Berckeley Investment Group, Ltd. v. Colkitt

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit
7-25-2006
Berckeley Inv Grp v. Colkitt
Precedential or Non-Precedential: Precedential
Docket No. 04-3844
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PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 04-3844
BERCKELEY INVESTMENT GROUP, LTD.
v.
DOUGLAS COLKITT;
SHORELINE PACIFIC INSTITUTIONAL FINANCE,
THE INSTITUTIONAL DIVISION OF
FINANCE WEST GROUP;
NATIONAL MEDICAL FINANCIAL
SERVICES CORPORATION
Douglas R. Colkitt,
Appellant
On Appeal from the United States District Court
for the Middle District of Pennsylvania
(D.C. No. 97-cv-01242)
District Judge: Honorable James F. McClure, Jr.
Argued February 21, 2006
Before: McKEE, FISHER and ROTH,* Circuit Judges.
(Filed: July 25, 2006)
Peter Konolige
Andrew J. Kennedy (Argued)
Marcy L. Colkitt & Associates
P.O. Box 607
Indiana, PA 15701
Attorneys for Appellant
Joel Magolnick (Argued)
Moscowitz, Moscowitz & Magolnick
1111 Brickell Avenue, Suite 2050
Miami, FL 33131
Attorney for Appellee Berckeley Investment
Group, Ltd.
Michael J. Lawson (Argued)
Morgan, Lewis & Bockius
One Market, Speer Street Tower
San Francisco, CA 94105
Attorney for Appellee Shoreline Pacific
Institutional Finance
*
The Honorable Jane R. Roth assumed senior status on
May 31, 2006.
2
OPINION OF THE COURT
FISHER, Circuit Judge.
In May 1996, Appellant Douglas Colkitt, M.D., entered
into an “Offshore Convertible Securities Purchase Agreement”
(the “Agreement”) with Appellee Berckeley Investment Group,
Ltd., an offshore financing entity based in the Bahamas. The
Agreement provided that Colkitt would receive $2,000,000 from
Berckeley in exchange for 40 convertible debentures, which
Berckeley could convert after a specified time period into
unregistered shares of stock held by Colkitt. The number of
shares to be converted was controlled by a formula based on the
current market value of the shares less a 17% discount for
Berckeley.
The relationship between the parties quickly deteriorated,
as Colkitt accused Berckeley of “short selling” in order to
deflate the market price of the stock and thereby obtain more
shares upon conversion. When the time came for Colkitt to
convert the unregistered shares to repay his debt to Berckeley,
he balked and ended up converting only a small percentage of
the shares that Berckeley requested. Thereafter, each party filed
suit against the other. There is no dispute that Colkitt breached
his end of the bargain. Colkitt, however, asserts that he was
justified in not complying with the Agreement because
Berckeley made material misrepresentations in the Agreement
3
that violated federal securities laws and constituted common law
fraud.
Following seven years of protracted litigation, including
a previous appeal to this Court, Berckeley Inv. Group, Ltd. v.
Colkitt, 259 F.3d 135, 137 (3d Cir. 2001) (“Berckeley I”), the
District Court found in favor of Berckeley on the parties’ cross-
motions for summary judgment. The District Court awarded
damages to Berckeley in the amount of $2,611,075.52. Colkitt
appeals that decision on a number of grounds, primarily relating
to the District Court’s analysis of federal securities laws. For
the reasons set forth herein, we will affirm in part, reverse in
part, and remand the case to the District Court for further
proceedings.
I. BACKGROUND
Douglas Colkitt, M.D., is the Chairman of the Board and
principal shareholder of National Medical Financial Services
Corporation (“NMFS”), a corporation whose shares were traded
on the NASDAQ stock exchange. Looking to obtain financing
for an unrelated business venture, Colkitt sought out lenders
who would be willing to lend him money in exchange for the
right to convert his unregistered shares of NMFS stock. See,
e.g., GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 194-95
(3d Cir. 2001).
In the spring of 1996, Colkitt entered into negotiations
with Berckeley Investment Group, Ltd., a Bahamian corporation
headquartered in Nassau, Bahamas. On May 30, 1996, the
4
negotiations culminated in the Agreement between the parties.1
Under the Agreement, Berckeley purchased 40 convertible
debentures from Colkitt at $50,000 per debenture, for a total of
$2,000,000.2 Each debenture represented an unsecured loan for
a one-year term, which also obligated Colkitt to pay to
Berckeley six percent interest on a quarterly basis. In lieu of
receiving repayment in cash per these terms, however,
Berckeley was entitled under the Agreement to convert its
debentures into NMFS shares. The Agreement provided that,
upon demand by Berckeley, Colkitt would issue unregistered
shares of NMFS at a 17% discount off the then-prevailing
market price of the stock.3 Berckeley was entitled to convert up
1
Defendant-Appellant Shoreline Pacific Institutional
Finance (“Shoreline”) brokered the Agreement between Colkitt
and Berckeley. Berckeley I, 259 F.3d at 137.
2
A debenture is a debt secured only by the debtor’s
earning power, not by a lien on any specific asset. A convertible
debenture is one that the holder may change into some other
security, such as stock. See Black’s Law Dictionary 430 (8th
ed. 2004).
3
For example, suppose that Berckeley wanted to convert
$1,000,000 of the debentures into NMFS shares, and that the
current market price for NMFS stock was $25 per share. The
conversion price would be $20.75 per share ($25 per share
* 0.83). At a rate of $20.75 per share, Berckeley would be
entitled under the Agreement to 48,192.77 shares of NMFS
stock.
The 17% discount received by Berckeley represented, in
5
to one-half of the principal amount into unregistered NMFS
shares one hundred (100) days after the closing of the
Agreement, and the remaining principal amount one hundred
twenty (120) days after the closing date.
Several of the contractual provisions in the Agreement
are key to an understanding of the dispute between the parties.
The parties acknowledged that the Agreement was entered into
pursuant to Regulation S of the Securities Act of 1933, 17
C.F.R. §§ 230.901-.04, and that it would be “governed by and
interpreted according to the law of the State of New York.” In
paragraph 2.5 of the Agreement, Berckeley warranted that all
subsequent offers or sales of the debentures or shares would be
undertaken in accordance with the registration requirements of
the 1933 Securities Act:
All subsequent offers and sales of the Debentures
or the Shares will be made (a) outside the United
States in compliance with Rule 903 or 904 of
Regulation S, (b) pursuant to registration of the
Debentures or the Shares, respectively, under the
Securities Act, or (c) pursuant to an exemption
from such registration. Buyer understands the
conditions of the exemption from registration
part, the fact that “the National Medical shares held by Colkitt
for the transaction were not registered with the Securities and
Exchange Commission, as would be required for sales of those
shares within the United States by Section 5 of the Securities
Act of 1933.” See Berckeley I, 259 F.3d at 137 (internal citation
omitted).
6
afforded by Section 4(1) of the Securities Act and
acknowledges that there can be no assurance that
it will be able to rely on such exemption. In any
case, Buyer will not resell the Debentures or the
Shares to U.S. Persons or within the United States
until after the end of the forty (40) day period
commencing on the date of completion of the
Offering (the “Restricted Period”).
Berckeley further represented that it was aware that Colkitt was
relying upon the accuracy of its representations regarding
federal and state securities laws, and that its “purchase of the
Debenture or the Shares pursuant to this Agreement is not part
of a plan or scheme to evade the registration provisions of the
Securities Act.” For his part, Colkitt represented that he would
“take no action, including but not limited to the further sale of
securities pursuant to Regulation S of [NMFS] that are held by
[Colkitt], that will affect in any way the running of the
Restricted Period or the ability of Buyer to freely resell the
debentures or the Shares in accordance with applicable
securities laws and this Agreement.” In addition, Colkitt agreed
to place 300,000 shares of NMFS stock in escrow to cover the
$2,000,000 aggregate amount of the debentures. He further
agreed that “[i]f the price has decreased so that the shares in
escrow are insufficient for the conversion of all outstanding
Debentures, [Colkitt] agrees to place in escrow additional shares
representing that number of shares necessary for the conversion
of all outstanding Debentures plus an additional 100,000
shares.”
7
Berckeley upheld its end of the Agreement when it wired
$2 million via Shoreline to Colkitt. Colkitt, however, did not.
Following the expiration of the one hundred day period,
Berckeley began making demands on Colkitt to convert the
debentures into NMFS stock. Berckeley made five such
demands on Colkitt during September 1996 to convert $300,000
worth of the debentures into 40,133 shares of stock.4 On each
occasion, Colkitt failed to comply with the conversion demands.
Following repeated requests for conversion, Colkitt finally
converted 18,230 shares on November 5, 1996.5 Colkitt,
however, refused to convert any additional shares, including
$160,000 worth of the debentures demanded by Berckeley on
4
Berckeley specifically made the following demands on
the following dates in September 1996:
Conversion Shares Due
Date Face Value Price (truncated)
9/13/96 $80,000 7.6152 10,505
9/16/96 $60,000 7.6775 7,815
9//19/96 $90,000 7.5115 11,981
9/26/96 $20,000 7.1795 2,786
9/26/96 $50,000 7.0965 7,046
$300,000 40,133
5
That figure represented Berckeley’s conversion demands
made on September 13, 1996, and September 16, 1996.
8
November 6, 1996.6 Colkitt further refused to make required
quarterly interest payments that were due on the debentures
under the Agreement, and to repay the balance due on the
Debentures at the end of the term.
II. PROCEDURAL HISTORY
Berckeley filed suit in the District Court on August 13,
1997, alleging that Colkitt breached the Agreement by failing to
convert the debentures.7 After the District Court made several
procedural rulings,8 Colkitt filed a second amended
counterclaim complaint containing five counts against
Berckeley for violations of federal securities laws and the
Pennsylvania Securities Act, common law fraud, and breach of
contract. Following discovery, both parties filed cross-motions
for summary judgment. In a decision dated December 7, 1999,
the District Court granted Berckeley’s motion and denied
Colkitt’s motion. The District Court recognized in the order that
there were three remaining issues for its consideration: (1) the
6
The conversion price for the $160,000 demand made on
November 6, 1996, does not appear in the record.
7
Berckeley also sued NMFS for breach of contract, and
Shoreline for breach of contract and breach of fiduciary duty.
The District Court dismissed NMFS as a party to the action, and
the merits of Berckeley’s claims against Shoreline are not at
issue on appeal.
8
The lengthy procedural history in the District Court is
summarized in our decision in Berckeley I, 259 F.3d at 138.
9
amount of damages to which Berckeley was entitled on its
breach of contract claim against Colkitt; (2) Berckeley’s breach
of contract and breach of fiduciary claims against Shoreline; and
(3) Shoreline’s cross-claims against Colkitt for breach of
contract and contractual indemnity. The District Court stated
that it would defer the entry of a final judgment pending
disposition of the remaining claims, and it requested the parties
to file a statement “suggesting how the court shall proceed with
the remaining claims/issues.”
Berckeley and Shoreline suggested that Berckeley be
permitted to file a motion for entry of final judgment against
Colkitt, thus staying proceedings involving Shoreline for one
year, because satisfaction of Berckeley’s judgment against
Colkitt would dispose of any remaining claims by or against
Shoreline. In contrast, Colkitt stated his intention to seek leave
for immediate appeal of the District Court’s summary judgment
decision pursuant to Fed. R. Civ. P. 54(b) and/or 28 U.S.C.
