Hollinger v. Titan Capital Corp.

Decision Date13 November 1990
Docket NumberNo. 87-3837,K-J,87-3837
Citation914 F.2d 1564
Parties, Fed. Sec. L. Rep. P 95,500 Kay HOLLINGER; Richard Llewelyn Jones; Edward E. Nissen; Judy D'Arcy;udy, Ltd., Plaintiffs-Appellants, v. TITAN CAPITAL CORP.; Emil Wilkowski; Painter Financial Group, Ltd., Defendants-Appellees.
CourtU.S. Court of Appeals — Ninth Circuit

Peter B. Camp, Seattle, Wash., for plaintiffs-appellants.

Christopher B. Wells, Lane, Powell, Moss & Miller, Seattle, Wash., for defendant-appellee, Titan Capital Corp.

James S. Scott and James M. Shaker, Scott & Scott, Yakima, Wash., for defendant-appellee Painter Financial Group, Ltd.

Paul Gonson, S.E.C., Washington, D.C., for amicus curiae, S.E.C.

W. Reese Bader and Barbara Moses, Orrick, Herrington & Sutcliffe, San Francisco, Cal., for amicus curiae, Securities Industry Ass'n.

Appeal from the United States District Court for the Western District of Washington.

Before GOODWIN, Chief Judge, SCHROEDER, ALARCON, NORRIS, NELSON, CANBY, HALL, WIGGINS, BRUNETTI, THOMPSON, and RYMER, Circuit Judges.

WILLIAM A. NORRIS, Circuit Judge:

Emil Wilkowski, a dishonest securities salesman, embezzled money entrusted to him by four clients. As a result, Wilkowski was convicted of criminal securities fraud and grand theft. In this civil action for alleged violations of federal securities and state laws, the victimized investors seek to recover their losses from a brokerage firm and a financial counseling firm with which Wilkowski was associated. The district court granted summary judgment to both defendants, which plaintiffs now appeal.

On appeal, the panel called sua sponte for the case to be heard en banc to review various questions of Ninth Circuit securities law raised by this case. They are as follows:

1. What standard of recklessness meets the scienter requirement for a claim under Sec. 10(b) and Rule 10b-5? 1

2. Is a broker-dealer a "controlling person" with respect to its registered representatives within the meaning of Sec. 20(a) of the 1934 Act? 2 And does plaintiff or defendant bear the burden of proving the good faith exception to controlling person liability under Sec. 20(a)?

3. May broker-dealers be held vicariously liable under the common law doctrine of respondeat superior for securities law violations committed by their registered representatives?

We will address each of these questions in the course of considering appellants' various claims under the federal securities laws.

I

Defendant/appellee Painter Financial Group, Ltd. ("Painter") was formed in May 1983 to provide financial counseling and to sell insurance to individuals and small businesses. Shortly thereafter, Emil Wilkowski rented space in Painter's office in Bellevue, Washington, from which he sold insurance and counseled individuals as a Painter representative. During the summer of 1983, Wilkowski met appellants Judy D'Arcy and Kay Hollinger, two business partners who were seeking financial advice. Wilkowski assisted them with a real estate transaction and was soon doing their bookkeeping, advising them on tax matters, and offering them investment advice.

In November 1983, Wilkowski and several other Painter representatives in the Bellevue office applied to the National Association of Securities Dealers ("NASD") for registration as securities salesmen for defendant/appellee Titan Capital Corporation ("Titan"), a registered broker-dealer firm regulated by the Securities and Exchange Commission ("SEC") and by the NASD. Sales representatives of broker-dealers must be registered with the NASD if the broker-dealer is a member of this self-regulatory organization.

When Wilkowski filled out his application for registration with the NASD, he answered "no" to questions asking whether he had ever willfully made a false statement, been the subject of a major legal proceeding, or been convicted or pleaded guilty to a felony. He supplied a photo and fingerprints as requested. The NASD registered Wilkowski as a securities salesman for Titan on December 12, 1983, and on January 26, 1984, Wilkowski entered into a contract in which Titan authorized him to engage in the securities business as a registered representative of Titan, operating out of Painter's office in Bellevue. That office became a Titan branch office: Titan provided Wilkowski with business cards and stationery and required the office to display a sing with Titan's logo.

