Appendix — Randall v. Loftsgaarden
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85 as 5 1 9 | Supreme Court, U.S, 7 |
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No. SEP 24 1908
= “SPANIOL, JR.
IN THE am CLERK
Supreme Court of the Anited States
October Term, 1985
DR. WILLIAM C. RANDALL, DP... 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 RESEARCTI COMPANY, a Minnescta corpora-
tion; and 2361 BUILi2ING CORPORATION, a Minne-
sota corporation,
Respondents.
APPENDIX
Robert Arthur Brunig
O’CONNOR & HANNAN
3800 IDS Tower
80 South Eighth Street
Minneapolis, Minnesota 55402
Telephone: (612) 343-1200
A‘torney for Petitioners
Of Counsel:
Terence M. Fruth
FRUTH & ANTHONY, P.A.
1300 International Centre
900 Second. Avenue South
Minneapolis, Minnesota 55402
Telephone: (612) 3249-6969
1985—Northwest Brief Printing Co., 3010 2nd St. No., Minneapolis 55411—588-7506
APPENDIX INDEX
Page
Decision and Judgment (8th Cir. Jul. 1, 1985)....... A-l
Amended Judgment (D. Minn. Mar. 26, 1984)...... B-1
Order (D. Minn. Feb. 22, 1984).............00005 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
SORES GS DED ce ccc ic ce rtesewecessesds G-1
A-l
APPENDIX
APPENDIX A
UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
No. 84-5053
No. 84-5058
No. 84-5059
Dr. Roger E. Austin, Dr. Tom W. Anderson, Dr. Myrel
A. Neumann, and Dr. William C. Randall,
Appellees,
Vv.
B. J. Loftsgaarden; Alotel Incorporated, a Minnesota cor-
poration; Property Development and Research Com-
pany, a Minnesota corporation and 2361 Building Cor-
poration,
Appellants.
Appeals from the United States District Court
for the District of Minnesota
Submitted: January 17, 1985 Filed: July 16, 1985
Before LAY, Chief Judge, and HEANEY, BRIGHT,
ROSS, McMILLIAN, ARNOLD, JOHN R. GIBSON,
FAGG, and BOWMAN, Circuit Judges.
A-2
PER CURIAM.
This en banc hearing arises from a retrial on the issue of
damages ordered by this Court in Austin v. Loftsgaarden,
675 F.2d 168 (8th Cir. 1982) (Austin I). In Austin I, we
affirmed the jury’s verdict that Loftsgaarden and three of
his closely-held corporations (hereinafter Loftsgaarden)
violated state and federal securities laws, but held that the
district court erred in ruling that the plaintiff-investors’
rescissionary damages could not be reduced by the “tax
shelter™ benefits they received as a result of their invest-
ments. Thereafter, we denied plaintiffs’ petition for re-
hearing or rehearing en banc.
On remand, the district court deducted plaintiffs’ tax
benefits from their damage awards and both sides appeal.
After oral argument before a panel of this Court, the pan-
el issued an order setting two issues for en banc
consideration: First, whether Austin I should be recon-
sidered as it relates to the offset of tax benefits fron:
rescissionary damages awarded in a private securities
fraud action involving an investment that was structured
and marketed as a tax shelter; and second, assuming that
Austin I was properly decided, what is the proper measure
of plaintiffs’ rescissionary damages?
‘In Austin I, we defined “tax shelters” as investments which allow the
investor
to offset certain “artificial losses” (that is noneconomic losses but
losses which are available as deductions under the present tax laws)
not only against the income from those investments but also against
the [investor's] other income, usually from his regular business or
professional activity.
675 F.2d at 183 (citing Staff of Joint Comm. on Internal Revenue
Taxation, 94th Cong., Ist Sess.,. Overview of Tax Shelters 1 (Comm.
Print 1975) ).
A-3
FACTS
The facts in this case are set forth in detail in Austin I,
675 F.2d at 173-76. We briefly review them here.
Plaintiffs Austin, Anderson, Neumann and Randall, in-
vested over $152,000 in Alotel Associates (hereinafter
Associates), a limited partnership organized by defendant
B. J. Loftsgaarden to help finance the building and oper-
ation of a Ramada Inn in Rochester, Minnesota. Lofts-
gaarden’s offering memorandum claimed that purchasers
of the limited partnership interests would receive sub-
stantial tax benefits during the first three years of their
investments and thereafter would share in the hotel’s pro-
jected profits.
The Rochester Ramada opened several months behind
schedule in 1974 at a construction cost substantially in ex-
cess of that projected. Thereafter, the ho‘el incurred sig-
nificant operating losses and Loftsgaarden requested the
limited partners to extend to Associates several large
loans to prevent insolvency. The limited partners hired a
lawyer and an accountant to investigate Loftsgzaarden’s
stewardship of the project, which revealed that Lofts-
gaarden had knowingly committed several frauds on the
limited partners. Although Loftsgaarden resigned as gen-
eral partner and the limited partners made additional
loans,’ the partnership ultimately defaulted on its obliga-
tions and the hotel was foreclosed upon.
The four plaintiffs’ then filed this securities fraud action
*The jury found that these advances w_-e not induced by any misrepre-
sentations by Loftsgaarden and thus the plaintiffs could not recover
them.
*The numerous other limited partners were initially parties to this action
but subsequently dropped their claims.
A-4
against Loftsgaarden. The jury found that Loftsgaarden
had violated “section 10(b) of the Securities Exchange
Act of 1934, 15 U.S.C. § 78j(b); Rule 10b-5, 17 C.F.R.
240.10b-5; the antifraud provision of the Minnesota Se-
curities Act, Minn. Stat. §§ 80A.01, et seg., 80A.23; and
[had committed] common law fraud. The jury rendered
an advisory verdict—in which the district court con-
curred—that defendants were liable for violating § 12
(2) of the Securities Act of 1933. 15 U.S.C. § 771(2).”
Austin I, 675 F.2d at 172 (footnotes omitted.) The court
applied a rescissionary measure of damages in the amount
of the consideration each plaintiff paid for his limited part-
nership unit or units, prejudgment interest from the date
of purchase, and attorneys’ fees for plaintiffs Randall and
Neumann for a total judgment of $273,720.
We affirmed the findings of liability, but vacated the
award of damages and remanded to the district court,
stating “the court committed reversible error in refusing
to allow proof of any economic benefits received by
plaintiffs on account of the investment and in failing to in-
struct the jury that the damage award must be reduced
by any value shown to have been received by plaintiffs.”
Austin I, 675 F.2d at 181.
On remand, the district court awarded to plaintiffs
damages in the amount of their consideration paid, with
eight percent interest thereon, less tax benefits received,
for a total amount as follows. Anderson, $35,172: Austin,
$31,277: Neumann, $39,371: and Randall, $31,569. It
also granted attorneys’ fees under Minn. Stat. § 80A 23,
subd. 2 as follows: Anderson, $0; Austin, $0; Neumann.
$29,000; and Randall, $20,000. In addition, the court
granted costs of $5,321.83 to Austin, Anderson and
A-5
Neumann and $2,955.49 to Randall. We now consider
the two issues raised before the Court en banc.
DISCUSSION
I. Should Austin I be reconsidered as it relates to the-
Offset of tax benefits from rescissiOnary damages
awarded in a private securities fraud action -in-
volving an investment structured and marketed as a
“tax shelter”?
The starting point for our analysis is that the petition
for rehearing or rehearing en banc in Austin I was de-
nied, 675 F.2d at 168, and that, accordingly, its holdings
are now law of the case. As we stated in Otten v. Stonewall
Ins. Co., 538 F.2d 210 (8th Cir. 1978):
Law of the case principles have heen stated with
clarity and consistency in this court over a long period
of time. “This court has repeatedly he'd that the de-
cision on former appeal is the ‘law of the case’ on a
question presented in that former appeal, unless
the evidence introduced at the subsequent trial is sub-
stantially different from that considered on the first
appeal, and must be followed in all subsequent
proceedings in such case in both district and appel-
late courts unless that decision is clearly erroneous
and works manifest injustice. * * * While this rule
of practice is not a limit of power, it is nevertheless a
salutary one, and should be departed from only after
careful consideration of situations arising in spe-
cific cases.”
Id. at 212 (citations omitted).
The appellees contend that the damages holding in
Austin I is “clearly erroneous” and works a “manifest in-
justice” and thus should be reversed. After a careful review
A-6
of Austin I, the relevant cases, the arguments of the par-
ties and the Tax Division of the Justice Department and the
Securities and Exchange Commission, appearing as
amicus curiae, we abide by our previous decision. In doing
so, we note that since our opinion in Austin I, the United
States Court of Appeals for the Second Circuit has sub-
stantially adopted the views that we expressed in that case.
Salcer v. Envicon Equities Corp., 744 F.2d 935 (2d Cir.
1984).°
Our decision in Austin I was based on the principle
that: “[DJamages for securities fraud are determined
in accordance with the extent to which false and mislead-
ing information actually harmed the complaining
party.” Austin I, 675 F.2d at 180 (citation omitted). We
noted that for this reason, the courts typically used the
out-of-pocket measure of damages,” but that where a
rescilssionary measure of damages is applied, the “ac-
tual damages principle requires that a_ rescissionary
* * * award be reduced by any value received as
a result of the fraudulent transaction.” Austin I, 675
F.2d at 181 (citation omitted). We held that this principle
applied not only to the 1933 Act claims and the claim
under Minn. Stat. § 80A.23(2),° (both of which explicitly
*But cf. Burgess v. Premier Corp., 727 F.2d 826 (9th Cir. 1984) (apply-
ing different rule in case of actual rescission).
