Appeal from an order of the District Court for the Southern District of New York, Gerald L. Goettel, Judge, 462 F. Supp. 209 (1978), dismissing for want of subject-matter jurisdiction an action by a Luxembourg investment trust and its liquidators under § 10(b) of the Securities Exchange Act and the SEC's Rule 10b-5. Reversed in part, affirmed in part and remanded.
Before Friendly, Oakes and Newman, Circuit Judges.
This is an appeal from an order of the District Court for the Southern District of New York dismissing, for want of subject-matter jurisdiction, a Rule 10b-5 action by a Luxembourg investment trust and its liquidators, 462 F. Supp. 209 (1978). It again raises vexing questions with respect to the reach of the anti-fraud provisions of our securities laws with respect to transactions having substantial foreign elements. Here, as in other cases on this subject,*fn1 we are obliged to pick out boundaries as best we can although the statutory language gives little aid.*fn2 The appeal illustrates the infinite variety of situations that may arise; the ground rules we have endeavored to lay down, notably in Bersch, supra, 519 F.2d at 993, although alleged by both sides to be dispositive in their favor, do not lead ineluctably to one result or the other, at least as to one of the transactions here at issue. Decision is further complicated by the fact that, as in Schoenbaum, supra, the issue of subject-matter jurisdiction arises in the context of a situation in which the managers of the defrauded corporation are allegedly implicated in the fraud. Finally, if subject-matter jurisdiction is found to exist, our task is far from ended, since we are then faced with serious issues whether the complaint is sufficient with respect to the defendants who are before us and whether the action is time-barred.
IIT's Transactions in King-related Securities
Many members of the cast of characters in this case are not new to our courtroom. Plaintiff-appellant IIT, an International Investment Trust, was organized under the laws of the Grand Duchy of Luxembourg in 1961. Before it and its liquidators were forced to spend most of their time in court,*fn3 IIT provided an investment vehicle by which fundholders could participate in a portfolio of securities chosen and managed by allegedly "(qualified) professional investment counsel."*fn4 IIT was controlled and managed by IIT Management Company, S.A. (Management), a Luxembourg corporation, which was in turn controlled by its parent Investors Overseas Services, Ltd. (IOS), first a Panamanian and then a Canadian corporation whose "troubled existence", see 519 F.2d at 1003, has spawned many actions besides the present one. Both Management and IOS were operated out of Geneva, Switzerland, although plaintiffs allege that "all the top persons" controlling the once vast financial empire were Americans, notably Bernard Cornfeld and Edward M. Cowett. The transactions which form the basis of IIT's complaint occurred before Cornfeld lost control of IOS to Robert Vesco.
IIT currently has 144,496 fundholders residing in 154 countries. Some 218 reside in the United States, although it is unclear how many of these are American citizens.*fn5 At the height of its prosperity in the late 1960's and early 1970's, IIT held assets worth $375 million, about forty percent of which were in American securities. This prosperity, however, was short-lived. Late in 1972 the Securities and Exchange Commission charged that Vesco was looting the assets of the IOS funds and, in the wake of the resulting scandal, the Grand Duchy of Luxembourg placed all Luxembourg investment funds under supervision of the Bank Control Commissioner. One year later, upon petition of that Commissioner, the Luxembourg district court declared IIT an involuntary bankrupt. Georges Baden, Jacques Delvaux, and Ernest Lecuit, were appointed liquidators of the fund and are co-plaintiffs in this action.
The transactions giving rise to the present case, which occurred between January 16 and October 26, 1969, involved three series of acquisitions by IIT of securities related to a complex of companies controlled by one John M. King, an American oil and gas entrepreneur based in Denver. King allegedly controlled King Resources Company (KRC), a publicly traded Maine corporation, and The Colorado Corporation (TCC), a private company largely owned by him. Both the public side of the King complex (KRC) and the private side (TCC) bought and sold natural resource properties and offered a variety of investments in the nature of tax shelters. The two companies had numerous subsidiaries. One of these, King Resources Capital Corporation, N.V. (KRCC), a wholly-owned Netherlands Antilles subsidiary of KRC, figures prominently in this case. Like IIT, King and his companies have fallen on hard times, but were not named as defendants in this action because stays were issued by courts in bankruptcy proceedings involving them.
