Appendix — Clark v. Watchie

~r-

In the Supreme Court

of the United States

OCTOBER TERM, 1974

RICHARD A. CLARK, JAMES H. EVANS,

WESTON M. LENNOX, DAVID A. MOFFATT,

SAMUEL L. SAVIDGE, GEORGE L.

ZIMMERMAN and HELEN D. BLOOMFIELD,

Petitioners,

v.

H. R. WATCHIE and SHEILA WATCHIE,

his wife, H. R. WATCHIE & ASSOCIATES,

INC., a Washington corporation, E. JOSEPH

McCAMBRIDGE and JANE DOE

McCAMBRIDGE, his wife, GENE LYNN and

JANE DOE LYNN, his wife,

Respondents.

APPENDIX TO PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

JOSEPH C. McKINNON

1510 IBM Building

Seattle, Washington 98101

Counsel for Petitioners

STEVENS-NESS LAW PUB. CO., PORTLAND, OR:. 6.75

oa

INDEX TO APPENDIX

Page

Text of SEC Rule 10b-5, 17 C.F.R. § 240, 10b-5.... A-1

Text of Rule 23 of the Rules of Civil Procedure for

the United States District Courts ................... A-1

Opinion of Court of Appeals —....... smadoiies seinieiiniaates A-5

Text of June 5, 1975 Order of the United States

Court of Appeals for the Ninth Circuit Deny-

ing Respondents’ Petition for Rehearing ____ A-18

District Court Order Denying Class Status to | :

ibaiidiaeisiniiaadiaanitalansiiaiiae ieiibimebneaiiiaate lei D iis ....A-1

Report of Special Master _... ........................... A-23

Portion of Plaintiffs’ Preliminary Pretrial State-

Ment Entitled “What Plaintiffs dhanened to

I = acceded 4 — A-42

Plaintiffs’ Disputed Contentions in Pretrial ny -

Portion of Page 286 of Transcript of Deposition

— gS GREENER ere EE eee. A-70

APPENDIX

Text of SEC Rule 10b-5

17 C.F.R. § 240, 10b-5

Rule 10b-5. Employment of Manipulative and Decep-

tive Devices.

It shall be unlawfui for any person, directly or in-

directly, by the use of any means or instrumentality

of interstate commerce, or of the mails, or of any fa-

cility of a national securi*is exchange,

(1) to employ any device, scheme or artifice to

defraud,

(2) to make any untrue statement of a material

fact or to omit to state a material fact necessary in

order to make the statements made, in the light of the

circumstances under which they were made, not mis-

leading, or

(3) to engage in any act, practice or course of

business which operates or would operate as a fraud

or deceit upon any person,

in connection with the purchase or sale of any

security.

Text of Rule 23 of the Rules of Civil Procedure

for the United States District Courts

(a) Prerequisites to a Class Action. One or more

members of a class may sue or be sued as representa-

tive parties on behalf of all only if (1) the class is so

numerous that joinder of all members is impractic-

A2

able, (2) there are questions of law or fact common

to the class, (3) the claims or defenses of the repre-

sentative parties are typical of the claims or defenses

of the class, and (4) the representative parties will

fairly and adequately protect the interests of the

class.

(b) Class Actions Maintainable. An action may be

maintained as a class action if the prerequisites of

subdivision (a) are satisfied, and in addition:

(1) the prosecution of separate actions by or

against individual members of the class would create

a risk of

(A) inconsistent or varying adjudications with

respect to individual members of the class which

would establish incompatible standards of conduct

for the party opposing the class, or

(B) adjudications with respect to individual

members of the class which would as a practical mat-

ter be dispositive of the interests of the other mem-

bers not parties to the adjudications or substantially

impair or impede their ability to protect their inter-

ests; or

(2) the party opposing the class has acted or re-

fused to act on grounds generally applicable to the

class, thereby making appropriate final injunctive

relief or corresponding declaratory relief with respect

to the class as a whole; or

(3) the court finds that the questions of law or

fact common to the members of the class predominate

A3

over any questions affecting only individual members,

and that a class action is superior to other available

methods for the fair and efficient adjudication of the

controversy. The matters pertinent to the findings in-

clude: (A) the interest of members of the class in

individually controlling the prosecution or defense of

separate actions; (B) the extent and nature of any

litigation concerning the controversy already com-

menced by or against members of the class; (C) the

desirability or undesirability of concentrating the lit-

igation of the claims in the particular forum; (D) the

difficulties likely to be encountered in the manage-

ment of a class action.

(c) Determination by Order Whether Class Ac-

tion to be Maintained; Notice; Judgment; Actions

Conducted Partially as Class Actions.

(1) As soon as practicable after the commence-

ment of an action brought as a class action, the court

shall determine by order whether it is to be so main-

tained. An order under this subdivision may be condi-

tional, and may be altered or amended before the de-

cision on the merits.

(2) In any class action maintained under subdi-

vision (b) (3), the court shall direct to the members of

the class the best notice practicable under the circum-

stances, including individual notice to all members who

can be identified through reasonable effort. The no-

tice shall advise each member that (A) the court will

exclude him from the class if he so requests by a spec-

ified date; (B) the judgment, whether favorable or

A4

not, will include all members who do not request ex-

clusion; and (C) any member who does not request

exclusion may, if he desires, enter an appearance

through his counsel.

(3) The judgment in an action maintained as a

class action under subdivision (b)(1) or (b) (2),

whether or not favorable to the class, shall include

and describe those whom the court finds to be mem-

bers of the class. The judgment in an action main-

tained as a class action under subdivision (b) (3),

whether or not favorable to the class, shall include and

specify or describe those to whom the notice provided

in subdivision (c) (2) was directed, and who have not

requested exclusion and whom the court finds to be

members of the class.

(4) When appropriate (A) an action may be

brought or maintained as a class action with respect

to particular issues, or (B) a class may be divided in-

to subclasses and each subclass treated as a class, and

the provisions of this rule shall be construed and ap-

plied accordingly.

(d) Orders in Conduct of Actions. In the conduct

of actions to which this rule applies, the court may

make appropriate orders: (1) determining the course

of proceedings or prescribing measures to prevent un-

due repetition or complication in the presentation of

evidence or argument; (2) requiring, for the protec-

tion of the members of the class or otherwise for the

fair conduct of the actidn, that notice be given in

such manner as the court may direct to some or all

A5

of the members of any step in the action, or of the

proposed extent of the judgment, or of the opportun-

ity of members to signify whether they consider the

representatition fair and adequate, to intervene and

present claims or defenses, or otherwise to come into

the action; (3) imposing conditions on the represen-

tative parties or on intervenors; (4) requiring that

the pleadings be amended to eliminate therefrom al-

legations as to representation of absent persons, and

that the action proceed accordingly; (5) dealing with

similar procedural matters. The orders may be com-

bined with an order under Rule 16, and may be al-

tered or amended as may be desirable from time to

time.

(c) Dismissal or Compromise. A class action shall

not be dismissed or compromised without the approval

of the court, and notice of the proposed dismissal or

compromise shall be given to all members of the class

in such manner as the court directs.

Opinion of Court of Appeals

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

RICHARD A, CLARK, JAMES H. EVANS, WESTON

M. LENNOX, DAvis A. MOFFAT, SAMUEL L.

SAVIDGE, GEORGE L. ZIMMERMAN and HELEN

D. BLOOMFIELD,

Plaintiffs-Appellants,

Vv.

A6

H. R. WATCHIE and SHEILA WATCHIE, his wife;

H. R. WATCHIE and ASSOCIATES, INC., a

Washington corporation; E. JosepH McCaM-

BRIDGE and JANE DoE McCAMBRIDGE, his wife;

GENE LYNN and JANE DoE LYNN, his wife,

Defendants-Appellees.

No. 74-1382

OPINION

[April 2, 1975]

On Appeal from the United States District Court

for the Western District of Washington

Before: CHAMBERS and WRIGHT, Circuit Judges,

and THOMPSON,* District Judge.

THOMPSON, District Judge:

This appeal is from a summary judgment in favor

of Defendants-Appellees. The district court held that

the doctrines of res judicata and collateral estoppel

preclude a 10b-5 suit subsequent to a state court judg-

ment in a partnership accounting suit. The Court also

denied class status to Plaintiffs-Appellants. We re-

verse the first determination and affirm the second.

H. R. Watchie was President of H. R. Watchie &

Associates. In 1961, Watchie formed a large land syn-

dicate limited partnership known as Cougar Mountain

Associates. H. R. Watchie was the general partner

of Cougar Mountain Associates and H. R. Watchie &

* Honorable Bruce R. Thompson, United States District

Judge for the District of Nevada, sitting by designation.

A7

Associates was its management corporation and real

estate broker.

Limited partnership units were to be sold to the

public. The partnership agreement provided for six

hundred limited partnership units. Each limited part-

ner was to contribute $20,000 for each unit; $5,000

down and yearly assessments of $1,750 up to the total

as required. Prospective purchasers were invited to

clubs and restaurants to hear a sales talk by H. R.

Watchie. After Watchie’s presentation, commissioned

salesmen met with the prospective purchasers to show

them property which the partnership planned to buy

and to persuade them to purchase partnership units.

Each of the apellants purchased one or more units.

Cougar Mountain Associates ultimately purchased

or entered into contracts to purchase sixty-six parcels

of property. Watchie had an ownership interest in

forty-three of those parcels. Some of the parcels of

property purchased by the partnership were pur-

chased from Watchie’s brokerage customers.

In 1967, because of its precarious financial con-

dition, the partnership was forced to pledge all its as-

sets to borrow money at high interest rates. CMA Cor-

poration was organized to replace Watchie as general

partner of Cougar Mountain Associates. The new

general partner terminated the management contract

of H. R. Watchie & Associates.

On October 29, 1968, two suits—one in state court,

the other in federal court—were instituted against

H. R. Watchie. The state complaint alleged that

A8

Watchie breached his fiduciary duty to the partner-

ship by mismanaging the partnership affairs from

1961 to 1967. The federal complaint alleged a violation

of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78j(b) and Rule 10b-5, 17 C.F.R. § 240-10b-5.' The

federal complaint alleged that Appellees, acting indi-

vidually and in conspiracy, made material misrepre-

sentations and omissions in connection with the sale

of the partnership units in 1961 and 1962. Lynn, Mc-

Cambridge and Gustaveson were added as defend-

ants in the federal suit only in July, 1969.

The Court found that Watchie had acted in good

faith but had failed to obtain appraisals on several

properties as required by the partnership agreement.

Judgment was entered against him for $515,880.44,

the excess of the purchase price of these properties

over their fair market value.

On November 26, 1971, relying on a report of the

special master, the district court denied Appellants’

motion for a determination that the suit be certified

as a class action. An appeal of that decision was with-

drawn by Appellants.

