Dellastatious v. Williams

PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

RICHMOND A. DELLASTATIOUS, 

Plaintiff-Appellant,

and

FRANK ROMANO,

Plaintiff,

v.

DONALD F. WILLIAMS; RAY KELLY,  No. 00-1577

Defendants-Appellees,

and

ADRIAN GLUCK; CRAIG NOVAK;

HOWARD KESSEL; SURROUNDVISION

ADVANCED IMAGING; LASERVISION

TECHNOLOGIES, INCORPORATED,

Defendants.



RICHMOND A. DELLASTATIOUS, FRANK 

ROMANO,

Plaintiffs-Appellees,

v.

DONALD F. WILLIAMS; RAY KELLY,

Defendants-Appellants,

 No. 00-1595

and

ADRIAN GLUCK; CRAIG NOVAK;

HOWARD KESSEL; SURROUNDVISION

ADVANCED IMAGING; LASERVISION

TECHNOLOGIES, INCORPORATED,

Defendants.



2 DELLASTATIOUS v. WILLIAMS

Appeals from the United States District Court

for the Eastern District of Virginia, at Alexandria.

Leonie M. Brinkema, District Judge.

(CA-98-1656-A)

Argued: December 6, 2000

Decided: February 22, 2001

Before WILKINSON, Chief Judge, WIDENER, Circuit Judge, and

William L. GARWOOD, Senior Circuit Judge of the

United States Court of Appeals for the Fifth Circuit,

sitting by designation.

Affirmed by published opinion. Chief Judge Wilkinson wrote the

opinion, in which Judge Widener and Senior Judge Garwood joined.

COUNSEL

ARGUED: Michael Joseph, DYER, ELLIS & JOSEPH, P.C., Wash-

ington, D.C., for Appellant. Philip Richard Croessman, BASTIA-

NELLI, BROWN & KELLEY, CHARTERED, Washington, D.C., for

Appellees. ON BRIEF: Richard A. Kirby, DYER, ELLIS &

JOSEPH, P.C., Washington, D.C.; David S. Bracken, COHEN,

DUNN, CURCIO, KEATING & ROHRSTAFF, P.C., Alexandria,

Virginia, for Appellant. Tina S. Tisinger, BASTIANELLI, BROWN

& KELLEY, CHARTERED, Washington, D.C., for Appellees.

OPINION

WILKINSON, Chief Judge:

Richmond Dellastatious brought this securities fraud action against

Donald Williams and Raymond Kelly claiming that they were liable

as "control persons" under the Securities Exchange Act of 1934 and

DELLASTATIOUS v. WILLIAMS 3

the Virginia Securities Act. See 15 U.S.C. § 78t(a); Va. Code § 13.1-

522(C). The district court granted Williams and Kelly’s motion for

summary judgment, holding that they were not control persons and

that they satisfied the statutes’ good-faith defense. Because Williams

and Kelly were corporate directors who acted in good faith reliance

on a corporate decision-making process, we affirm the judgment of

the district court.

I.

LaserVision Technologies, Inc. developed a camera system that

created souvenirs for fans at sporting events. In 1997, LaserVision

formed SurroundVision Advanced Imaging, LLC, ("SAIL"), to

finance the marketing of the technology. LaserVision was SAIL’s

corporate parent and a managing member of SAIL. Adrian Gluck, the

president of LaserVision, served as CEO, president, and director of

SAIL. Defendant Donald Williams, a director of LaserVision, served

as a manager of SAIL. Defendant Raymond Kelly had no connection

to SAIL except by virtue of his role as an outside director of LaserVi-

sion. Despite its connections to LaserVision, SAIL also had some of

its own officers. For instance, Craig Novak served as SAIL’s execu-

tive vice president and director, and Howard Kessel served as SAIL’s

chief financial officer.

In October 1997, Gluck invited plaintiff Richmond Dellastatious to

become an equity investor in SAIL. In November 1997, SAIL sent

Dellastatious offering documents regarding the sale of the SAIL

securities ("November Offering Memorandum"). On December 3,

1997, Dellastatious invested $201,000 in SAIL. He subsequently pur-

chased an additional $60,000 worth of SAIL’s shares.