§ 1292(b). The District Court sided with Berckeley, which
subsequently filed a motion for entry of final judgment against
Colkitt. Berckeley and Shoreline then moved to stay
Berckeley’s claims against Shoreline and Shoreline’s claims
against Colkitt. On March 30, 2000, the District Court granted
Berckeley’s and Shoreline’s motions and entered judgment in
the amount of $2,611,075.52 against Colkitt.
Colkitt appealed the decision of the District Court. On
appeal, however, Colkitt argued that we lacked appellate
jurisdiction because the District Court had failed to comply with
Rule 54(b) and indicate expressly that there was no “just reason”
for delaying Colkitt’s appellate rights. On July 26, 2001, we
10
issued an opinion agreeing with Colkitt that we lacked appellate
jurisdiction, and we remanded the matter back to the District
Court. See Berckeley I, 259 F.3d at 146. On August 23, 2001,
Berckeley filed with the District Court a motion to amend the
judgment so that it comported with the requirements of Rule
54(b). Colkitt opposed the motion. On September 8, 2004, the
District Court granted Berckeley’s motion and entered an order
certifying the judgment as final.9 This appeal followed.
III. STANDARD OF REVIEW
We have jurisdiction over Colkitt’s appeal from the order
of the District Court pursuant to 28 U.S.C. § 1291. We exercise
plenary review over the District Court’s entry of summary
judgment in favor of Berckeley. Morton Int’l, Inc. v. A.E. Staley
Mfg. Co., 343 F.3d 669, 679 (3d Cir. 2003). We therefore apply
the summary judgment standard set forth in Federal Rule of
Civil Procedure 56(c). Under that standard, we will affirm the
judgment of the District Court “if the pleadings, depositions,
answers to interrogatories, and admissions on file, together with
the affidavits, if any, show that there is no genuine issue as to
any material fact and that the moving party is entitled to a
judgment as a matter of law.” Fed. R. Civ. P. 56(c).
In deciding the motion for summary judgment, our job is
to ascertain solely whether there is a dispute of material fact:
9
The record is unclear as to why there was a thirty-eight
month delay between the date of our opinion remanding the case
back to the District Court and the District Court’s subsequent
order.
11
we are not permitted to make factual findings, which remains
the province of the jury. See Bragen v. Hudson County News
Co., 278 F.2d 615, 618 (3d Cir. 1960). When determining
whether there are any genuine issues of material fact, we draw
all inferences in favor of the non-moving party. Pa. Prot. &
Advocacy, Inc. v. Pa. Dep’t of Pub. Welfare, 402 F.3d 374, 379
(3d Cir. 2005) (citations omitted). Although the non-moving
party receives the benefit of all factual inferences in the court’s
consideration of a motion for summary judgment, the non-
moving party must point to some evidence in the record that
creates a genuine issue of material fact. Id. (citing Fed. R. Civ.
P. 56(e)). In this respect, summary judgment is essentially “put
up or shut up” time for the non-moving party: the non-moving
party must rebut the motion with facts in the record and cannot
rest solely on assertions made in the pleadings, legal
memoranda, or oral argument. See Jersey Cent. Power & Light
Co. v. Lacey Twp., 772 F.2d 1103, 1109-10 (3d Cir. 1985). In
addition, if the non-moving party has the burden of proof at trial,
that party must set forth facts “sufficient to establish the
existence of an element essential to that party’s case.” Celotex
Corp. v. Catrett, 477 U.S. 317, 322 (1986).
IV. DISCUSSION
A. THE DISTRICT COURT DID NOT ABUSE ITS DISCRETION
IN CERTIFYING THE ORDER AGAINST COLKITT AS A
PARTIAL FINAL JUDGMENT PURSUANT TO RULE 54(b)
The threshold issue confronting the Court is whether the
District Court abused its discretion in certifying the order
against Colkitt as a partial final judgment pursuant to Rule
12
54(b). Rule 54(b), which governs the certification of final
decisions in multiple-claim actions, provides:
When more than one claim for relief is presented
in an action, whether as a claim, counterclaim,
cross-claim, or third-party claim, or when
multiple parties are involved, the court may direct
the entry of a final judgment as to one or more but
fewer than all of the claims or parties only upon
an express determination that there is no just
reason for delay and upon an express direction for
the entry of judgment. In the absence of such
determination and direction, any order or other
form of decision, however designated, which
adjudicates fewer than all the claims or the rights
and liabilities of fewer than all the parties shall
not terminate the action as to any of the claims or
parties, and the order or other form of decision is
subject to revision at any time before the entry of
judgment adjudicating all the claims and the
rights and liabilities of all the parties.
Fed. R. Civ. P. 54(b) (emphasis added). We have explained that
the rule was designed in an attempt “to strike a balance between
the undesirability of piecemeal appeals and the need for making
review available at a time that best serves the needs of the
parties.” Allis-Chalmers Corp. v. Philadelphia Elec. Co., 521
F.2d 360, 363 (3d Cir. 1975) (citations omitted).
A decision to certify a final decision under Rule 54(b)
involves two separate findings: (1) there has been a final
13
judgment on the merits, i.e., an ultimate disposition on a
cognizable claim for relief; and (2) there is “no just reason for
delay.” Curtiss-Wright Corp. v. General Elec. Co., 446 U.S. 1,
7-8 (1980). The parties do not dispute that the District Court’s
decision entering summary judgment in favor of Berckeley on
all claims against Colkitt constituted a final judgment. The
dispute lies over whether the District Court abused its discretion
in certifying that judgment for immediate appeal under Rule
54(b) on the basis that there was “no just reason for delay.”
The Supreme Court has analogized the function of
district courts under Rule 54(b) as akin to a “dispatcher”:
district courts are to consider judicial administrative interests, as
well as the equities involved in the case, in order to determine
whether discrete final decisions in multiple-claim actions are
ready for appeal. Curtiss-Wright Corp., 446 U.S. at 8.
Recognizing that the District Court is “most likely to be familiar
with the case and with any justifiable reason for delay,” we
apply an abuse of discretion standard of review to the District
Court’s determination that there is no just cause for delay.
Berckeley I, 259 F.3d at 140 n.4, 145.10 We apply as a
benchmark against the District Court’s exercise of discretion
whether that discretion was applied in the “interest of sound
judicial administration.” Curtiss-Wright Corp., 446 U.S. at 10.
Our proper role in this regard “is not to reweigh the equities or
reassess the facts but to make sure that the conclusions derived
from those weighings and assessments are juridically sound and
10
We subject questions of law concerning the
interpretation of the requirements of Rule 54(b) to plenary
review. Berckeley I, 259 F.3d at 140 n.4.
14
supported by the record.” Id. As a result, we “should disturb
the trial court’s assessment of the equities only if we can say
that the judge’s conclusion was clearly unreasonable.” Id.Our decision in Berckeley I is illustrative of this general
principle. In Berckeley I, we determined that there were three
principal defects in the District Court’s original order entering
judgment in favor of Berckeley. First, contrary to the explicit
requirement of Rule 54(b), the District Court’s opinion did not
contain an express determination that there was “no just reason
for delay.” Berckeley I, 259 F.3d at 141. We concluded that
such an express determination was a jurisdictional prerequisite
required by Rule 54(b), and thus declined to adopt Berckeley’s
position that “general references to the necessity of expedition”
were sufficient. Id. (citation omitted).
Second, the District Court’s original order stated only
that it was granting “final judgment” with respect to the claims
between Berckeley and Colkitt; it did not cite, or even discuss,
Rule 54(b). Thus, it was unclear whether the District Court
intended to enter a partial final judgment in accordance with
Rule 54(b). Although stopping short of holding that citing to
Rule 54(b) is a jurisdictional prerequisite, we concluded that
“where there is a concurrent failure to make an express
determination of no just cause for delay, we cannot reasonably
conclude that the District Court intended to enter a partial final
judgment pursuant to that Rule.” Id. at 144.
Finally, we noted that the District Court did not discuss
in its opinion any factors relevant to whether there was a just
reason for delay. We have set forth several factors that courts
15
should consider when assessing that there is a “just reason for
delay” under Rule 54(b):
(1) the relationship between the adjudicated and
unadjudicated claims; (2) the possibility that the
need for review might or might not be mooted by
future developments in the district court; (3) the
possibility that the reviewing court might be
obliged to consider the same issue a second time;
(4) the presence or absence of a claim or
counterclaim which could result in set-off against
the judgment sought to be made final;
(5) miscellaneous factors such as delay, economic
and solvency considerations, shortening the time
of trial, frivolity of competing claims, expense,
and the like.
Allis-Chalmers Corp., 521 F.2d at 364. Although the factors set
forth in Allis-Chalmers are not jurisdictional prerequisites – but
instead constitute “a prophylactic means of enabling the
appellate court to ensure that immediate appeal will advance the
purpose of the rule,” Carter v. City of Philadelphia, 181 F.3d
339, 345 (3d Cir. 1999) – the District Court’s original order did
not contain any statement of reasons as to why there was no just
cause for delay. Berckeley I, 259 F.3d at 145. We held that this
omission, when combined with the other two omissions in the
order and our inability to ascertain the propriety of the
certification from the record, precluded us from exercising
appellate jurisdiction over the merits of Colkitt’s appeal. We
thus dismissed the appeal for lack of jurisdiction and remanded
the case to the District Court. Id. at 146.
16
On remand, the District Court addressed each of the
Allis-Chalmer Corp. factors to determine whether to enter a
final judgment with respect to all claims between Berckeley and
Colkitt. First, the District Court concluded that the adjudicated
claims between Berckeley and Colkitt and the outstanding
unadjudicated claims did not conflict because “the other pending
claims may easily be resolved upon execution of the order of
final judgment against Colkitt.” (App. VI at 5.) Second, the
court stressed that the procedural posture of this case presented
the possibility that immediate appellate review might actually
moot the remaining proceedings in front of the District Court,
which were wholly derivative of the claims on appeal. (Id.)
Whether Shoreline will owe damages to Berckeley and whether
Colkitt will be required to indemnify Shoreline depends upon
Colkitt’s underlying liability to Berckeley and Colkitt’s ability,
if applicable, to satisfy the judgment. Third, the District Court
stated that it was unlikely that the remaining claims between
Berckeley and Colkitt could be revisited a second time on
appellate review because the remaining claims did not involve
Berckeley and Colkitt. (Id. at 6.) Finally, the District Court
mentioned two judicial economy considerations weighing in
favor of certification: (1) depending upon the result on appeal,
immediate appellate review could shorten the time for trial or
eliminate the need for a trial altogether; and (2) any further
delay in the lengthy proceedings could prejudice Berckeley’s
ability to execute the judgment. (Id.)
Colkitt has once again appealed the District Court’s
certification decision on the basis that we lack appellate
jurisdiction. Colkitt’s primary argument is that the District
Court abused its discretion in certifying the judgment under
17
Rule 54(b) because the adjudicated claims are factually and
legally intertwined with the non-adjudicated claims. A close
review of the District Court’s September 2004 order, however,
reveals that all of the defects in the original order certifying
judgment have been remedied. The District Court’s decision
rested upon pragmatic considerations, particularly the fact that
a final appellate determination could moot the remaining
derivative claims existing between the parties. Although the
Allis-Chalmers Corp. analysis was framed by the converse
scenario, i.e., in which appellate review might be mooted by
further developments in the district court, the District Court’s
evaluation of the procedural posture of this case was reasonable.
