Appeal from the District Court of the United States for the Southern District of New York.
before SWAN, AUGUSTUS N. HAND, and CHASE, Circuit Judges.
This is an action for deceit brought against the members of the firm of Haskins & Sells, certified public accountants. Haskins & Sells audited the books and accounts of G. L. Miller & Co., Inc., a Delaware Corporation, as of the close of business August 31, 1925, and delivered to the corporation a balance sheet purporting to show its financial condition as of that date after giving effect to proposed new financing, namely, the sale of 30,000 shares of preferred stock at par -- $3,000,000. This balance sheet was used by the corporation in selling its preferred stock to the public, and Haskins & Sells knew that it was to be so used. The plaintiffs are persons who purchased shares of the preferred stock between October 24, 1925, and June 3, 1926, in reliance upon the balance sheet, which they assert was fraudulently false and misleading. In September, 1926, the corporation was adjudicated bankrupt, its assets were insufficient to pay the allowed claims of creditors, and the plaintiffs lost their investments in their entirety. This action was begun in October, 1928. Jurisdiction of the District Court rests upon diversity of citizenship, and each of the plaintiffs sued on his own behalf for $3,000 or more. Their separate causes of action were tried together for convenience. After a trial lasting thirteen weeks, the jury found a verdict for the defendants. Judgment thereon was entered May 18, 1934. Seventeen of the plaintiffs have appealed. The appellees are the original defendants, excepting Charles S. Ludlam, against whom the action had abated by death. The enormous record on appeal, consisting of more than 4,000 printed pages and several hundred documentary exhibits, was not filed until January, 1936, and the case did not come on for argument until a year later. The errors assigned relate solely to refusals to charge as requested, no exceptions having been taken by the appellants to the charge as given.
G. L. Miller & Co., Inc., was organized under the laws of Delaware in October, 1930. It took over the assets, good will, and liabilities of G. L. Miller & Co., a Florida corporation, and issued therefor 1,000 shares of no par value stock. This was issued to Mr. G. L. Miller, who remained throughout the owner of all the common stock of the corporation, except for qualifying shares issued to employee-directors. The net book value of the assets, exclusive of good will, so taken over was about $7,500 after deducting liabilities. In 1923 the corporation declared a common stock dividend of 100 per cent. Thus there were 2,000 shares outstanding at the time of the proposed new financing in 1925. The business of the Miller Company consisted in underwriting mortgage bonds on real estate, usually on buildings to be constructed, acting as trustee under the mortgage indentures, and selling the bonds to the public. The common course of business involved three agreements: An underwriting agreement under which Miller & Co. purchased the mortgagor's bonds; a trust indenture, under which Miller & Co. as trustee was to receive from the mortgagor in equal monthly installments sums sufficient to enable it to pay semiannually to the bondholders the yearly interest, the federal income tax thereon (up to 4 per cent.), and the amount required for annual redemption of the bonds, which matured serially; and a disbursing agreement, under which Miller & Co. agreed to advance the amount of the mortgage loan as construction progressed. For the money thus advanced Miller & Co. depended upon the sale of the mortgage bonds.
At the time of the audit in question Miller & Co. had received from mortgagors for interest, income tax, and bond-redemption payments due under the trust indentures funds totalling approximately $1,377,000. These were held by it as trustee for the bondholders, but were commingled with its own cash, and the audit is claimed to be intentionally fraudulent in not adequately disclosing the amount of cash held in trust. Another ground of attack relates to payments made by Miller & Co. to complete the construction of mortgaged buildings. In selling bonds Miller & Co. represented that the mortgagor had agreed to provide the money necessary to complete the building under construction, and had furnished a surety bond guaranteeing completion free of all liens prior to that of the mortgage indenture. In fact, surety bonds were not furnished, and frequently the mortgagor defaulted in completing the structure. To make good such defaults Miller & Co. advanced very large sums out of its own funds. These were represented by notes of affiliates or subsidiaries of Miller & Co. and were shown in the audit as "secured," although, as the District Judge charged, they were not secured. Furthermore, in numerous instances Miller & Co. had itself guaranteed to bondholders completion of the buildings under construction, and the audit made no mention of such contingent liabilities running into many millions of dollars. It is also charged that the defendants made a false certificate as to the net earnings of Miller & Co. for the year 1924 and the first eight months of 1925. The audit is printed in the margin.*fn1
Note: The Company carries life insurance on the life of Mr. G. L. Miller, President, for $500,000.00.
Our audit of the books and accounts of the G. L. Miller & Company, Incorporated, discloses that the net earnings of the Company for the year ended December 31, 1924, were in excess of 2 1/2 times the dividend requirements of the contemplated issue of 30,000 shares of 8% cumulative preferred stock, and that the net earnings for the eight months ended August 31, 1925, were in excess of 3 times the dividend requirements of said stock for the said eight months.
New York, September 30, 1925. HASKINS & SELLS
Certified Public Accountants.
The specific items which are challenged will be referred to hereafter in discussing the alleged errors of the court in refusing to charge as requested.