°The parties are in dispute over whether the out-of-pocket measure of
damages would ea recovery similar to that approved here. See
Salcer, 744 F.2d at 940 n.5, Brief of SEC at 22-23. We need not
address this issue, however. Austin I limited its holding to tax shelter
— \ om a recissionary measure of damages is applied. 675 F.2d
at 183.
“In Hayden v. MacDonald, 742 F.2d 423 (8th Cir. 1984), plaintiffs
brought claims under Minn. Stat. § 80A.23(1), which provides that,
in an action for rescission and restitution based on the nonregistration
of securities in Minnesota, “the purchaser shall be entitled to recover
the consideration paid for the security * * * less the amount of any
income received on the security.” Because the Minnesota courts had
not directly addressed the issue, we deferred to the district court's
interpretation of “income received” as not including tax benefits. Id.
at 440-41. We now overrule that decision.
A-7
limit damages to the “actual damages” sustained), but
also to the common law fraud claim’ and the claim un-
We do not believe that Minnesota could have intended to treat
fraudulent sellers more kindly than those who have simply neglected
to register their securities. Although the phrase “actual damages” does
not appear in subsection (1), the principle that a plaintiff should not
be placed in a better position than he would have been in but for the
fraud — the principle, in other words, that no recovery in excess of
actual damages should be permitted — is plainly implicit in that pro-
vision. In actions for rescission based on sales of unregistered securities,
the statute says, “the amount of any income received on the securities”
is to be subtracted from “the consideration paid for the security together
with interest” in computing damages.
Moreover, to allow greater recoveries under subsection (1) than
under subsection (2) leads to results that are anomalons in the extreme.
Subsection (1) governs not only simple actions for sale of unregistered
securities (arising under Minn. Stat. §80A.08), but also actions for
misrepresenting that registration of a security means that state officials
are recommending that security (a practice made unlawful by Minn.
Stat. §80A.18). Otherwise, a defendant who tells a buyer that the filing
of a registration statement means that the Commissioner of Commerce
is recommending purchase of the security registered would be liable
for the full amount of consideration paid, and would receive no credit
for tax benefits conferred on the buyer, however substantial. But a
defendant who commits some other kind of fraud, however flagrant,
would receive such credit, solely because the action against him arises
under §80A.23(2) instead of §80A.23(1). The Minnesota Supreme
Court, of course, can resolve this matter authoritatively and have the
last word on the subject.
Our brother Heaney, post p. 26, takes the position that “it is bad
policy” to reach the Hayden issue because it “was not presented to us
vy the parties” and “we need not decide” it. We would like to explain
briefly why we disagree with this statement. The Court en hanc was
convened to decide whether we should adhere to the panel's decision in
Austin I. Plaintiffs, seeking disapproval of Austin I, argued that it was
inconsistent with Hayden. We agree. The logical implications of
Austin I, which is now approved by the Court en banc, are completely
inconsistent with Hayden, for reasons we have given. The Court en banc
is convened infrequently, though perhaps not infrequently enough,
and we believe it is good judicial policy to use those infrequent occasions
to bring consistency to our case law. If we were to leave Havden on
the books, without indicating one way or the other whether it is still
good law. we would almost guarantee that the Court en banc would
have to meet again when the Hayden issue arose, unless, of course. the
Supreme Court of Minnesota had, in the meantime, resclved the ques-
tion, an event the likelihood of which we have no way of estimatiig.
For these reasons, we believe it is a wise use of the Court's time and
energy to say now that Hayden is inconsistent with the position we now
take in Austin II, and, therefore, to state unequivocally that Hayden is
abandoned.
"In Berg v. Xerxes-Southdale Office Bldg. Co.. 290 N.W.24 612, 615
(Minn. 1980), the Court implied that tax benefits must be considered in
determining damages under a Minnesota common law securities fraud
A-8
der section 12(2) of the 1934 Act. Although the 1934
Act does not explicitly limit rescissionary damages to “ac-
tual damages” sustained, we noted that:
Under § 12(2), the defendant guilty of prospectus
fraud shall be liable to plaintiff, who may sue either
at law or in equity in any court of competent juris-
diction, to recover the consideration paid for such
security with interest thereon, Jess the amount of any
income received thereon, upon the tender of such
security, or for damages if he no longer owns the
security.
Id. at 181 (emphasis in original).
Because we found that section 12(2) implicitly incor-
porates the “actual damages” principle and that the words
“income received” should be construed as including the
tax benefits bargained for and received in the special case
of a tax shelter investnient, we concluded that the plaintiffs’
damages must be reduced by the tax benefits they re-
ceived.
The plaintiffs now contend that we should reconsider
both of the above findings of Austin I. First, they argue
that the “actual damages” language in section 28(a) of
the 1934 Act does not justify subtracting tax benefits
from awards under section 12(2) of the 1933 Act h--
cause section 28 (a) applies only to the 1934 Act and the
words “actual damages” do not appear anywhere within
the 1933 Act. We reject this contention. Although the
words “actual damages” do not appear in the 1933 Act,
claim, at least where the case involves a limited partnership offering
which includes the promise of artificial tax savizigs. 290 N.W.2d at 615-
16. See note 4, supra. See also Weise v. Red Owl Stores, Inc., 286 Minn.
199, 175 N.W.2d 184, 187 (1970) (the out-of-pocket rule also governs
an award of damages for common law securities fraud).
A-9
the courts have nonetheless applied the actual damages
principle of section 28(a) to bar punitive damages’ un-
der section 17(a) of the 1933 Act, Globus v. Law Re-
search Serv., Inc., 418 F.2d 1276, 1278, 1283-86 (2d
Cir.), cert. denied, 397 U.S. 913 (1970), and have con-
strued the rescission and restitution remedy provided by
section 12 (2) as substantially equivalent to the damages
permitted under section 28 (a). Cf. Affiliated Ute Citizens
v. United States, 406 U.S. 128, 155 (1972). The goal of
rescission under section 12 (2) is to return the parties to
the status quo ante, “and hence a plaintiff can recover no
more than his or her ‘net eccnoinic loss,’ ” i.e., “actual
damzuges.” Salcer, 744 F.2d at 940; Austin I, 675 F.2d
at 181; Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d
38, 49 n.22 (2d Cir.), cert. denied, 439 U.S. 1039 (1978).
We also reject plaintiffs’ contention that tax savings are
neither “income” nor are they “received” within the mean-
ing of section 12 (2). They cite United Housing Foundation,
Inc. v: Forman, 421 U.S. 837 (1975) in support of their
argument, but that case is inapposite. The plaintiffs in
United Housing were tenants who were required to pur-
chase refundable non-interest bearing shares in a non-
profit housing cooperative in order to rent a low-cost apart-
ment. After a rent increase was imposed to meet costs,
plaintiffs brought fraud claims under the Securities Act
of 1933 and the Securities Exchange Act of 1934, alleging
that they were misled in the purchase of the shares by mis-
representation in the cooperative’s information bulletin.
“We reject the SEC’s argument that the actual damages principle is only
intended to prohibit awards of punitive damages or duplicate state and
federal recoveries based on the same conduct. See also Shapiro v. Mid-
west Rubber Reclaiming Co., 626 F.2d 63, 70 (8th Cir. 1980), cert.
denied, 49° U.S. 1079 (1981).
A-10
The Court looked to “economic reality,” 421 U.S. at 848,
in determining that the shares were not securities. It noted
that the plaintiffs’ purchase of the shares was motivated
by a desire to obtain housing, not to make a profit in the
sense of a “return on investment.” The Court was not per-
suaded that the plaintiffs expected a profit on their non-
interest bearing refundable shares (which were akin to a
“security deposit”) simply because they were able to re-
duce their taxes by deducting that portion of their monthly
rental charges which were applied to interest on the mort-
gage. 421 U.S. at 855. The Court noted that “[e]ven if
the tax deductions were considered profits, they would not
be the type associated with a security investment since
they do not result from the managerial efforts of others.”
Id. 421 U.S. at 856 n.20.
United Hous‘ng is not only distinguishable on its facts;
if anything, its analysis tends to support our position in
Austin I. Like the United Housing Court, the Austin /
Court looked to “economic reality” in considering the tax
aspects of a tax shelter investment.” Additionally, unlike
the marginal tax benefits referred to in United Housing,
the tax benefits in the case at hand were a primary moti-
vation behind the investment and resulted from Lofts-
gaarden’s efforts in structuring and operating the part-
nership to take advantage of relatively complicated tax
rules. See Salcer, 744 F.2d at 941 (“plaintiffs’ argument
*See also Salcer, 744 F.2d at 941 (“To ignore the state’s tax benefits
actually realized by the plaintiffs would be unrealistic.”); Bridgen v.
Scott, 456 F. Supp. 1048, 1061 (S.D. Tex 1978) (“Requiring the jury
or this Court to try this case without reference to the tax consequences
of the transaction would be requiring the jury and this Cuurt to live
in an artificial ‘never-never’ land. The plaintiffs’ position that the tax
consequences of this transaction should be ignored is simply not real-
istic and is tantamount to requesting this Court and the jury to try this
case blindfolded.”).
