Opinion ID: 286871
Heading Depth: 1
Heading Rank: 2

Heading: Midwestern's aiding and abetting Dobich's fraudulent actions and its motive for doing so

Text: 23 The price of Midwestern stock rose rapidly during the last half of 1964. From $69 per share in June there was an increase to $93 per share in December. Dobich Securities presented to Midwestern for transfer approximately twenty-one per cent of the total shares presented for transfer by all brokers from May 1964 until July 1965. The market was thin in Midwestern stock and the effect of the Dobich Securities' buying was to drive up the price of the stock. This seems to have been a substantial reason for the rise in price since Midwestern's earnings for 1964 were less than they were in 1963. Midwestern's officers knew that Dobich was largely responsible for the increased activity in Midwestern's stock and that this had an effect on the price. 24 On October 27, 1964 merger negotiations began between Midwestern and the Illinois Mid-Continent Life Insurance Company. An agreement was reached the next day that one share of Midwestern stock would be exchanged for ten shares of Mid-Continent stock. Mid-Continent was quoted at $9.50 per share and Midwestern at $88. The ten-for-one exchange ratio was based primarily on the then market price since the adjusted book values of the two companies did not support the exchange ratio agreed upon. 25 The Mid-Continent stockholders, after a proxy contest, refused to approve the merger in February 1965. During the proxy fight the officers of Mid-Continent argued that, The adjusted book value of the share has little relationship to the value of the shares in that the value of the shares is primarily established by the market value in over-the-counter trading. 26 Schwanz admitted that it would have been embarrassing for Midwestern if the SEC or the Indiana Securities Commission had investigated Dobich while they were in the middle of the proxy fight in Chicago. He also admitted that if Dobich Securities had been put out of business in November or December 1964, there could have been a serious decline in the bid and asked price of Midwestern stock. 27 The district court found that a pronounced change in Midwestern's attitude took place between October 13 (when Sheets wrote Dobich that, if Midwestern received any information after two weeks about Dobich's late delivery of stock, future inquiries would be referred to the Indiana Securities Commission for suitable investigation) and November 30. We are convinced that the court was justified in adopting such a view. 28 After receiving the October 13th letter, Dobich sent lulling telegrams and letters to his customers who had purchased Midwestern stock but had not received their certificates. A typical telegram read in part: Midwestern United Life has made a nice move upward. Dobich Securities Corporation has worked hard to alert the public to this situation. If you are late receiving your certificate, do not be alarmed. We are now solving that problem. A typical letter read in part: 29 Please do not become alarmed if delivery is made later than usual because we are creating a heavy interest in this particular stock. The unusually large volume has two effects; it makes our processes a little slower and at the same time, it causes your holdings to increase in value. 30 This maneuver by Dobich apparently worked for a time because Midwestern received no complaints between October 15 and November 23. 31 On November 23 Robert Dillon was visited by two Midwestern agents. Dillon had purchased 200 shares of Midwestern stock in September 1964. Some time later he received one of the lulling telegrams and a follow-up letter. Dillon inquired of the agents how long it took to transfer Midwestern stock. He did not identify the broker from whom he had made his purchase; however, one of the agents said, I hope you are not talking about Mr. Dobich. The agent immediately called Schwanz who then discussed the matter with Sheets. Thereafter, on November 30, Sheets wrote two letters, one to Dillon and the other to Dobich. The letter to Dobich read in part: 32 We are suggesting to Mr. Dillon that, in the event he does not receive his stock immediately or does not receive a satisfactory explanation for the delay, he turn the matter over to his personal attorney and/or contact the Indiana Securities Commissioner. 33 Dillon received a carbon copy of this letter along with a letter suggesting that if he did not hear from Dobich right away, he should contact either the Indiana Securities Commissioner or his personal attorney. 34 The same procedure was followed with reference to a complaint sent to Midwestern on November 30 by Frederick Volkee except that Dobich was sent a blind carbon copy of Midwestern's response to the complaining customer. 