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June 9, 1975

Howard C. Hirsch, et al., Plaintiff-Appellants
Edmond Du Pont, et al., Defendants-Appellees

Carter, District Judge.

The opinion of the court was delivered by: CARTER

CARTER, District Judge:


 The amended complaint alleges in substance that defendants violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), in connection with the purchase by plaintiffs and sale by certain defendants of general and limited partnership interests in F. I. duPont, Glore Forgan & Co. Common law claims based on pendent jurisdiction are also asserted. In May, 1974, plaintiffs entered into a settlement with all defendants except the New York Stock Exchange, Inc. ("Exchange") and Haskins and Sells, an accounting firm. The Exchange and Haskins and Sells now move for summary judgment dismissing the federal securities laws claims of plaintiffs Paul L. Kohns and Marshall S. Mundheim, primarily on the ground that the general partnership interests purchased by them *fn1" were not "securities," as defined in § 3(a)(10) of the Exchange Act, 15 U.S.C. § 78c(a)(10), and § 2(1) of the Securities Act, 15 U.S.C. § 77b(1). No motion is made with respect to plaintiff Howard C. Hirsch, who received only limited partnership interests.

 The Amended Complaint

 The amended complaint alleges that prior to July, 1970, plaintiffs were general partners of Hirsch & Co., a brokerage firm; that on or about July 2, 1970, pursuant to written agreement, Hirsch & Co. was liquidated and its assets were transferred to defendant Francis I. duPont & Co. ("duPont") and then to defendant F. I. duPont, Glore Forgan & Co. ("duPont Glore"), a successor partnership to duPont; and that as part of the transaction, duPont and duPont Glore "offered for sale and sold to * * * the plaintiffs herein certain securities consisting of general and limited partnership capital units of F. I. duPont, Glore Forgan & Co." It is further alleged that in connection with this transaction, all defendants knowingly made untrue statements and omitted to state material facts concerning duPont's compliance with Exchange capital requirements, its net worth and sources of capital, and its "back office" difficulties and problems with customers' accounts. It is alleged that the Exchange and Haskins and Sells, who were auditors to both Hirsch & Co. and duPont, failed to disclose these matters; that the Exchange expressly approved and encouraged the transaction; and that as a result, plaintiffs purchased the partnership interests for more than they were worth and sustained damages.

 Background Facts

 On this motion for summary judgment, the following background facts are undisputed. Since the early 1940's, plaintiff Kohns had been the managing general partner at Hirsch & Co., and by 1965, he had become in practical fact, the chief operating officer, with responsibility for all aspects of Hirsch & Co.'s business. Mundheim assisted Kohns in these duties, in addition to having "direct responsibility" for the firm's foreign and commodity business, while plaintiff Howard C. Hirsch, as senior partner, had assumed a less active role as "counselor" to Hirsch & Co. (Kohns Tr. 6-8; Mundheim Tr. 9, 11-13). *fn2" The general partners of Hirsch & Co. decided upon the "merger" with duPont and Glore Forgan, Staats, Inc. ("Glore"), the third firm involved in the merger, because they believed that a medium-sized firm such as Hirsch & Co. could not survive in Wall Street. (Mundheim Tr. 45; Kohns Tr. 41-42). Glore would contribute its strong underwriting department to the new firm (Kohns Tr. 99), while Hirsch & Co. would bring in its substantial European business. (Kohns Tr. 128). Hirsch and Mundheim also viewed the merger as a means of reducing their activities or retiring while perpetuating the business of Hirsch & Co. (Hirsch Tr. 49; Mundheim Tr. 47-48; Kohns Tr. 43). For this reason, Mundheim testified, he preserved an option under the agreement with the new firm to withdraw his capital and retire after six months. (Mundheim Tr. 212, 290). Kohns felt quite differently, wishing to remain active in the new firm and "die with his boots on." (Kohns Tr. 43). On July 2, 1970, the Hirsch & Co. partners entered into an agreement with duPont ("the Agreement"), and Articles of Limited Partnership ("Articles") of the new partnership, duPont Glore, were adopted. Under the Agreement, duPont purchased certain of the assets and assumed certain of the liabilities of Hirsch & Co. (Agreement, p. 1). In payment for the assets, duPont credited certain Hirsch & Co. assets to the accounts of the former Hirsch partners who became general, limited or "special" *fn3" partners of duPont and then of duPont Glore, as their respective capital contributions to duPont and duPont Glore. *fn4" (Agreement § 5(a)). On the closing date, Kohns and Mundheim were admitted as general partners of duPont and duPont Glore. (Agreement § 6). In the course of these transactions, the plaintiffs' accounts in duPont Glore were credited with the following amounts: *fn5" General Partnership Limited Partnership Interests Interests Hirsch $400,000 Kohns $307,000 $593,000 Mundheim $307,000 $593,000

