Source: http://openjurist.org/8/f3d/1079
Timestamp: 2015-11-28 20:30:13
Document Index: 102528658

Matched Legal Cases: ['§ 10', '§ 78', '§ 240', '§ 523', '§ 523', '§ 523', '§ 523', '§ 523', '§ 1962', '§ 1964']

8 F3d 1079 Stone v. Kirk Jwk | OpenJurist
8 F. 3d 1079 - Stone v. Kirk Jwk HomeFederal Reporter, Third Series 8 F.3d
8 F3d 1079 Stone v. Kirk Jwk 8 F.3d 1079
62 USLW 2354, Fed. Sec. L. Rep. P 97,808,RICO Bus.Disp.Guide 8409,39 Fed. R. Evid. Serv. 1076
David STONE and Colleen Stone, Plaintiffs-Appellees,v.John Wilson KIRK and J.W.K. Land and Cattle Company, Inc.,Defendants-Appellants.
No. 91-5833.
Argued Feb. 20, 1992.Decided Nov. 1, 1993.
Joel C. Morgan, J. Randall Reinhardt (argued and briefed), Reinhardt, Morgan & Arnold, Lexington, KY, for plaintiffs-appellees.
Lawrence R. Webster, Pikeville, KY, Felix J. Gora (argued), Ralph F. Mitchell (briefed), Rendigs, Fry, Kiely & Dennis, Cincinnati, OH, for defendants-appellants.
Before: MARTIN, MILBURN and NELSON, Circuit Judges.
This is a securities fraud case that arises out of sales of tax shelters designed to give investors the benefit of large investment tax credits. The credits were ultimately disallowed by the Internal Revenue Service, which found the tax shelters to be fraudulent and abusive.
The individual defendant, a certified public accountant who received hidden commissions on sales he made to groups of accounting clients and others, went bankrupt after the filing of the lawsuit. An adversary proceeding on the dischargeability of his asserted debt to the plaintiffs, who were client-investors, was consolidated for trial with the securities fraud case.
The jury returned a verdict in favor of the plaintiffs, finding them entitled to compensatory and punitive damages and finding the debt nondischargeable in bankruptcy. The compensatory damages were trebled under the Racketeer Influenced and Corrupt Organizations Act ("RICO").
The defendants contend on appeal that (1) judgment should have been entered in their favor because the tax shelters did not come within the statutory definition of a "security;" (2) the question of dischargeability was for the court to decide, not the jury; (3) judgment should have been entered for the defendants on grounds of insufficiency of the evidence with respect both to the fraud claim and the RICO claim; (4) the trial court committed reversible error in letting a certified public accountant from Kentucky testify as an expert on professional standards in West Virginia; (5) the award of compensatory damages was excessive; and (6) the court erred in awarding punitive damages.
We conclude that the tax shelters were investment contracts, a type of investment expressly included within the statutory definition of securities; that there was sufficient evidence to support the jury's finding of liability under the securities laws, but not to support the award of treble damages under RICO; that no significant error was committed as to the expert witness' testimony; and that any error in submitting the issue of dischargeability to the jury was harmless, given the collateral effect of the judgment for the plaintiffs on the securities fraud issue.
We further conclude that the jury applied an erroneous measure of damages in its calculation of the amount recoverable under the securities laws, and we conclude that punitive damages should not have been awarded here. We shall therefore affirm the judgment as to liability for securities fraud and as to dischargeability in bankruptcy, reverse the award of punitive damages and treble damages, and remand the case for a redetermination of actual damages.
I. Statement of the Facts.
Plaintiff David Stone, a mechanic with a high-school education, worked in a coal mining business conducted by Amber Coal Company. The company had offices in the eastern part of Kentucky, the state in which David Stone and his wife, plaintiff Colleen Stone, resided.1
Amber Coal Company's principals gave Mr. Stone an equity interest in the company in exchange for his services as a mechanic. As part of the compensation package, Mr. Stone testified, defendant John Wilson Kirk, who was Amber's accountant, prepared the Stones' individual income tax returns. Mr. Kirk, who was not licensed in Kentucky, maintained an office in Williamson, West Virginia.
In 1980 or thereabouts, Mr. Stone testified, the profitability of Amber's coal business rose to a point where Stone began earning hundreds of thousands of dollars a year. The top federal income tax bracket at that time was 50 percent, and defendant Kirk recommended that the Stones buy tax shelters from him to reduce their heavy tax burden. Each tax shelter was organized as a joint venture among several investors. The investors pooled their funds and jointly empowered Mr. Kirk to conduct the affairs of the venture as their agent.
Mr. Kirk allegedly represented that the tax shelters were good investments from a business standpoint and that there was "[n]ot a thing wrong with [them]" as far as the Internal Revenue Service was concerned. Some of the conversations about the tax shelters took place at Amber Coal Company's office in Kentucky, some took place at Kirk's office in West Virginia, and one took place at the Stones' Kentucky home.