IIT's first acquisition of King-related securities occurred between January 16 and October 26, 1969, during which period IIT bought about $8 million face value of KRCC subordinated convertible debentures. The debentures had been issued in Europe on November 27, 1968, to raise $15 million in the eurodollar market. This offering was closely coordinated with a domestic offering of an additional $25 million in debentures of KRC which occurred on November 26. The KRCC debentures were guaranteed by KRC and convertible into KRC common stock. The bulk of IIT's purchases were made abroad, although IIT alleges it purchased $50,000 face value of the debentures through defendant Arthur Lipper Corporation (Lipper) in the United States. IIT sold its KRCC debentures between July 28, 1970 and February 5, 1971 at a loss of $8,765,698.
IIT's second acquisition of King-related securities was the purchase between January 16 and March 20, 1969, of 200,000 shares of KRC common stock. IIT purchased its shares in the United States over-the-counter market for $16.8 million, availing itself of the brokerage services Lipper performed for IIT and the other members of the IOS complex. These shares were sold between October 6 and November 4, 1970, at a loss of approximately $14 million.
IIT's final acquisition of King-related securities was a July, 1969 purchase of a $12 million 15 year convertible note from TCC. IIT alleges that the purpose of this loan was to make TCC a seemingly attractive merger partner for KRC, although no such merger took place. TCC defaulted on the note and has never paid any principal or interest to IIT. As noted, TCC is now in bankruptcy.
IIT commenced the instant action by filing a complaint in the District Court for the Southern District of New York on July 17, 1975. The complaint, correctly characterized by Judge Goettel as "flagrantly verbose," 462 F. Supp. at 212 & n.7, alleged violations of sections 5, 11, 12, 15, and 17 of the Securities Act of 1933; section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 adopted thereunder; section 206 of the Investment Advisers Act; section 352-c of the General Business Law of New York; breach of fiduciary duty and contract; misappropriation; and failure to disclose these numerous violations of the law. As the briefs and arguments indicate, however, the focus of the complaint is Rule 10b-5. See 462 F. Supp. at 217, 221 & n.25.
According to the complaint and various affidavits and memoranda submitted by plaintiffs in the district court,*fn6 the three transactions outlined above were the result of a conspiracy to defraud IIT between those in control of IOS and Management, together with Lipper and those in control of the King complex. The King empire allegedly required "continuous injections of vast sums of cash to survive," some of which it obtained from IIT's purchases. For their part, the IOS and Management defendants received personal kickbacks, opportunities to join in KRC tax avoidance schemes, and the ability to over-value King-related assets so as to increase their management fees and performance bonuses.*fn7 Lipper, the United States broker for the IOS complex, was allegedly involved in all three transactions. Its recompense included not only the sizable commissions it gained from the IOS brokerage business but also a special right, allegedly given in connection with the TCC note transaction, to purchase 10,000 shares of TCC stock at what was thought to be a bargain price. Lipper and individuals at Lipper also allegedly partook of KRC investment and tax avoidance schemes involving projects as diverse as the development of Sinai oil properties and the leasing of jet aircraft.
In addition to alleging this general conspiracy to raid IIT for the benefit of the King complex, Lipper, and those in control of IOS and Management, the complaint also charged that the KRCC debenture prospectus was false and misleading in various respects, and that IIT "relied upon the prospectus and other false and misleading statements or nondisclosures in connection with the purchase of" the KRCC debentures and the KRC common stock as well, "or, in the alternative, the defendants are estopped from denying such reliance." Chief among the misrepresentations and omissions charged were failure to disclose a KRC and TCC fraudulent investment scheme in near-worthless arctic properties; failure to disclose fully transactions with related companies like TCC; failure to disclose the conspiracy with those in control of IOS; failure to state revenues and net income properly and to account properly for expenses; and failure to disclose KRC's constant need for a vast, steady supply of cash. The complaint does not charge any relation between the allegedly deficient prospectus and the TCC note, although it does allege that certain of the defendants involved with the King complex and TCC failed to disclose important facts in connection with this transaction.
