Rehearing and Rehearing En Banc Denied August 23, 1985.
KRAVITCH, Circuit Judge:
On cross-appeals from a judgment of the United States District Court,
A. The Primary Actors
Robert J. Allen and H. William Alexander were the principal actors in this scheme. The two men organized a corporation, Alexander & Allen, Inc., in the state of Florida in August 1972. On February 26, 1974, the corporation changed its name to R.J. Allen & Associates, Inc. From 1972 to October 1974, this entity was in the business of selling securities commonly referred to as municipal bonds. Alexander and Allen also were the sole shareholders in two other entities, A & A Enterprises, and All Enterprises.
As part of its business, Alexander & Allen, Inc. engaged in the underwriting of industrial development revenue bonds of numerous issuers. Although these bonds came within the definition of municipal obligations, they were not general bonds issued by a political entity nor were they secured by the taxing power of any political unit. Rather, their strength as investments depended entirely on the ability of a company funded by the bond sales to put the proceeds to use and generate revenue sufficient to meet the principal and interest payments when due. Thus, these bonds were a speculative, high risk investment, includable in the class of municipal securities because interest payments received by bondholders were tax exempt.
In July 1973, C. David Smith, a loan officer at Barnett Bank, was introduced to Alexander and Allen by a friend who related that the two were dissatisfied with their present bank. Smith asked them to move their financial business to Barnett Bank and the two agreed. Shortly thereafter, they opened a checking account at Barnett Bank and applied for and received a $50,000 loan. On the loan application form they stated that the source of repayments would be "income from bond sales." Alexander and Allen, through their several businesses, maintained a substantial banking relationship with Barnett Bank until the SEC's action commenced in the fall of 1974.
B. The Tuskegee Bond Issue
In early 1973, Alexander and Allen became involved in the planning of a hydroponic tomato farming project in Alabama. To finance their proposal, the two men
Alexander & Allen, Inc. was named to act as underwriter for the bond issue,
Class representative Dean Woods testified that he placed his order for the bonds during the latter part of 1973. He did not receive the bonds at that time because none of the bonds were to be released until all were purchased. When the closing date finally arrived, only a small portion of the bond issue had been ordered by investors. Because the underwriter had not yet sold enough bonds or raised money in another fashion to pay for the entire issue, Covington County Bank did not deliver the bonds at the closing as planned. As an alternative, the underwriter suggested that Covington County Bank allow piecemeal distribution of the bonds. The trustee agreed to this, releasing bonds as Alexander & Allen, Inc. paid for them.
Although it complied with the underwriter's request to allow piecemeal distribution of the bonds, Covington County Bank was not comfortable with this gradual distribution. Eager to dispel the trustee's anxieties, Allen went to Barnett Bank, hoping to obtain a letter of recommendation to assure Covington County Bank of the underwriting firm's trustworthy character. Apparently, Allen initially sought Smith's assistance, but Smith was not present in the office at the time, so Allen turned to R.E. Prentiss, the Bank's vice president. Prentiss drafted a letter in an effort to comport with the request. Not satisfied with Prentiss' letter, however, Allen, accompanied by Alexander, returned to Barnett Bank the next day. They found Smith, explained why Prentiss' letter was not sufficient, and asked Smith to write a stronger letter. Smith addressed the following letter to L.R. Deal, President of Covington County Bank:
In fact, Smith had not reviewed the investment banking agreement and was not aware whether the corporation had fulfilled similar agreements. Rather, he wrote the letter, stating essentially what Alexander and Allen wanted him to write, as a favor to them because of the substantial amounts they kept on deposit with Barnett Bank. Shortly after receiving this letter, Covington County Bank began to distribute the proceeds of the bond issue to A & A Enterprises, thereby violating its trust agreement because a portion of the bonds had not been purchased by the underwriter.
Sales and distribution of the bonds continued through the spring and summer of 1974, but the entire bond issue was never exhausted. During this period, Covington County Bank made several disbursements of the proceeds of the bond issue, totalling $550,000, to A & A Enterprises, which was deposited in an account at Barnett Bank. Over the next few months, some of the deposited funds were used for purposes varying from those stated in the prospectus; for example, $6,000 was used to prepay twelve months' rent for H. William Alexander & Associates, a brokerage firm; Alexander received $6,000 in the form of a personal loan; Alexander used $50,000 more to secure a personal loan from Barnett Bank in the form of certificates of deposit; and Alexander took $4,500 to pay for stock in another corporation, Arthritis Clinic International.