' Rule 10b-5, 17 C.F.R. § 240, 10b-5, provides in part: |

“It shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality of

interstate commerce * * *

“(b) To make any untrue statement of material fact

or omit to state a material fact necessary in order to

make the statements made * * * not misleading * * *

in connection with the purchase or sale of any security.”

2 Defendant Gustaveson’s motion to dismiss was granted

vrior to the order granting summary judgment in favor of

Watchie, Lynn, and McCambridge.

A9

On October 25, 1973, following the special mas-

ter’s report, the district court granted Appellees’ mo-

tion for summary judgment. The master had con-

cluded that since the issues in the state and federal

cases were similar, the findings of the state court

estopped the Appellants from further pursuing their

federal claim.

THE RES JUDICATA/COLLATERAL ESTOPPEL

EFFECT OF THE STATE JUDGMENT

ON THE 10b-5 SUIT.

We must first deal with res judicata. It is only

when the prior judgment does not fit into that doc-

trine that it is necessary to inquire into the collateral

estoppel effect of the judgment. Exhibitors Poster

Exchange, Inc. v. National Screen Service Corp., 421

F, 2d 1313, 1316 (5th Cir. 1970).

The doctrine of res judicata will apply to preclude

a second suit only if the causes of action in the two

suits are identical.* The Securities Exchange Act of

1934, 15 U.S.C. § 78aa, gives exclusive jurisdiction to

the federal courts to consider Rule 10b-5 claims.* In

Abramson v. Penwood Inv. Corp., 392 F.2d 759, 762

(2nd Cir. 1969), the Court said that a Rule 10b-5

claim “is a different cause of action from the claim

See 1B Moore’s Federal Practice, § 0.441(2) at 3777

(2nd Edition 1974).

4 The Securities Exchange Act of 1934, 15 U.S.C. § 78aa,

provides:

“The district courts of the United States * * * shall

have exclusive jurisdiction of violations of this chapter

or the rules and regulations thereunder * * *.”

A10

for breach of fiduciary duty and is one which is cog-

nizable only in federal courts. Res judicata cannot be

applied to foreclose the federal claim in this case.

Lynn and McCambridge were not parties in the

state suit. We must, therefore, preliminarily consider

whether they have standing to assert the defense of

collateral estoppel. Under traditional collateral estop-

pel theory, the doctrine of mutuality of estoppel re-

quired that the party asserting the defense must have

been a party to the earlier litigation. In Blonder-

Tongue Laboratories v. University of Illinois Founda-

tion, 402 U.S. 313, 320-828 (1971), the Supreme

Court criticized and rejected the doctrine of mutuality

of estoppel. Thus, Lynn and McCambridge may assert

the defense.

Appellants should not, however, be collaterally

estopped from asserting their 10b-5 claim against

those Appellees. The master’s report was premised on

the notion that the 10b-5 claim was based solely on a

conspiracy theory. The master reasoned, and Appel-

lees similarly contend, that a conspiracy could not

have existed given the finding of Watchie’s good faith

by the state court. However, even if the finding of

Watchie’s good faith would foreclose the determina-

tion of Watchie’s involvement in a conspiracy, Lynn

and McCambridge could be found to have conspired to-

gether to sell securities in violation of Rule 10b-5.

Moreover, since the amended 10b-5 complaint points

to the acts of Appellees as individuals as well as con-

spirators, the finding of Watchie’s good faith does not

Ee a mene

All

preclude the finding of individual security violations

on the part of Lynn and McCambridge.

Watchie was named as a defendant in both suits.

Collateral estoppel will preclude relitigation of those

matters or issues that were litigated and were neces-

sary to the state court judgment.® A three-part test

to determine the applicability of the doctrine was dis-

cussed by the Court in Blonder-Tongue Laboratories,

supra, at 323-24. Appellants here are not collaterally

estopped from bringing the 10b-5 suit unless each of

the following questions is answered affirmatively:

Was there a final judgment on the merits? Was the

party against whom the plea is asserted a party or in

privity with a party to the prior adjudication? Was

the issue decided in the prior adjudication identical

with the one presented in the action in question?

The first question presents little problem within

the context of this case. The state court judgment was

clearly a final judgment on the merits.

The second question is also to be answered affirm-

atively. The parties against whom collateral estoppel

is asserted were parties in the state suit.° The state

suit was filed as a class action under Washington

State C.R. 23(b) (1).” The federal suit was filed un-

5 1B Moore’s Federal Practice, § 0.441(2), at 3777.

6 It is insignificant that CMA Corporation was a plaintiff

in the state suit and not in the federal suit. For collateral

estoppel purposes, it is important only that all the plaintiffs

2 the federal suit had the opportunity to litigate the state

claim.

7 Washington State C.R. 23(5b)(1) is identical to Rule

23(b) (1), Federal Rules of Civil Procedure.

a

Al2

der 23(b)(3) of the Federal Rules of Civil Proce-

dure.® Appellants contend that the plaintiffs in the

two actions are not the same because notice was not

given to absent class members in the state suit and,

consequently, those absent members cannot be bound

by judgment. That contention is without merit.° In

effect, plaintiffs in the two actions are the same class,

namely, that class of limited partners of Cougar

Mountain Associates.'°

Determination of the third question involves in-

quiry into whether the factual issues in the two suits

and the standards applied in each are identical. See

Peterson v. Clark Leasing Corp., 451 F. 2d 1291,

1292 (9th Cir. 1971).

The factual issues in the two suits are not ident-

ical. The state suit asked for a partnership accounting

and damages. The state complaint alleged that Wat-

@ Appellants originally contended that class status could

be onal in the federal suit under 23(b) (1), Federal Rules

of Civil Procedure. Appellants have subsequently conceded

that 23(b) (3), Federal Rules of Civil Procedure is the only

appropriate class action provision for a 10b-5 suit. Cf. La-

Mar v. H&B Novelty & Loan Co., 489 F. 2d 461, 466-467

9th Cir. 1973).

; 2 See 3B ate Federal Practice, § 23.55 at 1152: —

“There will be situations where the class is cohesive,

or where the legal relationship of the members enables

one or more to stand in judgment for all and where the

representatives are truly representative—a most im-

portant factor. In these * * * situations we suggest that,

although some notice to the members may be desirable

and may be given * * * a judgment should be res judi-

cata to all the class, even in the absence of notice, in

the (b) 1 and (b) (2) situations where the require-

ments of Rule 23 have been satisfied.”

10 Except of course those limited partners named as de-

fendants in the action.

pemietind en ern

ee _ .

er ee

A13

chie mismanaged the partnership from 1961 through

1967. Each allegation related to the buying, selling

or appraising of real property. The answer and coun-

terclaim were also confined to the management of the

partnership. The state court held that Watchie made

mistakes of judgment but that he did not breach his

fiduciary duty to the partnership. The state suit, then,

resolved issues of non-disclosure with respect to the

operation of the partnership itself from 1961 to

1967.

The federal complaint alleges that Appellees, by

concealing material facts, violated and conspired to

violate Rule 10b-5 in the sale of limited partnership

units in 1961 and 1962. In Watson v. Roberts, Scott

and Company, Inc., 466 F. 2d 1348 (9th Cir. 1972),

we held that in cases in which the state court did not

decide issues of fact or law that would be dispositive

of a federal action, the state judgment could not col-

laterally estop litigation of a subsequent federal suit.

Here, neither complaint nor answer referred to fed-

eral securities law. Only one finding of fact in the

state judgment mentions the selling of partnership

units.'' That finding stands alone and lacks relevant

substance. It is therefore unnecessary to the state

judgment. See Fibreboard Paper Products Corp. v.

East Bay Union of Machinists Local No. 1304, 344

1! Finding of Fact No. 70 states:

“When he had engaged in selling the units of lim-

ited partnership during 1961 and 1962, defendant H. R.

Watchie had represented that he had special experience

* * * with respect to the buying, selling and development

of raw land.”

Al4

F. 2d 300, 306 (9th Cir.), cert. denied 382 U.S. 826

(1965), wherein we said that “where estoppel by

judgment is asserted, the earlier determination must

have been of a question of fact essential to the earlier

judgment.”

Not only were the factual settings in the two suits

different, but different legal standards are to be ap-

plied to assess liability in each suit. We considered

the legal standard applicable to a 10b-5 claim in

White v Abrams, 495 F.2d 724, 734 (9th Cir. 1974).

There we said that “we reject scienter or any other

state of mind as a necessary and separate element of

a 10b-5 action.” Under the Abrams standard, liability

can be based on negligence, either with respect to the

facts involved or the disclosure required.

In the state suit, the Court found no breach of

fiduciary duty on the part of Watchie since all his

mistakes were honest. Watchie’s mistakes in judg-

ment could have been negligent but since they were

honest, he was absolved of the alleged breach of fidu-

ciary duty.'?

The federal test, as set out by this Circuit, holds

12 Subsequent to the state judgment, the Supreme Court

of Washington posited the standard to be applied when

analyzing an alleged breach of fiduciary duty. In Bassan v.

Investment Exchange Corp., 83 Wash. 2d 922, 524 P. 2d

233 (1974), the court apparently rejected a state of mind

standard in determining whether one has breached his fidu-

ciary duty. Thus, the Washington standard for breach of

fiduciary duty is now more similar to this Circuit’s 10b-5

standard. Nevertheless, when collateral estoppel is the issue,

it is the standard applicable at the time of the earlier de-

cision which is significant.

~ a a LTTTT

Ald

a defendant to a higher standard of accountability

than the Washington standard for breach of fiduciary

duty.

MAINTENANCE OF A 10b-5 SUIT

AS A CLASS ACTION

Before permitting a suit filed under Rule 23(b)

(3) of the Federal Rules of Civil Procedure to be

maintained as a class action, the Court must find that

the questions of law or fact common to the members

of the class predominate over any questions affecting

only individual members. The Court must also find

that a class action is superior to other available meth-

ods for the fair and efficient adjudication of the con-

troversy.

The district court adopted the special master’s re-

port without extensive comment. The report stated

that none of the Appellees made written representa-

tions to the purchasers of limited partnership units.

The master reasoned that since the alleged omissions

and misrepresentations were oral, separate determina-

tions would have to be made of what was disclosed to

each limited partner. He concluded that questions of

law or fact common to the members of the class do not

predominate over questions affecting only individual

members.

Appellants contend that we should hold that com-

mon questions predominate. They reason that it is

important that the presentations of some salesmen

may have differed from others only if the element of

Al16

reliance is a prerequisite to ultimate liability. In sup-

port of their contention that reliance is not an ele-

ment in a 10b-5 suit, Appellants cite Affilinted Ute

Citizens v. United States, 406 U.S. 128, 153-154

(1972). There the Supreme Court said that “positive

proof of reliance is not a prerequisite to recovery. All

that is necessary is that the facts withheld be ma-

terial in the sense that a reasonable investor might

have considered them important in the making of the

decision.”