The defendants with which we are here concerned fall into three groups: (1) the international accounting firm of Arthur Andersen & Co. (Andersen); (2) Bear, Stearns & Co., Adams & Peck and Burnham and Company (the underwriter defendants); and (3) Arthur Lipper and Arthur Lipper Corp. (referred to collectively as Lipper), securities brokers for IIT during the period embraced by this complaint. See Arthur Lipper Corp. v. SEC, 547 F.2d 171 (2 Cir. 1976), cert. denied, 434 U.S. 1009, 98 S. Ct. 719, 54 L. Ed. 2d 752 (1978).
Andersen is alleged to have "aided and abetted" the aforementioned conspiracy, partly because of its accounting work on the false and misleading prospectus. Andersen served as the independent certified public accountant for KRC and the IOS complex during the period in question and for IIT from its inception. Andersen terminated its relationship with the IOS companies on May 1, 1971, after the audit work for 1970 was completed. It became auditor for TCC early in 1970 but allegedly had done other work for TCC prior to that time. Andersen did its work for the King complex out of its Denver office, and there audited and certified the financial statements used in both the dollar and eurodollar debenture prospectuses. According to the complaint, Andersen "failed to prepare financial statements for King Resources Company reflecting the true financial condition of said company and failed to insure that full and correct financial information was provided in the Eurodollar prospectus." IIT also stresses that Andersen's role as auditors for both the King and the IOS companies put it in a unique position to see the developing relationship between the two groups, yet it never informed either the IIT fundholders or the appropriate regulatory bodies.
The underwriter defendants Bear, Stearns & Co., Adams & Peck, and Burnham & Co. and its successors are also alleged to be liable as aiders and abettors of the conspiracy to defraud IIT.*fn8 The three were lower-bracket underwriters with a total participation of $600,000 in the eurodollar debenture offering out of the $15 million face value total of the offering and of $750,000 in the dollar debenture offering out of the total of $25,000,000. The complaint charges that the underwriter defendants "knew, or should have known" that the prospectus which they circulated contained the material misrepresentations and omissions discussed above. The complaint further alleges that the underwriter defendants failed to take proper steps to learn the true condition of KRCC and KRC, failed to make a proper investigation of the facts, failed to disclose the involvement of IOS with the King complex, and failed to insure that the proceeds of the eurodollar offering were used for the purposes stated in the prospectus.
The Lipper defendants were charged both as principals and as aiders and abettors, as more fully discussed below.
IIT's complaint concluded with a request for compensatory damages totalling $35 million and another $35 million in punitive damages, plus attorneys' fees.
The case came before Judge Goettel on various motions filed by Andersen, Lipper, and the underwriter defendants. They moved to dismiss for lack of subject-matter jurisdiction under Fed.R.Civ.P. 12(b)(1) and for failure to state a claim upon which relief can be granted under Fed.R.Civ.P. 12(b)(6). They also asserted that plaintiffs' claims were barred by the statute of limitations, and Andersen moved to dismiss on the ground that plaintiffs lacked capacity to prosecute the action pursuant to Fed.R.Civ.P. 17(b). See 462 F. Supp. at 211 & n.1. In an opinion delivered on December 7, 1978, Judge Goettel denied Andersen's motion under Rule 17(b),*fn9 but granted the motions to dismiss the complaint as to all defendants for lack of subject-matter jurisdiction. He did not reach the issues of failure to state a claim on which relief can be granted or the statute of limitations. Plaintiffs filed a timely notice of appeal on December 26, 1978.
The District Court's reasons for finding lack of subject-matter jurisdiction
Judge Goettel began his discussion of subject-matter jurisdiction by rejecting the argument that Rule 10b-5 applied to the transactions here in question because of their effects within the United States. Distinguishing Schoenbaum, supra, because the victim in that case was a corporation whose shares were listed on the American Stock Exchange, with a substantial minority of American shareholders, he cited Bersch, supra, as holding that an unparticularized deleterious effect on the American economy from lessened ability to attract offshore investment funds did not provide the necessary effect, 519 F.2d at 989, and Vencap, supra, as holding that such effect was not provided "simply because half of one percent" of the shares of the allegedly defrauded fund were "held by Americans." 519 F.2d at 1017. In this the judge was clearly right, and we need say no more about "effects" as a basis of subject-matter jurisdiction save in one respect noted in Part V below.