A-11
that defendants are not entitled to ‘credi.’ for the tax bene-
fits because the latter were ‘provided’ by the govern-
ment rather than by the defendants must be rejected * * *
[Tjhat the tax benefits were paid by the government
rather than by the defendants does not lessen the de-
fendants’ role in securing them.”).
In any event, Austin I did not hold that tax benefits re-
ceived are a form of income in a strict accounting sense.”
Rather, we held that section 12(2)’s requirement that
“income received” be deducted in determining resc:ssion-
ary damages simply reflected that ali economic benefits
bargained for and received must be deducted from plain-
tiffs’ damages because “the strictly compensatory nature
of damages awarded in private securities fraud actions
requires that such value he taken into account in de-
termining whether and to what extent damages were in-
flicted upon plaintiffs.” Austin I, 675 F.2d at 183.
The plaintiffs claim that their tax benefits have not
been “received” must also be rejected because they have
stipulated that they have received permanent tax bene-
fits from their investments in Associates. Similarly, we re-
ject the contention of the Tax Division and the SEC
that plaintiffs’ tax benefits “may” prove to be illusory be-
cause they “may” experience recaptme upon sale or other
disposition of the hotel. All of the plaintiffs in this case
have already experienced all possible recapture when the
hotel was foreclosed upon in 1978 We also reject, as with-
out a factual basis, the Tax Division’s claim that “it is
far from clear that all the proper income recognition and
recapture provisions were taken into account.” Brief of
*Loftsgaarden, in an apparent change jin strategy, now contends that the
tax benefits are not income received but are instead a return of consider-
ation. We address this claim infra.
A-12
Tax Division at 11. All of the plaintiffs’ tax returns from
the relevant tax years have already been audited and are
now closed.
We also find without merit the Tax Division’s claim that,
under the “tax benefit rule,” the plaintiffs, upon receiving
rescissionery damages, will have to amend their prior tax
returns to eliminate all tax benefits previously received
as a result of their investments in Associates. The “tax
benefit rule” does not require elimination of tax benefits
already received. See Hayden v. McDonald, 742 F.2d at
440. Rather, it provides that a taxpayer who claims a de-
duction resulting in a tax benefit one year and who later
obtains a recovery or repayment in a later year must in-
clude the recovery or repayment as ordinary income in the
year of recovery.” See Hillsboro National Bank v. Com-
missioner, 460 U.S. 370, 103 S. Ct. 1134, 75 L.Ed.2d
130, 142-44 (1983); Salcer, 744 F.2d at 943: 1 Mertens,
Law of Federal IncOme Taxation, § 7.34 at 7-115, §
7.37 at 7-130. We need not address the contention of the
Tax Division and the SEC that the tax consequences of
the rescissionary award will “wash out” any prior tax sav-
ings, because we are not presented with such a situation
in this case.
The plaintiffs next contend, with support from the
SEC, that the collateral source rule requires that Section
12(2) awards not be reduced by tax benefits. This rule
“prohibits taking into consideration benefits received
from third parties as the result of wholly separate and dis-
tinct transactions, such as those received under insur-
™We need not decide whether a different situation might exist in a case
involving actual rescission. See Salcer, 744 F.2d at 943; Burgess v.
Premier Corp., 727 F.2d at 838.
A-13
ance policies negotiated independently.” Salcer, 744 F.2d
at 941. We agree with the Salcer Court that the tax bene-
fits of plaintiffs’ investments are not a collateral source
because “although paid by the government, [they] ema-
nate directly from the tax shelter sought by the plaintiffs
and provided by defendants, without which plaintiffs
could not have realized any tax benefits. Benefits result-
ing directly from a transaction under attack must be
credited toward the damage award.” Jd. at 941-42.
For similar reasons, we reject plaintiffs’ claim that we
should ignore their tax benefits because otherwise the
defendants will unjustly “retain” the consideration pre-
viously paid by the plaintiffs. First of all, it does not ap-
pear that the defendant has “retained” any of plaintiffs’
consideration; rather these monies were paid to the part-
nership and were invested in the project. Moreover, the
purpose of the private civil remedies provided by the feder-
al and relevant Minnesota securities laws is not to pena'-
ize defendants, but to compensate plaintiffs for any actual
monetary loss. See id. at 941. This actual monetary loss
cannot be determined without reference to tax benefits
bargained for and received.
We also reject the similar argument of amici that de-
ducting tax benefits from damages will deprive the govern-
ment of just tax revenues. The government is entitled only
to those revenues which are authorized under the tax laws.
These laws create incentives for real estat> projects to
further public »volicy objectives. such as the creation of
employment, enhancement of the real estate tax base and
the local business climate. The Rochester Ramada project
met all of the tax code criteria and thus generated the in-
come tax benefits which the plaintiffs enjoyed. Th’s case
is therefore very similar to Salcer, where the Court stated:
A-14
Nor can‘ we agree with the notion that our ruling
makes “the government the banker for fraudulent
tax shelter activity,” Burgess v. Premier Corp., su-
pra, 727 F.2d at 838. As Judge Broderick noted,
there was no such activity in this case; the fraud, if
any, pertained only to the investment aspects of the
Greenspoint Project. The government got the residen-
tial development that it hoped to encourage by offer-
ing the tax benefits taken by the plaintiffs. Thus, it
is “banking” precisely what it agreed to “bank.”
There is no suggestion that the project did not meet
federal requirements as a viable housing develop-
ment entitling its owners to tax benefits.
Id. at 941.
There is no legal justification for awarding a party dam-
ages to which he is not entitled merely to provide revenue
for the government to tax.
Next, we reject plaintiffs’ claim that the consideration
of tax benefits in determining rescissionary damages in a
tax shelter case creates unnecessary complexities. Our
opinion in Austin I, 675 F.2d at 183, deals at length with
this contention. We noted that “the complexity of evi-
dence relating to plaintiffs’ tax savings is not a viable
reason for precluding such evidence in light of Norfolk &
Western R. Co. v. Liepelt, 444 U.S. 490, 100 S. Ct. 755,
62 L.Ed 2d 689 (1980).” Jd. We cannot agree that the
retrial of the damages issue on remand reflects such
complexity that Austin ] must now be reversed.
Finally, plaintiffs and the SEC” contends that Austin I’s
‘**The SEC also argues that tax benefits should be considered in computing
prejudgment interest, but not in computing damages. We agree with
the Salcer Court, 744 F.2d at 942, that this argument “is so unrealistic
and disproportionate as to border on the frivolous” and “must be
rejected out of hand.”
A-15
tax benefit offset rule discourages private enforcement of
the antifraud provisions of the federal securities laws in
an area in which the Commission itself is unable to de-
vote substantial resources.” While it is unclear that this will
be the result of the offset rule because most defrauded tax
shelter investors will still be able to obtain at least some
damages, we agree wi‘ the Sal/cer Court that it is for the
legislature, not for th courts, to authorize the award of
more than “actual dameges” in order to encourage the
filing of private damage actions. Salcer, at 941. See also
e.g., Alveska Pipeline Service Co. v. Wilderness Society,
421 U.S. 420 (1975) (shifting of attorneys’ fees by court
to create incentives is permissible).
In sum, we affirm the holding of Austin I “that in a
private securities fraud action involving an investment
structured and marketed as a tax shelter, where a re-
scissory measure of damages is applied, evidence of any
benefit derived by the plaintiff/investor via tax savings
nfust be permitted.” Austin I, 675 F.2d at 183-84.
Il. How should the plaintiffs’ rescissory damages he
computed?
On remand, the district court first determined the
amount Of permanent tax benefits received by each of the
plaintiffs as follows: Anderson, $29,615.00: Austin, $33,-
330.00; Neumann, $57,014.00; Randall, $36,404.00. The
parties do not contest this finding: accordingly, we adopt
these figures as the amovnt of tax benefits received by
each plaintiff.
The court then determined that each plaintiff was en-
'*Most tax shelter securities are sold in private offerings exempt from the
registration requirements of the 1933 Act.
A-16
titled to prejudgment interest at the rate of eight percent
simple interest under section 12(2) of tht 1933 Act. The
interest rate has been approved by the panel opinion
announced today along with the en banc opinion.
The court then determined rescissory damages in ac-
cordance with the specific language of section 12 (2);
cordance with the specific language of section 12(2);
less the amount of any income received thereon.” Under
the district court’s amended determination, this computa-
tion produced the following results:
Plaintiff Austin
Consideration paid June 6, 1973: $35,000
Simple interest at 8% to February
22, 1984: $31,277
Subtotal $64,610
Minus tax benefits: — $33,333
Total damages: $31,777
Plaintiff Neumann
Consideration paid August
21, 1973: $35,000
Plus consideration paid
October 19, 1973: $17.500
Simple interest at 8% to February
22, 1984: $43,885
Subtotal $96,385
Minus tax benefits: — $57,014
Total damages: “$39,371
“The court originally ordered compound interest but amended its judg-
ment by ordering simple interest.
