The opinion of the court was delivered by: GOETTEL
This securities case raises novel questions about derivative actions under section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 15 C.F.R. § 240.10b-5, and subject matter jurisdiction under the federal securities laws. The case presents the general issue whether, or to what extent, foreign shareholders in foreign corporations may assert, in a United States court, 10b-5 fraud claims in a derivative action against their own management and alleged American co-conspirators.
The plaintiff, IIT, was an "international investment trust" organized under the law of the Grand Duchy of Luxembourg. It is now in liquidation there. The individual plaintiffs are IIT's liquidators, appointed by a Luxembourg court. The action is not the first involving IIT in this circuit and is yet one more "product of the troubled existence of Investors Overseas Services ("IOS")." IIT v. Vencap, Ltd., 519 F.2d 1001, 1003 (2d Cir. 1975).
The complaint originally named sixty-eight individual and corporate defendants, all alleged to be members of one or more conspiracies to defraud IIT. Several defendants have moved to dismiss for lack of subject matter jurisdiction under Fed.R.Civ.P. 12(b)(1).
Defendant Arthur Andersen & Co. has also moved to dismiss, under Fed.R.Civ.P. 17, on the ground that the plaintiffs lack capacity to prosecute this action. All the moving defendants also assert that the statute of limitations bars the plaintiffs' claims.
The complaint alleges that IIT was operated under Luxembourg law much like the open-ended mutual funds common in this country.
Investors, virtually all of whom were foreigners residing in countries other than the United States, bought units of participation in the IIT "fund." The fund was managed by IIT Management Co., a corporation organized under Luxembourg law and not registered in this country under the Investors Advisors Act, 15 U.S.C. §§ 80b-1 to 80b-21. IIT Management was in turn controlled by its parent, IOS, Ltd., first a Panamanian and then a Canadian corporation, made somewhat infamous by Bernard Cornfeld and later by Robert Vesco.
IIT Management, although incorporated in Luxembourg, was based primarily in Geneva, Switzerland.
As a result of a 1967 consent order of the Securities and Exchange Commission ("SEC"), IOS agreed not to sell shares in IIT to Americans. It appears that currently there remain about 144,496 fundholders of IIT, who reside in 154 different countries. Apparently 218 of the fundholders now reside in the United States.
In its heyday, during the late 1960's and early 1970's, IIT's assets totalled in the hundreds of millions of dollars, and IIT Management invested IIT funds in securities from all over the world, including substantial amounts in American securities.
The complaint is a general attack on the relations between IIT and an American entrepreneur named John King. King allegedly controlled a group of American corporations operating principally from Denver, Colorado. This King group included King Resources, Inc., a publicly traded Maine corporation headquartered in Denver, the Colorado Corp., a private company incorporated under the law of Colorado, and various subsidiaries of both. In addition, King Resources also allegedly controlled a Netherlands Antilles subsidiary called King Resources Capital Corp. ("KRCC").
The complaint alleges generally a massive conspiracy among the "King complex," IOS and IIT Management to defraud the fundholders of IIT. The allegations, although flagrantly verbose,
center on three series of acquisitions by IIT of King-related securities.
The first was a series of purchases of "eurodollar" convertible debentures issued by KRCC, the Netherlands Antilles subsidiary of King Resources. The debentures were issued in November, 1968, by KRCC, in a foreign offering outside of the United States, and they were guaranteed by King Resources, the American parent. Because they were issued by the foreign subsidiary of King Resources and offered only outside the United States, "no action" treatment was requested and received from the SEC, and the offering was not registered under the Securities Act of 1933 (the "1933 Act"). The eurodollar debenture offering, however, was made at the same time as a domestic offering of King Resources common stock which was registered under the 1933 Act. The complaint alleges that IIT bought approximately $ 8 million worth of the eurodollar debentures in the "aftermarket," I. e., not directly on the offering but during a six-month period following the offering. These purchases were made in Europe through European brokers.
