APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY. (D.C. Civil Action No. 1561-70)
Kalodner, Adams, and Rosenn, Circuit Judges.
An incredible misuse of funds in stock market speculation*fn1 by Douglas Schotte, president of the Eatontown National Bank (ENB), rapidly culminated in its financial collapse. This appeal involves a series of complex issues spawned by that catastrophe. The appellants, four named plaintiffs in the district court, brought suit in the District of New Jersey under the federal securities laws on behalf of themselves as purchasers of ENB's shares between January 1, 1967, and August 8, 1970, on behalf of the class of all other shareholders of the bank who purchased stock during that period, and derivatively on behalf of the now defunct bank.*fn2 The appellants are Eugene Landy, a bank director, Gloria Landy, his wife, Harry Gross, his wife's uncle, and Freehold Glass Co., Inc., Gross's corporation.
The United States Comptroller of the Currency closed ENB on August 8, 1970, after the discovery of the vast misappropriations of funds. According to appellants' complaint, Schotte devised a simplistic scheme of speculation in the securities market, hoping euphorically that the stocks purchased would rise in value prior to the time for payment. Without any authorization, he traded in the name of the bank and covered his losses with cashier's checks issued without consideration to the bank. Apparently, Schotte delayed payment for the purchased securities until the brokers pressed him, a delay often considerable because of a mixture of broker backroom office problems and their desire to retain Schotte's burgeoning business. When pressed for payment, Schotte either sold the stock if it had appreciated or issued a cashier's check signed by him as president of ENB. He allegedly concealed the scheme by making false statements to the shareholders and causing ENB to issue false financial statements. The scheme failed, leaving ENB with a devastating loss estimated at four million dollars.
The defendants in this suit are:
(1) Twelve brokerage firms that opened accounts and executed transactions with Schotte, and sixteen individuals associated with these brokerage firms;
(2) The New York Stock Exchange (NYSE);
(3) The National State Bank of Elizabeth, New Jersey (the Elizabeth Bank);
(4) The Federal Reserve Bank of New York (the Reserve Bank);
(5) Edward R. Burt & Co. (Burt), a firm of certified public accountants;
(6) The Federal Deposit Insurance Corp. (FDIC) in its capacity as receiver for the Eatontown Bank; and
Schotte and the FDIC, as receiver (standing in for the defunct bank), are allegedly liable under section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, and rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, as a result of the scheme and false representations.
As to the brokers and firms, the complaint avers: they are liable under rule 10b-5, and, independently liable, for violation of the New York Stock Exchange "know your customer" rule and regulations of the Board of Governors of the Federal Reserve System; they allowed Schotte to open accounts in violation of the National Banking Act; they knew that the accounts were a part of a scheme to defraud the shareholders; they knew Schotte was not acting in a fiduciary capacity as he purported; they allowed the fraud to continue in order to garner the commissions generated, ultimately aggregating three million dollars; and four individual brokers made misleading statements to the appellants.
The complaint alleges that the Elizabeth Bank was the correspondent bank for ENB and provided its computer services. When Schotte would issue the cashier's checks without depositing the necessary funds, the payee would deposit the checks in its bank and they would be cleared through the Reserve Bank. Although ENB did not have the requisite funds to cover the checks and pay the Reserve Bank, Schotte induced the Elizabeth Bank to somehow credit an ENB account with the funds necessary to pay the Reserve Bank. The complaint also alleges that: Schotte was in some manner able to return the same check as many as four or five times and have funds credited at the Elizabeth Bank; the Elizabeth Bank was negligent in handling the ENB account; the funds created by the Elizabeth Bank did not appear on the ENB books, thus allowing Schotte to misappropriate approximately four million dollars; and the returned cashier's checks were manually processed, and the daily statements of account of ENB revealed to the Elizabeth Bank the misuse of the account.
The complaint also alleges that the Reserve Bank was liable because it continued to process and reprocess the same cashier's checks, thus allowing payment for checks with the same or similar checks. The actions were allegedly negligent, violated contractual agreements with ENB, and violated the Reserve Bank's own rules and regulations.
