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Fed. Sec. L. Rep. P 97,727samuel Weaver and Alice Weaver, Appellants, v. Marine Bank, 637 F.2d 157 (3d Cir. 1981) :: Justia
Justia › US Law › Case Law › Federal Courts › Courts of Appeals › Third Circuit › 1981 › Fed. Sec. L. Rep. P 97,727samuel Weaver and Alice Weaver, Appellants, v. Marine Bank
Fed. Sec. L. Rep. P 97,727samuel Weaver and Alice Weaver, Appellants, v. Marine Bank, 637 F.2d 157 (3d Cir. 1981)
US Court of Appeals for the Third Circuit - 637 F.2d 157 (3d Cir. 1981) Argued Sept. 18, 1980. Decided Dec. 15, 1980. Rehearing Denied Jan. 26, 1981. As Amended Jan. 28, 1981
The district court did not conclude that the conduct of the Bank's agents which a fact finder might find, if it occurred "in connection with" the sale or purchase of a security, would not be a violation of Rule 10(b) (5). The court appears to have assumed, without deciding, that liability might be predicated upon a conclusion that as an insider, having access to information not available to the public, the Bank had a duty to disclose material adverse information, or that even if the Bank were not treated as an insider it might be found to be an aider and abettor in a fraud committed by the Piccirillos. See, e. g., SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968), cert. denied, 404 U.S. 1005, 92 S. Ct. 561, 30 L. Ed. 2d 558 (1971) (an insider is one who has access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the benefit of anyone); Monsen v. Consolidated Dressed Beef, 579 F.2d 793, 799 (3d Cir.), cert. denied sub nom. First Pennsylvania Bank N.A. v. Monsen, 439 U.S. 930, 99 S. Ct. 318, 58 L. Ed. 2d 323 (1978) (plaintiffs have the burden of establishing that there has been a wrongful act, and that the alleged aider and abettor knew of and substantially assisted in the wrongdoing); Landy v. FDIC, 486 F.2d 139, 162-63 (3d Cir. 1973), cert. denied, 416 U.S. 960, 94 S. Ct. 1979, 40 L. Ed. 2d 312 (1974) (an aider and abettor is liable if an independent wrong exists, he knew of the wrong, and substantial assistance was given in effecting it). Rather, the court concluded that if a wrong occurred, on the undisputed facts as a matter of law it did not take place "in connection with the purchase or sale of any security." 15 U.S.C. § 78j(b).
The Weavers urge that a fact finder could hold that the Bank's manipulative and deceptive conduct fell within the proscription in section 10(b) because it was in connection with the purchase of a security from the Piccirillos, and also in connection with the sale of a security to the Bank. If they are right on either contention, summary judgment should not have been granted in favor of the defendant. We address those questions separately, starting with the definition of security in the Securities and Exchange Act of 1934 quoted in the margin.2 II.
A fact finder certainly could on the record before us find that the Bank's manipulative and deceptive conduct, if it took place, was in connection with the execution and delivery of an agreement between the Piccirillos and the Weavers by which, in consideration of their pledge of a $50,000 certificate of deposit to enable Columbus Packing to obtain a working capital loan, they were given a fifty percent interest in the anticipated profits of the Piccirillos' slaughterhouse. Nor is there any question but that the transaction between the Piccirillos and the Weavers would qualify as a sale. The narrower question is whether whatever interest was sold by the Piccirillos falls within one of the categories of securities set forth in section 3(a) (10). It is a settled rule of construction of that definitional section that the categories are not mutually exclusive. "Instruments may be included within any of (the Act's) definitions, as a matter of law, if on their face they answer to the name or description." Tcherepnin v. Knight, 389 U.S. 332, 339, 88 S. Ct. 548, 555, 19 L. Ed. 2d 564 (1967), quoting SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 351, 64 S. Ct. 120, 124-125, 88 L. Ed. 88 (1943). More specifically, an interest can be both a certificate of interest or participation in any profit-sharing agreement, and an investment contract. Tcherepnin v. Knight, 389 U.S. at 339, 88 S. Ct. at 555. We hold that the agreement whereby the Piccirillos and the Weavers each would receive fifty percent of the profits of Columbus Packing could be found by a trier of fact to be either or both.
