Petition for Writ of Certiorari — Randall v. Loftsgaarden
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SEP 24 1985
JOSEPH F. SPANIOL. J
No. | CLERK lL, JR,
IN THE
Supreme Court of the Gnited States
October Term, 1985
DR. WILLIAM C. RANDALL, DR. ROGER E. AUSTIN,
DR. TOM W. ANDERSON and DR. MYREL A.
NEUMANN,
Petitioners,
vz
B. J. LOFTSGAARDEN; ALOTEL INCORPORATED, a
Minnesota corporation; PROPERTY DEVELOPMENT
AND RESEARCH COMPANY, a Minnesota corpora-
tion; and 2361 BUILDING CORPORATION, a Minne-
sota corporation,
Respondents.
PETITION FOR WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
Robert Arthur Brunig
O’CONNOR & HANNAN
3800 IDS Tower
80 South Eighth Street
Minneapolis, Minnesota 55402
Telephone: (612) 343-1200
Attorney for Petitiuners
Of Counsel:
Terence M. Fruth
FRUTH & ANTHONY. P.A.
1300 International Centre
900 Second Avenuc South
Minneapolis, Minnesota 55402
Telephone: (612) 249-6969
1985—Northwest Brief Printing Co., 3010 2nd St. No., Minneapolis 55411—588-7506
4\
\\
QUESTIONS PRESENTED
1. Whether favorable tax consequences to defrauded
investors in a limited partnership, together with imputed
interest thereon, constitute “income received” which section
12(2) of the Securities Act of 1933 requires be deducted
from the consideration paid when the investors’ purchase
of the securities is rescinded.
2. Whether favorable tax consequences to defrauded
investors in a limited partnership, together with imputed
interest thereon, are to offset rescissionary damages award-
ed pursuant to section 10(b) of the Securities Exchange
Act of 1934 and Securities and Exchange Commission Rule
10b-5 to insure that the investors-do not recover more than
“actual damages.”*
*A similar issue is raised both by a petition for certiorari in Salcer v.
Envicon Equities Corp., No. 84-1447 (U.S., filed Mar. 13, 1985) and
a petition for certiorari in Freschi v. Grand Coal Venture, No. 85-
377 (US., filed Sept. 6, 1985).
— Ft @
or
-
Pe Pa a eee ee a eee a ee
TABLE OF CONTENTS
Page
QUESTIONS PRESENTED ......... ......-.--- i
MI ccc ccc cc ccc cccce ii
TABLE OF AUTHORITIES ................... iv
ccc acccecccecescce 1
os civ eue veces 1
JURISDICTIONAL STATEMENT .............. 2
STATUTES AND REGULATION ............... 2
STATEMENT OF THE CASE ................. 2
REASONS FOR ISSUING THE WRIT
I. The Eighth Circuit’s Decision Conflicts With The
Decisions Of Other Courts of Appeal ......... 7
A. The Eighth Circuit’s Decision Conflicts With A
Decision Of The Ninth Circuit As To The
Proper Interpertation Of Section 12(2) ..... 7
B. The Eighth Circuit’s Decision Conflicts Both
With Decisions Of The Ninth Circuit And With
Decisions Of The Second Circuit As To The
Measure Of Damages Under Rule 10b-5 ... 10
II. The Eighth Circuit’s Decision Disregards The Lan-
guage Of The Applicable Statutes ............ 14
A. The Eighth Circuit’s Decision Distorts The
Normal Meaning Of Section 12(2) ......... 15
B. The Eighth Circuit’s Decision Misinterprets
ee ld 6s 66 9 9 6 aes 0c ss 0c 17
Ill. The Eighth Circuit’s Decision Is Contrary To Prec-
DPCUCUEG USSG ESdccsececcecscccccces 23
A. The Eighth Circuit’s Decision Fails To Defer
To This Court’s Precedent ............... 23
B. The Eighth Circuit’s Decision Fails To Defer
To Other Courts’ Precedent .............. 25
IV. The Eighth Circuit’s Decision Undercuts The Dis-
closure Requirements Of The Federal Securities
PRP OOOOC POOL OTTO CE CECE PPT EE 27
SA a a Saree he eee 30
APPENDIX
Decision and Judgment (8th Cir. Jul. 16, 1985)... .A-1
Amended Judgment (D. Minn. Mar. 26, 1984)..... B-1
Order (D. Minn. Feb. 22, 1984) ............... C-1
Decision and Judgment (8th Cir. Apr. 7, 1982)... .D-1
Findings of Fact, Conclusions of Law and Order for
Judgment (D. Minn. Aug. 15, 1980)........... E-1
Memorandum Order (D. Minn. Aug. 15, 1980)... .. F-1
SES GS TR oka 8h nds cece cess ccc G-1
TABLE OF AUTHORITIES
Cases:
Austin v. Loftsgaarden, 768 F. 2d 949 (8th Cir. 1985)
sbbie uencksens abe sabe neues 1,5,11, 26
Austin v. Loftsgaarden, 675 F. 2d 168 (8th Cir. 1982)
secesveneeusedescaens 1, 4, 6-11, 13, 16-18. 20, 22
Bayoud v. Ballard, 404 F.Supp. 417 (N.D. Tex. 1975) 26
Berg v. Xerxes-Southdale Office Bldg. Co., 290 N.W.2d
Ges SEED 6.6 000655 cee ns cocennsticees: 26
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723
SRD ait be ehddapekerke dée¥e.s C8V0C6 cee os 18
Borovoy v. Bursar Realty Corp.. 86 Mich. App. 732,
pe ere ree oe 27
Bridgen v. Scott, 456 F.Supp. 1048 (S.D. Tex. 1978). 26
iv
Burgess v. Premier Corp., 727 F.2d 826 (9th Cir. 1984)
Coheeeneebeeedeencsbantsesvcanecees 8, 12, 19, 26
Cereal Byproducts Co. v. Hull, 16 Ill. App. 2d 79, 147
N.E.2d 383, affd, 15 Ill. 2d 313, 155 N.E.2d 14
Ge Aa de ae eehigeiacceedebescss<eie 21, 27
Consumer Prod. Safety Comm'n v. GTE Sylvania, Inc.,
Gee es SP NED bcc cece Pesentsasded sues 14
Cooper v. Hallgarten & Co., 34 F.R.D. 482 (S.D.N.Y.
SS ee ees ry 25
Danzig v. Jack Grynberg & Assoc., 161 Cal. App. 3d
1128, 208 Cal. Rptr. 336 (1984), petition for cert.
filed, 53 U.S.L.W. 3826 (U.S. May 14, 1985) (No.
eS a ee eng ee 27
Dennison v. Head Constr. Co., 54 Md. App. 310, 458
eT ea da che doce dass neces sens 20
Dupuy v. Dupuy, 551 F.2d 1005 (Sth Cir.), cert denied,
Ce ED ee ndducbengsdnecestdese 26
Eichel v. New York Cent. R.R., 375 U.S. 253 (1963). 29
Eisenberg v. Gagnon, 766 F.2d 770 (3d Cir. 1985).12. 24
Eisner v. Macomber, 252 U.S. 189 (1920) ......... 16
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).10, 14
Freschi v. Grand Coal Venture, 767 F.2d 1041 (2d Cir.
1985), petition for cert. filed, 54 U.S.L.W. 3154 (US.
Sept. 6, 1985) (No. 85-377) ............... i, 13, 27
Funston v. United States. 513 F. Supp. 1000 (M_D.
I ere a oe eee od ewe cee unne 21
G & R Corn. v. American Sec. & Trust Co.. 523 F.2d
Se, EE ccc dudwcees} saceaewces 26
Gerstle v. Gamble-Skogmo. Inc.. 478 F.2d 1281 (2d
Sh eee bre kd dl ied 4 lees deec ees 9
Hanover Shoe. Inc. v. United Shoe Mach. Corp., 392
Oe ee ee eee 23-25
Harris v. Metropolitan Mall. 112 Wis. 2d 487, 334
es eee eb aawe 27
Havden v. McDonald. 742 F.2d 423 (8th Cir. 1984) .
eres by 8 PP eee ry ey er oe 19. 92
Helveringe v. Hammel, 311 U.S. 504 (1941)......... 14
Vv
Herman & MacLean v. Huddleston, 459 U.S. 375
CEE cd nes vicsenenedsésesdbooeenssons+ss 10, 23
Hickman v. Groesbeck, 389 F. Supp. 169 (D. Utah
EE cidachads sbncdnodantseneteve eee ceeces 26
Hokama v. E.F. Hutton & Co., 566 F. Supp. 836 (C.D.
