Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 74 C 2865 - Alfred Y. Kirkland, Judge.
Cummings and Tone, Circuit Judges, and William J. Jameson, Senior District Judge.*fn* Tone, Circuit Judge, concurring.
Plaintiff is a resident of Illinois and has been a member of defendant Local Union 705 of the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America since 1951. He also purports to serve as the representative of the class of all members of all affiliate locals of the Teamsters International who have "purchased and acquired an interest in a Teamsters' pension fund." The original defendants were Local 705, the International Brotherhood, three classes (Teamster local unions with pension funds similarly situated to Local 705, trustees of such pension funds and all officers of locals with such pension funds), and Louis Peick, an officer of Local 705 and a trustee of its pension fund. Additional defendants added by amendment are Local 705's Pension Fund and seven individuals representing that pension fund and all other Teamster pension funds.
According to the complaint, the Teamsters locals negotiate labor contracts with companies across the United States for the benefit of their members who are employees of such companies. Under these contracts, Teamster members agree to provide their services as employees of the companies in return for wages and various other forms of consideration. Since 1955, most of those labor contracts negotiated by the Teamsters have provided for the establishment of pension funds for their union members. Under the labor contracts, the employing companies make set payments into the pension funds for Teamster members "as part consideration for the labor services provided by such union members " (Complaint par. 12). These payments are held in trust and invested by pension trust fund trustees who are equally divided between employer and union representatives. Therefore, the Teamster member employees contribute their labor services in return for their participating interest in the pension trust funds and their wages and fringe benefits.
Again, according to the complaint, the Teamsters pension plans do not differ inter se in any material respect for the purposes of this case. Each was a defined benefit pension plan where employees are offered various benefits if they meet certain eligibility requirements. Actuarial assumptions based on estimated union member turnover, mortality and the rate of return on fund capital are used to determine the amount the employer must contribute so that the pension fund will be able to pay the promised benefits to union members as they retire without jeopardizing the payment of benefits to future and antecedent retirees. The pension trust funds have lengthy vesting periods. If a Teamster member does not meet the length of service requirement of the vesting period, the entire contribution paid into the trust fund for him is forfeited, thereby extinguishing his interest in the fund. Local 705's pension fund had a twenty-year vesting period, a typical provision.
In addition to the lengthy plan-vesting periods, most of the Teamsters pension plans require continuity of employment with employers who have entered into labor contracts with the Teamsters.*fn1 Under this continuity or "break-in-service" rule, no pension benefit is available to a Teamster union member who has been employed by covered employers for the full vesting period but whose employment with covered employers is not continuous and uninterrupted. Employer-paid contributions are also forfeited when the union member cannot meet the break-in-service requirement of his pension plan's vesting rule.
The monies contributed to the pension funds are invested by the trustees thereof, and it is alleged that each trust fund "over the long run [is] reasonably expected to grow through the accumulation of dividends, interest and other earnings " (Complaint par. 15). Failure to meet the length or continuity requirements of the pension fund's vesting provision also causes the forfeiture of a union member's participating interest in these accumulated earnings. When the complaint was filed in 1974, plaintiff had worked for covered employers for 22 1/2 years, but his service was interrupted by an involuntary four-month break in service from December 1960 to April 1961.*fn2 Because of this interruption in service, Local 705 has refused to pay plaintiff any pension benefits whatsoever and the employer contributions paid on his behalf and the earnings accumulated therefrom have been forfeited.
Count I of the complaint asserts that beginning in 1955 and continuing to the present, defendants misrepresented certain material facts and omitted to make other material facts by making misleading statements which in general related to the value of a member's participating interest in his local pension fund. The misrepresentations concerned misleading statements as to the length and continuity requirements of the pension plan's vesting provision. Defendants are said to have made omissions of material facts by failing to inform the members that they would receive no pension benefits whatsoever if they did not meet the length or continuity requirements of the vesting provision and that, upon failing to satisfy these requirements, the contributions made on their behalf into the fund and the earnings accumulated therefrom would be forfeited. Defendants allegedly also omitted to state that the fund's actuarial basis was arbitrary. Other omissions are said to be the failure to disclose pertinent information needed to disclose the actuarial basis upon which the funds were grounded and the actuarial likelihood that a union member will not receive any pension benefits at all. Finally, plaintiff alleged a failure to state that the defendants have unlawfully diverted pension funds for the benefit of persons other than the pension trust beneficiaries.
Plaintiff claims in Count I that although he purchased an interest in the pension fund by providing labor service to an employer with a labor contract with the Teamsters, he sustained substantial losses which were a direct and proximate result of a violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder by the defendants. Besides requesting class relief, plaintiff requested the district court to find that defendants violated Section 10(b) and Rule 10b-5 and to reform the pension fund agreements by deleting the length and continuity requirements of the vesting provision. The plaintiff also sought a judgment requiring defendants to pay pension benefits unlawfully withheld from plaintiff and his class. In addition, a judgment was sought in the amount of any interests which had been diverted from their proper purposes.
