Freeman v. Laventhol & Horwath

• Citation: 915 F.2d 193
• Decision Date: 17 September 1990
• Docket Number: No. 89-6259,89-6259
• Parties: , Fed. Sec. L. Rep. P 95,490 Adrian FREEMAN, et al., Plaintiffs-Appellees, v. LAVENTHOL & HORWATH, et al., Defendants-Appellants.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 193

915 F.2d 193

59 USLW 2209, Fed. Sec. L. Rep. P 95,490

Adrian FREEMAN, et al., Plaintiffs-Appellees, v. LAVENTHOL & HORWATH, et al., Defendants-Appellants.

No. 89-6259.

United States Court of Appeals Sixth Circuit.

Argued July 31, 1990.

Decided Sept. 17, 1990.

Harvey L. Pitt, (argued) Washington, D.C. (Marc P. Cherno, Irwin Blum, Don Catinello, and Fried, Frank, Harris, Shriver & Jacobson, Washington, D.C.; David S. Cupps, Sandra J. Anderson, Daniel J. Buckley, and Vorys, Sater, Seymour & Pease, Columbus, Ohio; Barry S. Augenbraun, James S. Gkonos, and Laventhol & Horwath, Philadelphia, Pa., on the brief), for appellants Laventhol & Horwath.

Harvey L. Pitt, (argued) Washington, D.C. (Jerre B. Swann, Thomas H. Christopher, and Kilpatrick & Cody, Atlanta, Ga., on the brief), for appellants Aaron Rose, et al.

J. Michael Rediker, (argued) Orlando, Fla. (Richard H. Adams, Jr., Richard D. Connor, Jr., Christopher T. Vernon, and Smathers, Pleus & Adams, Orlando, Fla., on the brief), for appellees.

Gregory G. Little, and Hunton & Williams, Knoxville, Tenn., Robert Dean Pope, James W. Featherstone, III, and Hunton & Williams, Richmond, Va., filed a brief, for amicus curiae National Ass'n of Bond Lawyers.

Louis A. Craco, Deborah E. Cooper, and Willkie Farr & Gallagher, New York City, William T. Garcia, and Willkie Farr & Gallagher, Washington, D.C., filed a brief, for amicus curiae American Institute of Certified Public Accountants.

Before: MILBURN, GUY and TIMBERS, ^* Circuit Judges.

TIMBERS, Circuit Judge:

This is an interlocutory appeal from an order entered April 13, 1989, in the Eastern District of Kentucky, William O. Bertelsman, District Judge, denying appellants' motion for partial summary judgment, or, in the alternative, to dismiss appellees' claims of fraud on the new issue market.

This class action arises from the sale of tax-exempt municipal bonds to finance the construction of a retirement center. The complaint alleges violations of various state and federal securities laws. Our concern, on this appeal, is limited to appellees' allegations of securities fraud in violation of Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78(j)(b) (1988), and Rule 10b-5 promulgated thereunder. 17 C.F.R. 240.10b-5 (1990). Appellees plead the fraud on the market theory to satisfy the reliance element of their 10b-5 action. We adopted that theory in Levinson v. Basic, Inc., 786 F.2d 741 (6th Cir.1986), vacated on other grounds, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (hereinafter Levinson ).

Appellants moved for partial summary judgment, or, in the alternative, for dismissal, contending (1) that the presumption raised by the fraud on the market theory does not arise in a case involving the issuance of municipal bonds in a primary market; and (2) that appellees' claims were barred by the statute of limitations. The district court denied the motion and on May 18, 1989 certified its order for interlocutory appeal pursuant to 28 U.S.C. Sec. 1292(b) (1988). On October 3, 1989, we granted permission to appeal pursuant to the same statute on the limited legal issue of whether a presumption of reliance based on the fraud on the market theory arises in a case involving a new issue of municipal bonds in a primary market.

On appeal, appellants contend that (1) the fraud on the market theory does not raise a presumption of reliance in a case involving newly issued tax-exempt municipal bonds in a primary market; (2) we should not recognize a presumption of reliance based on the fraud created the market theory; and (3) even if we were inclined to recognize such a presumption, appellees' claims are insufficient under that theory.

For the reasons that follow, we reverse and remand.

I.

We shall summarize only those facts and prior proceedings believed necessary to an understanding of the issues on appeal.

Appellees are investors in the North River Retirement Center, Inc. (hereinafter North River). Appellants comprise the participants in the bond issue: the directors, feasibility consultants, project manager, project coordinator, marketing agent, and indenture trustee of North River, as well as various underwriters, broker-dealers, accountants, and attorneys.