Ge EE we knsddaon Seunek oceedsd ge gareesse 27
Houlihan v. Anderson-Stokes, Inc., 78 F.R.D. 232
ty EEE 0. 6b nitod 0006 cen dcbesckeutedcese 26
Hueper v. Goodrich, 314 N.W.2d 828 (Minn. 1982).. 20
Iowa-Des Moines Nat'l Bank v. Schwerman Trucking
Co., 288 N.W.2d 198 (Iowa 1980) .......... 21. 27
Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert. denied,
- gg Re EE Seer rer TS ee ee 9
Johns Hopkins Univ. v. Hutton, 297 F. Supp. 1165 (D.
Md. 1968). rev’d on other grounds, 422 F.2d 1124
(4th Cir. 1970), cert. denied, 416 U.S. 916 (1974)
iehininineetumimdbnenmenda hae hes 8. 10,17. 25
Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523
CE nso vikabautbon theese sen GUUS Peuaceues 24-25
Kananen v. Matthews, 555 F.2d 667 (8th Cir.). cert.
denied sub nom. Kananen v. Califano, 434 U.S. 939
Ebb ces chetaes oc ue eb wa wae bh cee des oe 14
Kardon v. National Gypsum Co., 69 F. Supp. 512 (E.D.
CE dint pdnedsuweddeeentedaweetowes é 19
Kauffman v. Sidereal Corp.. 695 F.2d 343 (9th Cir.
Pe inc cntedusidinhscubas comiaedeetore 20
Lumber Terminals. Inc. v. Nowakowski, 36 Md. App.
Ply 0d i OD oo vttowousveret ss es'ss 21
Murphv v. Cady, 30 Supp. 466 (D. Me. 1939). affd.
113 F.2d 988 (1st Cir.). cert. denied, 311 U.S. 705
SD tb 0 bse bob eenkt weve eedeneere tics 17
NLRB v. Gullett Gin Co., 340 U.S. 361 (1951)...... 29
Norfolk & W. Ry. v. Liepelt, 444 U.S. 490 (1980). . 24-25
Oliver-Elec. Mfe. Co. v. I.0O. Teigen Constr. Co., 183
F.Supp. 768 (D. Minn. 1960) ................. A
Osoftky v Zipf. 645 F.2d 107 (2d Cir. 1981) ....... 18
Red Bank Oil Co., 20 S.E.C. 83 (1945) ........... 28
vi
Rhode v. Hershberger Explorations, Inc., 349 F. Supp.
ceveverrne wees eer eee 22, 25
Salcer v. Envicon Equities Corp., 744 F.2d 935 (2d
Cir. 1984), petition for cert. filed, 53 U.S.L.W. 3688
(U.S. Mar. 13, 1985) (No. 84-1447) ...........
oN CeetwdeSSNe eee Nes keeew™ i, 13, 18, 20, 22, 27
Sharp v. Coopers & Lybrand, 83 F.R.D. 343 (E.D. Pa.
1979), rev'd on other grounds, 649 F.2d 169 (3d
Cir. 1981, cert. denied, 455 U.S. 938 (1982) 25-26
Smith v. Bader, 83 F.R.D. 437 (S.D.N.Y. 1979)... .25-26
Spatz v. Borenstein, 513 F.Supp. 571 (N.D. Ill. 1981). 2
Superintendent of Ins. v. Bankers Life & Cas. Co., 404
OR PT Pee TTT Teer TT eT eT Tee 10
United Housing Foundation, Inc. v. Forman, 421 U.S.
DE s.cheane beak ebebtussbeevssccces 16
United States v. Gray, 199 F.2d 239 (10th Cir. 1952). 20
United States v. Naftalin, 441 U.S. 768 (1979)... .28. 30
United States v. Standard Brewery, Inc., 251 U.S. 210
DE cue baa wed 0p hed pbhetessaee nes as see 14
Western Fed. Corp. v. Davis, 553 F. Supp. 818 (D.
Ariz. 1982), affd sub. nom. Western Fed. Corp v.
Erickson, 739 F.2d 1439 (9th Cir. 1984) ...... 9. 22
Western Fed. Corp. v. Erickson, 739 F.2d 1439 (9th
SL bp bccbsveseseaceosevsbsaes 8, 10, 12. 26
Wiesenberger v. W.E. Hutton & Co.. 35 F.R.D. 556
EG) 626 aneccectaseeembakeees 25
Wolf v. Banco Nacional de Mexico, S.A.. 739 F.2d
1458 (9th Cir. 1984). cert. denied, 83 L.Ed.2d 778
I eh ee en ean bees ae 16
Statutes:
Section 23 of the Minnesota Uniform Securities Act,
RS eee eee 4
Section 3 of the Securities Act of 1933, 15 U.S.C. § 77c 28
Section 4 of the Securities Act of 1934, 15 U.S.C. § 77d 28
Vii
Section 12 of the Securities Act of 1933, 15 U.S.C.
D UEe -kvcccncnccenesonsuaben i, 2, 4, 6-8, 10, 14-17
Section 10 of the Securities Exchange Act of 1934, 15
ly Mh 6 oes onuncsuaseeeuunees i, 2,4, 10, 13
Section 28 of the Securities Exchange Act of 1934, 15
Cee Of PU Seb cheneceseresecec eve 2, 14, 17-18
Sections 1311-1314 of the Internal Revenue Code, 26
es Ge SIND -vcasveswesccerccececeses 22
Sections 346-347 of the Judicial Code of 1911, 28
SEE sed deeds rth dbceers cokcenenées 2
Regulation:
Rule 10b-5 of the Securities and Exchange Commission,
Be as OF US cc cccccccsceces i, 2,4, 10, 13
S. Banoff, To What Extent Will Benefits from Tax Shel-
ters be Permitted to Offset Rescission Damages, 57
Mer fos 6 BT, . re 13, 23
Bureau of Nat'l Affairs, Inc., Daily Report for Execu-
Sb ce whee onc coves cecoces 28
11976) FD. SL. L.. REP. GOCE)... cc cccccecs 28
tio). off i 60 oe | ee 28
T. Hazen, Administrative Enforcement: An Evaluation
of the SEC’s Use of Injunctions & Other Enforce-
ment Methods, 3t HASTINGS L. J. 427 (1979)... 28
T. Hazen. THE LAW OF SECURITIES REGULA-
TRI basing eet et ci teins 27-28
L. Loss, SECURITIES REGULATION (2d ed. 1961)
enuesadibabadseatica aca ari bien OD
Note, Austin v. Loftsgaarden: Securities Fraud in Real
Estate Limited Partnership Investments, 16 CREIGH-
ee es es WE EE rossi oce eussscc 26, 29
Note, Insiders Liability under Rule 10b-5 for the Pur-
chase of Actively Traded Securities, 78 YALE L. J.
Pe Liao taleewnes bb ouees 18
Note, Real Estate Limited Partnerships & Allocational
Efficiency: The Incentive to Sue for Securities Fraud,
eg eer 29
Note, Tax Shelter Schemes & Damages in the Eighth
Circuit, 18 CREIGHTON L. REV. 1307 (1985)... 14
RESTATEMENT (SECOND) OF TORTS (1979) .. 19
R. Thompson, The Measure of Recovery under Rule
10b-5, 37 VAND. L. REV. 349 (1984) ....20-21, 30
ee ee a hook aneeh.oe bee on 28
Washington Post, Jun. 4, 1984 .......0........2-. 29
Wt teenie owe
No.
IN THE
Supreme Court of the Gnited States
October Term, 1985
DR. WILLIAM C. RANDALL, DR. ROGER E. AUSTIN,
DR. TOM W. ANDERSON and DR. MYREL A.
NEUMANN,
Petitioners,
v.