 Kohns and Mundheim's general partnership interests represented 35 and 33 "voting units" respectively, out of a total of 1,365 voting units.

 The new firm had 74 general partners and several limited partners, assets of $400 million and total capital funds of $60 million. (Camhy Affidavit, para. 2).

 In September, 1970, two months after its formation, the new firm was not in compliance with Exchange capital requirements. As a result of the Exchange's demands, new reserves had to be created, reducing the firm's net worth by $15 million. (Camhy Affidavit, para. 3). Despite a contribution of capital from a group including H. Ross Perot, the financial condition of duPont Glore continued to deteriorate, and in December, 1970, Kohns and Mundheim were told that if they attempted to withdraw their capital the firm would be unable to pay it. Accordingly, Mundheim and Kohns became subordinated lenders of duPont Glore on December 14, 1970, and December 31, 1970, respectively. (Mundheim Tr. 364; Kohns Tr. 4).



 Summary judgment should be granted where the pleadings, depositions and affidavits filed in the case "show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Rule 56(c), F.R. Civ. P.; Poller v. Columbia Broadcasting System, Inc., 368 U.S. 464, 467, 7 L. Ed. 2d 458, 82 S. Ct. 486 (1962). On this motion, the material facts are undisputed; and the issue of whether, on the basis of those facts, the general partnership interests were "securities" is a question of law which may be resolved by the court on summary judgment. Jennings and Marsh, Securities Regulation, 294 n. a (3d ed. 1972); cf. SEC v. W. J. Howey Co., 328 U.S. 293, 301, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946) (Frankfurter, J.,dissenting).

 Defendants' principal contention is that Kohns and Mundheim, as general partners, received and exercised the right to participate actively in the management and control of duPont Glore, and that for this reason, their general partnership interests did not constitute "securities," as that term has been defined in the statutes and decisional law.

 Before discussing defendants' contention, it would be well to consider the argument that the nature of Kohns' and Mundheim's participation after July 2 in duPont Glore, the successor partnership, is immaterial since the fraud was allegedly perpetrated before plaintiffs became general partners in order to induce them to purchase their interests, and the misrepresentations concerned the financial condition of duPont, one of the predecessor partnerships. With respect to plaintiffs' general partnership interests, *fn6" I deem these considerations irrelevant to the analysis that must be made under §§ 10(b) and 17(a). Section 10(b) prohibits fraud only if it is "in connection with the purchase or sale of any security * * *." Section 17(a) prohibits fraud only if it is "in the offer or sale of any securities * * *." The Agreement and affidavits clearly show that the individual plaintiffs' only participation in the July 2 transaction was as purchasers of general and limited partnership interests. *fn7" Thus in order to recover under § 10(b) or § 17(a), Kohns and Mundheim must establish that those interests were "securities." As the discussion below indicates, that issue turns on the nature of the investor's participation in the enterprise after he purchases his interest. SEC v. W. J. Howey Co., supra, 328 U.S. at 198-99. In every case in which plaintiff purchases an interest in an enterprise for the first time, he obviously has no participation before the purchase. But in none of the cases cited below is it suggested that that fact is relevant to the issue of whether the interest purchased is a security.

 Since the general partnership interests were not conventional securities such as shares of corporate stock, it must be determined whether they constituted "investment contracts" within the meaning of § 2(1) of the 1933 Act and § 3(a)(10) of the 1934 Act. *fn8" The classic definition of an "investment contract" is given in SEC v. W. J. Howey Co., supra, where the United States Supreme Court held that an offering of units of a citrus grove development coupled with a contract whereby the management performed all cultivating and marketing services and remitted the proceeds to the investors constituted an offering of "investment contracts":

"In other words, an investment contract for purposes of the Securities Act means 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 * * *." 328 U.S. at 298-99.