35 With respect to complaints received from Dobich's customers after December 1, 1964, Midwestern followed a procedure which effectively foreclosed the possibility that complaining customers would proceed before the Indiana Securities Commission. Those who inquired about the delay in the delivery of their stock from Dobich were advised to first contact Dobich Securities. Some were further advised to proceed before the Indiana Securities Commissioner if a satisfactory explanation or delivery was not made by Dobich. Midwestern's letters were a signal to Dobich. They directed customers to contact Dobich and thus allowed him to arrange for delivery without fear of any Indiana Securities Commission interference. 36 We agree with the district judge's appraisal of the Dillon letter on November 30. Judge Eschbach's memorandum opinion on this matter read: 37 Sheets' letter to Dobich on November 30    gave Dobich an opportunity to deliver to Dillon and keep Dillon away from the Securities Commission. It must be remembered that until this time, Dobich had no reason to think that if a complaint about late delivery came to MULIC, MULIC would do anything less serious (from Dobich's point of view) than forward the inquiry directly to the Indiana Securities Commission. It is reasonable to conclude that Dobich, until this time, had good cause to fear that MULIC might even take its whole history of complaints to the Commission. Dobich had tried at the October 12 meeting to convince Schwanz and Sheets that he was worth protecting, but up until November 30 Dobich had no reason to suspect that his efforts had been successful. So it much have come as an extremely pleasant surprise to Dobich to learn that so long as he delivered Dillon's shares, MULIC would keep still. Nowhere in his letter did Sheets suggest that Dobich was appropriating his customers' money or that his conduct was improper or that Dobich was giving MULIC a bad name. In short, all the expressions of generalized concern about Dobich's activities, so evident in the letters of September 28 and October 13 and in the meeting of October 12, were gone. In their place was a letter indicating that so long as the particular complaint was satisfied, MULIC had no further concern. 38 We also agree with the judge's view that Dobich would interpret the Dillon letter to mean that Midwestern did not intend to carry out its threat to refer future inquiries to the Indiana Securities Commission; rather, that Midwestern would give him an opportunity to continue in business so long as he satisfied complainants by prompt delivery of their stock. Further, it is reasonable to infer that Sheets must have known Dobich would interpret the Dillon letters in this fashion. 39 The reason for this change of attitude on Midwestern's part is not hard to guess. Midwestern was trying to accomplish the Mid-Continent merger. It was to Midwestern's advantage to keep its stock at the price it was selling for in November and December. If the price declined, the success of the merger was endangered since the merger was based upon the relative market values of the two stocks. The rise in price of Midwestern's stock had been generated by Dobich's abnormal selling activities which in turn required him to cover his short sales in a thin market. If Dobich's operations were reported either to the Indiana Securities Commission or the SEC by Midwestern, those operations would undoubtedly have come to an end and the prop holding up the price of Midwestern's stock would no longer exist. 40 We believe that the district judge could reasonably reach this conclusion after considering all the evidence. We also believe that it was reasonable to conclude further that the procedure adopted in the Dillon matter and thereafter encouraged Dobich to continue his activities without fear of a report from MULIC to the Indiana Securities Commission, and that this encouragement substantially aided and abetted Dobich in the continuation of his fraudulent operations after December 1, 1964. We think it was also reasonable to conclude that Midwestern aided Dobich in the continuation of his fraudulent activities by not carrying out its threat contemplated in its October 13th letter and by its failure to report either to the Indiana Securities Commission or the SEC its knowledge of Dobich's activities after realizing that Dobich did not intend to be even with the board as he promised. Under the circumstances, this calculated silence constituted part of Midwestern's plan to aid and abet Dobich in his fraudulent activity. 