A-17
Plaintiff Randall
Consideration paid November
13, 1973: $35,000
Simple interest at 8% to Febru. y
22, 1984: $28,770
Plus consideration paid 1975: $2,512
Simple interest at 8% to February
22, 1984: $1,691
Subtotal $67,973
Minus tax benefits: — $36,404
Total damages $31,569
Plaintiff Anderson
Consideration paid
June 2, 1973: $35,000
Plus interest at 8% to Fehruary
22, 1984: $29,787
Subtotal $64,787
Minus tax benefits: — $29,615
Total damages: $35,172
/
Although the parties and amici suggest several varia-
tions from this damage computation formula, we believe
they raise only three serious contentions. First, defendant
Loftsgaarden argues that, under the section 12(2) dam-
age computation formula, tax benefits are a return of “con-
sideration paid” and thus must be deducted from con-
sideration paid before adding on interest. As the district
court noted, this course would drastically reduce the
awards to Anderson and Austin and eliminate the awards
to Neumann and Randall. We agree with the district
court that this approach must be rejected. As we noted
A-18
previously, Austin I did not indicate that tax benefits
should be treated as a return of consideration. Instead, in
holding that tax savings must be subtracted from damages
we quoted section 12(2) and italicized the phrase, “less the
amount of any income received thereon.” Austin I, 675
F.2d at 181. Similarly, in Hayden v. McDonald, 742 F.2d
at 441, we characterized Austin I as “implicitly construing
the ‘income’ language in a federal securities statute to in-
clude tax considerations.” At least one commentator has
also characterized Austin I as “classifying tax benefits
received by the plaintiff as ‘income’ within the meaning
of section 12(2) of the 1933 Act.” Note, Austin v. Lotfs-
gaarden, etc., 16 Creighton L. Rev. 1140, 1151 (1983).
Cf. S. Banoff, “To What Extent Will Benefits From Tax
Shelters Be Permitted to Offset Rescission Damages?,” 57
J. Tax’n 154, 156 (1980).
Additionally, whether or not tax benefits may be con-
sidered “income” in a strict accounting sense, tax benefits
are far more dissimilar to “consideration.” Moreover, al-
though we find that section 12(2)’s ianguage “income
received thereon” may properly be construed as including
tax benefits bargained for and received, we do not agree
that tax benefits can be considered a “return” of consider-
ation.
Finally, treating tax benefits as consideration returned
would, even under Loftsgaarden’s calculations, mean that
the plaintiffs would not be compensated for the‘r actual
damages. For example, using Lcftsgaarden’s calculations
of plaintiff Neumann’s net interest cost (as we explain
further below), he would receive no Gamages even though
A-19
he suffered net economic loss of at least $992.” Lofts-
gaarden no doubt prefers the zero judgment figure to the
$992 figure, in part because this would lend substantial
support to his argument before the panel that Neumann is
not entitled to the $29,000 in attorneys’ fees granted by
the district court. In short, we cannot agree that the dis-
trict court erred in refusing to treat the tax benefits as a
return of consideration for purposes of determining the
order of computation under the formula set forth in sec-
tion 12 (2).
Loftsgaarden next contends that the district court erred
in awarding prejudgment interest on the total amount of
consideration paid by each plainti’f from the date paid
until February 22, 1984, rather than awarding interest
only on the amount of money which each plaintiff was
“out-of-pocket” during each year of the investment, We
agree. The goal of prejudgment interest is to compensate
plaintiffs for the loss of the use of their money. See Cant v.
A. C. Becker & Co., 384 F.Supp. 814 (N.D. Ill. 1974);
‘“Loftsgaarden's calculations indicate that Neumann invested $52,500,
lost $5,506 in opportunity cost on the use of his money at 8% simple
interest and received $57,014 in tax benefits for a net economic loss
of $992. By subtracting the $57,014 in tax savings from the $52,500
consideration paid, befere considering Neumann’s opportunity cost
in that he did not receive the $57,014 back until several years after he
invested the $52,500, Neumann receives zero in damages.
Loftsgaarden cites Johns Hopkins University v. Hutton, 297 F. Supp.
1165, 1233 (D. Md. 1968), aff'd in part and rev'd in part on other
grounds, 422 F.2d 1124 (4th Cir. 1970) as support, but that case is
inapposite. In that case, the court treated “repayment of principal” as a
return of consideration. A repayment of principal bears no similarity
to tax benefits received. However, even if we were to change Austin I's
rationale and treat tax benefits as a return of consideration, plaintiffs
at minimum would be entitled to their net opportunity cost in damages.
This could be done by reducing the amount of the tax benefits received
to present value at the time of the investment using, for purposes of this
opinion, the 8% discount rate. We prefer, however, to affirm the district
court’s treatment of tax benefits as “income received.”
A-20
Chris-Craft Industries, Inc. v. Piper Aircrafter Corp., 384
F.Supp. 507, 527 (S.D.N.Y. 1974), modified, 516 F.24
172 (2d Cir. 1975), rev’d on other grounds, 430 US. 1
(1977). Because 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. Gerstle
v. Gamble-Skogmo, Inc., 478 F.2d 1281, 1307 (2d Cir.
1973) (prejudgment interest should be computed on the
“net difference between value of assets given and value re-
ceived”): Murphy v. Cady, 30 F. Supp. 466, 470 (D. Me.
1939). affd, 113 F.2d 988 ‘Ist Cir.), cert. denied, 311
U.S. 705 (1940) (reaching similar result by determining
that plaintiff was entilitd under section 12(2) ”to recover
the amount paid for [the security] with interest, less the
amount received with interest”).
Loftsgaarden has submitted what we find is a reason-
ab'y accurate determination of the net interest costs in-
curred by the plaintiffs taking into account the amount
of money invested, and the tax benefits received by each
vla‘nt‘ff during each year of their investment in Associates.
These calculations, prepared by John M. Carlson, Certi-
fied Public Accountant, are as follows:”
**These calculations are based on the eight percent rate affirmed by the
panel opit :on attached at the end of this opinion. These calculations
take into account recapture and also net out plaintiffs’ interest costs by
their interest gains on the amount of ordinary income above the amount
of their investments retained in each year because of tax benefits con-
ferred by their investments in Associates. These calculations also assume
that each plaintiff did not receive the tax benefits umil April 15 of each
year, when their tax returns were due. Although this does not take into
account the benefits of potential reduced payments of estimated tax,
we find that the calculations present a reasonably accurate and straight-
forward method of determining net prejudgment interest costs.
A-2i
RANDALL
Net Reduction Interest
(increase in) Cost
Tax Liability (earned) at
Invested Current Carryback Balance Days 8% annum
11/13/73 35,000 35.000 153 1,174
4/15/74 4,499 30,501 365 2,440
4/15/75 21,268 9,233 365 739
4/15/76 10,481 (1,248) 365 (100)
4/15/77 10,272 (11,520) 365 (922)
4/15/78 7,297 (18,817) 365 (1,505)
4/15/79 (21,855) 3,038 365 243
4/14/80 4,442 (1,404) 1,339 (412)
12/15/83 35,000 36,404 (1,404) 3,682 1,657
ANDERSON
6/ 2/73 35,000 35,000 317 2,432
4/15/74 11,221 23,779 365 1,902
4/15/75 17,149 6,630 365 530
4/15/76 10,987 (4,357) 365 (349)
4/15/77 11,011 (15,368) 365 (1,229)
4/15/78 7,972 (25,340) 365 (1,867)
4/15/79 (35.974) (12,624) 365 1.011
4/15/80 7,249 5,386 1.339 1,580
12/15/85 35,000 29,615 5,385 3,846 4,010
NEUMANN
8/21/73 35.000 35,000 58 445
10/19/73 17,500 $2,000 178 2.048
4/15/74 19,560 32,940 368 2.635
4/15/75 9.858 23,092 365 1.847
7/15/75 3,677 19,415 91 387
4/15/76 14.431 4,984 274 299
4/15/77 4,888 96 365 &
7/15/77 77 19 91
4/15/78 9,000 (8,981) 274 (539)
4/15/79 (5,236) (3,745) 365 (299)
4/15/80 769 (4,514) 1,339 (1,325)
12/15/83 52.500 $3,260 3,754 (4.514) 3.765 5,506
AUSTIN
6/26/73 35,000 35,000 29% 2.248
4/15/74 13,066 21.934 365 1.785
4/15/75 19.259 2.675 365 214
4/15/74 10,863 (8,188) 365 (655)
4/18/77 3.324 (11.512) 365 (921)
4/15/78 7.646 (19.168) 34S (1,822)
4/15/79 (26,274) 7.116 368 569
4/15/80 5,449 1,667 1.339 489
12/15/83 35,000 33,333 —-1667«3.82? 2.166
A-22
SUMMARY
Damages
and
Invested + Interest Cost — Tax Benefit = Interest
Randall 35,000 1,657 36,404 253
Anderson 35,000 4,010 29,657 9,395
Neumann 52,500 5,506 57,014 992
Austin 35,000 2,166 33,333 3,833
Next, both plaintiffs and defendants contend that in
order for the plaintiffs to be truly made whole, and to be
returned to ‘he status quo ante, both the tax benefits re-
ceived and the tax consequences of their recovery must be
taken into account. Dicta in Hayden v. McDonald, 742
F.2d 423, 440 (8th Cir. 1984) supports this contention,
and, as the parties are in agreement, we agree that the
tax consequences of plaintiffs’ recovery must be considered.
