Appeal, pursuant to 28 U.S.C. § 1292(b), from parts of an order of the District Court for the Southern District of New York, Gerard L. Goettel, Judge, 552 F. Supp. 439 (1982). The order was made in actions against the public accounting firm of Arthur Andersen & Co. by four commercial banks which had made loans to Frigitemp Corporation and its wholly owned subsidiary, Elsters, Inc., the loan to Elsters being guaranteed by Frigitemp and secured by a pledge of all of Elster's stock. The order denied Andersen's motion to dismiss or to grant summary judgment with respect to those portions of the complaint which alleged violations of the federal securities laws. The Court of Appeals held (1) that renewal notes issued by Frigitemp were not securities within § 10(b) of the Securities Exchange Act of 1934 or § 17(a) of the Securities Act of 1933; and (2) that although the pledge of the Elsters stock was a sale and purchase of a security, Andersen's alleged knowing mispresentations of Frigitemp's financial condition were not sufficient to make the transaction one in connection with the purchase and sale of a security since Andersen was not alleged to have made any misrepresentations with respect to Elsters or its pledged stock. Accordingly the order denying Andersen's motion was reversed. Van Graafeiland, Circuit Judge, concurs in the first but dissents from the second holding, in an opinion.
Friendly, Van Graafeiland and Meskill, Circuit Judges. Van Graafeiland, Circuit Judge, concurring and dissenting.
Arthur Andersen & Co. (Andersen) appeals, pursuant to 28 U.S.C. § 1292(b), from so much of an order of Judge Goettel in the District Court for the Southern District of New York, 552 F. Supp. 439 (1982), as denied its motion to dismiss the claims alleging violations of the federal securities laws in three actions brought by four commercial banks*fn1 which had made loans to Frigitemp Corporation (Frigitemp) and its wholly owned subsidiary, Elsters, Inc. (Elsters). The appeal raises important issues concerning the application of § 10(b) of the Securities Exchange Act of 1934 and the SEC's Rule 10b-5 and of § 17(a) of the Securities Act of 1933 to commercial bank loans evidenced by notes and, in one instance, secured by a pledge of a security.
Frigitemp was a publicly held company whose stock was listed on the American Stock Exchange. The company was primarily in the business of selling, manufacturing and installing interior furnishings in hotels, restaurants, institutions and ships. During the early and mid-1970's, Frigitemp embarked on a course of rapid expansion, acquiring a number of other companies. It acquired Elsters for stock on January 11, 1977, effective as of December 31, 1976. In the early 1970's Frigitemp financed its operations by obtaining various secured and unsecured credit lines extended by several institutions, including Manufacturers Hanover and Security Pacific National Bank. The company's rapid expansion over the next several years, however, required larger amounts of capital to sustain its operations. After having mixed success in forays into the public debt and equity markets,*fn2 Frigitemp looked to the Banks for financing.
By a contract dated December 31, 1975 (the Secured Credit Agreement), the Banks agreed to provide Frigitemp with a line of credit up to $8 million. Pursuant to the Secured Credit Agreement, the Banks advanced $6.5 million to Frigitemp beginning in 1976. The loans were evidenced by Frigitemp's promissory notes maturing on July 1, 1977, and were secured by a pledge of Frigitemp customer notes receivable.
In September, 1976, the Banks and Frigitemp began discussing the need to restructure Frigitemp's debt. Pending such restructuring, three banks in September, 1976, advanced $1.5 million evidenced by Frigitemp's one month promissory note to each bank; in October, 1976, they advanced an additional $3.5 million. Frigitemp gave each bank a promissory note maturing on February 28, 1977, which included the $1.5 million owed on the September financing. This maturity was later extended to April 30, 1977. In February, 1977, Frigitemp received an additional $4 million unsecured loan from all four banks, evidenced by promissory notes also maturing April 30, 1977.
In addition to the loans evidenced by the $6.5 million of secured notes maturing July 1, 1977, and the $9 million of unsecured notes maturing April 30, 1977, Frigitemp had other financial needs. As described by the report of Worden & Risberg, management consultants,*fn3 Frigitemp, in the latter half of 1976,
experienced a substantial buildup of trade payables due to cost incurred on customer-caused delays -- for which they have not yet been reimbursed -- and to a substantial increase in contract backlog -- for which they had to begin placing purchase commitments. These factors have created a serious working capital deficit that is now affecting both vendor confidence and job completion.
