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Kline v. First Western Government Securities

filed: May 2, 1994; As Corrected May 4, 1994.


On Appeal From the United States District Court For the Eastern District of Pennsylvania. (D.C. Civil Action No. 83-01076).

Before: Greenberg, Roth and Lewis, Circuit Judges.

Author: Roth


ROTH, Circuit Judge :

This appeal arises from a suit alleging, among other things, violations of § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), in connection with plaintiffs' investment in forward contracts through defendant First Western Government Securities ("First Western"). Defendant Arvey, Hodes, Costello & Burman ("Arvey"), a Chicago law firm, issued three opinion letters concerning the tax consequences of these investments. Plaintiffs Ernest P. Kline and Eugene F. Knopf allege that Arvey's opinion letters contained both affirmative misrepresentations and material omissions in their treatment of these transactions. They further contend that they relied upon these opinion letters in deciding to invest with First Western and that as a result they incurred substantial financial losses. The district court denied Arvey's motion for summary judgment on the misrepresentation claim but granted it on the omissions claim. We conclude that both the misrepresentation and omissions claims should be tried. We will therefore affirm in part and reverse in part, and we will remand the case to the district court for further proceedings consistent with this opinion.


It is important to emphasize at the outset that, because we are reviewing the partial grant of a motion for summary judgment, we must view the facts in the light most favorable to the non-moving party. Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587, 89 L. Ed. 2d 538, 106 S. Ct. 1348 (1986). Thus, "the evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in his favor." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986).

The central figure in this case is defendant Sidney Samuels, who founded First Western in 1978. Prior to that time Samuels was a general partner in Price & Company ("Price"). According to plaintiffs, First Western's trading program was substantially similar to Price's and indeed was modeled on it. Significantly, Arvey represented both Price and First Western. Arvey assisted Samuels and his partner, Larry Price, in the formation of Price, drafted Price's limited partnership agreement and its 1977 offering memorandum, and represented it in connection with IRS civil and criminal investigations. Arvey began assisting Samuels in setting up First Western while he was still a general partner in Price. The firm became First Western's general counsel and assisted in the drafting of forms to be used by First Western, including the brochure describing the program. There is some suggestion in the record that Arvey helped design the straddle transactions used by First Western. (Joint Appendix ("JA") at 154.) At First Western's request, Arvey also provided it with three opinion letters addressing the federal income tax treatment of these transactions. These opinion letters were dated September 20, 1978, June 8, 1979, and November 12, 1980.

The transactions engaged in by First Western involved forward contracts to purchase and sell money market instruments, specifically Government National Mortgage Association securities ("GNMA's") and Federal Home Loan Mortgage Corporation participation certificates ("FMAC's"). A "forward contract" is a contract to purchase or sell a specified security, at a designated interest rate, on a fixed future date. In a straddle transaction an investor enters into a pair of forward contracts, agreeing both to buy and sell securities in the future. The difference between the "buy" contract and the "sell" contract results in a "spread" position, resulting in gain or loss to the investor depending on whether interest rates rise or fall. Accordingly, before entering into a straddle an investor must decide how to "bias" the spread by predicting whether interest rates will rise or fall.

First Western's agreements with its customers provided that a customer could arrange for the cancellation of his obligations under a forward contract prior to the settlement date. First Western would then "charge or credit the customer's account with an amount equal to the profit First Western or the customer, respectively, would be entitled to receive in the event delivery was effectuated pursuant to such contract as of the date of cancellation." (Arvey Opinion Letters, 9/20/78, JA at 138; 6/8/79, JA at 562.) Typically investors would choose to cancel the losing side of their straddle. The tax treatment of the resulting loss was the subject of the Arvey opinion letters.

In the opinion letters Arvey concluded that, if First Western and a customer agreed "to cancel a forward contract prior to its settlement date, the consequent gain or loss realized by the customer should constitute ordinary gain or loss to be recognized by the customer in the year in which the contract is canceled." (Arvey Opinion Letter, 6/8/79, JA at 563.)*fn1 The three letters also contained language advising First Western that the Internal Revenue Service and the courts might arrive at a contrary Conclusion.

