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DECKERT v. INDEPENDENCE SHARES CORP.

May 18, 1939

DECKERT et al.
v.
INDEPENDENCE SHARES CORPORATION et al.,* 1 Reversed, 108 F.(2d) 51.



The opinion of the court was delivered by: KALODNER

The complainants are owners and holders of certain contract certificates purchased from Capital Savings Plan, Inc., since merged with and now Independence Shares Corporation, a Pennsylvania corporation.

The principal defendant is the Independence Shares Corporation, a trust and investment corporation, organized, existing, and doing business under and by virtue of the laws of the Commonwealth of Pennsylvania, with its principal place of business in Philadelphia. The individual defendants are officers and directors of the Independence Shares Corporation.

 The Pennsylvania Company for Insurances on Lives and Granting Annuities is a banking corporation, organized, existing, and doing business under and by virtue of the laws of the Commonwealth of Pennsylvania, with its principal place of business in Philadelphia. The Pennsylvania Company, &c., is trustee under several agreements between the trustee and the Independence Shares Corporation and certain of its predecessor companies.

 The complainants seek the appointment of a receiver for the Independence Shares Corporation, with full power and authority to take into possession all the property and assets of the Independence Shares Corporation, and the trust assets held by The Pennsylvania Company, &c., under its agreements with the Independence Shares Corporation. They also seek determination of liabilities, liquidation and distribution and dissolution of Independence Shares Corporation.

 The complainants ground their action on alleged misrepresentations and fraudulent statements made to them at the time they purchased Capital Savings Plan contract certificates from the predecessor of the Independence Shares Corporation. They aver that they and other plan holders have been, and are being defrauded by the Independence Shares Corporation.

 The complaint also avers that the Independence Shares Corporation is insolvent.

 The jurisdiction of this court is invoked under its general equitable and receivership powers, and under Section 22(a) of the Act of Congress of May 27, 1933, entitled the "Securities Act of 1933," as amended and supplemented (Act of May 27, 1933, c. 38, Title 1, Section 22(a), 48 Stat. 86, U.S.C.Title 15, Section 77v(a), 15 U.S.C.A. § 77v(a).

 As previously stated, the principal offices of the Independence Shares Corporation, and of The Pennsylvania Company, &c., are within the Eastern District of Pennsylvania. All the individual defendants are residents of the Eastern District of Pennsylvania.

 Eight of the nine complainants are residents of the Eastern District of Pennsylvania. The ninth complainant, Abe Zubrow, is a resident of the State of New Jersey. All the complainants individually own $2,000 contract certificates, on which sums ranging from $80 to $500 have been paid in installments.

 Prior to December 31, 1938, the Independence Shares Corporation was a whollyowned subsidiary of Capital Savings Plan, Inc. The officers and directors of the two corporations were substantially the same. On December 31, 1938, there was a merger of Capital Savings Plan, Inc., and Independence Shares Corporation, under which the latter acquired all of the liabilities, as sets, fonctions, and business of Capital Savings Plan, Inc., which was an investment and trust corporation, organized, existing, and doing business under any by virtue of the laws of the Commonwealth of Pennsylvania. Capital Savings Plan, Inc., was originally incorporated in Pennsylvania on October 15, 1931.

 Independence Trust Shares registered with the Securities and Exchange Commission prior to the merger of the two companies on May 2, 1938, under the Securities Act of 1933, 15 U.S.C.A. § 77a et seq. The registration was with respect to Independence Trust Shares Purchase Plans, providing for maximum aggregate payments of $6,720,000, with a maximum of 5600 Monthly Payment Plans, and $480,000 under a maximum of 960 Full Paid Plans.

 From January, 1932, to April, 1938, and under three different trust agreements, the defendant Capital Savings Plan, Inc., issued and sold to members of the public residing in the Eastern District of Pennsylvania and elsewhere, securities, namely Capital Savings Plan Contract Certificates, which are participations in an investment trust or scheme commonly known as an "Installment Investment Plan," for which The Pennsylvania Company, &c., is trustee and defendant Capital Savings Plan, Inc., was sponsor and distributor.

 These certificates are monthly payment plans issued and sold in unit denominations of $1200 providing for the payment of $10 per month on a periodic or installment basis over a period of ten years. They could be purchased in one-half units of $600 or any multiple thereof. They could be secured with life insurance protection providing that upon the death of the purchaser the insurance company would pay to the trustee in one lump sum the installment payments remaining unpaid, which sum ranges downward on a $1200 unit certificate, from $1190 to $10.

