Metge v. Baehler

• Decision Date: 15 May 1985
• Docket Number: No. 84-1201,84-1201
• Citation: 762 F.2d 621
• Parties: Fed. Sec. L. Rep. P 92,037 Thelma T. METGE, Executrix of the Estate of August Metge, and Elizabeth G. Shepard, on behalf of themselves and on behalf of all others similarly situated, Appellants, v. Robert L. BAEHLER, John E. Gustafson, Richard Pigott, Abe Clayman, H. Dale Bright, Allen R. Loomis, Robert E. Boyt, Albert W. Moritz, R.D. Needham, Carl Redding, John S. Rice, DeWayne Trask, Marlow Samuelson, Bonnie Weaver, Lloyd Jackson, John Fereday, E.J. Sprengeler, Bankers Trust Company, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 621

762 F.2d 621

Fed. Sec. L. Rep. P 92,037

Thelma T. METGE, Executrix of the Estate of August Metge and Elizabeth G. Shepard, on behalf of themselves and on behalf of all others similarly situated, Appellants, v. Robert L. BAEHLER, John E. Gustafson, Richard Pigott, Abe Clayman, H. Dale Bright, Allen R. Loomis, Robert E. Boyt Albert W. Moritz, R.D. Needham, Carl Redding, John S. Rice DeWayne Trask, Marlow Samuelson, Bonnie Weaver, Lloyd Jackson, John Fereday, E.J. Sprengeler, Bankers Trust Company, Appellee.

No. 84-1201.

United States Court of Appeals Eighth Circuit.

Submitted Dec. 12, 1984.

Decided May 15, 1985.

W. Don Brittin, Jr., Des Moines, Iowa, for appellants.

Bennett A. Webster, Des Moines, Iowa, for appellee.

Before HEANEY, BRIGHT and ROSS, Circuit Judges.

HEANEY, Circuit Judge.

In this securities fraud class action, the district court granted Bankers Trust Company's (BTC) motion for summary judgment. Appellant Thelma Metge appeals on behalf of herself and 635 others similarly situated, arguing that the district court erred on the facts and law regarding BTC's liability as a controlling person and as an aider and abettor, and that the district court abused its discretion in dismissing pendent state claims against BTC. We affirm on the controlling person issue, but reverse and remand on the issues of aiding and abetting and pendent jurisdiction.

I. BACKGROUND.

Investor's Equity, Inc. (IEI), is an Iowa corporation which originally was involved in the business of buying, selling, and servicing real estate contracts on low-cost homes. Fluctuating business conditions in 1969 caused IEI to form Investor's Mortgage and Finance Company (IMF) to raise capital for IEI by selling unregistered, unsecured, one-year renewable securities called thrift certificates (certificates), which resembled promissory notes. Subsequently, IEI also issued thrift certificate guaranty bonds, which unconditionally guaranteed the certificates. Initially IMF transferred proceeds from certificate sales to IEI in exchange for IEI real estate contracts; but by the end of 1970, IMF was loaning the certificate proceeds to IEI in exchange for IEI's unsecured promissory notes. Certificate sales were brisk and by mid-1974, the outstanding balance had risen to $1.5 million.

IEI invested the certificate proceeds in speculative real estate ventures which, by 1971, began to erode IEI's financial standing. Over time, certificate proceeds grew, representing a larger share of IEI's financing. Meanwhile, BTC had become heavily involved in financing IEI, and engaged in a series of banking strategies which kept IEI in business. By mid-1974, however, the State of Iowa prohibited the sale and renewal of unregistered thrift certificates. In August, 1974, IEI declared bankruptcy; as a result, certificate holders received only twelve and one-half cents on each dollar of accrued interest and no repayment of principal. BTC lost $543,703 in principal and $107,807 in accrued interest on its loans to IEI and its subsidiaries.

The appellant class of certificate holders sued BTC and seventeen individual appellees in federal district court, alleging state common law fraud and violations of federal securities laws stemming from misrepresentations and nondisclosure of relevant facts in connection with the sale of securities. In their federal securities law count, the appellants maintained that BTC is liable for violations of section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. Sec. 78j) and Rule 10b-5 (17 C.F.R. Sec. 240.10b-5) on theories of aiding and abetting, conspiracy and controlling person liability. The district court granted summary judgment for appellees, and the appellants appeal on all grounds except the conspiracy theory. We consider each of these arguments in turn.

II. THE AIDING-AND-ABETTING THEORY OF LIABILITY UNDER SECTION 10(b) AND RULE 10b-5.

A. Legal Principles of Liability.

This Court has previously set forth a three-pronged test to establish aiding-and-abetting liability. These requirements include:

(1) the existence of a securities law violation by the primary party (as opposed to the aiding and abetting party);

(2) "knowledge" of the violation on the part of the aider and abettor; and

(3) "substantial assistance" by the aider and abettor in the achievement of the primary violation.

