Petition — First Pennsylvania Bank N. A. v. Monsen

Se ee

Supreme Court, U, ain

FILED

SEP 8 i978

IN THE MICHAML RODAK, JR. CLERK

Supreme Court of the United States

October Term, 1978

No. 78-68-4094

FIRST PENNSYLVANIA BANK N. A.,

Petitioner,

v.

GEORGE R. MONSEN, et al.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT.

Of Counsel: Mixes H. Snore,

WinsTon J. CHURCHILL,

NorMAN R. BRADLEY,

38th Floor, Centre Square West,

Philadelphia, PA 19102

(215) 972-7759

Attorneys for Petitioner,

First Pennsylvania Bank

N.A.

SAUL, Ew1nc, REMICK

& SAUL.

International Printing Co., 711 So. 50th St., Phila., Pa. 19143 — Tel. (215) 727-8711

TABLE OF CONTENTS.

Page

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ATER AIUD CEU EUGENE 2... nc ccnccnscccccecesscess 3

cdc aslns seany gue rnvanae ead soee 4

REASONS FOR GRANTING THE WRIT ..........00seeeeccecees 8

Maa nih budnehdit oe deccctnnne cares ene bpaea en ll

TABLE OF APPENDICES.

Page

A. Opinion of the United States Court of Appeals for the

ME hn ie es Kah tk coh ede db tha deeces Al

B. Memorandum and Order of the United States District

Court for the Eastern District of Pennsylvania ......... A25

a, UN GUE GUY IE oon ci rien dcssncvovesvess A32

TABLE OF CITATIONS.

Cases: Page

Birnbaum v. Newport Steel Corp., 193 F. 2d 461 (2d Cir.),

cert. denied, 343 U. S. 956 (1952) .........ceseeeeeees 9

Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723 (1975) 9

Cost v. Ads, 408-U. &.-G0CIGTS) on bivcicvcnscconscnscccee 9

Ernst & Ernst v. Hochfelder, 425 U. S. 185 (1976) ......... 8, 10

Foremost-McKesson, Inc. v. Provident Securities Co., 423

RB, Be Ge eC iidinsicc Us tacts tnesecagtensan seeds. 10

Gould v. American-Hawaiian Steamship Co., 535 F. 2d 761

(RES, BOD oss dies nl viescnecvdaves cnsvseerried'as 10

TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438 (1976) 9

Statutes:

Securities Act of 1933:

Section 18(1), 15 U. S.C. $771) 2... csccceees 2, 3, 6, 8

Section 12(2), 15 U.S. C. $778) .....cecicccces. 2, 3, 6, 8

es ee ee veya caens cs abagsaeaneks 5

Securities Exchange Act of 1934:

Section 10(b), 15 U. S. C. § 78j(b) ............ 2, 3, 5, 6, 8, 9

Rule 10b-5, 17 C. F. R. § 240.10b-5 .............. 2, 3, 8, 9, 10

Section 14(a), 15 U. S.C. A. 78a(n) ...........eeeeee 10

gee ere errr eee r er tre Teer ere re ye 10

Section 47, 16'U. S.C. OTTO cn ccccccesen wr ekpenees 5

OO. BG en ot kc roma cedenads¢evesneastesthancken 1

Rules:

Federal Rules of Civil Procedure, Rule 50 ................. 5

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT.

Petitioner, First Pennsylvania Bank N. A. (“Bank”),

respectfully prays that this Court grant a Writ of Certiorari

to review the opinion and judgment of the Court of Ap-

peals for the Third Circuit entered on June 14, 1978. That

decision reversed the district court’s judgment n.o.v. in

favor of the Bank on the securities claim, thereby reinstat-

ing the jury’s verdict against the Bank, and affirmed the

district court’s dismissal of the plaintiffs’ pendent state

claim and its refusal to enter judgment on that claim.

OPINIONS BELOW.

The opinion of the Third Circuit to which this Petition

is addressed is unofficially reported in [Current] Fep. Src.

L. Rep. (CCH) at § 96,479 and has not yet been officially

reported. A copy of the Opinion is reproduced as Ap-

pendix A to this Petition at pages Al through A24. The

Memorandum and Order of the United States District

Court for the Eastern District of Pennsylvania dated April

27, 1977 has not been officially reported; it appears as

/ ppendix B at pages A25 through A31.

JURISDICTION.

The opinion and judgment of the Third Circuit were

filed on June 14, 1978. No Petition for rehearing was filed.

This Petition for a Writ of Certiorari is being filed within

ninety (90) days of that date.

Jurisdiction of this Court is invoked pursuant to 28

U.S.C. § 1254(1).

2

2 Petition for Writ of Certiorari

QUESTIONS PRESENTED.

1. Whether it is proper to impose civil liability on a

commercial bank as an aider-abettor under Section 10(b)

of the Securities Act of 1934 and Rule 10b-5 thereunder

because the bank made secured commercial loans (begin-

ning in 1968) to a customer knowing that the customer

was also borrowing money on an unsecured basis from

employees and others and issuing notes to the lenders with-

out any proof of either knowledge by the Bank that the

issuer was committing securities law violations or intent by

the Bank to defraud.

2. Whether it is proper to impose civil liability on a

commercial Bank as an aider-abettor under Sections 12(1)

and 12(2) of the Securities Act of 1933 because the Bank

made secured commercial loans (beginning in 1968) to a

customer knowing that the customer was also borrowing

money on an unsecured basis from employees and others

and issuing notes to the lenders without proof of either

knowledge by the Bank that the issuer was committing

securities law violations or intent by the Bank to violate

the securities laws.

3. Whether civil liability for aiding and abetting

exists under sections 12(1) and 12(2) of the 1933 Act and

under section 10b of the 1934 Act, or whether liability may

be predicated only on the express provisions of the acts

governing direct liability and liability of controlling

persons.

Petition for Writ of Certiorari 3

STATUTES AND RULE INVOLVED.

The federal statutes involved here are: Sections 12(1)

and 12(2) of the Securities Act of 1933, 15 U. S. C.

U. S. C. §§ 771(1) & (2) and Section 10(b) of the Secu-

rities Exchange Act of 1934, 15 U. S. C. § 78j(b). The

rule involved is Rule 10b-5 promulgated by the Securities

and Exchange Commission, 17 C. F. R. § 240.10b-5.

There are constitutional provisions involved herein.

The text of the Statutes and Rule are set forth as

Appendix C, at pages A32 through A34.

4 Petition for Writ of Certiorari

STATEMENT OF THE CASE.

Consolidated Dressed Beef (“Consolidated”) oper-

ated an abbatoir, slaughtering beef cattle and selling meat

to dealers and food chains and selling meat by-products

in Philadelphia and the surrounding area. Prior to 1965,

certain members of the Silverberg family owned and oper-

ated a meat packing business under the name of Philadel-

phia Dressed Beef Company, a partnership. In 1965 that

partnership purchased all of the stock of Consolidated and

continued to do business under the name of Consolidated.

Beginning at least in 1955 (and possibly as early as the

1930s) Philadelphia Dressed Beef Company began mak-

ing payroll deductions from employees’ salaries and issuing

interest bearing promissory notes to the employees.

Philadelphia Dressed Beef, and later Consolidated,

also borrowed money from non-employees, many of whom

were friends and relatives of the Silverbergs.

First Pennsylvania Bank was first approached by Con-

solidated in August, 1968. The Bank requested, received

and reviewed various financial statements of Consolidated

which included, among other things, information about

Consolidated’s liabilities to noteholders, as well as to other

lending institutions. These notes were explained to the

Bank by Consolidated’s president as representing loans to

Consolidated by employees, friends and relatives of the

Silverbergs evidenced by unsecured promissory notes.

The Bank accepted this explanation, had no reason to

know that notes of this type might be (or might later be

held by some lower courts to be) securities and in any

event had no knowledge of any securities-law violations by

the issuer. The Bank’s concern was the quantity and

quality of the collateral it held as security for its loans to

Consolidated and the adequacy of Consolidated’s sources

of money. (In that latter connection there is evidence

Petition for Writ of Certiorari 5

that the Bank encouraged Consolidated to continue to

borrow money from employees and others, and that the

Bank account officer knew that the Company did not fully

inform all noteholders of the financial condition of Con-

solidated. )

The Bank first lent money to Consolidated in Octo-

ber, 1968. The loans consisted of an accounts receivable

loan, a term loan secured by railroad freight cars, a line of

credit secured by liens on trucks, cars, machinery and

equipment and by first and second mortgages on Consoli-

dated’s real estate. The initial loans totalled more than

$3,750,000. The Bank took security interests in certain

assets of Consolidated and perfected its security interests

under the Pennsylvania Uniform Commercial Code. The

Bank’s loans to Consolidated began to go bad in Septem-

ber, 1969, when a strike closed the plant for nine weeks.

