generally defined "actual damages" under section 28(a) by referring to either the out-of-pocket or the rescissory measure of damages, and has suggested that consequential damages may also be had in appropriate cases:

Under the general rule, a plaintiff may recover the difference between the value of the consideration paid and the value of the securities received, plus consequential damages that can be proven with reasonable certainty to have resulted from the fraud.... The trial judge has the discretion to apply a rescissionary remedy which entitles a plaintiff to a return of his consideration less any value received on the investment.... Thus, a plaintiff in an action under § 10(b) is generally limited to recovery of out-of-pocket losses or actual damages.

Volk v. D.A. Davidson & Co., 816 F.2d 1406, 1413 (9th Cir.1987) (citing Arrington v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 651 F.2d 615, 621 (9th Cir.1981); Blackie v. Barrack, 524 F.2d 891, 909 (9th Cir.1975), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976)) (other citations omitted) (emphasis added).

In this case, the plaintiffs argue that the back taxes and interest paid to the IRS, as well as the sums paid to the CPA, qualify either as out-of-pocket losses or...