Hokama v. EF Hutton & Co., Inc.

• Decision Date: 17 June 1983
• Docket Number: No. CV 82-6330 MRP. MDL No. 541.,CV 82-6330 MRP. MDL No. 541.
• Court: U.S. District Court — Central District of California
• Parties: Yosh HOKAMA, et al., Plaintiffs, v. E.F. HUTTON & CO., INC., et al., Defendants.

566 F. Supp. 636

Yosh HOKAMA, et al., Plaintiffs, v. E.F. HUTTON & CO., INC., et al., Defendants.

No. CV 82-6330 MRP. MDL No. 541.

United States District Court, C.D. California.

June 17, 1983.

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Marshall B. Grossman, Robert A. Shlachter, Alschuler, Grossman & Pines, Los Angeles, Cal., Richard A. Zellner, David C. Weiner, Hahn, Loeser, Freedheim, Dean & Wellman, Cleveland, Ohio, John R. Elrod, Elrod & Lee, Siloam Springs, Ark., Gary B. Garson, Cleveland, Ohio, for plaintiffs.

Rex Heinke, Gibson, Dunn & Crutcher, Dennis C. Brown, Munger, Tolles & Rickershauser, Los Angeles, Cal., David E. Massengill, Simpson, Thacher & Bartlett, New York City, Joseph P. Conran, Husch, Eppenberger, Donohue, Elson & Cornfeld, St. Louis, Mo., Robert W. Fischer, Jr., Adams, Duque & Hazeltine, Alan E. Freidman, Tuttle & Taylor, Los Angeles, Cal., William E. McCurdy, Jr., St. Louis, Mo., Bryan, Cave, McPheeters & McRoberts, Los Angeles, Cal., Linda S.A. Burke, Sessions, Fishman, Rosenson, Boisfontaine & Nathan, New Orleans, La., for defendants.

MEMORANDUM AND ORDER

PFAELZER, District Judge.

Defendants' motions to dismiss and for summary judgment came on regularly for hearing on April 18, 1983 before the Honorable Mariana R. Pfaelzer. The Court, having considered the papers filed and oral arguments made, now files this Memorandum, which shall constitute its Findings of Fact and Conclusions of Law.

I. BACKGROUND

Plaintiffs are "Type A" limited partners in defendant Wellspring Barge Limited Partnership ("the Partnership"), a limited partnership organized for the purpose of owning and operating river barges. Defendant Wellspring Energy Co. ("Wellspring") is the sole general partner. Defendant John P. Madgett, III ("Madgett") is president, treasurer, a director, a fifty percent shareholder, and the alleged alter ego of Wellspring. Defendant Consolidated Barge & Grain Co. ("Consolidated") is also a fifty percent shareholder and the alleged alter ego of Wellspring. In addition, it conducts the Partnership's barge operations under an exclusive management agreement with the Partnership. Defendant Robert E. Frane ("Frane") is president, chairman of the board, a principal shareholder, and the alleged alter ego of Consolidated. Madgett, Consolidated, and Frane are all alleged to be general partners by virtue of their alter ego status. Defendant Equitable Shipyards, Inc. ("Equitable"), is a manufacturer of barges which sold them to the Partnership and provided interim financing for their purchase. Defendant Continental Illinois National Bank ("CINB") provided permanent financing for the purchase of the barges. Defendant E.F. Hutton, Inc. ("Hutton") marketed the limited partnership interests through its tax shelter department. Hutton is also the sole shareholder of E.F.H. Barge, Inc., a "Type B" limited partner, and is alleged to have become a general partner by virtue of its extensive participation in partnership affairs.

The terms on which the limited partnership interests were offered are detailed in the Private Placement Memorandum distributed to prospective investors, and in the Partnership Agreement. "Type A" limited partners were required to invest $150,000 per unit ($50,000 in cash, a $25,000 promissory note due in 1982, and a $75,000 promissory note due in 1984), and to assume a pro-rata share of the partnership indebtedness. In exchange, the limited partners received substantial tax benefits, primarily in the form of pro-rata allocations of the depreciation deductions and investment tax credit attributable to the barges. They also received the right to deduct their pro-rata shares of any partnership operating losses, and to receive cash distributions when partnership revenues permitted. No such distributions were projected until 1991 at the earliest, however.

The present litigation appears to have been precipitated by a series of cash calls made on the limited partners after the Partnership experienced poor initial operating results. Wellspring has already called upon plaintiffs for additional contributions of approximately $25,000 per unit, and apparently plans to make further cash calls in the near future.