The firm of Edward R. Burt & Co. prepared certified financials for ENB in the years 1967, 1968, 1969, and 1970. In addition, they were retained to conduct four partial examinations of ENB on a surprise basis each year. They allegedly issued an erroneous certification of the condition of the bank, which constituted a misstatement in violation of rule 10b-5, negligence under the New Jersey common law, and a breach of duty of care owed the shareholders. The certified financial statements, in reliance on which plaintiffs claimed to have purchased their shares, were also alleged to be false and misleading because they failed to state important facts.
The New York Stock Exchange is allegedly liable for willfully failing to enforce its rules pertaining to members. It allegedly allowed member firms to operate with incomplete records and lost securities. Plaintiffs say the records are in such disorder that it is impossible to trace the approximately two hundred million dollars in securities traded by Schotte or to determine whether the securities held by the brokers are actually assets of ENB. Moreover, according to the complaint, it would have been impossible for Schotte to perpetrate the fraud if the Exchange enforced its rules 410, 415-21, and 425 on proper recordkeeping, and had it enforced rule 325 requiring the brokerage firms to maintain an adequate capital base.
Appellants sued the various defendants in a number of capacities. All defendants except the Elizabeth Bank, the Reserve Bank, and the NYSE were sued by the plaintiffs on behalf of themselves, derivatively on behalf of the bank, and on behalf of the class of all stockholders who purchased during the relevant period. The three designated defendants were sued only derivatively. In addition, the brokers' liability for violations of Federal Reserve Board regulations was asserted only derivatively.
In an opinion and order dated September 9, 1971, the district court denied the motions of the FDIC and Burt (except insofar as suit was brought against them derivatively) to dismiss the complaint, but granted similar motions by the brokers, the Elizabeth Bank, the Reserve Bank, and the NYSE. Schotte made no motion. In an opinion and order dated December 9, 1971, the district court granted Burt's motion to dismiss the class action against it, granted its motion for summary judgment against Gloria Landy, Gross, and Freehold Glass, and denied summary judgment against Eugene Landy. Plaintiffs have appealed from the aforesaid orders and judgments, except from the dismissal of the class action.*fn3
These decisions left standing only the claim of Eugene Landy against defendant Burt and the claims of the named plaintiffs as individuals and on behalf of the class against the FDIC as receiver and against Schotte. Subsequent to the district court decisions in this case, the FDIC, as receiver, initiated a suit on behalf of the bank against defendant corporate brokers, several additional brokerage firms, and accountant Burt.*fn3a
We affirm the orders of the district court except that part of the order of September 9, 1971, dismissing the derivative counts against the parties not named as defendants in the suit since brought by the FDIC, as receiver.
We will consider the multiplicity of issues involved in the claims brought by the various plaintiffs in their varying capacities against the many defendants in the following order:
I. Can any of the claims be brought derivatively?
II. As to the claims brought by the plaintiffs individually, was the district court disposition of them correct as to
No separate discussion of the claims against the Elizabeth Bank, the Reserve Bank, or the New York Stock Exchange is included as those claims are all brought derivatively. There is also no separate discussion of the validity of the class action in light of our disposition of the individual claims.
A threshold question in this multi-faceted suit is whether the plaintiffs can maintain a derivative action on behalf of ENB in the absence of a demand upon it to bring suit. Plaintiffs brought derivative actions against each of the brokerage firms named as defendants, the individual brokers, and all others named as defendants in the first 30 counts of their complaint. They also brought derivative actions against the accountant, the NYSE, the Elizabeth Bank, the Reserve Bank, and the FDIC, the latter as a nominal defendant in its capacity as receiver. In their original complaint, they explained their failure to request institution of this suit by the FDIC as follows:
Because of the receivership of the Eatontown National Bank, no demand can be made upon the shareholders to bring this action, nor upon the directors of the Eatontown National Bank. Further, the Federal Deposit Insurance Corporation, in its role as creditor, will be in a conflict of interest with its role as Receiver in pursuing the aforesaid claim.
