Nelson v. Serwold

• Decision Date: 03 April 1978
• Docket Number: 75-3833,Nos. 76-1001,s. 76-1001
• Citation: 576 F.2d 1332
• Parties: Fed. Sec. L. Rep. P 96,399 Kenneth N. NELSON, Plaintiff-Appellant, v. O. E. SERWOLD and Helen Serwold, his wife, Defendants-Appellees. Kenneth N. NELSON, Plaintiff-Appellee, v. O. E. SERWOLD and Helen Serwold, his wife, Defendants-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1332

576 F.2d 1332

Fed. Sec. L. Rep. P 96,399

Kenneth N. NELSON, Plaintiff-Appellant, v. O. E. SERWOLD and Helen Serwold, his wife, Defendants-Appellees.

Kenneth N. NELSON, Plaintiff-Appellee, v. O. E. SERWOLD and Helen Serwold, his wife, Defendants-Appellants.

Nos. 76-1001, 75-3833.

United States Court of Appeals Ninth Circuit.

April 3, 1978.

Rehearing En Banc Denied in No. 76-1001 June 26, 1978.

William D. Cameron (argued) of Williams, Lanza & Kasterner & Gibbs, Seattle, Wash., for Kenneth N. Nelson.

William A. Helsell (argued), of Helsell, Fetterman, Martin, Todd & Hokanson, Seattle, Wash., for O. E. and Helen Serwold.

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

Before KOELSCH and WRIGHT, Circuit Judges, and CALLISTER, District Judge. ^*

PER CURIAM:

The plaintiff, Kenneth N. Nelson, was awarded.$3,003.48 plus interest and costs in this 10b-5 action against defendants Serwold. They were found to have violated Rule 10b-5 of the regulations promulgated under § 10(b) of the 1934 Securities and Exchange Act (hereinafter "Act"), and its Washington counterpart, RCW § 21.20.010, by failing to reveal the existence of the "control group" under which 56% of a telephone company's stock, held in the name of O. E. Serwold, was in fact beneficially owned by Serwold and other members of the "group," and by failing to disclose an informal, long-range intent of the "control group" to modernize the telephone company and ultimately to sell it.

Plaintiff asserts on appeal that the district court erred by not basing relief on a rescissory theory of damages requiring a complete disgorgement of profits.

On their cross-appeal, defendants contend that the omissions in the representations made through their attorney were not material. They also insist that Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), decided after the district court's determination, requires reversal in light of the district court's finding of an absence of scienter.

We believe that the district court's finding that defendants failed to disclose material matters is amply supported by the evidence. We also believe the evidence supports a finding that the defendants acted knowingly or recklessly, a standard adequate to support Rule 10b-5 liability after Ernst & Ernst.

Finally, we reverse on the issue of damages, and remand so that the district court can recompute plaintiff's damages based on a rescissory theory. Affiliated Ute Citizens v. United States, 406 U.S. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972).

FACTS

Poulsbo Rural Telephone Association (Poulsbo Telephone), a Washington corporation, was formed in 1908. Serwold was employed there as a lineman in the 1930's and became its president in 1957. He and his wife were directors of the company.

Serwold desired to modernize the company's equipment and install a dial system. He applied for a loan from Pacific Mutual Life Insurance Company in the mid-1950's. Poulsbo Telephone's attorney advised him to obtain "control" of the company so that he could deal effectively with the lender. Because he did not have funds to acquire control, he discussed the matter with social friends Rudie and Evelynn Iversen, William H. Gee, and J. Paul Coie. In 1956, the Serwolds, the Iversens, Gee, and Coie agreed to pool cash sufficient to acquire a controlling interest. Stock so acquired was to be owned of record by Serwold and beneficially owned as follows: approximately 30% for the Serwolds, 30% for the Iversens, 30% for Gee, and 10% for Coie. The group's desire to modernize was motivated, at least in part, by its plan to develop the company into a marketable enterprise. It acquired 56% of Poulsbo Telephone's stock as of 1959 and thereafter Serwold discontinued active efforts to acquire more stock.

On October 17, 1962, Earl A. Korth (Korth), a Wisconsin attorney, wrote to Poulsbo Telephone advising that stock certificate No. 305 for 36 shares issued to R. Norman had been found in his file in the Estate of Nels Nelson, Deceased. Korth asked information on the "status" of the stock. Serwold referred the letter to Coie who responded on December 11, 1962 that, upon receipt of "satisfactory evidence of present ownership, we . . . may be in a position to offer $5.00 per share." No other information about the status of the stock was provided.