In reaching his decision to invest in SAIL, Dellastatious relied, at

least in part, on the November Offering Memorandum. An earlier

draft of this offering document had been prepared for SAIL by Gluck,

Novak, Kessel, and Isaac Cohen, LaserVision’s attorney. Sometime

prior to November 1997, one of LaserVision’s directors, Larry Ber-

kowitz, reviewed and criticized the draft memorandum. Berkowitz

had previously been a securities lawyer with the Securities and

Exchange Commission. LaserVision’s directors were informed that

the problems with the memorandum were technical in nature and

4 DELLASTATIOUS v. WILLIAMS

would be corrected in accordance with Berkowitz’s wishes. The

memorandum was then revised effective November 12, 1997. This

was the November Offering Memorandum that SAIL sent to Dellasta-

tious. There is no evidence that, after this revision, Berkowitz had any

further objections to the November Offering Memorandum.

Sometime near the beginning of December 1997, SAIL’s offering

memorandum was revised again. At the previous month’s meeting, a

committee had been formed to review SAIL’s offering memorandum.

Gluck, Berkowitz, and Williams were named to serve on the commit-

tee. According to the minutes from LaserVision’s December meeting,

the memorandum was revised so that SAIL could raise an additional

$2 million in equity capital. The final revision to the offering memo-

randum was completed in March 1998. It was mailed to Dellastatious

at this time. Shortly thereafter, however, SAIL ceased operations.

Dellastatious’ shares are now worthless.

On November 18, 1998, Dellastatious and Frank Romano, another

SAIL shareholder, sued in federal district court. Named as defendants

in the complaint were SAIL, three of SAIL’s officers (Gluck, Novak,

and Kessel), LaserVision, and two outside directors of LaserVision

(Williams and Kelly). The gravamen of plaintiffs’ complaint was that

SAIL’s November Offering Memorandum was misleading in several

material respects. First, plaintiffs alleged that the memorandum mis-

represented the closeness of the relationship between LaserVision and

SAIL. Plaintiffs argued that SAIL was essentially a shell corporation

run by LaserVision and LaserVision’s directors. Plaintiffs also

alleged that the November Offering Memorandum grossly overstated

SAIL’s projected revenues and misrepresented the nature of SAIL’s

assets. Finally, plaintiffs alleged that Williams and Kelly, although

perhaps not directly responsible for the securities fraud, were liable

as "control persons" under Section 20 of the Securities Exchange Act

of 1934, 15 U.S.C. § 78t(a), and the Virginia Securities Act, Va. Code

§ 13.1-522(C).

On October 15, 1999, the district court granted Williams and

Kelly’s motion for summary judgment. The court assumed that plain-

tiffs could prove that one of the other defendants was primarily liable

for securities fraud violations. However, the court determined that

neither Williams nor Kelly were control persons of any liable party.

DELLASTATIOUS v. WILLIAMS 5

The court also held that Williams and Kelly lacked the requisite cul-

pability for control person liability. Williams and Kelly subsequently

moved for sanctions and attorneys’ fees against plaintiffs and their

counsel. The district court denied this motion.

In October 1999, Dellastatious and Romano settled their claims

against the three SAIL officers, Novak, Gluck, and Kessel. On April

13, 2000, the court ordered that judgment against SAIL and LaserVi-

sion be entered in favor of Dellastatious. The court awarded Dellasta-

tious $285,801.97 for his claims under § 13.1-522 of the Virginia

Code and $156,694.70 for his common law fraud claim. In addition,

the court granted judgment against Romano in favor of SAIL and

LaserVision.

Dellastatious now appeals the district court’s holding that Williams

and Kelly were not liable as control persons under either the state or

federal securities laws. Williams and Kelly cross-appeal the district

court’s denial of their motion for sanctions.

II.

A.

Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78t(a), provides for derivative liability of persons who "control"

those who are primarily liable under the Exchange Act.1 However,

control persons may escape liability by proving that they acted in

good faith with regard to the securities violation. See 15 U.S.C.

