Opinion ID: 608133
Heading Depth: 1
Heading Rank: 2

Heading: analysis

Text: The Case Against Keim 29 The Issuer. The notes and mortgages given to the Investors by the Venture in 1985 and 1986 were investment contracts constituting securities under the Securities Act of 1933, 15 U.S.C. § 77b(1) (Supp.1992). SEC v. Howey Co., 328 U.S. 293, 301, 66 S.Ct. 1100, 1104, 90 L.Ed. 1244 (1946); Safeway Portland Employees' Fed. Credit Union v. C.H. Wagner & Co., 501 F.2d 1120, 1123 (9th Cir.1974). Accordingly, the Venture was an issuer under the statute. 15 U.S.C. § 77b(4) (1981). 30 The Issuer's Scienter. If the representations made by LaPrade were false, the issuer had the scienter that Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) requires for Rule 10b-5 liability. Id. at 212-14, 96 S.Ct. at 1390-91. The issuer is chargeable with the knowledge of LaPrade, the head of its Management Committee, acting to market the issuer's securities. That LaPrade acted through Incor cannot insulate the issuer from his knowledge. The issuer is equally possessed of scienter if the providing of the appraisal reports to Incor for fund-raising is found to have been the providing of information not fraudulently but recklessly. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir.1990), cert. denied, --- U.S. ----, 111 S.Ct. 1621, 113 L.Ed.2d 719 (1991). Such recklessness would be established by showing that knowing of Incor's fund-raising, the issuer provided the reports to be read by laypersons in  'an extreme departure from the standards of ordinary care'  and with the danger of misleading the purchasers of the securities  'so obvious'  that the issuer must have been aware of it. Id. (quoting Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir.), cert. denied, 434 U.S. 875, 98 S.Ct. 224, 225, 54 L.Ed.2d 155 (1977). 31 The Controlling Persons of the Issuer. In general, the determination of who is a controlling person for purposes of liability under 15 U.S.C. § 78t is an intensely factual question. See 4 Louis Loss & Joel Seligman, Securities Regulation 1724 (1990). A director is not automatically liable as a controlling person. Burgess v. Premier Corp., 727 F.2d 826, 832 (9th Cir.1984) (a director who was uninvolved in the company's day-to-day cattle business and was without experience in the business and had nothing to do with the prospectuses issued to the doctor investors was not a controlling person, nor was a director who had minimal interaction with the company, due partly to ill health). Citing Burgess, Loss and Seligman observe: Accordingly, although a person's being an officer or director does not create any presumption of control, it is a sort of red light. 4 Loss & Seligman, supra, at 1724 (emphasis in original). It is not uncommon for control to rest with a group of persons, such as the members of the corporation's management. Id. at 1722. 32 Here the persons controlling the issuer in every material respect were the Management Committee, whose decisions, as the Joint Venture Agreement specifies, were binding on the Venturers. The major or significant business decisions affecting the Venture were to be made by the Management Committee. Every decision which might materially affect the Venture was the Management Committee's to make. A line was drawn by the agreement between decisions of this kind which were confided to the committee and day-to-day business decisions and operations. 33 The terms and representations on which the Venture's financing were obtained were not a day-to-day affair. They were major or significant. They materially affected the Venture. They had to be determined by the Management Committee. 34 In the words of the agreement, Parkland was initially to contribute administrative, and financing and development expertise. The agreement did not specify that this obligation of Parkland was to continue beyond the beginning of the Venture. In particular, the raising of additional funds was expressly left to the judgment of the Management Committee which was to determine whether additional funds are required for the Venture's operations and purposes from time to time. It was further expressly provided in the agreement that neither of the Venturers had the authority to act for the other Venturer, so Parkland had no authority to raise money by itself. As the agreement puts it, instead the management of the business affairs of the Venture shall be vested in a Management Committee. The members of this committee were a narrowly defined group charged with the task of making these decisions, hence it is reasonable to presume that [they] had the power to control. Wool v. Tandem Computers Inc., 818 F.2d 1433, 1441 (9th Cir.1987). 