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September 27, 1978

Stanley SHARP et al.

The opinion of the court was delivered by: LORD, III

Plaintiffs, investors in an oil drilling venture, alleged in this class action that the defendant, a major accounting firm, is liable to them for misstatements in several opinion letters which advised them as to the supposed tax consequences of those investments. Four theories of liability have been advanced by the plaintiffs: (1) liability for violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and of Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, by employees of the defendant (Count One); (2) liability as a controlling person of its employees under § 20(a) of the Securities Exchange Act (also Count One); (3) fraudulent misrepresentations by defendant's employees (Count Two); and (4) negligent breach by employees of the defendant of their common law duty owed to plaintiffs (Count Three). We have pendent jurisdiction over the last two claims.

We certified a class consisting of all persons who purchased these securities after July 22, 1971, 70 F.R.D. 544 (E.D.Pa.1976). There ensued an apparent novelty in our jurisprudence: a jury trial of issues common to the class under the Rule 10b-5, § 20(a) and pendent claims. These issues included foreseeability of damages, the exercise of reasonable care, whether there were misrepresentations and omissions and, if so, their materiality and scienter, and whether the defendant controlled an employee for § 20(a) purposes and adequately supervised him. We bifurcated the trial, and individual issues such as reliance, amount of damages and statute of limitations defenses have not yet been tried. After the jury returned answers to special interrogatories, plaintiffs moved for judgment n. o. v. with respect to one of those answers and to vacate the judgment as to Count Three (negligence), and the defendant moved for judgment on all counts in accordance with those answers, for judgment n. o. v. on the fraud and Securities Exchange Act counts and for a new trial on various grounds. We will grant only the plaintiffs' motion to vacate the judgment as to Count Three.


 Plaintiffs are persons who purchased limited partnership interests in oil wells to be drilled in Kansas and Ohio, of which Westland Minerals Corporation (WMC) was general partner and promoter. As a result of criminal fraud by WMC, many of these wells were never drilled and much of the invested money was diverted to WMC's own use. Economic Concepts, Inc. (ECI), the selling agent for these limited partnerships, and WMC sought to engage in April 1971 the services of defendant in rendering opinions as to the federal income tax consequences of these limited partnerships. In July the defendant decided to write such opinion letters, and on July 22, 1971, an opinion letter signed by a Coopers & Lybrand partner in its name was sent to Charles Raymond, president of WMC, stating that "based solely on the facts contained (in the WMC Limited Partnership Agreement) and without verification by us" a limited partner who contributed $ 65,000 in cash could deduct approximately $ 128,000 on his 1971 tax return. That letter was drafted by defendant's employee Herman Higgins, who was at that time a tax supervisor working directly under the supervision of four partners of defendant. The letter was written specifically for the use of one Muhammed Ali, a potential WMC investor, with regard to reducing the amount of taxes that would be withheld from a fight purse. In early October 1971 Higgins told David Wright, a partner in the defendant firm, that copies of the July 22 letter had been shown to individual investors besides Ali, and Wright determined that a letter which would be seen by other investors should be more complete. Higgins redrafted the opinion letter, and on October 11, 1971, defendant sent another opinion letter, signed in defendant's name by Wright, and a covering letter to Raymond.

 The jury found that the October 11 letter contained both material misrepresentations and material omissions, and that Higgins acted either recklessly or with intent to defraud in preparing the letters. Much of the evidence concerning those misrepresentations and omissions and their recklessness came from plaintiffs' expert witness, Professor Bernard Wolfman of the Harvard Law School, a specialist in federal income taxation. Most of his testimony was not rebutted by the defendant. Professor Wolfman explained the principles behind this tax shelter: a taxpayer who in 1971 contributed $ 25,000 to a partnership involved in a bona fide oil drilling venture, which then obtained for each $ 25,000 contribution an additional $ 25,000 bona fide bank loan that was fully secured by partnership property (the as yet undrilled wells) and then expended all of that $ 50,000 for drilling, could under the law applicable in 1971 deduct the full $ 50,000 from his taxable income. The effect would be to accelerate the tax deduction available to the investor in 1971. Professor Wolfman's expert testimony in concert with other evidence provided the basis for the jury's findings that the October 11 letter misrepresented or omitted to state material facts in at least three ways.

 First, Professor Wolfman testified that writing such a letter was reckless on its face in that it omitted to state that the non-recourse loan which the letter assumed lending institutions would make to WMC, the value of which loan would be deductible by the taxpayer according to the opinion letter, would have to be secured by collateral (I. e., the oil wells) whose value was equal to or greater than the amount of that loan. Non-recourse loans of the type contemplated by the opinion letter (I. e., with no personal liability to the limited partners) are very rarely entered into by banks for oil drilling ventures, according to Professor Wolfman, because it is hard to secure them fully by undrilled wells, whose value is not known. Unless the value of the property used by the partnership to secure the loan were equal to the amount of the loan, Professor Wolfman explained, the amount of the loan would not be deductible to the limited partner under § 752(c) of the Internal Revenue Code. To assume this unlikely fact that the loans would be thus secured without stating the assumption was itself reckless, he said.