One of the unsettling factors was a receivable of $11 million from Litton Industries, Inc.; the 1976 year-end financial statements of Frigitemp, certified by Andersen and dated May 10, 1977, recognized $8.9 million of this as income.*fn4 However, the receivable remained unpaid and Frigitemp's working capital deficit was interfering with its ability to operate. Suppliers, for example, were beginning to hold up on deliveries. As the consultants' report concluded, and as the Banks realized, Frigitemp needed "approximately $4 million additional working capital to get through the current cash crunch it [was] experiencing." Frigitemp thus needed not only to refinance the $15.5 million owing under the Secured Credit Agreement and the unsecured loan transactions, but to obtain an additional $4 million. It sought to achieve this latter financing by a loan to its newly acquired subsidiary Elsters, as described below.
The restructuring transaction occurred in early August, 1977. Although evidenced by three different agreements, an officer of Manufacturers Hanover averred that these "were structured as, and were intended to be, part of one single, integrated refinancing package", and we shall assume for present purposes that this was the case.
Under one set of agreements, the Banks extended the maturity date of the $6.5 million of notes issued under the Secured Credit Agreement from July 1, 1977 to July 1, 1978; the notes were amended by endorsements dated August 9, 1977 (the Note Endorsements). Under a second set of agreements, substituting for the $9 million of unsecured notes which had become due on April 30, 1977, Frigitemp issued to the Banks the same amount of unsecured notes dated August 9, 1977 and maturing March 31, 1978 (the Replacement Notes). Finally, the Banks advanced $4 million to Elsters for which they received promissory notes dated August 8, 1977, maturing March 31, 1978; Frigitemp guaranteed these notes and pledged as security 100% of Elsters' common stock, 750 shares, pursuant to a Pledge and Security Agreement.
Frigitemp filed a petition in bankruptcy on March 20, 1978. By that time only approximately $4 million of the $15.5 million Frigitemp debt had been repaid.*fn5 At the same time Elsters ceased engaging in business. The Banks have realized some $2 million on the Elsters notes.
In this action, commenced in 1979, the Banks seek to hold Andersen and three principal officers of Frigitemp liable for their losses. The complaints allege that the Banks entered into the transactions with Frigitemp and Elsters in reliance on Frigitemp's financial statements audited and certified by Andersen for the years 1973-1976.*fn6 The Banks allege that Andersen knew that Frigitemp's financial statements were false and misleading in numerous respects, including the following: material overstatement of profits from long term contracts because of consistent understatement of the cost to Frigitemp of fulfilling such contracts; material overstatement of Frigitemp's income and current assets by inclusion of amounts claimed for material costs and work done as addition to or changes from specifications; and material overstatement of Frigitemp's accounts receivable by the inclusion of overbillings, of inclusion of unbilled and unbillable amounts, allocation of payments on current to older receivables, the $8.9 million Litton claim mentioned above, and other claims for work not performed. The first claim in the complaints alleges that in making such certifications Andersen violated or aided and abetted in the violation of § 17(a) of the Securities Act of 1933,*fn7 § 10(b) of the Securities Exchange Act of 1934,*fn8 and Rule 10b-5 issued thereunder.*fn9 Three other claims in the complaints allege violations of state law.
After answer and extensive discovery Andersen moved, in February, 1982, upon the affidavit of its counsel, Edward J. Ross, the exhibits submitted therewith, the pleadings and all the prior proceedings, for an order pursuant to Fed. R. Civ. P. 12(b)(1) and (6) and 56(b) dismissing the actions for lack of subject matter jurisdiction or, in the alternative, granting summary judgment in its favor on the claims pleaded under the federal securities laws, and, in either event, dismissing the pendent claims. In April, 1982, the Banks submitted an answering affidavit of one of their counsel, an affidavit of Richard J. O'Neill, a Vice-President of Manufacturers Hanover, who had been involved in the transactions between the Banks and Frigitemp, and a statement of material facts, pursuant to S.D.N.Y. Civ. R. 3(g). Mr. Ross submitted a further affidavit accompanied by numerous exhibits in May, 1982.
After receiving briefs and hearing argument, Judge Goettel filed a comprehensive opinion denying Andersen's motion, 552 F. Supp. 439 (S.D.N.Y. 1982). He first addressed the question whether any of the Frigitemp notes were securities within the pertinent provisions of the 1933 and 1934 Acts. He discussed the relevant authorities, particularly this court's decision in Exchange National Bank v. Touche Ross & Co., 544 F.2d 1126, 1137-38 (1976). We will analyze that decision in detail below; it is sufficient here to say that we noted that under the statutes, any note having a maturity exceeding nine months was a security under the 1934 Act and any note was a security under the antifraud provisions of the 1933 Act unless the context otherwise required. We proceeded to give many instances where the context did so require and said that:
When a note does not bear a strong family resemblance to these examples and has a maturity exceeding nine months, § 10(b) of the 1934 Act should generally be held to apply.
