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Rochez Brothers Inc. v. Rhoades

decided as amended december 3 1975.: September 29, 1975.



Staley, Rosenn and Hunter, Circuit Judges.

Author: Staley


STALEY, Circuit Judge.

We are asked to determine whether a corporation is derivatively liable when its president has violated the fraud provisions of the Securities Exchange Act of 1934. Appellant, Rochez Brothers, Inc. ("Rochez"), appeals from the district court's finding that no evidence was presented to establish the liability of the corporate defendant, M.S. & R., Inc. ("MS&R"). Rochez argues that MS&R is liable under three theories: As a principal under agency concepts; as an aider-abettor and conspirator; and as a controlling person under Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. ยง 78t(a). We affirm the judgment of the district court, finding no support for appellant under any of its theories.

This case arose from a buy-sell agreement whereby Joseph Rochez sold fifty per cent of the MS&R issued and outstanding stock to Charles R. Rhoades. The essential facts have been well set forth in the district court's opinion*fn1 and in Judge Van Dusen's opinion in Rochez Bros., Inc. v. Rhoades, 491 F.2d 402 (3d Cir. 1974) and will not be repeated. It is sufficient here to briefly summarize the facts. Rhoades, President of MS&R, was found guilty of violating Rule 10b-5 of the Securities and Exchange Commission by his failure to disclose to Rochez, the Executive Vice President of MS&R, information that affected the value of the stock purchased by Rhoades from Rochez. Rhoades did not tell Rochez about two prospective purchasers of MS&R which were brought to Rhoades' attention by a financial adviser, Royce, employed by Rhoades to help him arrange financing for the purchase from Rochez. In September 1967, Rhoades entered into an agreement with Rochez for the purchase of Rochez's fifty per cent interest in MS&R; in July 1968, Esterline bought one hundred per cent of the MS&R stock then held by Rhoades and two other persons.

Suit was brought by Rochez and the case was tried to the court. Judgment was entered against Rhoades and in a separate order dismissed as to MS&R. The district court predicated its finding of guilt on the fact that Rhoades failed to disclose material information concerning possible buyers of MS&R prior to the sales agreement of September 1967. The court further held that Rhoades acted on his own at all times and "not in the course or scope of his employment," and because of this, MS&R could not be secondarily liable.*fn2 Rochez and Rhoades appealed seeking reversal of the district court's order. Rochez contended that MS&R was secondarily liable whereas Rhoades contended that he was not liable at all.

This court affirmed the liability of Rhoades. On the issue of corporate liability, Judge Van Dusen vacated the district court's order and remanded the case because the district judge failed to comply with Rules 41(b) and 52(a) of the Federal Rules of Civil Procedure by not making findings of fact to support the dismissal of MS&R. Rochez, supra at 413.

The district court on remand made findings of fact and remained of the view that "no sufficient evidence appears in the record" that would establish the liability of MS&R.*fn3 The district court maintained that the only time MS&R's facilities or employees were used by Rhoades was in the preparation of financial forecasts. These forecasts were not relied on by Rochez in the course of business nor by the district court in finding Rhoades' 10-b violation. Rochez, 353 F. Supp. at 802. The district court also found, in concluding MS&R was not liable, that these activities by the MS&R employees were "ministerial functions" and the employees had no reason to know that they were involved in anything unlawful or fraudulent. Considering de novo appellant's new theory of liability under Section 20(a), the district court found that MS&R was not a "controlling person" and at all times acted in good faith. The court concluded, therefore, that MS&R was not liable under Section 20(a).


Appellant first urges us to find MS&R liable under the principles of agency. There is no doubt that the fraud of an officer of a corporation is imputed to the corporation when the officer's fraudulent conduct was (1) in the course of his employment, and (2) for the benefit of the corporation. This is true even if the officer's conduct was unauthorized, effected for his own benefit but clothed with apparent authority of the corporation, or contrary to instructions.*fn4 The underlying reason is that a corporation can speak and act only through its agents and so must be accountable for any acts committed by one of its agents within his actual or apparent scope of authority and while transacting corporate business.*fn5 A corporation, however, is not liable for the fraud of its officer when the officer acted as an individual for his own account and the defrauded party knew that the officer was not acting for the corporation. Upon reviewing the record and the district court's findings of fact, we find no basis for imputing liability to MS&R. The circuit courts are split on what standards are applied to find secondary liability. This court has yet to express what standards govern secondary liability when a director is found guilty of a securities act violation. We are of the opinion that, after reviewing the legislative history of the 1934 Act and the pertinent cases, the principles of agency, i.e., respondeat superior, are inappropriate to impose secondary liability in a securities violation case.

It is helpful to evaluate the legislative history of the 1934 Act and specifically Section 20(a) thereof, which governs liability of controlling persons.*fn6 By enacting Section 20(a), Congress wanted to impose liability on persons who were able to directly or indirectly exert influence on the policy and decision-making process of others. Although Section 20(a) does not define "control," it is clear that the evidence in each case must be examined to determine to what extent the controlling person was involved in the fraudulent scheme. The legislative history of Section 20(a) illustrates that Congress intended liability to be based on something besides control. That something is culpable participation.

The Senate and the House each advanced its version of what standard should govern controlling persons. The Senate proposed an "insurer's liability" standard, while the House opted for a "fiduciary standard" which would impose a duty of due care. S. Rep. 47, 73d Cong., 1st Sess. 5 (1933) (The Fletcher Report); H.R. Rep. 85, 73d Cong., 1st Sess. 5 (1933); H.R. Rep. 152, 73d Cong., 1st Sess. 27 (1933). The House version was adopted, indicating that Congress did not intend anyone to be an insurer against the fraudulent activities of another. What Congress did intend was to impose liability on those who were controlling persons and who were "in some meaningful sense culpable participants in the fraud perpetrated by controlled persons." Lanza v. Drexel & Co., 479 F.2d 1277, 1299 (2d Cir. 1973).

Judge Adams in Kohn v. American Metal Climax*fn7 reviewed the legislative history of Rule 10b-5 and concluded that Congress, through the use of words such as "'cunning,' 'manipulative,' 'deceptive,' 'fraudulent,' 'illicit,' 'fraud,' and lack of 'good faith'" intended that liability would not attach unless the element of culpability was present. Kohn, supra at 280. Since the standard of culpability is ever-present in the securities laws, it is reasonable that the same standard should be included in Section 20(a). Section 20(a) also provides a good faith defense. If we were to apply respondeat superior, the availability of this good faith defense would be bypassed. Therefore, to use respondeat superior for imposing secondary liability would not advance the legislative purpose of the 1934 Act and in fact would also undermine the Congressional intent by emasculating Section 20(a).

We also find support for this position in several cases that dealt with the question of applicable standards for secondary liability. In Myzel v. Fields, 386 F.2d 718 (8th Cir. 1967), cert. denied, 390 U.S. 951, 19 L. Ed. 2d 1143, 88 S. Ct. 1043 (1968), the Eighth Circuit indicated that liability for securities act violations was governed by Section 20(a) and not by any agency theories. In Kamen & Co. v. Paul H. Aschkar & Co.,*fn8 the trial court awarded judgment to the plaintiff on agency principles. On cross appeal, the plaintiff contended that since the employee was liable, the employer should also be liable. The Ninth ...

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