MacKethan v. Peat, Marwick, Mitchell & Co.

• Decision Date: 05 October 1977
• Docket Number: Civ. A. No. 74-0013-R.
• Citation: 439 F. Supp. 1090
• Court: U.S. District Court — Eastern District of Virginia
• Parties: Edwin R. MacKETHAN, Receiver of the Norfolk Savings and Loan Corp., Plaintiff, v. PEAT, MARWICK, MITCHELL & CO., et al., Defendants.

439 F. Supp. 1090

Edwin R. MacKETHAN, Receiver of the Norfolk Savings and Loan Corp., Plaintiff, v. PEAT, MARWICK, MITCHELL & CO., et al., Defendants.

Civ. A. No. 74-0013-R.

United States District Court, E. D. Virginia, Richmond Division.

October 5, 1977.

Jordan A. Pugh, III, Norfolk, Va., Oren R. Lewis, Jr., Gary R. Sheehan, Arlington, Va., J. Vernon Patrick, Jr., Michael L. Edwards, Birmingham, Ala., John E. Fricker, Arlington, Va., for plaintiff.

James L. Sanderlin and R. Gordon Smith, Robert H. Patterson, Jr., McGuire, Woods & Battle, Richmond, Va., Gordon E. Campbell, Campbell, Lustig & Hancock, Norfolk, Va., for defendants.

Leonard P. Novello, Peat, Marwick, Mitchell & Co., New York City, Kenneth H. Lambert, Jr., Williams, Worrell, Kelly & Greer, Norfolk, Va., William H. King, Jr., Wellford L. Sanders, Jr., McGuire, Woods & Battle, Richmond, Va., for Peat, Marwick, Mitchell & Co.

Robert A. Holmes, Norfolk, Va., for A. Page Ware, Jr.

John B. King, Jr., Vandeventer, Black, Meredith & Martin, Norfolk, Va., for Charles H. McCoy, Jr.

Ransom W. Etheridge, Virginia Beach, Va., for F. Littleton Powell.

MEMORANDUM

MERHIGE, District Judge.

Norfolk Savings and Loan Corporation (NS&L), a state-chartered industrial loan association, was closed on January 2, 1973. Thousands of persons, including those who had purchased Norfolk Savings and Loan "certificates of investment" (CI's) suffered immediate monetary loss. Certain of the NS&L officers were subsequently convicted in Federal Court of mail fraud and other crimes in connection with the operation of the corporation.

Edwin R. MacKethan, plaintiff, was appointed receiver of NS&L. Defendants are Peat, Marwick, Mitchell & Co. (PMM), an accounting firm; certain of its employees and senior partners; and former officers and directors (hereinafter "Officers") of NS&L. Plaintiff alleges, inter alia, that defendant Officers concealed material financial information in violation of the anti-fraud provisions of the Securities Act of 1933 ("1933 Act"), 15 U.S.C. § 77g, and the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78j(b). PMM is alleged to have aided this claimed fraud by failing to disclose certain facts and issuing materially misleading and deceptive reports of NS&L's financial condition.

The matter comes before the Court on defendants' motion to dismiss for lack of subject matter jurisdiction. Plaintiff contends that this Court has jurisdiction pursuant to § 22(a) of the 1933 Act¹ and § 27 of the 1934 Act.² Defendants, on the other hand, contend that the certificates of investment issued by NS&L are not "securities" within the meaning of those Acts,³ so that the antifraud provisions invoked by plaintiff are inapplicable.

In determining whether the certificates of investment issued by NS&L are "securities" subject to provisions of either Securities Act, the Court is guided by two principles. First, the Acts are remedial in nature, and should therefore be construed broadly to effectuate the statutory policy affording extensive protection to the investing public. See Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967). Second, the Court must look both at the form⁴ and the substance⁵ of the instrument in issue to determine whether the underlying transaction embodies significant characteristics commonly associated with securities.

The relevant facts are these: NS&L was an industrial loan association incorporated pursuant to § 6.1-227 et seq., Code of Virginia, Title 6, (1950). Under state law it was authorized to make loans to corporations and individuals, but was prohibited from accepting deposits. Instead, industrial loan associations such as NS&L were permitted to sell "certificates of investment," to obtain operating capital.⁶ CI's were not eligible for any federal deposit insurance. NS&L itself was not subject to federal banking regulations, and was substantially less regulated than state banks.⁷

CI's were debt instruments, not equity shares. The holders were entitled to a fixed rate of interest regardless of NS&L's profits or losses, and had no voting rights. The CI's could be purchased under either a fully paid or instalment account plan. The former was similar to a certificate of deposit issued by a bank: the purchaser bought a promise to pay a fixed sum, plus interest, at a specified rate, at a future date. The latter had some of the characteristics of an ordinary savings account: the purchaser bought a CI with a small initial payment and then could make periodic "deposits." Money on "deposit" earned interest at a rate specified in the initial contract. Neither type of CI was negotiable, but purchasers could withdraw their savings, generally without notice.