The classic example of a certificate of interest or participation in a profit-sharing arrangement cited by Professor Loss is a contract whereby the buyer furnishes funds and the seller the skill for speculating in the stock or commodities markets under an arrangement to split any profits. 1 Loss, Securities Regulation 489 (2d ed. 1961). Aside from the brief reference to it in Tcherepnin, this clause has not often been considered by the Supreme Court. Cf. International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 558 n.11, 99 S. Ct. 790, 796, 58 L. Ed. 2d 808 (1979). There are, however, ample applications elsewhere of that clause to arrangements which are quite closely analogous to that before us. See, e. g., SEC v. Addison, 194 F. Supp. 709, 721-22 (N.D. Tex. 1961) (written agreements in connection with loans to the effect that defendants would cause contracts to be executed conveying to lenders a percentage interest in profits from defendants' mining operations); William Tell Productions, Inc., Sec. Act Rel. 3852 (1957), 3-4 (fractional interest in a percentage of gross revenues to be realized from an exclusive production of a copyrighted television production). No reason occurs to us why a sale of an interest in the future profits of a slaughterhouse ought to be treated differently. In the cited interest or participation in a profit-sharing agreement cases the interest was offered to more persons than a husband and wife. The nature and size of the offering, however, bears only on whether the interest sold is exempt from registration under the Securities Act of 1933, not on whether the interest is a security. Section 10(b) of the 1934 Act covers both registered and unregistered securities. The Columbus Packing interest is evidenced by a writing calling for a participation in its future profits derived as a result of the Piccirillos' management of the slaughterhouse. A jury could find that it was a certificate of interest or a participation in a profit-sharing agreement.3
In contrast with the profit-sharing agreement clause, the investment contract clause has received a fairly extensive exegesis in the Supreme Court. In the leading case of SEC v. W. J. Howey Co., 328 U.S. 293, 66 S. Ct. 1100, 90 L. Ed. 1244 (1946), contracts for the sale of units of land in a citrus grove development, coupled with contracts with the promoter for cultivating, harvesting, and marketing the crop were found to be investment contracts. The crop from the entire grove was to be sold, and the net proceeds distributed to the separate land owner in the proportion that the land of each produced the crop. If there is a difference between a profit-sharing agreement and an investment contract, probably it is in the fact that the latter includes transactions such as that in Howey, in which the purchaser did not share the profits on his investment with others, but kept the net proceeds himself. The court capsulized the test for distinguishing an investment contract from a mere commercial or consumer transaction as "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." 328 U.S. at 301, 66 S. Ct. at 1104. In subsequent cases the Court has adhered to this test,4 although recently the justices have differed as to its application to a specific set of facts. In United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S. Ct. 2051, 44 L. Ed. 2d 62 (1975), a majority of the Court held that an investment in a cooperative housing project was not a security. Justice Powell, writing for the Court, quoted the Howey test and further stated:
The touchstone is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. By profits, the Court has meant either capital appreciation resulting from the development of the initial investment, as in Joiner, supra (sale of oil leases conditioned on promoters' agreement to drill exploratory well), or a participation in earnings resulting from the use of investors' funds, as in Tcherepnin v. Knight, supra (dividends on the investment based on savings and loan association's profits). In such cases the investor is "attracted solely by the prospects of a return" on his investment. Howey, supra, (328 U.S.) at 300 (66 S. Ct. at 1103-1104). By contrast, when a purchaser is motivated by a desire to use or consume the item purchased "to occupy the land or to develop it themselves," as the Howey Court put it, ibid. the securities laws do not apply.