In so arguing, Appellants misconceive the issue.

Although they might not have to establish reliance to

ultimately succeed in the suit, Appellants must show,

as a condition to class status, that any misrepresenta-

tions or non-disclosures were common to the class."

They have not done so for they have not shown that

the alleged misrepresentations and non-disclosures in-

volved every limited partner.'*

13 In this connection, the Second Circuit case, Herbst v.

International Telephone and Telegraph Corp., 495 F. 2d 1308

(2nd Cir. 1974), is inapposite. The Court held that since in-

dividual reliance was not an element, the district court did

not err in holding that common issues of law and fact were

predominant. In Herbst, the alleged misrepresentations were

issued through a written prospectus. In certifying the suit

as a class action, the district judge could have assumed that

all class members received the standardized prospectus. A

similar assumption cannot be made in this case. Further-

more, other courts have held that oral misrepresentations

lead to individual questions because they are not standardized

in the same sense as misrepresentations appearing in a pro-

spectus or financial statement. See Moscarelli v. Stamm, 288

F. Supp. 453, 462 (E.D. N.Y. 1968) ; Simon v. Merrill Lynch,

Pierce, Fenner and Smith, Inc., 482 F. 2d 880, 882 (5th Cir.

1973).

14 Appellants have the burden of showing that common

questions predominate. Cf. Poindexter v. Teubert, 462 F. 2d

1096, 1097 (4th Cir. 1972).

ee —

Al7

In Price v. Lucky Stores, Inc., 501 F. 2d 1177

(9th Cir. 1974), we said:

“A class action determination under Fed. R.

Civ. P. 23 is one of a trial court’s considered dis-

cretion. (Citations omitted.) * * * This is so be-

cause the district court is in the best position to

consider the most fair and efficient procedure for

conducting any given litigation. Such a determin-

ation by the Court will not be disturbed on appeal

unless the party challenging it can show an abuse

of discretion.” 501 F. 2d at 1179.

Other circuits have similarly deferred to the judg-

ment of a district court in determining whether a suit

should be maintained as a class action. See City of

New York v. International Pipe and Ceramics Corp.,

410 F. 2d 295 (2nd Cir. 1968) ; Wilcox v. Commerce

Bank of Kansas City, 474 F. 2d 3386 (10th Cir.

1973); Castro v. Beecher, 459 F.2d 725 (1st Cir.

1972) ; Hackett v. General Host Corp., 455 F. 2d 618

(3rd Cir. 1972).

If the trial judge has made findings as to the pro-

visions of the Rule and their application to the case,

his determination of class status should be considered

within his discretion. Price, supra, at 1179; City of

New York, supra, at 248; Wilcox, supra, at 345. Here,

the special master analyzed the provisions of Rule

23(b) (3) and determined that the common questions

of law and fact did not predominate over the indi-

vidual questions. We hold that this analysis which was

adopted in full by the trial court, meets the test set out

in Price, supra.

A18

Accordingly, we hold that the trial court did not

abuse its discretion when it made a class action de-

termination against Appellants.

The judgment of the district court is vacated and

the case is remanded for consideration consistent with

this Opinion.

Text of June 5, 1975 order of the United States

Court of Appeals for the Ninth Circuit denying

respondents’ petition for rehearing

Before: CHAMBERS and WRIGHT, Circuit Judges,

and THOMPSON,* District Judge.

for the District of Nevada, Reno, Nevada, sitting by desig-

nation.

A petition for a rehearing has been filed; also

bills of costs and objections thereto have been filed.

Good cause appearing, IT HEREBY IS ORDERED:

1. The slip opinion dated April 2, 1975 in the

action entitled above is hereby amended as follows:

(a) The second full paragraph on page 7

thereof is hereby amended to read as follows:

“The federal test, as set out by this Circuit,

holds a defendant to a higher standard of account-

ability than that adopted by the Washington

Court in the state action.”

(b) Footnote 12 on page 7 of said opinion

shall be stricken.

2. Pursuant to Rule 39(a), Federal Rules of Ap-

* Hon. Bruce R. Thompson, United States District Judge

A19

pellate Procedure, both parties having prevailed in

part, each party shall bear his own costs on appeal

and costs on appeal are not allowed to any party.

3. The petition for a rehearing is denied.

District Court Order Denying

Class Status to Suit

UNITED STATES DISTRICT COURT

WESTERN DISTRICT OF WASHINGTON

AT SEATTLE

RICHARD A. CLARK, et al.,

Plaintiffs,

v.

H. R. WATCHIE, et ux, et al.,

Defendants,

GENE LYNN,

Third Party Plaintiff,

v.

ROBERT W. BRATTON, et ux, et al.,

Third Party Defendants.

CIVIL ACTION

No. 7980

FINDINGS AND ORDER CONCERNING

CLASS ACTION MOTION

Plaintiffs filed a motion for determination by this

court that this case be designated a class action. This

A20

motion was heard before Special Master Kenneth

S. Treadwell, to whom this motion and all other pre-

trial proceedings had been referred. The Special

Master filed his report containing his findings of fact

concerning the class action issues and concluding that

the motion for a class action treatment should be de-

nied. Plaintiffs filed objections to the report and also

noted a request that the court hear certain motions to

amend their complaint prior to a determination of the

class action issue. The matter of the motion to amend

had been previously noted before the Special Master

and had been reserved for ruling after the court’s

determination of the class action issues and of certain

motions for summary judgment which had been

brought by the defendants Lynn and Gustaveson. This

court has previously heard the plaintiffs’ motion to

allow an amendment of the complaint prior to consid-

eration of the class action and after a review of the

briefs and records concerning said motion affirmed

the Special Master’s ruling in that regard.

Applications for review of the Special Master’s

report on the class action issue were heard before the

undersigned on November 11, 1971. At the hearing

the plaintiffs were represented by Joseph C. McKin-

non and the defendant Lynn by Payton Smith, defend-

ants Gustaveson by Arnold J. Barer, and the 3rd

party defendant Elizabeth A. Clark by William Wes-

selhoeft. Mr. Alec Brindle and Mr. C. M. McCune, at-

torneys for certain third party defendants were also

present for a portion of the argument and hearings

on that date.

A21

This court has considered the briefs of counsel

submitted in connection with the class action motions,

the transcripts of the arguments before the Special

Master regarding said issue, arguments of counsel,

and the files and records submitted to date as well as

the Special Master’s report. Based on the above, this

court makes the following findings:

A. The evidence and records fully support the

findings of fact of the Special Master concerning

class action treatment and his report is affirmed and

adopted.

B. This court, based upon its own review of the

files and records finds that class action treatment

should be denied. In so denying class action treat-

ment and making said findings, this court has consid-

ered and adopts as its own findings, the following

portion of the Special Master’s report:

“This action grows out of an alleged conspir-

acy entered into in early 1961 between the vari-

ous defendants who allegedly devised a plan to

defraud investors in Cougar Mt. Associates. The

scheme called for the creation of the limited part-

nership and the sale of limited partnership units

to investors by the use of concealment, half

truths and false statements, the later sale to the

partnership of real estate, in which the defend-

ants had some interest, at exorbitant prices. In

order to sell the units, H. R. Watchie, conducted

well over one hundred public meetings in which

he made an oral presentation, later the prospects

present were contacted by one of some twenty

salesmen who would make a further oral sales

A22

‘pitch.’ Some 400 different investors each paid

or committed to pay $20,000 for a unit. Each

prospect received a printed copy of the Articles of

Limited Partnership but nothing more. The pur-

chasers of the units came from every walk of life,

lawyers, stockbrokers, doctors, real estate sales-

men and brokers, and the statements made to each

varied and the reliance placed on the sales ‘pitch’

by such diverse purchasers must of necessity

varied.

“None of the defendants issued or published

any written representations in writing. The con-

cealment of material facts, half truths and false

statements alleged by the plaintiffs were oral and

the statements made or not made will vary in the

case of every sale made to a limited partner.

Therefore, it cannot be found that ‘question of

law or fact common to the members’ predominates

over questions affecting individual members of the

class. Since a separate determination will have to

be made as to each limited partner with regard

to misrepresentation or failure to disclose facts,

it follows that a class action in this case could

verv well require the trial of some 380 separate

claims.” .

From the foregoing findings this court concludes

that the class action motion should be denied and IT

IS SO ORDERED.

DATED this 26th day of November, 1971.

UNITED STATES DISTRICT JUDGE

s/ Walter T. McGovern

A23

Report of Special Master

IN THE DISTRICT COURT OF THE

UNITED STATES FOR THE WESTERN

DISTRICT OF WASHINGTON, AT SEATTLE

RICHARD A. CLARK, et al.,

Plaintiffs,

v.

H. R. WATCHIE, et ux, et al.,

Defendants,

GENE LYNN,

Third Party Plaintiff,

v.

ROBERT W. BRATTON, et ux, et ai.,

Third Party Defendants.

CIVIL ACTION

FILE NO. 7980

REPORT OF SPECIAL MASTER

RE: SUMMARY JUDGMENT AND

CLASS ACTION ORDER

During the 1950’s and early 60’s the land values

east of Lake Washington were increasing in value at

a fairly rapid rate. H. R. Watchie operated a real

estate business in that area under the name and style

of Lakemont Realty Company. Later the business was

incorporated and the name changed to H. R. WAT-

CHIE and Associates, Inc.

Commencing in the middle 1950’s Mr. Watchie

A24

organized groups of individuals into syndicates for

the purpose of acquiring unimproved land. The syndi-

cate would hold land until it increased in value and

then sell it. Because of the rapid increase in land

values Watchie was able in many cases to sell the

land at double what the syndicate paid for it. In a

number of instances one of Watchie’s syndicates

would sell to another syndicate organized by Watchie.

In early 1960 Watchie embarked upon a more ex-

panded operation and in May of 1961 organized Cou-

gar Mt. Associates. This was a limited partnership

organized under the laws of the State of Washing-

ton and authorized to sell 600 limited partner units

to the public. H. R. Watchie was the sole general

partner. A limited partnership unit required an initial

capital contribution of $5,000 and additional annual

contributions of $1,750 not to exceed $15,000 making

each limited partnership unit cost $20,000.

The purpose of this partnership was to purchase

and sell real property and the articles of partnership

gave Watchie very broad powers in determining the

price, amount and location of the property. The ar-

ticles also authorized Watchie to purchase for the

partnership property in which he had an interest and

further permitted him to act as agent and broker and

receive commissions on such purchases and sales.'

Approximately 400 limited partnership units were

sold to the public by Watchie and salesmen employed

by him. In additional approximately 50 limited part-

1Sec. A 4 and 5 Articles of Limited Partnership.

A25

nership units were transferred to H. R. Watchie for

commisisons and equities owned by him in property

sold to the partnership.