§ 78t(a). To determine whether the good-faith affirmative defense has

been satisfied under section 20(a), defendants must show that they did

1

Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78t(a), provides:

Every person who, directly or indirectly, controls any person lia-

ble under any provision of this chapter or of any rule or regula-

tion thereunder shall also be liable jointly and severally with and

to the same extent as such controlled person to any person to

whom such controlled person is liable, unless the controlling per-

son acted in good faith and did not directly or indirectly induce

the act or acts constituting the violation or cause of action.

6 DELLASTATIOUS v. WILLIAMS

not act recklessly. Negligence on the part of defendants is insufficient

to establish liability. See Carpenter v. Harris, Upham & Co., 594

F.2d 388, 394 (4th Cir. 1979). "[O]ur task is to examine what the

defendants could have done under the circumstances to prevent the

violation, and then ask whether the defendants — aware that they

could take such measures — decided not to. This is just to say that

we are to determine whether there is a genuine issue of fact regarding

the defendants’ recklessness." Donohoe v. Consolidated Operating &

Prod. Corp., 30 F.3d 907, 912 (7th Cir. 1994); see also G.A. Thomp-

son & Co. v. Partridge, 636 F.2d 945, 960 (5th Cir. 1981) (to qualify

for the good-faith defense, controlling persons must establish that

they did not act recklessly).

The Virginia Securities Act, Va. Code § 13.1-522(C), also estab-

lishes a defense for control persons. The statute allows control per-

sons to avoid liability if they can prove that they "did not know, and

in the exercise of reasonable care could not have known, of the exis-

tence of the facts by reason of which the liability is alleged to exist."

Va. Code § 13.1-522(C).2 Dellastatious argues that the Virginia good-

faith defense is stricter than its federal counterpart because it requires

defendants to prove that they were not negligent, as opposed to not

reckless. For purposes of this appeal we will assume that defendants

must show that they acted reasonably in order to satisfy Virginia’s

good-faith defense.

B.

Dellastatious contends that Williams and Kelly are liable as control

persons under both federal and Virginia law for the fraud committed

by SAIL. See 15 U.S.C. § 78t(a); Va. Code § 13.1-522(C). We shall

2

The Virginia Securities Act, Va. Code § 13.1-522(C), provides in

part:

Every person who directly or indirectly controls a person liable

under . . . this section, including every partner, officer, or direc-

tor of such a person, . . . shall be liable jointly and severally with

and to the same extent as such person, unless able to sustain the

burden of proof that he did not know, and in the exercise of rea-

sonable care could not have known, of the existence of the facts

by reason of which the liability is alleged to exist.

DELLASTATIOUS v. WILLIAMS 7

assume, without deciding, that Williams and Kelly were control per-

sons under both the federal and state laws. See 15 U.S.C. § 78t(a)

(extending liability to "[e]very person who, directly or indirectly, con-

trols" one liable for securities violations); Va. Code § 13.1-522(C)

(extending liability to "[e]very person who directly or indirectly con-

trols" one liable for securities violations, "including every partner,

officer, or director of such a person").

Dellastatious argues that, at the very least, there is a genuine issue

of fact regarding whether Williams and Kelly acted in good faith. We

disagree. Williams and Kelly have carried their burden of proving that

they acted reasonably. As a result, they are entitled to the good-faith

affirmative defense under both federal law and Virginia’s allegedly

more-exacting standard.

A defendant can satisfy the good-faith defense by demonstrating

that he used reasonable care to prevent the securities violation. See

Donohoe, 30 F.3d at 912 (interpreting 15 U.S.C. § 78t(a)); see also

Va. Code § 13.1-522(C). One way to determine whether Williams and

Kelly acted with "reasonable care" pursuant to Va. Code § 13.1-

522(C), is to consider whether they complied with the duties estab-

lished for directors under state law.3 Virginia Code § 13.1-690 estab-

lishes "the standard by which to evaluate a director’s discharge of

duties in Virginia." Willard v. Moneta Bldg. Supply, Inc., 515 S.E.2d

277, 284 (Va. 1999).4 If a director acts in accordance with that stan-

3

While Dellastatious brought several different claims against Williams

and Kelly in their different capacities, all of Dellastatious’ claims revolve

around Williams and Kelly’s roles as directors of LaserVision. The key

to Dellastatious’ theory is that SAIL is a shell corporation and that Laser-

Vision and its officers are the bad actors. As a result, we assess the rea-

sonableness of Williams and Kelly’s conduct with an eye toward the

duties owed by corporate directors.