Defendants' contention that these certificates are not securities is largely premised upon what the Court views as a mistaken interpretation of two Supreme Court opinions. In Tcherepnin v. Knight, supra, the Court held withdrawable capital shares in an Illinois savings and loan association to be securities under the 1934 Act, noting that the shares had most of the features of common stock: earnings were tied to the profitability of the association; each shareholder had voting rights; shares were negotiable; and the money raised by sales of shares was considered part of the capital structure of the association under Illinois law. In United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975), the Court held that stock in cooperative housing projects was not "stock" within the meaning of the Securities Acts because the primary purpose of purchasers of such shares was "solely to acquire subsidized low-cost living space," (represented as one share of stock) 421 U.S. at 851, 95 S.Ct. at 2060, and not an investment for profit. The Court again recited the various features which are generally associated with stock.

Defendants point out that none of these indicia are present in the CI's issued by NS&L. Factually, that contention is well taken. Stock, however, is not the only form of security. The Securities Acts encompass debt as well as equity instruments within their scope. Neither voting rights, negotiability, nor earnings keyed to profits is a requisite feature of all forms of securities. The shares held to be securities in Tcherepnin, supra, were declared nonnegotiable under Illinois law. Thus, the several factors highlighted by defendants in support of their contention that CI's are not securities "serve only to distinguish among different types of securities. They do not, standing alone, govern whether a particular instrument is a security under the Federal Securities Law." Tcherepnin v. Knight, supra, 389 U.S. at 343, 88 S.Ct. at 557.

Plaintiff's position, that the certificates of investment are securities subject to the antifraud provisions of Securities Acts, is supported by the Securities and Exchange Commission. The Commission, in its amicus curiae memoranda in Burrus, Cootes & Burrus v. MacKethan, 537 F.2d 1262 (4th Cir. 1976), has urged that since NS&L certificates of investment "were represented to be an investment, . . . evidenced an obligation of a corporate enterprise, and . . . were sold upon the promise of economic benefits," they should be deemed "securities" to effectuate the broad remedial purposes of the securities laws. Memorandum of the Securities and Exchange Commission, Amicus Curiae in Support of the Plaintiff-Appellee's Petition for Rehearing and Suggestion for Rehearing en banc (filed September 13, 1976). The view of an agency charged with administering the governing statute is entitled to great weight. See, e. g., Saxbe v. Bustos, 419 U.S. 65, 74, 95 S.Ct. 272, 42 L.Ed.2d 231 (1974); Investment Company Institute v. United States, 401 U.S. 617, 626-27, 91 S.Ct. 1091, 28 L.Ed.2d 367 (1971).

For the defendants to prevail on the instant motion, the Court would have to be satisfied that under no set of facts could plaintiff substantiate his contention that the instruments upon which jurisdiction of this Court is invoked are securities. See Jenkins v. McKeithen, 395 U.S. 411, 421, 89 S.Ct. 1843, 23 L.Ed.2d 404 (1969).

For purposes of a motion to dismiss, the material allegations of the complaint must be taken as admitted, id., and the complaint is to be liberally construed in favor of the plaintiff. See Federal Rule of Civil Procedure 8(f).

Viewing the pleadings in the manner in which it must, the Court is not satisfied that plaintiff will fail to prove that either or both forms of CI's are securities. In Forman, supra, the Supreme Court stated that the distinguishing feature of "securities transactions . . . is an investment where one parts with his money in the hope of receiving profit from the efforts of others . . .." 421 U.S. at 858, 95 S.Ct. at 2063. On the pleadings, purchasers of NS&L certificates of investment surely meet that test.

Specifically, there are two theories in support of the Court's jurisdiction of the instant action. Certificates of investment may be "evidences of indebtedness"⁸ within the 1933 Securities Act and/or "investment contracts"⁹ under both the 1933 and 1934 Acts. As the Supreme Court stated in Tcherepnin, policy considerations must play a large role in making this determination. Proof of circumstances surrounding the sale transaction may cause an instrument to be labeled a security where its form alone would not require such a conclusion. See SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 64 S.Ct. 120, 88 L.Ed. 88 (1934); SEC v. Continental Commodities Corp., 497 F.2d 516, 527 (5th Cir. 1974). The plaintiff here alleges that the manner in which NS&L advertised its certificates of investment brings these transactions within the purview of the Federal Securities laws. The Securities Exchange Commission suggests that the absence of adequate regulation should be considered.

The Court concludes that each of the foregoing factors is relevant to its determination of...