The opinion of the court was delivered by: LASKER
These three actions arise out of the activities of Defendant Black Watch Farms, Inc. ("Black Watch") which was between 1963 and 1970 in the business of selling Aberdeen Angus breeding cattle and maintaining the animals for the accounts of the purchasers. The purchasers were primarily well-to-do professional and business people who seem to have bought the cattle not out of any particular yearning for the wild west, but as tax shelters. The hoped-for advantages never materialized since Black Watch ran into financial difficulties and allegedly defaulted on its maintenance agreements covering the cattle, resulting in substantial losses for many investors. Black Watch filed in bankruptcy in September, 1970, and these lawsuits followed.
Plaintiffs in O'Shea (the pre-prospectus action) are herdowners who purchased their cattle prior to the time (in May 1969) Black Watch effected a registration statement under the Securities Act of 1933. Plaintiffs in Bickart and Ingenito (the post-prospectus actions) bought their herds pursuant to a prospectus dated May 26, 1969.
Defendants, in addition to Black Watch itself,
are a varied group including Black Watch's shareholders, officers and directors, some of its salesmen, its accountants, most of its lenders, and Bermec Corp. and State Mutual Life Assurance Co. of America ("State Mutual") alleged controlling persons of Black Watch.
The extensive and somewhat diffuse complaints allege violations of the securities laws (§§ 5, 12 and 17(a) of the Securities Act, 15 U.S.C. §§ 77e, 77l and 77q and § 10(b) of the Exchange Act, 15 U.S.C. 78j(b)) as well as common law fraud and usury. Before us are parallel motions by the pre-prospectus plaintiffs and the post-prospectus plaintiffs for an order consolidating the three cases and for a determination pursuant to Rule 23, Federal Rules of Civil Procedure that the entire lawsuit proceed as a class action with two subclasses (pre- and post-prospectus purchasers). Also before us is a motion by defendants State Mutual, Richard H. Wilson and C. John McLoughlan, Jr. (officers of State Mutual as well as directors of Black Watch) and West End Livestock, Inc., ("West End") to dismiss the complaints as against them. We refer to all plaintiffs as a group unless otherwise specified.
A. The Class Action Motion.
The named plaintiffs entered into agreements with Black Watch during the period 1967-68
by which each herdowner purchased a herd of cattle from Black Watch, receiving certificates of title covering each animal, and entered into a maintenance contract under which Black Watch was to provide complete care for the herdowner's animals. In addition, almost all plaintiffs financed the purchase price for the animals by a cash down payment and a set of promissory notes payable to Black Watch, generally over a three year period. In the period before mid-1968, when defendant Bermec acquired control of Black Watch, the basic selling unit was a herd of ten female animals for $35,000; after mid-1968, a herd consisted of 36 female animals and a 1/3 interest in a breeding bull for $100,000. Maintenance fees were $500. per animal per year for a ten animal herd, and $350. per animal per year for a 36 animal herd. There were, evidently, certain minor variations in the terms of the contracts between herdowners and Black Watch, the relevance of which will appear later in the discussion. Black Watch pledged most of the herdowner notes given in payment for the cattle to several lending institutions; the principal noteholders have been named as defendants in these actions, and plaintiffs seek, among other things, a mandatory injunction to prevent enforcement of the notes by the holders.
Black Watch, which began selling herds in 1963, took the position until 1968 that its transactions with herdowners (consisting of a purchase contract, maintenance contract and note) did not constitute securities within the meaning of the Securities Act and did not register its contracts with the SEC until March 20, 1969, the date of the first prospectus. After Bermec acquired control in mid-1968, counsel for both Bermec and Black Watch sought a no-action letter from the SEC; the SEC advised that the sale of cattle together with a maintenance contract constituted a security in the nature of an investment contract, which would require registration. Black Watch then suspended its selling program until a registration became effective. The Bickart plaintiffs purchased their herds pursuant to the prospectus and issued notes in full or part payment for their herds; the Ingenito plaintiffs paid entirely by cash. Otherwise, the "package" of transactions entered into by plaintiffs in all three actions appears to have been substantially identical.
