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Armstrong v. McAlpin

decided: January 24, 1983.

MICHAEL F. ARMSTRONG, AS RECEIVER OF CAPITAL GROWTH COMPANY, S.A. (COSTA RICA) AND CAPITAL GROWTH COMPANY, S.A. (PANAMA), ROBERT MOORE, SUING ON HIS OWN BEHALF AND DERIVATIVELY ON BEHALF OF CAPITAL GROWTH FUND, AND FRANCESCO GALOFARO, SUING ON HIS OWN BEHALF AND DERIVATIVELY ON BEHALF OF CAPITAL GROWTH REAL ESTATE FUND, INC., PLAINTIFFS-APPELLANTS-CROSS-APPELLEES,
v.
CLOVIS MCALPIN, CAPITAL GROWTH REAL ESTATE FUND, INC., DEFENDANTS-APPELLEES-CROSS-APPELLANTS, NEW PROVIDENCE SECURITIES, LTD., S.A., NEW PROVIDENCE SECURITIES, LTD., ARAWAK TRUST COMPANY, LTD., BROWN BROTHERS HARRIMAN & CO., GOLDMAN, SACHS & CO., EHG ENTERPRISES INC., SHEFFIELD ADVISORY COMPANY, SHEFFIELD ADVISORY COMPANY, S.A., FIDUCIARY TRUST COMPANY, BRADFORD TRUST COMPANY, SION PLAZA, S.A., SANFORD C. SHULTES, ARIEL E. GUTIERREZ, ENRIQUE GUTIERREZ, JOSEPH D. SCHWERIN, KOITCHO BELTCHEV, CAPITAL GROWTH MANAGEMENT COMPANY, LTD., HAYDEN STONE & CO., ALBERTO ALVAREZ, ANTONIO PENA CHAVARRIA, HACIENDA CAFETALERA SANTA ELENA, LTD., JOSE FIGUERES FERRER, MOORE & SCHLEY, CAMERON & CO., WILLIAM HUTCHINSON & CO., R. H. PRINGLE, P. J. RAFFERTY, SOCIEDAD AGRICOLA INDUSTRIAL SAN CRISTOBAL, S.A., AND CAPITAL GROWTH FUND, DEFENDANTS-APPELLEES



Plaintiffs-appellants appeal from a judgment of the United States District Court for the Southern District of New York (Werker, J.) dismissing their securities fraud complaint on motion of the defendants. Cross-appellants appeal from the order of Judge Werker denying their motion to disqualify plaintiffs' attorneys. On the primary appeal we affirm in part and reverse and remand in part. On the cross-appeal, we dismiss for lack of finality.

Waterman and Van Graafeiland, Circuit Judges, and Pollack, District Judge.*fn*

Author: Van Graafeiland

VAN GRAAFEILAND, Circuit Judge:

Plaintiffs-appellants appeal from a judgment of the United States District Court for the Southern District of New York (Werker, J.) dismissing their securities fraud complaint on motion of the defendants. Cross-appellants appeal from the order of Judge Werker denying their motion to disqualify plaintiffs' attorneys. We affirm the judgment in part and reverse and remand it in part. Because we are reversing the judgment in favor of cross-appellant McAlpin and remanding for further proceedings as to him, we dismiss the cross-appeal from the disqualification order on the ground that the order no longer is final in character.

In 1962, a Texas resident named Clovis W. McAlpin moved to Nassau, Bahamas, where he organized New Providence Securities, Ltd. and became active in the field of investment management. McAlpin retained ownership of approximately sixty percent of New Providence's stock and became its chief executive officer.

On July 24, 1962, New Providence and Chase Manhattan Trust Corporation, Ltd., another Bahamian company, entered into a trust agreement pursuant to which Chase became the trustee of an investment trust to be known as First Bahamas Investment Trust. Under the terms of the trust agreement, the purchases and sales of trust assets were to be the sole prerogatives of New Providence, the trustee's obligations in substance being the administration and custodianship of the trust property. The trustee was authorized to take such action as it believed in good faith was for the benefit of the trust property, and, in any litigation regarding the trust property in which the trustee was a party, it would be deemed to represent the shareholders of the trust. The certificates to be issued to shareholders were to contain provisions that the shareholders would be bound by the provisions of the trust agreement.

First Bahamas was an open-end mutual fund, whose projected rate of growth was based in large measure upon the leverage authorization given it to borrow amounts equal to seventy percent of the gross value of the trust property. However, First Bahamas was limited in its investments to the shares of SEC-approved open-end mutual funds or trusts and United States Treasury Bills.

