Holdsworth v. Strong, 75-1144

• Decision Date: 19 November 1976
• Docket Number: No. 75-1144,75-1144
• Citation: 545 F.2d 687
• Parties: Fed. Sec. L. Rep. P 95,744 K. Jay HOLDSWORTH and Dona S. Holdsworth, Plaintiffs-Appellees, v. Kline D. STRONG, Defendant-Appellant. SECURITIES AND EXCHANGE COMMISSION, Amicus Curiae.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 687

545 F.2d 687

Fed. Sec. L. Rep. P 95,744

K. Jay HOLDSWORTH and Dona S. Holdsworth, Plaintiffs-Appellees, v. Kline D. STRONG, Defendant-Appellant.

SECURITIES AND EXCHANGE COMMISSION, Amicus Curiae.

No. 75-1144.

United States Court of Appeals, Tenth Circuit.

Submitted July 8, 1976.

Decided Sept. 29, 1976.

Rehearing Denied Nov. 19, 1976.

Edwin S. Kahn, of Holland & Hart, Denver, Colo. (Clifford L. Ashton and Brent M. Stevenson, of Van Cott, Bagley, Cornwall &amp Harold G. Christensen, of Worsley, Snow & Christensen, Salt Lake City, Utah, for plaintiffs-appellees.

McCarthy, Salt Lake City, Utah, on the brief), for defendant-appellant.

Harvey L. Pitt, Gen. Counsel, Paul Gonson, Assoc. Gen. Counsel, David J. Romanski, Asst. Gen. Counsel, Vernon I. Zvoleff, Atty., Washington, D. C., on the brief, for Amicus Curiae, Securities and Exchange Commission.

Before HILL, SETH, HOLLOWAY, McWILLIAMS, BARRETT and DOYLE, Circuit Judges.

DOYLE, Circuit Judge.

Plaintiffs-Appellees prevailed in an action for rescission of a sale of stock. Appellant Kline D. Strong was found to have made the sale by using false representations and fraudulent devices. The suit was brought pursuant to Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Recovery was also obtained on a parallel claim in common law fraud.

The Holdsworths, husband and wife, sold their shares of stock in a closely held corporation called Sans-Copy to Strong, who had owned the majority of the stock in this corporation. Strong persuaded them to sell the stock, generally representing that the company was unable and would be unable to pay dividends. In truth, the company was continuously increasing its volume and had demonstrated earning capability.

The cause was tried to the court as an equity case, the Holdsworths' demand for a jury trial having been denied. It required four days to complete. At the end of the trial the judge announced from the bench that there was clear evidence of fraud and that Mr. Strong had violated Rule 10b-5 as well as all of the elements of a common law fraud case under the law of Utah. He then set forth his findings in oral form. These were later incorporated in a formal set of findings of fact and conclusions of law which were signed December 21, 1974. Strong did not seek a new trial nor did he challenge the findings and conclusions in the trial court. Instead he appealed at once to this court.

Both Kline D. Strong and the appellee K. Jay Holdsworth are attorneys; Holdsworth is an accountant as well. Paul Tanner, who was also a part of the enterprise in question, was and is an accountant. The mentioned parties formed the subject corporation. Its purpose was to develop, manufacture and sell time-keeping systems for law offices. Originally there were 60 shares of common stock which were divided equally among the three incorporators and their wives. Each couple paid $300 for 20 shares. It was contemplated at the outset that all three would participate in the management of the corporation. It did not work out as planned, however; Mr. Strong ended up in complete charge of the business. In its initial stages he performed research and other preliminary work developing the idea and introducing it to the legal profession. Essentially, it was a simple system for recording the time spent by lawyers working for clients.

In July 1959, Sans-Copy entered into an agreement with Reynolds and Reynolds granting to the latter the exclusive right to manufacture and market the system except in Utah. Under the agreement Sans-Copy was to receive a royalty of 30 percent on gross sales and Strong was to promote the time-keeping system at bar association conventions and meetings. It was as a result of this change of condition that the shares in the corporation were changed; Strong informed Holdsworth that since he was doing most of the work he believed that he should own a controlling interest. Holdsworth and Tanner agreed to this, and as a result Strong was given 52 shares of the 100 shares of the outstanding stock in the corporation.