The parties have extensively briefed, and orally argued before the court, the question whether plaintiffs have satisfied the several prerequisites to the grant of class action status specified in Rule 23. However, merely reading the complaints and surveying the roll of defendants indicates that plaintiffs' most difficult hurdle is to meet the requirement of Rule 23(b) (3) that questions of law or fact common to the class predominate over individual questions and that a class action is the superior method for adjudication of the disputes between the parties.
The O'Shea plaintiffs allege that all members of the proposed class of pre-prospectus purchasers had the right to rescind their contracts because (a) Black Watch's sales constituted sales of unregistered securities, in violation of § 12(1) of the Securities Act, 15 U.S.C. § 77l(1); and (b) the Black Watch defendants and control persons, in connection with the sales, allegedly employed both oral and written misleading representations or omissions of material facts, in violation of § 12(2) and § 17(a) of the Securities Act, 15 U.S.C. § 77l(2), and § 77q(a); and § 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b). Plaintiffs number among the claimed misrepresentations and omissions the true value of the herds, future selling prices of the cattle, expected progeny rates; and the fact that the animals would be scattered over many different farms, that there was no present market for the securities, and that there was a risk of near-total loss if Black Watch failed to honor its maintenance obligations.
The O'Shea plaintiffs further allege that the Black Watch defendants took certain actions from January 3, 1969 (when the SEC refused a no-action letter) to September 4, 1970 (when Black Watch filed in bankruptcy) to conceal from plaintiffs, and deprive them of their alleged right to rescind their transactions. They assert that Black Watch was already in serious financial trouble by mid-1969 and in danger of defaulting on its herd maintenance obligations. The Black Watch defendants allegedly failed to inform herdowners of the SEC's advice to register any new offerings and of the material in the May 26, 1969 prospectus (which evidently was not mailed to the pre-prospectus herdowners) stating that prior investors had a right to demand rescission, and that Black Watch might be forced into liquidation because of severely decreased cash flow.
Additionally, the Black Watch defendants are claimed to have engaged, during the twenty month period spanning the issuance of the prospectus and the filing in bankruptcy, in a course of conduct intended to forestall the complaints of herdowners and to keep them paying on their contracts. Among the acts and devices complained of are an alleged "buy-out" proposal, offered to some unhappy herdowners by which they could pay a substantial sum to Black Watch in return for a release on their notes; the offer of new notes containing extended payment terms and release and waiver provisions in exchange for the original notes; and reduced maintenance charges or other modifications of the existing contracts. In short, the O'Shea plaintiffs claim the Black Watch defendants carried out an orderly program to assuage the doubts and complaints of unhappy herdowners and conceal from them their alleged right to rescind.
The O'Shea plaintiffs' claims against the noteholder defendants (including State Mutual, which is also charged as a control person of Black Watch) cast them as co-conspirators or aiders and abettors of the alleged fraud by the Black Watch defendants. The noteholder defendants, who acquired herdowner notes beginning in 1968, were at the time of their acquisition allegedly aware of fraud in Black Watch's sales practices, its deteriorating financial condition and the possibility of wholesale demands for rescission. They are claimed to have conspired with the Black Watch defendants to conceal from herdowners the precarious condition of Black Watch, and to keep them paying on their notes. The purpose of the scheme, as plaintiffs characterize it, was to bolster Black Watch's precarious cash position and, since herdowner notes were allegedly Black Watch's principal asset, to protect the noteholders' own interest in keeping Black Watch afloat. In addition to the § 10(b) antifraud claims, the O'Shea plaintiffs contend that many, if not all of the herdowner notes are usurious. Proof of any of these assertions would, of course, puncture the noteholders' status as holders in due course.
Plaintiffs in Bickart and Ingenito purchased their herds pursuant to a prospectus dated May 26, 1969. They charge fraud by the Black Watch defendants in the use of an allegedly false prospectus, failure to update the prospectus to disclose subsequent material events, (chiefly Black Watch's declining financial condition) and extensive oral and written misrepresentations and projections (similar to those charged in O'Shea) by Black Watch salesmen made independent of the prospectus. Like the O'Shea plaintiffs, the Bickart plaintiffs further assert that the noteholder defendants joined with the Black Watch defendants beginning in mid-1969 to lull herdowners into retaining their securities and paying on their notes while failing to disclose (as plaintiffs claim) that Black Watch was being operated chiefly for the benefit of its creditors. The devices allegedly used to lull the Bickart plaintiffs are the same as those in O'Shea.