During 1970 and 1971, Consolidated continued to lose

money. In January, 1972 the Bank called its loans and

liquidated all of Consolidated’s assets subject to its security

interests. The Bank lost approximately $1,000,000 on its

loans to Consolidated. The holders of the unsecured

promissory notes lost an additional approximately

$400,000.

The named plaintiffs filed this class action in April,

1972, representing all holders of unpaid promissory notes

issued by Consolidated. The Complaint was based upon

alleged violations of the Securities Act of 1933 and section

10(b) of the Act of 1934 and common-law constructive

trust. Jurisdiction was invoked under section 22 of the

Securities Act of 1933, 15 U. S. C. § 77v, and section 27

of the 1934 Act, 15 U. S. C. §77aa. At the close of the

plaintiff's case, First Pennsylvania Bank moved for a di-

rected verdict pursuant to Rule 50 of the Federal Rules

of Civil Procedure. After extensive oral argument, the

6 Petition for Writ of Certiorari

District Court denied the motions for a directed verdict,

except as to the common-law constructive trust claim,’

which was dismissed for lack of pendent jurisdiction. The

Court directed a verdict against Consolidated for violating

section 12(1) of the 1933 Act* and the other securities

claims were submitted to the jury, which returned a ver-

dict on liability upon special interrogatories in favor of

plaintiff against Consolidated for violating section 12(2)

of the 1933 Act and section 10(b) of the 1934 Act,

against the individual defendants for violating § 10(b)

of the 1934 Act* and against the Bank for aiding and

abetting violations by Consolidated of both acts.“ The

jury found that the Bank did not directly violate § 10(b)

of the 1934 Act.

The parties agreed to the amount of damages, except

for three claims which were tried by the Court non-jury.

Judgment was entered against First Pennsylvania Bank

and all the individual defendants, jointly and severally, in

the amount of $152,561.44 in favor of those members of

the plaintiff class holding notes issued on or after Novem-

ber 28, 1968, and against Consolidated in the amount of

$421,629.30.

First Pennsylvania Bank filed a Motion for Judgment

Notwithstanding the Verdict; the other defendants filed a

Motion for Judgment N. O. V. or, in the alternative, a New

Trial. Plaintiffs filed a Motion to Reinstate Count III and

enter Judgment thereon in favor of plaintiffs or, in the

alternative, for a new trial on Count III. After oral argu-

ment, the Court, by Memorandum and Order dated April

27, 1977, granted First Pennsylvania Bank’s Motion and

1. Count III of the Complaint.

2. Count I of the Complaint.

3. Count II of the Complaint.

4. Count IV of the Complaint.

Petition for Writ of Certiorari 7

denied the Motion of the other defendants as well as plain-

tiffs Motion. Plaintiffs and the individual defendants ap-

pealed and First Pennsylvania Bank filed a cross-appeal

with respect to the court’s denying pendent jurisdiction of

the common-law claim.

The Court of Appeals, by its Opinion dated June 14,

1978, reversed the district court’s judgment N. O. V. in

favor of the Bank on the securities claims, reinstating the

jury's verdict and affirming the district court’s dismissal

of the plaintiffs pendent state claim and its refusal to grant

judgment on that claim.

8 Petition for Writ of Certiorari

REASONS FOR GRANTING THE WRIT.

Certiorari should be granted to consider whether civil

liability for aiding and abetting is appropriate under sec-

tions 12(1) and 12(2) of the 1933 Act and section 10(b)

of the 1934 Act, which was specifically noted as not con-

sidered or decided in Ernst & Ernst v. Hochfelder, 425

U. S. 185, n. 7 at 192 (1976). Certiorari should be granted

to consider whether the Third Circuit's standard of liability

is inconsistent with Ernst & Ernst v. Hochfelder, since it

imposes liability even though the Bank acted without ac-

tual intent to deceive, manipulate or defraud, as spe-

cifically found by the jury. Certiorari should be granted

to consider whether a commercial bank making secured

loans had a duty (in 1968) to police the manner in which

its customer borrowed money from friends and employees.

The decision of the Third Circuit, if it is to stand as

law, sets standards which apply to all commercial lending

institutions who lend money to issuers and affects many

lenders, many borrowers and huge sums of money. The

effect of this decision therefore far transcends the indi-

vidual litigants here.

The decision below is fundamentally at odds with

Ernst & Ernst v. Hochfelder, where this Court limited the

scope of private actions under section 10(b) and Rule

10b-5 by requiring the plaintiff to prove scienter® on the

part of the defendant. Although the plaintiff in Hoch-

felder sought compensation from Ernst & Ernst on the

ground that the auditor aided and abetted the fraud, this

Court decided the case as one of direct liability, refraining

from considering aiding and abetting liability:

In view of our holding that an intent to deceive, ma-

nipulate, or defraud is required for civil liability under

5. The Court defined scienter as an “intent to deceive, manipu-

late, or defraud.” 425 U. S. at 193.

Petition for Writ of Certiorari 9

§10(b) and Rule 10b-5, we need not consider

whether civil liability for aiding and abetting is ap-

propriate under the section and the Rule, nor the

elements necessary to establish such a cause of action.

425 U. S. 192 n. 7.

The decision of the Court of Appeals raises an im-

portant question of federal law which has not been, but

should be, settled by the Supreme Court. There should be

no liability for aiding and abetting by inaction alone, espe-

cially where the alleged aider-abettor conducts transac-

tions in the ordinary course of its business. This is in

keeping with the recent trend by the Supreme Court to-

ward limiting access to the federal courts by private parties

in securities actions under the 1934 Act. In Blue Chip

Stamps v. Manor Drug Stores, 421 U. S. 723 (1975), this

Court limited the class of private plaintiffs in damage ac-

tions under section 10(b) and Rule 10b-5 by affirming the

Birnbaum * rule, requiring a plaintiff to be either a pur-

chaser or seller of securities. The Court observed that

[While much of the development of the law of de-

ceit has been the elimination of artificial barriers to

recovery on just claims, we are not the first court to

express concern that the inexorable broadening of the

class of plaintiff who may sue in this area of the law

will ultimately result in more harm than good. 421

U. S. at 747-48.

In Cort v. Ash, 422 U. S. 66 (1975), this Court declined to

imply a private cause of action for a shareholder who had

brought suit derivatively on behalf of a corporation. And

in TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438

(1976), this Court unanimously held that an omission

6. Birnbaum v. Newport Stee! Corp., 193 F. 2d 461 (2d Cir.),

cert. denied, 343 U. S. 956 (1952).

10 Petition for Writ of Certiorari

from a proxy solicitation is “materia]” for the purposes of

section 14(a) of the 1934 Act only “if there is a substan-

tial likelihood that a reasonable shareholder would con-

sider it important in deciding how to vote,” 426 U. S. at

449, thereby adopting a standard of materiality requiring

a relatively high threshold of proof to establish liability.

In Foremost-McKesson, Inc. v. Provident Securities Co.,

423 U. S. 232 (1976), section 16(b), which allows a cor-

poration to recover any profits its insiders realize from a

short-term purchase and sale of the company’s securities,

was held to apply only to those stockholders whose se-

curities holdings qualified them as “insiders” before the

initial short-term purchase.

Likewise, in Hochfelder, this Court expressed its con-

cern about the growing class of possible private plaintiffs

in securities cases. 425 U. S. at 191 n. 33. Respondents

in the instant case did not prove, nor did the jury find,

any actual intent to deceive, manipulate or defraud by the

Bank, all of which are now required. Therefore, cer-

tiorari should be granted.

The Third Circuit applied an erroneous standard for

the aider-abettor’s knowledge of a securities violation, cit-

ing Gould v. American-Hawaiian Steamship Co., 535 F. 2d

761 (3d Cir. 1976), which stated in dictum’ that the

knowledge required for aiding and abetting can be actual

or constructive, 535 F. 2d at 780. That standard does not

apply, however, to a 10b-5 case, since Gould involved a

false or misleading proxy statement in violation of section

14(a) of the 1934 Act, 15 U. S. C. A. 78a(n), where the

proper standard of liability is negligence, 535 F. 2d at 777.

