Hirsch v. DuPont
| Decision Date | 09 June 1975 |
| Docket Number | No. 72 Civ. 775.,72 Civ. 775. |
| Citation | 396 F. Supp. 1214 |
| Parties | Howard C. HIRSCH et al., Plaintiffs, v. Edmond duPONT et al., Defendants. |
| Court | U.S. District Court — Southern District of New York |
Shea, Gould, Climenko & Kramer, New York City by Sheldon D. Camhy, New York City, for plaintiffs.
Milbank, Tweed, Hadley & McCloy, New York City by Russell E. Brooks, New York City, for defendant New York Stock Exchange.
Cahill, Gordon & Reindel, New York City by David R. Hyde, James P. Tracy, New York City, for defendants Haskins and Sells.
The amended complaint alleges in substance that defendants violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), in connection with the purchase by plaintiffs and sale by certain defendants of general and limited partnership interests in F. I. duPont, Glore Forgan & Co. Common law claims based on pendent jurisdiction are also asserted. In May, 1974, plaintiffs entered into a settlement with all defendants except the New York Stock Exchange, Inc. ("Exchange") and Haskins and Sells, an accounting firm. The Exchange and Haskins and Sells now move for summary judgment dismissing the federal securities laws claims of plaintiffs Paul L. Kohns and Marshall S. Mundheim, primarily on the ground that the general partnership interests purchased by them1 were not "securities," as defined in § 3(a)(10) of the Exchange Act, 15 U.S.C. § 78c(a)(10), and § 2(1) of the Securities Act, 15 U.S.C. § 77b(1). No motion is made with respect to plaintiff Howard C. Hirsch, who received only limited partnership interests.
The amended complaint alleges that prior to July, 1970, plaintiffs were general partners of Hirsch & Co., a brokerage firm; that on or about July 2, 1970, pursuant to written agreement, Hirsch & Co. was liquidated and its assets were transferred to defendant Francis I. duPont & Co. ("duPont") and then to defendant F. I. duPont, Glore Forgan & Co. ("duPont Glore"), a successor partnership to duPont; and that as part of the transaction, duPont and duPont Glore "offered for sale and sold to * * * the plaintiffs herein certain securities consisting of general and limited partnership capital units of F. I. duPont, Glore Forgan & Co." It is further alleged that in connection with this transaction, all defendants knowingly made untrue statements and omitted to state material facts concerning duPont's compliance with Exchange capital requirements, its net worth and sources of capital, and its "back office" difficulties and problems with customers' accounts. It is alleged that the Exchange and Haskins and Sells, who were auditors to both Hirsch & Co. and duPont, failed to disclose these matters; that the Exchange expressly approved and encouraged the transaction; and that as a result, plaintiffs purchased the partnership interests for more than they were worth and sustained damages.
On this motion for summary judgment, the following background facts are undisputed. Since the early 1940's, plaintiff Kohns had been the managing general partner at Hirsch & Co., and by 1965, he had become in practical fact, the chief operating officer, with responsibility for all aspects of Hirsch & Co.'s business. Mundheim assisted Kohns in these duties, in addition to having "direct responsibility" for the firm's foreign and commodity business, while plaintiff Howard C. Hirsch, as senior partner, had assumed a less active role as "counselor" to Hirsch & Co. (Kohns Tr. 6-8; Mundheim Tr. 9, 11-13).2 The general partners of Hirsch & Co. decided upon the "merger" with duPont and Glore Forgan, Staats, Inc. ("Glore"), the third firm involved in the merger, because they believed that a medium-sized firm such as Hirsch & Co. could not survive in Wall Street. (Mundheim Tr. 45; Kohns Tr. 41-42). Glore would contribute its strong underwriting department to the new firm (Kohns Tr. 99), while Hirsch & Co. would bring in its substantial European business. (Kohns Tr. 128). Hirsch and Mundheim also viewed the merger as a means of reducing their activities or retiring while perpetuating the business of Hirsch & Co. (Hirsch Tr. 49; Mundheim Tr. 47-48; Kohns Tr. 43). For this reason, Mundheim testified, he preserved an option under the agreement with the new firm to withdraw his capital and retire after six months. (Mundheim Tr. 212, 290). Kohns felt quite differently, wishing to remain active in the new firm and "die with his boots on." (Kohns Tr. 43).