The Ingenito plaintiffs paid cash for their herds and as a result they sue only the Black Watch defendants and Bermec and State Mutual (alleged control persons) on grounds similar to those already described.
The pre-prospectus (O'Shea) subclass is defined as "those purchasers of Black Watch securities prior to May 26, 1969, who (i) had the right to rescind their purchases, and (ii) were induced by the fraudulent conduct of the defendants to take no action or accept a new security
in lieu of exercising their right to rescind." The post-prospectus class (Bickart and Ingenito) is defined as all persons "who purchased investment contracts of Black Watch pursuant to the Prospectus dated May 26, 1969. . . ."
Plaintiffs contend that the state of facts described (which we take as true for purposes of this motion) presents the following questions of law or fact common to the class: (1) whether the bundle of obligations binding Black Watch and herdowners was a security required to be registered under the Securities Act of 1933, and if so, whether the pre-prospectus purchasers' right of rescission (provided by § 11) for violation of § 12 of the Act was time-barred when the O'Shea action was commenced; (2) whether a projection sheet (which the parties agree was generally, if not always, used as part of the Black Watch sales presentation) misrepresented anticipated herdowner profits, progeny rates and sales prices for cattle, in violation of § 10(b); (3) whether the Black Watch defendants omitted to disclose in connection with the underlying sales transactions certain material information relating to Black Watch's operating procedures and financial condition; (4) whether the prospectus issued in 1969 was false and misleading, and should have been updated; (5) whether fraud was practiced on the herdowners by "lulling" them into retaining their investments by means of the various contractual modifications detailed above; (6) whether the noteholder defendants aided and abetted the alleged fraud by holding themselves out as holders in due course and withholding from heredowners certain information about Black Watch's precarious financial position.
Plaintiffs' papers specify several other questions claimed to be common to all of them, but those just described are the principal ones. We conclude, for the reasons set forth below, that these are not common issues even as to members of the proposed subclasses (pre- and post-prospectus herdowners, respectively) and consequently that common issues do not predominate over individual issues as required under Rule 23(b) (3).
The first issue (the O'Shea plaintiffs claims under § 5 and § 12 of the 1933 Act) is not seriously pressed on this motion. Defendants insist, and plaintiffs do not seriously dispute (apart from advancing a curiously arcane tolling theory) that the § 12 claims of most (if not all) the O'Shea plaintiffs are time-barred by the relatively short limitations periods imposed by § 13 of the 1933 Act, 15 U.S.C. § 77m. However, we need not decide whether the § 12 claims are time-barred since plaintiffs have failed affirmatively to plead compliance with the statute of limitations, as they are required to do. Newberg v. American Dryer Corp., 195 F. Supp. 345 (E.D. Pa. 1961); Premier Industries, Inc. v. Delaware Valley Financial Corp., 185 F. Supp. 694 (E.D. Pa. 1960); cf. Fischman v. Raytheon Mfg. Co., 9 F.R.D. 707 (S.D.N.Y. 1949), rev'd on other grounds, 188 F.2d 783 (2d Cir. 1951).
Moreover, even assuming some plaintiffs could plead compliance with the statute of limitations, the § 12 claims may well be unamenable to class treatment: The O'Shea named plaintiffs bought their herds on an individual basis, not pursuant to a general public offering, but over the period from 1967 to 1969. Members of the O'Shea class purchased beginning in 1963. Since it is undisputed that many herdowner contracts were back-dated (which evidently resulted in extra interest charges to Black Watch and extra depreciation deductions for some herdowners), simply determining when the statute of limitations in fact began to run on the § 12 claims would involve a separate inquiry as to each herdowner. Finally, even assuming a number of plaintiffs' proposed class to have timely sued, nothing in the present record suggests that they are numerous enough to warrant class status.