B. J. LOFTSGAARDEN; ALOTEL INCORPORATED, a
Minnesota corporation; PROPERTY DEVELOPMENT
AND RESEARCH COMPANY, a Minnesota corpora-
tion; and 2361 BUILDING CORPORATION, a Minne-
sota corporation,
Respondents.
PETITION FOR WRIT OF CERTIOKARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
Petitioners respectfully pray that a writ of certiorari issue
to review the en banc judgment and opinion of the United
States Court of Appeals for the Eighth Circuit entered in
this proceeding on July 16, 1985.
OPINIONS BELOW
The en banc opinion of the Eighth Circuit and the accom-
panying panel opinion (hereinafter “Austin II”) are re-
ported at 768 F.2d 949 and are set forth in Appendix A.
The unreported Amended Judgment and Order of the dis-
trict court on an earlier remand are set forth in Appendices
2
B and C. The earlier opinion of a panel of the Eighth Cir-
cuit (hereinafter “Austin I’) is reported at 675 F.2d 168
and is set forth in Appendix D. The unreported Findings of
Fact, Conclusions of Law and Order for Judgment and
Memorandum Order of the district court are set forth in
Appendices E and F.
JURISDICTIONAL STATEMENT
The judgment of the Court of Appeals for the Eighth
Circuit was entered on July 16, 1985. This petition for
certiorari is being filed within ninety days of that date.
This Court’s jurisdiction is invoked pursuant to 28 U.S.C.
§ 1254(1).
STATUTES AND REGULATION
The case involves section 12(2)} of the Securities Act of
1933, 15 U.S.C. §771(2); section 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. §78j(b); section 28(a)
of the Securities Exchange Act of 1934, 15 U.S.C.
§$78bb(a); and Rule 10b-5 of the Securities Exchange Com-
mission, 17 C.F.R. §240.10b-5. Because of the length of the
statutes and regulation, their text is set forth in Appendix G.
STATEMENT OF THE CASE
Petitioners are four investors who purchased one or more
units’ in Alotel Associates, a limited partnership formed to
operate a Ramada Inn in Rochester, Minnesota. Respon-
dents are the individual and corporate general partners of
Alotel Associates and their affiliates.
Respondents distributed an Offering Memorandum to
potential investors, including Petitioners. The Offering
1The price of each unit was $35,000.00.
3
Memorandum purported to describe the limited partner-
ship, the Ramada Inn project, the terms available for financ-
ing the partnership’s activities and the timetable for con-
structing the Ramada Inn. The Offering Memorandum
contained a pro forma projection of cash flow, of resale
price and profit at the time of sale and of the tax conse-
quences of a limited partner’s investment.
The Offering Memorandum misrepresented the rate and
aniount of interest to be paid for construction financing,
the length of a ground lease, the completion date and the
terms of financing available for furnishings and equipment.
The Offering Memorandum described a non-existent com-
mitment for long-term financing. The Offering Memoran-
dum omitted information about the control B. J. Lofts-
gaarden (“Loftsgaarden”) exercised over Alotel Incor-
porated, Property Development and Research Company
(“PDRC”) and 2361 Building Corporation, about PDRC’s
anticipated profits on a sale of land, about a commitment fee
to be paid to PDRC and about Loftsgaarden’s ownership of
arc-TECH, inc., a sx which was to design the building
and to supervise construction.
The limited partners’ investments and the available loans
proved insufficient to construct and furnish the Ramada Inn.
Alotel Associates had no initial operating capital. Alotel
Associates was forced to obtain additional investors. The
additional investments proved insufficient, and the business
continued to flounder. The investors made several loans to
Alotel Associates.’ Alotel Associates ultimately defaulted
on its loans and its rental payments, and its creditors fore-
closed.
*The total loans “assessed” against each unit was $8,500.00.
4
Petitioners brought suit under section 12(2) of the Secur-
ities Act of 1933 [hereinafter “section 12(2)”], section
10(b) of the Securities Exchange Act of 1934 [hereinafter
“section 10(b)”], undvr Securities and Exchange Commis-
sion Rule 10b-5 (hereinafter “Rule 10b-5”), under the
antifraud provisions of the Minnesota Uniform Securities
Act and under the common law of Minnesota. Petitioners
alleged fraud and omission of material information and
sought rescission or damages.
Respondents denied liability. They also argued that reduc-
tions in Petitioners’ federal and state income tax liabilities
which flowed from Petitioners’ investments in Alotel Associ-
ates constituted “income received,” which section 12(2)
mandates be deducted from any recovery which the district
court awarded to Petitioners if it granted rescission.
Respondent also argued that the tax consequences reduced
the “actual damages” to which Petitioners might be entitled
under section 10(b) and Rule 10b-5.
The district court sustained objections to evidence which
Respondents sought to introduce concerning the tax conse-
quences of Petitioners’ investments in Alotel Associates. The
district court determined that the “out-of-pocket [and] re-
scissionary measures [of damages] would yield the same
results.” Appendix at F-7. Based upon the jury’s verdict
and its own findings, the district court awarded Petitioners
judgment in amounts equal to the amounts of their invest-
ments plus interest* on the amounts of their investments.*
5Interest was awarded pursuant to the statutory mandates in section 12(2)
and in Minn. Stat. §80A.23, subd. 2. Another basis would have been
the provision of Minnesota law which allows an award of prejudgment
interest if a judgment is for a “sum certain” or does not depend on any
contingency and can be ascertained by reference to a generally recog-
nized standard. See, e.g., Oliver-Elec. Mfe. Co. v. 1.0. Teigen Constr.
Co., 183 F. Supp. 768, 769 (D. Minn. 1960).
‘The district court denied Petitioners a return of their “loans” to Alotel
Associates. Austin IT at 951 n.2.
5
Respondents appealed. The Eighth Circuit affirmed the
jury’s and the district court’s findings of liability, but the
Eighth Circuit vacated and remanded to the district court
for a new trial on the issue of damages. The Eighth Circuit
held that
in a private securities fraud action involving an invest-
ment structured and marketed as a tax shelter, where a
rescissory measure of damages is applied, evidence of any
benefit derived by the plaintiff/investor via tax savings
must be permitted.
Austin I at 183-84. The Eighth Circuit also held that “the
damage award must be reduced by any value shown to have
been received by plaintiffs.” Austin J at 181.
On remand, the district court stated:
[T]he starting point for assessing damages will be the
amount each plaintiff paid Loftsgaarden for his invest-
ment (in other words, the plaintiff's consideration). To
this, the court will add 8 percent interest from the date
the consideration was paid to the date of this order. Fi-
nally, the amount of each plaintiff's tax benefits will be
subtracted from the sum of his consideration and interest.
Appendix at C-5. The district court then made the follow-
ing calculations and awards:
Plaintiff Anderson
Consideration paid June 2, 1983: $35,000.00
Plus interest at 8% to February 22,
1984: $64,787.00
Minus tax benefits: $29,615.00
Total Damages: $35,172.00
Plaintiff Austin
Consideration paid June 6, 1983:
Plus interest at 8% to February 22,
1984:
Minus tax benefits:
Total Damages:
Plaintiff Ne[u]mann
Consideration paid August 21, 1973:
Plus consideration paid October 19, 1973:
Plus interest at 8% to February 22,
1984:
Minus tax benefits:
Total Damages:
Plaintiff Randall
Consideration paid November 13, 1973:
Plus interest at 8% to February 22,
1984:
Plus consideration paid 1975:
Plus interest at 8% to February 22,
1984:
Subtotal:
Minus tax benefits:
Total Damages:
Appendix at B-1-2.
$35,000.00
$64,610.00
$33,333.00
$31,277.00
$35,000.00
$17,500.00
$96,385.00
$57,014.00
$39,371.00
$35,000.00
$63,770.00
$ 2,512.00
$ 4,203.00
$67,973.00
$36,404.00
$31,569.00
Respondents again appealed. The Eighth Circuit sua
sponte granted en banc consideration as to whether Austin I
should be reconsidered and as to whether damages had
been calculated properly if Austin I had been decided
properly. Austin II at 951. The Eighth Circuit holds that
Austin I had been correctly decided and that Austin I
requires a further reduction in the recovery when ever a
court order rescission under section 12(2); it adopts a
| 7
formula for computing damages: two times the sum of the
amount pad for the security with interest, less the amount
of tax benefits received with imputed interest. The Eighth
Circuit therefore reduced the awards to the following: Austin
($7,666), Anderson ($18,790), Neumann ($1,984), Ran-
dall ($506). Austin II at 961.