 The trustee upon receipt of each periodic or installment payment deducted and still deducts the various fees and charges. The fees include a service fee of $60 on a $10 per month unit certificate, deducted from the equivalent of the first nine monthly payments; a trustee fee of 25 cents per $10 payment or fraction thereof, deducted from each monthly payment; and, on installment payment plans with insurance, an insurance fee deducted in decreasing amounts from each monthly payment.

 The remaining balance after fees and charges are deducted was and is used by the trustee at the direction of the defendant Independence Shares Corporation and its predecessor, Capital Savings Plan, Inc., to acquire from defendant Independence Shares Corporation, Independence Trust Shares for the account of each purchaser. These shares are interests in an installment investment trust for which The Pennsylvania Company, &c., is trustee and of which defendant Independence Shares Corporation is issuer, sponsor and depositor.

 Each Independence Trust Share represents a 1/1000 interest in a deposit unit previously created by defendant Independence Shares Corporation with funds borrowed or supplied by it. The deposit unit consists of one share each of the common stock of forty-two corporations and cash accumulations to the proper proportion of a distribution account. The price at which Independence Trust Shares were and are sold to the Trustee for the account of the purchasers of Capital Savings Plan Contract Certificates was not and is not the actual creation cost of each share, but was and is computed upon the last sales price of each of the forty-two common stocks which make up the deposit unit, as of the day before the Trustee makes the purchase, to which was and is added odd-lot brokerage, commissions and taxes. To the total of this was and is added an arbitrary charge or load of nine per cent (now reduced to 7 1/2 per cent) and any distributable accumulations which may then be applicable to the deposit unit. This nine per cent arbitrary charge or load was divided, 1 1/2 per cent to defendant Independence Shares Corporation and 7 1/2 per cent to the defendant Capital Savings Plan, Inc., and was a source of income to the defendant Capital Savings Plan, Inc. through the ten-year term in addition to the $60 service charge which is deducted from the first nine payments or their equivalent. Independence Trust Shares were and are subject to an additional charge of 2 1/2 per cent of currently distributable income and currently distributable principal, which charge is deducted semi-annually and paid to the trustee.

 The Installment Investment Plan of Capital Savings Plan, Inc., was in effect a trust upon a trust, with two sets of trustees' fees, and with two sets of sponsors' fees, expenses, charges and other costs of operation deducted from the moneys paid in by the purchasers and from the earnings derived from the underlying common stocks in the portfolio of Independence Trust Shares. The Independence Trust Shares purchased by the trustee are held in a common portfolio, but the account of each purchaser is credited with the shares or fractional shares to which he is entitled. At any time the purchaser may receive the Independence Trust Shares which are credited to his account or the liquidating value thereof in cash. The liquidating value of each share was and is computed at the bid price maintained by defendant Independence Shares Corporation and was and is based upon the market bid price of the forty-two common stocks underlying the shares plus the applicable portion of the distributable accumulations and less odd-lot brokerage, commissions and taxes. This price is customarily approximately ten per cent less than the then offering price of the shares.

 Defendant Independence Shares Corporation maintains offices in Philadelphia and Pittsburgh, Pennsylvania, and has general agencies in other cities and sub-divisions of Pennsylvania. Defendant Independence Shares Corporation is represented, and its certificates were offered and sold in defined territories, by junior salesmen, senior salesmen and general agents. Their sole remuneration is dependent upon commissions, and over-riding commissions, based upon the amount of certificates sold, the initial commission being payable only after delivery of the certificates and being contingent thereafter upon receipt by the trustee of subsequent installment payments. Many of the salesmen were part-time representatives, such as office workers, public employees, factory workers, school teachers and insurance salesmen.

 The offer and sale of Capital Savings Plan Contract Certificates was discontinued on April 9, 1938. However, the holders of approximately 95 per cent of all the outstanding Capital Savings Plan Contract Certificates are continuing and will continue to send in their periodic cash installments to the trustee, for the purchase of Independence Trust Shares, and the trustee uses and will continue to use the aggregate of these periodic cash installments to purchase Independence Trust Shares from defendant Independence Shares Corporation for the accounts of said holders.