The details of the Sans-Copy process is not of primary importance, but a brief description will help general understanding. It was and is a method for recording and keeping records of the time spent by a lawyer on a client's case. It furnishes a daily log as well as separate slips to be Strong was being paid compensation for his efforts, and Holdsworth and Tanner were given some shares of newly created stock which provided for them to get a small dividend annually. These dividends were paid irregularly in the Class A common stock until 1970, at which time they were abruptly terminated. ¹

sorted for use in determining bills. The system was intended to provide an easy way for lawyers to keep time sheets and to prevent double or triple entry accounting.

After 1962, there were neither board meetings nor financial statements furnished to Holdsworth and Tanner. Holdsworth did not participate in the management of the corporation and his knowledge was restricted to information furnished by Strong.

In 1971, Strong notified Holdsworth and Tanner that the company had invaded capital in issuing 1970 dividends. For that reason, they were told that no dividends would be forthcoming at that time.

Holdsworth and Strong also owned a ranch, and subsequently, in January 1972, during the course of a conversation between Strong and Holdsworth having to do with the ranch, Strong offered to buy the Holdsworth shares for $1500. Strong at that time represented to Holdsworth that the corporation would never pay dividends in the future. He repeated this oral statement in a letter to the Holdsworths a short time later. Based on that statement and others, the Holdsworths sold their shares for $1500 and a general release. In the same year, Holdsworth learned that Sans-Copy had realized a gross income exceeding $100,000 and his knowledge moved them on May 17, 1973, to give notice of rescission. When Strong rejected this attempt, they started the present suit on May 31, 1973. Their claims were based on the following material misrepresentations and omissions (summarized and paraphrased hereafter):

Strong's statement that it was unlikely that dividends would be paid in the future; that the corporation was unable to pay present or future dividends on the preferred shares; omission by Strong to state material facts necessary to render the statements non-misleading; that at the end of the fiscal year ending November 30, 1971, Sans-Copy had gross receipts in excess of $96,000; gross receipts were increasing each year since 1969; Sans-Copy was a growing enterprise; deductions were unnecessarily excessive and improper and many of these were paid to Strong and his relatives; that Strong had borrowed from the corporation and not repaid the loans; furthermore, that the $1500 was an unfair price in light of the earnings of the corporation and its growth potential. It was also alleged that Strong had employed schemes and devices to defraud, had engaged in acts, practices and a course of business which had operated as a fraud and had breached his fiduciary responsibility to the Holdsworths, violating their special relationship of trust and confidence.

After a trial to the court, it was ordered that Strong return the common stock and the reversions in the Class A common stock to the Holdsworths.

THE TRIAL COURT'S FINDINGS

In the trial court's findings of fact and conclusions of law it was brought out that the Holdsworths and Strongs were close friends and that this had been an important element in their entering into the enterprise. The trial court also considered some of the excessive expenditures which had been made by Sans-Copy to Strong's law firm. Excessive loans made to Strong from Sans-Copy funds were detailed. Amounts paid to Strong's immediate family and payment of personal expenses to Strong from the funds of Sans-Copy without approval or authorization of Holdsworth or Tanner The court also found that:

were pointed out as was payment of funds to Strong and his law firm in 1971 charged as attorney's fees but for which no legal services had been rendered.

In 1970-71, the net worth of Strong was shown to have increased substantially; the defendant had misrepresented that there had been an invasion of capital in the payment of dividends in 1970.

There was in fact a surplus for that year. During 1971, Strong had diverted a large sum of money from Sans-Copy to a non-profit corporation, Utah Law Research Institute, of which he was the organizer and executive director.

In 1971, defendant diverted funds from Sans-Copy to make restitution to the profit sharing plan of his law firm; no legal services were rendered to Sans-Copy for this payment of $4570.

During the year 1971, the net worth of appellant Kline Strong increased $262,000 which, after adjustments claimed by appellant, showed an increase of $112,000.

Notwithstanding the foregoing, the trial court found, appellant maintained that Sans-Copy was unable to pay dividends and would be unable to pay dividends in the future. Representations in Strong's letter to Holdsworth offering to buy him out were knowingly false statements relied on by the Holdsworths in accepting the offer to buy their stock.

The sale of the stock without examination of the books was held to be excusable in view of the friendly relationship of the parties, being engaged in the ranching business together as well as Sans-Copy. The books and records, according to the further finding of the court, failed to accurately reflect the condition of the company; they were incomplete and had been adjusted and revised by the defendant. So examination would not have been helpful in learning the truth.

The court determined that the evidence was clear and convincing that false representations were made by defendant concerning the present facts, which representations the defendant knew to be false...