7. The dictum in Gould (that knowledge of th wrongful act

can be constructive) is inconsistent with the decision of the

Supreme Court of the United States in Ernst & Ernst (decided

only ten days earlier than Gould, on March 30, 1976).

Petition for Writ of Certiovari li

The result of the Third Circuit’s extension of securi-

ties law liability to the Bank in this case is particularly

unjust since the Bank has already lost more on its loans

than the class of lenders it is now required to compensate.

CONCLUSION.

For all the reasons set forth above, a Writ of Cer-

tiorari should be granted to review the opinion and judg-

ment of the United States Court of Appeals for the Third

Circuit.

Respectfully submitted,

Of Counsel: , Mixes H. SHore,

WINSTON J. CHURCHILL,

NorMAN R. BRADLEY,

Attorneys for Petitioner,

First Pennsylvania Bank

N. A.

SAUL, Ewi1nc, REMICK

& SAUL.

Dated: September 8, 1978

APPENDIX A.

UNITED STATES COURT OF APPEALS

For THE TuHirpD CIRCUIT

Nos. 77-1935

77-1936

77-1937

GEORGE R. MONSEN; JOSEPH J. OBERMEYER;

JAMES DELGADO; JOSEPH COSGROVE; ROB-

ERT COSGROVE; and JUSTIN ROSENSTOCK and

EVA ROSENSTOCK as Trustees for BENJAMIN

ROSENSTOCK; JUSTIN ROSENSTOCK and EVA

ROSENSTOCK as Trustees for RENEE ROSEN-

STOCK; JUSTIN ROSENSTOCK as Parent and

Natural Guardian of BENJAMIN ROSENSTOCK;

JUSTIN ROSENSTOCK as Parent and Natural

Guardian of ELI ROSENSTOCK; JUSTIN ROSEN-

STOCK as Parent and Natural Guardian of RENEE

ROSENSTOCK; CLAUDIA ROSENSTOCK; and

ELEANOR SCHWARTZ

D

CONSOLIDATED DRESSED BEEF COMPANY, INC.;

SAMUEL SILVERBERG; SIDNEY SILVERBERG;

EDWARD SILVERBERG; MICHAEL SILVER-

BERG; REUBEN SILVERBERG; NATHAN SIL-

VERBERG; ALAN SILVERBERG; and FIRST

PENNSYLVANIA BANKING AND TRUST COM-

PANY

GerorcE R. Monsen, et al.,

Appellants in No. 77-1935

SAMUEL SILVERBERG, et al.,

Appellants in No. 77-1936

? First PENNSYLVANIA BANK, N. A.,

Appellant in No. 77-1937

(Al)

A2 Appendix A

APPEAL FROM THE UNITED STATES District COURT FOR THE

EASTERN DISTRICT OF PENNSYLVANIA

D. C. Civil Action No. 72-799

Argued March 28, 1978

Before ApAMs, VAN DuseEN, and RosEnn, Circuit Judges

M. MELVIN SHRALOW, Esquire

Shralow & Newman

700 Widener Building

1339 Chestnut Street

Philadelphia, Pa. 19107

Attorneys for Appellants in

No. 77-1935

Lester H. Novack, Esquire

Cohen & Novack

226 South 16th St.

Philadelphia, Pa. 19102

Attorneys for Appellants in

No. 77-1936

Mixes H. SHore, Esquire

NorMAN R. BRADLEY, EsQuirE

Saul, Ewing, Remick & Saul

38th Floor, Centre Square West

Philadelphia, Pa. 19102

Attorneys for Appellant in

No. 77-1937

Opinion of the Court

(Filed June 14, 1978)

Appendix A A3

RosEnNn, Circuit Judge

In these appeals we are called upon primarily to de-

termine the propriety of imposing sanctions on a lending

institution as an aider-abettor because of that institution’s

actions in connection with a loan to a borrower who

violated the federal securities laws. We confront the per-

plexing dilemma of ascertaining when the legitimate busi-

ness relationship between a lender and its borrower leaves

the realm of propriety and enters the domain of proscribed

conduct.

This conundrum arises from a class action brought on

behalf of the holders of unregistered securities—promis-

sory notes—issued by the Consolidated Dressed Beef Com-

pany, Inc. (“Consolidated”), a company whose stock was

owned by the Silverberg brothers and Michael and Alan

Silverberg, the sons of one of the brothers, (collectively

“Silverbergs”), which borrowed money from the First

Pennsylvania Bank, N. A. (“Bank”). Plaintiffs, former em-

ployees of Consolidated and their families, who had made

loans on the promissory notes from the company, alleged

direct violations of sections 12(1) and 12(2) of the Secu-

rities Act of 1933 and section 10b of the Act of 1934” by

Consolidated,’ also violations of both acts by the Silver-

1. 15 U. S. C. §§ 771(1) & (2) (1976). Violations of section

1(1), prohibiting the offer or sale of an unregistered security, and

section 1(2), prohibiting the offer or sale of any security containing

untrue or materially misleading omissions of fact by means of inter-

state commerce, subject the seller or offeror to liability to the pur-

chaser of the security.

2. 15 U. S. C. § 78j(b) (1976). This section prohibits the use

of any “manipulative or deceptive device or contrivance” in con-

nection with the purchase or sale of a security and subjects the

fraudulent seller or purchaser to personal liabiltiy.

3. In count I of the complaint, plaintiffs allege that the notes

issued to them as members of the class by Consolidated constituted

a sale of securities, required to be registered under the Securities

Act of 1933, 15 U. S. C. § 77b(1) (1976), but that they were issued

A4 Appendix A

bergs as controlling persons,* and violations of both acts

by the Bank as an aider-abettor to Consolidated and the

Silverbergs.’ Plaintiffs also sought recovery from the

Bank on the basis of a pendent state claim predicated upon

a common law constructive trust theory alleging the Con-

solidated is insolvent and that the Bank has taken control

of all of Consolidated’s assets and applied the proceeds to

its debt.° After completion of the plaintiffs case, the

trial judge dismissed the pendent state claim and the jury

found for plaintiffs against all of the defendants on the

remaining securities claims and awarded damages. On

post-trial motions, the district court denied the Silver-

bergs’ requests for judgment notwithstanding the verdict

“n. o. v.”), denied both plaintiffs’ and the Bank’s request

for judgment on the dismissed state claim, and granted the

Bank’s request for judgment n.o.v. on all counts. We

affirm in part and reverse in part.

3. (Cont'd. )

unregistered and with untrue statements of material fact, in viola-

tion of §§ 771(1) & (2) of 15 U.S.C. In count II of the complaint,

plaintiffs allege that Consolidated had induced them to purchase

securities by means of fraudulent omissions and erroneous state-

ments of fact in violation of section 10b of the Securities Exchange

Act of 1934, 15 U. S. C. eu yy (1976) and rule 10b-5 promul-

gated thereunder, 17 C. F. R. § 240.10b-5 (1977).

4. The Silverbergs were alleged to be derivatively liable for

Consolidated’s securities violations in counts I and II of the com-

plaint, by virtue of their control over a primary violator of the

securities law. See 15 U. S. C. § 770 (1976) (“Every person who

. . . controls any person liable under sections 77k or 771 of this

title shall be liable . . . to the same extent as the controlled per-

son”) (1933 Act); 15 U. S. C. § 78t (1976) (liability for control of

any violator of the 1934 Act).

5. Count IV of the complaint.

6. Count III of the complaint.

Appendix A A5

1.