421 U.S. at 852-53, 95 S. Ct. at 2060-2061 (footnote omitted). Here there is no evidence whatsoever in the record that the Weavers wanted to use or develop the Columbus Packing slaughterhouse themselves. It does not appear that they were issuing their obligations to purchase a business they intended to manage.5 A fact finder could determine that the Weavers made a $50,000 investment motivated primarily by a desire to earn fifty percent of the profits earned by the use of those funds as working capital in a business run by the Piccirillos.
Under the 1934 Act the term purchase includes any contract to buy, purchase, or otherwise dispose of, and the term sale includes any contract to sell or otherwise dispose of. 15 U.S.C. § 78c(a) (13), (14). On March 17, 1978, the Weavers executed an assignment reading in part:
We have little doubt that if the Weavers had delivered a forged instrument the Bank would contend vigorously that it had made a purchase within the meaning of the 1934 Act, and that the Weavers ought to be prosecuted by the federal government. There is no reason for treating the Weavers' pledge of a valid instrument differently. Thus we agree with those cases in the Second Circuit which have consistently held that a pledge is a sale. Mallis v. Federal Deposit Ins. Corp., 568 F.2d 824, 829-30 (2d Cir. 1977), cert. dismissed sub nom. Banker's Trust Co. v. Mallis, 435 U.S. 381, 98 S. Ct. 1117, 55 L. Ed. 2d 357 (1978) (pledge is a contract to sell or otherwise dispose of); United States v. Gentile, 530 F.2d 461, 466-67 (2d Cir.), cert. denied, 426 U.S. 936, 96 S. Ct. 2651, 49 L. Ed. 2d 388 (1976) (pledge is a sale). See also Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1028-30 (6th Cir. 1979). There are contrary expressions in other courts.6 We do not find them persuasive, if for no other reason than that there is no reason to presume that Congress intended to exclude lending institutions extending credit on the security of pledged collateral from the protection of section 10(b). If a pledge is a purchase for the purpose of protecting a lender it is equally a sale for purposes of protecting the pledgor. Moreover, most of the courts which have intimated that the pledge transaction is not a sale have conceded that its foreclosure is.7 In this case since the Bank is the issuer of the certificate of deposit, foreclosure, if it is permitted, will take the form of a mere refusal to honor the certificate of deposit, and the setting off of the liability against the Columbus Packing debts. We conclude that on this record a fact finder could hold that a sale of the Weavers' certificate of deposit occurred.
That leaves the question whether the certificate of deposit was itself a security. We note at the outset that it was issued by Marine Bank. That fact is significant only for purposes of section 3(a) (2) of the Securities Act of 1933, which exempts from its registration requirements securities issued by banks whose issues are regulated by federal or state banking officials. 15 U.S.C. § 77c(a) (2). However, bank securities are not exempt from the antifraud provisions of the 1934 Act. See 2 Bromberg & Lowenfels, Securities Fraud & Commodities Fraud, § 6.5(312), at 136.1 (1979).
We can in this case also exclude the exception in the 1934 Act's definition of security for "currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months...." 15 U.S.C. § 78c(a) (10). The certificate of deposit pledged by the Weavers was certainly not currency. Furthermore, since the issuing bank had no obligation to pay for six years, it did not qualify for the nine month commercial paper exception.
