project actually exists or into the intent of the promoters to invest in a project.
All courts which have addressed this issue have also added an element of scienter to this analysis. Abell, 858 F.2d 1104, 1122; Ross v. Bank South, N.A., 885 F.2d 723, 729 (11th Cir. 1989) (en banc); Stinson v. Van Valley Development Corp., 719 F. Supp. 362, 366 (E.D.Pa. 1989), aff'd. 897 F.2d 524 (3d Cir. 1990) (adopting the rule in Abell). This Court agrees that the investor in a new issue can only rely on the integrity of the market to protect him or her from frauds which the promoter intends or dangers which the promoter recklessly disregards. The new issues market does not protect the investor from the incompetence or negligence of the promoter.
The Court rejects the "no chance of success" test urged by the plaintiffs in this litigation. An investor who has not read the offering statements cannot rely on the integrity of the market to weed out the high risk ventures. Indeed, new issues are inherently risky and any investor who enters the market without obtaining adequate information about the risks involved in the venture cannot rely on the integrity of the market for protection.
Moreover, the "no chance of success" test is unworkable in practice. Arguably, every venture has some chance of success under the most improbable set of circumstances, and thus has some value. Cf. Ross, 885 F.2d at 736 (Tjoflat, J., concurring) ("no matter how great the risk of nonpayment, a bond can virtually always be sold at some combination of price and interest rate"). By adopting the "no chance of success" formulation, the courts would then, necessarily, draw an even finer line of determining what the appropriate chance of success is.
In short, a new issue is marketable at some price if it is what it claims to be: a validly issued security, the terms of which are the same as the terms at which it is offered, the proceeds of which are intended to be used to finance some project. To successfully allege and prove a claim for relief under this theory, the purchaser of a security must show that the promoter of the venture was aware of or recklessly disregarded the infirmity in the security. Beyond this, investors in a new venture issue cannot rely on the integrity of an undeveloped market to protect them from risk.
The bonds issued by the Authority were entitled to be marketed. The plaintiff catalogues the fraudulent activities involved in the bond issue into five groups: 1) the Lewises' inexperience in hospital management and self-dealing; 2) the trustee's conflict of interest and breach of trust; 3) HMA's lack of ability to manage the hospital; 4) the misleading financial statements prepared by Price Waterhouse; 5) the opinion of bond counsel that the bonds were tax-exempt under Internal Revenue Code § 103. These defects in the bond issue are not sufficient, either individually or together, to make the bonds "not entitled to be marketed".
Taking all of the evidence in the light most favorable to the plaintiff, the Court can conclude only that the bonds were a bad investment. The plaintiff alleges that the Lewises had no prior construction experience on a job the size of the Mt. Vernon Hospital. The plaintiff also argues that HMA, as a new and highly leveraged company, was not in a position to adequately manage the hospital. There is nothing inherently wrong with novices attempting to run a business venture. A cautious investor would probably wish to avoid investing in such a project, but that does not make securities in the venture unmarketable.
The plaintiff also points to many instances of self-dealing. The instances stem mostly from UDE, Inc.'s, role as the construction contractor for the hospital. Plaintiff alleges that the amounts paid to UDE, Inc., and other contractual terms were the result of self-dealing rather than arm's length negotiations. Furthermore, plaintiff alleges that Boatmen's had a conflict of interest because its sister bank made loans to the Lewises. An investor who does not read the offering statements has no reason to believe that the project in which he or she is investing is free from self-dealing, since securities in projects involving self-dealing are not unlawful if the self-dealing is disclosed. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 473-474, 97 S. Ct. 1292, 51 L. Ed. 2d 480 (1977) ("Thus the claim of fraud and fiduciary breach in this complaint states a cause of action under any part of Rule 10b-5 only if the conduct alleged can fairly viewed as 'manipulative or deceptive' within the meaning of the statute.").
Similarly, the misstatements of the professionals involved in the bond offering are not enough to make the bonds "not entitled to be marketed." Had Price, Waterhouse utilized the forecast techniques suggested by the plaintiff, the interest rate on the bonds may have been different. Many cautious investors may have avoided the bond issue altogether. The bonds, though, would still have been entitled to be marketed at some combination of price and interest rate.
The misstatement of bond counsel regarding the tax-exempt status of the bonds poses a more serious question. A bond which is taxable is not entitled to be marketed on a tax-exempt market.
