Appeal from judgment entered in the Southern District of New York, Robert L. Carter, District Judge,
Mansfield, Timbers and Gurfein, Circuit Judges. Gurfein, Circuit Judge.
Of the several questions presented under the antifraud provisions of the federal securities laws, those under the Investment Advisers Act of 1940 appear to be of first impression at the appellate level.
The appeal is from a judgment entered in the Southern District of New York, Robert L. Carter, District Judge, 392 F. Supp. 740, dismissing the complaint, on cross-motions for summary judgment, in an action to recover damages for alleged violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b)(1970), and of Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5 (1976); and alleged violations of Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6 (1970), and of Rule 206(4)-1 thereunder, 17 C.F.R. § 275.206(4) (1976).
The essential questions presented and our rulings thereon are as follows:
(1) Whether the complaint states a claim upon which relief can be granted under Section 10(b) of the 1934 Act and Rule 10b-5.
(2) Whether defendants who are general partners of the investment partnership are investment advisers within the meaning of Section 202(a)(11) of the Advisers Act.
(3) Whether there is an implied private right of action for damages under the Advisers Act.
(4) Whether the complaint alleges compensable damages under the Advisers Act.
(5) Whether the complaint states a claim upon which relief can be granted under Section 206 of the Advisers Act and Rule 206(4)-1.
We affirm the dismissal of the Exchange Act claim; but as to the dismissal of the Advisers Act claim, we reverse and remand for trial.
The following summary of the essential facts is believed necessary to an understanding of our rulings on the questions presented.*fn1 The facts are not in dispute.
Plaintiffs Robert Abrahamson and Marjorie Abrahamson, husband and wife, were limited partners of defendant Fleschner Becker Associates (FBA), an investment partnership, from its inception on July 1, 1965 until they withdrew on September 30, 1970.
Defendants Malcolm K. Fleschner (Fleschner) and William J. Becker (Becker) are general partners of FBA. Fleschner was its founder and has been a general partner since its inception. Becker became a general partner on April 1, 1966. Defendant Harold B. Ehrlich (Ehrlich) was a general partner from October 1, 1968 through September 30, 1969. Defendant Harry Goodkin & Company (Goodkin) is a firm of certified public accountants which audited FBA's books and certified FBA's financial reports for the fiscal years 1966, 1967 and 1968.
In late 1964 and in 1965 plaintiffs had several conversations with Fleschner who expressed his intention of forming an investment partnership. He told plaintiffs that the partnership would have a conservative investment policy. Plaintiffs expressed their concern for financial security and conservatism in their investments.
By a partnership agreement dated July 1, 1965, FBA began as a small partnership. The original partners consisted of one general partner (Fleschner) and eight limited partners (plaintiffs, four members of Fleschner's family and two others). Plaintiffs' initial contribution was $150,000.
FBA grew rapidly. By April 1, 1966 it had two general partners and thirty-five limited partners; and by October 1, 1968 it had three general partners and sixty-six limited partners. Each partner had an account which represented the appreciated value of his contributions to the pooled funds, less withdrawals and certain fees. By October 1, 1968 FBA's assets were approximately $60 million.
For managing the partnership investments, the general partners received substantial fees. They were paid 20% of FBA's net profits and net capital gains for each fiscal year. In addition, the partnership agreement of October 1, 1968 provided for an annual salary of $25,000 for each general partner who managed the partnership's investments.
The limited partners did not participate in managing the partnership's investments. A limited partner could withdraw all or part of the balance in his capital account at the end of any fiscal year (September 30), provided that he gave the required advance notice. Prior to October 1, 1968, 30 days notice was required; thereafter, 60 days notice was required. There were similar notice requirements for withdrawal from membership in the partnership.
With the increase in the number of limited partners and the concomitant increase in the size of the firm's assets, certain changes were made in the structure of the partnership. The original July 1, 1965 partnership agreement was superseded by a new agreement dated April 1, 1966 which in turn was superseded by the October 1, 1968 agreement. The principal change effected by the 1966 agreement was the addition of Becker as a general and managing partner and the inclusion of additional limited partners. The 1968 agreement, in addition to authorizing salaries of $25,000 per year for those general partners who managed the partnership's investments, included Ehrlich as a general partner; added a large number of limited partners; expanded and detailed the stated purposes of the partnership; and made a number of other changes referred to below.