Petitioners now pray that a writ of certiorari issue to re-
view the Eighth Circuit’s decision.
REASONS FOR ISSUING THE WRIT
I.
THE EIGHTH CIRCUIT’S DECISION CONFLICTS WITH THE DE-
CISIONS OF OTHER COURTS OF APPEAL
A
The Eighth Circuit's Decision Conflicts With A Decision Of
The Ninth Circuit As To The Proper Interpretation Of Sec-
tion 12(2).
Section 12(2) provides that a defrauded purchaser of a
security who tenders the security to the seller is entitled
to recover the consideration paid for such security with
interest thereun, less the amount of any income received
thereon ....
The Eighth Circuit recognizes that “tax benefits received
are [not] income in a strict accounting sense.” Austin II at
955. Nevertheless, the Eishth Circuit holds that
section 12(2)’s requirement that “income received” be
‘John M. Carlson, an accounting expert called by Respondents, provided
the only testimony concerning whether “tax benefits” constituted “in-
come:” he readily conceded that “tax benefits” were not “income.”
deducted [requires] that all economic benefits bargained
for and received must be deducted.
Id
In so holding, the Eighth Circuit concedes that its inter-
pretation might conflict with the one adopted by the Ninth
Circuit in Western Fed. Corp. v. Erickson, 739 F.2d 1439,
1444 (9th Cir. 1984) and reaffirmed in Burgess v. Premier
Corp., 727 F.2d 826, 837-38 (9th Cir. 1984). The Eighth
Circuit seeks to justify a distinction by characterizing Peti-
tioners’ recovery under section 12(2) as “rescissionary
damages,” Austin II at 953, and by stating that “a different
situation might exist in a case involving actual rescission.”
Id. at 955 n.11; see also id. at 952 n.4.
The Eighth Circuit’s characterization flies in the face of
the district court’s findings and in the face of Austin I’s
rejection of an argument that “rescission under [section]
12(2) was not an available remedy.” Austin I at 179. The
characterization also disregards the statutory language
which permits recovery of damages under section 12(2)
only if a defrauded purchaser “no longer owns the security.”
15 U.S.C. § 771(2); see also Johns Hopkins Univ. v. Hut-
ton, 297 F. Supp. 1165, 1226 (D. Md. 1968), rev’d on
other grounds, 422 F.2d 1124 (4th Cir. 1970), cert. denied,
416 U.S. 916 (1974).
The Eighth Circuit’s best rationale is that its interpreta-
tion reflects “economic reality” and that to ignore “tax bene-
fits actually realized . . . would be unrealistic.” Jd. at 955 &
n.9. That rationale flies in the face of the cardinal principle
underlying rescission: “[r]Jescission voids the transaction and
returns to [each] part[y] the consideration [he] paid.”
Burgess v. Premier Corp., 727 F2d at 837. The Eighth Cir-
cuit gives lip service to the principle by stating that “[t]he
goal of rescission under section 12(2) is to return the parties
9
to the status quo ante,” Austin JI at 954, and purports to
return Petitioners to the status quo ante. The Eighth Circuit,
however, never purports to return Respondents to the status
quo unlawfully obtained profits. By permitting Respondents
to retain a profit of at least $100,000, id. at 963 (dis-
senting opinion), the Eighth Circuit’s interpretation fails to
apply another basic principle of rescission: in shaping a
remedy, a court should give the defrauded person, rather
than the defrauder, any windfall. Janigan v. Taylor, 344
F.2d 781, 186 (1st Cir.), cert denied, 382 U.S. 879
(1965); see also Gerstle v. Gamble-Skogmo, Inc., 478 F.2d
1281, 1305 (2d Cir. 1973); Johns Hopkins Univ. v. Hut-
ton, 297 F. Supp. at 1226.
The Ninth Circuit takes an opposite view. When a district
court ruled:
While this Court has considered the economic benefits
to the plaintiffs from their investments with the defend-
ants, as required by Austin [J], it concludes that the de-
fendants should not be given any credit,
Western Fed. Corp. v. Davis, 553 F. Supp. 818, 820 (D.
Ariz. 1982) (emphasis in original), the Ninth Circuit
affirmed:
Appellants argue that the district court erred by re-
fusing to reduce the judgment by the amount of tax bene-
fits appellees realized from their investment in the Project.
Our recent decision in Burgess v. Premier Corp., 727
F.2d 826, 837-38 (9th Cir. 1984) refused to deduct tax
benefits in a securities case and specifically endorsed the
reasoning of the district court in this case. The appellants’
argument is without merit.
10
Western Fed. Corp. v. Erickson, 739 F.2d at 1444; accord,
Johns Hopkins Univ. v. Hutton, 297 F. Supp. at 1232 (cash
payments to be applied to taxes were “not to be classified
as... ‘income’ ”).
The Ninth Circuit does not permit deduction of tax bene-
fits from a defrauded investor’s recovery under section
12(2). The Eighth Circuit limits such a recovery to the
purchaser’s consideration paid plus interest thereon less the
amount by which his state and federal income taxes are re-
duced as a result of his investment plus interest on the tax
reduction. Thus, the conflict is complete.
B.
The Eighth Circvit’s Decision Conflicts Both With Decisions
Of The Ninth Circuit And With Decisions Of The Second
Circuit As To The Measure Of Damages Under Rule 10b-5.
Neither section 10(b) nor Rule 10b-5 creates an express
private right of action. E.g., Herman & MacLean v. Hud-
dleston, 459 U.S. 375, 379-80 (1983); Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 196 (1976); Superintendent of
Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 13 n.9 (1971).
Nevertheless, courts have recognized such a private right for
almost forty years. Herman & MacLean v. Huddleston,
459 U.S. at 380 n.10; Kardon v. National Gypsum Co., 69 F.
Supp. 512, 513-14 (E.D. Pa. 1946). The “legal” remedy
for that right is “actual damages.” 15 U.S.C. § 78bb(a).
The Eighth Circuit purports to apply the “actual dam-
ages” limitation. In doing so, the Eighth Circuit concludes
that, in order to limit a defrauded purchaser’s recovery to
his “actual damages,” a court must reduce damages by “the
tax benefits [the purchaser] received.” Austin II at 955. In
so holding, the Eighth Circuit states:
11
[AJll economic benefits bargained for and received must
be deducted from plaintiffs’ damages because “the strictly
compensatory nature of damages awarded in private se-
curities fraud actions requires that such value be taken
into account in determining whether and to what extent
damages were inflicted upon plaintiffs.”
Id., quoting Austin I at 183. The Eighth Circuit goes on:
[I]n order for the plaintiffs to be truly made whole,
and to be returned to the status quo ante, both the tax
benefits received and the tax consequences of their re-
covery must be taken into account.
Id. at 960 (emphasis in original).
The Ninth Circuit rejects both the Eighth Circuit’s rea-
soning and its result:
[The defendants] claim that the tax benefits received
by the [plaintiffs] should be deducted from the damage
award. In this case, deduction of the tax benefits from
damages is inappropriate. The purpose of the damages is
to place the [plaintiffs] in as good a position financially
as that in which they would have been had they not made
the transaction. . . . At first appearance it seems inequi-
table to award the [plaintiffs] their pretax out of pocket
losses . . . . [T]o simply subtract the tax benefits from
damages would place an unfair burden on taxpayers
generally. . . . Such a result leaves the government bear-
ing the cost of defendants’ fraud. A better result is to set
damages equal to the [plaintiffs’] losses exclusive of tax
benefit. The [plaintiffs] will not receive a double benefit
from this measure of damages because under the tax
benefit rule their prior tax benefits will be disallowed. . . .
We are aware that in other circumstances tax conse-
quences have been considered in determining damages... ..
