Opinion ID: 852516
Heading Depth: 2
Heading Rank: 4

Heading: Reasonable Care Under Section 19(d)

Text: The ISL liability provisions differ in some respects from those found in the Uniform Securities Act of 1956. Kirchoff v. Selby, 703 N.E.2d 644, 650 (Ind.1998). In this case, however, the relevant Indiana language is identical to the Uniform Securities Act. An individual who is potentially derivatively liable for a violation by a seller of securities bears the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist. [8] Section 19(d) of Indiana's Act (which applies to buyers and sellers) tracks this language of the Uniform Act verbatim. Accordingly, precedent from other states adopting the Uniform Securities Act is useful. The plaintiffs rely principally on Robertson v. White, 635 F.Supp. 851 (W.D.Ark. 1986), and Hines v. Data Line Systems, Inc., 114 Wash.2d 127, 787 P.2d 8 (1990), in support of their position that directors have an affirmative duty to inquire to learn whether a corporation has registered its stock and/or disclosed material information to potential investors. Like Lean, the directors in Robertson opposed summary judgment based on the reasonable care defense, including a claim that they relied on the advice of counsel. Id. at 866. The Robertson court rejected this contention, concluding that the liability imposed on directors is strict, subject only to their showing that they were either unaware that the corporation was engaged in a securities transaction or that the directors reasonably believed that the securities being sold were properly registered or exempt. Id. After reviewing the evidence, Robertson summarized it as establishing: (1) that the directors did the best they could, but were unfamiliar with corporation and securities laws; (2) that the directors hired lawyers and accountants to help them, and the lawyers and accountants assured them that everything was all right, or at least failed to tell them of the legal hazards of the program; (3) that the state agency never contacted directors personally, or alerted them that they might be liable under the Act, because the Co-op had failed or was failing to do anything which the law requires. Id. at 867. The defendants admitted the underlying fact that the directors were aware that the corporation was offering demand notes. None of the directors suggested that they believed the notes were registered. Id. Instead, all simply assumed that the transaction conformed to applicable law. Id. The court found this presented no fact issue, and liability was established as a matter of law. Id. The court held that ignorance that this could violate the registration requirement was no defense. Id. Robertson further concluded that a director cannot delegate responsibility to his lawyer in order to escape liability for a securities violation. Id. Hines followed Robertson, holding that a director's ignorance of the facts giving rise to liability is a defense only to the extent that the director can prove that even by the exercise of reasonable care he would have remained ignorant of the true state of affairs. Hines, 787 P.2d at 18 (citing Robertson, 635 F.Supp. at 865). Lean contends that the language of these cases interpreting the counterparts of section 19(d) from other states may be taken as imposing too strict an obligation of affirmative action by a director. Relying on Everts v. Holtmann, 64 Or.App. 145, 667 P.2d 1028, 1035 (Ore.1983), which applies Oregon's version of the Uniform Securities Act, Lean also argues that the reasonable care demanded of a director varies with the director's role in the transaction. We agree with Lean on these two points. Despite the differences between federal and Indiana law in standards of conduct and the persons who may be liable, ultimately, both turn on reasonable conduct or belief of the defendant. Federal cases interpreting the 1933 Act hold outside directorsthose not engaged in the day to day management of the corporationto a lesser standard of investigation. See Laven v. Flanagan, 695 F.Supp. 800, 812 (D.N.J.1988); Feit v. Leasco Data Processing Equipment Corp., 332 F.Supp. 544, 577 (E.D.N.Y.1971) (What constitutes `reasonable investigation' and `a reasonable ground to believe' will vary with the degree of involvement of the individual, his expertise, and his access to the pertinent information and data.) quoted in In re WorldCom, Inc., 346 F.Supp.2d 628, 675 (S.D.N.Y.2004). This principle is generally applicable under section 19(d) as well. Reasonable care demands more of a director charged with investigating and presenting a proposal to the board than it does of a director whose only role is to evaluate management's proposal. The issue raised by Lean's defense, however, is whether it is sufficient for an outside director to assume compliance with all applicable laws with no explicit assurance from anyone, no documentation, and in the face of a number of facts that raise obvious points of inquiry. We think a director can reasonably rely on assertions from counsel and others with expertise as to some legal conclusions, and to that extent we think that some of the language from Robertson overstates the requirement of reasonable care. A director may reasonably rely both on assertions made directly by counsel or on reasonable assurances that competent counsel have reviewed and approved the transaction. In this case, however, like Robertson, there was no evidence of assurance from counsel, whether made directly by counsel or not, that the law applicable to the Abacus acquisition had been examined and that the transaction conformed to all applicable law. Nor is there any evidence that lawyers familiar with securities or financing issues had reviewed the transaction. Under