In Tcherepnin v. Knight, 389 U.S. 332, 88 S. Ct. 548, 19 L. Ed. 2d 564 (1967), referred to above in our discussion of investment contracts and profit sharing agreements, the Supreme Court held that withdrawable capital shares in a savings and loan association were securities. From an investor's standpoint those shares were the functional equivalents of certificates of deposit, except, perhaps, for the fact that the savings and loan in Tcherepnin was a mutual institution in which the depositors had an interest in profits. Here, Marine Bank's obligation is to pay a sum certain and a fixed interest return. It is in form and in fact a long term debt obligation. Although, technically, Tcherepnin is not controlling, functionally, from the depositor's standpoint, it is hard to distinguish long term deposit transactions with mutual institutions from similar deposit transactions with banks operated for the profit of stockholders. Moreover, when the Court wrote Tcherepnin it must have been aware that the Administrator of National Banks in a Statement of Policy on Advertising for Funds by National Banks, 31 Fed.Reg. 16581 (1966), endorsed the SEC's view that deposit and share accounts of banks are subject to the antifraud provisions of the securities laws. See 1 Bromberg & Lowenfels, Securities Fraud & Commodities Fraud, #4.6(374), at 82.15. Finally, we note that the Securities and Exchange Commission has taken the position that certificates of deposit issued by banks are securities.8
It should come as no surprise that the panel is divided on the issues in this case because what constitutes a security under the 1933 and 1934 Acts is a matter which continues to trouble courts and commentators. There is no disagreement here about the facts or the inferences that can be drawn from them, except as they shed light on the preliminary clause of the definitions in § 3(a) (10) of the Security Exchange Act: unless the context otherwise requires." 15 U.S.C. § 78c(a) (10) (1976).
The majority concludes that the interest sold by Piccirillo falls within one of the categories of security set forth in § 3(a) (10), but I am unable to accept that proposition based upon the facts of this case. The agreement here provided that in consideration for agreeing to act as co-obligor on Piccirillo's loan from the bank, Weaver would have the right, as long as Piccirillo was operating and in possession of the Columbus Packing premises:
In construing the Securities Act of 1933, 15 U.S.C. §§ 77a-77aa (1976), the Supreme Court noted that "courts will construe the details of an act in conformity with its dominating general purpose, will read text in the light of context and will interpret the text so far as the meaning of the words fairly permits so as to carry out in particular cases the generally expressed legislative policy." SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 350-51, 64 S. Ct. 120, 123-124, 88 L. Ed. 88 (1943) (footnote omitted).
Some years later, the Court emphasized that the focus of the Act is on the sale of securities to raise money for profitmaking purposes, on the exchanges on which securities are traded, and on the need for regulation to prevent fraud and protect investors. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 849, 95 S. Ct. 2051, 2059, 44 L. Ed. 2d 621 (1975). Thus, while the statutes are to be construed liberally, application is to turn on the economic realities underlying a particular transaction. Id. at 851-52, 95 S. Ct. at 2060. And as we cautioned in Lino "not every plan generating allegations of fraud is a violation of federal securities law." 487 F.2d at 695.
The majority believes that the Piccirillo agreement comes within the Exchange Act designation of an investment contract. In United Housing Foundation, Inc. v. Forman, the Court reaffirmed the explanation of the type of security that it had discussed in SEC v. W. J. Howey Co., 328 U.S. 293, 301, 66 S. Ct. 1100, 1104, 90 L. Ed. 1244 (1946). Describing its formulation as a "shorthand form ... (of) the essential attributes," the Court defined an investment contract as "an investment of money in a common enterprise with profits to come solely from the efforts of others." 421 U.S. at 852, 95 S. Ct. at 2061. Application of that definition to the circumstances present here raises two issues: first, whether a "common enterprise" existed when only two parties were involved in the transaction;1 and secondly, were the "profits" to come solely from the "efforts of others" when part of the consideration recited was Weaver's right to use Piccirillo's barn and pasture.
Although a security was found to exist in Howey, several significant facts in that case contrast starkly with the circumstances at hand. In Howey, there was a public offering, an advertising program, sales to persons who were not residents of the state, and, during a 28 month period, purchases by 42 persons. Similarly, in Tcherepnin v. Knight, 389 U.S. 332, 88 S. Ct. 548, 19 L. Ed. 2d 564 (1967), where the Court found capital shares in a savings and loan association to be an investment contract within the Securities Exchange Act, the plaintiff class consisted of more than 5,000 investors.