On July 2, 1970, the Hirsch & Co. partners entered into an agreement with duPont ("the Agreement"), and Articles of Limited Partnership ("Articles") of the new partnership, duPont Glore, were adopted. Under the Agreement, duPont purchased certain of the assets and assumed certain of the liabilities of Hirsch & Co. (Agreement, p. 1). In payment for the assets, duPont credited certain Hirsch & Co. assets to the accounts of the former Hirsch partners who became general, limited or "special"3 partners of duPont and then of duPont Glore, as their respective capital contributions to duPont and duPont Glore.4 (Agreement § 5(a)). On the closing date, Kohns and Mundheim were admitted as general partners of duPont and duPont Glore. (Agreement § 6). In the course of these transactions, the plaintiffs' accounts in duPont Glore were credited with the following amounts:5
General Partnership Limited Partnership
Interests Interests
Hirsch -- $400,000
Kohns $307,000 $593,000
Mundheim $307,000 $593,000
Kohns and Mundheim's general partnership interests represented 35 and 33 "voting units" respectively, out of a total of 1,365 voting units.
The new firm had 74 general partners and several limited partners, assets of $400 million and total capital funds of $60 million. (Camhy Affidavit, ¶ 2).
In September, 1970, two months after its formation, the new firm was not in compliance with Exchange capital requirements. As a result of the Exchange's demands, new reserves had to be created, reducing the firm's net worth by $15 million. (Camhy Affidavit, ¶ 3). Despite a contribution of capital from a group including H. Ross Perot, the financial condition of duPont Glore continued to deteriorate, and in December, 1970, Kohns and Mundheim were told that if they attempted to withdraw their capital the firm would be unable to pay it. Accordingly, Mundheim and Kohns became subordinated lenders of duPont Glore on December 14, 1970, and December 31, 1970, respectively. (Mundheim Tr. 364; Kohns Tr. 4).
Summary judgment should be granted where the pleadings, depositions and affidavits filed in the case "show 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." Rule 56(c), F.R.Civ.P.; Poller v. Columbia Broadcasting System, Inc., 368 U.S. 464, 467, 82 S.Ct. 486, 7 L.Ed.2d 458 (1962). On this motion, the material facts are undisputed; and the issue of whether, on the basis of those facts, the general partnership interests were "securities" is a question of law which may be resolved by the court on summary judgment. Jennings and Marsh, Securities Regulation, 294 n. a (3d ed. 1972); cf. S.E.C. v. W. J. Howey Co., 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244, 1251 (1946) (Frankfurter, J., dissenting).
Defendants' principal contention is that Kohns and Mundheim, as general partners, received and exercised the right to participate actively in the management and control of duPont Glore, and that for this reason, their general partnership interests did not constitute "securities," as that term has been defined in the statutes and decisional law.
Before discussing defendants' contention, it would be well to consider the argument that the nature of Kohns' and Mundheim's participation after July 2 in duPont Glore, the successor partnership, is immaterial since the fraud was allegedly perpetrated before plaintiffs became general partners in order to induce them to purchase their interests, and the misrepresentations concerned the financial condition of duPont, one of the predecessor partnerships. With respect to plaintiffs' general partnership interests,6 I deem these considerations irrelevant to the analysis that must be made under §§ 10(b) and 17(a). Section 10(b) prohibits fraud only if it is "in connection with the purchase or sale of any security * * *." Section 17(a) prohibits fraud only if it is "in the offer or sale of any securities * * *." The Agreement and affidavits clearly show that the individual plaintiffs' only participation in the July 2 transaction was as purchasers of general and limited partnership interests.7 Thus in order to recover under § 10(b) or § 17(a), Kohns and Mundheim must establish that those interests were "securities." As the discussion below indicates, that issue turns on the nature of the investor's participation in the enterprise after he purchases his interest. S.E.C. v. W. J. Howey Co., supra, 328 U.S. at 198-99, 66 S.Ct. 1100. In every case in which plaintiff purchases an interest in an enterprise for the first time, he obviously has no participation before the purchase. But in none of the cases cited below is it suggested that that fact is relevant to the issue of whether the interest purchased is a security.
Since the general partnership interests were not conventional securities such as shares of corporate stock, it must be determined whether they constituted "investment contracts" within the meaning of § 2(1) of the 1933 Act and § 3 (a) (10) of the 1934 Act.8 The classic definition of an "investment contract" is given in S.E.C. v. W. J. Howey Co., supra, where the United States Supreme Court held that an offering of units of a...
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