The parties disagree on how these tax consequences should
be determined. We find Loftsgaarden’s method to be
reasonably accurate and much simpler than plaintiffs’
formula and thus adopt Loftsgaarden’s method. This
method, which was also used in the “Reardon Report,”
which was cited in Hayden, takes into account the fact
that, because each plaintiff will have to pay taxes on his
award, the award must be calculated in an amount which
each plaintiff would have to recover in order to “net out”
their actual damage figure. We assume that each plaintiff
is still in the fifty percent tax bracket and thus must re-
ceive twice the above amount of damages and net interest
cost. Thus, in accordance with the panel’s affirmance of
the eight percent simple interest rate, each plaintiff is en-
titled to a damage award as follows: Anderson ($9,395 x
2 = $18.790): Austin ($3.833 x 2 = $7,666): Neumann
($992 x 2 = $1,984): Randall ($253 x 2 = $506).
In conclusion, the Court en banc affirms Austin I but
A-23
vacates and modifies the district court’s award of dam-
ages as Set forth above.
There are three remaining issues which were initially
heard by a panel of this Court. These issues are: (1)
Whether the district court, on remand, erred in its inter-
pretation of Austin ]; (2) whether attorney fees should have
been awarded; and (3) whether prejudgment interest was
properly calculated. For convenience, the panel’s opinion
is incorporated herein:
Before LAW, Chief Judge, and ROSS and McMILLIAN,
Circuit Judges.
Plaintiffs urge, on cross-appeal, that the district court
should have allowed them to retry their case on the “out
of pocket” damages theory. At the original trial the dis-
trict court noted that “out of pocket” and rescissionary
damages are essentially the same. However, plaintiffs
hoped to avoid the Austin I mandate to consider tax bene-
fits by changing to the “out of pocket” approach. On re-
mand, the district court refused to allow the change in
theories. We find no error. The plaintiffs tendered their
shares to defendants shortly before the original trial and
effectively elected the remedv of rescission. More import-
antly, plaintiffs should not be allowed to introduce a new
theory seme eight vears Jater. The case is now in its second
appeal, after two trials. both of which focused on re-
scissionary damages. We think it too late to change theor-
ies and f'nd no abuse of discretion by either trial judge.
Plaintiffs also argue that Austin I applies only to invest-
ments “exoresslv structured and marketed as a tax shelter.”
Austin I, 675 F.2d at 183. According to plaintiffs no fac-
tual finding has ever been mede that thir narticular invest-
A-24
ment was expressly structured and marketed as a tax
shelter. The Austin I court defined a tax shelter as any
investment which creates tax deductions through “arti-
ficial losses.” Jd. The court en banc has endorsed that
definition. Austin IJ, slip op. at 3. The evidence shows
plaintiffs were able to reduce their tax liability significant-
ly in the first few years of the investment through ac-
celerated depreciation and other deductions.
There are several contentions relating to attorney fees.
Defendants contend Neumann and Randall failed to prove
a cause of action which would support any award of fees
and, even if they did, the amount awarded was excessive.
Plaintiffs argue that the fees awarded were insufficient and,
furthermore, that fees should have been awarded to Aus-
tin and Anderson.
First, the method of damage calculation determined by
the court en banc makes it clear Neumann and Randall
were damaged and proved a claim for relief. We find the
award of fees to Neumann and Randall falls within the
range of discretion of the district court. In weighing the
arguments we find no abuse of discretion.
Second, plaintiffs cannot recover fees under federal se-
curities statute. The award to Newmann and Randa'l
was based on Minn. Stat. § 80A.23 (2) (1984). This
statute was not in effect before August 1, 1973. It is clear
from the record that Anderson and Austin purchased their
securities prior to that date. Under these circumstances the
district court was correct in holding that Anderson and
Austin were barred from recovery of attorney fees.
The issue of the method of calculating interest has been
resolved by the court en banc. Plaintiffs have argued that
the rate, eight percent. was too law. Defendants, on the
A-25
other hand, argue no interest can be awarded to Neumann
and Randall because they suffered no actual damage and
thus failed to prove a cause of action. As noted previously,
the court en banc’s method of damage calculation
shows Neumann and Randall did suffer damage and
proved a cause of action. While the district court, on re-
mand, was not bound by the original trial judge’s use of
eight percent as the rate of interest, plaintiffs point to
no evidence in the record which would suggest a higher
rate. Although we believe the rate of interest should be
based on a finding of fact from evidentiary proof, in the
absence of such proof we feel the district court did not err
in applying an eight percent rate as a traditional and fair
rate of interest.
The panel holds that the district court, on remand, cor-
rectly interpreted Austin I and did not err or abuse its dis-
cretion in the award of attorney fees and pre-judgment
interest. In conclusion, we remand to the district court for
entry of judgment as set forth in this opinion.
HEANEY, Circuit Judge. concurring and dissenting.
I concur in the majority’s opinion except insofar as it
overrules Havden v. McDonald, 742 F.2d 423 (8th Cir.
1984). I continue to believe that the issue is a doubtful one
and that in cases of doubt we should give great weight to
a decision of a United States District Court interpreting a
statute of the state in which it sits. Moreover, I think it is
bad policy to reach an issue that was not presented to us
by the parties and which we need not decide.
LAY, Chief Judge, dissenting, joined by BRIGHT, Cir-
cuit Judge.
A-26
I incorporate my concurrence in Hayden v. McDonald,
742 F.2d 423, 441-42 (8th Cir. 1984), and the reasoning
set forth therein for urging that tax benefits of plaintiffs
in a rescissionary damage action have no relationship to
their present claim, The Department of J ustice and the Se-
curities and Exchange Commission have presented strong
arguments against appellants’ theory in amicae briefs.
The majority invokes the doctrine of law of the case.
As Judge Learned Hand observed many years ago: “(Tit
is now well settled that the ‘law of the case’ does not rigidly
bind a court to its former decisions, but is only addressed
to its good sense.” Higgins v. California Prune & Apricot
Grower, Inc.. 3 F.2d 896, 898 (2d Cir. 1924). A court
should never be constrained by the weight of a prior er-
roneous decision. The purpose of an en banc hearing is
to draw on the wisdom of the full court and rectify earlier
errors. Reliance on precedent is a poor substitute for anal-
ysis.
The damages provisions of the federal statute, section
12(2) of the Securities Act of 1933, 15 U.S.C. § 771(2),
and the Minnesota Statute, Minn. Stat. § 80A.23 (1), are
quite similar:
§ 12(2): * * * recover the consideration paid for
such security with interest thereon, less the amount of
any income received thereon * * *.
§ 80A.23(1): * * * recover the consideration paid
for the security together with interest at the legal
rate, costs, and reasonable attorney’s fees, less the
amount of any income received on the securities.
The key words are “less the amount of any income re-
ceived * * *.” The majority concedes that the tax benefits
A-27
received by plaintiffs are not really “income.” Nonethe-
less, the court holds the benefits must be subtracted—not-
withstanding the clear language of the statute—in order
to give meaning to “actual income.” As Judge Arnold notes
in his concurrence, the present holding as to Minnesota
law cannot be rationally squared with Hayaen.
Loftsgaarden relies heavily on Salcer v. Envicon Equities
Corp., 744 F.2d 935 (2d Cir. 1984), cert. pending. The
Salcer court was concerned the plaintiff might receive a
windfall and, like the majority today, applied the tax bene-
fits in favor of the defendant, transferring any possible
windfall to the wrongdoer. The Ninth Circuit has held to
the contrary, using the same reasoning I urge this court to
adopt. Burgess v. Premier Corp., 727 F.2d 826, 837-38
(9th Cir. 1984). The Burgess court found that “to simply
subtract the tax benefits from damages would place an
unfair burden on taxpayers generally. * * * Such a result
leaves the government bearing the cost of defendants’
fraud.” Id. at 838. See also Western Federal Corp. v. Erick-
son, 739 F.2d 1439, 1444 (9th Cir. 1984).
Application of tax benefits to lessen damages in a re-
scissionary suit actually fails to comprehend the principle
behind a “tax shelter.” The investor receives no money
from the tax benefit; the investor simply is allowed tu de-
duct a certain amount from his ordinary income or applv
a credit toward tax owed for the particular tax year. The
actual value of the benefit depends on the income hracket
the investor is in, which in turn depends on other deduc-
tions that may be available to the taxpayer that year. This
fact alone demonstrates how speculative any benefit in tax
savings may be. More significantly, the tax benefit is not
a real or actual savings—it is usually only a deferral of
A-28
tax. Ultimately, in a time of recapture when the investment
is sold or otherwise disposed of, the taxpayer must return
to the government tax benefits gained unless the investor
suffers an actual loss. The court’s conversion of the tax de-
ferral to realized income by subtracting it from a plaintiff's
damages provides a windfall to the defendant—the fraudu-
lent party. The holding in this case violates the old principle
that “[i]t is more appropriate to give the defrauded party
the benefit even of windfalls than to let the fraudulent
party keep them.” Janigan v. Taylor, 344 F.2d 781, 786
(1st Cir.), cert. denied, 382 U.S. 879 (1965), quoted in
Myzel v. Fields, 386 F.2d 718, 747 (8th Cir. 1967), cert.
denied, 390 U.S. 951 (1968).
In mitigation, the majority believes Loftigaarden did not
benefit from any of the consideration paid by plaintiffs.
