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Goodwin v. Elkins & Co.

March 14, 1984

J. DONALD GOODWIN, APPELLANT
v.
ELKINS & CO., ROBERT G. HAYDEN, RICHARD SICHENZIO, AND GABRIEL F. NAGY APPELLEES



On Appeal from the United States District Court for the Eastern District of Pennsylvania.

Seitz, Chief Judge, Garth and Becker, Circuit Judges.

Author: Garth

Opinion ANNOUNCING THE JUDGMENT OF THE COURT

GARTH, Circuit Judge.

In this case, we are asked to give further definition to what constitutes a security within the meaning of federal securities law. Goodwin asserts that his partnership contract in a brokerage firm is a security interest, enabling him to invoke the provisions of the Securities Exchange Act in seeking vindication of his claims. The district court, 558 F. Supp. 1375, held otherwise, and dismissed Goodwin's claim brought under federal securities law, and remitted his common law claims to arbitration. We affirm.

I.

Plaintiff J. Donald Goodwin brought sui against the brokerage firm of Elkins & Co. n.1 Goodwin, a former general partner of Elkins, alleged that he was induced to sell his partnership interest back to the firm based upon false representations made by the defendants. His complaint charged a violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(b) (1976), and of SEC Rules 10(b)(5), promulgated thereunder. It also raised state common law claims of fraud and breach of fiduciary duty. Jurisdiction was based on 28 U.S.C. § 1331 (1976) (federal question jurisdiction), under the court's pendent jurisdiction, and also under 28 U.S.C. § 1332(a)(1976), since there existed diversity of citizenship.

Elkins moved to dismiss the federal securities claim under Fed. R. Civ. P. 12(b)(6), and to compel arbitration of the remaining state claims, since the Elkins Partnership Agreement contained an arbitration clause. The district court granted the motion to dismiss, finding that Goodwin's partnership interest could not constitute a "security" within the meaning of the Act. It also remitted the state claims to an arbitrator. It is from these rulings that Goodwin appeals.

II.

As required by a Rule 12(b)(6) motion, all the factual allegations of Goodwin's complaint must be taken as true. Goodwin was a general partner with Elkins, and a registered representative. He had been associated with that firm for more than 20 years when, in 1981, he became dissatisfied with the management policies of the firm, and announced his resignation as of October 1981. He was prevailed upon by several partners of the firm to withdraw his resignation and continue with the firm until at least March 31, 1982, however, so as to avoid undue prejudice to the firm. In February 1982, Goodwin was advised that it would be more convenient if his withdrawal from the firm were to take effect as of January 1, 1982.Goodwin agreed to that suggestion, and his withdrawal from the firm was effectuated as if it had occurred on January 1, 1982. Goodwin asserts that, in connection with the February agreement, he was falsely and fraudulently advised that no sale or merger of the firm was planned; and that the defendants fraudulently concealed from him the fact that such negotiations were then being actively pursued. On March 17, 1982, when Goodwin would still have been a partner but for the February agreement, the Elkins firm was purchased by, and merged into, Bache, Halsey, Stewart, a large New York brokerage house, in a transaction which was financially advantageous to the general partners of the Elkins firm. In his suit, Goodwin sought to recover the difference between the amount paid to him upon his withdrawal (representing the value of his interest calculated as of January 1, 1982) and the amount which would have been paid to him had his interest been valued as of the date originally agreed upon, March 31, 1982.

Two issues are raised on this appeal. First, Goodwin contends that the district court erred in finding as a matter of law that his complaint could not state a claim under federal securities law. He also argues that the state law claims of fraud and breach of fiduciary duty are not within the scope of the Partnership Agreement's arbitration clause, and therefore it was error to send the proceedings to an arbitrator. We address these issues in turn.*fn2

III.

A.

In enacting the Securities Exchange Act of 1934, we recognize that Congress intended to provide remedial legislation, which in turn must be liberally construed. Tcherepnin v. Knight, 389 U.S. 332, 336, 19 L. Ed. 2d 564, 88 S. Ct. 548 (1967). As the Supreme Court has noted, "the definition of 'security' in the Securities Exchange Act of 1934 is quite broad. The Act was adopted to restore investors' confidence in the financial markets, and the term 'security' was meant to include 'the many types of instruments that in our commercial world fall within the ordinary concept of a security.'" Marine Bank v. Weaver, 455 U.S. 551, 555-56, 71 L. Ed. 2d 409, 102 S. Ct. 1220 (1982) (quoting H.R. Rep. NO. 85, 73d Cong., 1st Sess., 11 (1933)).