As part of its usual registration process, the NASD requested the FBI to run a fingerprint check on Wilkowski. The FBI report, which was not completed until after the NASD had approved Wilkowski's registration, revealed that he had pleaded guilty in 1972 to three counts of felony forgery, for which he received a five-year suspended sentence. The NASD immediately sent a copy of the rap sheet to Titan and requested that Titan return to the NASD a written statement from Wilkowski, providing details about the conviction and an explanation of his failure to disclose the information on the registration form.

When Titan asked Wilkowski for an explanation, he responded with a letter explaining that he believed that pursuant to his plea agreement, his forgery conviction would be expunged upon his making restitution of $16,000. Without saying so explicitly, Wilkowski gave the impression that he had in fact made restitution by indicating that he believed the conviction had been removed from his record before he prepared the application for the NASD. Along with this explanation, Wilkowski submitted a new application form, on which he disclosed the forgery conviction. The NASD did not revoke Wilkowski's registration and Titan did not terminate him as a registered representative. Painter, however, did terminate Wilkowski as a financial counselor.

During the time that Wilkowski worked as a registered representative of Titan, he received funds from appellants to invest. Wilkowski legitimately invested some of the funds in securities through Titan. Sometimes, however, Wilkowski instructed appellants to make the checks payable to him personally, and they complied. Rather than investing these funds, Wilkowski diverted them for his own use. He used Titan stationery to generate bogus receipts and financial statements that indicated that the stolen funds had been used to purchase securities and mutual funds through Titan. Ultimately, Wilkowski's activities were discovered and he was convicted of criminal securities fraud and grand theft.

In this civil action, appellants seek to recover their losses under various antifraud provisions of the federal securities laws and under state law. The district We address appellants' various theories of liability under the federal securities laws in turn. In doing so, we make an independent determination whether appellees were entitled to summary judgment. Darring v. Kincheloe, 783 F.2d 874, 876 (9th Cir.1986). Summary judgment is appropriate if "there is no genuine issue as to any material fact and ... the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c).

                court awarded summary judgment to both Titan and Painter on all of appellants' federal claims and dismissed appellants' pendent state claims. 3   We affirm summary judgment in favor of Painter on all federal claims.  We affirm summary judgment in favor of Titan on all federal claims, except three:  1) the claim that Titan is liable for Wilkowski's wrongdoing as a "controlling person" under Sec. 20(a) of the 1934 Act, 15 U.S.C. Sec. 78t(a);  2) the claim that Titan is liable as a "controlling person" under Sec. 15 of the Securities Act of 1933 Act ("1933 Act"), 15 U.S.C. Sec. 77o 4;  and 3) the claim that Titan is liable as Wilkowski's employer under the common law theory of respondeat superior
                
II
A

Appellants claim that Titan is primarily liable under Sec. 10(b) of the 1934 Act and Rule 10b-5 for failing to disclose to investors Wilkowski's prior forgery conviction. 5 Section 10(b) makes it unlawful "[t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." 15 U.S.C. Sec. 78j(b). Rule 10b-5, which implements Sec. 10(b), makes it unlawful:

(a) to employ any device, scheme, or artifice to defraud,

(b) to make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.

17 C.F.R. Sec. 240.10b-5 (emphasis added). Appellants do not contend that Titan employed "any device, scheme or artifice to defraud" the people who invested with Wilkowski; rather, appellants proceed on the theory that Titan should be liable for failing to disclose Wilkowski's prior forgery conviction.

In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 96 S.Ct. 1375, 1380, 47 L.Ed.2d 668 (1976), the Supreme Court held that scienter is a necessary element in an action for damages under Sec. 10(b) and Rule 10b-5. The Court defined scienter as "a mental state embracing intent to deceive, manipulate, or defraud." Id. at 194 n. 12, 96 S.Ct. at 1381 n. 12. The Court adopted the view that the language of Sec. 10(b), in particular the terms "manipulative," "device," and "contrivance," revealed an unambiguous intent on the part of Congress to proscribe only "knowing or intentional misconduct." Id. at 197-99, 96 S.Ct. at 1382-83; see also Aaron v. SEC, 446 U.S. 680, 690, 100 S.Ct. 1945, 1952, 64 L.Ed.2d 611 (1980). Although the Court acknowledged that in some areas of the law recklessness is considered to be a form of intentional conduct, the Court reserved the question whether reckless behavior is actionable under Sec. 10(b) and Rule 10b-5. See 425 U.S. at 194 n. 12, 96 S.Ct. at 1381 n. 12.

Our circuit, however, along with ten...

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