The business of each joint venture entailed the leasing of a "master recording" that could be used for the production of phonograph records, tapes and cassettes. The recordings, which featured the work of such well known country music singers as Mel Tillis, Jerry Lee Lewis and Tammy Wynette, were owned by Sagittarius Recording Company, a corporation based in Columbus, Ohio.2 It has not been shown that defendant Kirk had any interest in or connection with Sagittarius other than as a sales representative operating on a commission basis.
Sagittarius acquired the master recordings at grossly inflated prices, making small cash payments up front and issuing long term promissory notes for the balance. The IRS subsequently determined that the notes were without recourse, notwithstanding that they were described by Sagittarius as recourse notes. Appraisals obtained by Sagittarius to support the fair market value claimed for the masters turned out to be fraudulent. Defendant Kirk had nothing to do with the purchase of the masters by Sagittarius, nor was he involved in obtaining the fraudulent appraisals.
Under the leasing programs offered by Sagittarius, investment tax credits based on the bogus purchase prices were supposed to be passed through to the lessee-investors. A district judge who handled another Sagittarius case found that "investors were lured into the scheme by promise of a ratio of tax write-off to lease payment of approximately eight to one...." Kolibash v. Sagittarius Recording Co., 626 F.Supp. 1173, 1178 n. 3 (S.D.Ohio 1986). Defendant Kirk, however, did not claim write-offs of that magnitude for the Stones.
Mr. Kirk first learned about the leasing programs from a Sagittarius vice-president who gave him an offering memorandum, or prospectus, and told him that the programs it described were good "exotic" tax shelters. (The prospectus emphasized that "THE LEASE PROGRAM DESCRIBED HEREIN INVOLVES A HIGH DEGREE OF RISK;" there is a conflict in the evidence as to whether Kirk disclosed this "high degree of risk" to the Stones.) Kirk's initial response, according to the testimony of his secretary, was to tell the Sagittarius man to get out of his office because "[t]here is no way that would work."
Discussions between Kirk and Sagittarius continued over a period of several months, notwithstanding Mr. Kirk's initial negative reaction, and in 1981 Kirk started selling leases of master recordings owned by Sagittarius. Although he testified, somewhat implausibly, that he began his sales efforts before he knew he would be getting commissions, he admitted that Sagittarius allowed him to keep at least 18 percent of what he took in.
There was evidence that Mr. Kirk invested some of his own money in the leasing programs so that "his clients and other people he tried to sell them to would feel more free buying them." Kirk committed himself to put $6,480 into the first joint venture for which Mr. Stone subscribed, for example. Mr. Kirk's former wife testified that Kirk kept in their home at Turkey Creek a white ledger book in which he maintained records of both his own investments and his receipts from other investors. She said that he told her "if the IRS ever came in, to be sure that they didn't get it."
Mr. Stone testified that Mr. Kirk represented that he "was going to get a small percentage of something for taking care of the book work"--Kirk's version was that he told his clients "everybody makes money on these deals"--but Kirk failed to disclose that Sagittarius was giving him a sizable percentage of the lease payments. Mr. and Mrs. Stone's understanding, they both testified, was that 100 percent of the lease payments were going to the company that owned the recordings.
There was abundant evidence that the "book work" mentioned in Mr. Stone's testimony was understood to be work performed by Mr. Kirk as agent for the joint ventures. Mr. Stone signed a total of three joint venture agreements, two in 1981 and one in 1982, each of which designated John Wilson Kirk as the venture's agent. The agreements empowered Mr. Kirk, acting on behalf of the joint venture, to sign leases with Sagittarius and to sign manufacturing/distribution contracts with companies which, it was contemplated, would make records and tapes from the masters and distribute the finished products.3 Mr. Kirk undertook to file partnership tax returns for the joint ventures and to render periodic accountings to the venturers. The joint venture agreements set Mr. Kirk's compensation at five cents for each album or cassette sold, plus (in the case of two of the agreements) an annual "administration fee" of $50 or $100. Mr. Stone knew of these provisions in the joint venture agreements, and he testified that he did not know that Kirk was taking sales commissions in addition to the compensation authorized in the agreements.
Mr. Kirk signed a manufacturing/distribution agreement on behalf of at least one of the joint ventures in which the Stones invested, but judging by the royalties the Stones received on this particular investment--a total of $3.87--Kirk's compensation as agent for the venture would have been minimal. The Stones received no return at all on the other joint ventures.