12
In such cases where there is prospective calculation
of damages for which no past tax benefits have been
claimed, it is appropriate to calculate damages net of
taxes. . . . [Such a] situation is clearly different from the
present tax shelter situation in which the [plaintiffs] have
received substantial benefits at government expense.
Burgess v. Premier Corp., 727 F.2d at 837-38. The Ninth
Circuit goes on to consider the holding in Austin I and de-
clines to follow it. Jd. at 838. The Ninth Circuit concludes:
While we agree that consideration of tax consequences
is relevant for certain purposes, we decline to make the
government the banker for fraudulent tax shelter activity.
Judge Hardy’s analysis in Western Federal Corp. v.
Davis, 553 F. Supp. 818, 820 (D. Ariz. 1982) is correct
in discerning that the economic benefit by way of tax
deductions is illusory because amended returns will have
to be filed under the tax benefit rule. Mertens Law of Fed-
eral Income Tax, §7.37.
Id.; accord, Western Fed. Corp. v. Erickson, 739 F.2d at
1444; Johns Hopkins Univ. v. Hutton, 297 F. Supp. at 1232
. (“amounts to be applied to taxes were payments for that
purpose, and are therefore not to be considered as either ‘in-
come’ or ‘consideration’ ”); cf. Eisenberg v. Gagnon, 766
F.2d 770, 782 (3d Cir. 1985).
The Second Circuit takes yet another approach. The
Second Circuit states:
To the extent that plaintiffs invested in a tax shelter,
all benefits they received from their investment, including
tax benefits, would have to be deducted in calculating
the rescissionary damages, if any to which they would
be entitled.
13
Salcer v. Envicon Equities Corp., 744 F.2d 935, 940-41 (2d
Cir. 1984), petition for cert. filed, 53 U.S.L.W. 3688 (U.S.
Mar. 13, 1985) (No. 84-1447); accord, Freschi v. Grand
Coal Venture, 767 F.2d 1041, 1050-51 (2d Cir. 1985),
petition for cert. filed, 54 U.S.L.W. 3154 (U.S. Sept. 6,
1985) (No. 85-377).° Although that part of the Second
Circuit’s decision is consistent with the Eighth Circuit's deci-
sion, see Austin II at 955, the Second Circuit goes on to
deny a plaintiff recovery of the interest and penalties as-
sessed against him and makes no allowance for the tax
consequences of the recovery. Freschi v. Grand Coal Ven-
ture, 767 F.2d at 1050-51.
The Ninth Circuit refuses to permit tax consequences of
an investment to increase or decrease damages available
under section 10(b) and Rule 10b-5. The Second Circuit
requires a reduction of damages based upon tax deductions
taken prior to recovery, but it does not permit an increase
of damages to compensate for taxes which are to be imposed
on the recovery, and it awards no interest because interest
would constitute “a windfail resulting from [the] oppor-
tunity to use money.” Freschi v. Grand Coal Venture, 767
F.2d at 1051." The Eighth Circuit requires a reduction for
tax deductions prior to recovery and an addition for taxes to
be imposed on the recovery itself and insists interest be
added to (and subtracted from) the annual balances.
*Salcer v. Envicon Equities Corp. and Freschi v. Grand Coal Venture
are Rule 10b-5 cases based on rescissionary damage theories, not section
12(2) rescission cases.
‘One commentator noted:
If [income tax benefits have been obtained by the investor and if
those benefits reduce rescission damages}, the investor is in effect pay-
ing to the general partner or promoter the tax benefits which [the in-
vestor] obtained—thereby providing a windfall to the defendants .
S. Banoff. To What Extent Will Benefits from Tax Shelters be Permitted
to Offset Rescission Damages, 57 3. TAXATION 154, 157 (1982).
14
Thus, there is a conflict which runs three ways. It is up
to this Court to resolve that conflict. Note, Tax Shelter
Schemes & Damages in the Eighth Circuit, 18 CREIGH-
TON L. REV. 1307, 1328 (1985).
il.
THE EIGHTH CIRCUIT’S DECISION MISINTERPRETS THE AP-
PLICABLE STATUTES.
In Ernst & Ernst v. Hochfelder, 425 U.S. at 197, this
Court stated that “the starting point” for the interpretation
of the federal securities laws “is the language [of the statute]
itself.” The Eighth Circuit disregards the clear language of
section 12(2) and effectively rewrites the statute under the
guise of interpreting it. The Eighth Circuit also miscon-
strues section 28(a) of the Securities Exchange Act of 1934
{hereinafter “section 28(a)”].
Absent a clearly expressed legislative intent to the con-
trary, the language of a statute must ordinarily be regarded
as conclusive. Consumer Prod. Safety Comm’n v. GTE
Sylvania, Inc., 447 U.S. 102, 108 (1980). In construing a
statute, the statute’s meaning must be sought first from the
language employed. If the language itself is plain, it is the
duty of a court to enforce the statute as written. United
States v. Standard Brewery, Inc., 251 U.S. 210, 217
(1920). If the wording of a statute is plain, simple and
straightforward, the words employed must be accorded
their normal meaning. Kananen v. Matthews, 555 F.2d
667, 670 (8th Cir.). cert. denied sub. nom. Kananen vy.
Califano, 434 U.S. 939 (1977); see also Helvering v. Ham- °
mel, 311 U.S. 504, 510-11 (1941).
15
A.
The Eighth Circuit's Decision Distorts The Normal Meaning
Of Section 12(2).
Section 12(2)’s language is straightforward. The statute
allows a defrauded purchaser
to recover the consideration paid for such security with
interest thereon, less the amount of any security reccived
thereon, upon tender of such security ....
The formula has three parts: (1) the consideration paid,
(2) interest on the consideration and (3) income received.
The district court consistently attempted to be faithful
to the canons of statutory construction. At the end of the
first trial, the district court refused to reduce the recovery
under section 12(2) on account of tax benefits. Appendix
at F-7-10. After the Eighth Circuit directed that “tax bene-
fits” be equated with “income,” the district court on remand
stated:
[The defendants’] approach would be to subtract the tax
benefits from consideration paid before adding on inter-
est, a course that drastically reduces or completely oblit-
erates each plaintiff's award. However, the clear language
of [section] 12(2) presents the order in which to consider
these items: “consideration paid . . . with interest thereon,
less the amount of any income received .. . .” These
words present an express directive to this court, and [the]
defendant[s] cite no cases directly on point which hold
to the contrary.
16
Appendix at C-7.
Although the Eighth Circuit acknowledges that “tax bene-
fits received are [not] a form of income in a strict account-
ing sense,” Austin II at 955, it nevertheless holds that
section 12(2)’s language “income received thereon” may
properly be construed as including tax benefits bargained
for and received... .
Id. at 958 (emphasis in original).
The Eighth Circuit disregards the “normal meaning” of
the word “income.” “Income” means “gain derived from
capital, from labor, or from both combined.” Eisner v. Ma-
comber, 252 U.S. 189, 207 (1920).° “Income” does not
include every favorable economic consequence,” see United
Housing Foundation, Inc. v. Forman, 421 U.S. 837, 855
(1975) (“payment of interest, with its consequent deduc-
tibility for tax purposes,” does not constitiute income within
context of federal securities laws), and “loss” does not in-
clude every unfavorable one. If “income” and “loss” were
to be construed to do so, damage calculations (and tax re-
turns) would be required to account for all unrecognized
appreciation, depreciation. changes in market price and op-
portunity costs. E.g., Wolf v. Banco Nacional de Mexico,
S.A., 739 F.2d 1458 (9th Cir. 1984), cert. denied, 83
L.Ed.2d 778 (1985) (claim of damage based on change in
value of Mexican peso in comparison to American dollar).
One commentator noted that “Austin is without precedent in classifying
tax benefits received by the plaintiff as ‘income’ within the meaning of
section 12(2).” Note, Austin v. Loftsgaarden: Securities Fraud in Real
Estate Limited Partnership Investments, 16 CREIGHTON L. REV.
1140, 1151 (1982).
*Respondents themselves did not argue that tax benefits constituted income.
Austin II at 958 (“Loftsgaarden argues that .. . tax benefits are a re-
turn of ‘consideration paid’). In addition, their expert witness testified
that “tax benefits” were not “income.”