The district court dismissed as "premature" the derivative causes of action on behalf of ENB against all defendants on the ground that plaintiffs, as shareholders of ENB, had no standing to institute suit in its behalf in the absence of a demand on and a refusal by the FDIC to bring such suit, as well as a failure to show why such demand need not have been made. It rejected plaintiffs' allegation that the FDIC's built in conflict of interest could serve as a basis for their derivative action because to do so would "severely restrict Congressional intent expressed in 12 U.S.C. § 1821(d)."
As a general principle, the responsibility for determining whether or not a corporation shall enforce in the courts a cause of action for damages is, like other business questions, ordinarily a matter of internal management left to the discretion of the directors, United Copper Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-264, 61 L. Ed. 1119, 37 S. Ct. 509 (1917). Otherwise a litigious stockholder could easily intrude upon authority of those who are vested with responsibility for the operation of the corporation's business. Whether to forego an action or to bring suit for damages is a matter of business judgment. Such decision may involve not merely a consideration of legal principles but a balancing of business interests and relationships.*fn4 The rationale of this principle is reflected in Rule 23.1 F.R.C.P. which provides, in substance, that a stockholder may not bring a derivative action to enforce a right of the corporation against a third party unless (1) the corporation has failed to enforce a right which might properly be asserted by it, and (2) the complaint alleges "with particularity the efforts, if any, made by the plaintiffs to obtain the action he desires from the directors or comparable authority . . ., and the reasons for his failure to obtain the action or for not making the effort."*fn5
On appeal, the plaintiffs urge that the district court erred in dismissing their derivative action because the defrauded ENB shareholders are not required to make demand upon the bank receiver to bring the suit or to rely upon it to prosecute their derivative claims, when, as in this case, there are serious conflicts of interests between the FDIC and the shareholders. They argue the conflict of interest rendered a demand by ENB's shareholders on the FDIC "presumptively futile" and they should be permitted to press their derivative claims independently of the FDIC without first having made demand.
They argue that the conflicts of interests are:
(1) The FDIC is a subrogee of the claims of ENB's depositors as the insurer of their accounts and is, therefore, a major creditor of ENB interested in recovering only the amount necessary to pay the claims of depositors.
(2) The FDIC, as an insurer of the accounts of depositors of the Elizabeth Bank, has an interest in the solvency of that bank which may be endangered by this action. They further assert a conflict since FDIC supervises and regulates the Elizabeth Bank and might have an interest in concealing that which it failed to discover previously.
(3) Both the FDIC and the Reserve Bank are quasi-governmental agencies which, along with the Comptroller of the Currency, share the supervision of national banks. Two of the three directors of the FDIC are the Comptroller of the Currency and the Chairman of the Board of Governors of the Federal Reserve System, to which the defendant Reserve Bank belongs. Thus, it is "unrealistic to presume conclusively, as did the Court below, that the FDIC would as vigorously prosecute the claim against the Reserve Bank as would the Eatontown shareholders." As evidence of a reluctance of the FDIC to prosecute the Reserve Bank, they assert that the FDIC has already paid it a claim for approximately three million dollars in overdrafts in the ENB account. They note that the Comptroller of the Currency is charged with examinations of ENB which failed to disclose the secret trading by Schotte, and that he might want to cover up that activity at this time. They aver also that in the suit finally instituted by the FDIC, as receiver, subsequent to the commencement of this action, the Elizabeth Bank and the Reserve Bank were not named as defendants.
The general rule is that a receiver may institute any suit on behalf of the corporation as the corporation itself might have commenced. W. Fletcher, Cyclopedia of the Law of Private Corporations § 7847 (1962 Revised Edition).