In marketing these units, some 100 meetings of

prospective purchasers were held in the Harbor Club

in Seattle or in the Blue Dolphin in Bellevue. At these

meetings H. R. Watchie would make a general presen-

tation as to the purposes and hopes of the endeavor.

These meetings would be followed up by various

salesmen contacting the people present in an effort

to close a sale. The salesmen employed by Watchie

were somewhat carefully selected to insure a group

of salesmen of diverse backgrounds and interests. The

sales staff consisted of former bank vice-presidents,

college graduates, retired business men, mechanics,

etc. so that there would be a salesman available for

every type of prospective purchaser. Consequently the

purchasers of partnership units covered the full spec-

trum of the community. Many purchasers were so-

phisticated land dealers and real estate salesmen,

many attorneys and doctors purchased units, and

many of the purchasers were former members of syn-

dicates that sold land to the partnership.

From the time of its inception through May, 1964,

Cougar Mt. and Associates acting through H. R.

Watchie purchased sixty-six parcels of land in Belle-

vue, Lake Sammamish, Redmond area totalling 3,961

acres at a total price to the partnership of $10,015,-

727.33. The partnership through June of 1966 sold

A26

some 675 acres of land for a total sales price of

$2,368,461.84.?

Forty-three properties or sixty-five percent of the

original sixty-six properties acquired by the partner-

ship were sold to the partnership by H. R. Watchie or

one of his controlled companies with H. R. Watchie or

one of his controlled companies acting as broker. These

forty-three properties comprise some 2400 acres or

sixty percent of the total acreage purchased. These

forty-three properties were acquired between Septem-

ber, 1958 and July, 1961, by syndicates organized by

Watchie for some $2,800,000. This same real estate

was then sold to H. R. Watchie or one of his con-

trolled companies to the Cougar Mt. Associates part-

nership for $5,500,000.° Twenty-six of the properties

referred to were acquired by the partnership at ex-

actly double the previous price paid by the seller. Of

the remaining seventeen properties, nine sold for more

than double the previous purchase price and eight

were sold to the partnership for less than double the

purchase price.

Sometime during the latter part of 1965 and early

1966 some of the limited partners became disenchanted

with Watchie’s operation and started to question his

business judgment and some of his financial trans-

actions. This disenchantment basically resulted from

the fact that the general partner was still calling upon

the limited partners for the annual assessment of

2 Beezer Report p. 65.

3 Beezer Report p. 55.

A27

$1,750 when they had been led to believe that only

two and at most three assessments would have to be

made.

These disenchanted limited partners held a num-

ber of informal conferences as a result of which a

formal meeting was called February 16, 1966, at the

Orcas Room of the Civic Center of all of the limited

partners. The general partner appeared and was ex-

amined relative to the partnership operations. This

meeting left many of the limited partners deeply con-

cerned and worried about their investment and dis-

satisfied with the information they had received from

Watchie. This group formed themselves into an in-

formal group known as the Cougar Mt. Associates

Protective Association and solicited contributions of

$100 each from all limited partners. They arranged

for the employment of the law firm of Schweppe, Doo-

little and Krug to make a complete detailed analysis

of the business Cougar Mt. Associates. This was done

with the aid of a firm of CPA’s and a firm of MAI

appraisers. This report (known as the Beezer Report

and filed as document + 216 in this proceeding) was

critical of Watchie’s management of the partnership

affairs and of the leyal opinion pointing out the fol-

lowing deficiencies:

1. A loan transaction involving $500,000 was

usurious.

2. That H. R. Watchie, the general partner, made

purchases of real property in excess of the fair mar-

ket value of said property. The real property pur-

chased by the partnership was valued by the apprais-

A28

ers as having a total value of $7,341,500. The partner-

ship had paid a total of $10,015,727.33 for this prop-

erty.

8. The general partner as of June 30, 1966, had

permitted unpaid real estate taxes to accumulate

against the properties purchased in the amount of

$151,995.52.

4. The Articles of partnership provided that H. R.

Watchie or related persons or entities may transfer

property interests to the partnership in which H. R.

Watchie or related persons has an interest of more

than ten percent providing the valuation of such

property was substantiated by at least three apprais-

ers’ valuations. The general partner failed to obtain

fully documented appraisals from the MAI appraisers

required but in lieu thereof obtained letters of opinion

from MAI appraisers.

The recommendation of the attorneys was that

the contents of the report be brought to the attention

of the general partner and the deficiencies corrected.

Also suggested more control of the partnership affairs

by the limited partners by use of a corporate form of

business organization to serve as a general partner.

While the protective committee investigation was

in progress the Securities and Exchange Commission

undertook a study of the affairs of Cougar Mt. Asso-

ciates. As a result of which the Securities and Ex-

change Commission commenced an action in the

United States District Court to enjoin Watchie from

making further assessments on limited partners of

Cougar Mt. Associates until a full disclosure had been

made to the limited partners by the general partner.

Such a report was prepared by the general partner

A29

under the supervision of the Securities and Exchange

Commission and in the summer of 1967 distributed to

all limited partners. That report made a full dis-

closure of the financial problems of Cougar Mt. and

Associates.

Following the completion of the Schweppe report,

Watchie consented to the creation of a corporation to

be formed to take over as a general partner. This

change was effected in the late summer of 1967 by

the resignation of Watchie and the substitution of the

corporation as general partner. Watchie and several

former limited partners of Cougar Mt. Associates

became directors of the new corporate general part-

ner and Watchie was elected President. Watchie func-

tioned in this capacity for a short time when disagree-

ments arose between him and the other directors over

the management of the affairs of the partnership.

Thereafter the managing corporate partner com-

menced an action against Watchie to recover partner-

ship assessments due on the approximate fifty limited

partnership units owned by Watchie. This suit was

settled by Watchie’s surrendering for cancellation all

the limited partnership units owned by him.

After the reorganization, the new corporate gen-

eral partner continued to operate the business of the

partnership calling on limited partners for assess-

ments and managing the property of the partnership.

All assessments due on limited partnership units

have now been made and collected except in the few

cases of a few limited partners who refused to pay

A30

their assessments and their units have been forfeited

and cancelled.

The foregoing then is a short history of the unsuc-

cessful land speculation of Cougar Mt. Associates.

Some seven years after most of the limited partners

had acquired their partnership units, on Oct. 29, 1969,

after years of investigation by accountants, attorneys

and appraisers of the some sixty-six land transactions

entered into by the partnership, a number of limited

partners acting for themselves and on behalf of all

other limited partners commenced this action against

H. R. Watchie and H. R. Watchie and Associates, Inc.

Almost a year later after many depositions and addi-

tional investigation by the attorneys for the limited

partners, the action was amended to include as party

defendants, the officers and directors of H. R. Wat-

chie and Associates, Inc.

The plaintiff’s theory is that the officers and di-

rectors of H. R. Watchie and Associates, Inc. con-

spired together to create Cougar Mt. Associates and

sell to that limited partnership a number of parcels

of land held by syndicates created by H. R. Watchie

prior to mid-summer 1961 at inflated prices. It is al-

leged that this conspiracy is in violation of Sec. 15b

of the Securities Exchange Act of 1934 and Security

and Exchange Rule 10b-5.

The defendants, Watchie and his wholly owned

corporation, H. R. Watchie and Associates, Inc., de-

nies most of the material allegations of the complaint

in their answer and counterclaim against one of the

A3l

plaintiffs, James H. Evans, for the sum of Two Mil-

lion Dollars for damages to Watchie. The other cor-

porate officers with the exception of Gene Lynn have

filed answers denying the plaintiff’s allegations. Gene

Lynn, however, filed an answer denying allegations of

the complaint and by Third Party Complaint asserts

claims against two classes of limited partners. The

first, some twenty-one limited partners who were

members of syndicates that sold land to the partner-

ship at a profit and second, some members of the so-

called “Cougar Mt. Protective Committee” who by

their actions caused the various limited partners to

meet the assessments due on their partnership units

for the years 1966 through 1968; these parties in

effect joined in that conspiracy and therefore they

are responsible along with the principal defendants

for any damages, his theory being that if a conspiracy

existed to defraud the limited partners, the members

of the committee joined in that scheme by soliciting

and urging members to pay such assessments.

STATUTE OF LIMITATIONS

Defendants, Lynn, Gustafson and McCambridge

moved for summary judgment on the grounds that the

claims of the plaintiffs arose more than three (3)

years prior to the filing of this action.

Since the Federal Securities Acts do not contain

any reference to a period of limitations, the Federal

Court must refer to and apply the statute of limita-

A32

tions of the appropriate State Court.‘

Fratt v. Robinson, 203 F.2d 627 (9th Cir. 1953). Bromberg

Security Law, 41, § 2.5 (1).

The applicable limitation statute of the State of

Washington is found in R.C.W. 4.16.080 (4). Tha°

statute provides in part as follows:

“Within three (3) years,...

“(4) An action for relief upon the ground of

fraud, a cause of action in such case shall not be

deemed to have accrued until the discovery by the

aggrieved party of the facts constituting the

frema. ..."

There are a number of cases dealing with factual

situations that will commence the running of the

statute. Generally the aggrieved party must discover

evidential facts sufficient to lead a reasonably prudent

person to believe that he has been defrauded. Factual

knowledge of the fraud will be inferred if the ag-

grieved party, by the exercise of due diligence could

have discovered it.®

The defendants have filed many affidavits and ex-

tensive memorandums analyzing the facts of this

complicated and involved case in an effort to show

that each one of the named plaintiffs had possession

of sufficient facts leading each to the belief that he

had been defrauded, and that this evidence had come

to the attention of each more than three years prior

to the commencement of this action.

4Turner V. Lundquist, 377 F.2d 44 (9th Cir. 1969).

5 Errion V. Connell, 236 F.2d 447 (9th Cir. 1956). Turner

v. Lundquist, 377 F.2d 44 (9th Cir. 1967).

A33

The position of the defendants is not without

merit, considering the fact that most of the limited

partnership units had been sold to the public before

the end of the year 1961, and that the plaintiff's orig-

inal action was not commenced until almost seven

years later in November of 1968, and the defendants,

Lynn, Gustafson and McCambridge were not made

parties until July 16, 1969.

While many of the plaintiffs had early doubts and

concerns about their investment and the manner in

which the general partner was handling the partner-

ship property, these concerns and doubts involved the

safety of the investment and not the possibility that

they had been defrauded. At the time the limited part-

ners purchased their units they had been led to be-

lieve that their investment would double in a very

short while and that only two or three annual assess-

ments would have to be made. A depressed real estate

market and high interest rates slowed up the rapidly

increasing property values that had been incurring

the previous decade. This concern about their invest-

ments is not factual evidence of fraud. It was not un-

til a number of limited partners banded themselves

together in the so called Cougar Mt. Protective As-

sociation and collected from limited partners $100

contributions creating a fund of well over $20,000

that any meaningful investigation could be made.