41 III. The causal connection between Midwestern's misconduct and the injury suffered by the members of the class 42 The district court found that except for either Midwestern's misconduct in actively assisting and encouraging Dobich commencing with issuance of the Sheets' letter on November 30, 1964 or its failure to report Dobich's activities to the Indiana Securities Commission, Dobich would have ceased his fraudulent activities on December 1, 1964 or would have been forced to do so by actions of the Securities Commissioner on December 21, 1964. As we previously stated, it is our view that the district court was justified in its interpretation of the November 30 letter as indicating Midwestern's intention not to refer inquiries directly to the Indiana Securities Commission so long as the specific complaints about tardy delivery received by Midwestern were satisfied by Dobich. By referring directly to Dobich the complaints of dissatisfied customers who potentially could filed charges before the Securities Commission, the possibility that the Securities Commission would interfere was substantially reduced. This affirmative conduct on Midwestern's part facilitated the commission of Dobich's fraud because it armed him with the knowledge that complaints to Midwestern would be referred to him first rather than to the State Commission. 43 The active assistance of Midwestern was not the only cause of customer loss after December 1, 1964. If Midwestern had reported its knowlege of Dobich's fraud to the Indiana Securities Commission, the evidence showed that the Indiana Securities Commission would have put Dobich out of business. Notwithstanding scattered failures on the part of the Indiana Securities Commission to follow up earlier complaints concerning Dobich's slow delivery of securities, the district court could reasonably believe the testimony of Martin K. Edwards who was the State Securities Commissioner on December 1, 1964. He testified that if Midwestern had reported all of the information concerning Dobich's conduct in its possession in late November 1964, the Indiana Securities Commission would have suspended or revoked Dobich's license. Further support for the finding that the Indiana Commission would have acted if Midwestern had reported Dobich's misconduct is found in the presumption that public officials properly discharge their official duties. Harrell v. Sullivan, 220 Ind. 108, 116, 40 N.E.2d 115, 118, 41 N.E.2d 354, 140 A.L.R. 455 (1942). 44 IV. Midwestern had a duty to report Dobich's activities to the Indiana Securities Commission or the SEC 45 The silence theory that underlies this case is that Midwestern, by failing to report Dobich's activities to the SEC or the Indiana Securities Commission, knowingly and purposefully encouraged an artificial build-up in the market for its stock so that it would be in a more favorable position to consummate the potential merger it was then negotiating. It is our view that the district court was correct in concluding that Midwestern's acquiescence through silence in the fraudulent conduct of Dobich combined with its affirmative acts was a form of aiding and abetting cognizable under Section 10(b) and Rule 10b-5. Here Midwestern's failure to report Dobich after December 1, 1964 was more than omission; it was a signal to Dobich that further inquiries would not be handled as earlier threatened, and that Dobich would be given an opportunity to cover his non-deliveries. Without deciding whether the failure to report Dobich's activities to the Indiana Securities Commission would in itself give rise to liability under Rule 10b-5, we find that under all the facts and circumstances of this case, Midwestern's actions amounted to a tacit agreement with Dobich to prevent complaints from reaching the Commission, thus facilitating the fraud and allowing Dobich's scheme to continue to Midwestern's benefit. Violations of this rule should be fashioned case by case as particular facts dictate. Kohler v. Kohler Co., 319 F.2d 634, 637-638, 7 A.L.R.3d 486 (7th Cir.1963). The district judge was correct in saying: 46 A basic philosophy of the Securities Exchange Act of 1934 is disclosure and is directed toward the creation and maintenance of a post-issuance securities market that is free from fraudulent practices. The investor's protection is the paramount consideration of much of the federal securities legislation and, in particular, of the 1934 Act here involved. The effect on an investor of an issuer corporation's failure to disclose improper activities of a brokerage firm dealing heavily in the issuer's stock, where the broker's activities create an appreciable risk of loss to that investor, may be just as dangerous and equally as damaging as a failure by the issuer to disclose information of its own improper activities affecting the value of its stock. The loss to the investor may well be the same. 259 F.Supp. at 680. 47