4

Section 13.1-690 states, in relevant part:

A. A director shall discharge his duties as a director, . . . in

accordance with his good faith business judgment of the best

interests of the corporation.

B. Unless he has knowledge or information concerning the mat-

ter in question that makes reliance unwarranted, a director is

8 DELLASTATIOUS v. WILLIAMS

dard, Va. Code § 13.1-690(C) provides a "safe harbor" that shields a

director from liability "for any action taken as a director, or any fail-

ure to take any action." Va. Code § 13.1-690(C); see also Willard,

515 S.E.2d at 284 (discussing § 13.1-690(C)’s safe harbor provision);

WLR Foods, Inc. v. Tyson Foods, Inc., 65 F.3d 1172, 1183 (4th Cir.

1995) (same). Although the few cases interpreting section 13.1-690

have concerned protections afforded directors under the business

judgment rule, the statutory text is in no way limited to that. In light

of 13.1-690(C)’s expansive safe harbor provision, it seems unlikely

that section 13.1-522(C) would hold directors to a higher standard of

care than that set forth under section 13.1-690.

Pursuant to section 13.1-690(B), as long as directors have no

knowledge that makes reliance unwarranted, they may rely on finan-

cial statements prepared by corporate officers, legal counsel, or public

accountants. See Willard, 515 S.E.2d at 285. In cases such as this,

where shareholders allege that directors have insufficiently supervised

the corporation’s affairs, directors can avoid liability by showing that

they attempted in good faith to ensure that an adequate corporate

information-gathering and reporting system was in place. In In re

Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 969-70 (Del. Ch.

1996), the leading case in this area, the Delaware Court of Chancery

entitled to rely on information, opinions, reports or statements,

including financial statements and other financial data, if pre-

pared or presented by:

1. One or more officers or employees of the corporation whom

the director believes, in good faith, to be reliable and competent

in the matters presented;

2. Legal counsel, public accountants, or other persons as to

matters the director believes, in good faith, are within the per-

son’s professional or expert competence; or

3. A committee of the board of directors of which he is not a

member if the director believes, in good faith, that the committee

merits confidence.

C. A director is not liable for any action taken as a director, or

any failure to take any action, if he performed the duties of his

office in compliance with this section.

DELLASTATIOUS v. WILLIAMS 9

held that directors are not liable under a failure to monitor theory

where they did not know of the specific bad acts within the corpora-

tion and they made a good faith attempt to assure that a reasonable

decision-making process existed. As Caremark indicates, mishaps

within a corporation do not alone entitle a plaintiff to bring suit

against directors in their personal capacities. Chancellor Allen point-

edly described claims for failure to adequately monitor corporate

activities as "possibly the most difficult theory in corporation law

upon which a plaintiff might hope to win a judgment." Id. at 967. His

statement reflects the reality that service as director of a corporation

should not be a journey through liability land mines.

Here, Williams and Kelly complied with Virginia’s standards for

directorial duties, and they likewise acted with reasonable care under

§ 13.1-522(C). Williams and Kelly were outside directors who served

on LaserVision’s board because they had invested $2.2 million in

LaserVision. They were not experts on the LaserVision technology

and they had no role in SAIL’s plan to market the technology. It was

reasonable for Williams and Kelly to delegate the creation and review

of SAIL’s offering documents to SAIL’s officers, Gluck, Novak, and

Kessel, and their attorney, Isaac Cohen. Gluck, SAIL’s CEO and

president, was a professional engineer who understood the LaserVi-

sion technology that SAIL would be marketing. Gluck was also a suc-

cessful entrepreneur who was experienced in raising capital for

companies. Novak, SAIL’s executive vice president, had a masters

degree in finance and previously had been a Managing Director at

Merrill Lynch. Kessel, SAIL’s chief financial officer, was a certified

public accountant who earlier had worked at a major accounting firm.

Cohen was an attorney experienced in drafting offering documents.

The offering documents then were also reviewed by Larry Berkowitz,

who previously had worked as an attorney for the Securities and

Exchange Commission.

