Appeal, pursuant to 28 U.S.C. § 1292(b), from an order of the District Court for the Southern District of New York, Inzer B. Wyatt, Judge, denying a motion to dismiss an action against accountants for a brokerage firm under § 17(a) of the Securities Act of 1933 and §§ 10(b), 15(c), 17(a) and 18(a) of the Securities Exchange Act of 1934 and Rule 10b-5, on the ground that the notes acquired by plaintiff were not a security. Affirmed.
Before: FRIENDLY, MANSFIELD and MULLIGAN, Circuit Judges.
This appeal raises the vexing question how far instruments bearing the form of promissory notes are securities within the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.
The Facts and the Proceedings in the District Court
This action by The Exchange National Bank of Chicago (the Bank) against the well-known accounting firm of Touche, Ross & Company (Touche) was brought in the District Court for the Northern District of Illinois and was transferred, pursuant to 28 U.S.C. § 1404(a), to the District Court for the Southern District of New York. The complaint was in four counts. Count I alleged violation of § 17(a) of the Securities Act of 1933, § 10(b) of the Securities Exchange Act of 1934, and the SEC's Rule 10b-5; Count II claimed a violation of § 18(a) of the 1934 Act; Count IV asserted a violation of §§ 10(b), 15(c), 17(a) and 18(a) of the 1934 Act; and Count III was a pendent state law claim for negligence. All four counts concerned the same transactions by the Bank and, apparently, the same conduct by Touche.*fn1
The transactions were between the Bank and a New York brokerage firm, Weis, Voisin & Co., Inc., later Weis Securities, Inc. (Weis), which was a member of the New York Stock Exchange (NYSE) and the American Stock Exchange. These transactions were the Bank's purchase from Weis of three unsecured subordinated notes dated July 31, 1972, in the aggregate principal amount of $1 million. The conduct was Touche's issuance on July 7, 1972, of opinions saying, among other things, that Weis' Statement of Financial Condition as of May 26, 1972 (the "Statement") and Weis' "Answers to Financial Questionnaire and Additional Information" (the Report), which Weis filed with the SEC pursuant to § 17 of the Securities Exchange Act, fairly presented the financial position of Weis and conformed to generally accepted accounting principles. The Bank alleged that it had relied on these opinions as well as the Statement and the Report, and that the latter were materially false and misleading in numerous respects as Touche knew or should have known when it issued its opinions; that when the false and misleading entries were discovered in May, 1973, Weis had already been placed in receivership and was then being liquidated; and that the notes have become worthless.
Touche moved to dismiss the complaint. Although the motion claimed that the complaint was defective in its allegations of fraud*fn2 and that a curative amendment would not be possible, the attention of the parties and the district court seems to have become concentrated on the contention that the notes were not securities within the 1933 or 1934 Acts; that the court thus had no jurisdiction over the three federal counts; and that, diversity of citizenship being absent, the pendent count should likewise be dismissed. A memorandum accompanying the moving affidavit discussed the issue of the status of the notes. Entitled "Promissory Note," with the amount and the date, July 31, 1972, at the top, each note extended over nearly nine typewritten pages. The three notes were payable on July 31, 1973, October 31, 1973, and January 31, 1974, respectively, "upon written demand received by the Company at least six (6) months prior to such date, or upon such date thereafter as may be specified by the Lender upon written demand received by the Company at least six months prior to the payment date so specified."*fn3 Interest was payable after each note's maturity date, at a rate "3% in excess of the prime commercial loan rate of the Lender then in effect for short-term borrowings, but in no event less than 9% per annum." The rights of the holder were subject and subordinate to all general creditors but were senior to all other subordinated creditors except existing obligations to Fidelity Corporation and Security National Bank.*fn4 The note was prepayable on three days' written notice from the Company with the prior written approval of NYSE. If any action were commenced by a general creditor within 12 months after the maturity of the note, Weis would furnish the holder with copies of the pleadings and the holder would have the right to contest the action if Weis did not do this in good faith. The note was transferable only to a person approved by NYSE as provided in its Rule 325.20. The Bank forewent any right to take as security any property of the "member organization" that might come into its possession and waived any right of set-off.