Next, the complaint states that, during the same approximate time period, IIT was caused to invest in the common stock of King Resources, ultimately in an amount in excess of $ 14 million. King Resources common was traded on the over-the-counter market in the United States, and these purchases were executed in this country. Plaintiffs allege that IIT's losses on the eurodollar debentures and King Resources common stock eventually amounted to over $ 22 million.
The third challenged transaction is a $ 12 million loan from IIT to the Colorado Corp., a privately owned American corporation allegedly controlled by King. The complaint alleges that in July of 1969, the IIT Management defendants caused IIT to purchase a convertible note in that sum from the Colorado Corp., which was never intended to be, and was not in fact, repaid to IIT.
As alleged more substantially in one of the plaintiffs' memoranda, the Quid pro quo for the IIT Management principals in these King-related acquisitions included personal kickbacks, special opportunities for tax avoidance schemes involving various King Resources properties, and the ability to overvalue some of the King assets in the IIT portfolio so as to increase the management fee paid by the fund to IIT Management. The complaint alleges that all of the principals in IIT Management were involved in these fraudulent transactions by which they effectively stole money from the fund. The directors of IIT Management Co. included both Americans and foreign citizens. Of the six IIT Management principals who allegedly had direct responsibility for IIT's investments, two are alleged to be citizens of foreign countries.
The roles of the non-IIT Management defendants were allegedly those of aiders and abettors and co-conspirators. In connection with both the purchases of the eurodollar debentures and of King Resources common, the complaint alleges that virtually all the major documents involved were false and misleading. Plaintiffs focus especially on the prospectus used in the KRCC foreign offering, and allege that it misstated drastically the financial picture of King Resources (the American guarantor). Because IIT Management was allegedly involved completely in the fraud and hence cannot be described as being deceived, the complaint states that IIT either "relied upon the (misleading) prospectus . . . or, . . . the defendants are estopped from denying such reliance." Defendant Arthur Andersen, the accountants for King Resources and IIT, allegedly certified false financial statements of King Resources and provided misleading "comfort letters" to the underwriters involved in the European offering at the closing of the agreement among underwriters in London.
Defendants Bear, Stearns & Co., Adams & Peck and Burnham & Co. and its successors (the "underwriter defendants") were lower-bracket underwriters in the eurodollar debenture offering.
Although it is unclear how these defendants allegedly participated in the purchases of King Resources common and the loan to the Colorado Corp., plaintiffs do allege that they knew of the misleading character of the eurodollar prospectus and aided in the scheme to have IIT buy large amounts after the offering. The lead and co-managing underwriter for the foreign offering, however, was Investors Bank Luxembourg, S. A., itself a Luxembourg investment bank alleged to have been a subsidiary of IOS and directly controlled by Cornfeld and the other IOS principals.
Defendants Arthur Lipper and Arthur Lipper Corp. (referred to collectively as "Lipper") are described as the securities brokers for IIT during the period embraced by the complaint. The plaintiffs allege that through Lipper's brokerage work for IIT and the other "dollar funds"
he became intimately aware of the dealings of the IIT Management insiders, as well as the King principals. Through an elaborate communications mechanism, which began in Switzerland and traveled through London and Canada to the United States, Lipper executed the orders for King Resources common stock placed by IIT. In addition, Lipper is said to have participated in the negotiations regarding the $ 12 million "loan" to the Colorado Corp. and to have received for his efforts improper options to purchase stock in the Colorado Corp. at depressed prices. The complaint also alleges that as a result of his efforts to bring IIT and the King group together, he was given personal opportunities to invest in various King Resources projects, involving everything from jet planes to properties in the Sinai peninsula.
In essence, then, the complaint describes a massive conspiracy through which the IOS defendants including IIT Management diverted monies from the fund for their personal benefit. John King and his group of companies were allegedly the primary vehicle by which the fraud was perpetrated.
