State v. Diacide Distributors

• Decision Date: 08 July 1999
• Docket Number: No. 97-1815.,97-1815.
• Citation: 596 N.W.2d 532
• Parties: STATE of Iowa ex rel. Craig A. GOETTSCH, Appellant, v. DIACIDE DISTRIBUTORS, INC., Kathleen M. Starnes, Larry E. Kellogg, Bruce E. Nelson, Richard C. Johnson, and J.R. Grady, Defendants, and Sam McHose, Appellee.
• Court: Iowa Supreme Court

596 N.W.2d 532

STATE of Iowa ex rel. Craig A. GOETTSCH, Appellant, v. DIACIDE DISTRIBUTORS, INC., Kathleen M. Starnes, Larry E. Kellogg, Bruce E. Nelson, Richard C. Johnson, and J.R. Grady, Defendants, and Sam McHose, Appellee.

No. 97-1815.

Supreme Court of Iowa.

July 8, 1999.

Thomas J. Miller, Attorney General, and Anuradha Vaitheswaran, Assistant Attorney General, for appellant.

J. Russell Hixson of Dickinson, Mackaman, Tyler & Hagen, P.C., Des Moines, for appellee. Considered by McGIVERIN, C.J., and LARSON, NEUMAN, SNELL, and CADY, JJ.

McGIVERIN, Chief Justice.

This appeal involves further proceedings related to the State's securities fraud case against several defendants. See Iowa Code ch. 502 (1993). In a prior decision, we reversed a district court decision and judgment that dismissed claims against one of the defendants, Sam McHose, for lack of evidence that McHose aided and abetted securities fraud. See State ex rel. Goettsch v. Diacide Distribs., Inc., 561 N.W.2d 369 (Iowa 1997) (Diacide I). We remanded the case to the district court for further proceedings to allow the district court to grant appropriate relief consistent with our decision. Id. at 384.

In the appeal now before us, the State challenges the district court's judgment on remand concerning assessment of monetary relief and raises other issues concerning the disposition of attached assets.

Upon our review, we affirm in part, reverse in part and remand.

I. Background facts and proceedings.

A. Diacide I.

We briefly summarize the facts giving rise to the State's securities fraud case that was involved in Diacide I. See id. at 370-71.

In 1988 Kathleen Starnes and her brother, Joseph Grady, incorporated Diacide Distributors, Inc. to promote, sell, and distribute certain products, including an environmentally-friendly insecticide. Starnes was president of Diacide and Grady was vice-president. The insecticide was manufactured and packaged by White Mountain of America, a corporation based in Grinnell, Iowa.

Defendant Sam McHose became involved in the venture when he provided the initial financing to assist Diacide in purchasing the insecticide from White Mountain and to market the product. In November 1989, McHose, through his family-held corporation, E.S.P. & S., Inc. (ESP), entered into a written agreement with White Mountain to purchase 4000 cans of the insecticide at $4 per can. White Mountain and Starnes agreed to re-purchase the insecticide from ESP at a price of $5.50 per can. Herman Tripp, an owner of White Mountain, conceived the terms of the agreement and Starnes executed it as director of marketing for White Mountain.

In the latter part of 1990 and early part of 1991, ESP, McHose's family-held corporation, loaned money to Diacide for inventory, marketing expenses, and operating expenses. Diacide agreed to repay the loans within sixty to 120 days at 16.66% interest. As of December 1991, Diacide allegedly owed ESP and McHose $102,283 on these loans.

In early 1992, Starnes began looking for additional capital, allegedly to keep Diacide going. To this end she recruited three licensed insurance agents, Richard Johnson, Bruce Nelson, and Larry Kellogg, to sell ninety-day-marketing-inventory receipts and ninety-day-contract notes (Diacide notes). Certain promises and guarantees concerning the return on the investment were made to customers who purchased the notes. From the early part of 1992 through 1994, Starnes and her sales crew sold Diacide notes to more than seventy investors, mostly elderly people. As was later discovered, the note program was a fraud or "Ponzi scheme." See id. at 378 (defining "Ponzi scheme"). Diacide used funds collected from new investors to pay off those whose notes had come due and to pay those involved in the scheme, their relatives or associates. As a result of the scheme, sixty-five of those investors lost more than $1.4 million.