In these appeals from a grant and denial of judgment

n. 0. v., we must view the evidence in the light most favor-

able to the party that secured the verdict, drawing all

reasonable inferences that the jury might have drawn to

support its decision, Thomas v, E, J, Korvette, Inc, 476

F’, 2 471, 474 (3d Cir, 1973), An analysis of the record

reveals the following facts, drawn from the pre-trial fac.

tual stipulations of the parties and a close reading of the

testimony adduced at trial,

Jonsolidated is a now defunct Pennsylvania corpora.

tion which was until January of 1972, in the business of

slaughtering, dressing, selling, and delivering meat and

meat products, Its officers and directors are members of

the Silverberg family, Prior to 1965, certain of the Silver-

bergs owned and operated a meat packing business under

the name of Philadelphia Dressed Beef Company, a part.

nership, and in 1965 that partnership purchased all of the

stock of Consolidated, continuing business under that

name,

The initial payroll borrowing program was com-

menced by Philadelphia Dressed Beef Company by 1955—

possibly as early as the 1930's—and then continued by

Consolidated when it was acquired, Payroll deductions

were made from the company's employees’ salaries and

promissory notes were issued in exchange, This arrange.

ment was voluntary on the part of the employees who

could elect to accept full salary instead of the notes, Any

employee choosing to participate, however, was asked to

sign a company prepared authorization form, Records

were kept by the company of the amount of payroll dedue-

tious authorized by each participating employee,

At the end of three months of these deductions, the

company issued a note in the name of the employee lender

A6 Appendix A

for the face value of the total of the payroll deductions

made for the preceding quarter. These notes called for the

repayment of the principal after five years and provided

for the payment of interest to the employee every three

months until maturity,

At first, the notes bore interest at a rate of seven per-

cent per year, but subsequently the interest rate was raised

to eight percent per annum, Employees participating in

the program had the option of receiving interest quarterly

or having the company accumulate it as consideration for

additional notes, In 1970, after pressure from the note.

holders, Consolidated accelerated the maturity date on the

notes from five years to either one or two years, Em-

ployees enjoyed the option of accepting one-year notes,

bearing an interest rate of one percent less than the two-

year notes, or of accepting two-year notes,

At the same time, Consolidated had also instituted a

parallel note program for non-employees and for those

employees who lent the company supplementary funds

outside of payroll deductions, Interest on these notes was

paid either monthly or yearly and could also, at the elec-

tion of the noteholder, be accumulated in return for addi-

tional notes,

Testimony at trial revealed that none of the note.

holders were given financial information about Consoll-

dated prior to their loans to the company, It is undisputed

that the loans were generated out of employee loyalty to

Consolidated and confidence in the Silverbergs’ ability to

manage the company, The notes were never registered

under either state or federal law,

Consolidated kept detailed records on the progress of

both the employee and non-employee note programs, first

by hand and later by computer, Printouts eventually con-

tained information showing the total deductions from each

employee's paychecks, listed as a “savings” programs, as

Appendix A A7

well as showing data from the non-employee plans. This

information, payment for the notes, and the notes them-

selves, all travelled in interstate commerce or through the

mails,

By August of 1968, the company had continuously

conducted its note program without ever missing a paye

ment to its lenders, although it had accumulated a debt of

several hundred thousand dollars through the program, At

this time, however, the meat industry was beginning to

change substantially, To successfully compete under these

changed circumstances, Consolidated required additional

funds, It therefore communicated with the Bank to are

range for supplementary financing, The Bank requested

and received various financial data from Consolidated, ine

cluding financial reports from 1966, 1967, and 1968 which

contained information about the company's extensive

liabilities incurred through the note programs, These

reports were reviewed and analyzed by officers and em-

ployees of the Bank,

In September of 1968, John C, Wilson, manager of the

Bank's branch office with which Consolidated did business,

was requested by the Bank to pursue the Consolidated

loan request, He spoke with Samuel Silverberg by tele-

phone about conditions at Consolidated’s plant, reviewed

the company’s financial statements, and attended meetings

at and toured Consolidated’s plant,

Further meetings also were held in Wilson's office, At

these meetings, financial statements containing entries de-

scribing the note program were discussed, Wilson asked

for an explanation of these entries, and in response, Con-

solidated furnished the Bank with detailed statements list-

ing each of the employee and non-employee lenders,

Consolidated also furnished the Bank sample copies of the

notes, forms, and sufficient additional information to in-

A8 Appendix A

form the Bank that the noteholders were primarily Con-

solidated’s employees, their families, and friends of the

Silverbergs, all of whom had loaned funds to Consolidated

in reliance on the Silverbergs’ ability to conduct a success-

ful business. On September 18, 1968, following the de-

livery of this detailed information by Consolidated, the

Bank entered into a financing arrangement with the com-

pany, ,

Under the terms of the lending agreement, the Bank

became « secured creditor and the noteholders’ obligations

were effectively subordinated. The Bank was also given

the power to restrict Consolidated from borrowing from

any source other than the Bank. The record, however,

reveals that the Bank not only did not bar additional fi-

nancing elsewhere, but actually encouraged the continua-

tion of financing through the note program. The Bank

had informed Consolidated of its desire to have Consoli-

dated raise funds through unsecured promissory notes,

because it provided needed cash to the company and cre-

ated assets from which the Bank could satisfy its debt.

Consolidated, with the Bank's knowledge, never informed

the noteholders that their increased investments in the

company was subordinated to the Bank's security interest.

Yet, knowing of this lack of disclosure and that the note-

holders did not have adequate financial information about

Consolidated, and that they had invested solely on faith

in the Silverbergs, the Bank permitted—even encouraged

additional utilization of the note program,

Following consummation of the lending agreement

between the Bank and Consolidated, the Bank regularly

received monthly profit and loss figures, quarterly and

semi-annual financial statements, and yearly reports from

Consolidated, The Bank was keenly aware of the detri-

orating condition of the company due to marketing and

Appendix A AQ

supply changes in the industry,’ but it nonetheless refused

to curb Consolidated’s use of the note program.

By January of 1972, Consolidated’s position was so

precarious that the Bank was forced to seize control of the

company’s assets, Consolidated was prevented by ar-

rangement with the Bank from paying any interest on its

notes or honoring them as they matured. The Bank pro-

ceeded to liquidate Consolidated’s assets and to apply the

proceeds to the company’s outstanding debt to the Bank.

Although the Bank’s loan was only partially satisfied none

of the noteholders received any payment whatsoever after

1972 and their debt remains unsatisfied,

At trial the following legal conclusions were also stipu-

lated: (1) the notes on which the plaintiffs brought suit

were securities under the Securities Acts of 1933 and 1934,

(2) the notes were not registered under federal or state

laws; (3) interstate commerce was used in transporting

the notes; and (4) Consolidated was liable for the face

amount of each of the notes. Prior to trial, the district

court ruled as a matter of law that Consolidated had vio-

lated section 12(1) of the Securities Act of 1933, 15

U.S. C, § 771(1) (1976) by its failure to register the notes.

With this factual background, the case was submitted

to the jury on written interrogatories. The jury found

7, Although 1968 had been a profitable year for Consolidated,

in 1969, it began to suffer dramatic losses, In 1969, a strike oc-

curred during the company’s — rofit season, and had the

effect of seriously eroding profits, Similarly, changes in the meat

industry also began to affect the company's financial condition,

In 1970 the Chicago stockyards closed, making it difficult for

Consolidated to purchase live cattle, the mainstay of its business,

As a result, the company was forced to discontinue slaughtering

and to buy dressed carcasses, which both decreased profit margins

- _ Consolidated with a large overhead for the unused portion

of its plant,

In the nine-month period ending July 31, 1971, Consolidated

lost $824,000, The Bank knew of these losses by virtue of financial

statements from Consolidated,

Al0 Appendix A

Consolidated liable under section 12(2) of the 1933 Act,

15 U. S. C. § 771(2) (1976) and section 10b of the 1934

Act, 15 U.S. C. § 78j(b) (1976), because of its misleading

statements and omissions in connection with the note pro-

gram, The jury also found the Silverbergs liable as con-

trolling persons on the securities counts and the Bank liable

as an aider-abettor to Consolidated for its securities viola-

tions, The jury exonerated the Bank of any direct liability

under section LOb of the 1934 Act. The jury returned a

verdict against Consolidated for $421,639.30 and against

the Bank and the Silverbergs for $152,561.44,

The Bank requested judgment n, 0. v. on all counts in-

cluding the dismissed pendent state claim; it stated that it

was entitled to judgment as a matter of law due to the

insufficiency of proof of any securities violation, The Sil-

verbergs also moved for judgment n. 0, v. on all counts of

liability against them. The plaintiffs requested that the

dismissed state claim be reinstated and that judgment be

entered in their favor.

The district court granted the Bank's motion for judg-

ment n, 0. v. on the securities counts, stating that the evi-

dence was insufficient to provide aiding and abetting, All

of the other motions were denied, Plaintiffs appeal the

grant of judgment n, o. v, in favor of the Bank; the Silver-

bergs appeal the denial of their motion for judgment

n. 0. v.; both the Bank and the plaintiffs appeal the dis-

missal of the pendent state count and the refusal of the

court to grant a judgment on the merits of that cause of

action. We consider each of these claims seriatim,

Il,

Plaintiffs appeal from the grant of judgment n, o. v. in

favor of the Bank on all of the counts of the complaint

alleging aiding and abetting of securities violations by the

Appendix A All

Bank. To sustain a charge of aiding and abetting, the

plaintiffs have the burden of establishing: (1) that there

has been a commission of a wrongful act—an underlying

securities violation; (2) that the alleged aider-abettor had

knowledge of that act; and (3) that the aider-abettor

knowingly and substantially participated in the wrong-

doing. Gould v, American-Hawatian Steamship Co., 535

F, 2d 761, 779 (3d Cir, 1976); Rochez Brothers, Ine. v.