When the number of participants was much smaller, a different result has been reached. The Court of Appeals for the Seventh Circuit in Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 100 (7th Cir. 1977), concluded that the requirement of a common enterprise includes both multiple investors and a pooling of their funds. In that case, an arrangement through which individual investors deposited funds with a commodity broker in separate discretionary accounts for investment in a profit sharing arrangement was held to be neither an investment contract nor a profit sharing plan within the Securities Act. Wasnowic v. Chicago Board of Trade, 352 F. Supp. 1066 (M.D. Pa. 1972), aff'd mem., 491 F.2d 752 (3d Cir.), cert. denied, 416 U.S. 994, 94 S. Ct. 2407, 40 L. Ed. 2d 773 (1974). Cf. SEC v. Continental Commodities Corp., 497 F.2d 516 (5th Cir. 1974) (multiple investors but no pooling).
The rationale employed by the Seventh Circuit in requiring multiple investors to satisfy the commonality requirement is persuasive, and I would follow Hirk for that reason alone. But even more compelling is that the result is in keeping with the general purpose of the Securities Exchange Act to regulate the securities markets where the public trades, and to scrutinize the various arrangements which are offered to the public as investments. United Housing Foundation, Inc. v. Forman, supra 421 U.S. at 837, 95 S. Ct. at 2053. In the case at bar, no widespread public interest is affected.2 The transaction was a face to face encounter involving two parties who made a loan agreement. See Great Western Bank and Trust Co. v. Kotz, 532 F.2d 1252, 1262 (9th Cir. 1976) (Wright, J., concurring). Here there is no distribution of a widely offered instrument commercially known as a security, as is the case with the various schemes involving transactions regulated by the Act. See, e. g., SEC v. C. M. Joiner Leasing Corp., supra 320 U.S. at 352-53, 64 S. Ct. at 124; Hirk v. Agri-Research Council, Inc., supra at 103; SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974). In addition, there is no suggestion that the laws of Pennsylvania do not provide for an appropriate resolution of the dispute in this case. Indeed, as the majority notes, the plaintiff included pendent state claims in his complaint.3
If the other circumstances of the case at hand were not involved, the 50% share of the profits would carry the day on a similar basis. But more weight being given to Weaver's right to Piccirillo's barn and pasture is warranted when the arrangement is viewed in toto. Obviously, that benefit was of more value to Weaver than it would be to an out of state resident or to a person who had no connection with cattle raising. It is more in the nature of a "personal use" accomodation, shaped to fit the particular needs of the private parties involved. Thus, the arrangement between Weaver and Piccirillo does not have an equivalent money value to all persons, another characteristic generally attributable to true securities. See United Housing Foundation, Inc. v. Forman, supra 421 U.S. at 851, 95 S. Ct. at 2060. Moreover, when this factor is added to the lack of such features as common enterprise, use of a public market, public offering, and need for federal regulation, the conclusion is inescapable that the transaction between Weaver and Piccirillo does not qualify as a security within the meaning of the Securities and Exchange Act.
Section 3(a) (10) of the 1934 Act includes among its definitions of security, "certificate of deposit, for a security." The majority is correct in not relying on this language as a basis for its finding that the certificate of deposit under scrutiny here falls within that clause. The certificate in this case is an entirely different obligation, being a type of time deposit with a bank, rather than a receipt for a security as that term is used in the statute.
The majority does rely to some extent on the fact that the certificate is not due until six years after issuance, and that the Act's exclusion of obligations having a maturity of less than nine months is therefore inapplicable. The negative inference that the certificate is a security because it is not expressly exempted, however, is not determinative. That is, a note payable in less than nine months may be a security in some situations while a similar obligation of a longer maturity may be outside the Act's ambit in other cases. McClure v. First National Bank of Lubbock, 497 F.2d 490, 495 (5th Cir. 1974), cert. denied, 420 U.S. 930, 95 S. Ct. 1132, 43 L. Ed. 2d 402 (1975).