35 Webb's memorandum of July 3, 1985 shows that the Management Committee on June 17, 1985 specifically discussed the precarious situation regarding our financial capabilities to meet our obligations to the Incor investors. According to that memorandum, the members of the Management Committee, including Keim, were informed that the Venture would run out of money as soon as October 1985. The Management Committee then decided to use for current obligations funds previously earmarked for interest payments to Incor's investors. 36 According to the minutes of the Management Committee for July 10, 1985, which Keim attended, there was explicit discussion of the financing package--necessarily a reference to the package to be put together by Incor, the company doing the financing. Sheet 16 of that package, dealing with the residential property of the project, was discussed in terms of expected profits. The amount to be raised was discussed. Keim specifically addressed the tapping of pension plan money. Keim also took the lead in stating what rate of interest should be paid. 37 Webb's memorandum of the June 17, 1985 meeting and the minutes of the meeting of July 10, 1985 show the Management Committee acting by consensus, not by vote. The committee does not appear to have been dominated by LaPrade or by the Parkland members as a whole. Keim appears as a vocal and active participant in the management of the Venture. 38 Keim states that in fact he had no control over LaPrade, Smith and Incor and argues that this undisputed fact should relieve him of liability as a controlling person. Keim misunderstands the basis on which his liability is alleged. He is sued not because he controlled those marketing the investment contracts but because he was one of the persons controlling the issuer of the investment contracts. 39 The Controlling Person's Scienter. To establish the liability of a controlling person, the plaintiff does not have the burden of establishing that person's scienter distinct from the controlled corporation's scienter. If the plaintiff had this obligation, the controlling person provision would hardly make anyone liable who would not be so otherwise. G.A. Thompson & Co. v. Partridge, 636 F.2d 945, 960 (5th Cir.1981). But a defendant who is a controlling person of an issuer with scienter has the burden of proving his absence of scienter. Hollinger, 914 F.2d at 1575; Partridge, 636 F.2d at 960. Under the controlling person statute that means that Keim, as a person controlling the issuer, was subject to liability unless he establishes that he acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. 15 U.S.C. § 78t(a) (1981). 40 Some of our earlier cases took the position that in proving the liability of a controlling person, the plaintiff has the burden of showing that the defendant does not come within the good faith exception. E.g., Christoffel v. E.F. Hutton & Co., 588 F.2d 665, 668-69 (9th Cir.1978). But it has now been established that this burden falls upon the controlling person. Hollinger, 914 F.2d at 1575. Although Hollinger is specifically directed to a broker-dealer in relation to its registered securities salesman, id. at 1575 n. 24, we have extended the holding beyond this context. See San Mateo County Transit Dist. v. DeArman, Fitzgerald and Roberts, Inc., 979 F.2d 1356 (9th Cir.1992). There is no reason to construe the statute as though it were restricted only to broker-dealers and their salespersons. Congress was well aware of the special duties owed by a broker-dealer and could have put the rules on control person liability solely in that context if it so desired. See e.g., 15 U.S.C. §§ 78k and 78o. Congress did not act in this restricted way. Those controlling an issuer of securities are liable for the conduct of the issuer and so are liable if an issuer intentionally or recklessly permitted the fraudulent marketing of its securities. 41 Consequently, Keim has the burden of proving his good faith. His own declaration of innocence does not meet that burden when the Investors have offered evidence disputing his ignorance of the financing; when Webb's memo of July 3, 1985 shows Keim was aware that Incor had recruited the Investors and that the interest payments to them were in jeopardy; when the minutes of the Management Committee for July 10, 1985 show him as a participant in the discussion of financing; when his letter to LaPrade of November 27, 1985 and the affidavit of Sprague show him pressing for his $100,000 developer's fee; when Sprague's affidavit shows him influential enough to avoid giving the personal guarantee extracted from the others; when Sprague has deposed that Keim was told that the loans from the Investors were to be secured on the basis that they would be half the value of the property; and when his responsibilities as a member of the Management Committee necessarily made him familiar with the cash needs and cash resources of the Venture. In the face of these proffered facts, Keim's alleged good faith and his not having directly or indirectly induced the allegedly fraudulent marketing of the Venture's notes could not be determined by summary judgment. Accordingly, summary judgment in his favor is reversed. 