Two semiannual interest payments were made to the investors in the Tuskegee bond issue. On October 1, 1974, the SEC brought an action against the underwriter, Alexander, Allen, and several other individuals, alleging securities violations arising out of certain Industrial Development Revenue Bond issues, including the one in Tuskegee. In SEC v. R.J. Allen & Associates, 386 F.Supp. 866 (S.D.Fla.1974), the district court held that the defendants had violated the securities laws, enjoined the defendants from committing further violations, appointed a receiver for the underwriter, and ordered that the defendants "disgorge" all monies received from investors. Since the SEC proceeding, the bonds have been in default.
In 1975, purchasers of the Tuskegee bond issue formed a class to bring suit against Covington County Bank and other defendants. This action ultimately settled. The instant case was initiated in 1978, charging that Barnett Bank was secondarily liable for the securities fraud
The court opined that this transaction was really of secondary importance, however, because Smith's letter was sufficient to impose liability on the bank for aiding
II. ELEMENTS OF AIDING AND ABETTING
In Woodward v. Metro Bank of Dallas, 522 F.2d 84 (5th Cir.1975),
522 F.2d at 94-95 (quoting SEC v. Coffey, 493 F.2d 1304, 1316 (6th Cir.1974), cert. denied, 420 U.S. 908, 95 S.Ct. 826, 42 L.Ed.2d 837 (1975)).
In discussing the knowing and substantial assistance requirement, the court focused on the kinds of assistance an aider and abettor might offer to the primary violator. For a defendant whose only role is to remain silent in the face of securities violations, liability might depend upon a duty owed to the other parties to the transaction. A defendant who is not under any duty to disclose can be found liable as an aider and abettor only if he acts with a high degree of scienter, that is, with a "conscious intent" to aid the fraud. On the other hand, liability could be imposed upon an aider and abettor who is under a duty to disclose if he acts with a lesser degree of scienter. For an aider and abettor who combines silence with affirmative assistance, the degree of knowledge required should depend upon how ordinary the assisting activity is in the involved businesses. Id. at 96-97.
Id. at 97. The court reiterated that the assistance must be substantial, a conclusion to be drawn after evaluating all the circumstances. Id.
Although Woodward was decided prior to the decision in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), in which the Supreme Court announced that scienter, "a mental state embracing an intent to deceive, manipulate, or defraud," 425 U.S. at 193 n. 12, 96 S.Ct. at 1381 n. 12, was a necessary element of proof in a cause of action for damages under section 10(b) and Rule 10b-5, the Fifth Circuit required proof of scienter at the time the Woodward court acted. 522 F.2d at 93; see Sargent v. Genesco Inc., 492 F.2d 750, 761 (5th Cir.1974). The Hochfelder court declined to address the issue of whether "reckless" behavior is sufficient for civil liability under section 10(b) and Rule 10b-5. 425 U.S. at 193 n. 12, 96 S.Ct. at 1381 n. 12. The rule in this circuit is that "severe recklessness" satisfies the scienter requirement. White v. Sanders, 689 F.2d 1366, 1367 n. 4 (11th Cir.1982); Broad v. Rockwell International Corp., 642 F.2d 929, 961 (5th Cir.) (en banc), cert. denied, 454 U.S. 965, 102 S.Ct. 506, 70 L.Ed.2d 380 (1981).
Broad, 642 F.2d at 961-62.
III. DID BARNETT BANK AID AND ABET THE VIOLATION?
The parties agree that plaintiffs were the victims of a securities fraud. Indeed, in the words of Chief Judge Fulton, who presided at the action brought by the SEC, the scheme amounted to "a horrible fraud, one that has been vicious and brutal. It is difficult to imagine how anyone could contrive and execute a more diabolical scheme." SEC v. R.J. Allen & Associates, 386 F.Supp. 866, 874 (S.D.Fla. 1974). The primary violations included Alexander & Allen, Inc.'s solicitation of purchasers for bond issues by making numerous material misrepresentations and omissions. In particular, the court found a failure to disclose that the principals of the underwriter also controlled the recipient of the proceeds, a relationship that allowed Alexander and Allen to derive substantial benefits from any sales of the bond issue. Id. at 872-73. In addition, the underwriter engaged in other practices that "so pervaded their business that they rendered the entire operation a fraudulent and deceptive scheme and course of conduct designed to defraud investors," id. at 873, including: false assurances to customers that the bond issues were insured; unkept promises to customers that the underwriter would repurchase bonds; sending bonds that differed from the ones customers ordered; and accepting customers' money without purchasing bonds ordered. Id. at 873-74.