The American Law Institute shares this view, for its proposed Federal Securities Code specifically excludes from the definition of security an interest in a deposit account with a bank, and "a bank certificate of deposit that ranks on a parity with an interest in a deposit account with the bank." Ali Fed. Securities Code, § 299.53(b) (5) (Mar. 15, 1978 Draft). As the Committee comments, "although literally one may find an "evidence of indebtedness" or (when interest is paid) an "investment contract," it seems logical to exclude these interests along with traditional insurance policies and annuity contracts from the definition of "security." The exclusion extends to savings and checking accounts, as well as time and demand deposits, but not to custody accounts. The proposed exemption does not apply to savings and loan associations in recognition of the distinction between Tcherepnin-type interests and the usual commercial bank transactions.4
Since I would hold that the certificate of deposit was not a security, I need not address the issue of whether a pledge constitutes a sale, a point of conflict between the circuits that may soon be resolved by the Supreme Court. United States v. Rubin, 609 F.2d 51 (2d Cir. 1979), cert. granted, 445 U.S. 960, 100 S. Ct. 1645, 64 L. Ed. 2d 234 (1980).
Section 3(a) (10) provides in pertinent part:
15 U.S.C. § 78c(a) (10). As is here relevant, the definition of security is essentially the same as in § 2(1) of the Securities Act of 1933, 15 U.S.C. § 77b(1). In any event, the definitions have been considered to be virtually identical. See, e. g., United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 847 n.12, 95 S. Ct. 2051, 2058, 44 L. Ed. 2d 621 (1975); Tcherepnin v. Knight, 389 U.S. 332, 342, 88 S. Ct. 548, 556, 19 L. Ed. 2d 564 (1967).
See Tcherepnin v. Knight, 389 U.S. 338, 88 S. Ct. 554 (withdrawable capital shares in savings and loan association are investment contracts); International Brotherhood of Teamsters v. Daniel, 439 U.S. at 558, 99 S. Ct. at 795-796 (1979) (noncontributory, compulsory pension plan is not an investment contract). The Howey rule was anticipated in SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 64 S. Ct. 120, 88 L. Ed. 88 (1943)
See, e. g., Lincoln Nat'l Bank v. Herber, 604 F.2d 1038, 1044 (7th Cir. 1979); National Bank of Commerce of Dallas v. All American Assurance Co., 583 F.2d 1295, 1299-30 (5th Cir. 1978); Reid v. Hughes, 578 F.2d 634, 638 (5th Cir. 1978); McClure v. First Nat'l Bank of Lubbock, Texas, 497 F.2d 490, 495-96 (5th Cir. 1974), cert. denied, 420 U.S. 930, 95 S. Ct. 1132, 43 L. Ed. 2d 402 (1975); Rispo v. Spring Lake Mews, Inc., 485 F. Supp. 462, 467-68 (E.D. Pa. 1980)
As the dissent correctly notes, the Supreme Court has granted certiorari on the question of whether a pledge of stock to a bank as collateral for a bank loan is an offer of sale for a security under § 17(a) of the Securities Act of 1933. Rubin v. United States, 445 U.S. 960, 100 S. Ct. 1645, 64 L. Ed. 2d 234 (1980), granting cert. to United States v. Rubin, 609 F.2d 51 (2d Cir. 1979).
See MacKethan v. Peat, Marwick, Mitchell & Co., 439 F. Supp. 1090, 1094 (E.D. Va. 1977), referring to the amicus curiae brief of the Securities & Exchange Commission filed in Burrus, Cootes & Burrus v. MacKethan, 537 F.2d 1262 (4th Cir. 1976)
We do not rely on the language "certificate of deposit, for a security" in section 3(a) (1). That language refers to a type of security irrelevant to the issues in this case
See FitzGibbon, What is a Security? A Redefinition Based on Eligibility to Participate in the Financial Markets, 64 Minn. L. Rev. 893 (1980)