This is patently wrong. There was evidence at trial showing
Loftsgaarden received over $100,000 profit from the in-
vestment scheme. Under the majority”s approach, Lofts-
gaarden gains both his own profit from the scheme and
the advantage of plaintiffs’ speculative tax benefits. Such
a result seriously undercuts the broad protective purpose
of the Securities Act of 1933. See United States v. Naftalin,
441 U.S. 768. 774-777 (1979).
The maiority adopts the macnanimous suggestion in
Loftsgaarden’s brief that. in all fairness, plaintiffs’ ulti-
mate damages should be doubled in order to offset the tax
consequences of recovery—assuming plaintifis are in
the fifty percent bracket. This serves to demonstrate how
speculative and inaccurate the consideration of tax con-
sequences can be in a suit involving rescissionary damages.
A defendant should not have to pay damages based on the
plaintiff's tax bracket in a given vear. This is not a dam-
A-29
age caused by the defendant. Their theory is that to make
plaintiffs whole and restore the status quo ante we must
account for the tax treatment of plaintiffs’ recovery. How-
ever, the relevant statutes clearly require the court to re-
store the consideration paid to the defrauding party, with
interest, less any income actually received from the invest-
ment. And tax benefits concededly are not income re-
ceived from the investment.’ Consideration of tax bene-
fits involves the court in the problems of recapture and
net gains or losses. In turn, the court finds it must consider
each plaintiff's income and deductions in the year of re-
covery to net out “actual damages” based on applicable
tax rates. Rather than making up an artificial theory of
damage by doubling the net gain, it is much simpler and
more accurate to provide the plaintiff with restitution of
his investment. The statutes provide a clear and simple
formula. For example, Anderson invested $35,000 for a
period of seven years. Loftsgaarden paid Anderson no in-
terest or dividends and returned no principal. Anderson
should recover $35,000 with interest for those seven years.
Anderson will have to pay tax on the interest at ordinary
income rates. In addition, he may be required to recapture
past benefits. The tax transaction is between Anderson
and the government and shou'd not affect Loftsgaarden’s
liability. By this method a plaintiff recovers exactly what
he lost: the principal, and interest he would have earned
had that principal been invested in a legitimate security.’
If depreciation deductions were actually “income.” then every taxpayer
who takes such a deduction would have to include it as gross income on
the next year’s tax return, rather than applying it to the property's basis.
*It is reasonable to assume that if plaintiffs had not invested in Lofts-
gaarden’s fraudulent scheme, they would have invested in another
legitimate project which would have returned similar tax henefits as
well as principal and interest over the life of the investment. The maior-
ity’s approach will not make plaintiffs truely whole because the tax
benefits are subtracted from the return of principal and interest.
A-30
This procedure is far more simple than requiring trial
courts to undertake complicated and speculative eviden-
tiary hearings on the mechanics of tax deferral plans and
plaintiffs’ tax status in given years of investment.
Today’s holding provides the wrongdoer a surety by
which to avoid liability, allowing the fraudulent party to
use the United States Treasury for security in any fraudu-
lent transaction. To the extent a defendant can, by his
wrongful act, create a tax loss for the innocent victim, the
defendant will be allowed to escape liability, shifting the
burden of the loss onto the government. I do not believe
section 12(2) or section 80A.23 (1) was designed to ac-
complish this result. Accordingly, I dissent.
A true copy.
Attest:
CLERK, U. S. COURT OF APPEALS, EIGHTH CIR-
CUIT.
B-1
APPENDIX B
UNITED STATES DISTRICT COURT
DISTRICT OF MINNESOTA
FOURTH DIVISION
Dr. Roger E. Austin, Dr. Tom W. Anderson, Dr. Myrel
A. Neumann and Dr. William C. Randall,
Plaintiffs,
vs.
B. J. Loftsgaarden; Alotel Incorporated, a Minnesota cor-
poration; M.S. Noah; John W. Burg; Lyman H. Coult;
Robert R. Dunlap; and Property Development & Re-
search Company, a Minnesota corporation,
Defendants.
Civil 4-76-82
AMENDED JUDGMENT
Upon defendants’ motion for amended findings of fact
and an amended judgment, and pursuant to Fed. R.
Civ.P. 52 and 59, this court finds that the amount of pre-
judgment interest awarded to plaintiffs in its order of Feb-
ruary 22, 1984 be amended as follows to reflect simple
interest at 8 per cent:
Plaintiff Anderson
Consideration paid
June 2, 1973: $35,000
Plus interest at 8% to February
22, 1984: $64,787
Minus tax benefits: $29,615
Total damages: $35,172
B-2
Plaintiff Austin
Consideration paid June
6, 1973:
Plus interest at 8% to February
22, 1984:
Minus tax benefits:
Total damages:
Plaintiff Neumann
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:
Sub total:
Minus tax benefits:
Total damages:
$35,000
$64,610
$33,333
$31,277
$35,000
$17,500
$96,385
$57,014
$39,371
$35,000
$63,770
$2,512
$4,203
$67,973
$36,404
$31,569
B-3
This order amends only the interest calculations of the
February 22 order, and the rest of that order—including
awards of attorneys’ fees and costs—stands intact.
IT ISSO ORDERED.
Dated: March 26, 1984.
/s/ Miles W. Lord
Chief Judge
C-1
APPENDIX C
(Title of Cause.)
Civil 4-76-82
ORDER
The plaintiffs in this case are four investors in a limited
partnership who claim they were defrauded by defendants
because of misrepresentations, half-truths and omissions in
the Offering Memorandum used to attract them to a project
to build and operate a Ramada Inn in Rochester, Minne-
sota. In a 1980 trial before Judge Larson of this court,
plaintiffs prevailed on various claims against defendant
B. J. Loftsgaarden and three of his closely-held corpora-
tions (hereinafter Loftsgaarden).’ A jury found Loftsgaard-
en liable on claims under §10b(5) of the Securities Ex-
change Act of 1934, Rule 10b-5, Minn. Stat. $S0A.01 ef
seq., 80A.123, and common law fraud. The jury also
found, in an advisory opinion adopted by Judge Larson,
that Loftsgaarden had violated § 12(2) of the Securities
Act of 1933.
Loftsgaarden appealed. The Eighth Circuit Court of Ap-
pea!s affirmed on the issue of liability, but remanded on the
issue of damages. Austin v. Loftsgaarden, 675 F.2d 168
(8th Cir. 1982). Specifically, the appeals court held that
the amount of tax benefits received by plaintiffs as a re-
sult of this investment must be deducted from the damages
assessed against Loftsgaarden. /d. at 183-84.
This court held a bench trial on the tax benefits question
on December 2, 1983, after which time the parties sub-
mitted additiona! briefs and affidavits. In addition to tax
*Defendants Noah and Coult were found not liable.
C-2
benefits, two other issues are now before this court: whether
plaintiffs are entitled to prejudgment interest and whether
plaintiffs are eligible for an award of attorneys’ fees against
Loftsgaarden.
AMOUNT OF TAX BENEFITS RECEIVED BY PLAIN-
TIFFS.
At the 1980 trial, Judge Larson refused to admit Lofts-
gaarden’s evidence on the amount of tax write-offs these
high-income plaintiffs enjoyed as a result of their Ramada
investment losses, stating that the court was “not going to
get into a lot of complicated tax testimony.” (T. 23) Judge
Larson later characterized Loftsgaarden’s tax benefit ar-
gument as “sophistic malarky.” Memorandum Order No. 4-
76-82 (D. Minn. Aug. 15, 1980).
The appeals court saw otherwise:
[W]e hold that the court committed reversible er-
ror in refusing to allow proof of any economic bene-
fits received by plaintiffs on account of the investment
and in failing to instruct the jury that the damage
award must be reduced by any value shown to have
been received by plaintiffs.
* KK
In conclusion, we hé@id that in a private securities
fraud action involving an investment structured and
marketed as a tax shelter. where a rescissory measure
of damages is applied. evidence of any benefit derived
by the plaintiff/investor must be permitted.
Austin, 675 F.2d at 181 and 183-84.
At the December hearing before this court, three of the
four plaintiffs accepted Loftsgaarden’s calculations on the
C-3
amount of tax benefits they had received. Therefore, this
court also adopts Loftsgaarden’s accounting on these three
plaintiffs as follows:
Anderson tax benefits: $29,615.00
Austin tax benefits: $33,333.00
Neumann tax benefit: $57,014.00
The fourth plaintiff, Randall, refused to concur with
the computations of Loftsgaarden’s accountant. Indeed,
plaintiff Randall continued to steadfastly maintain that he
received no tax benefits at all in an argument that appears
to be an attempt to reopen the issue conclusively decided
by the Eighth Circuit. See Plaintiff Randall’s Trial Brief
at 5-6. This court refuses to entertain such an argument at
this juncture in the proceedings.
Plaintiff Randall also asserted that he is entitled to re-
scind his entire investment, thereby recovering his money
and amending his IRS returns to disgorge any tax benefits.
Under this approach, plaintiff Randall again declares that
there are no tax benefits to charge against his damage
award. However, this court finds Randall’s argument to be
an untimely attempt to change the damage theory in this
case. Both Judge Larson and the Eighth Circuit held that
ages, not rescission itself. By attempting to change the
theory of damages at this late date, plaintiff Randall is
struggling to further protract and complicate a proceedings
that has already dragged on far too long. That will not be
tolerated by this court.