The charge which Judge Patterson delivered to the jury was an exceptionally clear exposition of the applicable law. Since there was no contractual relationship between the plaintiffs and the defendants, liability could be imposed only for fraud; a mistake in the balance sheet, even if it were the result of negligence, could not be the basis of a recovery. Ultramares Corp. v. Touche, Niven & Co., 255 N.Y. 170, 174 N.E. 441, 74 A.L.R. 1139. Fraud presupposes not only an untrue statement but also a fraudulent intent. On the question of falsity of the representations the jury was told that the issue was whether the defendants' representations, "in the sense to be taken by an ordinary reasonable man," were, in fact, true or untrue -- whether a true or a false impression was created. On the question of intent, the jury was told that fraud may be established by showing that a false representation has been made, either knowingly, or without belief in its truth, or in reckless disregard of whether it be true or false; and that the issue was whether the defendants had an honest belief that the statements made by them were true. "If they did have that honest belief, whether reasonably or unreasonably, they are not liable. If they did not have an honest belief in the truth of their statements, then they are liable, so far as this third element [scienter] is concerned." The jury was also told that an intent to deceive may be inferred from a lack of honest representation; and that, so far as alleged concealments or omissions were concerned, the issue was whether the omission to state certain matters was deliberate and intended to conceal. It was further charged that, if the audit made "was so superficial as to be only a pretended audit and not a real audit, then the element of knowledge of falsity of their representations is present, and they may be held liable." Reading the charge as a whole, it seems to be in strict conformity with the established law. Ultramares Corp. v. Touche, Niven & Co., 255 N.Y. 170, 174 N.E. 441, 74 A.L.R. 1139; Knickerbocker Merchandising Co. v. United States, 13 F.2d 544 (C.C.A.2); Fidelity & Deposit Co. v. Drovers' State Bank, 15 F.2d 306 (C.C.A.8); Panther Rubber Mfg. Co. v. Commissioner of Int. Rev., 45 F.2d 314 (C.C.A.1). And apparently the plaintiffs themselves thought it accurate and satisfactory at the time, for in response to the court's invitation to state exceptions to the charge as delivered, counsel replied that he had none. However, both sides had previously handed to the court requested instructions, and at the conclusion of the charge Judge Patterson remarked that many of the requests had been given in substance and that, to the extent not thus covered, the requests were refused and an exception granted in each instance. The requests handed up by the appellants numbered 82; and their assignments of error involve 40 alleged refusals to charge as requested, although they had failed to point out any errors in the charge as given. A similar grant of blanket exceptions has been criticized for the burden it passes to an appellate court. People v. Katz, 209 N.Y. 311, 103 N.E. 305, Ann. Cas. 1915A, 501.In the federal courts the doctrine is firmly established that exceptions should be specifically taken so that the trial judge may have an opportunity to reconsider the matter and remove the ground of exception. Where the exceptions are not specific, an appellate court is under no duty laboriously to relate each of the requested instructions to the charge as given, in order to determine that no error was committed.American Sugar Refining Co. v. Nassif, 45 F.2d 321, 326 (C.C.A.1) and authorities there cited. Nevertheless, if a refused instruction constituted plain error and had resulted in a miscarriage of justice, we should hesitate to ignore it because exceptions were taken as they were in the case at bar. Accordingly, we have examined all of the errors assigned, but we shall discuss only those relating to requested instructions which appear to be the most significant.
The Subject of Trust Funds: The first item of assets on the general balance sheet is "Cash, Including Time Certificates of Deposit . . . $4,663,099.93." This figure was obtained by adding to the actual cash the estimated proceeds from sale of the new preferred stock. The actual cash included $1,477,000 of trust funds which Miller & Co. as trustee had received from mortgagors on account of payments due under trust indentures. Miller & Co. was itself the beneficiary of $100,000 of these trust funds, but the remainder, $1,377,000, was held in trust for other bondholders. The inclusion of this sum as a general cash asset of the company without further explanation would plainly give a false impression as to the company's cash position. The main defense against this charge was the defendants' contention that an adequate explanation was supplied by the item on the liability side of the balance sheet, "Funds for Bond Interest and Redemption . . . $1,966,938.40." In round figures this sum represented the aforesaid amount of $1,477,000 actually received from mortgagors plus an amount of $489,000 which was accrued and treated on the company's books as received, although in fact it had not been. The defendants point out that the word "Funds" necessarily meant trust funds, since the "Bond Interest and Redemption" referred to could relate only to bonds on mortgaged property, Miller & Co. having no bond issue of its own. On the question whether there was ambiguity in this item, there was testimony both ways and the judge so charged, after calling the jury's attention to the respective contentions of the parties. He had previously stated that the sum of about $1,400,000.00 was received by Miller & Co. as trustee under the mortgages.
The appellants complain because their requested instructions numbered 25 to 31, inclusive, were not given. They urge that the jury was simply left with the conflicting contentions of counsel on the subject of trust funds. In substance, their complaint seems to be that the court did not point out with particularity how to apply to this subject the general rules he laid down for determining whether representations were false and made with fraudulent intent. Such a complaint is not well taken. The judge was under no obligation to discuss in detail the evidence relating to each item of the alleged misrepresentations, and particularly is this true where no request was made to amplify the charge as given. Request No. 25 was to the effect that cash received as trustee can form no part of the company's assets. It is incredible that the jury did not so understand. The court had charged that about $1,400,000 was held in trust, and the issues between the parties, as shown by the court's statement of their respective claims and the general charge, was whether the balance sheet disclosed this trust obligation to the ordinary reader, and whether the accountants could honestly believe that it did. Several of the requested instructions, for example, No. 28, assumed that the balance sheet concealed the true financial condition by failure to disclose the trust.This was for the jury to decide, and such requests were properly refused. Request No. 26 asserted that it was the duty of Haskins & sells to show clearly on the balance sheet that these trust funds did not belong to Miller & Co. As a principle of correct accounting we should suppose this to be true, but the issue for the jury was not that, but was whether a false impression of financial worth was intentionally created.Request No. 31 asserted that prospective investors in the ...