Stokes v. Lokken, 644 F.2d 779, 782-83 (8th Cir.1981). Because the theory of aiding-and-abetting liability is a matter of common law, the courts have not yet elaborated the full meaning of these factors. Nevertheless, certain aspects of the practical applications of these tests are clear. The factors--particularly the second and third--are not to be considered in isolation, but should be considered relative to one another. Id. at 784. Practically speaking, this means that "where there is a minimal showing of substantial assistance, a greater showing of scienter is required." Id., citing Woodward v. Metro Bank of Dallas, 522 F.2d 84, 95 (5th Cir.1975). Thus, the two factors vary inversely relative to one another and where, as here, the evidence of substantial assistance is slim, the requirement of knowledge or scienter is enhanced accordingly.

The common law character of this three-part test requires further elaboration of the law before we apply the legal test to the facts of this case. Regarding the first prong of the test, we note that the existence of an underlying securities law violation by the primary party is not at issue in this case. Although BTC does not concede the existence of a violation, it recognizes that the appellants adduced sufficient evidence to give rise to a question of fact, which relieves us of further inquiry on this issue.

Regarding the "substantial assistance" factor, we note that the district court properly held that the appellants had the burden of showing that the secondary party proximately caused the violation. In approving this standard, we rely on decisions in other courts that have required a showing of "substantial causal connection between the culpable conduct of the alleged aider and abettor and the harm to the plaintiff[,]" Mendelsohn v. Capital Underwriters, Inc., 490 F.Supp. 1069, 1084 (N.D.Cal.1979), or a showing that "the encouragement or assistance is a substantial factor in causing the resulting tort[.]" Landy v. Federal Deposit Insurance Corporation, 486 F.2d 139, 163 (3d Cir.1974), cert. denied, 416 U.S. 960, 94 S.Ct. 1979, 40 L.Ed.2d 312 (1975) (quoting Restatement of Torts Sec. 436.)

In further examining the "substantial assistance" requirement, we note that BTC's involvement amounted to inaction rather than positive deeds of manipulation or deception. The distinction between positive action and deliberate inaction is elusive, and we do not wish to foreclose appellants' strategies on remand, but the facts suggest that we examine the standard as it relates to substantial assistance through inaction.

Although courts are by no means unanimous in treating the question of substantial assistance in a case of inaction, most seem to agree that, if the aider and abettor owes the plaintiff an independent duty to act or to disclose, inaction can be a proper basis for liability under the substantial assistance test. E.g., Cleary v. Perfectune, 700 F.2d 774, 777 (1st Cir.1983) (citing cases which impose a duty to disclose where defendant possesses insider information, where a controlling person approves fraudulent practices, or where the law imposes special obligations on a profession). We find no such duty in this case. Nevertheless, the district court properly applied an exception to this rule in deciding the case under the so-called Woodward-Monsen rule. In Monsen v. Consolidated Dressed Beef Co., Inc., 579 F.2d 793 (3d Cir.1978), cert. denied, 439 U.S. 930, 99 S.Ct. 318, 58 L.Ed.2d 323 (1978), the Third Circuit evaluated the substantial assistance requirement in a case of inaction and concluded that inaction "may provide a predicate for liability where the plaintiff demonstrates that the aider-abettor consciously intended to assist in the perpetration of the wrongful act." Id. at 800 (emphasis in original). The Fifth Circuit took a similar tack in Woodward v. Metro Bank of Dallas, 522 F.2d 84 (5th Cir.1975):

When it is impossible to find any duty of disclosure, an alleged aider-abettor should be found liable only if scienter of the high "conscious intent" variety can be proved. Where some special duty of disclosure exists, then liability should be possible with a lesser degree of scienter.

Id. at 97 (footnote omitted).

Simply put, in the absence of a duty to act or disclose, an aider-abettor case predicated on inaction of the secondary party must meet a high standard of intent. As applied here, Woodward and Monsen require that the aider-abettor's inaction be accompanied by actual knowledge of the underlying fraud and intent to aid and abet a wrongful act. The requisite intent and knowledge may be shown by circumstantial evidence. Woodward, 522 F.2d at 96. ¹

B. Application of the Law to the Facts.

At the outset, we note the standard governing reliance on inferences in a summary judgment motion: direct proof is not required to create a jury question, but to avoid summary judgment, "the facts and circumstances relied upon must attain the dignity of substantial evidence and not be such as merely to create a suspicion. * * * Furthermore, an inference which a jury is entitled to draw must be based upon proven facts and not upon other inferences." Impro Products, Inc. v. Herrick, 715 F.2d 1267, 1272 (8th Cir.1983), cert. denied, --- U.S. ----, 104 S.Ct. 1282, 79 L.Ed.2d 686 (1984), citing Admiral Theatre Corp. v. Douglas Theatre Co., 585 F.2d 877, 884 (8th Cir.1978).

In evaluating the record under this standard, we must determine whether the bank understood that the thrift certificates were worthless and, as a result, prolonged the business lives of IEI and IMF for its own benefit...