Id. at 1138 (footnote omitted). Judge Goettel held that the Note Endorsements, although having a maturity of more than nine months, "which were for a short term and which were secured by Frigitemp's customer notes receivable, bear a strong family resemblance to 'short-term notes secured by an assignment of accounts receivable, '" one of the examples cited in Exchange National Bank, and thus the context otherwise required that these not be considered securities within § 10(b) of the 1934 Act or § 17(a) of the 1933 Act. 552 F. Supp. at 448 (quoting Exchange National Bank, supra, 544 F.2d at 1138).
Turning to the Replacement Notes, Judge Goettel found that these bore no resemblance to any of the examples cited in Exchange National Bank and thus considered them to be securities for the purposes of § 17(a) of the 1933 Act, which had no provisions with respect to length of maturity. Id. He thought their status under the 1934 Act was not so clear because at the time of issuance they had a maturity of less than nine months, although, as he pointed out, "the actual effect of the Replacement Notes was to extend the maturity date on the existing unsecured notes from April 30, 1977 until March 31, 1978, a period of eleven months," id. at 448 n.21, see also id. at 449. He concluded, however, that since under the "strong family resemblance" test the Replacement Notes would presumptively be securities under § 17(a) of the 1933 Act, it would make little sense to hold they were not securities under § 10(b) of the 1934 Act. Id. at 448-49. Finally, id. at 449-50, he rejected the argument that Exchange National Bank was no longer authoritative in the light of Marine Bank v. Weaver, 455 U.S. 551, 71 L. Ed. 2d 409, 102 S. Ct. 1220 (1982), citing our post-Marine Bank reaffirmation of Exchange National Bank in a different context in Golden v. Garafalo, 678 F.2d 1139, 1144-46 (2 Cir. 1982).
Judge Goettel then turned to the question whether the pledge of Elsters' stock would suffice to support jurisdiction over the federal securities laws claims even if the Replacement Notes were not securities. He thought it clear, citing Rubin v. United States, 449 U.S. 424, 431, 66 L. Ed. 2d 633, 101 S. Ct. 698 (1981), and United States v. Gentile, 530 F.2d 461, 466-67 (2 Cir. 1976), cert. denied, 426 U.S. 936, 49 L. Ed. 2d 388, 96 S. Ct. 2651 (1976), that a pledge of stock was a sale for purposes of § 17(a) of the 1933 Act and, citing Mallis v. Federal Deposit Insurance Corp., 568 F.2d 824, 828-30 (2 Cir. 1977), cert. granted, 431 U.S. 928, 97 S. Ct. 2630, 53 L. Ed. 2d 243 (1977), cert. dismissed, 435 U.S. 381, 98 S. Ct. 1117, 55 L. Ed. 2d 357 (1978), that it was a sale under § 10(b) of the 1934 Act. 552 F. Supp. at 450. He then addressed "the question that has been debated by the parties", namely "whether the alleged fraud occurred 'in connection with ' the pledge of Elsters stock." Id. at 450-51. He noted Andersen's argument that "because there was no misrepresentation or omission concerning the value of Elsters stock or Elsters' financial condition, the pledge of Elsters stock cannot be used to sustain jurisdiction under section 10(b)," and the Banks' reply "that, to sustain jurisdiction under section 10(b), the fraud must merely 'touch upon ' the sale, not relate to the value of the pledged securities." Id. at 451. The "touching" phrase comes from Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 12-13, 30 L. Ed. 2d 128, 92 S. Ct. 165 (1971), and the judge, although recognizing that "perhaps the Supreme Court will, when confronted with the issue, narrow the test for determining whether the 'in connection with ' requirement has been satisfied", thought himself bound by Supreme Court and Second Circuit precedent to hold that the "in connection with" requirement had been satisfied and that the pledge of the Elsters stock supported jurisdiction over the federal securities laws claims even if the Replacement Notes were not securities. 552 F. Supp. at 453-54.
The judge then reviewed and rejected other arguments of Andersen unnecessary here to describe. He ended his opinion by saying, 552 F. Supp. at 457-58:
Although the Court believes that the present state of the law in this circuit precludes dismissal of the Banks' claims under the securities laws, it recognizes that there is substantial ground for difference of opinion on the jurisdictional questions -- whether the Replacement Notes are securities and whether the pledge of Elsters stock is sufficient to support jurisdiction over this lawsuit. Because these are controlling legal questions, it appears that an immediate appeal from this decision will materially advance the ultimate termination of this litigation. Consequently, the Court will certify an ...