Korth wrote to Coie on January 22, 1963, showing ownership in the Nelson Estate and inquiring whether "any dividends . . . are accrued." There was no response for 27 months, during which time the Nelson Estate was closed. The administrator, Herbert Nilsson, retained the certificate in a safe deposit box.

On April 15, 1965, Coie wrote Korth:

If you will give us an affidavit and surrender Certificate # 305 for 36 shares . . ., the enclosed check of O. E. Serwold . . . in the sum of $180.00 may be cashed.

There have been no dividends ever declared since the formation of this company, and none can be anticipated for years because of mortgage commitments required to finance capital improvements. This is a regulated utility and there has never been a surplus from which dividends could have been declared.

In a letter to Nilsson on April 20, 1965, Korth indicated that he assumed that the $180.00 represented the fair market value of the stock. Coie received a copy of that letter. Nilsson relayed the information to the plaintiff. On July 9, 1965, Korth wrote Coie inquiring "whether or not Mr. Serwold would be willing to pay $250 ($6.94 per share) for the stock." Coie agreed and forwarded another Serwold check for the additional sum. In 1965, Poulsbo Telephone stock had a book value of approximately $60.00 per share.

Thereafter, on September 16, 1965, Korth mailed to Coie the endorsed stock certificate No. 305 and Nilsson's affidavit tracing ownership to the Nelson Estate.

Serwold, as president of Poulsbo Telephone, first received "feelers" in 1965 or 1966 from persons interested in purchasing all or part of the company's stock. In 1968 or 1969, Serwold and Telephone Utilities, Inc., of Ilwaco, Washington, discussed a possible sale of Poulsbo Telephone. Negotiations with United Utilities, Inc. (United), of Hood River, Oregon, began in December 1970, and resulted in the sale of all Poulsbo Telephone assets in 1971.

Under the Agreement and Plan of Reorganization, Poulsbo Telephone exchanged all its assets for United stock, which it then distributed to its shareholders. Poulsbo Telephone shareholders received 25 shares of United stock (a value of $500) for each share of Poulsbo Telephone. At the time of the exchange, Poulsbo Telephone stock had a book value of approximately $163.00 per share.

In 1971, plaintiff received a letter from Richard Peterson, R. Norman's nephew, alluding to the proposed transaction between Poulsbo Telephone and United. He then retained counsel and sued on June 20, 1972, having first obtained assignments from other relatives.

Over a two-year period the district court heard evidence and issued an oral opinion on September 20, 1974, a written opinion of October 25, 1974 as to liability, two letter-opinions on damages dated December 5, 1974, and January 23, 1975, and Findings of Fact and Conclusions of Law on September 29, 1975.

DISCUSSION

I. RULE 10B-5 LIABILITY.

Material Omission

Rule 10b-5 makes it unlawful "to make any untrue statement of a material fact or to omit to state a material fact necessary . . . to make the statements made, in the light of the circumstances under which they were made, not misleading. . . ." 17 C.F.R. § 240.10b-5. A statement or an omission is material if it reasonably could have been expected to influence the decision to sell. Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 153, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972).

The district court concluded that Coie's representations to Korth with respect to (a) nondeclaration of dividends, (b) available surplus for dividends, and (c) mortgage restrictions on dividend payments did not amount to material misrepresentations which would expose defendants to Rule 10b-5 liability. The evidence supports these conclusions.

However, considering the disclosures in their entirety, the district court did find liability for material omissions, particularly for the defendants' failure to disclose the existence of the "control group," and the informal, long-range plan of the control group to acquire a majority of Poulsbo Telephone stock and build the company into a marketable entity. We agree.

Clearly, a "group" was formed to acquire control of Poulsbo Telephone. Equally clear is the fact that while Serwold appeared as owner of record of 56% of Poulsbo Telephone stock at the time of the sale, its beneficial ownership was divided among members of the "group."

The existence of a plan to acquire control of Poulsbo Telephone, strengthen and sell it is supported by the facts that the control group set out to acquire a majority of the stock; they ceased affirmative efforts to acquire stock after achieving control; they set out on a plan of modernization; they entertained "feelers" from and negotiated with potential purchasers of the company; and they eventually sold it for a substantial gain.

We find more than sufficient evidence to sustain the district court's findings of the existence of the control group and its long range plan. We also agree with the district court's conclusion that knowledge of these facts would have influenced a reasonable investor's conduct.

Defendants assert that the relationship between the attorneys representing the plaintiff and themselves was "casual." They so characterize it to justify their failure to disclose the existence of the "group," its long range objective to sell Poulsbo Telephone, and any additional financial information. Their position is not well taken. Korth, in his initial letter to Poulsbo Telephone, which Coie answered, requested information as to the "status" of the stock....