Count II of the complaint sought similar relief under Section 17(a) of the Securities Act of 1933. However, neither this nor any other count of the complaint charged that the registration requirements of that Act were applicable.*fn3
Four months after the docketing of his complaint, plaintiff filed an affidavit which we treat as part of the pleadings for purposes of our review of the order below denying the motion to dismiss. The affidavit showed that he had only an elementary school education and had joined Local 705 in April 1950 when he became a truck driver with an employer who had a collective bargaining agreement with that Union. He worked continuously as a truck driver with Local 705 contracting employers from April 1950 through November 1973, except for an interruption from December 5, 1960, until April 1961, when he was involuntarily laid off wholly because of the adverse economic condition of his employer.*fn4 Plaintiff tried unsuccessfully to find any trucker's work during this time period. He retired because of cataracts on December 1, 1973, at the age of 63. Since his retirement, Daniel has not worked at all.
In 1955, plaintiff learned of Local 705's pension fund and understood that as a Local 705 member he would be eligible to receive retirement benefits upon completing 20 years of employment with Local 705 covered employers. He believed that employer contributions to the Local 705 pension fund would finance the retirement payments which he would receive after 20 years of employment. This retirement plan was a material factor in his continuing employment with Local 705 covered employers. If he had known that Local 705 would interpret the pension plan as requiring uninterrupted service of 20 years, he would have sought employment elsewhere with an adequate retirement plan. The communications he received from Local 705 did not disturb his understanding that he would receive a pension after 20 years of employment with covered employers.*fn5
In June 1971, plaintiff received a letter from defendant Peick stating that after 20 years of covered service and at 60 years of age or over, a retired employee would receive a monthly pension of $400. He expected to receive such a pension on his retirement. One of Local 705's booklets advised him that the purpose of the pension fund was to take care of him and his family in case of retirement and that the funds afforded protection to him, his wife and unmarried children under 18 years of age. He relied on such assurances that the fund would provide for financial security in his old age.
He did not learn until December 1973 that his involuntary 4-month layoff caused the Draconian result of total forfeiture of his pension. He never learned of the success or failure of the trustees' management of the Local 705 pension fund, nor was he advised of the type of investments being made by the trust fund. During several months prior to his December 1, 1973, retirement, he visited Local 705's office on five to eight occasions to arrange for his pension and was not then advised that he was ineligible to receive it. After Daniel's retirement, he was told for the first time that his 4-month involuntary break in service made him ineligible to receive any pension benefits. On December 26, 1973, and on March 28, 1974, he appeared before the Local 705 trustees, but they refused to reverse the prior denial of his pension. He and his fellow Local 705 members had always had the common understanding that they would receive a retirement benefit after 20 years of covered employment and that no employer contributions could be forfeited. Other members of Local 705 were shocked to learn that a Local 705 member with Daniel's record of employment could be denied all pension benefits because of a temporary break in service. Indeed neither the defendants nor the amici who support their position dispute that this is "unfair in the extreme, shocking to the conscience" (Secretary of Labor's Br. at 21).
Local 705, Peick and the International Brotherhood of Teamsters filed motions to dismiss Counts I and II of the complaint on the ground that the court lacked subject-matter jurisdiction and that they failed to state a claim upon which relief could be granted.*fn6 Local 705 and Peick also maintained that the action under Counts I and II was barred by the limitations provisions of the Securities Act of 1933 and the Illinois Statute of Limitations.*fn7 On March 1, 1976, the district judge handed down a memorandum opinion and order denying the motions to dismiss as to all counts and holding the anti-fraud provisions of the securities laws applicable. This opinion is reported in 410 F. Supp. 541. The effect of the opinion is to require defendants, when offering a defined pension plan to a member, to disclose the actuarial probability, here perhaps as low as 8% (410 F. Supp. at 551), that a member actually will receive pension benefits, and factors such as risk of loss, breaks in service, death before retirement age, and plan termination, that can cause this member to be deprived of his benefits, or otherwise defendants must face fraud liability under the securities acts. Subsequently, the court entered an order denying defendants' motions to reconsider its refusal to dismiss Counts I and II but certified their application for interlocutory appeal under 28 U.S.C. § 1292(b). The certification was limited to Counts I and II of the complaint. The controlling question of law certified to this Court can be easily identified by the district court's careful circumscription of its holding below with respect to Counts I and II, viz.:
"The Court makes no finding here beyond the narrow holding that the complaint alleges the sale of a security for purposes of application of the anti-fraud provisions of the Securities Acts, and that the complaint alleges violations of those provisions. The Court makes no finding with respect to applicability of any other sections of those Acts to employee pension plans such as the one here litigated." 410 F. Supp. at 553.