17
The Eighth Circuit also disregards the normal meaning of
another portion of section 12(2). The Eighth Circuit con-
cedes that under section 12(2) a defrauded purchaser will
only be entitled “to recover the amount paid for [the secu-
rity] with interest, less the amount received with interest.”
Austin II at 959, quoting Murphy v. Cady, 30 F. Supp. 466,
470 (D. Me. 1939), aff'd, 113 F.2d 988 (1st Cir.), cert.
denied, 311 U.S. 705 (1940). The sentence structure and
rules of syntax require that the words “interest thereon”
modify only “consideration paid” and mandate that interest
be calculated only on the consideration. No reasonable
construction permits calculating or deducting interest on
the “income received.” See Johns Hopkins Univ. v. Hutton,
297 F.Supp. at 1233. Nevertheless, the Eighth Circuit holds
that
[b]ecause plaintiffs were not deprived of the use of the
entire amount of their investments over the ten year
period, prejudgment interest is due only on the amount
of money they were out-of-pocket at any given time.
Austin II at 959. That interpretation is contrary to the stat-
ute’s plain meaning.
B.
The Eighth Circuit's Decision Misinterprets Section 28(a).
Section 28(a) provides:
The rights and remedies provided by this chapter shall
be in addition to any and all other rights and remedies
that may exist at law or in equity; but no person per-
mitted to maintain a suit for damages under the provi-
sions of this chapter shall recover, through satisfaction
of judgment in one or more actions, a total amount in
18
excess of his actual damages on account of the act com-
plained of ....
The Eighth Circuit concludes that “a plaintiff can recover
no more than his ‘net economic loss’” and holds that “net
economic loss” is to be equated with “actual damages.”
Austin II at 954; accord, Salcer v. Envicon Equities Corp.,
744 F.2d at 940.
That interpretation begs the question of what is intended
by the term “actual damages.” The sentence structure sug-
gests that Congress meant only to prevent duplicative re-
covery whenever a plaintiff asserted a state law claim as
well as a federal securities law claim.
The first clause of section 28(a) demonstrates that fed-
eral remedies do not preempt state remedies. The phrase
“actual damages,” which is included in the following clause
in section 28(a), is designed to prevent a plaintiff from
recovering more than once if he pursues both federal and
state causes of action.” E.g., Osofsky v. Zipf, 645 F.2d
107, 111 (2d Cir. 1981).
If this Court is not able to determine the intent from the
language of the statute, it is entitled to consider “practical
factors” and considerations of “policy” to explicate congres-
sional intent in adopting section 28(a). See Blue Chip
Stamps v. Manor Drug Stores, 421 U.S. 723, 749 (1975).
All practical and policy considerations favor excluding tax
benefits from a calculation of damages.
The Eighth Circuit’s decision assumes that the tax bene-
fits of investing in a limited partnership are attributable to
1°A strict construction of section 28(a), which refers only to “a suit for
damages,” may preclude any limitation on the equitable remedy of
rescission. See Note, Insiders Liability under Rule 10b-5 for the Pur-
chase of Actively Traded Securities, 78 YALE L. J. 864, 874 n.51
(1969).
19
the promoter and must be accounted for when damages are
calculated. The assumption is false. Tax deductions are
allowed by the government, not by the promoter; the bene-
fit, if any, which results from the deductions is based upon
the investor’s tax situation; nothing is attributable to the
promoter. See Hayden v. McDonald, 742 F.2d 423, 441-42
(8th Cir. 1984) (concurring opinion). By crediting a pro-
moter who defrauded investors with tax benefits conferred
by the government, the Eighth Circuit makes the “govern-
ment . . . the banker for fraudulent tax shelter activity.”
Burgess v. Premier Corp., 727 F.2d at 838.
Several harmful effects flow from the Eighth Circuit’s
decision. First, the Eighth Circuit’s decision vitiates the “col-
lateral source” rule. The rule is set forth in RESTATE-
MENT (SECOND) OF TORTS §920A(2) (1979):
Payments made to or benefits conferred on [an] injured
party from other sources are not credited against the
tortfeasor’s liability, although they cover all or a part of
the harm for which the tortfeasor is liable.
The rule means that
a benefit that is directed to the injured party should not
be shifted so as to become a windfall for the tortfeasor.
If the plaintiff was himself responsible for the benefit, as
by maintaining his own insurance or by making advan-
tageous employment arrangements, the law allows him
to keep it for himself. If the benefit was a gift to the
plaintiff from a third party or established for him by law,
he should not be deprived of the advantage that it con-
fers. The law does not differentiate between the nature
of the benefits, so long as they did not come from the
defendant or a person acting for him.
Id. comment b (emphasis added). The Eighth Circuit holds
that
20
the tax benefits of plaintiffs’ investments are not a collat-
eral source because “although paid by the government,
[they] emanate directly from the tax shelters sought by
the plaintiffs and provided by defendants, without which
plaintiffs could not have realized any tax benefits. Benefits
resulting directly from a transaction under attack must be
credited toward the damage award.”
Austin II at 956, quoting Salcer v. Envicon Equities Corp.,
744 F.2d at 941-42. That analysis misconstrues the nature
of a “collateral source.”
Every collateral source results directly from the tort or
transaction at issue. Health and disability insurance are
collateral sources even though they compensate an injured
or disabled party for medical expenses and lost income re-
sulting directly from the injury caused by the tortfeasor.
E.g., Denison v. Head Constr. Co., 54 Md. App. 310,
319-22, 458 A.2d 868, 873-74 (1983); Hueper v. Good-
rich, 314 N.W.2d 828, 830-31 (Minn. 1982). Such insur-
ance is considered to come from a “collateral source” and
does not reduce the damage for which the tortfeasor is
liable. The rule applies even if the tortfeasor provides the
benefits or contributes to a fund which does so. E.g., Eichel
v. New York Cent. R.R., 375 U.S. 253, 254-55 (1963);
NLRB v. Gullett Gin Co., 340 U.S. 361, 364 (1951); Kauff-
man v. Sidereal Corp., 695 F.2d 343, 346-47 (9th Cir.
1983); United States v. Gray, 199 F.2d 239, 244 (10th Cir.
1952) (government’s provision of veterans hospitalization
benefits does not diminish portion of damage award against
government which constituted cost of treatment).
The proper question is whether the benefit comes from
Respondents. Petitioners’ tax benefits come from a third
party, i.e., the government, and are established by law. R.
Thompson, The Measure of Recovery under Rule 10b-5, 37
VAND. L. REV. 349, 390 (1984) (“plaintiff who receives
21
a tax benefit obtains his advantage from the government,
not from the defendant”). The tax benefits do not come
from Respondents. Any other interpretation would mean
that tax benefits which emanate from sources collateral to
the investment, i.e., (1) tax incentives created by the gov-
ernment to encourage improvements to real estate and (2)
an investor’s other taxable earnings, would inure to a de-
frauder and not to the investor whom the incentives were
intended to benefit and who had other earnings. See Fun-
ston v. United States, 513 F. Supp. 1000, 1010 (M.D. Pa.
1981) (“tax benefit conferred by [the state] is from a col-
lateral source”); Jowa-Des Moines Nat'l Bank v. Schwer-
man Trucking Co., 288 N.W.2d 198, 205 (Iowa 1980)
(“tax saving [is to be] treated as a collateral source”);
Cereal Byproducts Co. v. Huli, 16 lll. App. 2d 79, 81, 147
N.E.2d 383, 384, affd, 15 Ill. 2d 313, 155 N.E.2d 14
(1958) (tax consequences of theft loss treated as being
from collateral source); Lumber Terminals, Inc. v. No-
wakowski, 36 Md. App. 82, 97, 373 A.2d 282, 291-92
(1977) (“[t]axes are strictly between plaintiff as taxpayer
and the government as collector, and are of no legitimate
concern of the defendants” ).
Second, the Eighth Circuit’s decision does violence to
the rule which prohibits fiduciaries from profiting from
transactions with their beneficiaries. Here Loftsgaarden
committed a massive fraud; yet the Eighth Circuit allows
him to take an undisclosed profit, to profit further from the
ability to use for twelve years the monies he obtained and
to return only a fraction of the original profit.