As the following excerpts show, each of the letters also provided that the opinions were based on facts as provided by First Western and were for the use of First Western only:

September 20, 1978, letter:

The following paragraphs contain a summary of such transactions as you [First Western] have described them to us. (JA at 135.)

This opinion is subject to the consummation of the transactions between First Western and its customers under the facts and conditions described above and is further expressly conditioned on your representation that the transactions entered into by First Western and its customers will be for the purpose, and with a reasonable expectation, of economic gain. (JA at 140.)

This letter is intended for your personal use only and is not intended to be, and should not be, relied upon by persons other than First Western. (JA at 149.)

June 8, 1979, letter:

You have advised us that the facts set forth below constitute an accurate and complete presentation of all relevant information with regard to such transactions. (JA at 558.)

This opinion is subject to the consummation of the transactions between First Western and its customers pursuant to the facts and conditions described above and is further expressly conditioned on your representation that such transactions will be consummated by the customers of First Western with a reasonable expectation of economic gain. (JA at 563.)

This letter is intended for your personal use only and is not intended to be, and should not be, relied upon by persons other than First Western. (JA at 574.)

November 12, 1980, letter:

You have advised us that the facts set forth below constitute an accurate and complete presentation of all relevant information with regard to the transactions between First Western and its customers, and that no material fact necessary to make the information herein not false or misleading has been omitted. (JA at 576.)

The Conclusions set forth herein are based upon the facts and conditions described in this letter as you have represented them to us and we express no opinion as to the tax treatment of any transaction to the extent the facts may differ from those contained herein.

We express no opinion concerning any federal income tax consequence other than as specifically set forth in this letter, and no opinion is expressed with respect to state and local taxes, federal or state securities laws, or any other federal or state law not explicitly referenced herein. We also express no opinion as to the advisability of undertaking any transaction described in this letter, in that any such determination must take into account the individual facts and circumstances affecting the particular taxpayer.

This letter is intended solely for the internal use of First Western and, accordingly, it is not intended to be, and should not be, relied upon by any person other than First Western. Further, this letter is not to be quoted or otherwise referred to in any documents, including financial statements of First Western, nor is it to be filed with or furnished to any government agency or other person without the express prior written consent of this firm. Such consent has not been given, and will not be given, unless the person to whom this letter is to be furnished has previously agreed, in writing, that he will not rely upon the opinions and Conclusions expressed herein, but will make his own independent evaluation of the federal income tax consequences of any transactions to be entered into with First Western. (JA at 591.)

A couple of themes emerge from these excerpts. First, Arvey stressed that its view of the transactions' validity hinged on whether they were entered into with a reasonable expectation of generating a profit. Second, the letters asserted that Arvey's Conclusions might be changed by facts and circumstances unique to individual customers' accounts. Arvey also made these points in response to inquiries from potential First Western customers about its opinion letters. (JA at 365-77.)

Despite the letters' statement that they were for the exclusive use of First Western, Arvey was aware at least as early as May 31, 1979, that its opinion letters had reached potential investors. (JA at 365.) The record before us reflects some ten instances in which potential First Western investors contacted Arvey regarding its opinion. (JA at 365-78.) As the following excerpt from an October 21, 1980, letter to Arvey from an attorney representing a potential investor makes clear, Arvey was put on notice that its efforts to dissuade reliance were not always successful:

Surely you realize that First Western Government Securities is using your letter in an effort to obtain investors and is furnishing copies of your letter with brochures indicating the mechanical operation of the program. As a result, notwithstanding statements made in your October 16, 1980, letter, please be advised that my client is awaiting my receipt of your opinion letter before making a decision as to his investment with First Western Government Securities. (JA at 376.)

Plaintiffs Kline and Knopf invested in forward contracts with First Western in December 1980, after reading and relying upon Arvey's June 1979 and November 1980 opinion letters. They incurred losses on their investments, deducted these losses in their income tax filings, and had their deductions disallowed by the IRS.