The Stones' total investment--represented in large part by checks made out to defendant J.W.K. Land and Cattle Company, a corporation of which John Wilson Kirk was president--approximated $90,000. The jury could properly have found that Mr. Kirk kept more than 18 percent of this sum for himself and an employee. With respect to the 1981 Sagittarius programs, Mr. Kirk testified that it was "normal" for him to receive an 18 percent commission. Mr. Kirk acknowledged that his secretary received five percent of the investments made in 1982, and that he himself received an additional 18 percent of the 1982 investments. Both Mr. Stone and Mrs. Stone testified that if they had known of these commissions, they would not have invested in the tax shelters.
The investments proved costly, of course; the Stones lost their $90,000, the anticipated tax benefits were disallowed, and the Internal Revenue Service demanded penalties and interest on the overdue taxes. The Stones ended up owing the IRS a total of about $280,000 in back taxes, interest and penalties. The penalty portion, according to Mr. Stone's testimony, totaled just under $45,000.
II. The Proceedings in the District and Bankruptcy Courts.
In March of 1986 the Stones brought suit in a Kentucky federal district court against John Wilson Kirk, J.W.K. Land and Cattle Company, Sagittarius Recording Company, The Cambridge Company, and others. In addition to setting forth a claim for securities fraud under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, and Rule 10b of the Securities and Exchange Commission, 17 C.F.R. § 240.10b, plus a claim for treble damages under RICO, the complaint alleged common law fraud, breach of contract, and professional negligence on the part of Mr. Kirk. All of the defendants except Mr. Kirk and J.W.K. Land and Cattle Company ultimately settled out of court or were dismissed for other reasons.
Mr. Kirk filed a Chapter 7 bankruptcy petition in July of 1987, and his corporation subsequently followed suit. In October of that year the Stones initiated an adversary proceeding in which they sought to have their claims against Mr. Kirk held nondischargeable in bankruptcy pursuant to subsections (2), (4) and (6) of 11 U.S.C. § 523(a). Commenced originally in the bankruptcy court, the adversary proceeding was later transferred to the district court and consolidated there with the securities fraud case.
In November of 1988 Mr. Kirk moved for summary judgment on the dischargeability of the Stones' claims. The motion was accompanied by an affidavit in which Kirk asserted that he had not known anything was amiss with the Sagittarius programs until two years after the Stones made their investments. The district court denied the summary judgment motion, noting Mr. Kirk's failure to disclose his large commissions and other evidence suggesting that he should have known of the likelihood that the IRS would disallow the investment tax credit.
In a "statement of jury issues" filed in November of 1989, the plaintiffs took the position that the issue of dischargeability should be tried to the jury. The defendants filed a written response in which they renewed an offer to stipulate the facts and let the court determine dischargeability on the basis of the stipulation. Nothing came of this offer, and about a year later the defendants filed a motion to strike the plaintiffs' jury demand. The district court denied the motion.
The consolidated cases were tried to a jury in April of 1991. The defendants moved for judgment at the conclusion of the plaintiffs' case, and the motion was denied except insofar as the plaintiffs claimed nondischargeability under 11 U.S.C. § 523(a)(6), a subsection dealing with "willful and malicious injury...." The defendants renewed their motion at the conclusion of all the evidence, whereupon the court directed a verdict for defendant Kirk on the issue of dischargeability under § 523(a)(4). (This subsection deals with "fraud or defalcation while acting in a fiduciary capacity....") The plaintiffs' claim of nondischargeability under § 523(a)(2)--a subsection dealing with money obtained by "false pretenses, a false representation, or actual fraud"--was submitted to the jury, as were the securities fraud and RICO claims.
Although the court's charge to the jury included an instruction on punitive damages, which instruction came immediately after one on damages under the 1934 Act, the jury was given no instructions regarding the plaintiffs' common law fraud claim. Neither was the jury asked to decide the claims for breach of contract and professional negligence.
Responding to a series of written interrogatories, the jury found that the plaintiffs' claims against John Wilson Kirk were not discharged in bankruptcy under the court's instructions regarding 11 U.S.C. § 523(a)(2); that defendant Kirk "acted with fraud and deceit" in connection with the sale of master recording leases, as described in the court's instruction on securities fraud; that compensatory damages in the amount of $430,800 would adequately compensate the plaintiffs for any loss suffered; that the amount of punitive damages necessary to deter future misconduct was $500,000; and that the defendants violated 18 U.S.C. § 1962(c) by engaging in an enterprise through a pattern of racketeering activity, as described in the court's RICO instruction. The court entered judgment on the jury's verdict, trebling the compensatory damages pursuant to RICO (see 18 U.S.C. § 1964) and awarding interest on a total of $1,792,400 from August 29, 1982. The court subsequently denied a motion for judgment n.o.v. and/or a new trial, and the defendants filed a timely notice of appeal on June 25, 1991.
III. The Investment Contract/Security Issue.
The threshold question presented by the plaintiffs' securities fraud claim is whether what the plaintiffs invested in was actually a "security." See Union Planters Nat. Bank v