Third, the Eighth Circuit’s decision reduces government
fevenue. The decision limits the defrauder’s liability for
damages and thereby reduces the investor’s recovery.. Be-
22
cause the investor’s recovery would have been taxable, the
decision guarantees that the public purse is to be used to
provide a profit to fraudulent promoters. See Western Fed.
Corp. v. Davis, 553 F. Supp. at 821. ;
Fourth, the Eighth Circuit’s analysis accounts for some,
but not all, of the tax consequences of the transaction: the
tax benefits that a plaintiff receives during the time prior to
the limited partnership’s insolvency, the taxes paid at the
time of insolvency and the assumed taxes to be paid as a
result of an award of “damages.” The analysis does not take
into account the need to amend earlier returns, see, ¢.g.,
Western Fed. Corp. v. Davis, 553 F. Supp. at 820; Rhode v.
Hershberger Explorations, Inc., 349 F. Supp. 993, 994 (D.
Minn. 1972), or the government’s ability to correct an error
made in a prior tax year and to obtain an adjustment of tax
liability despite the running of the ordinary period of limi-
tations. See 26 U.S.C. §§1311-1314; but see Austin Il at
956; Salcer v. Envicon Equities Corp. 744 F.2d at 942-43.
Finally, the Eighth Circuit’s rule creates anomalous
damage awards. Investors in different tax brackets, but
identically situated in every other way, are to receive dam-
ages in differing amounts. Damage awards will vary widely
based upon factors which have nothing to do with the in-
vestments or with the frauds which occasion the awards if
tax consequences must be considered. Even though Randall,
Austin and Anderson each invested $35,000.00 and even
though none received any cash or cash equivalent as a return
on his investment in Alotel Associates, each is to recover a
different amount: Randall ($506), Austin ($7,666) and
Anderson ($18,790). Jd. at 961; compare Hayden v. Mc-
Donald, 742 F.2d at 425 & 439 (56 plaintiffs and presumably
56 different results). Disparate treatment of investors based
23
upon differences in their taxable income undermines the
purposes of the federal securities laws. See Herman & Mac-
Lean v. Huddleston, 459 U.S. at 390 (defrauded investors
are persons whom securities laws seek to protect).
The rule also enables plaintiffs and defendants to in-
crease the amount of damages. Because tax benefits depend
upon an investor’s “ordinary income” and marginal tax
bracket, a plaintiff may manipulate the timing of his receipt
of such “ordinary income” and thereby increase his dam-
ages. A defendant may also manipulate the amount of tax
benefits (and of damages) by his own ability to make elec-
tions. S. Banoff, To What Extent Will Benefits from Tax
Shelters be Permitted to Offset Rescission Damages, 57 J.
TAXATION 154, 155-56 (1982).
THE EIGHTH CIRCUIT’S DECISION iS CONTRARY TO PRECE-
DENT.
A.
The Eighth Circuit's Decision Fails To Defer To This Court's
Precedent.
The impact of income taxes on damages available is a re-
curring subject for this Court’s consideration. The appli-
cable principles are the subject of no less than three sepa-
rate, significant opinions.
In Hanover Shoe, Inc. v. United Shoe Mach. Corp., 392
U.S. 481 (1968), this Court first addressed a party’s argu-
ment that an adversary’s damages must be reduced to the
“after-tax profits that [the adversary] failed to receive.”
Id. at 503. This Court held that
to diminish the actual damages by the amount of taxes
that [a plaintiff] would hav paid had it received greater
24
profits in the years it was damaged would be to apply a
double deduction for taxation, leaving [the plaintiff] with
less income than it would have had if [the defendant] had
not injured it.
Id. This Court recognized that changing rates of taxation,
expired statutes of limitation and difficulties in recomputing
taxes which would have accrued over a period of years,
stated that
the rough result of not taking account of taxes for the
year of injury but then taxing recovery when received
seems the most satisfactory outcome,
id., and held that damages should equal pre-tax profits and
that the IRS should be permitted to tax the recovery. /d.
In Norfolk & W. Ry. v. Liepelt, 444 U.S. 490 (1980),
this Court considered the question of whether a refusal of an
instruction that any award of damages would not be sub-
ject to income taxation was error. Jd. at 491. This Court
recognized an injured individual’s after-tax income, not his
gross income before taxes, was the relevant factor in calcu-
lating the damages sustained by his dependents when he
died. Jd. at 493-94. This Court again recognized the com-
plexities in predicting the many variables; nevertheless, it
held that the danger of overcompensation based on an er-
roneous assumption concerning taxability required the ad-
mission of expert testimony concerning income tax liability
for future wages and the giving of an instruction that a judg-
ment would not be taxable. /d. at 497-98.
In Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523
(1983), this Court offered guidance to those seeking to
reconcile its pronouncements in Hanover Shoe with those in
Liepelt. This Court stated that, when the damage award
25
itself is to be tax-free, the evidence to be considered is that
concerning after-tax amounts. This Court implied that,
when the damage award itself is taxable, evidence of taxes
paid or to be pid should be excluded. Jd. at 547-51.
The Eighth Circuit interprets Liepelt to apply to Peti-
tioner’s claims for damages and for rescission even thoug!
the Eighth Circuit recognized that each would “have to pay
taxes on his award.” The Eighth Circuit fails to consider
Hanover Shoe or Pfeifer. In doing so, the Eighth Circuit
glosses over Liepelt’s predicate that its holding applies only
when an award of damages is not taxable.
The Eighth Circuit's Decision Fails To Defer To Other Courts’
Precedent.
Courts had been interpreting the federal securities laws
and had been providing remedies for over thirty years before
the deductibility of tax benefits surfaced as an issue. See
Cooper v. Hallgarten & Co., 34 F.R.D. 482 (S.D.N.Y.
1964). When defendants began to argue that they should be
able to reduce a plaintiff's recovery by an amount equal to
the tax benefits flowing from an investment, courts uni-
formly rejected those arguments. See, e.g., Rhode v. Hersh-
berger Explorations, Inc., 349 F. Supp. at 944; Johns Hop-
kins Univ. v. Hutton, 297 F. Supp. at 1232; Wiesenberger v.
W.E. Hutton & Co., 35 F.R.D. 556, 557 (S.D.N.Y. 1964);
Cooper v. Hallgarten & Co., 34 F.R.D. at 484.
Courts eventually allowed discovery of information con-
cerning tax benefits because of the information’s relevance
to issues other than damages. See Smith v. Bader, 83 F.R.D.
437, 438-39 (S.D.N.Y. 1979); Sharp v. Coopers & Ly-
brand, 83 F.R.D. 343, 352 (E.D. Pa. 1979), rev’d on other
26
grounds, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455
U.S. 938 (1982); Houlihan v. Anderson-Stokes, Inc., 78
F.R.D. 232, 233-34 (D.D.C. 1978). Courts which per-
mitted such discovery considered the tax benefits relevant
to the issue of valuation of the investment, see Dupuy v.
Dupuy, 551 F.2d 1005, 1025 (Sth Cir.), cert. denied, 434
U.S. 911 (1977); Smith v. Bader, 83 F.R.D. at 439; accord,
Berg v. Xerxes-Southdale Office Bldg. Co., 290 N.W.2d
612, 615 (Minn. 1980), to the issue of misrepresentation of
tax benefits, Bridgen v. Scott, 456 F. Supp. 1048, 1062
(S.D. Tex. 1978); Bayoud v. Ballard, 404 F. Supp. 417,
426 (N.D. Tex. 1975), to the issue of causation, see Houli-
han v. Anderson-Stokes, Inc., 78 F.R.D. at 234, to the issue
of reliance, see Smith v. Bader, 83 F.R.D. at 439; Sharp v.
Coopers & Lybrand, 83 F.R.D. at 352, and to the issue of
laches. See Hickman v. Groesbeck, 389 F. Supp. 769, 780
(D. Utah 1974).