 On May 2, 1938, defendant Independence Shares Corporation filed with the Securities and Exchange Commission a registration statement covering a new issue of Independence Trust Shares to be used as the underlying medium of investment for all Capital Savings Plan Contract Certificates outstanding, and as the underlying medium of investment for a new issue of certificates called Independence Trust Shares Purchase Plans. A registration statement covering these latter certificates was filed by Independence Shares Corporation on May 19, 1938.

 The Independence Trust Shares Purchase Plans are participations in an investment trust or scheme commonly known as an "Installment Investment Plan," for which The Pennsylvania Company, &c., is custodian and defendant Independence Shares Corporation is sponsor. They are substantially similar to the Capital Savings Plan Contract Certificates issued and sold by Capital Savings Plan, Inc., during the period December, 1932, through April 9, 1938. By contract dated May 14, 1938, defendant Capital Savings Plan, Inc., was underwriter for and had the exclusive right until January 1, 1939, to offer, sell and distribute Independence Trust Shares Purchase Plans.

 After January 1, 1939, Independence Shares Corporation itself sponsored, issued and sold Independence Trust Shares Purchase Plans, taking over and using substantially the same sales persons, selling organization and selling practices of Capital Savings Plan, Inc. Defendant Independence Shares Corporation absorbed the assets, liabilities and functions of Capital Savings Plan, Inc. and Capital Savings Plan, Inc., was dissolved.

 The following is an excerpt from the Prospectus (June 8, 1938; also January 3, 1939) issued by the Independence Shares Corporation:

 "The Independence Trust Shares Purchase Plan is a systematic Program by means of which an individual may purchase Independence Trust Shares and thus acquire an interest in a well-diversified list of representative American corporations.

 "Independence Trust Shares are shares of an investment trust of the fixed type issued under an Agreement and Declaration of Trust dated as of April 2, 1930 entered into between the Sponsor of these Plans and The Pennsylvania Company for Insurances on Lives and Granting Annuities, as Trustee, which Agreement and Declaration of Trust is entirely separate from the Independence Trust Shares Purchase Plans. The Independence Trust Shares are created in units of 1000 shares by depositing with the Trustee one share of the common stocks of each of 42 corporations and cash accumulation to the proper proportion of a distribution account. Each Independence Trust Share, therefore, represents 1/1000th interest in one share of each of the 42 corporations and a proportionate interest in the distribution account.The 42 corporations include banks, railroads, oil companies, utilities, industrial companies and insurance companies, a complete list of which will be found in the Prospectus relating to Independence Trust Shares which is attached to this Prospectus. These corporations were chosen for their comparative stability of earning power and for their future possibilities."

 The above excerpt, it will be noted, describes the Independence Trust Shares as "an investment trust of the fixed type." The "fixed type" of trust has a fixed list of securities which the management cannot change. This description of "fixed type" in the Prospectus is at variance with the description of the nature of the trust shares given by the President of the Independence Shares Corporation, and by counsel for The Pennsylvania Company, &c., in the preliminary hearing of this complaint. The President of Independence Shares Corporation, Alfred H. Geary (pages 120, 121, notes of testimony), described the trust shares as "an investment trust of the semifixed type." The "semi-fixed type" trust is one with a fixed list of securities, with the management allowed to eliminate those securities which in their judgment are insecure, but not to add others; they must stay within the fixed list for all their investments.

 Francis H. Bohlen, Jr., Esquire, counsel for The Pennsylvania Company, &c. (page 56 notes of testimony), described the trust shares as a "limited management" type, and as a "fixed trust subject only to limitations."

 It may be appropriate to say at this point that there are some 20,000 plan holders who have paid in approximately $4,000,000.

 As above stated, the Independence Shares Corporation registered with the Securities and Exchange Commission in 1938. Subsequent to the registration, on June 22, 1938, the Securities and Exchange Commission filed a complaint against the Capital Savings Plan, Inc., and the Independence Shares Corporation, alleging that: "for at least three years last past the defendant, Capital Savings Plan, Inc., has engaged, and is now engaging, and the Independence Shares Corporation is about to engage, in acts and practices which constitute violations of Section 17(a) of the Securities Act of 1933 [ 15 U.S.C.A. § 77q (a)]."

 The complaint asked that the two defendants named, and:

 "their officers, agents, employees, and sales personnel be enjoined and restrained from * * * obtaining money or property by means of untrue statements of material facts or omissions to state facts necessary in order to make the statements made in the light of the circumstances under which they were made not misleading and particularly concerning:

 "(a) Any comparison of the operation of the plan to the operation of a savings bank account or other type of deposit account.