The Lipper defendants, Arthur Andersen and the underwriter defendants all allegedly aided and abetted the scheme by giving substantial assistance to IIT Management with knowledge of the true nature of the acquisitions being made for the fund by IIT Management. As a result of the losses allegedly suffered by IIT on its various acquisitions, the complaint requests almost $ 35 million in compensatory damages and another $ 35 million in punitive damages.
Defendant Arthur Andersen raises the threshold issue of plaintiffs' capacity to prosecute this action. The attack under Fed.R.Civ.P. 17(b)
is two-pronged. First, Andersen contends that IIT, as an "indivision organisee" under Luxembourg law, was merely a legal form of joint ownership which has no legal identity or capacity under Luxembourg law. Second, Andersen asserts that the Luxembourg proceedings that led to the appointment of the three liquidators of IIT should not be recognized here under principles of international comity.
On the first prong of the attack, Andersen has submitted substantial papers analyzing the legal status of IIT under Luxembourg law.
Andersen's argument is that IIT's status under Luxembourg law was that of a piece of jointly owned property, which is comparable to a piece of real estate or other property jointly owned in our legal system. The structure was not formally authorized by Luxembourg statute, but rather was established under general principles of property ownership derived from France, Belgium and other civil law countries. As Andersen describes it, this judicial "nonentity," like a tract of jointly owned real property in our country, could not sue or be sued in its own name, or act for itself in any manner under Luxembourg law.
Rather, all legal and business actions involving the fund were undertaken by IIT Management Co., which had the legal authority under Luxembourg law and the IIT Fund Regulations, to do so.
The fund itself, however, viewed as a piece of property, I. e., As a stock portfolio, had no identifiable legal personality and was not considered a corporate entity of its own under the law of Luxembourg.
The plaintiffs argue in response that although not a statutorily recognized corporate body, IIT's legal personality was established implicitly, in a De facto manner, by Luxembourg practice. Plaintiffs, for instance, point to an apparent recognition by Luxembourg authorities of IIT as a taxable entity separate from the management company. Neither plaintiffs nor Andersen however, has pointed to any Luxembourg judicial authority directly on point on the question whether IIT, or another mutual fund indivision, could sue or be sued in its own name. But despite an extended debate on some of the more esoteric aspects of Luxembourg law, it seems clear that the legal identity of the fund itself is no longer the real issue involved in the capacity question in this Court. The overriding issue, in the present posture of the case, is the capacity of the liquidators, appointed by a Luxembourg court, to sue on behalf of the fund. On this issue, the factual background of the liquidation proceedings in Luxembourg must be briefly considered.
In November, 1972, the SEC filed a complaint against Robert Vesco (the successor to Cornfeld) and forty-one other defendants, alleging that he was effectively looting the assets of the IOS funds, including IIT. See SEC v. Vesco, 72 Civ. 5001 (S.D.N.Y., filed Nov. 27, 1972). This was the beginning of widespread publicity regarding the IOS complex. Undoubtedly at least in part induced by the growing scandal, Luxembourg's Grand Duke issued the Grand Ducal Decree of December 22, 1972, which submitted Luxembourg investment funds to the supervision of that country's Bank Control Commissioner. In June, 1973, after further disclosures had been made, a meeting of securities officials from the SEC, Luxembourg, Germany, and Canada and a representative of the International Association of Shareholders of IOS Funds ("IASIF") was held in Luxembourg. The parties at that meeting decided to attempt to petition for the liquidation of the various IOS funds in their domicile countries.
While Luxembourg proceedings involving IIT were pending, the Luxembourg district court declared IIT Management Co. bankrupt on August 1, 1973. On December 18, 1973, upon the petition of the Bank Control Commissioner, the court declared IIT in involuntary liquidation and appointed the three individual plaintiffs here as liquidators.
Arthur Andersen, the first litigant in this country to mount a full attack on the capacity of the liquidators,
now challenges the procedural due process of the Luxembourg proceedings which led to their appointment. Andersen asserts that because the Luxembourg proceeding was "ex parte," with no formal notice to IIT fundholders, and in violation ...