Rhoades, 527 F’, 2d 880, 886 (3d Cir, 1975) (“Rochez II")

(stating the third element alternatively as “substantial as-

sistance in effecting” the wrongful act); Landy v. Federal

Deposit Insurance Corp., 486 F. 2d 139, 162-63 (3d Cir,

1973), cert, denied, 416 U, 8, 960 (1974),"

Knowledge of the underlying violation is a critical

element in proof of aiding-abetting liability, for without

this requirement financial institutions, brokerage houses,

and other such organizations would be virtual insurers of

their customers against security law violations. Culpabil-

ity of some sort is necessary to justify punishment of a

secondary actor and mere unknowing participation in

another's violation is an improper predicate to liability.

See Ruder, Multiple Defendants in Securities Law Fraud

Cases; Aiding and Abetting, In Pari Delicto, Indemnifica-

tion, and Contributions, 120 U, Pa, L, Rev. 597, 638 (1972),

In Landy v, Federal Deposit Insurance Corp., supra,

we indicated that the aider-abettor's knowledge of a se-

curities violation must be actual, However, in Gould v.,

American-Hawatian Steamship Co., supra, we stated that

the “requirement of knowledge may be less strict where

the alleged aider and abettor derives benefits from the

wrongdoing.” 535 F, 2d at 780. Nevertheless, even in

such a situation, “the proof offered must establish con-

== = = Se cee =

8, See Woodward v. Metro Bank of Dallas, 502 F, 2d 84, 95

{oya) Cir, 1975); SEC v. Coffey, 493 F. 2d 1304, 1316 (6th Cir,

Al2 Appendix A

scious involvement in impropriety or constructive notice

of intended impropriety.” Id.° Such involvement may be

demonstrated by proof that the alleged aider-abettor “had

general awareness that his role was part of an overall

activity that is improper.” SEC v. Coffey, 493 F. 2d 1304,

1316 (6th Cir. 1974), accord, Gould v. American-Hawaiian

Steamship Co., supra, 535 F. 2d at 880. In determining

this awareness, “the surrounding circumstances and ex-

pectations of the parties are critical.” Woodward v. Metro

Bank of Dallas, 522 F. 2d 84, 95 (5th Cir. 1975).*°

Equally important as knowledge in establishing an

aider-abettor’s liability, is proof of his substantial assist-

ance or participation in the primary securities violation.

The securities laws comprehend that mere knowledge of a

violation alone, without assistance or a duty to disclose

the violation, is not an actionable wrong. See Ruder,

supra, 120 U. Pa. L. Rev. 644. Nor have courts extended

vicarious liability where the secondary defendant’s conduct

is nothing more than inaction. Such inaction, however,

may provide a predicate for liability where the plaintiff

demonstrates that the aider-abettor consciously intended

to assist in the perpetration of a wrongful act. Gould v.

American-Hawaiian Steamship Co., supra, 535 F. 2d at

780; Rochez II, supra, 527 F. 2d at 889.

9. It has been suggested by the Fifth Circuit that when an

alleged aider-abettor conducts what appears to be no more than a

transaction in the ordinary course of business, the degree of knowl-

edge must be higher than in the typical case. Woodward v. Metro

Bank of Dallas, supra, 522 F. 2d at 95. In the former situation, the

court suggests that no liability may be found unless there is “clear

proof of intent to violate the securities law.” Id. at 97.

10. Analysis of aiding and abetting knowledge unavoidably

“harks back to the nature of the security that is the object of the

transaction.” Woodward v. Metro Bank of Dallas, supra, 522 F. 2d

at 95. In the case of publicly issued stock the alle ed aider-abettor

may be more easily charged with knowledge of the circumstances

> eames the sale of a security than in the privately sold security.

ee i TA

Appendix A A13

It sometimes may be difficult for a court to reach a

decision as to whether an alleged aider-abettor’s conduct

is sufficient to constitute substantial assistance or partici-

pation in a wrongful act. We therefore have pointed to

the Restatement of Torts § 876 (1937) (liability for con-

tributory tortfeasors) * for guidance to district courts for

making that determination. The Restatement instructs the

trier of fact to consider the following factors in determin-

ing whether a defendant’s conduct constitutes substan-

tial assistance: (1) the amount of assistance given by the

defendant, (2) his presence or absence at the time of the

tort, (3) his relation to the other person, and (4) his state

of mind. Landy wv. Federal Deposit Insurance Corp.,

supra, 486 F. 2d at 162.

In applying the above standards to the proof adduced

by plaintiffs at trial, the district court concluded that the

evidence was insufficient to support the jury’s finding of

aiding and abetting by the Bank and that the verdict

should be reversed. The court concluded, first, that the

Bank rendered no assistance to the securities violation,

second, that the Bank never participated in the sales and

was absent at the time they occurred, third, that the Bank

made no representations to the buyers of the notes and

owed them no legal duty of disclosure, and fourth, that

although the Bank gave limited encouragement to Consoli-

dated to continue the note program, the evidence failed to

11. Section 876 of the Restatement provides in pertinent part:

§876 Persons Acting in Concert

For harm resulting to a third person from the tortious con-

duct of another, a person is liable if he

* Ga °

(b) knows that the other’s conduct constitutes a breach of

duty and gives substantial assistance or encourage-

ment to the other so to conduct himself,

oO ° °

Al4 Appendix A

show any intention by the Bank to further a securities

violation.”

Plaintiffs claim that the district court’s review of the

evidence was unduly narrow, that the court incorrectly ap-

plied the standards governing aiding-abetting liability, and

that therefore the verdict must be reinstated. Plaintiffs

assert that this overly restrictive approach to the evidence

caused the court to erroneously avoid the cardinal princi-

pal of review of a jury’ verdict—that judgment n.o.v.

should not be awarded as long as “there is conflicting evi-

dence or there is insufficient evidence to make a ‘one-way’

verdict proper.” Thomas v. E. J. Korvette, Inc., supra,

476 F. 2d at 474. We agree.

There is no question that the record clearly estab-

lishes the first element of proof of aiding-abetting. Con-

solidated committed underlying securities violations of

sections 12(1) & (2) of the 1933 Act and of section 10b of

the 1934 Act. (See pp. A9-A10, supra.) As to the second

and third elements, the district court, in its opinion dis-

posing of the post-trial motions, stated that the evidence

showed: (1) that the note program was instituted on be-

half of friends and employees of the Silverbergs, (2) that

the Bank had knowledge of the promissory note program

and should have known of its illegality, (3) that the Bank

as a secured lender encouraged the note program to con-

tinue, thus improving the Bank’s position at the expense of

the noteholders, and (4) that the Bank had the authority

to require Consolidated to discontinue the note program.

Taking the evidence in the light most favorable to the pre-

12. The district court also indicated its concern that the evi-

dence failed to prove scienter by the Bank in its aid of Consoli-

dated’s securities violations as required by Ernst & Ernst v. Hoch-

felder, 425 U. S. 185 (1976), in a private cause of action for

damages. We consider the sufficiency of the Bank’s scienter at

n. 17, infra.

Appendix A AIS

vailing party, the record sufficiently supports the jury’s

findings that the Bank had knowledge of the underlying

securities violations and substantially assisted or partici-

pated in their accomplishment.

Evidence of Knowledge of the Primary Violation

Olinto R. Serafini, who worked for Philadelphia

Dressed Beef Company and for Consolidated from 1942 to

1972 as its bookkeeper, office manager, and comptroller,

testified that the Bank was advised that funding from the

note program had continuously increased over the years

prior to the Bank’s loan, that Consolidated had begun to

lose substantial amounts of money, that no financial infor-

mation was given to the noteholders, and that the note-

holders never received information of the declining profit

margins of Consolidated.

Wilson, manager of the Bank’s branch dealing with

Consolidated’s loan, substantiated this testimony. He

stated: the Bank had extensive knowledge of the note pro-

gram; the Bank understood that the funds derived from

this program were lent to Consolidated principally on con-

fidence in the Silverbergs and faith in the company; the

transactions were not at arm’s length; the securities were

not registered; '* the Bank, with assistance from its own

securities analyst, had discussed the possibility of Con-

solidated making a public issue of stock; and the Bank

considered the noteholders as investors. Ralph Henry,

Wilson’s superior at the Bank, confirmed that the Bank

knew that the funds produced by the note program were

obtained on faith, without financial information.