The Eighth Circuit was the first to totally reject existing
precedent and to permit defendants to introduce evidence
of tax benefits and to require that those benefits offset dam-
ages. Austin I at 183; Note, Austin v. Loftsgaarden: Secu-
rities Fraud in Real Estate Limited Partnership Investments, _
18 CREIGHTON L. REV. 1140, 1151 (1982) [“Austin
is without precedent in classifying tax benefits as income
within the meaning of section 12(2)”]. Other courts con-
tinued to reject the Eighth Circuit’s aproach. E.g., Eisen-
berg v. Gagnon, 766 F.2d at 782 (deductability of losses
not to be considered in assessing damages); Western Fed.
Corp. v. Erickson, 739 F.2d at 1444; Burgess v. Premier
Corp., 727 F.2d at 837-38; G & R Corp. v. American Sec.
& Trust Co., 523 F.2d 1164, 1176 (D.C. Cir. 1975); Spv:z
v. Borenstein, 513 F. Supp. 571, 577-86 (N.D. Ill. 1981);
27
see also Danzig v. Jack Grynberg & Assoc., 161 Cal. App.
3d 1128, 1139-40, 208 Cal. Rptr. 336, 343-44 (1984),
petition for cert. filed, 53 U.S.L.W. 3826 (U.S. May 14,
1985) (No. 84-1784) (limited partners’ tax consequences
irrelevant to their rescissionary recovery based upon mis-
representation ); Harris v. Metropolitan Mall, 112 Wis. 2d
487, 501-02, 334 N.W.2d 519, 526 & n.21 (1983); lowa-
Des Moines Nat'l Bank v. Schwerman Trucking Co., 288
N.W. 2d at 205; Borovoy v. Bursar Realty Corp., 86 Mich.
App. 732, 738, 273 N.W.2d 545, 548 (1979) (tax conse-
quences “do not enter into the computation of damages”
under state securities laws); Cereal Byproducts Co. v. Hall,
16 Ill. App. 2d at 81, 147 N.E.2d at 384; cf. Hokama v.
E.F. Hutton & Co., 566 F. Supp. 836, 847-48 (C.D. Cal.
1983). The Second Circuit, however, adopted the Eighth
Circuit’s approach. See Freschi v. Grand Coal Venture,
767 F.2d at 1050-51; Salcer v. Envicon Equities Corp., 744
F.2d at 940-44.
There was no reason to reject precedent. The Second and
Eighth Circuits should have deferred" to the rationale and
holdings of the earlier cases.
IV.
THE EIGHTH CIRCUIT’S DECISION UNDERCUTS THE DIS-
CLOSURE REQUIREMENTS OF THE FEDERAL SECURITIES
LAW.
The Securities Act of 1933 is “a system of full disclos-
ure.” T. Hazen, THE LAW OF SECURITIES REGULA-
TION §1.2 at 7 (1985); see also 1 L. Loss, SECURITIES
“Neither the Second Circuit nor the Eighth Circuit deferred to the ex-
pertise of the SEC with respect to the interpretation of the federal
securities laws or the expzrtise of the Tax Division with respect to the
interpretation of the invernal revenue laws.
28
REGULATION 184 (2d ed. 1961). The Securities Ex-
change Act of 1934 is intended to regulate all aspects of
the public trading of securities, bars material mistatements
and omissions and requires full disclosure. /d.
The necessity of full disclosure is implemented by the
SEC’s examination of registration documents to determine
compliance with the securities laws’ disclosure requirements,
by the SEC’s initiation of injunction proceedings, by the
SEC’s administrative hearing and sanction procedures, by
criminal prosecutions and by private litigants’ sui*s for resti-
tution and damages. T. Hazen, THE LAW OF SECURI-
TIES REGULATION §1.3 at 10-11 (1985); 1 L. Loss, SE-
CURITIES REGULATION 302-C2 (2d ed. 1961); 2 L.
Loss, SECURITIES REGULATION 845-57 (2d ed.
1961); T. Hazen, Administrative Enforcement: An Evalua-
tion of the SEC’s Use of Injunctions & Other Enforcement
Methods, 31 HASTINGS L. J. 427 (1979); see also United
States v. Naftalin, 441 U.S. 768 (197°); Red Bank Oil Co.,
20 S.E.C. 863, 866 (1945).
The Securities Act of 1933 exempts certain securities
from its registration requirements because of the “small
amount involved” or because of the limited character of
the public offering, 15 U.S.C. §77c, and exempts certain
transactions because of the nature of the transactions or
the participants. 15 U.S.C. §77d. Most limited partnership
offerings” fall within one or more exemptions."* Therefore,
12The total amount invested in limited partnerships in 1983 was estimated
to be $8.4 billion. TIME, Nov. 26, 1984, at 26.
13[n 1980 there were approximately 211,000 real estate limited partner-
ships in existence. Bureau of Nat'l Affairs, Inc., Daily Report for
Executives (Feb. 21, 1984).
In a 12 month period during 1975-1976 only 10 limited partnerships
were registered with the S.E.C. [1976] 5 FED. SEC. L. REP. (CCH)
at 64,214. In a similar period during 1984-1985 less than 60 real estate
limited partnerships registered. [1985] 6 FED. SEC. L. REP. (CCH)
Br. 5 & 6 at 64,264-77.
29
the SEC has no opportunity to examine documents prior to
sale. Because neither SEC nor the Department of Justice
has the resources to police all of the fraudulent activity by
organizers of limited partnerships, the primary tool in
enforcing the disclosure requirements is the private civil
action. Note, Real Estate Limited Partnerships & Alloca-
tional Efficiency: The Incentive to Sue for Securities Fraud,
63 VA. L. REV. 669, 670-71 (1977).
The incentive to make full disclosure is in direct relation
to the likelihood and risk of a successful suit. Jd. at 671.
The Eighth Circuit’s decision makes it unlikely that de-
frauded investors will sue and minimizes the risk to the
fraudulent promoter in the unlikely event that they do sue.
Id, at 671-72. One commentator described the Eighth Cir-
cuit’s message to potential promoters:
Relax. Should a violation of the securities law occur,
promoters in the Eighth Circuit apparently need only
assure themselves that the investors get a large enough
tax deduction.
Note, Austin v. Loftsgaarden: Securities Fraud in Real Es-
tate Limited Partnership Investments, 16 CREIGHTON L.
REV. 1140, 1152 (1983).
Allowing the Eighth Circuit’s decision to stand encour-
ages thousands of promoters to omit or to misrepresent in-
formation material to potential investors. Like Loftsgaarden,
those promoters will hope to pocket in excess of $100,000,
to keep all of the money for twelve years and then to return
less than $30,000. The decision will discourage the tens of
thousands of investors who look at Randall and see only a
man who invested $42,500 as a result of a fraud, who spent
thousands of dollars trying to salvage his investment and
“Fraud continues to grow despite the efforts of federal.and state enforce-
ment agencies. Washington Post, Jun. 4, 1984, at A-11.
30
who was left with nothing but an expenditure of almost ten
years and additional thousands of dollars in attorney’s fees
in pursuit of his recovery of $506.
This Court must insist on the disclosure required by
statute. To do so, it must insure the continued viability of
the express and implied remedies for violations of the securi-
ties laws’ disclosure requirements. To do otherwise is to
undercut the protective purpose of the securities laws. See
R. Thompson, The Measure of Recovery under Rule 10b-5,
37 VAND. L. REV. 349, 390 (1984) (“[flocusing on the
defendant and resolvir.g doubts against the party commit-
ting the fraud is consistent . . . with the dual deterrent/
compensatory purposes of the federal securities laws” and
requires tnat there be no deduction for tax benetits); United
States v. Naftalin, 441 U.S. at 774-77.
CONCLUSION
For the foregoing reasons, a writ of certiorari should issue
to review the judgment and opinion of the Eighth Circuit.
Respectfully submitted,
/s/ Robert Arthur Brunig
O’CONNOR & HANNAN
3800 IDS Tower
80 South Eighth Street
Minneapolis, Minnesota 55402
Telephone: (612) 343-1200
Attorney for Petitioners
Of Counsel:
Terence M. Fruth
FRUTH & ANTHONY, P.A.
1300 International Centre
900 Second Avenue South
Minneapolis, Minnesota 55402
Telephone: (612) 349-6969
September 23, 1985.
slat) TE) SEE PET Ae 6 re oe ROY Sn ge: - wt ee ae — —— - —
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