42 The Sanctions Imposed on Piccoli. Rule 11 of the Federal Rules of Civil Procedure requires a district court to impose sanctions upon any person signing a pleading, motion, or other paper if it is either frivolous or filed for an improper purpose. Townsend v. Holman Consulting Corp., 929 F.2d 1358, 1365 (9th Cir.1990) (en banc). The imposition of sanctions is reviewed for abuse of discretion. Id. at 1365-66. A district court would necessarily abuse its discretion if it based its ruling on an erroneous view of the law or a clearly erroneous assessment of the evidence. Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405, 110 S.Ct. 2447, 2461, 110 L.Ed.2d 359 (1990). In granting Keim's motion for summary judgment and imposing sanctions upon Piccoli the district court failed to consider the argument advanced by Investors that Keim could be liable by virtue of his control over the Venture. We have held that Keim's control over the Venture precludes summary judgment in his favor. Piccoli's opposition to the motion was not frivolous. The district court's decision to impose sanctions for opposing summary judgment was based upon an erroneous view of the law and must be reversed as an abuse of discretion. Because the motion for summary judgment was properly opposed, Piccoli did not unreasonably and vexatiously multiply the proceedings. 28 U.S.C. § 1927 (Supp.1992). The award of costs in favor of Keim under § 1927 also was an abuse of discretion. 43 The district court further found sanctions appropriate under Rule 11 because Piccoli relied upon an unsigned affidavit in the Investors' response to Keim's motion for summary judgment. The district court correctly noted that relying on a false or misleading affidavit in responding to a summary judgment motion is an improper purpose under Rule 11. However, Piccoli did attach his own affidavit which explained that Conkling had rejected the unsigned affidavit as inaccurate and that the references to it in the motion papers were inserted before Piccoli knew of Conkling's refusal. Although he should have filed a formal motion for additional discovery time, Piccoli faced serious time and distance constraints. Under the circumstances, Piccoli's manner of handling the Conkling affidavit was not unreasonable enough to justify the imposition of sanctions. Nor were sanctions warranted, as the district court found, for inaccurate deposition summation. Piccoli's synopsis of Keim's deposition was argumentative but not false. 44 Before the summary judgment motion was heard, Piccoli supplied the Sprague affidavits that gave substance to the Investor's case. The sanctions were measured by the district court in terms of the expense Keim was put to in successfully moving for summary judgment over Piccoli's opposition. As Piccoli properly opposed the motion, we vacate the monetary award against Piccoli. The Case Against Godfrey 45 In connection with its fund-raising and the issue of the 1986 note, the Venture obtained an appraisal of its properties. The appraiser, Harvey H. Cornell, by letter dated September 6, 1985, transmitted the appraisal by letter to the Venture, stating: 46 Pursuant to a request from the officers of Los Caballos Development Associates, Inc., we have prepared a market value estimate for the above listed properties. The appraiser assumes the equestrian facility to be complete turn key as described in the appraisal. 47 The effective date of appraisal is July 31, 1985. 48 On the basis of our studies the estimated value of subject properties is: 49 Section I--Equestrian Center and Land Thirteen Million Dollars $13,000,000.00 50 Section II--Vacant Residential Lots (Sheet 16) One Million Seven Hundred Thousand $1,700,000.00 51 The basis for these conclusions may be found in the attached report of 34 pages. 52 Cornell signed this letter. Underneath his signature appears: Reviewed by Richard G. Godfrey, M.A.I. 53 The following page, entitled Cornell Appraisal, states Assumptions and Certifications. Nothing on this page indicates any assumption about the existence or non-existence of the equestrian center. The next page, appearing on Godfrey's stationery, states that he did not inspect the properties or independently verify or analyze the data. He concludes: Based on data and analyses presented in the reports, and assumptions and limited conditions included therein, I believe the conclusions on residential Lots 15 and 16 as well as the commercial lands described are reasonable as of August 31, 1985. 