13. The district court held that the Bank should have known

that the securities were required to be registered from its inspection

of the notes, the financial statements supplied by Consolidated, and

the Bank's familiarity with the securities laws.

Al6 Appendix A

Samuel Silverberg, the President of Consolidated, tes-

tified that the Bank was told that the noteholders had lent

money to Consolidated solely on the basis of trust and that

such lenders were provided with no financial information

about the company.“ In critical testimony, he revealed

that the Bank had demanded subordination of the note

program and guarantees of its continuation, with full un-

derstanding that the company could not disclose the junior

status of the notes to the noteholders and expect them to

continue to lend funds to the company.”

14. Samuel Silverberg’s testimony concerning the Bank’s knowl-

edge that the noteholders were given no financial advice about

Consolidated prior to their advances was as follows:

Q: In other words, these [the noteholders] were people

who had faith and trust in you, your family, and your family’s

company, isn’t that right?

A: That’s correct.

° fo] s

9: And, this was made known to the bank when they in-

quired about this plan, wasn’t it, that this is the kind of person

who was listed [in the statements sent to the Bank]?

A: That’s correct.

Q: It was also made known that the basis of the invest-

ment was trust and confidence, and not financial, technical in-

formation, isn’t that correct?

A: That’s correct. There was no technical, financial in-

formation given, to the best of my knowledge.

Q: And, this was made known in your discussions con-

cerning [the supporting material for the loan]?

A: That’s correct.

15. Silverberg testified that he notified the Bank of Consoli-

dated’s intention not to fully disclose to the noteholders their junior

a and the terms of the Bank’s loan to the company. He

stated:

They [the Bank] wanted to know what the notes were. I

told them strictly promissory notes. . . . A request was made

that the notes become subordinated to any bank debt. I told

them that could not be done without alienating all the note-

holders and having them disappear off the scene. And, after

that kind of discussion, it was finally agreed we'd just leave the

notes stay as notes.

(Emphasis supplied. )

Appendix A A17

Evidence of “Substantial Assistance”

Bank officers Wilson and Henry testified that the Bank

desired that the note program be subordinated to its posi-

tion and that the Bank encouraged Consolidated to ensure

the program’s continuation. In fact, it may be fairly

stated that the Bank attempted to extract a promise from

Consolidated that the program would continue.” They

also testified that the Bank had the power to prevent

further borrowing by Consolidated from the noteholders,

but that the Bank never exercised it.

16. Mr. Wilson’s testimony concerning the Bank’s insistence

upon the continuation of the note program is as follows:

Q: Isn't it . . . true that it was your concern that the

cash and capital of [Consolidated] not be —_— by a large

outflow of money represented by those notes

A: Yes.

= And, isn’t it true that you told Mr. Silverberg that it

was the bank’s desire that the practice or the past history of

the notes steadily increasing continued to be the case with this

company?

A: Yes.

Q: And, in fact, you encouraged Mr. Silverberg to con-

tinue to receive funds on this basis, because it was a very

economic way for the company to receive funds on an un-

secured basis, isn’t that correct?

A: Yes.

Mr. Henry, Wilson’s superior at the Bank confirmed Wilson’s testi-

mony:

* Did you and Mr. Wilson discuss whether the company

should be encouraged to continue or expand the issuance of

such notes in return for cash?

A: Yes.

Q: What was that discussion?

A: We encouraged the company to do this.

: Were you aware of whether the bank, through Mr.

Wilson or yourself or anyone else, asked for the company’s

assurance that it would continue to [do] so?

A: I assume we did.

A18 Appendix A

Sufficiency of Evidence of Aiding-Abetting

We believe that this evidence, taken in the light most

favorable to the verdict winner, is adequate to support the

jury’s finding of the Bank’s liability as an aider-abettor.

At a minimum, the evidence reveals: the Bank was well

informed about the note program; it knew that the notes

were unregistered; it either knew, or as a major metro-

politan banking institution should have known, of the reg-

istration requirement for the notes; it knew that the

noteholders were receiving no financial information, but

were trading on faith in the Silverbergs; it knew that Con-

solidated would not reveal either its financial difficulties or

the junior status of the promissory notes to the note-

holders; and with this knowledge the Bank demanded

subordination of the notes and actively encouraged Con-

solidated to continue the note program. It is true that

knowledge alone of the note program would have been an

insufficient predicate for aiding and abetting liability

against the Bank. Similarly, had the Bank merely re-

quired the continuation and subordination of the note

program without knowledge of the Silverbergs’ intent not

to disclose the subordination to the noteholders, liability

might not have been established. This combination of

knowledge and action by Bank, however, is sufficient evi-

dence to support the jury’s verdict on the Bank’s liability.

The district court held the proof insufficient to make

out a violation of the securities laws because it contained

no evidence of an intent by the Bank to assist a primary

violation of securities law.’ In determining the Bank’s

17: The court also held that the Bank rendered no assistance

to any securities violation, that it did not participate and was not

present at the sale of the securities, and that it made’no representa-

tions to the buyers and was under no duty to do so. We believe

that these conclusions are erroneous, as the evidence shows the

Bank’s active role in the continuation of the note program. It

Appendix A Al9

intent, however, the district court did not consider the

critical fact that the Bank knew that the company would

not reveal the Bank’s superior position to the noteholders,

and in the face of that position nonetheless insisted upon

the continuation of the note program. With Consolidated

in a deteriorating financial condition, the Bank's require-

ment of assurances of the continuation of an unregistered

security program knowing of Consolidated’s intention not

to disclose the weaknesses of the program, is tantamount

to proof that the Bank’s conduct was a major substantive

factor in aiding the fraud against the noteholders.""

17, (Cont'd, )

monitored the program monthly and made it clear as an initial

matter that the program would have to continue if Consolidated

were to obtain a bank loan, Although the Bank itself was not

present at the sale of the securities, it had full information on each

sale and it required Consolidated to inform it of the specifics of the

expanding note program, Finally, it is true that the Bank had no

direct duty to the purchasers of the notes, but it was not merely an

innocent third party, Rather, it enhanced jis position at the ex-

pense of the noteholders with knowledge of Consolidated’s decep-

tion of the noteholders,

The district court also stated its belief that the record insuffi-

ciently established the Bank's scienter in Consolidated’s violation of

section LOb of the 1934 Act, Scienter is “a mental state embracing

intent to deceive, manipulate or defraud.” Ernst & Ernst v, Hoch-

felder, supra, 425 U, S, at 194 n, 12. Without reaching the issue of

whether the Bank's reckless disregard of Consolidated’s deception

may constitute scienter, we hold that the Bank’s knowledge of the

company’s intention not to disclose the subordinated position of

the noteholders and the Bank’s intention to take advantage of the

noteholders’ junior status is sufficient proof of manipulative intent

to fulfill the scienter requirement and thereby support the Bank's

aiding and abetting liability,

18. This case is thus distinguishable from Woodward v, Bank

of Dallas, supra. In Woodward, plaintiff, an accommodation maker

of a borrower of the bank, sued the bank as an aider-abetter of the

borrower's securities violation—a duty and failure to disclose to the

plaintiff the borrower's hopeless financial condition. The bank had

ressured the borrower to find a guarantor for an additional loan,

cot there was no evidence that the bank had a continuing under-

standing of its borrower's intention to withhold information from

ae ee eee ree ee

A20 Appendix A

Therefore, the Bank cannot be heard to complain that it

did not substantially assist in Consolidated’s violations,

It may be that had we been the triers of fact in this case

we might not have held the Bank liable on this record, but

the evidence does provide adequate support for the jury's

verdict and under our limited role on appeal we cannot

usurp their function.

ITT,

The Silverbergs assert that the district court erred

in denying their motion for judgment n.o.v. on the securi-

ties violations. They request that we separate the evi-

dence of liability as to each of the Silverbergs individually.

We have viewed the evidence separately, but we nonethe-

less find sufficient evidence to support the verdict against

each of them.