 "(b) The extent to which and the time or times at which a purchaser may liquidate his securities or otherwise obtain the return of moneys paid in.

 "(c) The worth or liquidating value of the security at the end of 10 years or after a total of 120 payments have been completed or at any other time subsequent to the purchase thereof.

 "(d) The relation of The Pennsylvania Company for Insurances on Lives and Granting Annuities or any other trustee to the defendants or to the operation of the plan, or the responsibility of such company or any other trustee under the plan.

 "(e) Any guarantees or assurances of profit or against loss inherent in or attached to the security or any opportunities afforded thereunder.

 "(f) The life insurance feature of the plan.

 "(g) The nature and the character of the operation of the plan as a medium of investment or method for the installment or periodic purchase of trust shares or the manner in which moneys paid in thereon by purchasers thereof are invested in common stocks or the amount and percentage of all charges, fees, commissions and costs which are deducted from said moneys prior to such investment or from the income or return of principal of such investment

 "or any other untrue statements of material facts or omissions to state material facts necessary to be stated in order to make the statements made in the light of the circumstances under which they are made not misleading, similar to those specifically set forth above or of similar purport or object."

 After answer filed, making general denial, the Capital Savings Plan, Inc., and Independence Shares Corporation joined with the Securities and Exchange Commission in a consent decree June 23, 1938, restraining the two corporations from engaging in the practices complained of by the Commission.

 In essence, the instant proceeding is based on the same grounds as was set forth in the 1938 Securities and Exchange Commission complaint. The testimony adduced at five of six hearings held in the instant case overwhelmingly substantiates the allegations in the two proceedings.

 Before discussing this testimony and evidence, it is necessary to dispose of a motion to dismiss filed by the Independence Shares Corporation and the individual defendants, and a motion to dismiss filed by The Pennsylvania Company, &c.

 I shall consider the two motions in the order named.

 Independence Shares Corporation and the individual defendants moved to dismiss upon the grounds:

 (3) That the amount in controversy is less than $3000;

 (b) That there was not the requisite diversity of citizenship; and

 (c) That there is no jurisdiction in equity or for the appointment of a receiver because the complainants were unsecured simple contract creditors who had not reduced their claims to judgment had failed to realize upon execution process.

 All these contentions are without merit.

 Paragraph 1 of the bill of complaint contains jurisdictional averments stating that relief is sought under, inter alia, Section 22(a) of the Securities Act of 1933, as amended and supplemented, being the Act of May 27, 1933, Chapter 38, Title 1, Section 22(a), 48 Stat. 86, U.S.C. Title 15, Section 77v(a), 15 U.S.C.A. § 77v(a). The section referred to reads as follows:

 "(a) The district courts of the United States, the United States courts of any Territory, and the district court of the United States for the District of Columbia shall have jurisdiction of offenses and violations under this title and under the rules and regulations promulgated by the Commission in respect thereto, and, concurrent with State and Territorial courts, of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter. Any such suit or action may be brought in the district wherein the defendant is found or is an inhabitant or transacts business, or in the district where the sale took place, if the defendant participated therein, and process in such cases may be served in any other district of which the defendant is an inhabitant or wherever the defendant may be found."

 It becomes necessary in this connection to consider Chapter 38, Title 1, Section 12, of the Act (15 U.S.C.A. § 77 l), which reads:

 "Any person who --

 "(1) sells a security in violation of section 77e, or

 "(2) sells a security (whether or not exempted by the provisions of section 77c, other than paragraph (2) of subsection (a) thereof), by the use of any means or instruments of transportation or communication in interestate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he no longer owns the security."

 And finally, Chapter 38, Title 1, Section 16, of the Act (15 U.S.C.A. § 77p): "The rights and remedies provided by this subchapter shall be in addition to any and all other rights and remedies that may exist at law or in equity."

 It is evident that the allegations of the bill, which are assumed to be true for the purposes of the discussion of the motions to dismiss, bring the complaint within the provisions of the law quoted. For, according to those allegations, these defendants sold securities by means of a prospectus or oral communication, both of which included untrue statements of material facts or omitted to state material facts necessary to make the statements not misleading: wherefore under Section 12 they are liable to the purchaser for the amount of the consideration paid, with interest.

 We pass now to the other question raised by the motion to dismiss: That complainants are not entitled to come into equity because they are unsecured simple contract creditors who have neither ...


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