However, these bonds were tax-exempt. It is irrelevant that bond counsel was mistaken in determining the bonds were tax-exempt under one section of the Internal Revenue Code rather than another. Industrial Development Bonds, which are tax-exempt under Internal Revenue Code § 103, are just as entitled to be marketed on a tax-exempt market as bonds exempt under Internal Revenue Code § 501(c)(3).
Last, there is no evidence that the Lewises did not intend to invest the proceeds of the bond issue in the Mt. Vernon Hospital. In Abell, the court observed that "all of the careful analysis of securities pundits and expert calculations of experienced investors cannot replace the irrefutable knowledge gained from a single source: the actual track record of the securities." 858 F.2d at 1122. Likewise, all the conjecture regarding the intent of the Lewises to carry out the hospital project cannot replace the knowledge gained from reviewing the actual disposition of the proceeds of the bond issue.
The bond proceeds were invested in the hospital project. The hospital was built, although after the construction deadline, and was operating. Affidavit of David Knell, Feb. 22, 1990. More significantly, the Lewises loaned additional money to the hospital, expecting to be repaid from the hospital's profits. Deposition of Glen Lewis, Nov. 14, 1989, at pp. 822-824. Given these facts, the Court finds there is no genuine issue of fact as to the intent to carry out the project.
Under the standard adopted by the Court, summary judgment on the Section 10 and Rule 10b-5 claims must be granted in favor of the defendants. There is no dispute that the bonds were validly issued under substantive state law. There is no dispute that the bonds were issued and offered at 12.25%. The plaintiff has stipulated that the bonds were eventually declared tax-exempt. The facts overwhelmingly show an intent by the promoters to use the proceeds of the bond issue to invest in the Mount Vernon Hospital.
The Court therefore GRANTS defendants' Motion for Summary Judgment on the Section 10 and Rule l0b-5 claims.
Under Section 12(2) of the 1933 Securities Act, any person who sells or offers to sell a security by a prospectus which contains a false statement or material omission is liable to the purchaser of that security. 15 U.S.C. § 77l. All the defendants, except HOJ (the underwriter), have moved for summary judgment on the grounds that they did not sell or offer to sell the bond issue.
The Supreme Court recently clarified the liability of persons who sell or offer to sell securities under the 1933 Securities Act. In Pinter v. Dahl, the Court held that Section 12(1) of the Act imposes liability on those who pass title to a security and on a "person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner." 486 U.S. 622, 108 S. Ct. 2063, 2079, 100 L. Ed. 2d 658 (1988). The Court rejected the "substantial factor" test, voicing its concern that "the test also would extend § 12(1) liability to participants only remotely related to the relevant aspects of the sales transaction. Indeed, it might expose securities professionals, such as accountants and lawyers, whose involvement is only the performance of their professional services, to § 12(1) strict liability for rescission. The buyer does not, in any meaningful sense, 'purchas[e] the security from' such a person." Id., 108 S. Ct. at 2081.
The Court reached its conclusion in Pinter based on a statutory interpretation of § 12(1). Section 12(1) imposes strict liability on any person who offers or sells a security in violation of Section 5 of the Act (imposing a registration requirement for the sale of securities). The Court noted that the Act defines the terms "sell" and "offer to sell" in Section 2(3). The Court also interpreted the term "purchase", which is not defined in the Act. Based on its construction of these two terms, the Court reached its conclusion as to who can be liable under Section 12(1). In a footnote, the Court wrote
The question whether anyone beyond the transferor of title, or immediate vendor, may be deemed a seller for purposes of § 12 has been litigated in actions under both § 12(1) and § 12(2). Decisions under § 12(2) addressing the "seller" question are thus relevant to the issue presented to us in this case, and, to that extent, we discuss them here. Nevertheless, this case does not present, nor do we take a position on, the scope of a statutory seller for purposes of § 12(2).
Id. at 2076, n. 20.