Plaintiffs' second purportedly common issue, and the one pressed most vigorously, concerns the use of an allegedly misleading projection sheet given or displayed to each sales prospect (both pre and post-prospectus) as part of the Black Watch salesman's oral presentation. The sheets were a printed or handwritten form with spaces for projected average sales values of the animals, cash flow, five and ten-year yield in tax savings, and anticipated progeny rates of calves. Black Watch salesmen appear to have filled in the spaces on sheets according to the particular financial situation of the sales prospect and their own sales practices, in order to illustrate to a prospective herdowner how he might benefit from investing in Black Watch. It is undisputed that while the projection forms were identical (or nearly so), the particular figures supplied varied from prospect to prospect. (Katz Affidavit, p. 94-5). Plaintiffs argue, nonetheless, that the allegedly uniform use of a common sales technique, such as the projection sheets, presents the common issue whether Black Watch salesmen were guilty of fraudulent misrepresentations in violation of § 10(b). Such a contention misses the point, since it is not the use of any particular technique that offends § 10(b) but the use of a knowing, material misrepresentation to the detriment of investors. On a 23(b) (3) class action motion, the commonality of these misrepresentations, rather than the technique, is the critical issue.
It is clear that the projection sheets did not contain common and uniform representations. Even as to the named plaintiffs, the sales were made over a period of two years; since cattle prices fluctuated during this period (as plaintiffs' own papers acknowledge) the accuracy of any particular projection of cash flow cattle price and other investor benefits depends upon, of course, the prevailing market price at the time the projection was made. For other class members, who purchased herds over a six-year period (1963-69) the disparities are likely to be even greater. Such circumstances, where claimed affirmative misrepresentations are made over a long period of time, have been recognized as inappropriate for class treatment. Pearson v. Ecological Science Corp., 1973 CCH FED. SEC. L. REP. para. 94,030 (S.D. Fla. 1973). Moreover, it clearly appears on the record before us that herdowners were in fact shown projection figures which varied substantially even as to the named plaintiffs alone. The affidavit of George A. Katz, in opposition, cites depositions of various plaintiffs which establish that salesmen's projections cattle prices varied from a low of $1,000. per animal to a high of $3,200. These projections were made by twelve different salesmen in connection with sales presentations which resulted in purchases between September 1967 (plaintiff Lazarus) and February 1969 (plaintiff Bonat). (Katz Affidavit, paras. 172-174.) Similarly, depositions of plaintiffs disclose that projected progeny rates varied from 85% to 100%. (Katz Affidavit, para. 175.)
In our view, however, the greatest difficulty in treating the projection sheets as a common issue is that projection sheets were not the only, or even the major vehicle for selling the Black Watch program. As plaintiffs' supporting affidavits make clear, (and indeed, as the complaints claim on their face) a Black Watch salesman made his sales presentation in person. Consequently, not only the various figures embodied in the projection sheet, but also their context and significance would present individual issues of fact: the projection sheets were not self-explanatory. For example, the Katz affidavit cites deposition testimony of several plaintiffs, some of whose progeny projections were allegedly orally touted as "guarantees", while the projections given others were simply representations of opinion. (Katz Affidavit para. 175.)
The authorities which plaintiffs claim supports class treatment on the projection sheet issue are not persuasive, since they deal with printed, uniform circulars distributed to the class, without the additional element of oral representations. See Royal Air Properties, Inc. v. Smith, 312 F.2d 210 (9th Cir. 1962); Derdierian v. The Futterman Corp., 38 F.R.D. 178, FED. SEC. L. REP. (CCH) P91,575 (S.D.N.Y. 1965); S.E.C. v. Los Angeles Trust Deed & Mortgage Exchange, 186 F. Supp. 830 (S.D. Cal. 1960). We conclude that use of the projection sheet does not present a common issue.