The remaining claims in this case are wholly derivative of the
claims between Berckeley and Colkitt, arising from separate
agreements entered into between each of those parties and
Shoreline. Practically, however, if the summary judgment
decision of the District Court is upheld and Berckeley is able to
execute on the full amount of the judgment, Shoreline’s
indemnity claim against Colkitt would become moot and
Berckeley would no longer be compelled to continue its claims
against Shoreline.
These considerations are amplified when we take into
account the miscellaneous factors addressed by the District
Court. This case has been litigated by the parties for nearly ten
years, and it has been approximately six years since the District
Court entered its summary judgment order. In addition,
Colkitt’s shares of NMFS stock have experienced a steep
decline over the past decade, to the point that they are
practically worthless. Under these circumstances, it was
reasonable for the District Court to take into consideration the
18
possibility that any further delays might impact Berckeley’s
ability to execute on the judgment. See Curtiss-Wright Corp.,
446 U.S. at 11-12 (finding that the difference between statutory
and market interest rates, combined with the reality that the
prevailing party would not be able to execute the judgment for
many years due to the complexity of the litigation and the other
party’s declining financial position, was an appropriate basis to
certify the judgment under Rule 54(b)); see also Allis-Chalmers
Corp., 521 F.2d at 367 (Gibbons, J., dissenting) (referencing as
a factor the “ingenuity of debtors in devising reasons for not
paying liquidated indebtedness”).
Taking all of these factors into consideration – the
possibility that our determination on appeal might moot the
remaining claims, the derivative nature of the remaining claims,
the length of the litigation, and the possibility that further delays
might impair Berckeley’s ability to execute the judgment – we
find that the decision of the District Court to certify the order as
a partial final judgment was not “clearly unreasonable.”
Curtiss-Wright Corp., 446 U.S. at 10. As a result, we conclude
that we have appellate jurisdiction over the present appeal and
proceed to address the merits of the dispute.
B. SECTION 29(b) OF THE SECURITIES ACT OF 1934
Colkitt contends that he is entitled to rescind the
Agreement under Section 29(b) of the Securities Exchange Act
of 1934 (the “Exchange Act”). Section 29(b) provides in
pertinent part that:
19
Every contract made in violation of any provision
of this chapter or of any rule or regulation
thereunder, . . . [or] the performance of which
involves the violation of, or the continuance of
any relationship or practice in violation of, any
provision of this chapter or any rule or regulation
thereunder, shall be void.
15 U.S.C. § 78cc(b). Section 29(b) itself does not define a
substantive violation of the securities laws; rather, it is the
vehicle through which private parties may rescind contracts that
were made or performed in violation of other substantive
provisions. See National Union Fire Ins. Co. v. Turtur, 892
F.2d 199, 206 n.4 (2d Cir. 1989). Although the word “void” is
contained in the statute, the Supreme Court has read Section
29(b) to be “merely voidable at the option of the innocent
party.” Mills v. Elec. Auto-Lite Co., 396 U.S. 375, 387-88
(1970).
In order to void the Agreement under Section 29(b),
Colkitt must establish that: (1) the contract involved a
prohibited transaction; (2) he is in contractual privity with
Berckeley; and (3) Colkitt is in the class of persons that the
securities acts were designed to protect. Regional Properties,
Inc. v. Financial and Real Estate Consulting Co., 678 F.2d 552,
559 (5th Cir. 1982). See also Pompano-Windy City Partners,
Ltd. v. Bears Stearns & Co., Inc., 794 F. Supp. 1265, 1288
(S.D.N.Y. 1992). Colkitt must demonstrate a direct relationship
between the violation at issue and the performance of the
contract; i.e., the violation must be “inseparable from the
20
performance of the contract” rather than “collateral or tangential
to the contract.” GFL Advantage Fund, Ltd., 272 F.3d at 201.
In this case, Colkitt asserts that the Agreement was made
“in violation of” Section 10(b) and Rule 10b-5 of the Exchange
Act, and that the “performance” of the contract violated Section
10(b), Rule 10b-5, and Section 5 of the Securities Act of 1933
(the “Securities Act”) because Berckeley perpetuated securities
fraud in violation of the statutes. We consider each of these
arguments below.
1. Colkitt cannot advance a Section 29(b)
rescission claim pursuant to Section 5 of the
1933 Securities Act
Colkitt asserts that he is entitled to rescind the Agreement
under Section 29(b) of the Exchange Act based upon a violation
of Section 5 of the Securities Act. The District Court
determined that Colkitt could not rescind the Agreement under
Section 29(b) because the contract did not involve a prohibited
transaction. According to the District Court, Colkitt’s Section
5 claim asserted that a subsequent transaction was unlawful, and
“Section 29(b) does not reach into the future to void a
subsequent contract.”
We recently addressed the scope of Section 29(b)
regarding downstream securities transactions in GFL Advantage
Fund, Ltd. v. Colkitt, 272 F.3d 189 (3d Cir. 2001). In that case,
we considered a virtually identical financing transaction that
Colkitt entered into with GFL. Colkitt argued that he was
entitled to rescind the agreement between the parties because
21
subsequent short sales made by GFL following the agreement
violated Section 10(b). Before concluding that the short sales
did not constitute market manipulation in violation of Section
10(b), we addressed first whether Colkitt could even maintain a
Section 29(b) rescission claim based upon the subsequent short
sales. Surveying the applicable case law on the subject, we took
a narrow view of the phrases “made in violation of” and “the
performance of which involves the violation of” contained in
Section 29(b). The test, as we applied it in GFL Advantage
Fund, is whether the securities violations are inseparable from
the underlying agreement between the parties. Id. at 201. If an
agreement cannot be performed without violating the securities
laws, that agreement is subject to rescission under Section 29(b).
Id. at 202. Thus, we held that:
Despite the theory of Colkitt’s case, however,
GFL’s short sales are completely independent of
the parties’ respective obligations under the terms
of the notes – namely, GFL’s obligation to lend
Colkitt a total of $13,000,000, and Colkitt’s
obligation to repay the loans at GFL’s option with
shares of National Medical and EquiMed stock.
In the end, GFL’s alleged unlawful activity (i.e.,
its short sales) is too attenuated from the parties’
valid, lawful contracts (i.e., the National Medical
and EquiMed notes) or GFL’s performance
thereunder. Therefore, we conclude that the notes
were neither made nor performed in violation of
any federal securities laws as is required for
rescission under Section 29(b).
22
Id.Two cases we discussed in GFL Advantage Fund and
relied upon by Colkitt in the instant appeal confirm that
Colkitt’s Section 5 claim cannot proceed under Section 29(b).
In Grove v. First National Bank of Herminie, 489 F.2d 512 (3d
Cir. 1974), a debtor obtained a series of loans from a bank to
purchase registered securities. Regulation U, promulgated under
the Exchange Act, provided that such loans were limited to set
percentages of the value of the stock to be purchased. The bank,
however, failed to inform Grove of the Regulation U margin
requirements and loaned him the money. We held that Section
29(b) precluded the bank from recovering a loan deficiency
because the loans were made in direct violation of Regulation U.
Similarly, in Regional Properties, Inc. v. Financial and Real
Estate Consulting Co., a securities broker entered into an
agreement with the principals of several limited partnerships to
market the limited partnerships for a fee. 678 F.2d 552 (5th Cir.
1982). It turned out that the broker, a former New York lawyer
who had been disbarred, failed to register as a broker dealer as
required by Section 15(a)(1) of the Exchange Act. The Fifth
Circuit determined that the broker’s performance of the
agreement was a prohibited transaction under Section 29(b)
because the agreement, although lawful on its face, could not
have been performed by the unregistered broker without
violating the securities laws.
As we explained in GFL Advantage Fund, the key in both
of those cases was that neither agreement could be performed
without violating the securities laws. 272 F.3d at 202. In
contrast, in GFL Advantage Fund the downstream short sales
23
were neither connected to nor “inseparable” from the agreement
between the parties. Thus, we determined that the transactions
at issue in that case could not support a claim under Section
29(b), regardless of whether they violated Section 10(b). Id.In this case, although the Agreement contains references
to Section 5 that allegedly induced Colkitt to enter into the
Agreement, Berckeley’s downstream sales were tangential to the
parties’ basic obligations under the Agreement: Berckeley’s
obligation to loan Colkitt $2,000,000 and Colkitt’s obligation to
provide Berckeley with convertible debentures.11 At the time
the parties entered into the Agreement, the Agreement could be
performed without violating provisions of the securities laws.
Id. As we observed in GFL, “unlawful transactions made
pursuant to lawful contracts” do not fall within the ambit of
Section 29(b). Id. at 200 (quoting Slomiak v. Bear Stearns &
Co., 597 F. Supp. 676, 682 (S.D.N.Y. 1984)). Thus, to the
extent that a trier of fact determines that Berckeley’s
downstream sales of unregistered NMFS shares violated Section
11
The distinction between this claim and the Section
29(b) claim premised on a violation of Section 10(b) is readily
apparent. The Section 10(b) claim alleges that Berckeley made
material misrepresentations that induced Colkitt to enter into the
Agreement. If Colkitt is able to prove that claim, then the
Agreement was “made in violation of” Section 10(b). The
misrepresentations that induced Colkitt to enter into the
Agreement would be “inseparable from the underlying
agreement between the parties.” GFL Advantage Fund, 272
F.3d at 202.
24
5, those sales are too attenuated to establish a claim under
Section 29(b). See id. at 202.12
For these reasons, we will uphold the District Court’s
decision to grant summary judgment in favor of Berckeley as to
Colkitt’s Section 29(b) claim premised on a violation of Section
5 of the Securities Act.13
2. The District Court erred in dismissing
Colkitt’s Section 29(b) claim premised on a
violation of Section 10(b)
12
We agree with the District Court that the SEC’s
administrative decision in In re GFL Fund Ltd., 64 S.E.C.
Docket 1958, 1997 WL 330419 (June 18, 1997), does not
compel a different conclusion. In that case, the SEC brought
administrative proceedings against GFL for reselling
unregistered securities back into the United States. The SEC’s
administrative ruling was concerned solely with GFL’s resale of
the unregistered shares, not with any contracts GFL had entered
into with other parties. In fact, the SEC did not even mention
Section 29(b) in the administrative ruling. Thus, there was no
finding that the underlying contracts that enabled GFL to obtain
the unregistered shares violated Section 29(b). As such, we do
not find In re GFL Fund Ltd. helpful to our disposition of the
present case.
13
We therefore need not determine whether Section 29(b)
can ever support a rescission claim founded on a violation of the
1933 Securities Act.
25
Section 10(b) of the Exchange Act, 15 U.S.C. § 77(b),
makes it unlawful for any person to employ “manipulative or
deceptive” conduct “in connection with the purchase or sale of
any security.” In re Phillips Petroleum Sec. Lit., 881 F.2d 1236,
1243 (3d Cir. 1989). When the Exchange Act was passed in
1934, Congress granted the Securities and Exchange
Commission the authority in Section 10(b) to develop rules and
regulations to prevent such conduct “as the Commission may
prescribe as necessary or appropriate in the public interest or for
the protection of investors.” 15 U.S.C. § 77(b). The
Commission responded in 1948 by promulgating Rule 10b-5,
which establishes that manipulative or deceptive conduct
includes, inter alia, making an untrue statement of material fact
or omitting to state a material fact in connection with the
purchase or sale of securities.14
14
Employment of Manipulative and Deceptive Devices,
13 Fed. Reg. 8183 (Dec. 22, 1948), amended by 16 Fed. Reg.
7928 (Aug. 11, 1951). The full text of Rule 10b-5 provides:
It shall be unlawful for any person, directly
or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the
mails or of any facility of any national securities
exchange,
(a) To employ any device, scheme, or
artifice to defraud,
(b) To make any untrue statements of
material fact or to omit to state a material fact
necessary in order to make the statements made,
in the light of the circumstances under which they
26
As a private party, Colkitt must establish each of the
following elements to prove that Berckeley violated Section
10(b) and Rule 10b-5: (1) Berckeley made a misstatement of
material fact, (2) with scienter, (3) in connection with the
purchase or sale of a security, (4) upon which Colkitt reasonably
relied, and (5) that Colkitt’s reliance was the proximate cause of
his injury. In re Ikon Office Solutions, Inc., 277 F.3d 658, 666
(3d Cir. 2002).15 A Section 29(b) rescission claim premised on
a Section 10(b) violation, however, differs from a private
damages action brought under Section 10(b). In the Section
29(b) context, a plaintiff seeking rescission does not have to
establish reliance and causation. See GFL Advantage Fund, 272
were made, not misleading, or
(c) To engage in any act, practice, or
course of business which operates or would
operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any
security.