Thereafter we granted permission to appeal.*fn8 Three amici curiae have filed briefs urging reversal and four urge affirmance.*fn9 We affirm.
The securities cases in the Supreme Court's 1976 October Term have underscored its recently expressed methodology in interpreting the securities laws. See e.g., Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 97 S. Ct. 926, 51 L. Ed. 2d 124, 45 LW 4182 (1977); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S. Ct. 1292, 51 L. Ed. 2d 480, 45 LW 4317 (1977). Analysis begins with the relevant statutes themselves. After a study of their language and any court-added gloss, attention shifts to the statutes' legislative history. Additional considerations weigh in the balance. The history of the SEC's administration of the securities laws often can add a substantive gloss of its own which is entitled to the usual administrative deference (Investment Company Inst. v. Camp, 401 U.S. 617, 626-627, 91 S. Ct. 1091, 28 L. Ed. 2d 367) so long as it does not become law-making. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 212-214, 47 L. Ed. 2d 668, 96 S. Ct. 1375. And to the extent that these more cogent interpretive tools are not dispositive of the statutes' meaning, additional considerations of policy may tip the scales. Id. at 214 n. 33. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737, 44 L. Ed. 2d 539, 95 S. Ct. 1917. We shall use this methodology in our analysis of this case.
Both of the major anti-fraud portions of the federal securities laws are relied upon in this complaint. Count I charges a breach of Section 10 b of the Securities Exchange Act of 1934 (15 U.S.C. § 77j(b))*fn10 and Rule 10b-5 thereunder (17 C.F.R. § 240.10(b) -5)*fn11 while Count II alleges a violation of Section 17(a) of the Securities Act of 1933 (15 U.S.C. § 77q(a)).*fn12 This being an appeal from an order denying a motion to dismiss, the allegations concerning the use of the jurisdictional means and the making of material misrepresentations, the omissions to state material facts or the use of manipulative or fraudulent devices are treated as true by defendants. Their argument is based upon the phrase "in connection with the purchase or sale of any security" in Section 10 b and Rule 10b-5 and the phrase "sale of any securities" in Section 17(a). Defendants assert that these anti-fraud provisions are inapplicable on their face on the ground that plaintiff's interest in the pension fund is not a "security" and was not acquired by him in a "sale."
Plaintiff's Interest in the Pension Fund Is a "Security "
The term "security" is defined in Section 2(1) of the 1933 Act (15 U.S.C. § 77b(1))*fn13 and in Section 3(a)(10) of the 1934 Act (15 U.S.C. § 78c(a)(10)).*fn14 In each statute, the definition of "security" includes any "investment contract."*fn15 Since the same Congress which passed both the 1933 and 1934 Acts clearly indicated that its definition of "security" in the 1934 Act was intended to be "'substantially the same * * *'" as in the 1933 Act, cases construing either definition can be used interchangeably. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 847, 44 L. Ed. 2d 621, 95 S. Ct. 2051 n. 12; Tcherepnin v. Knight, 389 U.S. 332, 336, 342, 19 L. Ed. 2d 564, 88 S. Ct. 548. Therefore we need not break out separate lines of analysis in order to determine the existence of a security under Section 10 b of the 1934 Act and Section 17(a) of the 1933 Act.
In construing the statutory term "security," guidance is provided by two overriding principles. First, as remedial legislation the securities acts should be construed broadly to effectuate their purposes. Congress purposely defined the term "security" broadly, and it has been construed liberally by the Supreme Court in order to protect the public from speculative or fraudulent schemes. Tcherepnin v. Knight, 389 U.S. 332, 336, 338, 19 L. Ed. 2d 564, 88 S. Ct. 548. Secondly, in searching for content in the term "security," "form should be disregarded for substance and the emphasis should be on economic reality." Id. at 336.
With this background, attention can now focus on whether plaintiff's interest in the Teamsters' pension fund is an investment contract. An investment contract was defined by the Supreme Court in SEC v. W. J. Howey Company, 328 U.S. 293, 298-299, 90 L. Ed. 1244, 66 S. Ct. 1100, to mean
"a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise."
In United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852, 44 L. Ed. 2d 621, 95 S. Ct. 2051, the Supreme Court reiterated this rule and stated that
"this test, in short-hand form, embodies the essential attributes that run through all the Courts' decisions defining a security. 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."
"What distinguishes a security transaction [from every other form of commercial dealing] is an investment where one parts with his money in the hope of receiving profits from the efforts of others, and not where he purchases a commodity for personal consumption or living quarters for personal use." Id. at 858.*fn16
As demonstrated below, the elements of the Howey rule are present here, for under the Local 705 Pension Fund, money is invested in a common enterprise, the management of which is committed to a third party, and from which profits and income are reasonably expected.