On September 10, 1963, appellee Arawak Trust Company, Ltd. succeeded Chase Manhattan as trustee. Arawak had been organized by Kleinwort, Benson, Ltd., a leading London merchant banking house, and appellees Goldman, Sachs & Co. and Brown Brothers Harriman & Co. became shareholders of Arawak at Kleinwort, Benson's request, each of them owning approximately a ten percent interest in the company. Although Kleinwort, Benson and the Canadian Imperial Bank of Commerce each owned approximately a twenty percent interest in Arawak, neither was named as a defendant herein. In 1965, the name of First Bahamas Investment Trust was changed to Capital Growth Fund.

The trust agreement provided that it could be amended for any reason, provided the interests of the shareholders were not adversely affected thereby. If an amendment was made, the trustee was required to give each shareholder twenty days written notice setting forth the details of the amendment and the reasons therefor. On August 8, 1967, Arawak and New Providence sent letters to shareholders notifying them of proposed changes in the trust deed. Arawak's letter contained the precise language of the change, which was in substance that trust property would thereafter be invested in open-end investment companies or trusts, "the Investment Advisor of which" was registered with the SEC. New Providence's letter informed shareholders:

Instead of investing in U.S. mutual funds, we will invest in our own -- five or more -- open end investment trusts supervised by some of the best Investment Advisors in the United States. These Investment Advisors are all registered with the Securities and Exchange Commission in the United States.

Since the subsidiary trusts, unlike the parent trust, were not restricted in their choice of investments, the change proved to be an unhappy one for the shareholders. Extensive purchases and sales of common stock led to a substantial increase in handling and brokerage fees. Moreover, several of the subsidiary trusts' major investments were, at best, questionable in character.

In 1970, McAlpin formed the Capital Growth Real Estate Fund, a Panamanian investment company; and Capital Growth Management, a subsidiary of New Providence, became the Real Estate Fund's investment manager. The Real Estate Fund received $10,000,000 in assets from Capital Growth Fund in exchange for stock. Shortly after its formation, the Real Estate Fund also engaged in a series of questionable financial transactions.

On October 16, 1970, Arawak notified McAlpin that it wanted to resign as trustee, and asked that a new trustee be appointed. When McAlpin failed to comply with Arawak's request, Arawak petitioned the Bahamas Supreme Court to make the appointment. Although the record is somewhat obscure on this point, it appears that on April 7, 1971, the Court appointed Banco Anglo Costarricence of San Jose, Costa Rica, as trustee in place of Arawak, and, on May 4, 1971, Banco Anglo Costarricence was succeeded by appellee Sion Plaza, S.A., a Costa Rican corporation.

McAlpin then formed appellee Capital Growth Fund, S.A. under the laws of Costa Rica and merged the old Capital Growth Fund into the new one. To prevent shareholders from redeeming their shares, as they could under the existing open-end trust provisions, McAlpin, in July, 1971, took advantage of liberal Costa Rican laws to convert unilaterally the Costa Rican Fund from open-end to close-end. In August, 1971, the Fund's name was changed to Capital Growth Company, S.A., and the Real Estate Fund was merged into it. McAlpin then formed New Providence Securities, Ltd. (Panama), and the new firm became the investment manager for Capital Growth Company, S.A. In a complicated series of transactions, New Providence Securities, Ltd. became the owner of Capital Growth Company's common stock, and the fundholders' shares were converted to preferred stock.

In 1973, the Securities and Exchange Commission launched an investigation into McAlpin's activities, which culminated in an enforcement action brought in the United States District Court for the Southern District of New York on September 3, 1974. See SEC v. Capital Growth Company, S.A. (Costa Rica), et al., 391 F. Supp. 593 (S.D.N.Y. 1974). On September 24, 1974, the court appointed Michael F. Armstrong receiver for the Capital Growth Companies. Id. at 596. On September 17, 1976, Armstrong filed the instant action. Joining him as plaintiffs were Robert Moore, a shareholder of the original Capital Growth Fund, and Francesco Galofaro, the owner of a Capital Growth Real Estate Fund debenture, each of them suing derivatively on behalf of his Fund.

At a pretrial conference held on February 4, 1977, discussions were had concerning asserted insufficiencies in plaintiffs' complaint and the possibility of avoiding burdensome and expensive motions addressed to the complaint. Apparently satisfied that some of defendants' objections had merit, plaintiffs, on April 22, 1977, filed an amended complaint. On January 26, 1978, Judge Werker dismissed without prejudice seven of the causes of action alleged in the amended complaint, and on April 3, 1978, plaintiffs filed a second amended complaint.