The complaint contains twelve separate causes of action. It charges all the defendants except CINB with violating sections 12(1), 12(2), and 17(a) of the Securities Act of 1933 ("1933 Act"), 15 U.S.C. §§ 77l(1), 77 l(2), 77q(a); section 10(b) of the Securities Exchange Act of 1934 ("1934 Act") 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b5; and analogous provisions of the California Corporations Code. The Partnership, Wellspring, Madgett, Consolidated, Frane, and Hutton are charged with both primary and secondary liability under these provisions, while Equitable is charged only with secondary liability as a conspirator and as an aider and abettor of the primary violations. The complaint also contains causes of action for violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961-1968 (all defendants except CINB); common law fraud (all defendants except CINB); breach of fiduciary duty and gross negligence (all defendants except Equitable and CINB); breach of duty to investigate (Hutton only); and rescission (CINB only).

Defendants, variously grouped, have filed five separate motions to dismiss, or in the alternative for an order requiring a more definite statement. Specifically, they challenge the validity of several of plaintiffs' theories of liability, notably RICO and aiding and abetting under the federal securities laws, and argue that the complaint fails to allege fraud with particularity as required by Rule 9(b) of the Federal Rules of Civil Procedure. In addition, defendants have moved for summary judgment with respect to the eighth cause of action for sale of securities not qualified as required under California law. Equitable has moved for a transfer or stay of proceedings as to it.

II. DISCUSSION

A. Secondary Liability under the Federal Securities Laws

Consolidated, Frane, and Equitable contend that the Ninth Circuit no longer recognizes liability for aiding and abetting federal securities law violations. In support of this contention, they cite a number of district court cases which refuse to recognize such liability in connection with section 12(2) violations on the ground that liability under section 12(2) is expressly limited to persons who offer or sell securities. In Re Equity Funding Corp. of America Securities Litigation, 416 F.Supp. 161, 181 (C.D.Cal. 1976); McFarland v. Memorex Corp., 493 F.Supp. 631, 647-48 (N.D.Cal.1980); Briggs v. Sterner, 529 F.Supp. 1155, 1172-73 (S.D.Iowa 1981); Hagert v. Glickman, Lurie, Eiger & Co., 520 F.Supp. 1028, 1034 (D.Minn.1981). In addition, they rely on a series of Ninth Circuit cases, known collectively as the Seaboard cases, in which the Court included a number of footnotes expressing doubt as to the continuing validity of implied secondary liability under the securities laws. See Admiralty Fund v. Hugh Johnson & Co., 677 F.2d 1301, 1311 n. 12 (9th Cir.1982); Admiralty Fund v. Jones, 677 F.2d 1289, 1294 nn. 3-4 (9th Cir.1982); Admiralty Fund v. Tabor, 677 F.2d 1297, 1299 n. 2 (9th Cir.1982).

This Court does not agree with the defendants' interpretation of the Seaboard cases. In the footnotes referred to above, the Ninth Circuit merely acknowledged the suggestion which had been made by Professor Fischel that aiding and abetting and other "add on" theories of liability might be inappropriate in light of recent Supreme Court decisions adopting a restrictive approach to determining liability under the federal securities laws. See Admiralty Fund v. Hugh Johnson & Co., 677 F.2d at 1311 n. 12 (citing Fischel, Secondary Liability Under Section 10(b) of the Securities Act of 1934, 69 Cal.L.Rev. 80 (1981)). In each of the Seaboard cases, however, the decision of the Ninth Circuit was to reverse the granting of summary judgment on the express assumption that such "add-on" theories of liability remained valid. Admiralty Fund v. Tabor, 677 F.2d at 1299 (conspiracy and aiding and abetting Rule 10b-5 violation); Admiralty Fund v. Hugh Johnson & Co., 677 F.2d at 1311-12 (aiding and abetting Rule 10b-5 violation); Admiralty Fund v. Jones, 677 F.2d at 1294 ("participating" in section 12(2) violation). Moreover, the Supreme Court has since reiterated that "the securities laws combatting fraud should be construed `not technically and restrictively, but flexibly to effectuate their remedial purposes.' citation omitted," Herman & MacLean v. Huddleston, ___ U.S. ___, 103 S.Ct. 683, 690, 74 L.Ed.2d 548 (1983) (permitting concurrent Rule 10b-5 action for conduct expressly actionable under section 11 of the 1933 Act). While this statement does not conclusively answer the doubts expressed in the Seaboard footnotes, it suggests that the continuing validity of implied secondary liability cannot be determined simply by general references to trends in statutory construction. The resolution of the question of implied secondary liability rather must depend upon an analysis of the particular violation alleged.

In the Ninth Circuit, the status of aider and abettor liability under section 10(b) of the 1934 Act and Rule 10b-5 has recently been resolved. In Harmsen v. Smith, 693 F.2d 932 (9th Cir.1982), the Court stated that "in the absence of any authority or compelling reasons for holding that aider and abettor liability no longer exists, we hold that it remains a viable part of securities regulation," and dismissed any suggestion to the contrary in the Seaboard cases as dicta. Id. at 944. The Court went on to list elements of aiding and abetting in a section 10(b) case as (1) the existence of an independent primary wrong, (2) actual knowledge by the aider and abettor of the wrong and of his or her role in furthering it, and (3) substantial assistance in the...