Appeal from the United States District Court for the Northern District of Illinois, Eastern Division - No. 73 C 163 WILLIAM J. LYNCH, Judge.
Fairchild, Chief Judge, Thomas F. McAllister, Senior Circuit Judge,*fn* and Stevens, Circuit Judge.
Defendants Donald and Sally Rosenbloom and International Diversified Investments ("I.D.I.") appeal from a district court judgment that they violated § 10(b) of the Securities Exchange Act of 1934,*fn1 S.E.C. Rule 10b-5,*fn2 and § 12 of the Illinois Securities Act*fn3 during the solicitation of subscription agreements for the purchase of I.D.I. stock. The court awarded plaintiffs Thomas and Dorothy Hidell $25,000 and intervening plaintiff Harold Frieh $30,000. Plaintiffs also received interest, costs and reasonable attorney's fees.*fn4
In late 1970 and early 1971 the Rosenblooms had spoken with Frieh about forming a real estate investment corporation, and on December 20, 1970, Frieh orally agreed to purchase 6,000 shares of stock, for $30,000. The Rosenblooms were to invest $10,000 and would receive 56,000 shares. Frieh was to become an officer and director of I.D.I. On January 13, 1971, Frieh made an initial payment of $2,500 for his shares. His check for that amount was not deposited, however, until February 12. On January 18, the Articles of Incorporation for I.D.I. were filed in Delaware; these articles authorized the issuance of 56,000 shares of stock. On that same day those shares were issued to the Rosenblooms. Subsequently, on January 25 the articles were amended by the Rosenblooms to authorize the issuance of an additional 6,000 shares, but this amendment was not filed and registered with the Delaware Secretary of State until February 22. In the interim, on February 13, Frieh paid the additional $27,500 for his shares. The certificate for 6,000 shares of I.D.I. stock was issued to him on February 22.
Frieh's claims, upheld by the district court, basically centered on certain statements made to him, allegedly in violation of § 10(b) of the 1934 Act, Rule 10b-5, and § 12 of the Illinois Act, during this period. He also alleged, and the trial judge found, that I.D.I. failed to register the stock sold him as required under the provisions of § 5 of the Illinois Securities Act.*fn5
On February 11, 1971, the Rosenblooms prepared a prospectus and form subscription agreement and began approaching potential investors on behalf of I.D.I. On or about February 16, plaintiffs Thomas and Dorothy Hidell, after reviewing the prospectus, executed such a subscription agreement to purchase 1,000 shares. The agreement provided that it was not to become a binding contract unless subscriptions for 20,000 shares ($500,000) were obtained prior to September 30, 1971. The Hidells paid $25,000 between January 21 and September 19 for the 1,000 shares.
By September 17, 1971, it was clear that the goal of 20 subscriptions was not going to be reached by September 30. Only six 1,000-share agreements had been obtained. Thus, on that day Donald Rosenbloom and Frieh, pursuant to a resolution of the board of directors of I.D.I., wrote the subscribers informing them that, "We now believe that the immediate objective of I.D.I. can be achieved with equity capital of approximately $175,000 to $200,000," and that the $150,000 already provided by the six subscribers, plus the $40,000 invested by Rosenbloom and Frieh, would permit I.D.I. to commence operations.*fn6 The letter requested that the subscribers consent to the elimination of the 20,000 share condition.
On September 20, 1971, Donald Rosenbloom traveled to Philadelphia and convinced the Hidells to sign the amendment to the subscription agreement, informing them that at that time the company had $190,000 in capital. On September 29, however, Rosenbloom entered into a repurchase agreement, on behalf of I.D.I., with Jack Dougherty, another subscriber. Dougherty had required such reassurance as a condition of consenting to the proposed amendment. The Hidells did not learn of the repurchase agreement until April 14, 1972. When they sought to obtain a similar agreement from the corporation, it was denied them, Donald Rosenbloom casting the deciding vote to break a tie among the other directors.
The district court found that the defendants violated § 10(b) of the 1934 Act, Rule 10b-5, and § 12 of the Illinois Act by affirmatively stating to the Hidells that, as of September 20, 1971, I.D.I. had a capitalization of $190,000 and by failing to disclose Dougherty's misgivings that subsequently resulted in the repurchase agreement.
Defendants argue that the statement in the September 17 letter and any oral statements made to the Hidells on September 20 that an investment of $190,000 had been made in I.D.I. were not false when made because the repurchase agreement was not entered into until nine days after the Hidells consented to the subscription agreement amendment. Alternatively, they contend that the repurchase agreement entered into between Donald Rosenbloom and Dougherty was not a "material fact," as the term is used in Rule 10b-5 and § 12G of the Illinois Securities Act. We disagree on both grounds.
The record discloses that Donald Rosenbloom was aware of Dougherty's reluctance to sign the subscription agreement amendment before he went to Philadelphia on September 20 to meet with the Hidells. Dougherty testified that he had had conversations with Rosenbloom about a buy-back agreement prior to his receipt of the September 17 letter. Tr. 197. And Rosenbloom admitted that, although Dougherty had requested concessions prior to September 17, he never so advised the Hidells. Tr. 435. Consequently, when Rosenbloom convinced the Hidells to sign the amendment, by stating that an investment of $190,000 had been made, he failed to disclose the fact that one of the subscribers had indicated that he might not so agree without a repurchase agreement. The $190,000 investment statement was, therefore, seriously misleading, even if not wholly false, when made. Whether we view this as a false affirmative statement or as an omission, Rosenbloom himself had reason to believe that it was less than a completely truthful statement of the then-current status of the corporation's financing.*fn7
Having informed the Hidells that $190,000 had been invested, when he knew of Dougherty's demands and the significant likelihood that a repurchase agreement might be a condition of Dougherty's assent, we believe that Donald Rosenbloom was under an affirmative duty to notify the Hidells of the repurchase agreement on or after September 29 and to afford them the opportunity to cancel their consent to the subscription agreement amendment.*fn8 Similarly, Sally Rosenbloom, who signed the September 17 resolution approving the amendment to the subscription agreement, and who knew on September 29 of the repurchase agreement, was, as an officer and director of I.D.I., under the same duty of disclosure and is similarly liable under § 10b, Rule 10b-5, and § 12 of the Illinois Act.*fn9
Defendants present us with several alternative arguments with regard to the materiality of the failure to inform the Hidells of the repurchase agreement. They agree that the test of "materiality" was properly set forth by the court in S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d. ...