 One element of this definition has caused considerable controversy. That element is the requirement that the investor rely for profit " solely " on the efforts of others. Some subsequent cases have found this apparently narrow, inflexible requirement to be inconsistent with the Howey opinion's own admonition, 328 U.S. at 299, that its definition "embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits." See SEC v. Glenn W. Turner Enterprises, Inc., 348 F. Supp. 766, 774 (D. Ore. 1972), aff'd, 474 F.2d 476 (9th Cir. 1973). Other courts have noted that in some of the state law cases relied on by Howey, e.g., State v. Gopher Tire & Rubber Co., 146 Minn. 52, 177 N.W. 937 (1920), the investors contributed nominal efforts to the enterprise, and these courts have interpreted Howey not to preclude the finding of a security where the investor is required to perform nominal services or physical labor. SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 480 (5th Cir. 1974); J. Long, Partnership, Limited Partnership, and Joint Venture Interests as Securities, 37 Mo. L. Rev. 581, 599 n. 73 (1972). The primary concern in this regard has been that if the Howey requirement is interpreted literally, see, e.g., Gallion v. Alabama Market Centers, Inc., 282 Ala. 679, 213 So.2d 841 (1968); Georgia Market Centers, Inc. v. Fortson, 225 Ga. 854, 171 S.E.2d 620 (1969) (requirement that investors hand out "purchase authority" cards to potential customers in order to earn commissions precluded finding of security), *fn9" the test could easily be evaded by requiring the investor to contribute a modicum of effort. Lino v. City Investing Co., 487 F.2d 689, 692-93 (3d Cir. 1973); SEC v. Glenn W. Turner Enterprises, Inc., supra, 474 F.2d at 482; see Scholarship Counselors, Inc. v. Waddle, 3 CCH BLUE SKY L. REP. P 71,105 (Ct. App. Ky. 1974); State of Utah v. Dare to Be Great, Inc., 3 CCH BLUE SKY L. REP. P 71,096 (Dist. Ct. Utah 1972) (questioning whether Howey would have been decided differently if the contract had required the investor "to appear once a year to pull weeds along his row of trees.")

 Finally, some courts have stated that the reason Howey excluded the investor who participates in the enterprise from the protection of the disclosure and fraud provisions of the securities laws is that an investor does not need such protection where he obtains a degree of managerial control which affords access to information about the issuer. Polikoff v. Levy, 55 Ill.App.2d 229, 204 N.E.2d 807, cert. denied, 382 U.S. 903, 15 L. Ed. 2d 156, 86 S. Ct. 237 (1965); In the Matter of Continental Marketing Associates, Inc., 3 CCH BLUE SKY L. REP. P 71,016 (Ind. Sec. Comm'n 1969). The fact that the investor performs nominal services or physical labor gives him no access whatever to information about the issuer and affords no reason for depriving him of the protection of the securities laws.

 For all of these reasons, the SEC, *fn10" state securities commissions, *fn11" and many state *fn12" and lower federal courts have refused to apply Howey literally. It has also been suggested, erroneously in my opinion, that the Supreme Court has, sub silentio, abandoned the Howey test. See SEC v. Koscot Interplanetary, Inc., supra, 497 F.2d at 481. *fn13"

 However, despite the rejection of Howey in other jurisdictions, decisions of this district and circuit until recently *fn14" followed it and gave no indication that the Howey test would not be applied literally. *fn15" Glen-Arden Commodities, Inc. v. Costantino, 493 F.2d 1027, 1035 (2d Cir. 1974); Forman v. Community Services, Inc., 500 F.2d 1246, 1253-54 (2d Cir. 1974), cert. granted, 419 U.S. 1120, 95 S. Ct. 801, 42 L. Ed. 2d 819 (1975); Berman v. Orimex Trading, Inc., 291 F. Supp. 701, 702 (S.D.N.Y. 1968) (discretionary trading account); Maheu v. Reynolds & Co., 282 F. Supp. 423 (S.D.N.Y. 1967) (joint commodity account). In Glen-Arden Commodities, Inc. v. Costantino, supra, the Second Circuit said in reference to the Howey definition:

"This long-term construction placed upon an act of Congress is hardly one that we could disturb even if we wanted to, at this late date." 493 F.2d at 1035.