The Union Member as an Investor
In the present case, the money invested in the pension fund came from employer contributions paid on behalf of the employee. The local defendants maintain that non-contributing beneficiaries of a fund cannot be conceptualized as investing in the fund, citing SIPC and SEC v. Morgan, Kennedy & Cox, Inc., 533 F.2d 1314 (2d Cir. 1976). In Morgan, Kennedy, the Second Circuit was asked "to determine whether the one hundred and eight employee beneficiaries of a trust created under a profit-sharing plan qualify as 'customers' of a bankrupt broker-dealer for the purpose of receiving compensation for losses available to such customers under the Securities Investor Protection Act of 1970 (SIPA), 15 U.S.C. § 78aaa et seq." Id. at 1315. The statutory definition of "customer" read in pertinent part "persons (including persons with whom the debtor deals as principal or agent) who have claims on account of securities received, acquired or held by the debtor from or for the account of such persons * * *" (emphasis supplied). Id. at 1316. Prior Second Circuit law had used investor and customer status interchangeably. Id. at 1317. In Morgan, Kennedy it was the trust as an entity as represented by the trustees, rather than its beneficiaries, who were the customers of the debtor broker-dealer. The account was held in the trustees' names and the individual beneficiaries' identities were totally unknown to the broker-dealer. Moreover, control over investment decisions was exercised exclusively by the trustees. "The employee-beneficiaries * * * made no purchases, transacted no business, and had no dealings whatsoever with the broker-dealer in question respecting the trust account." Id. at 1318. Common sense mandated the conclusion that the individual beneficiaries were not customers of the broker-dealer. Because of the sui generis definition of customer/investor under the Securities Investor Protection Act of 1970, Morgan, Kennedy is irrelevant to the question whether the union members have made an investment in the meaning of the 1933 and 1934 Acts.
More relevant is the recent case of Klamberg v. Roth, 425 F. Supp. 440, [76-77 Transfer Binder] CCH Fed. Sec. L.Rep. [*] 95,747 (S.D. N.Y. 1976). There the court held that the plaintiff as beneficiary in an employee pension plan had standing to bring an anti-fraud action against the plan trustees:
"Fraud perpetrated by a trustee in the purchase or sale of securities on behalf of the trust has a tangible impact on each beneficiary, no matter how many beneficiaries are thereby affected and regardless of the precise purposes of the trust. The policies behind the Birnbaum rule are not undermined * * *" 425 F. Supp. at 443, Id. at 90,630.*fn17
The employer contributions to the plan's pension fund constitute a sector of the total employee compensation structure. Inland Steel Co. v. National Labor Relations Board, 170 F.2d 247 (7th Cir. 1948), certiorari denied, 336 U.S. 960, 93 L. Ed. 1112, 69 S. Ct. 887. "Regardless of the form they take, the employer's share of the cost of these plans or the benefits the employers provide are a form of compensation." Welfare and Pension Plans Disclosure Act of 1958, S.Rep. No. 1440, 85th Cong., 2d Sess. (1958), reprinted in 3 U.S. Code Cong. and Admin. News 4137, 4139. This thesis is accepted by the courts, see, e.g., Lewis v. Benedict Coal Co., 361 U.S. 459, 469, 80 S. Ct. 489, 4 L. Ed. 2d 442; Employing Plasterers' Assoc. v. Journeymen Plasterers' Protective and Benevolent Soc'y, 279 F.2d 92, 99 (7th Cir. 1960), and the commentators alike. P. Drucker, The Unseen Revolution 8, 34 (1976); Note, Legal Problems of Private Pension Plans, 70 Harv. L. Rev. 490, 494 (1957). Indeed the International Brotherhood has conceded*fn18 these pension funds "constitute a form of compensation for an employee's labor" (Br. 12).*fn19 Realistically speaking, employers are putting money into a fund for an employee's future use which he would otherwise be getting in his paycheck. Mundheim and Henderson, Applicability of the Federal Securities Laws to Pension and Profit-Sharing Plans, 29 Law & Contemp. Prob. 795, 803-804 (1964).
The International maintains that employees do not even have an interest in the pension plan except in the attenuated sense that they have a contingent expectancy of receiving pension payments at a future date. But mere contingent expectancies are the rule rather than the exception in the equity markets. Profits in an equity security require that the market value plus accrued dividends of a stock be greater than the stockholder's cash basis. Thus profits are contingent on the successful operation of the common enterprise, there the issuing corporation. Whether an employee is found to have covered employment before his benefits vest or a stockholder is forced to sell his stock at a net loss does not eject his interest in the respective common enterprises from the bounds of the Howey definition of security. Realizing this analogy is not exact, we think that a right to receive benefits, received as a form ...