 Second, the plaintiffs introduced evidence, principally through Higgins' testimony before a grand jury, that at the time Higgins drafted the October 11 letter he was aware of a number of facts because of his close relationship with ECI and WMC. In particular, this evidence suggested that Higgins as of October 11: (a) had recommended to WMC that it take the bank loans through mere bookkeeping transactions "without having to make a bank loan in the normal sense that we think of," (b) knew that WMC had acquired a bank, International Bank & Trust of the Bahamas (IBT), (c) knew that IBT was insolvent, or at least unable to make the loans necessary to fund the oil drilling ventures contemplated by the WMC limited partnership agreements and (d) knew that the actual drilling costs for each limited partnership would be less than $ 140,000. Higgins testified at his deposition that, while under the transaction contemplated by this "paper loan" WMC would not have access to the money it would "borrow" from IBT, that was "not a difference . . . that in my opinion would be that critical from the tax point of view." As it turned out, many of these facts were untrue as a result of WMC's fraud.

 Professor Wolfman stated that if the writer had made such a recommendation and was aware of these facts, the October 11 letter contained a number of misstatements: that the driller would receive $ 140,000 in cash, that there would be partnership borrowing and that such borrowing would be from a suitable bank or other lending agency. These misrepresentations, which the jury could have found were intentional or at least reckless, in turn rendered the opinion as to tax consequences a misrepresentation, again at best recklessly made, because it was based on assumptions known to be false.

 Third, the plaintiffs established that as of October 11 Higgins had decided to leave defendant's employ and that he had as of October 8 taken a leave of absence and was remaining there only to finish the opinion letter. There was evidence that by October 6 Higgins was working closely with ECI, WMC's selling agent, and on October 16 he got powers of attorney from Raymond to execute and file papers for WMC, of which Raymond was president, and for IBT, of which he was board chairman. Professor Wolfman testified that it was improper for an employee of an accounting firm who was employed by ECI to write a tax opinion letter and that the failure to disclose his relationship with the selling agent would be a material omission which would appear to have been intentional or reckless.

 The jury concluded that, while Higgins caused the material misrepresentations and omissions in the October 11 letter recklessly or with an intent to defraud, no partner of the defendant firm caused any misstatements with such scienter. It also found no misrepresentations or omissions in the July 22 letter, so that liability is limited to those relying on the October 11 letter. With respect to the plaintiffs' negligence claim, the jury determined that defendant failed to exercise reasonable care but said that it was not foreseeable to the defendant that plaintiffs would be injured as a result of its negligent misrepresentations. With respect to common law fraud, the jury determined there was clear and convincing proof that the misrepresentations and omissions were made recklessly but not that they were made with knowledge and intent to deceive. Again, liability can arise only from reliance on the October 11 letter. The responses to interrogatories under § 20(a) of the Securities Exchange Act were that the defendant had the power to control Higgins' wrongful activities and that its good-faith defense of reasonably adequate supervision of Higgins had not been made out.


 After considerable dubitation as to whether the defendant could owe a duty to the plaintiff investors to exercise reasonable care in writing its opinion letters, we charged the jury and included interrogatories as to negligence. The questions we deemed common to the class were the existence of a duty to the plaintiffs and the defendant's standard of care. After the jury found that the defendant was negligent but that the named plaintiff's injury was not foreseeable to it, we entered judgment for the defendant on Count Three on the ground that defendant owed no duty of reasonable care to plaintiffs whose injury was not foreseeable. Plaintiffs have moved for judgment n. o. v. on the foreseeability issue and assert they should be allowed to pursue individual damage claims on a negligence theory.

 There looms a threshold question of what common law governs as to this pendent claim. As a federal court exercising pendent jurisdiction, we are bound to invoke the choice of laws rules of the forum state, 1A Moore's Federal Practice P 0.305(3) at 3056 (1977), at least where there is direct authority from the highest court of a state. Cf. Towner v. Commissioner of Internal Revenue, 182 F.2d 903, 907 (2d Cir.), Cert. denied, sub nom. Estate of Farrell, 340 U.S. 912, 71 S. Ct. 293, 95 L. Ed. 659 (1950). The controlling Pennsylvania choice of laws principle in tort cases generally is that enunciated in Griffith v. United Air Lines, Inc., 416 Pa. 1, 203 A.2d 796 (1964), that the law of the state bearing the most significant relationship with the occurrences and parties in a case ought to be applied. Neither party has argued on these motions that the selection of applicable state law is significant or that a particular state law should apply. We believe, to the contrary, that determining whose law applies might be crucial to the liability of the defendant under the negligence claim on the issue of duty.