Similar problems exist in connection with plaintiffs' third proposed common issue (which relates only to the pre-prospectus subclass), allegedly uniform omissions to disclose at the time of sale certain material information relating to Black Watch's method of operations and finances. In the ordinary § 10(b) class suit based on material omissions, the finder of fact is faced with the relatively straight-forward problem whether the prospectus, or other written material, does in fact fairly represent the facts claimed to be omitted and if not, whether the omitted facts are material. In such a case, reliance (in effect, constructive reliance) is inferred from the finding of materiality itself. Affiliated Ute Citizens v. United States, 406 U.S. 128, 150-54, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1972).
However, such an inference is supportable for purposes of a class action determination only when contact with a prospectus or some other discrete source of information is the only (or at least primary) contact the investor has with the defendant. Such is not the case presented. It is reasonable to expect, since the Black Watch contracts were sold without a prospectus at arms length, that omissions of material facts will have to be separately established at trial for each O'Shea plaintiff. The proof of omission as to plaintiff A, who dealt with salesman X is not proof of material omissions as to plaintiff B who dealt with salesman Y. However, we need not be content merely to infer variations in the claimed omissions. In fact, the Katz affidavit establishes (and is not controverted by plaintiffs) that there were substantial variations among the named plaintiffs as to the alleged omissions detailed in the O'Shea complaint (at para. 9). On deposition, for example, some plaintiffs stated they were told that their cattle would be centralized at one location, while others were told they would be scattered among several sites -- an allegedly undisclosed factor of risk charged in Paragraph 9(e) of the O'Shea complaint. (See Katz Affidavit, para. 177.) There was also conflicting testimony relating to the allegedly undisclosed fact that Black Watch contracted for maintenance with third parties (Complaint, para. 9(d)) rather than leasing or owning maintenance facilites. (See Katz Affidavit, para. 178.) It is precisely because of the difficulties thus presented that the view that oral misrepresentations and omissions are not suited for class treatment finds strong support in the authorities. Simon v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 482 F.2d 880, 882 (5th Cir. 1973); Morris v. Burchard, 51 F.R.D. 530 (S.D.N.Y. 1971); Moscarelli v. Stamm, 288 F. Supp. 453 (E.D.N.Y. 1968); Goldstein v. Regal Crest, Inc., 59 F.R.D. 396, 17 F.R. Serv. 2d 680 (E.D. Pa. 1973), Comment, The Impact of Class Actions on Rule 10b-5, 38 U. Chi. Law Review 337, 342 (1971).
Plaintiff cites several decisions in which class action status was granted, notwithstanding individual variations in representations to investors, on the basis of a "common and allegedly fraudulent course of conduct," but the cases are distinguishable. In Grad v. Memorex, 61 F.R.D. 88, FED. SEC. L. REP. (CCH) P94,029 (N.D. Cal. 1973) several suits charging an issuer with misleading statements in earnings reports and press releases over a period of a year were consolidated for class treatment. The court held that, although there were variations among the several quarterly reports and releases involved, the allegation of a deceptive accounting method for reporting sales and net income was common to all of them. That case clearly differs from the one presented here, since Memorex involved only written representations in a few documents covering the same subject (earnings figures), rather than both written and oral representations raising the possibility of as many individual issues as there are herdowners.
Green v. Wolf Corp., 406 F.2d 291 (2d Cir. 1968), another key authority cited by plaintiffs, reached the same result as Memorex, supra, on similar facts (a series of prospectuses) and for the same reason, does not support plaintiffs' position. In Harris v. Palm Springs Alpine Estates, Inc., 329 F.2d 909 (9th Cir. 1964) (facts reported at 186 F. Supp. 830 (S.D. Cal. 1960)) class action treatment was granted for investors in a "secured 10% earnings program" which involved the purchase of discounted trust deeds or mortgages. Although investors were treated to a barrage of advertising and brochures about the program, no oral representations were made to them, so that proof of the alleged misstatements and omissions presented issues common to the class. See also, Fischer v. Kletz, 41 F.R.D. 377 (S.D.N.Y. 1966).