The fraud, however, did not end with the misrepresentations, omissions, and other activities described above. Until the proceeds of the bond issue were released to A & A Enterprises, they were accumulating at Covington County Bank. As it happened, the proceeds never should have been distributed, because the underwriter never purchased the entire issue. Thus, obtaining early release of the proceeds was part and parcel of the scheme to defraud the investors.
The second requirement for establishing the aiding and abetting violation requires proof of Barnett Bank's "general awareness" of its role in the primary fraud. As previously stated, where a defendant is under some duty to the defrauded party, liability can be imposed on an aider and abettor whose conduct is severely reckless. The court below applied a recklessness standard, reasoning that when Smith wrote the letter to the trustee bank, he assumed a special duty to the bank and the bondholders because of the "special code of confidence among bankers." We agree that the recklessness standard is appropriate here because of Smith's communication to the trustee bank. See First Virginia Bankshares v. Benson, 559 F.2d 1307, 1317 (5th Cir.1977), cert. denied, 435 U.S. 952, 98 S.Ct. 1580, 55 L.Ed.2d 802 (1978). Several courts have applied a recklessness standard to alleged aiders and abettors who have issued statements or certifications foreseeably relied upon by investors, reasoning that a duty to disclose arises under such circumstances. See, e.g., Fund of Funds, Ltd. v. Arthur Andersen & Co., 545 F.Supp. 1314, 1356-57 (S.D.N.Y.1982) (accountant's audit); Morgan v. Prudential Group, Inc., 527 F.Supp. 957, 960-61
Focusing our attention on the February 22nd letter from Smith to Covington County Bank, circumstances surrounding the letter support the inference that Smith was severely reckless. Alexander and Allen had already received a letter of recommendation from Barnett Bank's vice president. Not satisfied with this letter they turned to Smith, who had brought their account into the bank. After they told Smith why Prentiss' letter was not strong enough, Smith asked what would be more appropriate. The end result was a letter essentially dictated by Alexander and Allen and signed by Smith. Smith wrote this letter without knowing whether any of its details were in fact true.
Smith's assistance in the fraud was both knowing and substantial. The method used to assist the fraud was atypical. Woodward teaches that knowing assistance can be inferred from atypical business actions. 522 F.2d at 97. Although it is perhaps a common practice for a bank to write such a reference for one of its customers, the act of issuing a letter containing statements of which the writer has no knowledge, without even minimal investigation to determine whether its contents are accurate, solely for the purpose of "currying favor" with a good client, can hardly be regarded as "the daily grist of the mill." Moreover, Smith was aware that the bank receiving this letter would rely on this letter, treating it as an expression of confidence. The letter also played a substantial role in assisting Alexander and Allen to perpetrate the fraud. The district court found that Covington County Bank relied on this letter in deciding to release the proceeds of the bond issue that had been accumulating. Although the evidence on this question is far from overwhelming, there is sufficient evidence to support this finding, given our clearly erroneous standard of review. Fed.R.Civ.P. 52(a).
Barnett Bank contends that the district court's conclusion of substantial assistance was based on a "but for" test, which has been rejected as insufficient. See Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 61-62 (2d Cir.1985); Edwards & Hanly v. Wells Fargo Securities, 602 F.2d 478, 484 (2d Cir.1979), cert. denied, 444 U.S. 1045, 100 S.Ct. 734,
IV. COMPENSATORY DAMAGES
The appropriate method of computing damages in most Rule 10b-5 actions is the out-of-pocket rule. Huddleston v. Herman & MacLean, 640 F.2d 534, 555 (5th Cir.1981) (Unit A) affirmed in part and reversed in part on other grounds, 459 U.S. 375, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983). See Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 155, 92 S.Ct. 1456, 1473, 31 L.Ed.2d 741 (1972). In their brief, the class members claim gross out-of-pocket losses totaling $2,128,000, a figure unchallenged by Barnett Bank. From this, plaintiffs subtracted several items, including the amounts the class received in settlement of the Alabama class action, to arrive at a figure, $1,382,386, they claim represents their net unrecovered losses. Plaintiffs asked for and the district court awarded $550,000 in damages, an amount equal to the sum total of bond proceeds released to A & A Enterprises.
