Appeal from a judgment of the United States District Court for the Southern District of New York (John E. Sprizzo, Judge), holding defendant law firm liable for violating Section 12(2) of the Securities Act of 1933 by preparing and distributing, on behalf of a client, a private-placement memorandum containing a material misstatement. The district court held that plaintiff was not required to prove loss causation. Because we conclude that loss causation is an essential element of an action under Section 12(2) against nonselling collateral participants in a securities transaction, we reverse.
Timbers, Winter and Mahoney, Circuit Judges. Timbers, Circuit Judge, dissenting.
This appeal presents the question whether proof of loss causation is an essential element of an action under Section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77 l (1982), when the defendant is a collateral participant in a securities transaction and not an actual seller. The law firm Ruffa & Hanover appeals from a judgment, entered after a trial before Judge Sprizzo, holding it liable under Section 12(2) for having prepared and distributed a private-placement memorandum in connection with a private offering conducted by one of the firm's clients. The private-placement memorandum misstated a material fact. The district court held that plaintiff was not required to prove loss causation -- in other words, that the material misstatement pertained to the ultimate cause of his damages -- in order to recover against Ruffa & Hanover. We disagree and accordingly reverse.
In March 1981, plaintiff Kenneth J. Wilson was solicited to invest in the stock of Saintine Exploration and Drilling Corp., a newly formed contract driller of oil and gas wells. Fred Rodolfy, a principal shareholder of the company and chairman of its board of directors, told Wilson that Saintine was going to drill for oil in Honduras and would make a good investment. In early April, Ruffa & Hanover, Saintine's counsel, sent Wilson a "Confidential Private Placement Memorandum" and a "Subscription Package" for the private offering of 1,000,000 shares of Saintine's common stock. Ruffa & Hanover had prepared the memorandum and the other documents relating to Saintine's offering, and had forwarded these materials to Wilson at the request of Rodolfy and Robert D.P. Welch, Saintine's president. In mid-April, Wilson received a revised version of the private-placement memorandum, also prepared by Ruffa & Hanover.
The private-placement memorandum explained that Saintine had been formed in part for the purpose of participating in a joint venture to explore for and to develop petroleum products under certain concessions granted by the government of Honduras. In addition, the memorandum stated that:
The Company has contracted for the purchase from Centurion Oil & Minerals Company ("Centurion"), a Texas corporation, of Centurion's rights, pursuant to joint venture arrangements between Centurion, Petroleos Yojoa, S.A., a Honduras corporation ("Peysa"), Compania Explorada, S.A., a Honduras corporation ("Coexsa"), and Compass Corporation, a Texas corporation ("Compass"), regarding the exploration for and development of the oil and gas resources contained in certain tracts of land located in the Republic of Honduras (the "Honduran Concessions"). Approximately 114,988 acres are the subject of the Republic of Honduran government concessions granted by Peysa. Coexsa has applied to the Minister of Natural Resources of the Republic of Honduras for a concession covering 59,280 additional acres. The agreement between Centurion and Saintine provides that Centurion will also assign to Saintine its rights with respect to concessions granted to Saintine by the Honduran government.
Saintine agreed to purchase Centurion's interest in the venture and, accordingly, in its interest in production from the Concession, for $200,000. The terms of the agreement also provides [sic] that Centurion will retain a 4% working interest in production obtained from wells drilled on the Concessions by Saintine and that in the event that Saintine shall acquire any further concessions to explore and develop properties in Honduras, Saintine shall grant to Centurion a 1 % overriding royalty in production from such additional concessions. The closing of the agreement between Centurion and Saintine is scheduled to take place on or about June 30, 1981.
(emphasis added). The district court found, however, that Centurion and Saintine did not enter into an agreement with respect to the Honduran concessions until May 27, 1981, and accordingly that the April private-placement memorandum had falsely stated that the firms had reached such an agreement at that time. Specifically, the court found "incredible," in light of contrary documentary evidence, the testimony of William P. Ruffa (of Ruffa & Hanover) that an oral agreement had in fact been reached at the time the private-placement memorandum was issued.
On May 28, 1981, after receiving the private-placement memorandum and offering documents but before Saintine actually finalized the contractual arrangements described above, Wilson purchased 90,000 shares of Saintine common stock for $36,000. Although the false statement about the contractual arrangements was cured after Wilson's purchase, Saintine never engaged in any drilling in Honduras. In early 1982, Rodolfy telephoned Wilson to tell him that "you can expect a call from Mr. Welch, offering you your money back." According to Wilson, Rodolfy "said that they had done something wrong, or that the concession was wrong, something of that sort. . . . And I said, fine, I would be happy to have my money back." Soon thereafter, Welch refunded only $5,000 of Wilson's investment with the vague explanation that "we are somewhat disappointed on the sale of an asset for Saintine Exploration & Drilling Corporation." Welch nevertheless promised that the remaining $31,000 would be refunded within ninety days.
The refund never arrived, however, prompting Wilson to bring this suit against, among others, Saintine, Welch's estate, Rodolfy and Ruffa & Hanover. Wilson alleged that the defendants had violated Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982), Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5 (1987), and Section 12(2) of the '33 Act. Wilson's Section 10(b) claim against Ruffa & Hanover was dismissed before trial under Fed. R. Civ. P. 9(b) for failure to plead fraud with particularity. After a one-day bench trial, Judge Sprizzo entered judgment against Welch's estate, which defaulted, and against Rodolfy and Ruffa & Hanover. The court awarded plaintiff $47,513.40 in damages, including prejudgment interest.
The district court found that the defendants knew that the statement in the private-placement memorandum was false. As to Ruffa & Hanover, the district court held that, even though the law firm was not actually a seller of securities,
the evidence clearly establishes the type of material participation which the case law would find sufficient [to support liability]. They prepared the offering statement, they participated extensively [in] preparing the contents of that statement, they knew it was being sent ...