Sharp v. Coopers & Lybrand

Decision Date05 June 1981
Docket NumberNo. 80-2229,80-2229
Citation649 F.2d 175
PartiesFed. Sec. L. Rep. P 97,971 SHARP, Stanley L. v. COOPERS & LYBRAND, Appellant.
CourtU.S. Court of Appeals — Third Circuit

Matthew J. Broderick (argued), Jeffrey G. Weil, Richard A. Deak, Dechert, Price & Rhoads, Philadelphia, Pa., for appellant.

Theodore R. Mann (argued), Barry E. Ungar, Larry H. Spector, S. Mark Werner, Mann & Ungar, P. A., Philadelphia, Pa., for appellee; Ralph C. Ferrara, General Counsel, Jacob H. Stillman, Associate Gen. Counsel, Frederick B. Wade, Senior Sp. Counsel, David A. Sirignano, Atty., Washington, D. C., of counsel.

Paul Gonson, Sol., Securities and Exchange Commission, Washington, D. C., of counsel for amicus curiae.

Before ALDISERT and HIGGINBOTHAM, Circuit Judges, and MARKEY, Chief Judge. *


ALDISERT, Circuit Judge.

This appeal from verdicts in favor of the three named plaintiffs in a securities fraud class action raises several important questions under the antifraud provisions of the Securities Exchange Act of 1934. Specifically, we are asked to decide whether the district judge properly instructed the jury on imputed or secondary liability, on § 20(a) of the Act, on reliance, and on the measure of damages. For the reasons below, we affirm on all issues except the measure of damages, which we reverse and remand for a new trial.


The factual setting of this case 1 combines Caribbean intrigue, creative accounting, and high finance against the backdrop of investors attempting to limit their tax obligations. Westland Minerals Corporation was the promoter of a venture, the "Ohio Program," in which multiple limited partnerships were formed for the purpose of drilling for oil and gas. WMC sold interests in each of these partnerships from July 22, 1971, through early July, 1972. Each limited partnership was to spend $140,000 on drilling and developing a well. Of this amount, $65,000 was to be raised from contributions by investors in the partnership, and the balance from "suitable banks or other lending institutions."

As part of its sales presentation, WMC used a tax opinion letter issued by the accounting firm of Coopers & Lybrand, the appellant. WMC requested the letter in April, 1971, in behalf of one investor, Muhammed Ali, and on July 22, 1971, an opinion letter signed by a Coopers & Lybrand partner in the firm name was sent to the president of WMC. The letter stated that "based solely on the facts contained (in the WMC Limited Partnership Agreement) and without verification by us," a limited partner who contributed $65,000 in cash could deduct approximately $128,000 on his 1971 tax return. Herman Higgins, a tax supervisor employed by Coopers & Lybrand who worked directly under the supervision of four partners, drafted the letter. In October, 1971, Higgins told David Wright, a partner at Coopers & Lybrand, that WMC was showing copies of the letter to investors as part of its sales program, and Wright decided that a more complete letter should be drafted for those purposes. On October 11, 1971, Wright sent to WMC a revised letter, which he signed in the name of Coopers & Lybrand.

Under the investment plan, investors would purchase partnership shares in WMC's Ohio Program, with the money raised to be used in oil drilling. The investors would be limited partners in the sense that their liability would be limited, but their participation in the profits would be quite extensive once the oil started to flow. The plan's main attraction was the investors' ability to deduct twice the amount invested from their federal income tax returns in the first year of investment. The reason for this double deduction was that WMC would borrow on a nonrecourse basis, secured only by the oil wells, an amount of money approximately equal to that invested. Because the outside investors received their interests as limited partners, they did not subject themselves to liability on the loans merely by being partners; because the loans were nonrecourse, they were also not subject to them by explicit agreement.

The tax benefit arose because oil drilling requires large initial noncapital expenditures before any recovery can occur. These expenditures would be incurred in 1971, the year of investment. The partnership agreement allowed the profits and losses to be passed through the partnership to the partners. Not only would they be able to claim a total loss for the money actually invested, but they would also be able to claim a loss for the money borrowed and spent on the oil wells. The result was that each investor was able to deduct twice what he actually invested as ordinary (noncapital) losses, and could recover his investment in the first year by tax savings if he was in a fifty percent or higher tax bracket.