Barnett Bank challenges this amount as excessive because the court failed to reduce the award by the amount of bond proceeds put to their proper purpose. This argument is misguided. The entire bond issue defaulted after the recipients of the proceeds made only two interest payments. Thus, even if only a portion of the proceeds released were diverted to an improper end, this would not affect the amount the plaintiffs are "out-of-pocket."
Barnett Bank also argues that the court should have reduced the award by the amount received by the class as a result of the settlements of the Alabama class action suit. According to plaintiffs' figures, their out-of-pocket losses total over 1.3 million, after subtracting the amount recovered in the Alabama litigation. The Bank makes no showing that any of the figures reproduced in plaintiffs' brief, including the amount recovered in the Alabama lawsuit, are inaccurate.
Finally, the Bank argues that its liability should be limited to the amount of proceeds distributed before April 23, 1974, at which time the trustee bank knew that the underwriter could not perform its obligation to pay for the bonds within the time provided in the underwriting agreement. There is no evidence supporting Barnett Bank's theory that its participation in the securities fraud "ended" on that date. Accordingly, we affirm the award of damages.
The class cross-appealed the district court's refusal to assess attorneys' fees, punitive damages, and prejudgment interest against Barnett Bank. Punitive damages are not available in a 10b-5 action. Huddleston v. Herman & MacLean, 640 F.2d at 559. The class members claim that they proved violations of state law, for which punitive damages are available. The district court, however, declined to rule on the state law claims after making its conclusion with respect to 10b-5 liability.
The award of prejudgment interest in a 10b-5 case is governed by standards of fairness and rests within the district court's sound discretion. Blau v. Lehman, 368 U.S. 403, 414, 82 S.Ct. 451, 457, 7 L.Ed.2d 403 (1962); Wolf v. Frank, 477 F.2d 467, 479 (5th Cir.), cert. denied, 414 U.S. 975, 94 S.Ct. 287, 38 L.Ed.2d 218 (1973). We perceive no abuse of discretion in the district court's denying prejudgment interest in this case.
As for the award of attorneys' fees, in Alyeska Pipeline Service Co. v. Wilderness Society, 421 U.S. 240, 95 S.Ct. 1612, 44 L.Ed.2d 141 (1975), the Supreme Court expressed strong support for the "American Rule," which prohibits the imposition of the prevailing party's attorneys' fees on an opponent except when authorized by statute or when a traditionally recognized exception is applicable. There is no statutory provision permitting assessment of attorneys' fees in an action brought under Rule 10b-5. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 211 n. 30, 96 S.Ct. 1375, 1389 n. 30, 47 L.Ed.2d 668 (1976). Deviation from the "American Rule" may be appropriate if an unfounded action or defense is brought or maintained for oppressive reasons, or if an opponent has acted in bad faith, vexatiously, or wantonly. Alyeska, 421 U.S. at 258-59, 95 S.Ct. at 1622; Hall v. Cole, 412 U.S. 1, 5, 93 S.Ct. 1943, 1946, 36 L.Ed.2d 702 (1973). The bad faith or vexatious conduct must be part of the litigation process itself. Barton v. Drummond Co., 636 F.2d 978, 985 (5th Cir.1981) (Unit B);
The plaintiffs' claim for attorneys' fees is based upon the Bank's failure to turn over to the class $50,000 in certificates of deposit used to secure a personal loan to Alexander that was foreclosed by the bank. Plaintiffs argue that the Bank's retention of these funds violated several court orders and that Barnett Bank forced the plaintiffs to sue to protect their rights. Finding these allegations to be true, the court below nevertheless declined to award the plaintiffs attorneys' fees, a ruling with which we agree. Plaintiffs' recovery of the $50,000, which was part of the proceeds released to A & A Enterprises, was subsumed within the total award of $550,000, which was based on Barnett Bank's liability as an aider and abettor. Because they did not prevail on the theory that the Bank should have turned over the $50,000 to comply with a court's order, but instead were entitled to that sum for other reasons, they are not entitled to attorneys' fees under the bad faith exception.
For the foregoing reasons, the decision of the court below is AFFIRMED.
Fischel, Secondary Liability Under Section 10(b) of the Securities Act of 1934, 69 Calif.L.Rev. 80, 80 n. 4 (1981).