Nevertheless, the scope of federal securities laws is not without limitation, and Congress did not intend to create a federal cause of action for common fraud. Marine Bank, 455 U.S. at 556. It is therefore our task to determine whether the general partnership interest in a brokerage firm as described in Goodwin's complaint comes within the definition of the term "security."*fn3

The seminal case in this area, SEC v. W.J. Howey Co., 328 U.S. 293, 90 L. Ed. 1244, 66 S. Ct. 1100 (1946), defined an investment contract*fn4 as:

a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . .

Id. at 298-99.*fn5

Goodwin acknowledges the inherent difficulty in treating a general partner as the holder of a "security" under the Howey test, since by definition he is presumed to be personally involved in the management of the enterprise. Goodwin alleges, however, that in reality, he was invested with so little power and responsibility under the Elkins Partnership Agreement that his actual position was no more than that of a limited partner, and that effective control of the firm rested exclusively with the Managing Partner and the Management Committee of the firm. Goodwin asks that he be allowed to introduce evidence to support that allegation.We find, however, that even if his assertions were to be proved, the interest which Goodwin claims does not satisfy the requirement of a "security."

Even if the Elkins partnership may be deemed as a "common enterprise," as that term was used in Howey's definition of an investment contract, we are not persuaded by Goodwin's argument that he, as a general partner, could be "led to expect profits solely from the efforts of the promoter or a third party," and thus have his interest classed as an investment security. A general partner in Goodwin's firm, as in other similar firms, is unavoidably, even if unwillingly, a part of the operation of the enterprise. As the Sixth Circuit noted, "the managerial powers vested in general partners and the express right of inspection of documents gives them the kind of leverage and ability to protect themselves that takes them outside the intended scope of the '34 Act." Odom v. Slavik, 703 F.2d 212, 215 (6th Cir. 1983).

It is true that this Court has noted that the term "solely," as used in the Howey test (i.e. "a person invests his money in a common enterprise and is led to expect profits solely from the efforts of [another]"), is not to be read literally when considering the efforts made by an investor. Lino v. City Investing Co., 487 F.2d 689, 692 (3d Cir. 1973). Accord, SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476 (9th Cir.), cert. denied, 414 U.S. 821, 38 L. Ed. 2d 53, 94 S. Ct. 117 (1973). An investment contract or interest may still be classed as a security even if the investor is required to perform some duties, as long as those duties are "nominal or limited and would have little direct effect upon receipt by the participants of the benefits promised by the promoters." 487 F.2d at 692.

It is at this point that the views of the members of this panel to some extent diverge. Although the Court is unanimous that Goodwin's interest in the partnership does not qualify as a security under federal securities laws, Chief Judge Seitz and Judge Becker in their respective concurring opinions would confine their examinations to the Partnership Agreement, and so hold.While I agree with their conclusion, I would hold that Goodwin's interest does not qualify as a security primarily because the role of a general partner, by law, extends well beyond the permitted role of a passive investor.*fn6

Accordingly, to the extent that I reach the same result as my two colleagues, but do so wholly by reference to the Pennsylvania Partnership Act, this portion of the opinion (the remainder of Part III.A.) expresses only my views and not those of Chief Judge Seitz or Judge Becker.

Under Pennsylvania's Partnership Act, Pa.Cons.Stat. Ann. tit. 59, §§ 301-365 (Purdon Supp. 1983),*fn7 a general partner is an agent of the firm, and the act of every partner, with only certain exceptions,*fn8 binds the partnership. Id. § 321. Admissions or representations made by a partner concerning partnership affairs is evidence against the partnership. Id. § 323. Notice to a partner of any matter relating to partnership affairs operates as notice to the partnership. Id. § 324. A wrongful act or breach of trust by a partner renders the partnership liable, Id. §§ 325-26, and each partner is subject to unlimited liability for partnership losses. Id. § 327.

Each partner has equal rights in the management and conduct of partnership business, subject to the provisions of the partnership agreement. Id. § 331(5). Each partner, however, has what amounts to an absolute veto power over any act sought to be performed by the other partners which contravenes the partnership agreement. Id. § 331(8).

It is manifest that any person who possesses the powers, rights, and responsibilities described above cannot have invested his capital with the exception of profits derived solely from the efforts of others, and therefore cannot be the holder of a "security" as intended by the Act. Whatever subjective perceptions Goodwin may have entertained about his position in the firm, and whatever may have been the role he actually assumed, the legal interest which he enjoyed does not fall within the scope of the term "security" as intended by Congress. As noted by the court in New York Stock Exchange v. Sloan, 394 F. Supp. 1303 (S.D.N.Y. 1975):

Th3 determination whether the partnership interest of a general partner is a security does not and should not hinge on the particular degree of responsibility he assumed within the firm. The fact that a partner may choose to delegate his day-to-day managerial responsibilities to a committee does not diminish in the least his legal right to a voice ...


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