Turning to jurisdiction based on acts within the United States, the judge focused on the complicity of Management in all the fraudulent transactions. He thought that "(s)o long as the derivative action is one alleging total complicity on the part of foreign management, the ultimate focus of the theory remains a deception of foreign fundholders by foreign "directors'." 462 F. Supp. at 224. "Since virtually all the fundholders were foreign nationals residing in foreign countries, the deception, if it could be proved, must have occurred outside of the United States." Id. (emphasis in original). Furthermore, insofar as our decision in Goldberg v. Meridor, 567 F.2d 209 (2 Cir. 1977), cert. denied, 434 U.S. 1069, 98 S. Ct. 1249, 55 L. Ed. 2d 771 (1978), relied, as regards causation, on the ability of the deceived shareholders to have sought injunctive relief if they had known the facts, the court thought this case to differ from "a domestic case", 462 F. Supp. at 223, because, for reasons not clearly stated and somewhat contradicted by fn. 35 on p. 224, it assumed that any such suit would have had to be brought in Luxembourg. This would place "the plaintiffs in a curious position in that by establishing their right to an injunction under Luxembourg law, they could prove 10b-5 materiality; simultaneously, however, they would be offering a good reason not to apply Rule 10b-5 to the transactions, since the availability of relief under foreign law would then be at least partially evident."*fn10 Viewing the action as one that had "its genesis abroad . . . with a group of foreign managers of a foreign investment trust violating what would appear to be their fiduciary duties to their fundholders, and the foreign managers merely enlisting the aid of American aiders and abettors", 462 F. Supp. at 225, the court found no basis for subject-matter jurisdiction, even as to transactions consummated within the United States, see id. at 224 n.34.
We see no sufficient ground for this characterization of the transactions here at issue. Our decision in Goldberg v. Meridor, supra, did not find the nub of the action to be the directors' breach of fiduciary duty to the shareholders, see 567 F.2d at 221; indeed, that was the very ground that had been ruled out by Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S. Ct. 1292, 51 L. Ed. 2d 480 (1977). The holding rather was that, as we said in speaking of Schoenbaum, an action under Rule 10b-5 can lie if "there is deception of the corporation (in effect, of its minority shareholders) when the corporation is influenced by its controlling shareholder to engage in a transaction adverse to the corporation's interests (in effect, the minority shareholders' interests) and there is nondisclosure or misleading disclosures as to the material facts of the transaction." 567 F.2d at 217. The basic principle was that where the directors are parties to the fraud, deception, as stated by Chief Judge Seitz in Pappas v. Moss, 393 F.2d 865, 869 (3 Cir. 1968), "is fairly found by viewing this fraud as though the "independent' stockholders were standing in the place of the defrauded corporate entity . . . ." The relevance of the wrongdoing of the directors and managers is in relieving the corporation of having their knowledge attributed to it. The judge was thus mistaken in viewing all the American participants, even including the King group, as mere aiders and abettors of Management in perpetrating a fraud on IIT. While that is a fair description of the asserted role of Andersen, the underwriter defendants and perhaps even Lipper, the members of the King complex and other defendants were claimed to have been perpetrators of a fraud upon the fundholders, and the three sets of defendants here before us could be held, on proper allegations, for aiding and abetting a deception originating in the United States. An actual participant in a fraud is no less a principal because someone else originated the plan. IIT and its liquidators are complaining of deception practices on IIT by both the King complex, whose acts were primarily in the United States, and Management, whose acts were mainly outside it, both allegedly aided and abetted by the defendants here before us, without any attribution to IIT of knowledge on the part of Management. The ability of such a victim to maintain such an action was decided in Goldberg, we see no reason to depart from that decision, and we shall discuss subject-matter jurisdiction in that light.
Subject-matter jurisdiction: the King Resources common and TCC ...