Moore v. Fenex, Inc.

• Decision Date: 14 January 1987
• Docket Number: 85-3550 and 85-3551,Nos. 85-3520,s. 85-3520
• Citation: 809 F.2d 297
• Parties: Blue Sky L. Rep. P 72,469, Fed. Sec. L. Rep. P 93,103 Franklin MOORE; Julia A. Moore, on behalf of themselves and a class of persons similarly situated, Plaintiffs-Appellants, Cross-Appellees, (85-3520) v. FENEX, INCORPORATED, et al., Defendants, William West, Defendant-Appellee, Cross-Appellant, (85-3551) and Earle R. Frost, Jr. and Brownfield, Bowen, Bally & Sturtz, Defendants- Appellees, Cross-Appellants, (85-3550).
• Court: U.S. Court of Appeals — Sixth Circuit

Page 297

809 F.2d 297

Blue Sky L. Rep. P 72,469, Fed. Sec. L. Rep. P 93,103

Franklin MOORE; Julia A. Moore, on behalf of themselves and a class of persons similarly situated Plaintiffs-Appellants, Cross-Appellees, (85-3520) v. FENEX, INCORPORATED, et al., Defendants William West, Defendant-Appellee, Cross-Appellant, (85-3551) and Earle R. Frost, Jr. and Brownfield, Bowen, Bally & Sturtz Defendants- Appellees, Cross-Appellants, (85-3550).

Nos. 85-3520, 85-3550 and 85-3551.

United States Court of Appeals Sixth Circuit.

Argued Sept. 23, 1986.

Decided Jan. 14, 1987.

Michael E. Maundrell, argued John W. Hust, George D. Jonson, Cincinnati, Ohio, for defendants-appellees, cross-appellants.

James R. Adams, Frederick J. McGavran, argued, Frost & Jacobs, Cincinnati, Ohio, for plaintiffs-appellants, cross-appellees.

James R. Kirkland, argued, James R. Kirkland & Assoc., Dayton, Ohio, for defendant-appellee, cross-appellant.

Before MARTIN, GUY and NORRIS, Circuit Judges.

RALPH B. GUY, Jr., Circuit Judge.

Defendants Earle R. Frost, Jr., Brownfield, Bowen, Bally & Sturtz and William West appeal, and plaintiffs cross-appeal, judgment entered upon a jury verdict in this securities case. The case was brought as a class action under the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78a et seq. the Ohio Securities Act, Ohio Rev. Code Secs. 1707.41, 1707.43 and 1707.44, and Ohio common law claims of fraud and breach of fiduciary duty. After a lengthy jury trial, a verdict was returned in favor of plaintiffs on all counts. We reverse the judgment as to defendants Frost and Brownfield, and affirm as to defendant West. We also affirm as to the issues raised by plaintiffs.

The facts adduced at trial are rather complicated. Defendant Fenex, Inc., is an Ohio corporation organized in 1976 for the purpose of issuing and selling to the public joint venture interests in drilling various oil and gas wells in Ohio, primarily in Holmes, Perry, and Wayne Counties. HMW Company, Inc., a related organization, is an Ohio corporation organized in 1977 for the purpose of issuing and selling to the public limited partnership interests in oil and gas drilling equipment for specified oil and gas wells in this same area. Because Fenex and HMW are involved in Chapter 7 bankruptcy proceedings, this action was stayed as against them. Bethel Securities, Inc., is an Ohio corporation organized in 1978 to act as the sales arm of Fenex and HMW. A related non-party is Bethel Resources, Inc., the operating arm of the company, also currently involved in bankruptcy proceedings. These companies will be referred to by individual name or as the Bethel Group.

The Bethel Group companies were related by stock ownership, directorship and officers. As a group they were controlled by defendants Robert R. Hills and Rufus B. Hurst. Defendant William West was employed by Bethel Securities as a salesman selling HMW and Fenex programs from September, 1976 until February, 1981. In addition, West was elected to the Board of Directors of HMW in late November, 1980 and served until September of 1981. Defendant Frost was a partner in defendant law firm, Brownfield, Bowen, Bally & Sturtz. Between 1976 and approximately August or September of 1981, the Brownfield firm, through Earle R. Frost, represented the Bethel Group in all its dealings with the Ohio Division of Securities.

