Ruefenacht v. O'Halloran

Decision Date11 June 1984
Docket NumberNo. 83-5493,83-5493
Citation737 F.2d 320
PartiesFed. Sec. L. Rep. P 91,514 Max A. RUEFENACHT v. Christopher J. O'HALLORAN, Joachim K. Birkle and Continental Import & Export, Inc., and W. George Gould. Christopher J. O'HALLORAN, Third-Party Plaintiff, v. W. George GOULD, Esq., Third-Party Defendant. W. George GOULD, Third-Party Plaintiff, v. David BERNSTEIN, Autobern Trading Co., Inc., Ernest Stoecklin, Lenzenhof GMBH, Third-Party Defendant. Appeal of Max A. RUEFENACHT.
CourtU.S. Court of Appeals — Third Circuit

Peter S. Pearlman, Cohn & Lifland, Saddle Brook, N.J., for appellant.

Robert C. Epstein, Elizabeth A. Weiler, Hannoch, Weisman, Stern, Besser, Berkowitz & Kinney, P.A., Newark, N.J., for W. George Gould.

James T. O'Halloran, Tompkins, McGuire & Wachenfeld, Newark, N.J., for Christopher J. O'Halloran; Robert J. Kelly, Washington, D.C., of counsel.

Daniel L. Goelzer, Gen. Counsel, Jacob H. Stillman, Associate Gen. Counsel, Rosalind C. Cohen, Asst. Gen. Counsel, Lawrence W. Koltun, Atty., S.E.C., Washington, D.C., amicus curiae; Paul Gonson, Sol., Washington, D.C., of counsel.

Before GIBBONS and HUNTER, Circuit Judges, and RAMBO, District Judge. *

OPINION OF THE COURT

GIBBONS, Circuit Judge.

This appeal requires that we determine whether stock transferred to effectuate the sale of all or part of a business is a "security" within the meaning of the 1933 and 1934 Securities Acts. 1 The district court, holding that the purchase or sale of 50 percent of the stock of a business is a security only if the transaction satisfies the "investment contract" or "economic reality" test of SEC v. W.J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946), entered summary judgment for the defendants. The plaintiff, and the Securities and Exchange Commission as amicus curiae, urge that the district court erred in applying the Howey test in these circumstances. The question whether the Howey test applies to the sale of stock having the traditional attributes of stock ownership is the subject of considerable academic commentary 2 and has produced a split of authority in the circuits. 3 Joining the Second, Fourth, Fifth and Eighth Circuits, we hold that the Howey test does not apply to the sale of all or part of a business effectuated by the transfer of stock bearing the traditional incidents of stock ownership. Thus we reverse.

I. Facts and Proceedings in the District Court

Continental Import & Export, Inc., is an importer of wines and spirits. Joachim Birkle is president of Continental and, until 1980, owned or controlled 100 percent of its stock. Ruefenacht, the plaintiff, alleges that early in 1980 he purchased 2500 shares of Continental's stock for $250,000--said to represent 50 percent of the company--in reliance on financial documents and other oral representations made by Birkle, Christopher O'Halloran, a certified public accountant, and W. George Gould, Continental's corporate counsel.

In deposition testimony, Ruefenacht asserted that the consideration for the price paid for Continental's stock included a promise by him to devote certain efforts to the firm's business. In conformance with that promise, Ruefenacht engaged in various activities on behalf of company. In the summer of 1980, for example, he solicited contracts to import beverages on behalf of the firm. On other occasions Ruefenacht participated in the hiring of company employees. He also applied for and received a state liquor license (or solicitor's permit), representing at that time that he would sell alcoholic beverages to wholesalers and receive in return a salary and compensation for expenses. On another occasion Ruefenacht signed a banking resolution denominating himself an officer of Continental. That resolution was signed at Birkle's request for the purpose of permitting Ruefenacht to sign corporate checks when Birkle was out of the country.

The record also reveals that Ruefenacht participated in the affairs of Continental in other minor ways. He attended luncheon meetings, occasionally translated documents, maintained telephone contact with Continental employees on a regular basis, and visited warehouses considered for use by Continental. While engaging in these activities, however, Ruefenacht remained a full-time employee of another corporation. Moreover, his actions on behalf of Continental were at all times subject to the veto of Birkle.