17 C.F.R. § 240.10b-5.
15
Under the Private Securities Litigation Reform Act of
1995, Congress codified the common law loss causation
requirement as a statutory element of a Section 10(b) private
cause of action. See 15 U.S.C. § 78u-4(b)(4) (stating that “[i]n
any private action arising under this chapter, the plaintiff shall
have the burden of proving that the act or omission of the
defendant alleged to violate this chapter caused the loss for
which the plaintiff seeks to recover damages”).
27
F.3d at 206 n.6.16 Because Colkitt’s Section 29(b) and stand-
alone Section 10(b) claims overlap, we will consider the initial
three Section 10(b) elements in our disposition of his Section
29(b) claim.
Colkitt’s case does not present the “typical” fact pattern
seen in securities violations brought under Section 10(b). As we
have noted, the customary Section 10(b) claim concerns
“fraudulent material misrepresentation[s] or omission[s] that
affect[] a security’s value.” Newton v. Merrill Lynch, Pierce,
Fenner & Smith, Inc., 259 F.3d 154, 173 (3d Cir. 2001)
(“Newton II”) (collecting cases). In this case, Colkitt’s theory
of liability is not based upon an alleged material
misrepresentation relating to the value of NMFS stock, but
rather a misrepresentation regarding Berckeley’s intent to
comply downstream with the registration requirements
contained in the Securities Act. Colkitt’s argument in favor of
establishing Berckeley’s liability proceeds as follows:
• Section 5 of the Securities Act of 1933
requires a registration statement to be in
effect as to a security in order to (1) sell
the security in interstate commerce; or (2)
cause to be carried through interstate
commerce any such security for the
purpose or sale or for delivery after sale,
16
Similarly, the SEC does not have to establish those
elements in an enforcement proceeding. See Graham v. SEC,
222 F.3d 994, 1001 n.15 (D.C. Cir. 2000).
28
unless the security is exempt from
registration.17
• Berckeley represented in Paragraph 2.5 of
the Agreement that all subsequent sales of
converted shares would be made in
accordance with the registration
requirements of the Securities Act of 1933.
• Berckeley’s later-acknowledged sale of
18,320 unregistered NMFS shares violated
Section 5 and, therefore, the Agreement
because the shares were not registered and
Berckeley was an “underwriter” not
entitled to an exemption under Section
4(1). Because Berckeley was not exempt
under Section 4(1), it knowingly engaged
in a scheme and artifice to defraud at the
time it entered into the agreement.
• Colkitt relied upon Berckeley’s
representation to enter into the Agreement,
which resulted in Berckeley receiving
18,320 unregistered shares of NMFS at a
17% discount.
• Colkitt suffered the following damages
that were proximately caused by
Berckeley’s material misrepresentation:
17
See 15 U.S.C. § 77e(a).
29
(1) he sold shares to Berckeley at a 17 %
discount from their market value; (2) he
became liable under the Agreement to pay
interest and penalties; and (3) his NMFS
share holdings, placed in escrow, lost
value and became practically worthless.
There is no dispute between the parties that the Agreement was
made “in connection” with the purchase or sale of a security,
and Berckeley’s argument that Colkitt suffered no reliance
damages essentially addresses whether Colkitt’s reliance was the
proximate cause of his injury. Thus, the misrepresentation,
scienter, and causation prongs of the Rule 10b-5 case are in
dispute between the parties.18
a. Material issues of fact exist regarding
Berckeley’s intent to resell unregistered shares
and its status as an underwriter
At the outset, we examine whether there is sufficient
evidence in the record to create a material issue of fact that
Berckeley made a misrepresentation in paragraph 2.5 of the
Agreement. Colkitt bases his Section 10(b) claim on the
argument that Berckeley intentionally misrepresented in
Paragraph 2.5 of the Agreement that all subsequent sales of
converted shares would be made in accordance with the
18
We will examine the misrepresentation and scienter
issues as part of our resolution of the Section 29(b) claim, and
we will consider separately the causation prong in part IV.C,
infra.
30
registration requirements of the Securities Act of 1933.19 To
ultimately prove a misrepresentation, Colkitt must demonstrate
19
In the District Court, the primary argument advanced by
Colkitt to establish that Berckeley violated Section 10(b) was
that Berckeley had engaged in short selling in violation of the
Agreement. The District Court determined that Berckeley did
not engage in short selling, and Colkitt has not advanced this
issue on appeal.
We note that our recent decision in GFL Advantage
Fund, 272 F.3d at 202, addressed the effect of short sales in a
nearly identical financing transaction that Colkitt entered into
with GFL. We held that GFL’s short selling did not support
Colkitt’s Section 10(b) claim. In rejecting Colkitt’s argument
that the short selling constituted market manipulation, we stated
that “[t]he fact that these short sales may have contributed to a
decline in the stocks’ prices is not evidence of deceptive or
manipulative conduct, for there is no reason to believe these
prices were depressed artificially.” Id. at 207. We concluded
that “short selling, even in large volumes, is not in and of itself
unlawful and therefore cannot be regarded as evidence of market
manipulation.” Id. at 209. We further explained: “That short
selling may depress share prices, which in turn may enable
traders to acquire more shares for less cash (or in this case, for
less debt), is not evidence of unlawful market manipulation, for
they simply are natural consequences of a lawful and carefully
regulated trading practice.” Id. at 209-10. Rather, short selling
could only form a basis for a Section 10(b) claim if done “in
conjunction with some other deceptive practice that either
injected inaccurate information into the market or otherwise
artificially affected the price of the stock.” Id. at 207.
31
that, at the time Berckeley entered into the Agreement, it
intended to violate federal securities laws by reselling
unregistered shares of NMFS stock back into the United States
without entitlement to an exemption. Colkitt’s theory breaks
down into two discrete subissues as to which he must point to a
dispute of material fact: (1) that there is evidence in the record
that Berckeley intended at the time the Agreement was executed
to sell shares back into the United States without registering
them, and (2) Berckeley was aware at the time of the Agreement
that it would be reselling the shares as an “underwriter,” i.e., the
company knew that it was not entitled to an exemption from the
registration requirement under Section 4(1) of the Securities Act
of 1933.
(1) There is sufficient evidence that Berckeley
intended to resell NMSF shares back into the
United States without registering them
We first examine whether there is evidence in the record
that Berckeley intended at the time it entered into the Agreement
with Colkitt to resell unregistered NMSF shares back into the
United States. On the basis of three affidavits, two judicial
admissions, and the structure of the deal itself, we conclude that
there is sufficient evidence to create a material issue of fact that
Berckeley intended to resell NMSF shares back into the United
States without registering them.
The first affidavit was submitted by Martin Douglas Ho,
Berckeley’s Connecticut-based investment advisor. Ho
participated in negotiating and closing the transaction between
Berckeley and Colkitt, and he also was involved in the delayed
32
conversion and attempted conversions of the debentures. (App.
at 1173.) Ho stated in his supplemental affidavit that he sought
legal advice and provided investment advice in connection with
the transaction. Regarding the advice he provided to Berckeley,
Ho stated the following:
After thoroughly investigating the appropriateness
and legality of the transaction, I advised
Berckeley that, pursuant to the terms of the
Agreement and subject Debentures, and
applicable federal securities laws, including
Regulation S promulgated under the Securities
Act of 1933, and exemptions therefrom, after the
expiration of 40 days and certainly after the
expiration of 100 days – the initial restricted
period – Berckeley was permitted to sell the
common stock of National Medical in the United
States that was to be delivered by Colkitt.
I, on behalf of Berckeley, sought and obtained
legal advice which confirmed my understanding
of Regulation S and related exemptions and my
advice to Berckeley regarding the transaction and
its ability to resell the converted shares in the
United States after the expiration of 40 days or, in
this case, commencing after the initial restricted
period under the Agreement.
(App. at 1175 (emphasis added).) Specifically referencing
Paragraph 2.5 of the Agreement, which is at the crux of the
dispute between the parties, Ho stated the following:
33
All of the representations contained in Paragraph
2.5 were true and correct at the time that they
were made by Berckeley and continue to be true
and correct in that, among other things, Berckeley
intended to sell the converted shares pursuant to
an exemption from registration and, in good faith,
believed that it could do so based upon the advice
it obtained from me as well as its counsel. No
shares were sold prior to the Restricted Period.
The only shares of Colkitt’s that were ever sold
were the approximately 18,320 shares he
converted in November 1996. No securities
violation can be alleged as to this sale.
(App. at 1176-77 (emphasis added).)
Berckeley directors Milton Morales and Carlos Mijares
also submitted supplemental affidavits. Those affidavits, which
were identical, provided the following pertinent averments:
Prior to executing the Agreement, Berckeley was
advised by Mr. Ho that he conducted a complete
investigation as to the appropriateness and
legality of the transaction, that, pursuant to the
terms of the Agreement and Debentures, and
applicable federal securities laws, including
Regulations promulgated under the Securities Act
of 1933, and exemptions therefrom, the
transactions did not violate any laws and, that
after the expiration of 100 days – the initial
restricted period – Berckeley was permitted to sell
34
the common stock of National Medical in the
United States that was to be delivered by Colkitt.
****
Berckeley merely intended to convert the
Debentures into National Medical Shares after
100-120 days and slowly sell the stock thereafter
....
****
All of the representations contained in paragraph
2.5 were true and correct at the time that they
were made by Berckeley and continue to be true
and correct in that, among other things, Berckeley
intended to sell the converted shares pursuant to
an exemption from registration and, in good faith,
believed that it could do so based upon the advice
that it obtained from Mr. Ho, as well as its
counsel. No shares were sold prior to the
Restricted Period. The only shares of Colkitt’s
that were ever sold were the approximately
18,320 shares he converted in November 1996.
(App. at 1181-83; 1187-89 (emphasis added).)
In addition to these affidavits, Berckeley made two
binding judicial admissions in its complaint and in its brief on
35
appeal.20 Berckeley stated unequivocally in its complaint that
“[i]t was always Berckeley’s intent to exercise its conversion
rights as to all of the debentures as quickly as possible, selling
the National Medical stock in the market as quickly as
reasonably possible, and thereby maximizing its return.”
Furthermore, Berckeley stated in its brief on appeal to us that its
“intention was . . . to convert the Debentures into shares of
National Medical stock after a period of 100-120 days and then
proceed slowly to sell the stock in a reasonable manner as an
investment objective.” (Appellee’s Br. at 31.)