It was stipulated at trial that all seven of the Silver-

bergs were officers, directors, and shareholders of Con-

solidated and that they were in fact the only officers, di-

rectors, and shareholders of the company. Furthermore,

Serafini, Consolidated’s comptroller, testified that all of the

Silverbergs constituted the board of directors of the com-

pany and that each was present at the meetings of the

company in which the note program was discussed. He

18, (Cont'd, )

others from which it sought funds, The court concluded on such

facts that no liability would be justified. As is evident, in Wood-

ward the plaintiff did not establish the bank’s knowledge of its

borrower's fraud, That lack of knowledge is the critical difference

between that case and the instant one. e same distinction elimi-

nates the problem of aider-abettor liability for a bank envisioned

by Ruder, Multiple Defendants in Securities Law Fraud Cases:

Aiding and Abetting, Conspiracy, In Pari Delicto, Indemnifaction,

and Contribution, 120 U, Pa. L. Rev. 597, 630-31 (1972) (fear of

extension of liability to bank as aider-abettor when bank has no

knowledge of under ying violation ), cited by the Woodward court.

Woodward v. Metro Bank of Dallas, supra, 522 F. 2d at 96.

Appendix A A2l

specifically recollected his presence at meetings in which

the programs were described and discussed in full detail

among all of the Silverbergs, He stated that so far as he

knew, there were no parts of the program unknown to any

of them,

Such knowledge placed each of the Silverbergs on no-

tice as to Consolidated’s violations of the securities acts

and therefore subjected them to liability, as controlling

persons, for the company’s violations “to the same extent”

as the company. 15 U, S. C. §§ 770, 78t (1976), Under

Rochez II, supra, 527 F. 2d at 890, a director may not be

found liable unless he has culpably participated in the con-

trolled person’s unlawful activity. The knowledge of each

of the Silverbergs of the dynamics of the rote program

and their presence at board meetings at which the program

was considered is sufficient proof of their culpability to

support the jury’s verdict. We affirm the district court's

denial of the Silverbergs’ motions for judgment n.o.v.

Both the plaintiffs and the Bank contend that the

pendent state claim was erroneously dismissed by the trial

court. Each suggests that judgment be entered in its favor

as a matter of law. Our review of the district court's dis-

missal of this claim is confined to determining whether the

court abused its discretion. Under that standard we find

no reversible error.

The district court dismissed plaintiffs’ pendent state

claim asking for declaration of a constructive trust in its

favor of Consolidated’s assets seized by the Bank because

the court perceived a possibility of jury confusion between

that issue and the federal securities claims. In United

Mine Workers v, Gibbs, 383 U. 8. 715 (1966), the Supreme

Court indicated that “there may be reasons . . . such as the

likelihood of jury confusion . . . that would justify” dis-

missal of pendent state claims. Id. at 726-27; see Robinson

A22 Appendix A

v. Penn Central Co., 484 F, 2d 553, 556 (3d Cir. 1973)

(court has discretion to dismiss pendent state claim be-

cause of judicial economy and fairness to litigants even

after trial has begun). Following that principle, we find

no abuse of discretion by the trial court in its dismissal of

the plaintiffs’ state claim and express no view on the merits

of their cause of action.

IV.

To recapitulate, we conclude:

(1) The district court's judgment n.o.v. in favor of

the Bank on the securities claim will be reversed and the

jury's verdict reinstated.

(2) The denial of the Silverbergs’ motions for judg-

ment n.o.v. will be affirmed.

(3) The district court's dismissal of the plaintiffs’

pendent state claim and its refusal to grant judgment on

that claim to the plaintiffs or the Bank will be affirmed,

Appendix A A23

UNITED STATES COURT OF APPEALS

For THe Tap Cracuir

Nos. 77-1935

77-1936

77-1937

GEORGE R. MONSEN; JOSEPH J. OBERMEYER;

JAMES DELGADO; JOSEPH COSGROVE; ROB-

ERT COSGROVE; and JUSTIN ROSENSTOCK and

EVA ROSENSTOCK as Trustees for BENJAMIN

ROSENSTOCK; JUSTIN ROSENSTOCK and EVA

ROSENSTOCK as Trustees for RENEE ROSEN-

STOCK; JUSTIN ROSENSTOCK as Parent and Nat-

ural Guardian of BENJAMIN ROSENSTOCK;

JUSTIN ROSENSTOCK as Parent and Natural

Guardian of ELI ROSENSTOCK; JUSTIN ROSEN-

STOCK as Parent and Natural Guardian of RENEE

ROSENSTOCK; CLAUDIA ROSENSTOCK; and

ELEANOR SCHWARTZ

v.

CONSOLIDATED DRESSED BEEF COMPANY, INC.;

SAMUEL SILVERBERG; SIDNEY SILVERBERG;

EDWARD SILVERBERG; MICHAEL SILVER-

BERG; REUBEN SILVERBERG; NATHAN SIL-

VERBERG; ALAN SILVERBERG; and FIRST

PENNSYLVANIA BANKING AND TRUST COM-

PANY

Gronce R. Monsen, et al.,

Appellants in No. 77-1935

SAMUEL SILVERBERG, et al,

Appellants in No. 77-1936

Finst PENNSYLVANIA BANK, N, A.,

Appellant in No. 77-1937

A24 Appendix A

AppEAL From THE UNtrep States Districr Count FOR THE

EASTERN District OF PENNSYLVANIA

D. C, Civil Action No, 72-799

Present: ApAMs, VAN Dusen and Rosenn, Circuit Judges.

Judgment.

This cause on to be heard on the record from the

United States District Court for the Eastern District of

Pennsylvania and was argued by counsel on March 28,

1978.

On consideration whereof, it is now here ordered and

adjudged by this Court that the judgment of the said Dis-

trict Court, filed April 28, 1977, be, and the same is hereby

reversed insofar as it granted judgment n.o.v. in favor of

the Bank on the securities claim, and the verdict of the

jury on the said securities claim be, and the same is hereby

reinstated. With respect to the denial of the Silverbergs’

motions for judgment n.o.v. and the dismissal of the

plaintiff pendent state claim and its refusal to grant judg-

ment on that claim to the plaintiffs or the Bank, the said

judgment be, and the same is hereby affirmed.

ATTEST:

Tuomas F, Quinn

Thomas F’, Quinn

Clerk

June 14, 1978

Appendix B A25

APPENDIX B.

IN THE

UNITED STATES DISTRICT COURT

For THE Eastern District or PENNSYLVANIA

Civil Action No, 72-799

GEORGE R. MONSEN, et al.

v,

CONSOLIDATED DRESSED BEEF COMPANY,

INC,, et al.

Memorandum and Order.

Cann, J. April 27, )977

Presently before this court are post trial motions aris-

ing out of a jury trial in which the defendants, Consoli-

dated Dressed Beef Company (“Consolidated”) and the

Silverbergs' were found to have violated §§ 12(1) and

12(2) of the Securities Act of 1933" and § 10(b) of the

Securities Exchange Act of 1934" and rule 10b-5 * promul-

gated by the Securities Exchange Commission. The jury

1, The Silverbergs: Samuel, Sidney, Edward, Michael, Reuben

Nathan and Alan, “a were the principal officers, directors and

shareholders of Consolidated Dressed Beef Company, Inc.

2. 15 U.S. C, § 771.

3. 15 U.S, C, § 78).

4, 17 C. F. R. § 240,10b-5,

A26 Appendix B

also found that defendant, First Pennsylvania Bank

(“Bank”), aided and abetted those violations. The amount

of the judgment in favor of the plaintiff against Consoli-

dated is $421,629.30. The remaining defendants were

found to be jointly and severally liable in the amount of

$152,561.44. The Silverberg defendants move this court

for a judgment notwithstanding the verdict. The plaintiff

moves this court to reinstate Count III of his complaint,

which involves constructive trust violations, or in the al-

ternative for a new trial on that count.

The motions for judgment n.o.v. must.be decided by

applying the following legal principle.

[T]he motion for judgment n.o.v. may be granted only

when, without weighing the credibility of the evi-

dence, there can be but one reasonable conclusion as

to the proper judgment. Where there is conflicting

evidence, or there is insufficient evidence to make a

‘one-way verdict proper, judgment n.o.v. should not

be awarded. In considering the motion, the court

must view the evidence in the light most favorable to

the party who secured the jury verdict.

5A Moore's FepERAL Practice {§ 50.07[2] (2d Ed. 1975).

In viewing the evidence in the light most favorable to the

party who secured the jury verdict, I must deny the motion

for judgment n.o.v. asked for by the Silverbergs. The mo-

tion for judgment n.o.v. sought by the Bank is a much

closer question and will be discussed in detail below.

The evidence introduced at trial showed a course of

conduct on the part of Consolidated and the Silverbergs

in which they engaged in the sale of unregistered securities

in the form of promissory notes. These notes were sold to

employees of Consolidated and friends of the Silverbergs.