On June 1, 1978, the attorneys for McAlpin and Capital Growth Real Estate Fund, Inc. moved to disqualify the firm of attorneys representing plaintiffs as trial counsel because Theodore Altman, a partner in that firm, had been on the SEC staff and had actively participated in the Commission's investigation of McAlpin's companies. Judge Werker denied the motion, 461 F. Supp. 622 (S.D.N.Y. 1978), and his order was affirmed by this Court, 625 F.2d 433 (2d Cir. 1980) (en banc). However, the Supreme Court vacated the en banc decision on the ground that the interlocutory order denying the motion to disqualify was not appealable. 449 U.S. 1106, 101 S. Ct. 911, 66 L. Ed. 2d 835 (1981).

Following the Supreme Court's decision, Judge Werker took up defendants' pending motions to dismiss the second amended complaint. In an opinion and order dated July 14, 1981, he dismissed the complaint as to all defendants. [Current] Fed. Sec. L. Rep. (CCH) P 98,255. This appeal followed.

Discussion

Although the second amended complaint is fifty-seven printed pages in length and asserts twenty causes of action against thirty defendants, the liability of each defendant arises out of that defendant's connection with one or more of the following alleged wrongful acts or series of wrongful acts:

I.

The 1967 change in the terms of the trust agreement, already discussed, which allegedly resulted in the "fraudulent" payment of in excess of $4,240,750 in fees to New Providence. McAlpin, New Providence, Arawak, Brown Brothers, Goldman, Sachs, and Pringle and Rafferty, Arawak officers, are sought to be charged with liability. (First and Second Causes of Action.)

II.

In 1968, one of the subsidiary trusts entered into a joint venture with a Costa Rican partnership, controlled by appellee Jose Figueres Ferrer, to form the corporate appellee, Sociedad Agricola Industrial San Cristobal, S.A. The trust invested $2,000,000 in cash, and the partnership contributed its assets, which, although they actually had a negative partnership book value of $157,000, were valued on the corporation's books at $3,000,000. For its investment, the trust received $2,000,000 in common stock. The partnership received $2,000,000 in common stock and $1,000,000 in preferred stock. Recovery of $2,055,000 is sought against McAlpin, New Providence, Figueres, and San Cristobal, as principals, appellee Alberto Alvarez as broker, appellee Koitcho Beltchev as investment advisor, and appellee Hayden Stone & Co. as Beltchev's employer. Arawak, Rafferty, and Pringle are also charged with liability because, it is alleged, they took no steps to prevent or avoid the transaction and Arawak subsequently resigned as trustee without making disclosure of the facts. (Third, Fourth, and Fifth Causes of Action.)

III.

In September, 1969, one of the subsidiary trusts purchased 200,000 shares of appellee EHG Enterprises Inc., a Puerto Rican corporation controlled by appellees, Ariel and Enrique Gutierrez. The purchase price of $2,005,000 was allegedly far in excess of the stock's market value. Upon receipt of the money, EHG paid New Providence $100,000 as a brokerage commission, "loaned" New Providence an additional $400,000 and purchased $400,000 worth of bonds issued by the National Liberation Party of Costa Rica.

In September, 1972, Ariel Gutierrez purchased the 200,000 shares by paying $1,000,000 to New Providence, $300,000 to McAlpin personally, and $10,000 to a third party who assisted in consummating the deal.

McAlpin, New Providence, EHG, Ariel Gutierrez and Enrique Gutierrez are charged as principals, Beltchev, appellee Sheffield Advisory Company, S.A. and appellee Sanford Shultes as investment advisors, Alvarez as broker or intermediary, and Pringle and Rafferty as officers of Arawak. Recovery in the amount of $1,005,000 is sought. (Sixth, Seventh, and Eighth Causes of Action.)

IV.

Between October, 1970 and September, 1972, Growth Fund and the Capital Growth Companies executed approximately $247,000,000 in securities transactions, and fees of $1,100,000 and $1,400,000 were paid to New Providence and Beltchev respectively. In addition, $300,000 in commissions was paid to others. The average turnover rate approximated 550% in 1971, and 900% in 1972. McAlpin and New Providence are charged as the instigators of this alleged churning scheme, and Beltchev is charged as participating broker and aider and abettor. Recovery in the total amount of $2,800,000 is also sought from appellee Moore & Schley, a brokerage firm, which employed Beltchev from March 2, 1970, to December 8, 1971, and appellee William Hutchinson & Co., another brokerage firm, which employed Beltchev from December 8, 1971 to December 13, 1972. Shultes is alleged to have been an investment advisor in search of commissions, and Sheffield is alleged to be liable as Shultes' ...


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