With this fund, attorneys were employed, account-

ants and appraisers were put to work, and the so

called Beezer Report was produced, at a total cost in

excess of $25,000. That investigation began in May of

A34

1966 and the results were published in February,

1967. This report indicated some possible wrongdoing

by the general partner. However, it was not until fur-

ther investigation had been made that it appeared that

there might possibly be a violation of Rule 10b-5 in

the sale of the partnership. This violation, as alleged

by the plaintiff, is a conspiracy entered into by all the

parties defendants sometime during the summer of

1961 and did not come to light until after the com-

mencement of the original lawsuit and only after ex-

tensive depositions and investigation by plaintiff’s

attorney.

On a motion for summary judgment, in deciding

whether there is an issue of material fact in this case,

all doubts must be resolved against the moving party.°

Therefore, the Special Master finds that there is an

issue of material fact as to when the statute of limita-

tions commenced to run and the resolution of that

issue must await the trial.

MOTION FOR CLASS ACTION

The plaintiffs maintain that this action is a proper

class action pursuant to the provisions of Fed. R. Civ.

P. 23(b)(1)(B) or in the alternative under subsec-

tion (b) (3).

The class action is a device particularly suitable in

private actions to enforce rights created by the securi-

ties laws. To this end the provisions of Rule 23, Fed.

6 Cox v. American Fidelity & Casualty Co., 249 F.2d 616

(C.A. 9, 1957).

A35

R. Civ. P. must be literally construed with a view of

enhancing the use of class actions as a means vindi-

cating the rights of all members of a class.” One

court has said, “error should be in favor of maintain-

ing class actions.”® The reasons for this attitude are:

(1) Class actions are designed to conserve judi-

cial resources by avoiding a multiplicity of suits on

the same issue.

(2) Class actions are a means of compensating

many investors with small claims, and

(3) The class action is a means of deterring se-

curities frauds.

The applicable provisions of Rule 23, Fed. R. Civ.

P. are as follows:

“(a) Prerequisites to a Class Action. One or

more members of a class may sue or be sued as

representative parties on behalf of a!l only if (1)

the class is so numerous that joinder of all mem-

bers is impracticable, (2) there are questions of

law or fact common to the class, (3) the claims

or defenses of the representative parties are typ-

ical of the claims or defenses of the class, and (4)

the representative parties will fairly and ade-

quately protect the interests of the class.

(b) Class Actions Maintainable. An action

may be maintained as a class action if the pre-

requisites of subdivision (a) are satisfied, and in

addition:

(1) the prosecution of separate actions

7 Berland v. Mack, 48 F.R.D. 121, 125 (S.D. N.Y. 1969).

® Esplin V. Hirshi, 402 F2d 94, 101 (C.A. 1, 1968).

A36

by or against individual members of the class

would create a risk of

* * e * *

(B) adjudications with respect to in-

dividual members of the class which

would as a practical matter be disposi-

tive of the interest of the other members

not parties to the adjudications or sub-

stantially impair or impede their ability

to protect their interests; or

= * * s *

(3) the court finds that the questions of

law or fact common to the members of the

class predominate over any questions affect-

ing only individual members, and that a class

action is superior to other available methods

for the fair and efficient adjudication of the

controversy. The matters pertirent to the

findings include: (A) the interest of mem-

bers of the class in individually controlling

the prosecution or defense of separate actions;

(b) the extent and nature of any litiga-

tion concerning the controversy already com-

menced by or against members of the class;

(c) the desirability or undesirability of con-

centrating the litigation of the claims in the

particular forum; (d) the difficulties likely

to be encountered in the management of a

class action.”

To qualify as a class action a case must meet the

first four technical requirements set forth in subsec-

tion (a) and in addition the actions must be main-

A37

tainable under one or more of the alternative condi-

tions specified in subsection (b).

The plaintiffs maintain the facts of this case are

such that all of the prerequisites of subsection (a) are

present and that this action is maintainable under two

of the conditions specified by subsection (b).

The specific requirements of subsection (a) are:

First “the class is so numerous that joinder of all

members is impracticable—the class in this cause con-

sists of approximately 380 limited partners so it is

clearly not practical to join them all.”

Second “there are questions of law and common to

the class”—since each member of the class is a pur-

chaser of a limited partnership unit there are a num-

ber of common questions of law and fact but whether

these common questions predominate over questions

affecting only individual members is a serious issue.

Third “the claims or defenses of the representa-

tive parties are typical of the claims and defenses of

the class”—each plaintiff is an owner of one or more

limited partnership units and their claims for recov-

ery must be founded upon the same theory as ali mem-

bers of the class and to that extent are “typical.”

Fourth “the representative parties will fairly and

adequately protect the interests of the class’”—the

plaintiffs have a very substantial stake in the outcome

of this litigation. One plaintiff, Evans, has an $80,000

investment and the aggregate investment of all name

plaintiffs exceeds $240,000. This fact alone seems suf-

A38

ficient to guarantee adequate representation by these

plaintiffs of all members of the class.

Assuming that this action meets all the require-

ments of Rule 23(a) before it can be continued as a

class action one of the prerequisites of subsection (b)

must be met. The plaintiffs first contend that this

action falls within the provision of Rule 23(b) (1)

(B). This subsection permits class actions if the prose-

cution of separate actions would “as a practical mat-

ter be dispositive of the interest of the other mem-

bers not parties to the adjudications or substantially

impair or impede their ability to protect their inter-

ests.” The plaintiffs’ reason that a successful suit by

them would exhaust all the assets of the defendants

leaving nothing available for other members of the

class thus disposing of the interest of all absent class

members. Although the Advisory Committee note to

Rule 23 (39 F.R.D. 98) refers to situations where a

judgment in favor of one or more members of a class

will have an adverse effect on other class members

claiming the same fund, the “fund” the committee was

referring to does not include the aggregate assets of

the defendants but rather claims against a specific

trust fund, insurance proceeds of a recovered fraudu-

lent conveyance.® Therefore, if this action is to pro-

ceed as a class action it can only do so if there is a

finding that “questions of law or fact common to the

members of the class predominate over any questions

affecting only individual members.”

° 3B Moore’s Federal Practice 23.35(2).

A39

This action grows out of an alleged conspiracy en-

tered into in early 1961 between the various defend-

ants who allegedly devised a plan to defraud investors

in Cougar Mt. Associates. The scheme called for the

creation of the limited partnership and the sale of

limited partnership units to investors by the use of

concealment, half truths and false statements, the

later sale to the partnership of real estate, in which

the defendants had some interest, at exorbitant prices.

In order to sell the units, H. R. Watchie, conducted

well over one hundred public meetings in which he

made an oral presentation, later the prospects present

were contacted by one of some twenty salesmen who

would make a further oral sales “pitch.” Some 400

different investors each paid or committed to pay

$20,000 for a unit. Each prospect received a printed

copy of the Articles of Limited Partnership but noth-

ing more. The purchasers of the units came from

every walk of life, lawyers, stockbrokers, doctors, real

estate salesmen and brokers, and the statements made

to each varied and the reliance placed on the sales

“pitch” by such diverse purchase must of necessity

varied.

None of the defendants issued or published any

written representations in writing. The concealment

of material facts, half truths and false statements

alleged by the plaintiffs were oral and the statements

made or not made will vary in the case of every sale

made to a limited partner. Therefore, it cannot be

found that “question of law or fact common to the

members” predomniates over questions affecting indi-

A40

vidual members of the class.'° Since a separate de-

termination will have to be made as to each limited

partner with regard to misrepresentation or failure to

disclose facts, it follows that a class action in this

case could very well require the trial of some 380

separate claims.

Even if this action could have, at its inception,

qualified as a proper class action, that status was

changed when additional defendant, Lynn, brought

in some forty Third Party Defendants on the theory

that they had either profited by the defendants fraud

or joined in the conspiracy. The third party com-

plaints will require a separate hearing as to each.

If some of the class members profited from the

defendants fraud or joined in the conspiracy, the de-

fendants wiil be entitled to raise the issue of pari de-

licto against such members further complicating the

trial." |

Therefore, to permit this litigation to continue as

a class action will place a gigantic burden on the

court’s resources far beyond its capacity to manage

or effecitvely control.

The Special Master finds that this case does not

qualify as a class action either under F. R. Civ. P. 23

(b) (1) (B) or 23(b) (3).

The prevailing party on each motion will prepare

10 Morris v. Burchard, 4 C.C.H. Federal Securities Law

Reporter § 92, 910 (S.D. N.Y. 1971). Moscarelli v. Stamm,

288 F. Supp. 453 (E.D. N.Y. 1968).

11“The Impact of Class Actions on Rule 10b-5,” Univer-

sity of Chicago Law Review, 337 at 356.

A4l

and present appropriate orders in conformity with

these findings at the time of hearing before the Dis-

trict Judge.

Dated this 7th day of October, 1971.

Respectfully submitted,

Kenneth S. Treadwell

Referee-Special Master

A42

Portion of Plaintiffs’ Preliminary Pretrial Statement

Entitled ‘What Plaintiffs Expect to Prove,”’ R. 165-176

During the years 1958 and 1959 and 1960 and

the first few months of the year 1961, defendant H. R.

Watchie and Associates, Inc. (then known as Lake-

mont Realty, Inc.) was a real estate brokerage or-

ganization engaged in an unorthodox type of raw land

real estate business. Most of its activities related to

the sale of property interests that more nearly resem-

bled investment contracts than conventional interests

in real estate.

A few of the firm’s customers were relatively so-

phisticated real estate investors. They participated in

land syndicate sales arranged by H. R. Watchie and

Associates, Inc: after having examined the properties

and arrived at some independent conclusion as to value

and likelihood of appreciation.

Most of the customers knew little or nothing about

land values. Typically, they did not even look at land

in which their money would be invested. They merely

advanced sums of money to H. R. Watchie and Asso-

ciates, Inc. with the understanding that the funds of

several customers would be pooled and invested in

land that was likely to double in value in three years

or less. Selection of the land, and determination as to

the price to be paid for it, was left to the corporation.

It also selected the investors who would make up a

A438

given syndicate and selected a trustee to purchase the

land in his own name for the benefit of the syndicate

members.

Each member became obligated to pay his propor-

tionate share of real estate taxes and of installment

payments on the tract of land purchased by the syndi-

cate in which he participated. Aside from providing

his share of the initial investment and of such annual

payments as proved to be required before the land was

resold, the investor had nothing to do with the prop-

erty. He frequently would have only a general idea

of its location and would have no first hand informa-

tion whatsoever as to its value.

The syndicate members ordinarily signed an

agreement that the trustee selected by H. R. Watchie

and Associates Inc., could resell the property at any

time when a purchaser could be found who would pay

twice the price that the syndicate had agreed to pay

to its vendor. H. R. Watchie and Associates salesmen

and investors referred to such resales as “doubles.”