During the period plaintiffs were limited partners of FBA the general partners mailed monthly reports to all of the firm's limited partners. These reports were concise, two paragraph statements which set forth the percentage increase or decrease in the value of the firm's investments for the year to date and compared this performance with Standard & Poors 500 Stock Average.
The reports also included statements of the firm's investment policy. Between November 1967 and April 1968 the reports repeatedly represented that FBA was maintaining a "low risk stance" and "a most conservative posture."*fn2
In addition to the monthly reports, during 1967 and 1968 Goodkin mailed to the limited partners certified year end financial reports. These financial reports included balance sheets which showed the total of FBA's investments in securities. The balance sheets of September 30, 1967 and September 30, 1968 did not disclose that the firm was investing in unregistered securities.*fn3 Investments in such securities were included in the aggregate of all portfolio investments. The value of FBA's total investments in securities was denominated as the "market value" of the securities.
Despite the representations in the monthly reports that FBA's investments were most conservative and of low risk, between September 1967 and September 1968 the firm increased its investments in unregistered securities from approximately 15% to approximately 72% of its portfolio. Between September 1968 and September 1969 the firm's investments in unregistered securities fluctuated from about 72% to 88% of its portfolio.*fn4 During this latter period the monthly reports continued not to disclose the firm's sizable investments in unregistered securities.
In either December 1969 or January 1970 plaintiffs received the financial report for the fiscal year ending September 30, 1969. This report was not prepared by Goodkin, but by another accounting firm. A footnote to this report disclosed that approximately 77% ($30,411,868) of FBA's total investments in securities ($39,355,310) consisted of unregistered securities. The firm's total assets as of September 30, 1969 were $51,747,995.
Plaintiffs first learned of FBA's substantial investments in unregistered securities from the September 30, 1969 report. Having received this report in December 1969 or January 1970, it was too late for them to withdraw from the firm, in accordance with the partnership agreement, at the end of the fiscal year which ended September 30, 1969. Plaintiffs did withdraw at the end of the following fiscal year, on September 30, 1970. This was the earliest they could withdraw their investments or as partners under the terms of the partnership agreement.
During the five year period they were limited partners, both plaintiffs received substantial net profits.*fn5 Robert Abrahamson realized a net profit of $156,097; Marjorie Abrahamson a net profit of $133,081.35.
Both plaintiffs claim that as of late 1968 their investments were worth considerably more than indicated by the firm's financial reports, and that the firm incurred substantial losses on its investments in unregistered securities. Without apportioning between losses sustained from investments in unregistered securities and other losses,*fn6 Robert Abrahamson claims that between September 30, 1968 and the date of his withdrawal his capital account sustained losses totalling $454,979. Marjorie Abrahamson claims total losses of $799,821 during this period.
Plaintiffs commenced the instant action in the Southern District of New York on January 25, 1971. Jurisdiction was invoked under Section 27 of the Exchange Act, 15 U.S.C. § 78aa (1970), and Section 214 of the Advisers Act, 15 U.S.C. § 80b-14 (1970). The complaint embodies the claims stated above and summarized in our prior opinion. 537 F.2d 27.
Both sides having moved for summary judgment, Judge Carter on March 4, 1975 filed an opinion, 392 F. Supp. 740, granting defendants' motions and denying plaintiffs' motion. Without reaching the merits of plaintiffs' claims under either the Exchange Act or the Advisers Act, the judge held that, since plaintiffs had realized a net profit on their overall five-year investments in FBA, they had failed to prove damages compensable under the federal securities laws. From the judgment entered March 27, 1975 dismissing the complaint, the instant appeal has been taken.
We need not tarry with plaintiffs' claim under Section 10(b) of the 1934 Act and Rule 10b-5 for we find that each of the arguments urged by plaintiffs in ...