20
Judicial admissions are concessions in pleadings or
briefs that bind the party who makes them. See Parilla v. IAP
Worldwide Serv., VI, Inc., 368 F.3d 269, 275 (3d Cir. 2004)
(finding that the plaintiff was bound because she “expressly
conceded those facts in her complaint.”) (citing, inter alia, Soo
Line R.R. Co. v. St. Louis Southwestern Ry. Co., 125 F.3d 481,
483 (7th Cir. 1997) (noting the “well-settled rule that a party is
bound by what it states in its pleadings”); Glick v. White Motor
Co., 458 F.2d 1287, 1291 (3d Cir. 1972) (noting that
unequivocal “judicial admissions are binding for the purpose of
the case in which the admissions are made[,] including
appeals”)). See also Karkoukli’s, Inc. v. Dohany, 409 F.3d 279,
283 (6th Cir. 2005) (finding that the plaintiff’s “admissions of
statutory compliance by defendants in its briefs” constituted
“‘judicial admissions’ that estop [plaintiff] from raising a
statutory non-compliance argument in this appeal.”) (citation
omitted); Gospel Missions of America v. City of Los Angeles,
328 F.3d 548, 557 (9th Cir. 2003) (stating that court of appeals
has discretion whether to treat a concession in a pleading or
brief as a binding judicial admission).
36
Finally, the structure of the deal, as well as a lack of
evidence of any viable offshore market for the shares, see infra,
raises an inference that Berckeley intended to resell the
converted shares back into the United States. The deal provided
Berckeley with the unilateral option to convert one-half of the
debentures into NMFS shares 100 days from closing and the
remaining debentures 120 days from closing. In addition, the
Agreement provided that any unredeemed debentures would be
automatically converted into NMFS shares within one year.
Thus, in all likelihood Berckely knew that it would be holding
a large number of unregistered shares within one year of the
Agreement. These timetables built into the Agreement are even
more important when we consider that, for all practical
purposes, Berckeley could only receive the maximum return on
its investment (the 17% premium it received from Colkitt as part
of the deal) if it resold the unregistered NMFS shares back into
the United States. The affidavits and the admissions referenced
above confirm that it was Berckeley’s intent from the outset to
resell at least a portion of the unregistered NMFS shares “as
quickly as reasonably possible . . . thereby maximizing its
return.” As discussed more fully below, Berckeley has not
shown that there was any real marketplace for the unregistered
NMFS shares other than in the United States, thus adding to the
inference at this stage of the litigation that Berckeley intended
to resell unregistered shares back into the United States.
For these reasons, we find that there is sufficient
evidence at this stage of the proceedings to create a material
issue of fact that Berckeley intended, at the time of the
Agreement, to resell the converted shares back into the United
37
States following the Restricted Period set forth in the
Agreement.
(2) Material issues of fact exist as to whether
Berckeley was aware it was not entitled to an
exemption under Section 4(1)
In order to establish a Section 5 violation, Colkitt must
point to evidence that: (1) no registration statement was in
effect as to the securities; (2) Berckeley sold or offered to sell
the securities; and (3) the sale or offer was made through
interstate commerce. See Hill York Corp. v. American Int’l
Franchises, Inc., 448 F.2d 680, 686 (5th Cir. 1971),
distinguished on other grounds by Pinter v. Dahl, 486 U.S. 622(1988). It is undisputed that there are sufficient facts in the
record for Colkitt to establish the first two elements, and our
finding above that there is a factual dispute as to whether
Berckeley intended at the time of the Agreement to resell the
securities back into the United States is sufficient at this stage to
satisfy the third element. As a result, our next step is to
determine whether there are facts in dispute as to whether
Berckeley was aware it was not entitled to an exemption from
the registration requirement under Section 4(1) of the Securities
Act.
The burden of proving entitlement to an exemption rests
with the party claiming the entitlement. SEC v. Ralston Purina
Co., 346 U.S. 119, 126 (1953). The District Court did not
address whether Berckeley satisfied the definition of a “statutory
underwriter,” and there is no indication that the parties or the
District Court were aware that the burden of demonstrating an
38
entitlement to the exemption rested with Berckeley. Instead, the
District Court determined that Berckeley did not make a
misrepresentation because, based upon uncertainties in the
securities industry as to the applicability of the exemption in
1996, “the illegality of the transaction simply was not apparent.”
(App. at 43.)
Section 4(1) exempts from the registration requirements
under Section 5 “transactions by any person other than issuer,
underwriter, or dealer.” 15 U.S.C. § 77d(1). At issue here is
whether Berckeley was an “underwriter,” as there is no dispute
that Colkitt was an “issuer” and that Berckeley purchased
unregistered securities from Colkitt. Section 2(a)(11) of the
Securities Act defines the term “underwriter” in pertinent part
as “any person who has purchased from an issuer with a view to
. . . the distribution of any security. . . .” 15 U.S.C. § 77b(a)(11).
Because the burden of proving entitlement to the exemption
rests with Berckeley, it can establish that it is entitled to the
exemption if it proves that: (1) the acquisition of the
unregistered shares through conversion was not made “with a
view to” distribution; or (2) the sale of the 18,320 shares was not
made in connection with a “distribution.” See Ackerberg v.
Johnson, 892 F.2d 1328, 1336 (8th Cir. 1989).
Whether Berckeley’s acquisition of the unregistered
shares was made “with a view to” distribution focuses on
Berckeley’s investment intent at the time of the conversion. See
1 Thomas Lee Hazen, The Law of Securities Regulation 482 (5th
ed. 2005) (collecting cases). Because it is difficult to discern a
party’s intent at the time of purchase with respect to downstream
sales of unregistered shares, courts and commentators have
39
typically focused on the amount of time a security holder holds
on to shares prior to reselling them. Id.; see Ackerberg, 892
F.2d at 1336 (stating that “the courts look to whether the
security holder has held the securities long enough to negate any
inference that his intention at the time of acquisition was to
distribute them to the public”). Over time, courts have
developed the general presumption that a two-year holding
period is sufficient to negate the inference that the security
holder did not take the securities with a “view to distribute.”
Ackerberg, 892 F.2d at 1336.
Seizing upon the difficulty of determining a party’s
subjective intent at the time of purchase, the SEC adopted Rule
144, which creates an objective safe harbor to allow non-
affiliate sellers to comply with the Section 4(1) exemption. A
non-affiliate seller may fall within the Rule 144 safe harbor, and
not be deemed an “underwriter,” under two sets of
circumstances. First, the SEC has generally removed all
restrictions from the sale of securities by a non-affiliate who has
held onto the securities for a period of at least two years from
the date the securities were acquired from the issuer or an
affiliate of the issuer. 17 C.F.R. § 230.144(k). If the non-
affiliate seller has not held the securities for a period of at least
two years, the seller may fall within the Rule 144 safe harbor if
it complies with the following five criteria:
(1) adequate current public information about the
securities is available, i.e., the company must
have complied with the reporting requirements of
the Exchange Act or with Exchange Act Rule
15c2-11;
40
(2) at least one year has lapsed “between the later
of the date of the acquisition of the securities from
the issuer or from an affiliate of the issuer, and
any resale of such securities”;
(3) the amount of securities sold may not exceed
the greater of (a) one percent of the outstanding
class, or, (b) if traded on a national exchange, the
average weekly volume of trading in the securities
over the past four weeks preceding the filing of
notice as required Rule 144(h);
(4) the securities must be sold in “brokers’
transactions” or in transactions with a “market
maker,” and the seller is prohibited from soliciting
or arranging for solicitation orders to buy
securities in anticipation or in connection with
such transaction; and
(5) if the seller is going to sell more than 500
shares, or the aggregate sale price is greater than
$10,000, the seller must file a notice of the sale
with the SEC.
17 C.F.R. § 230.144(c)-(h). The seller must comply with each
of the elements in order to gain the benefit of the safe harbor.
Id. § 230.144(b).
Each safe harbor set forth under Rule 144 requires the
seller to have held on to the unregistered shares for a specified
time period, either one or two years. Because it is undisputed
41
that Berckeley sold the unregistered shares in this case before
even one year had elapsed, Berckeley cannot take advantage of
the Rule 144 safe harbor. In addition, Berckeley’s quick
turnaround sale of the converted shares at least creates an issue
of fact as to whether Berckeley acquired the shares with a “view
to distribution” under the statutory exemption as well. See
Gilligan, Will & Co. v. Securities and Exchange Comm’n, 267
F.2d 461, 467-68 (2d Cir. 1959) (finding that ten-month holding
period was sufficient to support SEC finding that security holder
bought shares “with a view to distribution”).21
21
In the initial years following the passage of the
Securities Act, resellers of unregistered securities frequently
made the argument that they were not underwriters because
“although they had the requisite investment intent at the time of
purchase, subsequent changes in their personal situations
necessitated the resale of securities.” See 1 Hazen, The Law of
Securities Regulation 484. This highly fact-specific inquiry
became known as the “change in circumstances” exception. See
generally Vohs v. Dickson, 495 F.2d 607, 620-21 (5th Cir.
1974); see also Neuwirth Inv. Fund, Ltd. v. Swanton, 422 F.
Supp. 1187, 1197 (S.D.N.Y. 1975) (finding that change in
circumstances exception applied and that security holder did not
take stock with a view to distribution where fifteen months
passed between purchase and resale and where stock was sold
only after security holder was forced into liquidation).
Although the SEC has taken the position that the “change
in circumstances” exception is no longer applicable after the
passage of Rule 144, commentators have expressed doubt that
the exception can be read out of the definition of an
“underwriter” under § 2(a)(11). See 1 Hazen, The Law of
42
Berckeley, however, can still demonstrate that it did not
act as an “underwriter” if the sale of the 18,320 shares was not
made in connection with a “distribution.” The registration
requirements of the 1933 Securities Act are “design[ed] . . . to
protect investors by promoting full disclosure of information
thought necessary to [make] informed investment decisions.”
Ralston Purina, 346 U.S. at 124. The legislative history of the
term “underwriter” reveals “that the congressional intent was to
Securities Regulation 485 (“To the extent that the change in
circumstances defense is a valid interpretation in terms of the
section 2(a)(11) statutory definition of one who purchases with
an intent to redistribute, the SEC cannot by administrative fiat
change the meaning of the statute.”); Louis Loss & Joel
Seligman, Fundamentals of Securities Regulation 325 n.241 (5th
ed. 2004) (noting that, although the “law largely has made a
transition from the subjectivity of the statutory standard to more
objective rule enforcement, . . . the statutes still exist and it still
can be argued . . . that the wording of § 2(a)(11) compels some
sort of change in circumstances doctrine.”). In addition, Rule
144 is generally considered to be non-exclusive, and sellers such
as Berckeley may still seek to invoke the statutory Section 4(1)
exemption. See 1 Hazen, The Law of Securities Regulation 490;
Loss and Seligman, Fundamentals of Securities Regulation 325
n.241; Marc I. Steinberg, Understanding Securities Law 139 (3d
ed 2001); II Louis Loss and Joel Seligman, Securities
Regulation 1138.47 n.580 (2d ed. 1999).
Because the parties have not addressed the application of
the “change in circumstances” exception to this case, however,
we need not decide whether that exception remains a viable
method of refuting “underwriter” status under § 2(a)(11).
43
include as underwriters all persons who might operate as
conduits for securities being placed into the hands of the
investing public.” 1 Hazen, The Law of Securities Regulation
476; see Van Dyke v. Coburn Enter., Inc., 873 F.2d 1094, 1097
(8th Cir. 1989) (stating that “[t]he design of the Act is to protect
investors by promoting full disclosure of information thought
necessary to make informed investment decisions”). As a result,
the focus of the term “underwriter” is on the concept of
“distribution.” Ackerberg, 892 F.2d at 1337.