The evidence also showed that the Bank made loans to

Appendix B A27

Consolidated on a secured basis. In addition, the Bank.

had knowledge of the promissory note program and should

have known of its illegality. The Bank enccuraged the

note program to continue which in turn improved the

Bank’s position as a secured creditor. Under the negative

covenants of the loan agreement, the Bank had the author-

ity to require Consolidated to discontinue the note pro-

gram.

The claim against the Bank is based on allegations of

aiding and abetting the other defendants in certain securi-

ties violations. In order “[t]o impose liability as an aider-

abettor under this section, it is necessary to find three

distinct elements: (1) The existence of an independent

wrongful act; (2) knowledge by the aider and abettor of

that wrongful act; and (3) substantial assistance in effect-

ing that wrongful act.” Rochez Brothers, Inc. v. Rhoads,

527 F. 2d 880, 886 (3d Cir. 1975); Landy v. Federal De-

posit Insurance Corporation, 486 F. 2d 139 (3d Cir. 1973);

Saltzman v. Zern, 407 F. Supp. 49 (E. P. Pa. 1976). The

requirements of showing substantial assistance presents the

plaintiff with serious problems in this case.’ In this cir-

cuit, in determining whether the assistance is sufficiently

substantial to make a party liable for aiding and abetting

the wrongful act of another, the courts have looked to the

RESTATEMENT OF Torts § 876 for guidance.® According

to this section of the REsTATEMENT the relevant considera-

tions are: (1) the amount of assistance given by the de-

fendant; (2) his presence or absence at the time of the

tort; (3) his relation to the other person; (4) his state of

5. Although it is not necessary for this court to consider the

question of scienter, the absence of proof on that issue raises an-

other problem for the plaintiff. See Ernst & Ernst v. Hochfelder,

425 U. S. 185 (1976).

6. Landy v. Federal Deposit Insurance Corporation, 486 F. 2d

139 ( 3d Cir. 1973); Saltzman v. Zern, 407 F. Supp. 49 (E. D. Pa.

1976).

A28 Appendix B

mind. RESTATEMENT OF Torts §876, Comment on

Clause (b).

When the evidence is viewed in the light most favor-

able to the party who secured the verdict, it is clear that

the evidence is insufficient for a jury finding of aiding and

abetting against the Bank and a judgment n.o.v. should be

entered. First, the Bank rendered no assistance to the

Silverbergs in regard to the securities violations. Second,

the Bank never participated in the offending sales and was

absent at the time they occurred. Third, the Bank made

no representations to the buyers of the notes nor did it

owe those buyers any legal duty of disclosure. Fourth,

while it is true that the Bank informally and to a limited

extent encouraged the Silverbergs to continue their note

program, the evidence failed to establish that the Bank’s

actions in that regard were intended to further any securi-

ties violations. Thus, each of the four considerations tends

to absolve the Bank of aiding and abetting liability.

The plaintiff urges, however, that even if the forego-

ing tests for substantial assistance are not met, the Bank

may be liable as an aider and abettor for mere inaction if

“the inaction was consciously intended to assist in the per-

petration of the wrongful act.” Gould v. American-

Hawaiian S.S. Co., 535 F. 2d 761, 780 (3d Cir. 1976).

See Rochez Brothers, Inc. v. Rhoads, supra. This argu-

ment of the plaintiff must be rejected.

Courts have generally been reluctant to extend aiding

and abetting liability when the secondary defendant’s ac-

tivity is limited to inaction. As a result of this reluctance

courts have required a stricter standard of proof in in-

action cases." Therefore, I conclude that even if the plain-

7. Rochez Brothers, Inc. v. Rhoads, 527 F. 2d 800 (3d Cir.

1975); Woodward v. Metro Bank of Dallas, 552 F. 2d 84 (5th Cir.

Ag 8 ~ aaa v. Midwest Stock Exchange, 503 F. 2d 364 (7th

ir. .

Appendix B A29

tiff had been able to prove that the Bank consciously

intended to assist in a wrongful act, the plaintiff must also

show that the consciously intended aid was substantial aid.

As was mentioned above, the plaintiff was unable to prove

substantial assistance, and therefore, there is a gap in the

proof of an element essential to plaintiff's cause of action

which necessitates the entry of judgment n.o.v.

If this court were to find otherwise, it would place

a burden on all banks making loans to police the actions of

their customers. Such a result might foreclose avenues of

financing for those who need them the most. The federal

securities laws do not, as the plaintiff suggests, place a

duty on persons who know of possible infractions to take

steps to safeguard possible victims.

The court also denies plaintiff's motion to reinstate

Count III or in the alternative for a new trial on that count.

At the close of the plaintiff's introduction of evidence at

trial, this court declined to accept pendent jurisdiction of

plaintiffs Count III which was based on a constructive

trust theory under Pennsylvania law.* It is settled law

that the denial or acceptance of pendent jurisdiction is

within the sound discretion of the trial judge. In the case

of Robinson v. Penn Central Co., 484 F. 2d 553 (3d Cir.

1973), the court stated that the trial court “remains free

throughout the proceedings to dismiss such a claim if that

seems the fairer course.” One of the major criteria to be

considered by the court in determining whether to accept

or deny pendent jurisdiction is the question of whether

the pendent claim will cause jury confusion. See Saltzman

v. Zern, supra.

In declining to accept pendent jurisdiction over

Count III, this court determined that, inter alia, further

8. It should be noted diversity of citizenship jurisdiction is

lacking.

A30 Appendix B

introduction of evidence on the constructive trust theory,

albeit by the defendant, would unduly confuse the jury

which had the burden of deciding the federal securities

issues. This confusion outweighed the judicial economy

and convenience of trying the issues together.

Epwarp N. Caun,

Edward N. Cahn, J.

Appendix B A31

IN THE

UNITED STATES DISTRICT COURT

For THE EASTERN DisTRICT OF PENNSYLVANIA

Civil Action No. 72-799

GEORGE R. MONSEN, et al.

v.

CONSOLIDATED DRESSED BEEF COMPANY,

INC., et al.

Order.

Anp Now this 27 day of April, 1977, Ir Is OrpEREp

that:

1. The motion of First Pennsylvania Bank for a judg-

ment notwithstanding the verdict is GRANTED.

2. The motion of the other defendants for a judgment -

notwithstanding the verdict is DENtEp.

3. The motion of the plaintiff to reinstate Count III

of its complaint or in the alternative for a new trial on that

count is DENIED.

By THE COURT:

Epwarp N. CAHN

Edward N. Cahn, J.

A32 Appendix C

APPENDIX C.

Securities Act of 1933.

Civil Liabilities Arising in Connection With

Prospectuses & Communications.

Sec. 12. Any person who—

(1) offers or sells a security in violation of section

5, or

(2) offers or sells a security (whether or not ex-

empted by the provisions of section 3, other than

paragraph (2) of subsection (a) thereof), by the use

of any means or instruments of transportation or com-

munication in interstate commerce or of the mails, by

means of a prospectus or oral communication, which

includes an untrue statement of a material fact or

omits to state a material fact necessary in order to

make the statements, in the light of the circumstances

under which they were made, not misleading (the

purchaser not knowing of such untruth or omission),

and who shall not sustain the burden of proof that he

did not know, and in the exercise of reasonable care

could not have known, of such untruth or omission,

shall be liable to the person purchasing such security from

him, who may sue either at law or in equity in any court

of competent jurisdiction, to recover the consideration paid

for such security with interest thereon, less the amount of

any income received thereon, upon the tender of such

security, or for damages if he no longer owns the security.

[15 U.S. C. 77(1)].

Appendix C A33

Securities Exchange Act of 1934.

Regulation of the Use of Manipulative and

Deceptive Devices.

Section 10. It shall be unlawful for any person,

directly or indirectly, by the use of any means or instru-

mentality of interstate commerce or of the mails, or of any

facility of any national securities exchange—

(b) To use or employ, in connection with the

purchase or sale of any security registered on a

national securities exchange or any security not so

registered, any manipulative or deceptive device or

contrivance in contravention of such rules and regula-

tions as the Commission may prescribe as necessary

or appropriate in the public interest or for the protec-

tion of investors. [15 U. S. C. 78(j)].

Rule 10b-5. Employment of Manipulative

Deceptive Devices.

It shall be unlawful 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 facility of

_any national securities 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

circinstances under which they were made, not mis-

leading, cr

A34 Appendix C

(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.

[17 C. F. R. 240.10b-5].