Finally, plaintiff Randall submitted an accountant’s cal-
culations under this court’s and the Eighth Circuit's theory
of damages that is at odds with that of Loftsgaarden’s ac-
C-4
countant. Randall claims his tax benefits totaled $26,-
085.59; Loftsgaarden claims the figure is $36,404. At the
December trial, it was established by the testimony of the
accountants that the major factor producing different
numbers was that Randall’s accountant used an estimated
tax rate of 54 percent, while Loftsgaarden’s used the ac-
tual rates reflected in the returns. Obviously, this court
finds that it is more appropriate to employ actual rates and
therefore accepts Loftsgaarden’s accounting. Thus, it is the
finding of this court that plaintiff Randall’s tax benefits
from this investment amounted to $36,404.
PREJUDGMENT INTEREST
All plaintiffs assert that they are entitled to prejudgment
interest on their damages awards under both § 12(2) of the
Securities Act of 1933, 15 U.S.C. 1(2), and Minn. Stat.
§80A.23, subd. 2. These statutes read as follows:
Any person who ... offers or sells a security ... [in
violation of this paragraph] ... shall be liable to the
person purchasing such security from him, who may
sue ... 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 ...
15 U.S.C. § 771(2).
Any ptrson who violates Section 80A.01 ... shall be
liable to any person damaged thereby ... to whom he
sold such security .... Damages in an action pursuant
to this subdivision shall include the actual damages
sustained plus interest from the date of payment ...,
costs and reasonable attorneys’ fees.
C-5
Minn. Stat. 80A.23, subd. 2.
In his post-trial memorandum, Judge Larson awarded
prejudgment interest at the traditional rate of 8 percent to
all plaintiffs under the federal statute cited above. Judge
Larson found that plaintiffs Randall and Neumann also
would be entitled to interest under the Minnesota Statute,
but that plaintiffs Austin and Anderson were not cov-
ered by the state law because they invested prior to
the act’s implementation date. Since the Eighth Circuit did
not disturb Judge Larson’s ruling that Loftsgaarden was
liable to all plaintiffs under the federal statute, this court
reiterates his order that all plaintiffs be awarded prejudg-
ment interest at 8 percent under §12(2) of the Securities
Act.
CALCULATION OF DAMAGES
Based on the foregoing discussion, the starting point for
assessing damages will be the amount each plaintiff paid
Loftsgaarden for his investment (in other words, the plain-
tiffs consideration). To this, the court will add 8 percent
interest from the date the consideration was paid to the
date of this order. Finally, the amount of each plaintiff's
tax benefits will be subtracted from the sum of his con-
sideration and interest. This computation produces the
following results:
Anderson
Consideration paid
June 2, 1973: $35,000.00
Plus interest at 8% to
February 22, 1984: $79,905.00
Minus tax benefits: $29,615.00
Total Damages: $50,290.00
C-6
Austin
Consideration paid
June 26, 1973: $35,000.00
Plus interest at 8% to
February 22, 1984: $79.501.00
Minus tax benefits: $33,333.00
Total Damages: $46,168.00
Neumann
Consideration paid
August 21, 1973: $35,000.00
Plus consideration paid
October 19, 1973: $17,500.00
Plus interest at 8% to
February 22, 1984. $117,532.00
Minus tax benefits: $57,014.00
Total Damages: $60,518.00
Randall
Consideration paid
November 13, 1973: $35,000.00
Plus interest at 8% to
February 22, 1984: $77,189.00
Plus consideration paid 1975: $2,512.00"
This additional item of consideration stems from $7,500 in loans from
Randall to Loftsgaarden. The full amount of these loans cannot be
included in Randall’s consideration since the jury found, and Judge
Larson and the Eighth Circuit concurred, that there was no liability for
the loans because there was no reliance on misrepresentation at the
time the loans were made. However, since Loftsgaarden included the
$7,500 in Randall’s basis for his calculation of tax benefits (which inures
to Loftsgaarden’s benefit), Randall should be able to claim that amount
as income invested. According to Loftsgaarden’s accountant, inclusion
of the $7,500 in Randall’s basis generated tax benefits of $2,512.
(Randall’s accountant states that inclusion of the loans resulted in tax
benefits of $2,025. Since no clear indication is given as to how this
figure was arrived at, the court accepts the calculations of Loftsgaarden’s
accountant. Surprisingly, Randall's calculations is more favorable to
the defendant than the defendant’s own figure.)
C-7
Plus interest at 8% to February
22, 1984: $4,650.00
Subtotal: $81,839.00
Minus tax benefits: $36,404.00
Total Damages: $45,435.00
Defendant Loftsgaarden disputes this straightforward
method of computation. His approach would be to sub-
tract the tax benefits from consideration paid before adding
on interest, a course that drastically reduces or completely
obliterates each plaintiffs award. However, the clear lan-
guage of § 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 defendant
cites no cases directly on point which hold to the contrary.
ATTORNEYS’ FEES
All plaintiffs have petitioned this court for attorneys’
fees under Minn. Stat. §80A.23, subd. 2, which specifically
provides for such an award. (None of the federal statutes
involved in this case authorizes attorneys’ fees.)
As noted above, however, §80A.23 does not apply to
all plaintiffs. Austin and Anderson purchased their inter-
ests in the limited partnership before August 1, 1973, the
Statute’s effective date. Judge Larson found that these
dates of sale were the crucial determinants in deciding
whether these two plaintiffs were covered by the new
statute, since the facts which formed the basis of their
claims was the fraud which took place when they pur-
chased their interests. Austin and Anderson point to some
broad language in the Eighth Circuit opinion to support
their contention that the new statute embraces their claims.
C-8
However, there is no indication anywhere in the opinion
that the Eighth Circuit was doing anything more than af-
firming Judge Larson’s findings on liability. Therefore, in
accordance with Judge Larson’s opinion, this court finds
that only plaintiffs Randall and Neumann can recover
their attorneys’ fees.
This ruling is somewhat mitigated by the fact that Austin
and Anderson shared attorneys with Neumann. As Judge
Larson found, most of the work performed by these
plaintiffs’ attorneys would have been done even if Neumann
had been the only client.
Judge Larson granted attorneys’ fees of $10,000 to
Randall and $15,000 to Neumann. In addition, Judge
Larson awarded costs of $1,308.62 to Randall and $2,-
210.53 to Neumann, Austin and Anderson. These amounts
have never been paid. This court now orders that they be
paid pursuant to this memorandum.
The fees considered by Judge Larson were those in-
curred through the trial of this action. Attorneys’ fees cover-
ing the appellate proceedings have already been paid.
Remaining for consideration, then, is the post-appellate
phase of this suit, that is, time spent on the issues of dam-
ages and prejudgment interest.
For this segment, plaintiffs Neumann, Austin and Ander-
son request attorneys’ fees of $16,174.17 based upon
hourly rates of $60 to $135. Plaintiffs’ attorneys faced a
complex case and a zealous defense. As already noted,
although only Neumann is entitled to fees, much of the
work was done for these three plaintiffs as a group by
their common attorneys. This court finds that a reasonable
fee for Neumann would be $14,000 and also awards these
three plaintiffs costs of $3,111.30. See Zoll v. Eastern
C-9
Allamakee Community School District, 588 F.2d 246
(8th Cir. 1978); State v. Paulson, 188 N.W.2d 424 (Minn.
1971).
Plaintiff Randall requests attorneys’ fees of $14,825
based upon rates of $50 to $100. However, this request
is based on a recalculation by Randall’s attorney who went
back through his time records to update his hourly fee to
the rate he currently charges, not the rate he charged at
the time the work was performed. This court finds that a
reasonable fee would be $10,000 plus costs of $1,647.87.
SUMMARY
Based upon the foregoing discussion, IT IS HEREBY
ORDERED THAT:
1. Damages awards be granted in the following amounts:
Anderson: $50,290.00
Austin: $46,168.00
Neumann: $60,518.00
Randall. $45,435.00
2. Attorneys’ fees be granted as follows;
Neumann: $29,000.00
Randall: $20,000.00
3. Costs be granted as follows:
Anderson, Austin
and Neumann: $5,321.83
Randall: $2,955.49
IT IS SO ORDERED.
Dated: February 22, 1984.
/s/ Miles W. Lord
Chief Judge
D-1
APPENDIX D
No. 80-1771
No. 80-1874
Dr. Roger E. Austin, Dr. Thomas W. Anderson, Dr. Myrel
A. Neumann and Dr. William C. Randall,
Plaintiffs, Appellees and Cross Appellants,
Vv.
B. J. Loftsgaarden; Alotel Incorporated, a Minnesota
Corporation; M. S. Noah; Lyman H. Coult; Property
Development & Research Company, a Minnesota Cor-
poration; and 2361 Building Corporation, a Minnesota
Corporation,
Defendants, Appellants and Cross Appellees.
Appeal from the United States District Court for the Dis-
trict of Minnesota
Submitted: June 17, 1981
Filed: April 7, 1982
Before McMILLIAN and ARNOLD, Circuit Judges, and
HANSON, Senior District Judge
HANSON, Senior District Judge.
Plaintiffs-appellees are four of twenty-two limited part-
ners who invested in a development to build and operate a
Ramada Inn Motel in Rochester, Minnesota. In the district
court they prevailed on various claims that they were de-
frauded by defendants-appellants B. J. Loftsgaarden and
D-2
three of his closely-held corporations because of misrep-
resentations, half-truths, and omissions that were found to
exist in the Offering Memorandum used to attract plain
tiffs to the project.’ A jury found Loftsgaarden and the cor-
porate defendants (hereinafter Loftsgaarden) liable upon
claims under § 10 (b) of the Securities Exchange Act of
1934, 15 U.S.C. §78j (b); Rule 10b-5, 17 C.F.R.