54 The Investors sued Godfrey for aiding and abetting the alleged fraud of Keim and for negligent misrepresentation. Godfrey moved for summary judgment. The Investors conceded that they could not prove that Godfrey had aided and abetted securities fraud. They opposed his motion for summary judgment on the state claim of negligent misrepresentation. 55 On May 30, 1991, the district court granted Godfrey's motion. It found that the information in the appraisal reports was not false because the undisputed facts established that the reports were prepared with the assumption that the equestrian center would be, but was not yet, completed and this fact was spelled out in the appraisal reports and cover letters accompanying the appraisals. In addition, the court found that Godfrey had no duty to the Investors. 56 Godfrey's Liability. 57 Arizona has adopted the Restatement of Torts, § 552, whose title is Information Negligently Supplied For The Guidance of Others. As the first Arizona case to apply this provision observed, the Restatement originally stated the liability in terms of one who negligently in the course of his business or profession supplies information, but revision inserted the term false between supplies and information. Arizona Title Ins. and Trust Co. v. O'Malley Lumber Co., 14 Ariz.App. 486, 484 P.2d 639, 644 (1971); Restatement (Second) of Torts § 552. The duty established by the Restatement is a duty not to make a misrepresentation, a duty not to misstate existing, ascertainable facts. O'Malley Lumber, 484 P.2d at 646. Explicitly adopting the Restatement (Second) and citing O'Malley Lumber with approval, the Arizona Supreme Court laid down the rule as governing one who supplies false information for the guidance of others in their business transactions. St. Joseph's Hosp. v. Reserve Life Ins. Co., 154 Ariz. 307, 742 P.2d 808, 813 (1987). 58 In the appraisal material certified by Godfrey relative to the land on which the equestrian center was to be built, the Summary of Salient Facts and Conclusions states the purpose of the appraisal to be market value cash or cash equivalent as developed. In the following paragraph Land Size is stated as 82.37 acres of potential commercial land. Potential is clearly not actual. Later in the report the proposed equestrian center is referred to and the 82.37 acres underlying it are described as vacant land. There are further references to the proposed state of the land which would alert any lender that nothing was now built. 59 The district court understood the Investors' case to be that Godfrey had implied that the equestrian center was completed. The district court found that such an implication was not made by Godfrey or by the appraisals he certified. Now, on appeal, the Investors in their Reply Brief explicitly disavow that such misrepresentation was the basis of this action. The Investors never contended that the deficiency in the appraisals was that they implied or asserted that the center had already been built. 60 The Investors say that their case now and throughout has been that four out of five sections of the appraisal--the sections involving over 2,000 acres--failed to disclose that the values given were predicated on completion of the center. (Emphasis added). This phrasing of the Investors' position fails for two reasons: First, the Sheet 16, July 31, 1985 appraisal of the residential lots speaks of Proposed Development and gives a Final Value Estimate of the property as developed. The August 31, 1985 appraisal of Lots 15 and 16 gives the Retail Value as if fully developed and subdivided and the Introduction refers to estimating the value of the property as it will be developed into salable residential lots. The August 31, 1985 appraisal of Lots 4-12 describes what is being valued as vacant commercial site at the Santa Fe Ranch and gives the Retail Value as if fully developed and ready for immediate sale and improvement. No reasonable person reading these reports would have understood that they were current valuations of raw land, as now argued by the Investors; they were estimates of land as developed. 61 Second, as the Investors now concede that the appraisal of the equestrian center made clear that it was as yet unbuilt, and as this appraisal was attached to the other appraisals circulated by Incor, no reasonable reader of these appraisals could have believed that the land was being currently valued as if the equestrian center was in place. 62 Summary judgment was properly granted in Godfrey's favor. 63 AFFIRMED as to Godfrey. REVERSED as to Piccoli. REVERSED and REMANDED as to Keim.