When a corporation is in receivership, any demand to bring suit in its behalf must be made upon the receiver rather than the directors. See, e.g., Wachsman v. Tobacco Products Corp., 129 F.2d 815, 819 (3d Cir. 1942); Long v. Stites, 88 F.2d 554 (6th Cir.), cert. denied, 301 U.S. 706, 81 L. Ed. 1360, 57 S. Ct. 939 (1937). This rule also applies to receivers of national banks. See, e.g., Lucking v. Delano, 129 F.2d 283 (6th Cir. 1942); Wales v. Jacobs, 104 F.2d 264 (6th Cir.), cert. denied, 308 U.S. 559, 60 S. Ct. 130, 84 L. Ed. 501 (1939); Davis Trust Co. v. Hardee, 66 App. D.C. 168, 85 F.2d 571 (1936). "The receiver . . . becomes to all intents and purposes the bank -- at least he stands in the place of the bank; . . . the receiver, after his appointment, represents the bank, its stockholders and creditors." O'Connor v. Rhodes, 65 App. D.C. 21, 79 F.2d 146, 148 (1935). Section 1821(d) of 12 U.S.C.*fn6 generally directs that the FDIC as receiver shall enforce the individual liability of the stockholders and directors, wind up the affairs of the closed bank, and pay to the depositors and other creditors the net amounts available for distribution to them. It also provides that the FDIC shall have all rights, powers, and privileges granted by law to a receiver of a national bank or District bank. 12 U.S.C. § 1819 specifically confers the power to sue.
A derivative suit by shareholders should not be precluded merely because a bank is in the receivership of the FDIC. The FDIC would remain free to exercise its control over the winding up of the bank and to institute suit itself on behalf of the corporation. Congress has given no indication that it intended to preclude derivative suits by the shareholders of a national bank in receivership. When a receiver refuses to bring suit or "where it would be a vain thing to make a demand upon [it], and it is shown there is a necessity for a suit for the protection of the interests of creditors," a stockholder is free to sue. O'Connor v. Rhodes, 65 App. D.C. 21, 79 F.2d at 149, aff'd sub nom. United States Shipping Board Merchant Fleet Corp. v. Rhodes, 297 U.S. 383, 80 L. Ed. 733, 56 S. Ct. 517 (1936). Moreover, we agree with the statement that:
To say that in every case the rule of exclusive power in the receiver is positive and admits of no exception, would be to sacrifice substantial rights to matters of form.
Id. at 148-49. We believe this case should be treated under the same principles applied to any derivative suit.
The allegations in plaintiffs' original and amended complaint, however, are merely general. The amended complaint alleges that a demand upon the FDIC would have been futile because, as receiver, it would be unable to sue because of its "conflict of interest between various government agencies and its regulatory and insurance functions." These allegations do not supply with particularity the reasons for failing to make the demand required by Rule 23.1. Instead of being "a statement of appropriate and convincing facts" that a demand would have been futile, O'Connor v. Rhodes, 79 F.2d at 148, it is merely a vague, conclusory statement.
Even had the plaintiffs averred with sufficient particularity, as required by Rule 23.1, their reasons advanced on appeal for failing to make a demand upon the receiver, we do not believe that the district court would have erred in dismissing the derivative claims as premature. We do not believe that even the reasons asserted on this appeal as grounds for relieving the plaintiffs of making demand upon the receiver to bring suit are adequate. In Ash v. International Business Machines, Inc., 353 F.2d 491, 493 (3d Cir. 1965), we stated:
The Supreme Court and, following it, the Courts of Appeals have repeatedly stated and applied the doctrine that a stockholder's derivative action, whether involving corporate refusal to bring anti-trust suits or some other controversial decision concerning the conduct of corporate affairs, can be maintained only if the stockholder shall allege and prove that the directors of the corporation are personally involved or interested in the alleged wrongdoing in a way calculated to impair their exercise of business judgment on behalf of the corporation, or that their refusal to sue reflects bad faith or breach of trust in some other way.
This principle enunciated in Ash applies with equal force to a national bank represented by a receiver mandated by congressional statute. Under the statutory schema created by Congress for our national banking system, the FDIC plays a vital role in the effective and efficient liquidation of insolvent national banks which is of far-reaching importance to the national government, the public, and the parties in interest. Reposed in it are broad powers, grave responsibilities, and delicate duties, all requiring the exercise of judgment and discretion. See Liberty National Bank v. McIntosh, 16 F.2d 906 (4th Cir. 1927). "He [the receiver] acts for the stockholders in dealing with the assets," and may even ratify a liquidating contract for the bank in place of the shareholders. Wegman v. National Bank of Commerce, 51 F.2d 288, 290 (W.D.N.Y. 1931).