After Ruefenacht paid $120,000 of the total $250,000 purchase price for Continental stock, he began to doubt the accuracy of certain representations made to him by Birkle and others. Soon thereafter he filed this action, alleging violations of sections 12(2) and 17(a) of the Securities Act of 1933, 15 U.S.C. Secs. 77l (2), 77q(a) (1982), section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) (1982), and Rule 10(b)(5), 17 C.F.R. Sec. 240.10(b)(5) (1983). Ruefenacht charges that financial statements prepared by O'Halloran and signed by Birkle overvalued Continental's goodwill and licenses by $243,000; that these financial statements assigned a $400,000 value to import or contract rights with no substantial worth; that the firm reported a surplus when in actuality it maintained a deficit; and that the defendants represented that net profits on sales between 1980 and 1981 would be $848,000 under a nationwide distribution program, and $1.197 million in the New York area, when in fact Continental was not seriously negotiating contracts for nationwide distribution at all and could not reasonably project these net earnings. In reliance on these representations, Ruefenacht alleges, he had purchased 1000 shares of Continental's stock and had advanced $120,000 to Birkle. The complaint seeks rescission and restoration of the amount paid. Ruefenacht also pleads pendent state claims for fraud and breach of fiduciary duties. 4

The district court granted summary judgment for defendants, concluding that the stock purchased by Ruefenacht was not a "security" within the meaning of the 1933 and 1934 Acts. The court so concluded not because the instrument purchased by Ruefenacht lacked any of the indicia of stock ownership; indeed, the court conceded that the "stock which Ruefenacht received contains all the attributes mentioned by the Forman 5 Court as indicating that the transaction did involve a security." App. at 220. Rather, the court held, the instrument was not a "security" because of the degree of Ruefenacht's control over Continental's business. "Because Mr. R[ue]fenacht intended to jointly manage Continental with Mr. Birkle," the district court reasoned, "he did not purchase 'securities' as defined in the federal acts." App. at 309. Finding no federal jurisdiction over the securities claims, the district court dismissed the complaint in its entirety.

II. History of the Sale-of-Business Doctrine

The 1933 and 1934 Securities Acts include within the definition of "security" a series of specific terms--e.g., "note," "stock," "bond," and "debenture"--and thereafter employ a number of more general phrases--e.g., "investment contract," "any interest or instrument commonly known as a 'security.' " 6 As early as 1943 the Supreme Court held that certain novel economic transactions were encompassed within these latter, more generic terms, even though not embraced by their more specific provisions like "stock," "bond," or "note." See SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 348-55, 64 S.Ct. 120, 122-25, 88 L.Ed. 88 (1943) (holding that leasehold interests in property adjacent to exploratory oil wells were "securities"). The Court's leading opinion on this point, SEC v. W.J. Howey Co., 328 U.S. 293 (1946), held that agreements for the sale of a citrus crop coupled with optional service contracts were "investment contracts." Howey propounded a definition of "investment contract" derived from descriptions widely employed in state "blue sky" laws: an investment contract, the Court held, is "a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party...." Id. at 298-99, 66 S.Ct. at 1102-03. This definition came to be known as the "Howey test" and led many courts to classify a variety of novel economic schemes as "investment contracts." 7

While the courts were giving the term "investment contract" a broad compass, the more specific term "note" was read narrowly, so as not to embrace every instrument comporting with the Acts' terms that is technically a "note" under state law. The first appellate holding that not every such "note" is a "security" under the federal Acts is this court's decision in Lino v. City Investing Co., 487 F.2d 689 (3d Cir.1973). 8 In Lino, this court held that a personal promissory note tendered as partial consideration for rights under a franchise agreement was not a "note" under the federal Acts. Id. at 693-96. Significantly, we did not apply the Howey test to the notes in question, as Part I of the opinion pointedly made clear by applying the Howey test to the franchise agreements themselves. Id. at 691-93. Rather, we examined the entire context of the note transaction, declining at that time to expound "a 'test' ... that would aid in determining whether there has been a purchase or sale of securities when a personal promissory note is involved." Id. at 696 n. 15.

Following Lino 's lead, several courts strove to define the circumstances under which a "note" should be considered a "security" under the Securities Acts. The Fifth Circuit sought to determine whether a note comprised an "investment." 9 The Ninth Circuit approached the problem on a slightly different tack, seeking to determine whether the lender supplies "risk capital" to the maker. 10 In a leading opinion written by Judge Friendly, the Second Circuit rejected both of these approaches. See Exchange National Bank of Chicago v. Touche Ross &...

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