The State of Iowa, through Craig A. Goettsch, Iowa superintendent of securities, filed an equity action against Diacide, White Mountain, Tripp, Starnes, Grady, Kellogg, Nelson, Johnson and McHose in Iowa district court on March 3, 1994.¹ The petition alleged that the defendants violated various provisions of the Iowa Uniform Securities Act, see Iowa Code chapter 502, and sought numerous items of relief against the defendants. Among other things, the State sought, on behalf of the investors, restitution and disgorgement of profits against all defendants. See Iowa Code § 502.604(2) (authorizing various forms of relief, including restitution and disgorgement of profits).² Specifically, as to McHose, the State contended that, among other things, he aided and abetted securities fraud.³

Pursuant to the State's request, the district court ordered the defendants to place certain funds in escrow pending the outcome of the proceedings and also ordered that the funds held in ESP's (McHose's family-owned corporation) bank account be frozen based on the State's contention that investor funds had been deposited into the account. The district court also ordered prejudgment attachment of McHose's personal and real property, including a non-homestead residence in Nevada, Iowa. The Nevada residence was sold while the case was pending in district court and all of the sale proceeds were placed in the escrow account pursuant to the district court's order.

After a trial was held against Diacide, Starnes, Grady and McHose, the district court concluded that Diacide, Starnes and Grady had committed numerous securities violations, including securities fraud.⁴ The court therefore entered judgment for restitution in favor of the State against Diacide, Starnes and Grady in the amount of $1,457,135. This amount represents all damages sustained by Diacide investors from the very beginning of the fraudulent Diacide note program.

The court dismissed the claims against McHose, however, finding there was insufficient evidence to support them. The district court ordered that all funds in ESP's corporate bank account, which had been frozen, and the proceeds from the sale of the Nevada property be released to McHose.

The State appealed and McHose cross-appealed. None of the other defendants appealed.

On appeal, we concluded, among other things, that (1) Iowa Code section 502.503(1) may be utilized by the State to impose secondary liability on persons who aid and abet securities fraud; (2) that the remedies established in section 502.604(2) (order of rescission, restitution, or disgorgement) may be utilized by the State against aiders and abettors as well as primary violators; and (3) that McHose aided and abetted the violation of Iowa Code section 502.401 antifraud provisions. Diacide I, 561 N.W.2d at 384. We ordered that the case be remanded for further proceedings to allow the district court to grant appropriate relief consistent with our opinion. Id.

B. District court proceedings upon remand.

Upon remand, the State sent a proposed order to the district court concerning appropriate relief and disposition of the case. The State also sent a copy of the proposed order to counsel for defendant McHose, requesting any response thereto as soon as possible and indicating that the State planned to submit the order to the court by June 3, 1997. McHose's counsel wrote to the State on June 6 expressing his disagreement with the terms of the proposed order and sent a copy of his letter to the court.

Without holding a hearing, and before receiving McHose's comments, the district court signed and filed the State's proposed order on June 9, 1997, entering judgment against McHose and in favor of the State for $1,457,135 and making disposition of certain attached and escrowed property. The parties, however, did not receive a copy of the order until July 12, 1997.

On August 12, 1997, McHose filed a combined motion to vacate or modify judgment and petition for relief pursuant to Iowa rule of civil procedure 252, requesting the court to vacate the June 9 order because the clerk of court failed to promptly notify the parties of that order. The State filed a resistance.

After hearing, the district court entered an order on October 16, 1997, sustaining McHose's motion to vacate the June 9 order. The district court also concluded that based upon our decision in Diacide I, "McHose had knowledge of the details of Diacide's note program on or about May 5, 1993. Thus, any investor monies he may have obtained after this date are tainted." The court further concluded, however, that it was not "equitable to enter a judgment against McHose requiring him to repay amounts taken from investors prior to his involvement with Defendants Diacide and Starnes." The court therefore did not hold McHose jointly and severally liable for the full $1,457,135 amount lost by investors, but rather only entered judgment for disgorgement in the amount of $102,283 in favor of the State against McHose for investors' funds that McHose used to repay himself for his investment in Diacide.

The district court also ordered that the frozen ESP bank account funds should be released to McHose. In addition, the court ordered that $19,141.33, which represents one-half of the proceeds from the sale of the Nevada property which was attached prior to judgment, should be returned by the State to Imogene McHose, wife of Sam McHose.

The State appealed.

II. Standard of review.

This case comes to us in part from an order and judgment on defendant McHose's motion to vacate the district court's judgment of June 9, 1997. See Iowa R. Civ. P. 252 (grounds for vacating or modifying judgment). Actions brought pursuant to rule 252(b) are law actions. In re Marriage of Cutler, 588 N.W.2d 425, 429 (Iowa 1999). Our standard of review in such cases is for correction of errors at law, not de novo. In re Marriage of Dunn, 455 N.W.2d 923, 924-25 (Iowa 1990).

However, after the district court ruled on McHose's motion to vacate and thereby set aside the June 9, 1997...