Furthermore, the evidence shows that SAIL’s system for drafting

and reviewing offering documents functioned properly. In October

1997, after Cohen had drafted the original offering documents, Ber-

kowitz reviewed them. When Berkowitz expressed concern regarding

the documents, this fact was communicated to LaserVision’s board.

The board was informed that the problems were technical in nature

and would be corrected. As far as Williams or Kelly knew, the offer-

10 DELLASTATIOUS v. WILLIAMS

ing documents were redrafted to accommodate Berkowitz’s concerns.

After the offering memorandum was revised, Williams stated that he

was unaware of any further complaints from Berkowitz. The very

fact, however, that Berkowitz’s concerns were presented to the board

suggests that a effective policy was in place and the reviewers were

scrutinizing what the drafters wrote.

Dellastatious can hardly suggest that Williams or Kelly should not

have relied on SAIL’s officers and legal counsel, all of whom by vir-

tue of their position or expertise were more intimately involved with

the production of the offering documents. Nevertheless, in an effort

to defeat summary judgment Dellastatious points to (1) Kelly’s prac-

tice of occasionally not reading the materials that LaserVision sent to

him; (2) Williams and Kelly’s knowledge that Berkowitz voiced con-

cerns about the original draft of the offering memorandum; (3)

Kelly’s general statement that he thought Gluck’s projections were

"pretty grandiose at times"; and (4) the fact that Williams was a mem-

ber of the committee charged with revising the November Offering

Memorandum.

However, none of these facts suggest that Williams and Kelly acted

unreasonably. The first three facts are subsumed by the presence of

SAIL’s system for identifying and correcting any errors in the offer-

ing documents. Williams and Kelly were neither negligent nor reck-

less in relying on those methods and on the experience of the other

directors. See Va. Code § 13.1-690(B). The fact that Williams served

on a revision committee also fails to raise a jury question regarding

his good faith. The minutes from LaserVision’s December meeting

state that the offering memorandum was revised so that SAIL could

raise an additional $2 million in equity capital. Williams saw the

offering documents for the first time near the beginning of December,

and SAIL sent Dellastatious the final version when it was completed

in March, 1998.

Williams and Kelly have presented sufficient evidence to show

they acted in good faith and diligently carried out their duties. At

most, the evidence reveals that Williams and Kelly had only a tangen-

tial relationship to SAIL and its efforts to raise capital. There is no

evidence that Williams and Kelly were aware of any irregularities in

the materials that were sent to Dellastatious. They were never charged

DELLASTATIOUS v. WILLIAMS 11

with drafting or revising any of the documents before SAIL submitted

them to Dellastatious in November. Nor did they ever meet or com-

municate with Dellastatious. Furthermore, none of the money that

Dellastatious invested in SAIL was dispersed to Williams or Kelly.

The district court aptly described their relationship with SAIL’s

efforts to raise capital as "on the far periphery."

A jury could not infer from their positions as outside directors of

LaserVision and SAIL that Williams and Kelly acted in bad faith.

Because Williams and Kelly have satisfied the standard of Virginia’s

good-faith defense, see Va. Code § 13.1-522(C), they also qualify for

the defense under section 20(a) of the Exchange Act. See 15 U.S.C.

§ 78t(a). We therefore affirm the district court’s grant of summary

judgment in Williams and Kelly’s favor.5

III.

For the foregoing reasons, the judgment of the district court is

AFFIRMED.

5

Williams and Kelly cross-appeal the district court’s denial of their

motion for sanctions under Fed. R. Civ. P. 11 and the Private Securities

Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(c) ("PSLRA"). The

district court denied defendants’ motion for sanctions but failed to make

the specific factual findings required under the PSLRA. See 15 U.S.C.

§ 78u-4(c)(1); see also Simon DeBartolo Group, L.P. v. Richard E.

Jacobs Group, Inc., 186 F.3d 157, 166-67 (2d Cir. 1999). Because the

PSLRA "does not in any way purport to alter the substantive standards

for finding a violation of Rule 11," Simon DeBartolo, 186 F.3d at 167,

and because our own review of the record provides no basis for awarding

sanctions in this instance, a remand here would be unnecessary.