the undisputed facts of this case, the plaintiffs have established that Lean knew, or in the exercise of reasonable care could have known, that the disputed transaction involved the unlawful issuance of unregistered securities. Accordingly, we hold as a matter of law the defense of reasonable care was not established. Lean, 61, has been a lawyer since 1973 and currently chairs the government relations practice of a large law firm in Toronto, Canada. In early 2000, two directors of GOLI approached Lean about joining GOLI's board. Lean did not receive or ask for anything in writing about GOLI before accepting. On February 18, 2000, the GOLI board elected Lean as a director and also as a member of its audit committee. At that time Lean was issued options to purchase 250,000 shares at $1.25 per share. Lean attended his first board meeting on March 28, 2000, thirty-nine days after being elected a director. A quorum of GOLI's directors, including its chairman, vice-chairman, president, and executive vice-president, were present at that meeting. The company's chief operating officer, corporate secretary, and in-house legal counsel also attended. At the meeting GOLI management presented a proposal to acquire Abacus by issuing GOLI shares to the Abacus shareholders, and the board adopted a resolution approving the proposed transaction. Lean did not recall seeing a prospectus in relation to the GOLI-Abacus transaction, and he does not contend that he believed the securities were registered. Lean concedes that he voted for the transaction at the meeting of GOLI's board of directors on March 28, 2000 and did not ask any questions that would have allowed him to discover that the stock being sold by GOLI was not registered. Lean also presents no evidence that anyone affirmatively represented to the board that the proposed transaction complied with applicable law in general or applicable U.S., Canadian, or state securities laws in particular. With respect to the nondisclosure allegation, Lean concedes that he knew of the issuance of options to him and others and made no inquiry as to the disclosure of these or other items that the plaintiffs contend were material omissions. Lean also knew, or in the exercise of reasonable care would have known, that within the past few weeks the company had issued shares at prices a small fraction of $6.00 per share, but there is no evidence in the record that directly establishes Lean's knowledge of the plaintiffs' valuation of the Abacus shares. Lean concedes that there was no discussion at the March 28, 2000 meeting concerning registration of the securities but contends that there would never be such a discussion at any board meeting. The minutes of the March 28, 2000 meeting indicate that management presented information to the board regarding Abacus Computer Services and answered various questions raised by the board regarding this acquisition. Lean did not recall the specifics of that discussion. Lean testified: The natural assumption is, you turn it over to your management and lawyers, and they've done their due diligence on the company, and I'm assuming [the purchasers] did their due diligence on GOLI before they were selling their company and accepting a big chunk of money, being shares. As for the corporation's failure to register the securities, Lean testified: I would assume two things. Number one: management, in their discussions with their counterparts, would disclose everything. I would assume [the purchasers] would ask whatever questions and [the purchasers'] lawyers, as part of the closing, would ask every question, and our lawyers would be required to make disclosures, make representations, and in the normal course, do everything so that they could conclude a transaction properly. Lean designated the deposition of John McConnell, Ph.D., as an expert on corporate governance issues. McConnell testified that Lean acted with reasonable care as an outside director of GOLI. According to McConnell, the issue of securities registration would be a detail that would not rise to the level of inquiry by the board of directors and would not be an issue that would arise in the ordinary course of conducting a board meeting, including a board meeting in which securities were being issued to effectuate an acquisition. McConnell's conclusion is based on his experience and background and learning. McConnell testified, however, that had a director wanted to know whether the securities of that corporation had been registered, he could have asked at a board meeting. McConnell also testified that legal counsel who would have been present at a board meeting would have been very likely to know whether the securities were registered, and had a director asked, they would have answered the question honestly. In McConnell's personal experience, the board of directors relied on counsel and management, but primarily counsel, to ensure that whatever legal registration requirements were in place would have been followed. Thus, in his opinion, Lean was not careless in performing his duties as a member of the board of directors by relying upon management and counsel to ensure or assure or take appropriate actions to assure that whatever legal statutes were applicable were being followed. McConnell, however, acknowledged that he saw no documents or any indication that any member of GOLI management made any written or oral report in Lean's presence regarding the topic of registration. McConnell also testified that directors review the prospectus prepared by legal counsel, presumably for untrue statements that would have been brought to the attention of the counsel and management as part of a director's duty. There was no documentation presented to the GOLI board.