Keirnan v. Homeland, Inc.

• Decision Date: 15 January 1980
• Docket Number: No. 76-1454,76-1454
• Citation: 611 F.2d 785
• Parties: Fed. Sec. L. Rep. P 97,248 James M. KEIRNAN, Plaintiff-Appellant, v. HOMELAND, INC., an Oregon corporation, and Otto J. Feucht, Jr., an Individual, Defendants-Appellees, Otto J. FEUCHT, Jr., Third-Party Plaintiff, v. Lyndon A. S. WILSON, Jr., Clemens Laufenberg, and Thomas W. Dant, Jr., Third-Party Defendants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 785

611 F.2d 785

Fed. Sec. L. Rep. P 97,248

James M. KEIRNAN, Plaintiff-Appellant, v. HOMELAND, INC., an Oregon corporation, and Otto J. Feucht, Jr., an Individual, Defendants-Appellees, Otto J. FEUCHT, Jr., Third-Party Plaintiff, v. Lyndon A. S. WILSON, Jr., Clemens Laufenberg, and Thomas W.

Dant, Jr., Third-Party Defendants.

No. 76-1454.

United States Court of Appeals Ninth Circuit.

Jan. 15, 1980.

John J. Haugh, Portland, Or., for plaintiff-appellant.

William B. Crow, Portland, Or., argued for defendants-appellees; William B. Crow, Miller, Anderson, Nash, Yerke & Weiner, Jack L. Orchard, Jr., Portland, Or., on brief.

Appeal from the United States District Court for the District of Oregon.

Before BROWNING and TANG, Circuit Judges, and TAKASUGI, ^* District Judge.

BROWNING, Circuit Judge:

Dr. James Keirnan filed this action against Homeland, Inc., a real estate investment company, and its president, Otto Feucht, for securities fraud. ¹ The district court dismissed the complaint after a bench trial. We affirm.

I

Dr. Keirnan alleged that defendants induced him to purchase a partnership interest in the now bankrupt Golfside Apartment Company by issuing a materially misleading prospectus in violation of section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10(b)-5.

Clemens Laufenberg, Homeland's salesman, showed Dr. Keirnan a prospectus forecasting an after-tax return to investors of 23.2% Per year. This forecast rested on the assumption that rents could be increased by about 4% While maintaining a vacancy rate of 5%. Further, the prospectus represented to investors that "(a) study by Homeland confirms that the (projected) rent schedule . . . is a reasonable one and competitive with similar property in the area."

When the forecast of return was made, vacancies at Golfside were approximately 30%. There was expert testimony that a reasonable prediction based on the vacancy rate in the area would have been 9% To 11%. The expert also testified that a realistic assessment at the time the prospectus was prepared would have revealed that rents could not be increased in the near future but would probably have to be decreased.

In a written statement admitted in evidence Mr. Laufenberg stated he had inspected the Golfside Apartments before presenting the investment to Dr. Keirnan, and that "the rents seemed to be high." Mr. Laufenberg's statement continued: "I became concerned in early January when Jim McCright, who was our property manager, moved into the golf course apartments adjacent to 'Golf-sides'. These were more attractive units that seemed to offer more at a lower rent. At that time it became evident to me that the 'Golf-sides' rents were unrealistic. . . . (A) little market research would have pointed out the unrealistic rent level that had (been) projected." Dr. Keirnan was not given these facts, nor was he informed of the actual vacancy rate.

As to the study described in the prospectus, Mr. Laufenberg's written statement said:

It was my impression that Homeland performed very little research prior to purchasing the "Golf-sides" apartments. They did not do any market research to speak of in the neighborhood or vicinity nor did they make a very close examination of the project other than the engineering report.

On the other hand, Laufenberg testified at trial that when he wrote this statement he was not aware of the market research that Homeland might have done; and Otto Feucht, Homeland's president, testified that before preparing the prospectus he had studied a real estate report that contained an analysis of the market condition in the relevant area. Feucht also testified that before the prospectus was prepared a Homeland employee "shopped" the other apartment buildings in the area to check their vacancy rates.

Golfside was an unprofitable investment. It was necessary to lower rents to alleviate a high vacancy rate. Consequently income was less than projected.

Based upon the conflicting evidence, the district court found that although projected maintenance expenses were reasonable when established, "the other representations made by the defendants were overly optimistic and based on inadequate research. This is particularly true on the occupancy rate which assumed increased rents. As a result, Golfside's profit potential was overstated."