 Our difficulty with making a choice of law analysis at this point is that we do not yet know in the case of each individual plaintiff which state has the most significant relationship with the occurrences and the parties. Normally, in a tort case this will be the state in which the injury occurred. However, individual cases may contain individual factors which could cause us, under Pennsylvania's choice of law rules, to look to a state other than the state of injury.

 But even if we were to reach the usual result in tort cases and apply the law of the state of injury, we still do not know which law to apply since on this record we do not know the state in which each of the individual plaintiffs was injured. That the interests of more than one state are involved is inevitable. The problem is that we do not know on this record how many or which states are involved with respect to each plaintiff's claim. Therefore, any discussion of the law of any given state at this time would be both premature and futile. Since the pendent common law claims involve several state law questions, such as the duty of accountants to third persons, reliance, statute of limitations defenses and damages, it is manifestly impossible for us to decide those questions as to each individual state until we first determine which state law to apply.

 The plaintiffs have moved for judgment n. o. v. with respect to the jury's finding that the defendant could not foresee that the named plaintiff would be likely to be injured by its negligence. Whatever its merits, we are unable to consider this motion because the plaintiffs did not move for a directed verdict under F.R.Civ.P. 50(a) as to foreseeability or as to Count Three generally. A motion for judgment n. o. v. based on a ground not raised in a party's motion for a directed verdict cannot be granted. C. Albert Sauter Co., Inc. v. Richard S. Sauter Co., Inc., 368 F. Supp. 501, 509 (E.D.Pa.1973); 5A Moore's Federal Practice P 50.08, at 50-86 & n.3 (1977). The Third Circuit has interpreted strictly the requirement of F.R.Civ.P. 50(b) that a motion for a directed verdict after the presentation of all evidence is a prerequisite to a motion for judgment n. o. v. DeMarines v. KLM Royal Dutch Airlines, 580 F.2d 1193 at 1195 n.4 (3d Cir. 1978); Lowenstein v. Pepsi-Cola Bottling Co. of Pennsauken, 536 F.2d 9 (3d Cir.), Cert. denied, 429 U.S. 966, 97 S. Ct. 396, 50 L. Ed. 2d 334 (1976); Beebe v. Highland Tank and Manufacturing Co., 373 F.2d 886 (3d Cir.), Cert. denied sub nom. National Molasses Co. v. Beebe, 388 U.S. 911, 87 S. Ct. 2115, 18 L. Ed. 2d 1350 (1967). See also 9 C. Wright & A. Miller, Federal Practice & Procedure § 2537, at 596-98 (1971). Indeed, to entertain the plaintiffs' motion might deprive defendant of its Seventh Amendment rights to a trial by jury on Count Three as to foreseeability. Lowenstein v. Pepsi-Cola Bottling Co. of Pennsauken, 536 F.2d at 11; Sulmeyer v. Coca Cola Co., 515 F.2d 835, 846 n.17 (5th Cir. 1975), Cert. denied, 424 U.S. 934, 96 S. Ct. 1148, 47 L. Ed. 2d 341 (1976), Citing Slocum v. New York Life Insurance Co., 228 U.S. 364, 33 S. Ct. 523, 57 L. Ed. 879 (1913). The importance of the policies served by the Rules and the Seventh Amendment forbids us under the law of this circuit to consider plaintiffs' arguments in chambers that plaintiffs' injuries were as a matter of law foreseeable as curing the failure to move for a directed verdict as to that interrogatory on that basis. Lowenstein v. Pepsi-Cola Bottling Co. of Pennsauken 536 F.2d at 12 & n.7. The plaintiffs' motion for judgment n. o. v. therefore will be denied.

 Although we cannot grant plaintiffs' motion, we conclude nevertheless in light of the uncertainty as to what state law applies that judgment should not have been entered as to any plaintiff on Count Three. For at least some plaintiffs, the lack of privity with defendant might not foreclose the existence of a duty. Similarly the non-foreseeability found by the jury might not foreclose all plaintiffs. It is possible that under the law of some states, foreseeability is not required to impose a duty on accountants to exercise reasonable care. More likely, some states may impose liability on accountants for negligence to all persons whom the accountants foresaw or should have foreseen would have Used or would have Relied on the opinion letter rather than those whose injury was foreseeable. See Restatement (Second) of Torts § 552 (1965) (limiting liability for negligently supplied false information without direct reference to foreseeability) and Illustrations 5, 6. Because there is no legal or factual finding which forecloses all plaintiffs from recovery on Count Three, we will vacate our judgment for defendant on that count.


 Defendant contends both that the jury's finding of non-foreseeability of injury compels judgment in its favor on Count Two, alleging fraudulent misrepresentation, and that it is entitled to judgment n. o. v. because there was no evidence of its scienter. We are again thrust into a situation in which we cannot decide what state law to apply without knowing with regard to each plaintiff all the states, laws and interests involved, and we are therefore unable to grant the defendant's motions at this time.


 A. Foreseeability and Rule ...

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