The first reason urged by defendants that FDIC, as a major creditor of ENB, has a conflict of interest which "could be extremely prejudicial to the interests of Eatontown's shareholders", flies in the face of Congressional directive. Congress has explicitly authorized the FDIC to act as receiver, 12 U.S.C. § 1819, and has required the Comptroller to appoint the FDIC as receiver of any insured national bank which is closed. 12 U.S.C. § 1821(c). Thus, under the federal banking laws the FDIC has the right to act for a closed (insolvent) bank and its stockholders. Moreover, in specifically providing in § 1821(d) that the FDIC as receiver should ". . . pay to itself for its own account such portions of the amounts realized from . . . [the] liquidation as it shall be entitled to receive on account of its subrogation to the claims of depositors . . .", Congress recognized that the FDIC would be functioning in the dual role of receiver and creditor. The FDIC's role as receiver had, as the district court aptly observed, "the primary objective . . . to marshal funds for distribution, a goal which would include protection of shareholders." [Emphasis added.] Plaintiffs' argument that as shareholders of ENB they should not be compelled to rely upon the FDIC to prosecute their derivative claims is essentially predicated on the proposition that the FDIC is "a major creditor of Eatontown" and as such its interest in recovering against defendants will be "limited to its losses arising out of the payment of the insurance claims of Eatontown's depositors." Implicit in this argument is the assumption that the FDIC will not carry out its statutory duties as receiver, obligations which transcend the interests of both creditors and stockholders. We will not make such a presumption in the absence of factual allegations supporting it.
The second reason advanced by plaintiffs, namely that the FDIC, as an insurer of the Elizabeth Bank, has a conflicting interest in its solvency, is also without merit. Nothing in this record intimates that a recovery against the Elizabeth Bank would in any way threaten its solvency or have an adverse impact on the FDIC, or that any other obligation of the FDIC would prevent or inhibit it from properly performing its statutory obligations.
We also find insufficient the third reason urged by plaintiffs, that the FDIC would not as vigorously press the claim against the Reserve Bank as would the ENB shareholders since both are "quasi-governmental agencies" and since directors on the Board of the FDIC have conflicting responsibilities in the Federal Reserve System and in the supervision of national banks.
Plaintiffs have attempted to substantiate their conflict of interest argument by asserting that two of the three directors of the FDIC are the Comptroller of the Currency and the Chairman of the Board of Governors of the Federal Reserve System. The Reserve Bank disputes the accuracy of the allegation that the Chairman of the Board of Governors of the Federal Reserve System is one of the three directors of the FDIC. Section 1812 of 12 U.S.C. provides that management of the FDIC "shall be vested in a Board of Directors consisting of three members, one of whom shall be the Comptroller of the Currency, and two of whom shall be citizens of the United States to be appointed by the President, by and with the advice and consent of the Senate." No designation whatsoever is made of the Chairman of the Board of Governors of the Federal Reserve System. By virtue of the foregoing statute, control of the FDIC Board of Directors could be in the two citizen members. Moreover, § 1821(d) expressly guards the FDIC as receiver of closed banks from supervision by the Comptroller of the Currency:
In the exercise of such rights, powers, and privileges the Corporation shall not be subject to the direction or supervision of the Secretary of the Treasury or the Comptroller of the Currency.
The mere presence under these circumstances on the Board of Directors of the FDIC of the Comptroller of the Currency does not per se constitute an inhibiting conflict of interest, especially in the absence of any specific allegation of the Comptroller's wrongful supervision of ENB which he might now desire to cover up, or of his bad faith as to any aspect of this litigation.