Despite these findings, the district court held the complaint should be dismissed for two reasons. First, the court found the misrepresentations in the prospectus were not "deliberate", but "resulted primarily from the speed with which this proposal was put together for sale before the end of the tax year." Second, the court found Dr. Keirnan "paid little attention to the profitability projections (because) (h)e was primarily concerned with (finding) a tax shelter" and "decided to invest primarily because three other physicians, including his friend Dr. Fisher, whose judgment he respected, had invested in Golfside and not because of any representations made by the defendants."

II

Subsequent to the decision below, the Supreme Court held in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), that simple negligence will not support a private cause of action under section 10(b) and Rule 10b-5. The Supreme Court left undecided, however, whether liability might be based upon reckless disregard for the truth. 425 U.S. at 193-94 n. 12, 96 S.Ct. 1375. In Nelson v. Serwold, 576 F.2d 1332, 1337 (9th Cir. 1978), we answered the reserved question in the affirmative, holding that "Congress intended the ambit of § 10(b) to reach a broad category of behavior, including knowing or reckless conduct."

Since the district court decided only that defendants' misrepresentations were not "deliberate", the judgment cannot be sustained for lack of proof of the required scienter unless on the evidence a reasonable person could not have found that defendants acted recklessly. See Robesky v. Qantas Empire Airways Ltd., 573 F.2d 1082, 1086 (9th Cir. 1978).

The defendants acted recklessly if they had reasonable grounds to believe material facts existed that were misstated or omitted, but nonetheless failed to obtain and disclose such facts although they could have done so without extraordinary effort. See Lanza v. Drexel & Co., 479 F.2d 1277, 1306 n. 98 (2d Cir. 1973) (en banc); Cohen v. Franchard Corp., 478 F.2d 115, 123 (2d Cir. 1973).

The occupancy rate of Golfside and the rental rates in comparable projects in the area were readily ascertainable. It would not have been unreasonable for the trial court to have found that the defendants acted recklessly by failing to inform Dr. Keirnan of the actual vacancy rate at Golfside and by failing to investigate more thoroughly rental and vacancy rates of comparable properties in the area before issuing a prospectus predicting so low a vacancy rate at increased rent and, consequently, so high a rate of return.

III

On the issue of reliance the district court wrote:

Keirnan knew that the figures in the prospectus were mere projections. He concedes that he paid little attention to the profitability projections in the prospectus. He was not looking for a conservative investment. He was primarily concerned with a tax shelter for some of his sizable income. Keirnan decided to invest primarily because three other physicians, including his friend Dr. Fisher, whose judgment he respected, had invested in Golfside and not because of any representations made by the defendants. Substantial reliance is necessary for recovery in a 10(b)-5 case. List v. Fashion Park, Inc., 340 F.2d 457 (2d Cir. 1965). ²

Dr. Keirnan contends that the district court's approach to the reliance issue was erroneous as a matter of law, and that under the correct legal principles Dr. Keirnan was entitled to judgment.

The first step in Dr. Keirnan's argument is that reliance should have been presumed once the materiality of the omissions and misrepresentations had been demonstrated. ³ Dr. Keirnan implies that the district court imposed a heavier burden on him, requiring that he establish reliance in fact. But nothing in the district court's findings supports the thesis that the burden of proving reliance was placed on Dr. Keirnan. Rather, the court found in direct and affirmative terms that Dr. Keirnan decided to invest in the project for tax purposes and because three other physicians decided to invest in the project, and not because of the defendants' misrepresentations and omissions. It was on this basis, and not because Dr. Keirnan failed to carry the burden of proving reliance that the court found for the defendants. We need not decide whether the rule established in Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972), that reliance is presumed in cases involving primarily a failure to disclose material facts, should be extended to cases such as this where affirmative misrepresentations played an equal or greater role. ⁴ Even if we agree with Dr. Keirnan that he established a prima facie case by showing material misrepresentations and omissions, and the requisite scienter, the district court's findings on reliance, if sustained, leave no doubt that this prima facie case was successfully rebutted. See Crocker-Citizens National Bank v. Control Metals Corp., 566 F.2d 631, 636 n. 3 (9th Cir. 1977).

The second step in Dr. Keirnan's argument is that in the circumstances of this case, the defendants cannot be permitted to rebut the...