The corporation obtained doubles for many of its

investors. Those customers did considerably better

than merely doubling their money. A typical syndicate

purchase was on installment real estate contract with

20% down and the balance to be amortized over a

ten to fifteen year period. If a syndicate’s tract of

land could be resold at a double in a year or two, syndi-

cate members received a paper profit of several hun-

dred percent after paying H. R. Watchie and Asso-

ciates, Inc. a ten percent commission on the resale.

A44

Most of the doubles resulted from sales by one

H. R. Watchie and Associates, Inc. syndicate to an-

other. On most such occasions no member of either

syndicate had independent knowledge as to the value

of the tract of land being purchased and sold. All of

the investors relied upon the corporation to fix the

price to be paid by the purchasing syndicate.

The price so fixed frequently gave the sellers a

double. The resulting word of mouth advertising

brought new investors to H. R. Watchie and Asso-

ciates, Inc. The availability of new investors provided

a market for land that was sold at prices fixed by

H. R. Watchie and Associates, Inc., rather than by

negotiation of buyer and seller in the light of the fac-

tors usually considered in fixing selling prices of sim-

ilar parcels of raw land. |

The corporation thereby created and maintained

an artificial market with unrealistically high prices

for raw land. Although the syndicate transactions

were conducted in that artificial market, they did

have some affect on the real market. Each of the H.

R. Watchie and Associates, Inc. syndicate transactions

became a matter of public record. Some buyers and

sellers who were unaware of the inbred nature of the

transactions arranged by H. R. Watchie and Associ-

ates, Inc. tended to consider such sales to be arms

length transactions which could serve as a measuring

stick for determining the value of comparable parcels

of land. During 1959 through 1962 most raw land

sales in a considertable area of land east of Lake

A45

Washington were made through that corporation.

Yet there was a limiting factor which made it

impossible for H. R. Watchie and Associates, Inc. to

continue indefinitely with a practice of doubling

prices of the tracts in short periods of time. In the

long run the highest prices that could be justified

for such tracts were the prices which land developers

and mass builders would pay for the land in order to

put it to use, as distinguished from acquiring it

merely for purpose of specualtion.

Most of the parcels sold by H. R. Watchie and

Associates syndicate were sold at prices considerably

higher than those which developers and builders were

willing to pay. Such land was actually appreciating in

value at a rate approaching twenty percent per year.

Unfortunately, it did not double and redouble in the

short periods of time that the syndicates held the

parcels before reselling them.

Although it appeared that H. R. Watchie and As-

sociates, Inc. was creating a bubble which was likely

to burst, it was receiving very large real estate com-

missions from its syndicate sales. Many of the com-

misisons are shown on Schedule E of the June 15,

1967 report of Cougar Mountain Associates. Some-

times two or even three commissions were received

on sales and resale of the same property in a period

of less than four years. In at least one instance there

were four commissions on one property in about three

years.

Those commissions were received on the tract

A46

shown as Cougar Mountain Associates’ property No.

32, on that Schedule E. As is there shown, a Mr.

Baird, who was one of Mr. Watchie’s associates, and

a corporation that was owned by Mr. Watchie, ac-

quired the property from a stranger for $15,000 on

October 9, 1958. A $1,500 commisison was paid by

the seller. On the same day, the property was resold to

a group of H. R. Watchie and Associates, Inc. inves-

tors for $25,000. H. R. Watchie and Associates, Inc.

received $1,250 as a second commission on the same

land. The first group of H. R. Watchie and Associ-

ates, Inc. investors resold the property to another such

group on November 15, 1959 for $45,000. $4,500 was

paid to H. R. Watchie and Associates, Inc. as its third

commisison on sales of this tract. The last syndicate

resold to Cougar Mountain Associates on January 8,

1962 for $90,000. The last sellers paid H. R. Watchie

and Associates, Inc. a commisison of $9,000. In 39

months the price of the property had advanced from

$15,000 to $90,000. In the same period of time H. R.

Watchie and Associates, Inc. had received commis-

sions on four sales of this same property in a total

amount which exceeded the original selling price of

the land.

In 1961 defendants H. R. Watchie, Gene Lynn,

E. Joseph McCambridge and James Gustavson con-

trolled H. R. Watchie and Associates, Inc. Mr. Wat-

chie was president of the corporation and owned its

stock. Mr. Lynn was executive vice president and

chief assistant to Mr. Watchie. Mr. McCambridge was

vice president and sales manager. Mr. Gustaveson

A47

had no office in the corporation but was a close asso-

ciate of the other defendants and participated with

them in the management of the corporation.

Early in 1961 the defendants devised a plan which

was calculated both to prevent the bubble from burst-

ing and to obtain large amounts of money for the de-

fendants. The plan was to create Cougar Mountain

Associates and cause it to pay high prices for most

of the properties being purchased by the H. R. Wat-

chie and Associates, Inc. syndicates as well as for a

considerable amount of property in which the de-

fendants had interests.

The plan had obvious advantages for the defend-

ants. The syndicate investors were to be given an op-

portunity to resell their properties at high prices so

that the syndicate members would have no claims

against the defendants. The sales would produce about

one million dollars of commissions for H. R. Watchie

and Associates, Inc. That would enable it to pay large

dividends to Mr. Watchie; to pay an extremely high

salary and generous commissions to Mr. Lynn, and

to pay large commissions to Mr. McCambridge and

Mr. Gustaveson. Further, each of the defendants

would benefit by sales, at high prices, of properties

in which he and related persons and entities had

interests.

The greatest advantage was that the plan, if suc-

cessful, would give the defendants a chance to gain

the time that was essential in order to prevent their

land sales bubble from bursting. If business had con-

A48

tinued to go on as before, there would soon have come

a time when it was no longer feasible to continue giv-

ing some groups of syndicates doubles at the expense

of other syndicates. There necessarily had to be some

limit to the extent that the prices charged on the

H. R. Watchie and Associates, Inc. private market

exceeded true market prices. Yet, if syndicates were

not continued to be given opportunities to resell at

high profits, the members might become disgruntled

and investigate their purchases. Such investigations

were likely to disclose that the prices paid by the syn-

dicates were far in excess of true market values.

Investigation of the market value of a single prop-

erty is neither costly nor difficult. Accordingly, it was

reasonable to fear that failure to arrange profitable

resales for the syndicates would result in several such

investigations. Each was likely to trigger others and

ultimately result in disaster for the defendants. Some-

thing had to be done. The partnership seemed to be

the answer.

Putting substantially all of the syndicated prop-

erties into a gigantic limited partnership that would

own dozens of parcels of raw land costing many mii-

lions of dollars would minimize, and almost eliminate,

any danger of an investigation of the fair market

values of properties acquired with funds of persons

who invested through H. R. Watchie and Associates,

Ine. No single investor could afford the great expense

of such an investigation. The likelihood that several

hundred partners could somehow manage to band

es

A49

together adn share the expense of a costly investiga-

tion must have appeared to be remote.

The evidence will justify an inference that defend-

ants believed that the partnership could purchase and

hold the syndicates’ properties for a few years until

general appreciation in raw land values in areas east

of Lake Washington caused the properties to become

worth as much as the partnership had paid for them.

Another advantage to defendants was that H. R.

Watchie as general partner would have complete con-

trol of the partnership. The partnership would not

buy any property unless his corporation received a

ten percent commission or a 1/9 markup, in lieu

thereof, on every acquisition. Cougar Mountain Asso-

ciates was not intended to sell property unless H. R.

Watchie and Associates, Inc. received a commission

on the sale. Further, H. R. Watchie and Associates,

Inc. would be able to provide management services to

the partnership at a price to be fixed by the corpora-

tion rather than at a price reached in competition

with other corporations providing similar services. All

of this would make it possible for the individual de-

fendants to continue to obtain large dividends, sal-

aries and commissions from H. R. Watchie and Asso-

ciates, Inc.

In the spring of the year 1961, while the defend-

ants were planning the creation of Cougar Mountain

Associates, they prepared a list of properties which it

would acquire. The list showed the prices which it

would pay for each of them. Most of the properties

A50

being purchased by the various H. R. Watchie and

Associates, Inc. syndicates were put on the list. The

syndicate members were not consulted about the prices

listed for their properties. A number of tracts of land

in which Mr. Watchie and his related persons and

entities had substantial interests were also included

on the list. Another parcel shown on the list was one

in which Mr. Lynn had a substantial interest so that

he stood to make a large profit if it was sold to the

new limited partnership. The list also included a prop-

erty which Mr. McCambridge would participate in

selling to the partnership at a large profit and a par-

cel on which defendant Gustaveson would benefit

handsomely if the indicated sale to the new partner-

ship were to be completed.

Unlawful Sales of the Securities

The plan was carried into effect. Defendants

caused Cougar Mountain Associates to be formed.

Defendant H. R. Watchie and Associates, Inc.; acting

under the direction and control of Messrs. Watchie,

Lynn, McCambridge and Gustaveson; was the exclu-

sive sales agency for the sale of the limited partner-

ship units to members of the public. Those individual

defendants personally participated in the sale of the

units as well as directing the sales activities of de-

fendant H. R. Watchie and Associates, Inc.

When they planned and created Cougar Mountain

Associates, the defendants were well aware that its

limited partnership units could only be sold by con-

A51

cealment of material facts and use of false statements

and half truths. Defendants planned to use conceal-

ment, half truths and false statements in the sale of

the units. The defendants also planned that the United

States mails and the facilities of interstate commerce

would be used in the sale of the units.

When the units were sold, the mails and facilities

of interstate commerce were used; material facts were

concealed from purchasers and prospective purchasers

of the units; half truths were told to them and mis-

statements were made to them.

Concealment of Muterial Facts

The things concealed from purchasers and pro-

spective purchasers of the limited partnership units

included the following material facts:

1. Defendants had created and were maintain-

ing an artificial market in raw land in an area

east of Lake Washington.

2. There was danger that persons who had

purchased properties at excessive prices in this

artificial market would learn that they had been

misled with respect to the value of their proper-

ties and would commence appropriate legal pro-

ceedings against the defendants.

8. One of the primary reasons for the forma-

tion of Cougar Mountain Associates was to pro-

tect against the risk of such lawsuits.

4. Mr. Watchie, the sole general partner of

Cougar Mountain Associates, had a fiduciary re-

lationship to most of the persons from whom he

A52

would cause the partnership to purchase real

estate.

5. Mr. Watchie would not, and did not, at-

tempt to negotiate the best possible prices or

terms for the partnership on its transactions with

persons with whom he had a fiduciary relation-

ship.

6. Cougar Mountain Associates would, and

did, pay more than the lowest prices which the

sellers would accept in its purchases of most of the

properties which it acquired.

7. The partnership agreement provided that if

$750,000 in initial capital contribution were not

obtained by August 25, 1961, all contributions

would be returned and the partnership termin-

ated. That amount was not obtained before that

date but the partnership was not terminated and

this failure to comply with the partnership agree-

ment terms was concealed from the purchasers

and prospective purchasers of the limited partner-

ship units.