Kline and Knopf allege that Arvey knew or recklessly disregarded the truth about First Western's trading program. As a result, they contend, Arvey in its opinion letters made material misrepresentations and omitted material facts concerning the actual structure of First Western transactions. Plaintiffs allege a number of misrepresentations. They allege that the opinion letters stated that under the First Western trading program investors would be required to make or accept delivery of the underlying securities when in fact no such requirement existed. They allege that the opinion letters represented that the prices of First Western's contracts moved independently, and thus subject to market risk, when in fact First Western's computer trading program artificially set the prices to eliminate any risk of loss.*fn2 They allege misrepresentations as to whether customers would be required to make additional margin deposits and as to how First Western calculated the fees it charged for cancellation of contracts. Finally, they allege that the opinion letters misrepresented the fact that First Western's transactions were designed to obtain tax losses and as structured could not support a reasonable expectation of economic gain.

As for material omissions, plaintiffs allege that Arvey made no reference to prior IRS investigations of Price & Company or Sidney Samuels' connection to that firm.*fn3 Furthermore, a number of investigations into First Western's trading program had commenced by the time Arvey issued its final opinion letter. The IRS had audited a number of First Western investors, the SEC had started an investigation and requested numerous documents from First Western, and the Minnesota Department of Commerce was investigating First Western. The only reference to these activities in the November 12, 1980, opinion letter was as follows: "Further, you have informed us that customers of First Western are being audited by the Service and that the Service has questioned the deductibility of losses realized by customers on the basis of the theory set forth by the Service in Rev. Rul. 77-185." (JA at 588.) The letter made no mention of the SEC or State of Minnesota investigations, or the IRS investigation into Price.

Arvey moved for summary judgment on the omissions claim, the misrepresentation claim, and tort and RICO claims not before us on this appeal. The district court denied summary judgment on all counts except those asserting liability for omissions of material fact. Because the district court believed that this case presents two "'controlling issues of law as to which there is a substantial ground for difference of opinion,'" Kline v. First Western Gov't Secs., 794 F. Supp. 542, 557 (E.D.Pa. 1992) (quoting 28 U.S.C. § 1292(b)), it certified for immediate appeal the following two issues: first, whether an attorney may be held liable for alleged misrepresentations of fact in an opinion letter when those alleged factual statements have been specifically attributed to another individual; and, second, whether attorneys may be held liable for omissions of fact in an opinion letter absent a duty to disclose.*fn4 The district court also ruled that Arvey did not meet its burden of proving that plaintiffs' reliance was unreasonable, id. at 552-54, but did not certify that issue for appeal.


The district court had subject matter jurisdiction over this case pursuant to 28 U.S.C. § 1331. This court has jurisdiction over this certified interlocutory appeal pursuant to 28 U.S.C § 1292(b). This court granted both parties' petitions to appeal on June 8, 1992.

Our review of a district court's grant of summary judgment is plenary. Erie Telecommunications, Inc. v. City of Erie, 853 F.2d 1084, 1093 (3d Cir. 1988). "On review the appellate court is required to apply the same test the district court should have utilized initially." Goodman v. Mead Johnson & Co., 534 F.2d 566, 573 (3d Cir. 1976), cert. denied, 429 U.S. 1038, 50 L. Ed. 2d 748, 97 S. Ct. 732 (1977).

A court may grant summary judgment only when the submissions in the record "show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c). "The inquiry performed is the threshold inquiry of determining whether there is the need of a trial--whether, in other words, there are any genuine factual issues that properly can be resolved only by a finder of fact because they may reasonably be resolved in favor of either party." Anderson v. Liberty Lobby, 477 U.S. at 250. Stated differently, "a motion for summary judgment must be granted unless the party opposing the motion can produce evidence which, when considered in light of that party's burden of proof at trial, could be the basis for a jury finding in that party's favor." J.E. Mamiye & Sons, Inc. v. Fidelity Bank, 813 F.2d 610, 618 (3d Cir. 1987)(Becker, J., Concurring). Thus, the ...

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