As indicated, several provisions of the notes were keyed to NYSE's Rule 325, entitled "Capital Requirements for Member Organizations and Individual Members." A basic proviso of this Rule was that no member "shall permit, in the ordinary course of business as a broker, his or its Aggregate Indebtedness to exceed 2000 per centum of his or its Net Capital. . . ."*fn5 "Aggregate Indebtedness" was defined to exclude, inter alia, "liabilities subordinated to general creditors pursuant to a separate agreement approved by the Exchange." Consistent with this, subordinated indebtedness appeared in Weis' balance sheet along with stockholder equity rather than as a current liability.
Opposing affidavits of Melvin K. Lippe, Vice Chairman of the Board of the Bank, of counsel, of a partner of the accounting firm of Coopers & Lybrand, who acted for the Trustee in the SIPC liquidation of Weis, and of a supervisor of the Administrative Staff of the Trustee in the Weis liquidation added flesh to the bare bones of the notes. The Lippe affidavit set forth the circumstances under which the Bank purchased the notes. Stripped of self-serving characterizations such as consistent references to the notes as investments, his factual allegations were subtantially as follows:
In the spring of 1972 Lippe was Executive Vice President and Chief Administrative Officer of the Bank and was particularly concerned with expanding the Bank's business; he was not part of the staff which handled normal commercial loans. Early in March, 1972, he was notified by the manager of the Bank's recently opened branch office in Tel Aviv, Israel, that Weis had sought approximately $1 million for the expansion of its brokerage activities both in the United States and abroad. Because the Bank was interested in developing a closer relationship between its new Tel Aviv branch and that of Weis, the only American brokerage firm then operating in Israel, and the interest rate proposed by Weis was attractive, Lippe instructed the branch manager that the Bank might be interested.
Shortly thereafter Arthur T. Levine, Weis' Chief Executive Officer, and Sol Leit, its Chief Operating Officer, came to Chicago to negotiate with Lippe. Lippe continued to be interested because of the potential for the Bank's Tel Aviv branch. Levine and Leit indicated that the Bank would be expected to purchase subordinated promissory notes, which would be listed as part of Weis' net capital pursuant to Rule 325; they presented a form of such a note which they said was in conformity with Rule 325. They also exhibited copies of the notes held by Security National Bank and Fidelity Corporation, see note 4 supra. Lippe requested the Weis representative to forward financial statements and any other documents certified by Touche; this led to the sending of the documents previously mentioned. On July 19, 1972, the Bank agreed to purchase for $890,750 three unsecured subordinated notes in the aggregate principal amount of $1 million and the transaction was consummated on August 7, 1972.*fn6
A reply affidavit by Touche's counsel urged that "most of the matters upon which plaintiff Exchange Bank purports to rely" in establishing that the notes were securities "involve in large portion conversations and states of mind with respect to which defendant Touche Ross was not a party and had no prior knowledge, and which cannot bind defendant Touche Ross (if at all) unless it has the right to cross-examine in detail the makers of plaintiff's affidavits and other pertinent witnesses." Counsel requested that "if and to the extent that the affidavits submitted by plaintiff Exchange Bank are deemed to raise issues of fact, the Court should permit, as a preliminary matter, discovery limited to such issues so that a full record can be developed for the determination of the threshold issue of subject matter jurisdiction." However, except for those conclusory assertions categorized as reflecting the Bank's "investment motives," which we have disregarded, the affidavit gave no indication what facts were disputed or as to precisely what discovery was sought.
After hearing argument Judge Wyatt denied the motion to dismiss for want of subject matter jurisdiction "on the ground that the transaction seems more in the character of an investment than of a commercial loan." He believed, however, that the question was "a close one" which should be reviewed by this court before preparation for trial and offered to make the statement required by 28 U.S.C. § 1292(b). Such a statement was incorporated in the order denying the motion to dismiss, and a panel of this court granted leave to appeal.
Propriety of Deciding a Rule 12(b)(1) Motion on Affidavits
We deal at the outset with a suggestion of the defendant that the district court could not properly deny its motion to dismiss for want of subject matter jurisdiction on the basis ...