Although we have not yet had the occasion to interpret
the Section 4(1) statutory exemption, those courts interpreting
the exemption have uniformly concluded that the term
“distribution” is synonymous with “public offering” as set forth
under Section 4(2). See Geiger v. SEC, 363 F.3d 481, 484 (D.C.
Cir. 2004); Ackerberg, 892 F.2d at 1337; SEC v. Dolnick, 501
F.2d 1279, 1282 (7th Cir. 1974); Quinn & Co. v. SEC, 452 F.2d
943, 946 (10th Cir. 1971); Gilligan, Will & Co., 267 F.2d at
466; Neuwirth Inv. Fund, Ltd. v. Swanton, 422 F. Supp. 1187,
1194-96 (S.D.N.Y. 1975); see also II Louis Loss and Joel
Seligman, Securities Regulation 1138.47 n.580 (2d ed. 1999)
(collecting authorities). We agree with the rationale of those
courts and similarly hold that the term “distribution” in
§ 2(a)(11) is synonymous with “public offering.”
In the landmark decision of SEC v. Ralston Purina, the
United States Supreme Court explained that whether an issuance
of stock is a “public offering” turns on the need of the offerees
for the protections of the securities laws:
44
Since exempt transactions are those as to which
“there is no practical need for the (the bill’s)
application,” the applicability of [the Section 4(2)
private placement exemption] should turn on
whether the particular class of persons affected
needs the protection of the Act. An offering to
those who are shown to be able to fend for
themselves is a transaction not involving any
public offering.
346 U.S. at 125 (internal punctuation omitted). See also Van
Dyke, 873 F.2d at 1098; Sorrell v. SEC, 679 F.2d 1323, 1326
(9th Cir. 1982) (stating that the “offeree’s access to financial
information about the investment, similar to what would be
found in a registration statement, is crucial”); Neuwirth Inv.
Fund, 422 F. Supp. at 1198. The percentage of outstanding
shares distributed to the public is not determinative, as the
application of the Section 4(1) exemption does not turn on the
percentage of the shares sold, even where the resales constitute
extremely small percentages of the outstanding stock. Geiger,
363 F.3d at 484. Rather, the key inquiry for the court is whether
the security holder can demonstrate that the sales were made to
individuals or entities that did not require the registration
protections of the Securities Act. Id.For example, in Geiger the United States Court of
Appeals for the District of Columbia determined that the resale
of unregistered shares comprising only 0.50% of all outstanding
shares constituted a “distribution” because the shares made their
way into the hands of the investing public. 363 F.3d at 484.
There, the D.C. Circuit was guided by an earlier decision of the
45
Ninth Circuit which upheld the SEC’s finding that the sale of
0.25% of shares of unregistered stock violated Section 5 of the
Securities Act. See Pennaluna & Co. v. SEC, 410 F.2d 861, 865
(9th Cir. 1969). In contrast, in Ackerberg the Eighth Circuit
determined that the sale of 12,500 shares of unregistered stock
did not constitute a “distribution” because the shares were sold
to a single sophisticated investor who had received detailed
information about the company prior to purchasing the
securities. Ackerberg, 892 F.2d at 1329, 1336-37. Similarly,
the United States District Court for the District of New York
concluded in Neuwirth Inv. Fund, Ltd. that the sale of 18,000
unregistered shares was not a “distribution” because the
unregistered stock was sold to two identifiable purchasers who
were sophisticated and experienced investors and who had asked
for and received information from the corporation prior to
purchasing the shares. 422 F. Supp. at 1199.
On the basis of the record we have before us, Berckeley
has not adduced any evidence to meet its burden that it is
entitled to an exemption under § 4(1). The record is clear that
Berckeley intended to resell a quantity of the shares within two
years. As stated in Beckeley’s complaint, “[i]t was always
Berckeley’s intent to exercise its conversion rights as to all of
the debentures as quickly as possible, selling the National
Medical stock in the market as quickly as possible.” Berckeley
has not advanced any evidence that there was any “market” for
NMFS shares outside the United States, particularly considering
that Berckeley placed the 18,320 shares for sale with a United
States broker. Inferring from these facts that the only market
for NMFS shares was in the United States, Berckeley did not
bring forward any evidence that the NMFS shares would be sold
46
solely to sophisticated investors who do not need the protections
of the registration requirements of the securities laws. To the
contrary, placing the 18,320 shares with a broker suggests that
those shares would be sold to the highest bidder without regard
to the bidder’s level of investing acumen. See Loss and
Seligman, Fundamentals of Securities Regulation 327 (noting
that “a sell order given to a stock exchange broker results in an
offer to the highest bidder in the world, which is certainly a
‘public offering’”). For these reasons, we find that Berckeley
failed to meet its burden to show it was entitled to an exemption
under Section 4(1).
Accordingly, we conclude that the record contains
sufficient evidence that Berckeley made a misrepresentation of
material fact regarding its intent to resell and its status as an
underwriter in a resale.
b. Material issues of fact exist regarding whether
Berckeley was reckless in its belief that it would
be entitled to the Section 4(1) exemption
Because that there is a factual dispute regarding whether
Berckeley intended at the time of the agreement to resell
illegally the converted shares back into the United States, we
must next determine whether Colkitt can point to sufficient
evidence that Berckeley had the requisite scienter to violate the
Section 5 registration requirement at the time it entered into the
Agreement.
A plaintiff can “plead scienter by alleging facts
‘establishing a motive and an opportunity to commit fraud, or by
47
setting forth facts that constitute circumstantial evidence of
either reckless or conscious behavior.’” In re Advanta Corp.
Sec. Litig., 180 F.3d 525, 534-35 (3d Cir. 1999) (quoting Weiner
v. Quaker Oats Co., 129 F.3d 310, 318 n.8 (3d Cir. 1997))
(additional citation omitted). Recklessness can be shown by a
statement or action “‘involving not merely simple, or even
inexcusable negligence, but an extreme departure from the
standards of ordinary care, and which presents a danger of
misleading buyers or sellers that is either known to the
defendant or is so obvious that the actor must have been aware
of it.’” Id. at 535 (quoting McLean v. Alexander, 599 F.2d
1190, 1197 (3d Cir. 1979)).
In concluding that Colkitt failed to produce sufficient
evidence to demonstrate Berckeley’s scienter, the District Court
relied upon an affidavit from Nancy Van Sant, a former SEC
lawyer reputed to have experience with offshore transactions
and the availability of exemptions in connection with those
transactions as of May 1996. Based on assumed facts
concerning Berckeley’s conduct, Van Sant drew multiple legal
conclusions. Particularly relevant here was her conclusion that
it was reasonable for Berckeley to have believed at the time of
the Agreement that it would be entitled to the Section 4(1)
exemption if and when it sold any shares. Van Sant reached this
conclusion after a fairly substantial legal analysis of the Section
4(1) exemption as applied to the facts she assumed:
In my experience as a securities litigator, and as
an attorney giving securities advice, in 1996,
Regulation S shares were routinely purchased
offshore, held for the restricted forty day period
48
and then resold in the United States pursuant to
the Section 4(1) exemption. This was common
and accepted practice in the securities industry in
1996. Given the common practice and the
confusion generated by the SEC’s adoption of the
Regulation S forty day restricted period, it would
not have been unreasonable for persons acquiring
shares in offshore transactions exempt under
Regulation S, or specifically the shareholders of
Berckeley, to believe that their resale of
Regulation S shares into the United States
marketplace upon the expiration of the Regulation
S restricted period (which was considerably
shorter than the contractual provisions restricting
the timing of the conversion of the shares); in
brokers transactions; and, in small amounts that
would not adversely affect the National Medical
trading market, was in compliance with applicable
securities law.
(App. at 1436-37.) The District Court explained that the above
paragraph (paragraph 18) was the “operative portion” of the
affidavit, and that the “remainder of the affidavit simply
explain[ed] the development of the law and why it was
reasonable to rely on the exemption under § 4(1).” (App. at 43.)
The District Court has discretion to determine whether
expert testimony will help the trier of fact. United States v.
Agnes, 753 F.2d 293, 303 (3d Cir. 1985), abrogated on other
grounds by Smith v. Borough of Wilkinsburg, 147 F.3d 272 (3d
49
Cir. 1998).22 In utilizing that discretion, however, the District
Court must ensure that an expert does not testify as to the
governing law of the case. Although Federal Rule of Evidence
704 permits an expert witness to give expert testimony that
“embraces an ultimate issue to be decided by the trier of fact,”
an expert witness is prohibited from rendering a legal opinion.
United States v. Leo, 941 F.2d 181, 195-96 (3d Cir. 1991).23
Such testimony is prohibited because it would usurp the District
Court’s pivotal role in explaining the law to the jury. First
National State Bank v. Reliance Elec. Co., 668 F.2d 725, 731
(3d Cir. 1981) (per curiam).
22
We review the District Court’s decision to admit expert
testimony for abuse of discretion. In re Unisys Savings Plan
Litig., 173 F.3d 145, 163 (3d Cir. 1999).
23
The Advisory Committee Notes to Rule 704 explain
that, although a witness may give an opinion as to an ultimate
issue, Rules 701, 702, and 403 “stand ready to exclude opinions
phrased in terms of inadequately explored legal criteria.” As the
committee notes further explain:
[T]he question, “Did T have capacity to make a
will?” would be excluded, while the question,
“Did T have sufficient mental capacity to know
the nature and extent of his property and the
natural object of his bounty and to formulate a
rational scheme of distribution?” would be
allowed.
See Fed. R. Evid. 704, advisory committee notes.
50
Notwithstanding this admonition, the line between
admissible and inadmissible expert testimony as to the customs
and practices of a particular industry often becomes blurred
when the testimony concerns a party’s compliance with customs
and practices that implicate legal duties. Two of our decisions
in this area provide guidance. In First National State Bank, the
district court permitted an expert on the Uniform Commercial
Code to testify as to the established custom in the banking
industry and to provide background information to help the jury
determine whether the bank’s conduct warranted status akin to
a holder in due course. Id. at 731. The district court did not,
however, permit the expert to “give his opinion as to the legal
duties arising” from the industry custom as to whether the bank
“lacked good faith and/or had notice of claims, thereby denying
it holder-in-due course status.” Id. On appeal, we rejected the
bank’s argument that the expert testified to a legal conclusion,
and we agreed with the district court that the expert’s testimony
was admissible.
Similarly in Leo, we held that the district court did not
abuse its discretion in permitting an expert in the field of
governmental contracting to testify as to the custom and
practices of the defense industry regarding the Armed Services
Procurement Act in a criminal fraud prosecution. 941 F.2d at
196-97. We stated that the expert’s testimony was admissible
because it was limited to an explanation of business custom, i.e.,
that defense contractors generally provided updated cost and
pricing data to the government during contract negotiations. Id.Key to our determination was that the expert did not give his
opinion as to what was required under the law, or whether the
defendant complied with the Act. Rather, the testimony was
51
permissible because the expert “testified, based upon his
experience in the defense industry, as to how firms such as [the
defendant’s] operated when performing contracts governed by
the Act.” Id. at 197.
This is a case in which we find that Van Sant’s
background testimony could be helpful to the jury. She is an
experienced former counsel for the SEC with expertise in
offshore securities transactions. The customs and business
practices in the securities industry at the time the parties entered
into the Agreement provides an important context which will aid
the jury in determining whether Berckeley had the requisite
scienter at the time to evade the registration requirements.