The practical problem with this is that banks are seldom if ever willing to lend money for oil drilling when their only security is the oil well. The reason is obvious: the well may not produce, and the bank will then have no security. Obtaining large amounts of loans was crucial to the scheme. Higgins, the Coopers & Lybrand associate, proposed a solution. He suggested that WMC borrow the money from a bank, and then use the money borrowed to purchase savings certificates from the bank, which the bank would hold as collateral. The net result of this arrangement was a paper transaction, by which WMC obtained loans on paper without actually receiving the money. 2 WMC decided to transact these loans through a bank in the Bahamas that it acquired in September, 1971, before Coopers & Lybrand issued the second opinion letter. The scheme began to unravel when WMC was indicted for securities violations. The IRS began denying the deductions taken by the investors, the wells were frequently dry, and WMC collapsed.

Stanley Sharp filed this suit on behalf of himself and 210 other WMC investors similarly situated on May 8, 1975, alleging violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities Exchange Commission rule 10b-5, 17 C.F.R. § 240.10b-5. 3 The trial judge granted class certification, and a jury trial of the class issues was held from February 27 through March 10, 1978. By answers to special interrogatories, the jury found that the October 11, 1971, tax opinion letter contained material misrepresentations and omissions, and that Herman Higgins had acted recklessly and intentionally. Although the jury found that no partner of Coopers & Lybrand had acted with scienter in causing the omissions and misrepresentations, the district court concluded as a matter of law that the firm was liable under the common law doctrine of respondeat superior for the actions of its employee, Higgins. Sharp v. Coopers & Lybrand, 457 F.Supp. 879, 891 (E.D.Pa.1978). The court also concluded as a matter of law that Coopers & Lybrand was liable for Higgins' conduct by virtue of § 20(a) of the 1934 Act, 15 U.S.C. § 78t(a). 457 F.Supp. at 893-94.

A second jury trial on the issue of damages sustained by the three named plaintiffs was held from May 12 through May 19, 1980. This jury found, also by special interrogatories, that the three class representatives had exercised due diligence, had filed their claims within one year of the date on which the fraud reasonably could have been discovered, and would not have invested in the partnerships absent the opinion letter. The jury also found that the "actual value" of a one-eighth limited partnership share in 1971 was $1,240.00. Based on these findings, the trial judge entered judgment in favor of Stanley L. Sharp in the amount of $6,885, Sam Geftic in the amount of $3,442.50, and H. James Conaway, Jr., in the amount of $6,193. Each representative also received prejudgment interest at the rate of six percent from December 31, 1971.


In this appeal, Coopers & Lybrand advances four principal arguments. 4 First, it argues that the trial judge erred in concluding after the first trial that Coopers & Lybrand was secondarily liable for the acts of its employee, Herman Higgins, under the common law doctrine of respondeat superior. Second, it argues that the trial judge erred by failing to give proper jury instructions on § 20(a) of the 1934 Act. Third, it argues that the trial court erred during the second trial in creating a presumption that the class representative relied on the misrepresentations and omissions of the second opinion letter. Finally, it attacks the measure of damages used by the district court in the second trial.


Appellant's primary argument is that it may not be held liable for the actions of Higgins in light of the jury's finding, in answer to a special interrogatory, that no Coopers & Lybrand partner possessed the necessary scienter to violate rule 10b-5. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201-11, 96 S.Ct. 1375, 1384-1389, 47 L.Ed.2d 668 (1976). The trial court rejected this argument, holding as a matter of law that Coopers & Lybrand was liable for the securities law violations of Herman Higgins committed in the scope of his employment. The district court noted that this court has not recognized respondeat superior as a basis for establishing secondary liability under rule 10b-5, see Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880, 884 (3d Cir. 1975) (Rochez II ), cert. denied, 425 U.S. 993, 96 S.Ct. 2205, 48 L.Ed.2d 817 (1976), but reasoned that this case presents a sufficiently egregious situation to distinguish it from the prevailing case law. It relied on a "broker-dealer" exception alluded to in Rochez II, id. at 886, reasoning that an accounting firm issuing a tax opinion letter to be used in selling securities is laden with the same public trust as a broker-dealer. 457 F.Supp. at 891.

As an alternative basis for imposing liability on Coopers & Lybrand, the district court relied on § 20(a) of the 1934 Act. The...

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