Harrison v. Dean Witter Reynolds, Inc.

• Court: U.S. Court of Appeals — Seventh Circuit
• Writing for the Court: Before KANNE, Circuit Judge, WOOD, Jr., Senior Circuit Judge, and SHARP; HARLINGTON WOOD, Jr.
• Citation: Harrison v. Dean Witter Reynolds, Inc., 974 F.2d 873 (7th Cir. 1992)
• Decision Date: 20 October 1992
• Docket Number: 91-1592,Nos. 91-1458,s. 91-1458
• Parties: Fed. Sec. L. Rep. P 96,993, 23 Fed.R.Serv.3d 898 Hudson T. HARRISON and Harrison Construction Incorporated, a corporation, Plaintiffs-Appellants, Cross-Appellees, v. DEAN WITTER REYNOLDS, INCORPORATED, a corporation, Defendant-Appellee, Cross-Appellant.

Page 873

974 F.2d 873

Fed. Sec. L. Rep. P 96,993, 23 Fed.R.Serv.3d 898

Hudson T. HARRISON and Harrison Construction Incorporated, a corporation, Plaintiffs-Appellants, Cross-Appellees, v. DEAN WITTER REYNOLDS, INCORPORATED, a corporation Defendant-Appellee, Cross-Appellant.

Nos. 91-1458, 91-1592.

United States Court of Appeals Seventh Circuit.

Argued Feb. 10, 1992.

Decided Sept. 8, 1992.

As Amended Oct. 13 and Oct. 20, 1992.

Rehearing and Rehearing In Banc

Denied Dec. 28, 1992.

Thomas P. Ward (argued), McBride, Baker & Coles, Chicago, Ill., for plaintiffs.

Paul B. Uhlenhop (argued) and Charles J. Risch, Lawrence, Kamin, Saunders & Uhlenhop, Chicago, Ill., for defendant.

Before KANNE, Circuit Judge, WOOD, Jr., Senior Circuit Judge, and SHARP, District Judge. ^*

HARLINGTON WOOD, Jr., Senior Circuit Judge.

For nearly eighteen months Hudson T. Harrison, an Illinois resident, sent his and his company's money to a Dean Witter Reynolds, Inc. ("Dean Witter") account executive and vice president, John G. Kenning, in Boca Raton, Florida, for investment in low-risk municipal bonds. Both Kenning and his assistant, John M. Carpenter, offered Harrison an opportunity he could not resist: If he sent money to them personally, they would place it in Carpenter's personal, employee account at Dean Witter and then invest it in a specially available, municipal-bond fund. This misuse of the employee account would yield Harrison a significantly increased return because the bonds would be purchased at Dean Witter's cost and at the reduced commission allowed on employees' own transactions. Dean Witter's rules prohibited using employee accounts in this manner.

All told, Mr. Harrison and his company, Harrison Construction Inc. (collectively "Harrison"), the plaintiffs-appellants here, invested roughly $4 million. A few payments, or investments, were made by wire transfer to Carpenter's personal checking account, but most were made by check, mailed to Carpenter's home. In return Harrison received personal, promissory notes signed initially by Carpenter and later by both Kenning and Carpenter. These notes offered annualized interest rates of approximately 18% to 60%. Dean Witter points out, however, that Harrison received two notes for each transaction: one accurately stated his anticipated return, and the other, which he used for income-tax purposes, materially understated it.

The scheme, however, was a fraud perpetrated by Kenning and Carpenter, who invested not in municipal bonds but in much riskier put options. These investments went sour. Harrison and roughly 125 other investors lost most of their money. Kenning and Carpenter were later sentenced to eight and four years' incarceration, respectively, in a federal penitentiary for their criminal acts and ordered to pay $8 million restitution.

Harrison sued not only Kenning and Carpenter but also Dean Witter, seeking to impose both vicarious and direct liability. He raised claims under Section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78j(b); Section 20(a) of the 1934 Act, 15 U.S.C. § 70t(a); the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961 et seq.; state common law; and one state statute. One of the RICO claims was dismissed early on. Harrison v. Dean Witter Reynolds, Inc., 695 F.Supp. 959 (N.D.Ill.1988). The other claims succumbed to Dean Witter's motion for summary judgment. Harrison v. Dean Witter Reynolds, Inc., 715 F.Supp. 1425 (N.D.Ill.1989). The case was then transferred from Judge Duff to Judge Lindberg, who imposed sanctions under Fed.R.Civ.P. 11 on Harrison's attorney, Thomas P. Ward, for raising two frivolous claims. Harrison v. Dean Witter Reynolds, Inc., 132 F.R.D. 184 (N.D.Ill.1990). These Rule 11 sanctions resulted in an award of attorney's fees in the amount of $20,860.50. Harrison v. Dean Witter Reynolds, Inc., No. 86 C 8003, Memorandum Opinion and Order, 1990 WL 165638 (N.D.Ill. Oct. 19, 1990). Kenning and Carpenter were then dismissed on Harrison's motion under Fed.R.Civ.P. 41(a), and final judgment was entered February 6, 1991. Harrison appeals the grant of summary judgment in favor of Dean Witter and the imposition of sanctions; Dean Witter appeals the partial denial of sanctions. For the reasons stated below we affirm in part and reverse in part.