8. H. R. Watchie would, and did, do things

which were such as to justify a conclusion that

he lacked the integrity and good judgment essen-

tial for the sole general partner of a multi-mil-

lion dollar partnership where the partnership

agreement gave the general partner permission

for extensive self-dealing. Such things include:

a. Committing the partnership to pur-

chase properties in which he had a personal

interest, without first obtaining the apprais-

als required by the partnership agreement.

a -

A53

b. Causing the partnership to purchase

those properties before there had been such

appraisals.

ce. Arranging to receive informal ap-

praisal opinion letters rather than the full

scale MAI appraisals required by the part-

nership agreement.

d. Causing those limited appraisals to be

deferred until general economic conditions

had caused the value of the parcels of land

to increase.

e. Giving the appraisers unjustified in-

structions and inaccurate information with

a view to causing the appraisal letters to

show valuations in excess of true market

values.

f. Causing the partnership to pay even

more than those estimated values for certain

properties in which Mr. Watchie and his re-

lated persons and entities had substantial in-

terests.

g. Causing the partnership to purchase

properties in which Mr. Lynn, Mr. McCam-

bridge and Mr. Gustaveson had substantial

interests without either MAI appraisals or

any attempt to negotiate the best possible

price of such properties for the partnership.

h. Causing the partnership to buy a large

tract of land, at a high price, for the benefit

of a different partnership.

i. Causing large commissions to be paid

to H. R. Watchie and Associates, Inc. at the

A54

expense of Cougar Mountain Associates un-

der circumstances where such commissions

were not properly payable under the terms

of the partnership agreement.

j. Causing two of the largest property

purchases of Cougar Mountain Associates to

be at prices which included prepaid interest

for five years in order to increase the amount

of commissions that would be paid to H. R.

Watchie and Associates, Inc.

k. Taking and causing H. R. Watchie and

Associates, Inc. to take 1/9 markups on prop-

erty sold to the partnership under circum-

stances where such markups were not au-

thorized by the partnership agreement.

1. Causing documents running in favor

of the partnership to be destroyed and re-

placed by papers running to him or to H. R.

Watchie and Associates, Inc. in order to

make it appear that a 1/9 markup was au-

thorized by the partnership agreement with

respect to certain transactions.

m. Causing Cougar Mountain Associates

to purchase services from corporations con-

trolled by him without competitive bidding or

any other objective method of determining

that the amount paid to such corporation was

fairly earned by them.

Half Truths

The defendants used and caused the using of half

truths in the sale of limited partnership units. Such

A55

half truths included the following material matters:

1. Members of the class were told that par-

ticipation in low down payment raw land invest-

ments could result in very high profits. The in-

vestors should also have been advised that be-

cause of the way Cougar Mountain Associates

was formed and operated there was little likeli-

hood of profit and high risk of loss for its limited

partners.

2. The investors and prospective investors in

the limited partnership units were advised that

the partnership would own a large amount of

view property. That was true. The investors

should also have been advised that because of the

remote location of many such view properties,

the high cost of development of some of them and

the high percentages of unusable land in some of

them, most of those view properties were not con-

sidered desirable by mass builders and land sub-

dividers.

3. Prospective purchasers of the limited part-

nership units were advised that the defendants

had made it possible for earlier investors to ob-

tain large profits on land which was resold for

them in a very short period of time. The investors

should also have been advised of the circumstances

of the artificial market in which those profits

were realized.

4. The investors and prospective investors

were advised that prices to be paid to Mr. Wat-

chie and his related persons and entities for any

property that they sold to the partnership would

be justified by two of three M.A.I. appraisals.

That statement should have been qualified by

A56

disclosure of the facts shown above with respect

to the purchases of property by Cougar Mountain

Associates from Mr. Watchie and his related per-

sons and entities and the facts shown above with

respect to the appraisals of such property.

5. Defendants represented that the cost of

sale of the limited partnership units would be

2%, or $400, per unit. That representation should

have been qualified by disclosure of the fact that

H. R. Watchie and Associates, Inc. would pay

sales commissions of 5% on the sale of the limited

partnership units although only 2% was paid to

the corporation by the partnership.

A57

4. Investment in limited partnership units of

Cougar Mountain Associates did not involve any

risk of loss since even in the even of a major

economic depression the annual assessments would

be sufficient to pay for all of the properties which

the partnership would be buying. The land then

could be held until conditions returned to normal.

5. An investor in the limited partnership units

could reasonably expect to receive a return sev-

eral times greater than the amount of his invest-

ment.

6. Cash flow projections for the partnership

indicated that there was little possibility of a

need for payment of more than three annual in-

False Statements stallments of $1,750 in addition to the down pay-

ment of $5,000 for each limit it.

The following false statements were made to pur- zh ae _— ™ tnership unit

chasers and prospective purchasers of the limited 7. The limited partnership units were such

partnershilp units: attractive investments that the total expense of

; selling the units would be only 2%, 400,

1. Defendants sincerely believed that there anit. ad y 2%, or $ and

would be no necessity for the partnership to col-

lect more than two or three annual installments Plaintiffs’ Disputed Contentions

upon the limited partnership units from the lim- . in Pretrial

ited partners, because the partnership would be | oe a >

financially self-sufficient in two or three years. | (a) During 1961 and 1962, defendant H. R.

2. The partnership would buy its land at | Watchie considered Lakemont Realty, Inc., to be a

wholesale prices. | team, not a one-man organization. Gene Lynn headed

the land development section of this team, while E.

3. No property would be purchased from H. :

Joseph McCambridge was in charge of sales.

R. Watchie or his related persons or entities until |

three M.A.I. appraisals had been made on each | (b) At all times during 1961 and 1962, defendant

such property and the prices to be paid for such ) McCambridge was both a de facto and a de jure vice

_ Sein daa pope rel bag oad president of Lakemont Realty, Inc., in charge of sales.

appraisals.

a tts Wits ice ow ae wom

A58&

At all such times, defendant Lynn was a de facto vice

president of the corporation, in charge of develop-

ment activities, but it may be that he never became a

de jure vice president until some time in 1962.

(c) The minute book of H. R. Watchie & Associ-

ates, Inc., does not show defendant Lynn as a vice

president until the year 1962. The minute book was

kept on a rather casual basis and does not necessarily

reflect the true state of affairs of the corporation at

any given time.

(d) Defendants Watchie and McCambridge were

directors of the corporation at all times during 1961

and 1962, but effective control of the corporation did

not lie with the directors. It rested with defendants

H. R. Watchie, Gene Lynn, and E. Joseph McCam-

bridge under an informal arrangement where H. R.

Watchie, the controlling stockholder, looked upon E.

Joseph McCambridge, Gene Lynn, and himself as a

sort of informal executive committee, providing the

top management of Lakemont Realty, Inc. While de-

fendant Watchie at all times had power to overrule

the opinions of defendants Lynn and McCambridge

and power to ignore their suggestions, he, as a prac-

tical matter, did not overrule their decisions in their

respective areas of authority. He considered all of

their suggestions and usually accepted and acted upon

their recommendations.

(e) While defendant McCambridge was in charge

of sales activities and reported directly to defendant

Watchie on sales matters and defendant Lynn was

ae treet stansnnirmcnarrcnc

A59

similarly in charge of land development matters and

reported directly to defendant Watchie on such mat-

ters, all defendants officed together in a small office

in Redmond, Washington. They continually discussed

matters of corporate business and activities on an

informal basis. All of them participated in discussions

of sales matters and discussions of land development

matters, as well as any other matters of importance

affecting the corporation and its activities. Each was

aware, at least in a general way, of what the other

was doing at any given time with respect to the busi-

ness of Lakemont Realty, Inc. — H. R. Watchie &

Associates, Inc.

(f) Defendant Lynn always showed interest in

all aspects of the business of the corporation and kept

himself informed of even small details of all corporate

activities, not just those of his land development de-

partment. He was a forceful and capable executive,

and by the time the sale of Cougar Mountain Associ-

ates limited partnership units to the members of the

public had begun, Mr. Watchie had developed a great

confidence in defendant Lynn. He had, as a practical

matter, become the chief assistant to defendant

Watchie, although not given any such official title.

(g) During 1960 and 1961, defendants considered

property owned by H. R. Watchie and by his related

persons and entities and by individuals and syndicates

considered to be Lakemont Realty, Inc. investors, to

constitute, in a loose sort of way, an inventory of that

corporation. During the winter of 1960-1961, all de-

fendants frequently discussed the formation of one

A60

large syndicate which could warehouse the greater

part of that inventory, and the prospective sale of its

securities.

(h) Plaintiffs cannot give the date of any such

discussion or the names of the individual defendants

who participated in each such discussion or the pre-

cise subject of any single such discussion on any spe-

cific date.

(i) The subjects discussed included the advisa-

bility of forming such a large entity and causing it

to warehouse the “inventory” of Lakemont Realty,

Inc., the prices to be charged for the property which

would be put into this new entity, the form of the new

entity and of its securities, the amounts to be charged

for each unit of its securities and the installment pay-

ments on such total charge, the reasonableness of the

prices to be paid H. R. Watchie and related persons

and entities for property which he and they would put

into the new entity, the methods to be used in selling

the securities of the new entity, the likelihood of a

successful sale of such securities, the approximate

amount each of the defendants expected to produce

for the new entity from sales of its securities which

each of the defendants expected to be able to make,

the requirement that each of the defendants have a

securities license in order to participate in the sale of

the units, the commissions which would have to be

paid in the sale of the units, the cost of selling the

securities, and the income which could be anticipated

by Lakemont Realty, Inc. from commissions on prop-

erties sold to the new entity.

A61

(j) During 1958, 1959, and 1960, Lakemont

Realty, Inc., had established a reputation for obtain-

ing “doubles” for its customers. They would buy, or

participate in small syndicates which would buy,

tracts of land recommended by the corporation which

would then be resold to a customer produced by the

corporation. The resale price would ordinarily be

exactly double the original purchase price. Most of the

persons participating in such transactions had little

knowledge of raw land real estate values and relied

upon Lakemont Realty, Inc., and its personnel for ad-

vice as to what to pay and advice as to when to sell

and on what terms. In many cases, the persons par-

ticipating in small syndicates which entered into such

transactions never inspected the land which their

syndicate purchased and then resold.

(k) By the end of 1960, Lakemont Realty had

created an artificial raw land real estate market

where customers of the corporation were engaging in

transactions between themselves at prices recom-

mended by the corporation which were substantially

in excess of the prices which land developers and mass

builders would pay to purchase the land for actual

use, rather than for speculation.

(1) By the beginning of the year 1961, defend-

ants had reason to hope that in two or three more

years the land purchased by Lakemont Realty, Inc.,

customers would become worth what they were pay-

ing for it.