In Esplin v. Hirschi, 402 F.2d 94 (10th Cir. 1968), which contains perhaps the most liberal construction of Rule 23(b) (3) in the context of a § 10(b) claim, defendants orally solicited plaintiffs' purchase of certain stock. In the course of the year following the purchase, the only communications sent to plaintiffs were several notices relating to shareholders' meetings and a financial statement. Plaintiffs charged that both the oral and written communications omitted certain material facts, in violation of § 10(b). On these facts, the trial court denied class action status; the Court of Appeals reversed after the trial at which defendants admitted nondisclosure of the omissions initially charged. Even so, the reviewing court found the § 10(b) class certification "an extremely close question," 402 F.2d at 99, after finding that the essence of the proposed class claim was not (as here) the issue of affirmative misrepresentation, but its converse; a "complete failure to disclose any material facts -- which default was necessarily common to all shareholders." 402 F.2d at 99-100. Though plaintiffs here charge important omissions, it is clear both from their pleadings and papers in support of this motion that affirmative misrepresentations (at least as to the Black Watch defendants) are an essential part of their claims. The claims of omissions cannot be said to predominate as required by Rule 23(b) (3).
Plaintiffs' final argument relating to Black Watch's alleged common course of conduct (including both affirmative misrepresentations and omissions) essentially concedes that there were variations in the sales pitch given to herdowners. They claim however, that since (for example) all the projection sheets were grossly misleading, that the only variations among them relate to the "magnitude of the lie" rather than the question whether there was a "lie" in the first place.
According to plaintiffs' relatively newfangled argument, since proof of reliance is not a prerequisite to class action status, see, e.g., Dorfman v. First Boston Corp., 62 F.R.D. 466, FED. SEC. L. REP. (CCH) P94,155 (E.D. Pa. 1973); Kronenberg v. Hotel Governor Clinton, 41 F.R.D. 42 (S.D.N.Y. 1966) or even to ultimate liability, Affiliated Ute Citizens v. United States, supra, the fact of somewhat varying representations made to herdowners (which they claim goes only to the reliance issue) is irrelevant to the predominant (as plaintiffs see it) common issue whether Black Watch engaged in a course of conduct by which it consistently misrepresented resale prices and progeny rates.
The argument misses the mark. Although plaintiffs do not have to allege or establish reliance in order to succeed on this motion, it must appear, as a condition to class status, that any misrepresentations or omissions were common to the class. Similarly, they will have to prove at trial not that they relied on the misrepresentations, if any, but that any misrepresentations were material. The requirement of such proof poses two stumbling blocks to class action status.
Quite apart from the fact that the sales were made over a period of time, while cattle prices (and consequently the accuracy of any projections) fluctuated, the precise quality of the representations -- which might range from a solid guarantee or representation of fact to a carefully hedged, highly contingent opinion -- would have to be separately proven at trial as to each plaintiff to establish liability. Moreover, as plaintiffs concede, many of them were evidently shown projection sheets, which salesmen then took with them. Consequently this "class issue" would in a practical sense be based entirely on alleged individual, oral misrepresentations or omissions: Establishing the precise delineation of the alleged projections presented to each plaintiff would create an unmanageable trial. Because the Black Watch defendants do not, of course, admit the substantial commonality and materiality of the alleged misrepresentations at this stage in the proceedings, we must conclude that plaintiffs "course of conduct rationale" does not present issues common to the class.
Plaintiffs' fourth purported common issue, which applies only to plaintiffs in Bickart and Ingenito involves the allegedly false and misleading prospectus distributed to the post-prospectus subclass, and the alleged failure of the Black Watch defendants to update it to reflect material changes in Black Watch's condition. We find that this issue is common to the post-prospectus class, assuming that the other requirements of Rule 23 are met, a question we reach below. Although the post-prospectus plaintiffs acknowledge (and indeed assert as an index of their kinship with the pre-prospectus plaintiffs) that they purchased herds pursuant to the same type of sales presentation as the pre-prospectus plaintiffs, this fact does not, as defendants urge, dilute or destroy the commonality of the prospectus issue in their case. Since, as we have noted, reliance on the prospectus need not be proven at trial, it is immaterial whether other, possibly non-misleading, representations were made to the post-prospectus herdowners in the course of the sales presentation. Proof that the prospectus was materially ...