ANALYSIS

Diversity jurisdiction exists over the state-law claims. Plaintiff, Hudson T. Harrison, is a citizen of Illinois. Plaintiff, Harrison Construction, Inc., is an Illinois corporation with its principal place of business in Illinois. The defendant, Dean Witter, is a Delaware corporation with its principal place of business in New York. The former defendants, Kenning and Carpenter, were citizens of Florida. The amount in controversy exceeds $50,000. 28 U.S.C. § 1332. We reserve for the moment Dean Witter's contention that we do not have jurisdiction over the appeal with respect to the Rule 11 sanctions imposed.

We review de novo a district court's decision to grant summary judgment, viewing the facts in a light most favorable to the nonmoving party. Prince v. Zazove, 959 F.2d 1395, 1398 (7th Cir.1992); Ooley v. Schwitzer Division, Household Manufacturing Inc., 961 F.2d 1293, 1297 (7th Cir.1992). "The movant has the burden of showing that there is no genuine issue of fact, but ... [under Fed.R.Civ.P. 56(e) the nonmoving party] must set forth specific facts showing that there is a genuine issue for trial." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 256, 106 S.Ct. 2505, 2514, 91 L.Ed.2d 202 (1986). Where a party who bears the burden of proof fails to establish an essential element in its case, "there can be 'no genuine issue as to any material fact' ... [and] all other facts [become] immaterial." Celotex Corp. v. Catrett, 477 U.S. 317, 322-33, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986) (quoting Fed.R.Civ.P. 56(c)). See also Matsushita Electric Industrial Co. v. Zenith Radio Corp., 475 U.S. 574, 585-87, 106 S.Ct. 1348, 1355-56, 89 L.Ed.2d 538 (1986).

SECTION 20(a) ¹

The district court based its grant of summary judgment on the proposition of law that under Section 20(a) of the 1934 Act the plaintiff must show "the defendant exercised some control over the wrongdoer with respect to the wrongful acts." Harrison v. Dean Witter Reynolds, Inc., 715 F.Supp. 1425, 1436 (N.D.Ill.1989) (citing Christoffel v. E.F. Hutton & Co., 588 F.2d 665, 668 (9th Cir.1978)). This is known as the "culpable participant" requirement or test. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1574-75 (9th Cir.1990) (en banc), cert. denied, --- U.S. ----, 111 S.Ct. 1621, 113 L.Ed.2d 719 (1991); Schlifke v. Seafirst Corp., 866 F.2d 935, 949 (7th Cir.1989). The court then found, as a matter of law:

Dean Witter exercised no control over Kenning and Carpenter with respect to their sales of promissory notes [ (the allegedly fraudulent acts) ]. It did not know of these sales, nor could it have known of them, since Carpenter and Kenning structured their arrangement with Harrison to ensure that Harrison would not send any money to them at the office. Further, the sales were conducted in the names of Kenning and Carpenter alone; the payments on the notes were by Carpenter's personal checks; and Harrison never contacted Dean Witter to inquire about his investments.

Harrison, 715 F.Supp. at 1437.

In applying the culpable-participant test from Christoffel, the district court used a test we have never approved, a test, the rigors of which contravene our prior holdings, and a test expressly overruled, en banc, by the Court of Appeals for the Ninth Circuit in Hollinger, 914 F.2d at 1575.

In Schlifke we stated,

This circuit has not crystallized the test for determining when liability may be imposed on a "controlling person," yet in Barker we stated that "the ability to persuade and give counsel is not the same thing as 'control', which almost always means the practical ability to direct the actions of the people who issue or sell the securities."

Schlifke, 866 F.2d at 949 (citing Barker v. Henderson, Franklin, Starnes & Holt, 797 F.2d 490, 494 (7th Cir.1986); emphasis in Barker ). We then stated, "We need not decide whether to adopt this more rigorous[, 'culpable-participation'] formulation for the [defendant] Bank was not a 'controlling person' even under the less demanding Metge test." Schlifke, 866 F.2d at 949. In Metge v. Baehler, 762 F.2d 621 (8th Cir.1985), cert. denied, 474 U.S. 1057, 106 S.Ct. 798, 88 L.Ed.2d 774; 474 U.S. 1072, 106 S.Ct. 832, 88 L.Ed.2d 804 (1986), the court had held:

[P]laintiffs must establish, first, that the defendant lender actually participated in (i.e., exercised control over) the operations of the corporation in general; then he must prove that the defendant possessed the power to control the specific transaction or activity upon which the primary violation is predicated, but he need not prove that this later power was exercised. [Quotation marks and citation omitted.] We approve this test because it complies with precedents which counsel broad remedial construction of the statute and because it complies with precedents that distinguish between actual exercise of control in the violator's principal affairs and potential control over the violation.

Metge, 762 F.2d at 631 (first emphasis in original, others added).

While the Schlifke court clearly did not adopt the culpable-participation test, neither did it expressly adopt the two-pronged Metge test. The court did state, however, it agreed "fully with the district court's analysis," which utilized the Metge test. Id. at 949. Significantly, the control-person test approved in Metge was that used by the district court in Metge v. Baehler, 577 F.Supp. 810, 817-18 (S.D. Iowa 1984), which in turn applied elements stated in Stern v. American Bankshares Corp., 429 F.Supp. 818 (E.D.Wis.1977).

There is no requirement that the controlling person exercise control over the particular...