Developments since this case was heard by the district court suggest, however, that the question of the propriety of derivative claims against some of the defendants should be remanded for further consideration by the district court. When this matter was originally heard, "the receiver . . . stated to the court that it does in fact intend to bring suit against all parties responsible for the collapse of the bank. Until that representation is either contradicted by specific acts or inaction or until plaintiffs make a demand upon the FDIC they are without standing to pursue the matter independently." (District Court opinion of September 9, 1971). Appellants have in their brief called to our attention that the FDIC has brought suit against many of the defendants named in this action since the district court's entry of its order of dismissal, but has not named the Elizabeth Bank, the Reserve Bank, Schotte, the NYSE, and some of the brokers as parties. See note 3A supra. This statement is conceded in the joint brief of appellee brokers and the briefs of the FDIC and the Reserve Bank and is controverted by none of the appellees.
Normally, the court of appeals will consider only the record and facts considered in the district court. We specifically held in Jaconski v. Avisun Corporation, 359 F.2d 931, 936 n.11 (3rd Cir. 1966), that:
We can consider the record only as it existed at the time the court below made the order dismissing the action.
See also Dictograph Products Company v. Sonotone Corporation, 231 F.2d 867 (2d Cir. 1956), petition for certiorari dismissed by stipulation, 352 U.S. 883, 77 S. Ct. 104, 1 L. Ed. 2d 82 (1956); Rule 10(a), Federal Rules of Appellate Procedure.*fn6a Neither Jaconski nor Dictograph Products Company, however, involved the right of an appellate court to take judicial notice of developments in the proceeding since the appeal was lodged.
The normal rule is subject to the right of an appellate court in a proper case to take judicial notice of new developments not considered by the lower court. 31 C.J.S., Evidence § 13, at 842 (1964).*fn6b The credibility of witnesses is not here involved. In Bryant v. Carleson, 444 F.2d 353 (9th Cir. 1971), the Ninth Circuit recognized this limited exception in taking judicial notice of developments since the appeal, including filings, motions and orders in the district court and court of appeals, relevant administrative action of the Administrator of the United States Department of Health, Education and Welfare, and a decision of the California Supreme Court in a related matter. See also United States v. Verlinsky, 459 F.2d 1085 (5th Cir. 1972); Kalimian v. Liberty Mutual Fire Insurance Company, 300 F.2d 547 (2d Cir. 1962). In Kirby v. Pennsylvania R. Co., 188 F.2d 793, 795 (3d Cir. 1951), this court took judicial notice of a paper describing the operation of the Railroad Adjustment Board, although acknowledging that the paper was "not in the record." See also Parliman v. Delaware, L. & W. R.R., 163 F.2d 726, 730 (3d Cir. 1947); United States v. Monjar, 154 F.2d 954, 956 (3d Cir. 1946).
Judicial notice is frequently taken, of course, of developments not of record subsequent to a lower court decision in the application of the mootness doctrine by appellate courts. See, e.g., Johnson v. New York State Education Department, 409 U.S. 75, 34 L. Ed. 2d 290, 93 S. Ct. 259 (1972) (matter called to court's attention in one of the parties' briefs); Bethlehem Mines Corp. v. United Mine Workers, No. 72-1466 (3d Cir. 1973). In the case sub judice, the justification for taking judicial notice is even greater because the subsequent developments were in the very court in which this suit was instituted, in a related matter, and merely involved notice of the filing of the new action and the parties thereto. This situation is similar to Pittsburgh Newspaper Printing Pressman's Union v. Pittsburgh Press Co., 479 F.2d 607 (3d Cir. 1973), in which we took judicial notice of subsequent arbitration and proceedings in the court of appeals. We also note that rule 201(f) of the Proposed Rules of Evidence for United States Courts and Magistrates, as explained by the Advisory Committee's Note, provides that judicial notice may be taken at any stage of the proceeding, even on appeal. 56 F.R.D. 183, 206.
We therefore take judicial notice of the complaint filed by the FDIC. Appellants suggest that we should consider on this appeal the subsequent developments in deciding the appropriateness of a derivative suit. We think it appropriate, however, to remand to the district court rather than decide this issue now. This is the course the Supreme Court adopted in Johnson v. New York State Education Department, 409 U.S. 75, 34 L. Ed. 2d 290, 93 ...