 Turning to the general partnership interests in the present case, it is clear that a partnership interest may be a security, Pawgan v. Silverstein, 265 F. Supp. 898 (S.D.N.Y. 1967) 1 L. Loss, Securities Regulation, 502 (2d ed. 1961); but, as I understand the law in this circuit, the partnership interest must satisfy the Howey test. New York Stock Exchange, Inc. v. Sloan, 394 F. Supp. 1303, CCH FED. SEC. L. REP. P 95,083 (S.D.N.Y. 1975); see also Pawgan v. Silverstein, supra, 265 F. Supp. at 900. In New York Stock Exchange, Inc. v. Sloan, supra, at 97,845, this court (Lasker, J.), applying Howey, adopted a bright-line rule that "general partners are not investors in 'securities '." The court said that this conclusion would not vary according to the degree of actual participation by the partner in the firm's affairs, because, under the New York partnership statute, neither his responsibility for the acts of the firm nor his right to a voice in partnership matters could be diminished by his decision to delegate his duties:

"In our view, however, the determination whether the partnership interest of a general partner is a security does not and should not hinge on the particular degree of responsibility he assumes within the firm. The fact that a partner may choose to delegate his day-to-day managerial responsibilities to a committee does not diminish in the least his legal right to a voice in partnership matters, nor his responsibility under state law for acts of the partnership. See N.Y. Partnership Law §§ 10, 11, 26. These factors critically distinguish the status of a general partner from that of the purchaser of an investment contract who in law as well as in fact is a 'passive investor '." CCH FED. SEC. L. REP. P 95,083 at 97,845.

 I agree in substance with this reasoning, and on the authority of Sloan, hold that the general partnership interests in the present case are not securities. As noted below, this conclusion would be justified if the only evidence before the court on this issue concerned the general partners' participation in duPont Glore by virtue of the voting powers inherent in their general partnership interests. Since Judge Lasker's opinion in Sloan apparently considers only voting powers, I will confine the present discussion to the voting powers of general partners in duPont Glore, leaving until a later section consideration of the managerial powers exercised by Kohns and Mundheim by virtue of their membership on various committees at duPont Glore.

 Before considering the voting powers in the present case, however, it should be noted that Judge Lasker's reasoning in Sloan does not apply to all general partnerships organized under New York law. It is true that under §§ 40(5) and 98(1), N.Y. Partnership Law, "[all] [general] partners have equal rights in the management and conduct of the partnership business * * *." *fn16" But this right is "subject to any agreement between them." § 40, N.Y. Partnership Law; see Dore v. LaPierre, 226 N.Y.S.2d 949, 953 (Sup. Ct. 1962); Napoli v. Domnitch, 34 Misc.2d 237, 248, 226 N.Y.S.2d 908, 915 (Sup. Ct.), modified on other grounds, 18 A.D.2d 707, 236 N.Y.S.2d 549 (2d Dept. 1962), aff'd, 14 N.Y.2d 508, 248 N.Y.S.2d 228, 197 N.E.2d 623 (1964). The partnership agreement or articles may provide that certain general partners have no "legal right to a voice in partnership matters," and, in such case, the general partnership interest may constitute an investment contract under the test set forth in Howey. Professor Bromberg has written:

"In theory, general partners have equal rights to participate in management. CRANE & BROMBERG ON PARTNERSHIP 374-375 (1968). This would seem to preclude one from relying solely on another for profits, and thus to rule out an investment contract. But the theoretical principle may be varied by the agreement of the partners, which may lodge all control in designated partners." 1 A. Bromberg, Securities Law: Fraud, Sec. 4.6 (331) (1973); Jennings and Marsh, supra, at 308.

 Thus in Pawgan v. Silverstein, supra, 265 F. Supp. at 900, where the articles of the general partnership vested all managerial and operational authority in the three "managing partners," this court (Metzner, J.) held that the interests of the 17 non-managing general partners were "securities."

 However, unlike in Pawgan, the Partnership Articles and Agreement in the present case provide that the general partners, through the exercise of their voting powers, are to have complete managerial control of the business of duPont Glore. Therefore, under the Howey test, as applied in New York Stock Exchange, Inc. v. Sloan, supra, the general partnership interests in the present case are not securities. Although, as noted below, certain responsibilities were delegated to several committees and a managing director, Article 21st vested the power of decision as to the firm's policies, ...

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