In accordance with First National State Bank and Leo,
however, Van Sant cannot testify as to whether Berckeley
complied with legal duties that arose under the federal securities
laws. Thus, Van Sant’s testimony that Berckeley’s sales of
NMFS stock were exempt from registration requirements, and
any testimony as to the legal effect of the various SEC
pronouncements regarding Rule 144 and Regulation S, are
inadmissible as improper legal opinions. Similarly, the portion
of paragraph 18 of the affidavit, opining that in light of the
apparent routine industry practice it was reasonable for
Berckeley to have believed that it was entitled to the Section
4(1) exemption, is inadmissible because it concerns Berckeley’s
legal duties resulting from the various SEC pronouncements.
Leo, 941 F.2d at 197. As to the remainder of the testimony
considered by the District Court, we conclude that the District
Court did not abuse its discretion in admitting Van Sant’s
52
testimony regarding securities industry custom with respect to
the Section 4(1) exemption.
Based solely on Van Sant’s opinion regarding industry
practices, the District Court concluded that, given the state of
affairs in the securities industry in May 1996, “the illegality of
the transaction simply was not apparent.” (App. at 43.) Van
Sant’s testimony regarding industry practice and custom,
however, is not determinative as to Berckeley’s state of mind.
Such an inference would run counter to our determination in
Newton v. Merrill, Lynch, Pierce, Fenner & Smith, 135 F.3d 266(3d Cir. 1998) (“Newton I”). In that case, the defendants
submitted multiple affidavits from investment brokers
explaining that the brokers followed the same allegedly
fraudulent investment practices as the defendants. The
defendants argued that the universal industry custom established
as a matter of law that the defendants did not have the requisite
scienter to violate Section 10(b). We rejected the defendants’s
claim that evidence of a “widely, if not almost universally
followed” practice in the securities industry was determinative
as to their state of mind. We explained that “[e]ven a universal
industry practice may still be fraudulent[,]” and that “ultimate
responsibility for construction and enforcement of the securities
laws must rest with the court.” Id. at 274 (citations omitted).
The touchstone of our decision in Newton I was that
universal industry practices are not “outcome determinative.”
Id. at 273. In the present case, we read the District Court’s
opinion as finding that the Van Sant affidavit on industry
custom was “outcome determinative” as to Berckeley’s state of
mind regarding its qualification for the Section 4(1) exemption.
53
Under Newton I, that conclusion cannot stand. Our decision in
Newton I, however, did not preclude the defendants from
introducing the proffered evidence of industry custom and
practice to demonstrate that they had not acted with the requisite
scienter. See id. (stating that “any evidence, derived from
knowledge of industry practice or elsewhere, that the plaintiffs
were generally aware of the defendants’ exclusive reliance on
the [allegedly fraudulent practices] would, of course, be quite
probative of whether the plaintiffs had the expectations they
claim”). Similarly in this case, Van Sant’s testimony regarding
securities industry practices in May 1996 will be probative of
Berckeley’s scienter at the time of the Agreement, but not
determinative.
Because the Van Sandt affidavit, standing alone, is
insufficient to establish that Berckeley did not have the requisite
scienter, we must examine the record to determine whether there
is any other evidence regarding Berckeley’s state of mind
concerning its qualification for the Section 4(1) exemption at the
time it entered into the Agreement. In order to defeat summary
judgment, Colkitt must point to evidence in the record creating
an issue of fact regarding whether Berckeley was reckless in its
belief that it would be entitled to an exemption under Section
4(1) of the Securities Act of 1933. Colkitt relies on several
Rules, Regulations, and Interpretive Guidances issued by the
SEC to argue that the law in 1996 was clear that no exception to
the Section 5 registration requirement existed under Section 4(1)
for unregistered securities acquired in offshore transactions.
(Appellant’s Br. at 42.) We agree that the authorities cited by
Colkitt create an issue of fact as to whether Berckeley’s belief
that it could freely resell the securities after the holding period
54
in the Agreement without otherwise complying with Section
4(1) was reckless.
Important to our conclusion is an understanding of the
interrelationship among Rule 144, which gives guidance on
“underwriter” status under Section 4(1); Regulation S, which
was adopted in 1990 to clarify the extraterritorial application of
the 1933 Act; and an interpretive release issued by the SEC on
June 10, 1995, entitled “Problematic Practices Under Regulation
S.” We examined the Rule 144 safe harbor in detail, supra, and
concluded that Berckeley could not fall under the safe harbor
because it resold the securities back into the United States
within one year of converting the debentures. See 17 C.F.R.
§ 230.144.
Regulation S was enacted in 1990 to provide generally
that an offer or sale of a security that occurs outside the United
States is not subject to the registration requirements under
Section 5 of the Securities Act. See 17 C.F.R. §§ 230.901-.05.
Under that regulation, “[s]ecurities acquired overseas, whether
or not pursuant to Regulation S, may be resold in the United
States only if they are registered under the Act or an exemption
from registration is available.” Offshore Offers and Sales, 55
Fed. Reg. 18306, 18322 (May 2, 1990). 17 C.F.R. § 230.904,
preliminary note 6. Regulation S contains two non-exclusive
safe harbor provisions, Rule 903 and Rule 904. Under Rules
903 and 904, an offer or sale of securities is deemed to occur
outside the United States if: (1) the offer or sale is made in an
offshore transaction; (2) no directed selling efforts are made in
the United States; and (3) additional considerations listed in
Rule 903(b) and/or 904(b) are satisfied. See 17 C.F.R.
55
§§ 230.903 - .04. Both safe-harbor rules contain a 40-day
“distribution compliance period” under which resales of
unregistered shares may not be made in any event. See id. The
SEC interpretive release issued in connection with Regulation
S explained that Regulation S did not alter the availability of the
Section 4(1) exemption for the resale of securities. Notice of
Adoption of Rule 144, SEC. Release No. 5223, 55 Fed. Reg.
18319 (January 11, 1972). The interpretive release further
stated that Regulation S did not apply to “any transaction or
series of transactions that, although in technical compliance with
the rules, is part of a plan or scheme to evade the registration
provisions of the Securities Act.” 55 Fed. Reg. at 18320.
In June 1995, in response to “a number of problematic
practices [that] . . . developed involving unregistered sales of
equity securities of domestic reporting companies purportedly
in reliance upon Regulation S,” the SEC published an
interpretive release entitled “Problematic Practices Under
Regulation S.” See Problematic Practices Under Regulation S,
SEC Release No. 33-7190, 60 Fed. Reg. 35663 (July 10, 1995).
That publication stated that the safe harbors under Rules 903
and 904 were not available “for a transaction or series of
transactions that, although in technical compliance with the
regulation, is part of a plan or scheme to evade the registration
requirements of the Securities Act.” Id. The publication was
concerned primarily with so-called “parking transactions,” under
which domestic issuers or distributors sold securities to offshore
shell entities to hold for the forty-day restricted period, after
which such securities were sold back into the United States. In
the end, proceeds from the sales would make their way, directly
or indirectly, back to the domestic issuer or distributer. Id. at
56
35664. The SEC made clear in the release that the forty-day
restricted period could not be used for this purpose, i.e., to
“wash off” resale restrictions such as the 2-year holding
requirement under Rule 144. The release concluded by stating
that “any distributions by a statutory ‘underwriter’ must be
registered pursuant to Section 5” unless subject to a statutory
exemption. Id.The net effect of all of these Rules and interpretive
releases is to create an issue of fact as to whether it would have
been reckless for Berckeley to rely solely on the forty-day
restricted period to foreclose any possibility that it was an
“underwriter” at the time it entered into the Agreement with
Colkitt. Berckeley argues that it was not reckless as a matter of
law because the 1995 interpretive release only solicited
comments as to whether Regulation S should be amended, and
that it was not until February 1997 – almost one year after the
parties’ transaction – that the SEC formally proposed changes
to Regulation S in order to stop certain abusive practices. See
Offshore Offers and Sales, SEC Release No. 33-7392, 62 Fed.
Reg. 9258 (Feb. 28, 1997). We view Berckeley’s argument as
a distinction without a difference. Although the SEC did not
propose formal Regulation S rule changes until February 1997,
the 1995 interpretive release was clearly directed to stop abusive
practices relating to the sale of unregistered securities. When
the SEC finally adopted amendments to Regulation S in
February 1998, the Commission explained that it first “acted to
stem abuses of Regulation S” in the June 1995 interpretive
release. Offshore Offers and Sales, SEC Release No. 33-7505,
63 Fed. Reg. 9362 (Feb. 25, 1998). The SEC further referenced
eight enforcement proceedings it had instituted against
57
participants in abusive Regulation S transactions between
June 5, 1992, and May 6, 1996, each of which took place prior
to the date of the Agreement on May 30, 1996.
Based upon all the information available to Berckeley at
the time it entered into the Agreement, we conclude that there is
an issue of fact as to whether Berckeley was reckless in its belief
that the resale of securities back into the United States would not
violate Section 5 of the Securities Act.24 This issue must be
24
We note that we are not determining that the failure to
follow an SEC interpretive release is per se reckless for
purposes of finding liability under the securities laws. An
interpretive rule is “one issued by an agency to advise the public
of the agency’s construction of the statutes and rules which it
administers.” Chrysler Corp. v. Brown, 441 U.S. 281, 302 n.31
(1979) (citation omitted). An interpretive rule is not binding
upon a court. Dismas Charities, Inc. v. United States Dept. of
Justice, 401 F.3d 666, 681 (6th Cir. 2004). Indeed, the SEC
itself has recognized that “no-action and interpretive responses
by the staff are subject to reconsideration and should not be
regarded as precedents binding on the Commission.” See SEC
Release No. 33-5089, 1970 WL 10582 (Oct. 29, 1970). Our
decision in this case does not elevate SEC interpretive releases
to the force of law; rather our focus is on Berckeley’s state of
mind when it entered into the Agreement. The sheer weight of
the interpretive releases and the eight enforcement proceedings
instituted by the SEC against participants in abusive Regulation
S transactions between June 5, 1992, and May 6, 1996, creates
an issue of fact that Berckeley intended to undertake an
unlawful course of conduct.
58
resolved by the trier of fact, which may or may not accept
Berckeley’s explanation that the law was so unclear at the time
to dispel Colkitt’s contention that it acted with scienter.
Accordingly, we will reverse the District Court’s grant of
summary judgment on Colkitt’s Section 29(b) claim premised
on a violation of Section 10(b) and remand the case for a trial on
the merits.
C. COLKITT’S SECTION 10(b) CLAIM
Berckeley has evidence at its disposal to counter the
interpretive releases, including the Van Sant testimony and
evidence that it sought out the advice of counsel prior to
entering into the Agreement. On the latter piece of evidence, we
realize that the record is sparse as to the nature of the advice
Berckeley received from its counsel. (App. at 1175-77, 1187-
89.) For purposes of the remand to the District Court, we
remind the parties that the attorney-client privilege cannot be
used as both a “shield” and a “sword”: Berckeley cannot rely
upon the legal advice it received for the purpose of negating its
scienter without permitting Colkitt the opportunity to probe the
surrounding circumstances and substance of that advice. See
Livingstone v. North Belle Vernon Borough, 91 F.3d 515, 537
(3d Cir. 1996) (“The attorney client privilege is waived for any
relevant communication if the client asserts as a material issue
in a proceeding that: (a) the client acted upon the advice of a
lawyer or that the advice was otherwise relevant to the legal
significance of the client’s conduct. ”) (quoting Restatement of
the Law Governing Lawyers §130(1) (Final Draft No.1, 1996)).