Although the Supreme Court has not squarely addressed the question of who can be liable as a seller under § 12(2), there is no reason to doubt the Court would adopt the reasoning of Pinter when faced with the question. The terms "sell" and "offer to sell" appear in § 12(2), and they should be defined in light of § 2(3). The term "purchase" appears in the body of § 12, and applies equally to § 12(1) and § 12(2). As a matter of statutory construction, the definitions in Pinter should govern liability under § 12(2). Furthermore, plaintiff has presented no reason, compelling or otherwise, why the reasoning of Pinter should not apply to § 12(2) liability. Three circuit courts which have addressed this question have decided that Pinter applies to claims under § 12(2), Moore v. Kayport Package Express 885 F.2d 531 (9th Cir. 1989); Wilson v. Saintine Exploration and Drilling Corp., 872 F.2d 1124 (2d Cir. 1989); In re Craftmatic Securities Litigation v. Kraftsow, 890 F.2d 628 (3d Cir. 1989), as well as a district court in the Northern District of Indiana, Ackerman v. Schwartz, 733 F. Supp. 1231 (N.D. Ind. 1989).
Under the definition of statutory seller in Pinter, the only defendants that can be held liable in this case are HOJ, its principals, the Lewises, the Lewis-controlled entities, and their officers and directors. Only these defendants arguably solicited the sale of the bonds motivated at least in part by a desire to serve their own financial interests. HOJ does not argue that it is not a statutory seller; similarly, HOJ's principals can be said to have solicited the sale motivated by a desire to serve their own financial interests. The Lewises, as well as the companies they controlled, also solicited sales of the bonds. The officers and directors of the Lewis-controlled entities may also have solicited the sale of the bonds motivated by a desire to serve the their financial interests.
The plaintiff also contends that the other defendants may be held liable under an aiding and abetting theory of liability. The Seventh Circuit has addressed the question of aiding and abetting liability under § 12(2), and has written:
Because this circuit has not previously recognized aiding and abetting liability in the 12(2) context, plaintiffs request that the court declare a new implied private right of action under this theory. But notions of aiding and abetting liability would be inconsistent with the intent and language of the statutory provision which expressly limits to offerors and sellers the categories of persons who may be sued. Accordingly, many courts have refused to circumvent the section 12(2) seller requirement by implying some sort of secondary liability. [Citations omitted]. If aiding and abetting claims were cognizable, it would, in effect, eviscerate the various "substantial factor", "proximate cause" and "privity" tests adopted by the circuit courts for imposing liability. [Citation omitted]. Even the Second Circuit, which has expressly acknowledged section 12(2) aiding and abetting liability, limits it to defendants who act with scienter. [Citation omitted.] Therefore, in the absence of a showing that the Bank acted with scienter, we see no reason at this time to imply a right of action for aiding and abetting under section 12(2).
Schlifke v. Seafirst Corp., 866 F.2d 935, 942 (7th Cir. 1989).
Plaintiff contends that the last sentence of the above-quoted language from Schlifke indicates that the question of aiding and abetting liability is open in the Seventh Circuit. While the question of aiding and abetting liability may technically be open in this circuit, the Court of Appeals seriously questions the wisdom of implying aiding and abetting liability. The plaintiff has not addressed these concerns. This Court believes that implying civil liability for aiding and abetting would seriously undermine the Congressional intent in limiting Section 12 liability to sellers. Significantly, the Second Circuit has rejected aiding and abetting liability for violations of Section 12 in light of Pinter. Wilson, 872 F.2d at 1127. Therefore, this Court will not imply aiding and abetting liability under Section 12. Accord Ambling v. Blackstone Cattle Co., 658 F. Supp. 1459, 1467-68 (N.D. Ill. 1987).
The plaintiff also seeks to hold the non-selling defendants liable on a conspiracy theory. Secondary liability for securities violations has been imposed based on a conspiracy under other parts of the securities laws, but in light of the Congressional intent to limit liability under Section 12 to statutory sellers, this Court will not allow the plaintiff to hold non-selling defendants liable under a conspiracy theory.
The Court thus GRANTS defendants' Motion in part, and DENIES it in part.
The defendants also seek summary judgment on the Section 12 claims as time-barred. The statute of limitations for claims under Section 12 is one year after the discovery of the untruthful statements, or after such discovery should have been made by the exercise of reasonable diligence, but in no event more than three years after the sale of the security. 15 U.S.C. § 77m. In Goldwater I, this Court held that the plaintiff had alleged sufficient facts to invoke the equitable tolling doctrine of fraudulent concealment. Goldwater I, 664 F. Supp. at 407. This Court found that the statute of limitations began to run in May, 1984.
The defendants argue that Dalton's deposition testimony indicates that he was aware of the fraud alleged in the complaint as early as February, 1982, when the bonds defaulted. This contention is based on the following testimony:
Q. What was your understanding of [the notice of default] after you read it?