(m) The formation of Cougar Mountain Associ-

a

A62

ates was planned by H. R. Watchie, E. J. McCam-

bridge, and Gene Lynn.

(n) One purpose of the plan to form Cougar

Mountain Associates was to permit warehousing of

properties purchased by Lakemont Realty, Inc., cus-

tomers until prices rose enough to make it possible to

sell the land to strangers at prices which equaled or

exceeded the amounts which had been paid for the

properties by those customers.

(o) It was part of the plan that Cougar Mountain

Associates would buy most of the properties held by

Lakemont Realty, Inc., customers and that the part-

nership would pay prices which would give most such

customers “doubles.”

(p) The list of properties prepared by H. R.

Watchie which showed properties which were in-

tended to be put into the new partnership and the

prices that would be paid for each of them was avail-

able to defendants McCambridge and Lynn during all

of the time while its units were being sold.

(q) Most of the properties on which Lakemont

Realty, Inc., received two or more successive commis-

sions (one on the sale to the person or group who

later sold the property to Cougar Mountain Associates

and the second or third commission being on the sale

to that partnership, all as shown on Schedule E to the

June 1967 report of Cougar Mountain Associates)

were included on that list at the prices Cougar Moun-

tain Associates was later caused to pay for them.

ae comet

A63

(r) Schedule E of the June 15, 1967, report of

Cougar Mountain Associates is a correct tabulation

of the facts purported to be summarized in that

schedule.

(s) The copy of the June 1967 Cougar Mountain

Associates report heretofore filed in this action is a

true copy of it.

(t) It was part of the plan for Cougar Mountain

Associates that it would buy tracts of land on real

estate contracts and that the total price for land pur-

chased would be equal to $20,000 for every limited

partnership unit sold. Money for interest payments

on real estate contracts, real estate taxes, develop-

ments costs, legal and accounting services, manage-

ment expenses, and the like would come from sales of

Cougar Mountain Associates real estate or from bor-

rowing.

(u) In planning Cougar Mountain Associates and

the sale of its limited partnership units, the defend-

ants were aware of the facts set out below and agreed

among themselves that it would not be necessary to

disclose those facts to prospective limited partners,

and those facts were not disclosed to such persons

when the units were sold:

(i) There was a list of the prices that the

partnership would pay for the properties that it

would purchase.

(ii) Many Lakemont Realty investors who

had purchased land through the corporation a

short time earlier would receive double their pur-

A64

chase prices on resales of the land to the partner-

ship.

(iii) The purchase price to Cougar Mountain

Associates of most of the properties which it

would buy would not be fixed, either by arm’s-

length bargaining or by appraisal, but would

instead be fixed by H. R. Watchie, who would be

the sole genera] partner of the purchaser and, at

the same time, be either the seller, one of the

sellers, or a fiduciary advising the seller as to

the price which should be charged and accepted.

(iv) The prices which the partnership would

pay for land would frequently exceed market

value.

(v) No cash-flow projection of the partner-

ship’s cash needs and had been or would be pre-

pared before the units were offered and sold to

the public.

(vi) Unless land values continued to rise rap-

idly and resulted in profitable sales of substan-

tial amounts of partnership land, Cougar Moun-

tain Associates would be required to borrow

money for its expenses.

(vii) Such borrowing would be costly and

would require a pledge of all or substantially

all of the partnership assets, because the

partnership would not be in a position to provide

the kind of collateral required by most institu-

tional lenders.

(v) It was the plan of the defendants to use con-

ventional business methods in the sale of the units,

including conventional correspondence sent by mail,

A65

ordinary use of local and long-distance telephone fa-

cilities, and travel by W. R. Watchie and others from

Oregon and California to the State of Washington,

all in connection with the sale of the units, and the

mails and facilities of interstate commerce were used

in and in connection with the sale of the units.

(w) In selling the units to the members of the

public, the defendants falsely represented: that the

partnership would buy land at wholesale prices; that

no property would be purchased by the partnership if

H. R. Watchie or his related persons or entities had a

10% or greater interest as seller of the property,

unless there were three M.A.I. appraisals of it and

the price to be paid by the partnership would not ex-

ceed the an:ount of the lowest of the two high apprais-

als; and that it was their state of mind that not more

than two or three annual assessments were likely to

be required.

(x) If defendants’ representations as to their

belief that there would be no need for more than two

or three annual assessments upon the limited partners

was not an outright falsehood with respect to the state

of mind of one or more defendants, it, in that event,

was at least a statement made with reckless disregard

for facts known to all of the defendants and was a

half-truth, in that defendants failed to disclose that

there was no cash-flow projection on which that opin-

ion could properly be based and failed to disclose the

extent of the cash-flow obligations which the partner-

ship would have.

a i i

A66

(y) All defendants represented to prospective

purchasers that investment in Cougar Mountain As-

sociates units was likely to result in a return many

times greater than the amount invested and it did

not qualify the representation by showing that there

were many facts which were such as to cast doubt

upon the accuracy of that forecast and which were

such as to give a reasonable investor reason for con-

cern that the investment was likely to result in a loss

rather than in a profit. Things that should have been

disclosed with respect to that representation included:

(i) The partnership would pay too much for

most of the properties which it would purchase.

(ii) The partnership would buy properties

without negotiation for the lowest price which

could be obtained by hard, fair bargaining.

(iii) No cash-flow projections had been pre-

pared for the partnership.

(iv) The amounts available from the annual

assessments were not large enough to pay interest

and amortization on real estate purchase con-

tracts, real estate taxes, management expense,

and development costs.

(v) There was likely to be a delay of years

before the properties being purchased by the

partnership from the “inventory” of Lakemont

Realty, Inc., would appreciate in value to the

point where they could be sold at a profit.

(vi) It probably would be necessary to bor-

row money with raw land as security and that

such loans must be expected to carry high interest

rates and to involve unwelcome and dangerous

forfeiture provisions.

la

ee RE eo ee

A67

(vii) Although a large percentage of the

money to be invested in the partnership would be

expended upon development of CMA No. 3 as a

commercial property, the development experience

of the defendants had primarily been with resi-

dential land and not with commercial property.

(viii) No soil tests had been made on tracts

of land the partnership was buying, although

such soil tests were necessary for many of the

tracts in order to estimate the cost of development

of them and to determine the suitability oi the

tracts for their intended uses.

(ix) No percolation tests had been made on

many tracts intended to be developed by the part-

nership into residential lots in areas where no

sewers existed.

(x) No slope analysis had been made of large,

Steep tracts of land acquired and to be acquired

by the partnership.

(xi) Some CMA parcels contained mine cav-

erns and mine shafts of undetermined extent with

an unknown number of unfenced and unmarked

entraces and air vents, so that it was not known

how much, if any, of this property could be sold

for residential construction without disclosure to

prospective »urchasers of the facts relating to

such mine ¢<.verns and mine shafts.

(xii) Most of CMA No. 12 and all of CMA

No. 15 and CMA No. 25 were zoned SE 35,000

square feet minimum as a matter of zoning board

policy so that there was little likelihood of less

adverse zoning in the future.

(xiii) Parts of CMA No. 12,CMA No. 15,

A68

CMA No. 22, CMA No. 25, and most of CMA No.

57 had high elevations and steep access so that

they would have a greater snow problem on roads

than then existed in Somerset, and that problem

had caused loss of sales in that subdivision.

(xiv) Development costs of Somerset had been

far in excess of estimates because of shale rock

formations near the surface, and there was rea-

son to fear similar conditions on the adjacent

Farmer property (CMA No. 57), but no tests

were made to determine if such a shale rock con-

dition existed on CMA No. 57.

(xv) The development manager of Lakemont

Realty, Inc. had not inspected the properties be-

ing acquired by Cougar Mountain Associates for

development to determine if such properties were

suitable for the intended development of them and

to determine the cost of such dewelopment.

(z) With regard to the sales representation that

view property commanded premium prices, the defend-

ants did not qualify that representation by disclosing

the fact that most mass builders and land develop-

ers were reluctant to develop view property until the

area where it was located had been built up and im-

proved with amenities such as stores, schools, church-

es, and the like.

(aa) Prospeertiive purchasers of the units were ad-

vised by defendants that the land to be purchased by

Cougar Mountain Associates would be selected by

experts, with the result that it would appreciate in

value more rapidly than other land in the same gen-

eral geographic area which an unsophisticated ob-

i ee es -

A69

server might consider comparable. The defendants did

not qualify that representation by showing that much

of the land was selected primarily because of a desire

to give a sale at a good price to its owner, rather than

because of business advantage to Cougar Mountain

Associates or by disclosing that Lakemont Realty,

Inc. — H. R. Watchie & Associates, Inc.’s expert on

land development had not evaluated such properties

to determine their suitability for their intended use

and to determine the cost of developing the properties

for their intended use.

(bb) Each of the defendants intended to and did

profit substantially from formation of Cougar Moun-

tain Associates and from the sale of its units to plain-

tiffs and to other members of the public. It was

planned that either H. R. Watchie or Lakement

Realty, Inc., would receive a 10% commission or a

one-ninth markup in lieu thereof on every property

acquired by the corporation. That occurred. Gene

Lynn’s position in Lakemont Realty, Inc., became

more importait, and his salary inereased to $50,000

per year. He received commissions in excess of $9,000

on his own sales of CMA units. E. Joseph McCam-

bridge obtained large commissions from the sale of

the partnership units. Defendants were able to pro-

vide large profits for persons who had dealt with

Lakemont Realty, Inc., in the purchase of interests

in raw land and thereby eliminate certain dangers.

Defendants each profited from sales of land to Cou-

gar Mountain Associates at large markups.

(ec) Cougar Mountain Associates limited part-

|

A70

nership units have a present value of approximately

$5,000. The shares of stock which have been issued in

lieu of one unit have an equivalent value. No interest

or dividends has been paid upon the units or the

shares.

(dd) Pursuant to the conspiracy alleged in these

contentions, defendants successfully concealed their

violations of the Securities and Exchange Act of

1934 and of SEC Rule 10b-5 from the plaintiffs until

1967.

(ee) Each of the defendants participated in con-

cealing those facts and aided and abetted H. R.

Watchie and H. R. Watchie & Associates, Inc., in

concealing them. The defendants had a fiduciary obli-

gation to disclose all material facts to the plaintiffs

at all times while their Cougar Mountain Associates

units were subject to annual assessments.

Portion of Page 286 of Transcript of

Deposition of H. R. Watchie

“A. I believe what I said, if not I will clarify

it, now, that the salesmen were instructed not to

hand out written material other than what we had

provided them and which had been cleared by the

Commissioner’s office. They were authorized to

quote or to parphrase the information that I had

given them, but not to add to it.

~ eer eee on Oetne

erste a tet con

A71

Q. When you say the information you had

given, you are referring to your afirmative pres-

entation, which you attempted to give from mem-

ory at these repeated sales meetings?

A. That’s correct.”