59
As we explained, supra, a party proceeding under a
Section 29(b) rescission claim has a lesser burden because it is
not necessary in that context to establish reliance and causation.
See GFL Advantage Fund, 272 F.3d at 206 n.6. In this case,
however, Colkitt has also alleged a stand-alone claim under
Section 10(b). The remaining issue for our consideration under
that claim is whether Colkitt has produced sufficient evidence
to create an issue of fact that Berckeley’s alleged
misrepresentation caused his injury.
Causation in the securities context is strikingly similar to
the familiar standard in the torts context, but with different
labels. In the securities realm, “but for” causation is referred to
as “reliance, or transaction causation,” and “proximate cause” is
known as “loss causation.” See Newton II, 259 F.3d at 172-73;
see also Bastian v. Petren Resources Corp., 892 F.2d 680, 683
(7th Cir. 1990) (stating that “what securities lawyers call ‘loss
causation’ is the standard common law fraud rule . . . merely
borrowed for use in federal securities law cases”) (emphasis in
original); 3 Hazen, The Law of Securities Regulation,
§ 12.11[1].
In order to establish reliance, or transaction causation, a
Section 10(b) plaintiff must prove that “but for the fraudulent
misrepresentation, the investor would not have purchased or
sold the security.” Newton II, 259 F.3d at 172. Stated
differently, the plaintiff must prove that “but for the wrongful
conduct, the transaction would not have gone through, at least
in the form that it eventually took.” 3 Thomas Lee Hazen, The
Law of Securities Regulation, § 12.11[2] (5th ed. 2005); see also
Suez Equity Investors, L.P., Sei Assocs. v. Toronto Dominion
60
Bank, 250 F.3d 87, 95-96 (3d Cir. 2001) (“Transaction causation
is based upon the plaintiff’s reliance upon the defendant’s
deceptive statements or omissions; that is, but for such conduct
by the defendant, the plaintiff would not have acted to his
detriment.”).
Loss causation is a more exacting standard for a Section
10(b) plaintiff to meet. To prove loss causation, the plaintiff
must demonstrate “that the fraudulent misrepresentation actually
caused the loss suffered.” Newton II, 259 F.3d at 173. Similar
to the concept of proximate cause in the tort context, loss
causation focuses on whether the defendant should be held
responsible as a matter of public policy for the losses suffered
by the plaintiff. Suez Equity Investors, 250 F.3d at 96. Thus,
“[t]he loss causation inquiry typically examines how directly the
subject of the fraudulent statement caused the loss, and whether
the resulting loss was a foreseeable outcome of the fraudulent
statement.” Id. The United States Court of Appeals for the
Seventh Circuit has succinctly explained that the loss causation
element requires the plaintiff to prove “that it was the very facts
about which the defendant lied which caused its injuries.”
Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d 645, 648
(7th Cir. 1997) (citing LHLC Corp. v. Cluett, Peabody & Co.,
842 F.2d 928, 931 (7th Cir. 1988)). In the typical Section 10(b)
case, a party can meet this burden by showing that the price of
a security was inflated due to a fraudulent misrepresentation.
Semerenko v. Cendant Corp., 223 F.3d 165, 184 (3d Cir. 2000);
Hayes v. Gross, 982 F.2d 104, 107 (3d Cir. 1992); Scattergood
v. Perelman, 945 F.2d 618, 624 (3d Cir. 1991). In such a case,
there is a direct causal nexus between the misrepresentation and
the plaintiff’s economic loss. Semerenko, 223 F.3d at 184.
61
Similarly, the loss causation element is satisfied where a
fraudulent misrepresentation or omission induces the plaintiff to
enter into the challenged transaction. See Hatrock v. Edward D.
Jones & Co., 750 F.2d 767, 773 (9th Cir. 1984) (stating that
“[t]he plaintiff . . . should not have to prove loss causation where
the evil is not the price the investor paid for a security, but the
broker’s fraudulent inducement of the investor to purchase the
security”), as cited in 3 Hazen, The Law of Securities
Regulation, § 12.11[3]. In contrast, a plaintiff does not meet the
loss causation element if he fails to prove that the drop in the
value of a security is related to the alleged misrepresentation.
Semerenko, 223 F.3d at 185; Robbins v. Koger Properties, Inc.,
116 F.3d 1441, 1446-49 (11th Cir. 1997). In that situation, it
cannot be said “that the alleged misrepresentation proximately
caused the decline in the security’s value to satisfy the element
of loss causation.” Id.Colkitt’s complaint asserts that his NMFS share holdings
lost value as a proximate cause of Berckeley’s alleged
misrepresentation.25 (App. at 955.) We disagree. Based on the
25
Colkitt also alleges that he suffered two other categories
of damages as a direct and proximate cause of Berckeley’s
alleged misrepresentation: (1) the sale of NMFS shares to
Berckeley at a 17% discount from their market value, and (2)
the possible requirement to pay interest and penalties on the
outstanding debentures under the Agreement. The current
record, as we have examined it, is unclear as to whether these
expenses would have been part of the cost of any deal Colkitt
could have made to obtain the financing in light of NMFS’s
precarious financial position at the time it entered into the deal.
62
record before us, there is absolutely no connection between the
price decrease in NMFS shares and Berckeley’s unrelated
alleged misrepresentation as to its intent to comply with offshore
registration requirements. In fact, Colkitt himself has attributed
the drop in the price of NMFS shares solely to repercussions
resulting from Berckeley’s short sales of NMFS stock, a practice
that the District Court determined did not violate Section 10(b)
or Rule 10b-5.26 For example, the following exchange took
place during Colkitt’s deposition regarding the reasons why he
never repaid the loan amount to Berckeley:
Q. Is the only reason that you did not repay
Berckeley in one form or another these
allegations that have been made in this
lawsuit that you believe that Berckeley
was involved in the short-selling of
National Medical Stock?
A. Yes.
Q. There is no other reason that you have for
not repaying the loan made by Berckeley?
See Berckeley I, 259 F.3d at 137 & supra note 3. We invite the
District Court upon remand to determine in the first instance the
nature of these expenses and their relationship, if any, to the
alleged misrepresentation.
26
Colkitt has not appealed that ruling and is thus bound
by it.
63
A. Well, obviously, the short-selling helped
collapse totally the price of the stock,
which obviously made my liquidity –
inability to pay, it was a downward cycle,
made it much more difficult.
****
Q. You don’t have any other reason for
failing to repay this loan from Berckeley
other than the allegations that you have
made in this case that Berckeley was
somehow involved in short-selling
National Medical stock and the
repercussions of those allegations; is that
correct?
A. Yeah, and the repercussions, that’s correct.
Q. Okay. Included in those repercussions is
your contention that there’s now some
issue of inability to repay?
A. Correct.
Q. Okay. Is there any other reason that you
have for not repaying this loan?
A. No.
(App. at 1018-19 (emphasis added).)
64
Once we strip away the short selling allegations, the
alleged misrepresentations in this case have no connection to the
decrease in the value of NMFS shares in the open market. That
misrepresentation simply did not affect the value of NMFS
stock. Accordingly, Colkitt cannot recover damages for the
decrease in value of his stock that was held in escrow because
that decrease was not proximately caused by Berckeley’s
alleged misrepresentation.
In summary, we will reverse the decision of the District
Court with respect to Colkitt’s Section 10(b) claim on limited
grounds. We hold that Colkitt failed to set forth sufficient facts
that the precipitous loss in value in his NMFS share holdings
was proximately caused by Berckeley’s alleged
misrepresentation. There is no evidence in the record that the
decline in the price per share of NMFS stock was connected in
any manner to alleged misrepresentations regarding Berckeley’s
intent to evade Section 5 registration requirements, and we will
affirm the decision of the District Court relating to this category
of damages.27 For these reasons, we will reverse in part, affirm
27
In this respect, our decision represents only a Pyrrhic
victory for Colkitt, who will not be able to recover his largest
category of damages from Berckeley, which is the drop in stock
prices connected to NMFS stock held in escrow. We note for
the record that Colkitt recognized the inherent possibility that
market forces might cause the share price of NMFS stock to
decrease when he agreed, in the Agreement, to place additional
shares of NMFS stock into escrow if the stock price decreased.
65
in part, and remand Colkitt’s remaining Section 10(b) claim to
the District Court for trial.28
28
As a result, to the extent we have determined that
Colkitt has stated a claim under Section 10(b), we will also
reinstate Colkitt’s claim that Berckeley’s conduct committed
common law fraud under New York law. We conclude that the
Agreement, which contains a choice of law clause in Paragraph
6.1, is governed solely by New York law. See Kruzits v. Okuma
Machine Tool, Inc., 40 F.3d 52, 56 (3d Cir. 1994) (stating that
the parties freely bargained for a choice of law provision and
that Pennsylvania courts “will only ignore a contractual choice
of law provision if that provision conflicts with strong public
policy interests”). As Colkitt fails to set forth any public policy
interest to invalidate the choice of law provision entered into
between two parties that freely bargained for the terms of the
Agreement, we find that the choice of law provision bars Colkitt
from proceeding under the Pennsylvania Securities Act and
Pennsylvania common law fraud. Accordingly, Colkitt will
have to prove that Berckeley’s conduct constituted fraud under
New York law. See Computerized Radiological Services v.
Syntax Corp., 786 F.2d 72, 76 (2d Cir. 1986) (stating that under
New York law, a plaintiff must prove the following elements of
fraud: “(1) that the defendant made a representation, (2) as to a
material fact, (3) which was false, (4) and known to be false by
the defendant, (5) that the representation was made for the
purpose of inducing the other party to rely upon it, (6) that the
other party rightfully did so rely, (7) in ignorance of its falsity,
(8) to his injury”) (citation omitted)).
66
D. CALCULATION OF DAMAGES
Having determined that Colkitt has adduced sufficient
facts to survive summary judgment on his Section 29 rescission
claim premised on a violation of Section 10(b), we must
necessarily vacate the District Court’s damages award in favor
of Berckeley. Colkitt will have the opportunity at trial to prove
that he is entitled to rescind the Agreement.29
29
We note that the record is unclear as to what damages
Berckeley would be entitled to for its “buy-in loss” should it
ultimately be successful at trial. Those damages represent the
losses that Berckeley allegedly suffered when it was forced to
buy NMFS shares on the open market to cover for existing
delivery obligations after Colkitt failed to follow through on his
duty to convert shares under the Agreement. As set forth in note
4, supra, Berckeley made conversion demands on five occasions
in September 1996. Colkitt honored only two of the conversion
demands and converted 18,320 shares. At around the same time
in September 1996, Berckeley entered into sales agreements to
sell 10,680 NMFS shares. Berckeley then purchased 10,680
shares on the open market in February 1997 to cover for its
existing delivery obligations from September. What is unclear
to us from the existing record is why Berckeley would have had
to purchase the shares on the open market when it already held
18,320 shares that would have covered the outstanding delivery
obligations. The answer may be that Berckeley sold a certain
number of shares, and that the 10,680 outstanding shares
represent the remaining shares upon which Berckeley still owed
delivery obligations. The parties’ current submissions, however,
are far from clear on this issue, and the parties should address
67
V. CONCLUSION
Based upon the foregoing reasons, we will affirm in part,
reverse in part, and remand the case to the District Court for
further proceedings consistent with this opinion.
this unanswered question on remand.
68