The plaintiff class consisted of all purchasers of Fenex oil and gas interests and HMW equipment ventures sold by Bethel Securities between mid-1976 through 1981. Plaintiffs alleged that during this time, defendants sold securities to the public in various oil and gas drilling programs and well equipment ventures. Plaintiffs' position was that basic representations in the offering circulars were false. The gravamen of their complaint was that defendants knew, or should have known, or intentionally remained ignorant of, the following material facts: (1) plaintiffs' investments were used as cash flow for the Bethel Group rather than the specific drilling programs and equipment ventures described in the offering circulars; (2) plaintiffs' oil and gas wells were not drilled in accordance with the timetables represented in the Fenex offering circulars; (3) contrary to express representations in the HMW offering circulars, plaintiffs' investments were transferred to Bethel Resources; (4) as a result of undertaking contractual obligations to drill about 75 oil and gas wells for an unrelated third party, the Bethel Group's problems in drilling and equipping oil and gas wells increased and magnified; and (5) through the use of "the sheet," the plaintiff class' investment funds were moved and shuffled between and among the companies in the Bethel Group and used for improper purposes, as a result of which plaintiffs' wells were not drilled and plaintiffs' equipment was not purchased. Plaintiffs alleged that none of the Bethel Group's operational, accounting and drilling difficulties or shuffling of investors' funds were revealed to past, present or potential investors. Rather, in an attempt "to play catch up" and to continue to generate funds to meet an increasing cash flow problem aggravated by rapidly spiraling inflation in the industry and exacerbated by the removal of investors' funds for improper purposes, as well as a complete lack of accounting and management controls and procedures, defendants continued to solicit funds from the public to cover past and current obligations. Plaintiffs sought $7.2 million, their total investment in the programs. Claims Against Frost and the Brownfield Firm

I.

Defendant Frost, a partner in defendant law firm Brownfield, Bowen, Bally & Sturtz, prepared the offering circulars of Fenex and HMW. Plaintiffs set forth two types of misconduct against these defendants: that defendants made a material misrepresentation in the circulars by stating that funds collected for different well programs would be segregated and used only for that particular well; and that defendants omitted a material fact in that they failed to disclose the precarious financial position of the companies.

The trial court essentially granted a partial directed verdict in favor of defendants as to all circulars prepared before September 25, 1980. It was established at trial that Frost had no knowledge of wrongdoing before that time. After that date, seven circulars were prepared by defendants, four of which were offered by HMW Company and three of which were offered by Fenex. (See Joint Appendix, Stipulated Facts, Pre-Trial Order). The last offering, issued in September, 1981, was rescinded on the advice of defendant Frost and the money was refunded to the investors. Consequently, the preparation of six offering circulars was the basis for the jury's finding of liability against these defendants.

Defendants Frost and the Brownfield firm were found liable on claims of federal securities law violations, Ohio common law fraud and breach of fiduciary duty. Defendants have challenged the jury's verdict as to each of these claims.

A.

Defendants Frost and the Brownfield firm challenge the finding of liability for breach of fiduciary duty in two ways. First, defendants contend that this issue was not properly pleaded against them and should not have been submitted to the jury. Second, defendants argue that they owed no fiduciary duty to the plaintiff investors.

It is undisputed that in count six of their complaint, plaintiffs set forth a claim for relief for breach of fiduciary duty against Fenex, HMW, Bethel Securities, and defendants McQueen and Hills. Frost and the Brownfield firm were not named in that count. Nevertheless, plaintiffs contend that the final pre-trial order controls the course of the trial, and that defendants were put on notice that an Ohio common law claim for breach of fiduciary responsibilities was asserted against them.

We note initially that this is not a case in which a plaintiff may argue that the issue was tried by consent of the parties. Our review of the record reveals no indication that defendants were or should have been aware that breach of fiduciary duty was actually being tried as against them. Accordingly, Fed.R.Civ.P. 15(b), permitting amendment of pleadings by implied consent, does not apply.

Issues incorporated in a pre-trial order may supersede the pleadings. Howard v. Kerr-Glass Mfg. Co., 699 F.2d 330, 333 (6th Cir.1983). The question then is whether the pre-trial order put the defendants on notice that they were being charged with breach of fiduciary duty. We are unable to conclude that it did.

The section of the pre-trial order that plaintiffs point to is the section entitled "Nature of Action and Jurisdiction." This section states:

This is a class action for compensatory damages arising under the Securities Exchange Act of 1934, as amended (the "1934 Act"), 15 U.S.C. Sec. 78, [78a] et seq., the Ohio Securities Act, Ohio Revised Code Secs. 1707.41, 1707.43 and 1707.44 (the "Ohio Act"), and Ohio common law claims of fraud and breach of fiduciary responsibilities. Plaintiffs also assert claims for punitive damages, which Defendants assert are not properly pleaded.

This section goes on to describe jurisdiction and venue, and the class nature of the action. Two sections later, plaintiffs' statement of the case is described, and the actions and positions of each of the defendants are generally set forth.

We cannot conclude that this pre-trial order would put Frost and the Brownfield firm on notice that claims advanced against other parties in the complaint were now being brought against them as well. The section plaintiffs rely on generally describes the claims set forth in the complaint; it does not indicate against whom those claims are being asserted. Furthermore, the order did not indicate that the complaint was being amended. There is no basis on which to hold that defendants should ignore a well-pleaded complaint and rely instead on a very general...