North River was intended to be a three story retirement community consisting of 175 separate residential units. It was financed through the sale of $18,230,000 of tax-exempt municipal bonds, issued by the City of Florence, Kentucky. They were sold pursuant to an Official Statement dated June 30, 1983. The bonds were sold to more than 1,500 investors in denominations of $5,000. The bond issue was divided into short term bonds totalling $10,500,000 with an interest rate of 10.5%, and long term bonds totalling $7,730,000 with an interest rate of 13.0%. They were secured by a first mortgage on the real and personal property of the project, together with its initial occupancy fees and revenues.

North River used the proceeds from the sale of the bonds to acquire, construct and equip the project, to pay interest on the bonds for the first 28 months after their delivery, to fund a debt service reserve of $1,000,000, to fund development and marketing expenses, and to fund the issuance of the bonds. The project was completed essentially on time and within the budget.

In July 1985, the indenture trustee, Bank South, N.A., declared the project to be in default. Only 7 of the 175 units had been sold. North River failed to make the December 31, 1985 first scheduled interest payment to bondholders. On December 31, 1986, it filed a petition for reorganization under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Sec. 1101 et seq. (1988). The project was sold for $6,025,000 during the bankruptcy proceedings. In re North River Retirement Center, Inc., No. 2-86-00989, slip op. at 5 (Bankr.E.D.Ky. April 4, 1987). Pursuant to a reorganization plan that was confirmed by the bankruptcy court, the bondholders will receive approximately $10,000,000 of their $18,230,000 investment. Id. at 4. North River currently is being operated as a retirement center under new ownership and management. It is not fully occupied.

Appellees commenced this class action on behalf of all purchasers of North River bonds on December 30, 1987. Appellees allege violations of various state and federal securities laws. On this appeal, we need only consider appellees' claims under Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78(j)(b) (1988), and Rule 10b-5 promulgated thereunder. 17 C.F.R. 240.10b-5 (1990).

Specifically, the complaint alleges that the Official Statement misrepresented or failed to disclose that (1) the feasibility consultant knew that the market could not support the project; (2) appellants knew that the lack of on site nursing care would result in the failure of North River; (3) prospective residents could not afford the fees, which were based on retiring the bond issue, not on what the market would bear; and (4) the marketing agent, financial consultant and feasibility consultant failed to disclose their association with another failed retirement center. The complaint alleges that, as a result of these misstatements and omissions, "the true value of the Bonds [was] substantially less than the price paid for them by Plaintiffs and the Class such that the Bonds would not have been marketed had accurate and complete information been fully disclosed in the Official Statement."

At least one of the named plaintiffs did not read the Official Statement before purchasing the bonds. The complaint, therefore, seeks to invoke a presumption of reliance by alleging a fraud on the market. It states: "Plaintiffs and the Class acted in justifiable reliance upon the integrity of the marketplace, in the absence of fraud in procuring the issuance of the Bonds, and the complete disclosure of all material facts by all of these Defendants in the issuance and sale of the Bonds."

On October 6, 1988, appellants filed a joint motion for partial summary judgment, or, in the alternative, for dismissal, as to plaintiffs' claims of fraud on the new issue market. This motion was denied by the district court on April 13, 1989. The court found that the factual allegations "if true, would entitle the plaintiffs to a presumption of reliance based upon the fraud on the market theory as outlined by the Sixth Circuit in Levinson."

On May 18, 1989 the district court certified its April 13 order for interlocutory appeal pursuant to 28 U.S.C. Sec. 1292(b) (1988). The court found that "[t]he issue regarding 'fraud on the market' can ... be regarded as an issue of law on which there might be substantial disagreement...." We granted permission to appeal, by order dated October 3, 1989, "only as to the fraud on the market theory."

This appeal followed.

II.

The district court treated appellants' motion as one for summary judgment. Summary judgment is proper when the evidence establishes "that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). We consider the facts in the light most favorable to the non-moving party. Matsushita Elec. Indus. Co. v. Zenith Radio, 475 U.S. 574, 587, 106 S.Ct. 1348, 1356, 89 L.Ed.2d 538 (1986).

We review the district court's denial of summary judgment under an abuse of discretion standard. Pinney Dock & Transport Co. v. Penn Central Corp., 838 F.2d 1445, 1472 (6th Cir.), cert. denied, 488 U.S. 880, 109 S.Ct. 196, 102 L.Ed.2d 166 (1988).

"The trial court may ... exercise a sound discretion in denying summary judgment where, although the movant may have technically shouldered his burden, the court is not reasonably certain that there is no triable issue of fact; where a portion of an action may be ripe for summary judgment but it is intertwined with another claim that must be tried; and in certain other situations."

6 Moore, Taggart, & Wicker, Moore's Federal...