§ 240.10b-5; the antifraud provisions of the Minnesota
Securities Act, Minn. Stat. §§ 80A.01, 80A.23; and com-
mon law fraud.” The jury also rendered an advisory ver-
‘Defendants Noah and Coult, officers and directors of the corporate
general partner, Alotel, Inc., were found not liable.
2810(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b),
provides:
It shall be unlawful for any person, directly or indirectly, by the use
of any means or instrumentality of interstate commerce or of the
mails, or 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 regulations as the
Commission may prescribe as necessary or appropriate in the public
interest or for the protection of investors.
Rule 10b-5 implementing §10(b), 17 C.F.R. §240.10b-5, provides:
Employment of manipulative and deceptive devices.
It shall be unlawful for any person, directly or indirectly, by the
use of any means or instrumentality of interstate commerce, or of
the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit
to state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were made,
not misleading, or '
(c) 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.
Minn. Stat. §80A.01 provides:
It is unlawful for any person, in connection with the offer, sale or
purchase of any security, directly or indirectly:
(a) to employ any device, scheme or artifice to defraud;
(b) to make any untrue statement of a material fact or to omit to
state material facts necessary in order to make the statements made,
in the light of the circumstances under which they are made, not
misleading; or
(c) to engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person.
D-3
dict—in which the district court concurred—that defend-
oants were liable for violating § 12(2) of the Securities Act
oof 1933. 15 U.S.C. § 771(2).’ The district court applied
a rescissory remedy, which resulted in an award to plain-
tiffs in the amount of the consideration that each had paid
for his limited partnership unit or units, prejudgment in-
terest from the date of purchase, and attorneys’ fees for
plaintiffs Randall and Neumann for a total judgment of
$273,720. Defendants raise a number of issues on ap-
peal mainly relating to the sufficiency of evidence on the
essential elements of these claims and the measure of dam-
ages. Plaintiffs cross-appeal from the district court’s de-
nial of certain portions of their requested attorneys’ fees.
We affirm as to the finding of liability, but remand for
further consideration on the issue of damages.
I.
B. J .Loftsgaarden is an attorney and the president and
sole shareholder of corporate defendants Alotel, Inc.,
Property Development and Research Company (PDRC),
o’$ 12(2) of the Securities Act of 1933, 15 U.S.C. § 77/(2) provides in
pertinent part:
Any person who —
(2) offers or sells a security .. ., by the use of any means or
instruments of transportation or communication in interstate com-
merce or of the mails, by means of a prospectus or oral communica-
tion, 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.
D-4
and 2361 Building Corporation. Through these corpora-
tions, Loftsgaarden intended to build and operate a Ra-
mada Inn in Rochester, Minnesota.“ To help finance the
$3.5 million project, he organized a limited partnership,
Alotel Associates, through which he expected to raise $1
million by selling 40 limited partnership units to not more
than 20 investors for $25,000 per unit. The remainder of
the money was to be obtained through a $2.31 million
mortgage loan from Larwin Realty and Mortgage Trust’
and a $240,000 furniture and fixtures loan from the First
National Bank of Rochester. Loftsgaarden and Alotel,
Inc., were tc serve as the project’s general partners.
In December 1971, Loftsgaarden prepared an offering
memorandum through which he hoped to interest investors
in the limited partnership units. The memorandum in-
dicated that the partnership would “operate as a ‘tax
shelter’ ”, leading to “significantly greater returns for per-
sons in relatively high income tax brackets.” Accordingly,
the memorandum outlined “Investor Suitability Standards”
requiring that each investor have a net worth in excess of
$200,000 excluding home and automobiles or that some
portion of the investor’s income was subject to federal and
state income taxes at a rate of fifty percent or more.
Paul Crawford, an investment advisor whom Loftsgaard-
en knew was not licensed to act as such. agreed to help
Loftsgaarden find suitable high income investors.
The attraction of such an investment to high tax bracket
*PDRC was the entity through which the real estate would be obtained
and 2361 was to serve as the project’s general contractor.
*The $2.31 million loan would initially be made by First National Bank
of St. Paul, which would supply interim construction financing to the
partnership. Once motel construction was completed, Larwin would
buy the loan from the St. Paul bank pursuant to a “take-out” commit-
ment and put in its place a first mortgage.
D-5
individuals lies in the tax treatment of the partnership’s
income and losses. Because the partnership is not taxed
as an entity, it serves as a conduit to the partners for all
its taxable income and losses. I.R.C. §§ 701, 702. Each
partner is permitted to take his or her share of the partner-
ship’s deductible losses “to the extent of the adjusted basis
of such partner’s interest in the partnership....” I.R.C. §
704 (d). But in a real estate investment such as the one
contemplated by Loftsgaarden, the limited vyartner’s
basis is not restricted to the amount of his actual invest-
ment (the amount “at risk”); rather, it may be increased
by the partner’s proportional share of any nonrecourse
loans made by the partnership. See I.R.C. § 465 (c)
(3) (D). Against such an increased basis, a limited part-
ner is able to receive from the partnership deductible
losses far in excess of the amount he or she has at risk in
the investment. By using accelerated methods of depre-
ciation, prepaying interest on loans, renting instead of
purchasing land, and other methods, the partnership is
able artific’ally to generate large amounts of deductible
losses and expenses in the early vears of the venture which
are passed on to the partners to use in offsetting other in-
come on their individual tax returns.* The result is that a
*One commentator offers the following example:
A hypothetical real estate partnership might show a $50. 90 loss
in one year. Assume that this loss was obtained by taking the differ-
ence between $60,000 of deductible depreciation and $10,000 of
gross rents in excess of operating expenses and interest. If mortgage
amortization. a nondeductible expense, were $2.000. then the partner-
ship would have a positive cash flow of $8,000. If under the partner-
ship agreement, one limited partner were entitled to 50% of the
partnership losses and 37.5% of the cash flow, that partner would
receive $3,000 in cash, but his tax return would reflect only his
share of the partnership's net loss, or $25,000.
Note, Real Eestate Limited Partnerships and Allocational Efficiency:
The Incentive to Sue for Securities Fraud. 63 Va.L.Rev. 669, 673 n.22
(1977). See also T. Dahlk, Real Estate Partnerships an? the Securities
Laws: A Primer, 12 Creighton L.Rev. 781. 783 (1979): R. Hrusoff,
Securities Aspects of Real Estate Partnerships, 11 Ca.W.L.Rev. 425,
458 (1975).
D-6
limited partner can often recoup his money in the year of
his investment through tax savings. Generally the tax
shelter serves only to defer taxation until the investment is
liquidated and each partner receives his or her propor-
tional share of the proceeds of the sale. Any gain realized
will be taxed partly at capital gains rates (assuming the
greater than one year holding period has been satisfied)
and partly at ordinary income rates (to the extent that the
accelerated depreciation taken exceeds the amount that
would have been taken if a straight-line method were
used). I.R.C. §§ 1231, 1250.
Under the terms of Loftsgaarden’s offering memoran-
dum, Alotel Associates planned to employ some of the
above-described methods to provide immediate tax savings
to the limited partners. The $2.31 million loan from Lar-
win would be a nonrecourse loan, thus serving to increase
each limited partner’s investment basis. In addition, rapid
depreciation methods would be used to generate large de-
ductible losses in the early years of the investment. Despite
these features, only one person was willing to make the
$50,000 minimum investment. This forced Loftsgaarden
to terminate the offering and revise ‘ne project to further
enhance the tax benefits and reduce the minimum pr'ce
per investor. Instead of purchasing land as originally con-
templated, the partnership would rent land thereby in-
curring another tax deductible expense.’ Since capital
’The land rental would be effected through a sale-leaseback arrangement
whereby the partnership would acquire the land. sell it to a third party,
and then lease it back from the third party purchaser. In reality, the
transaction worked as follows: Part of the land was purchased by the
partnership and then sold to Loftsgaarden’s corporation, PDRC. In turn
PDRC purchased the remainder of the land outright. then sold the
entire parcel to a third party, which leased the land back to PDRC.
Then PDRC subleased the land back to the partnership.
D-7
was no longer required to purchase land, the amount of
money Loftsgaarden needed to raise through the sale of
limited partnership units was reduced from $1 million
to $700,000. This also reduced the minimum investment
per limited partner from $50,000 to $35,000 and the total
number of units from 40 to 20.
In May 1973, Loftsgaarden revised the offering mem-
orandum to reflect these changes. An accounting forecast
included in the memorandum stated that the partnership
would suffer losses resulting in income tax savings during
its first three years; thereafter the business would begin to
show a profit. Again Crawford aided Loftsgaarden in find-
ing suitable high income investors. This time the offering
proved successful. In the surmmer and fall of 1973, plain-
tiffs—Drs. Roger Austin. Thomas Anderson, Mvrel
Neumann, and William Randall—were among those who
purchased units." The jury found that plaintiffs bought
their units in reliance on the representations made in
Loftsgaarden’s offering memorandum and upon the advice
of either Crawford’ or their own financial advisors who
‘in turn relied on the memorandum.
Among other matters, the offerine memorandum repre-
sented that Loftsgaarden could obtain interim construction
financing for the motel at an interest rate of nine and one-
half percent: that the construction loan interest would
amount to $130,000; that the land lease would run for
forty years with renewal! and purchase options: that con-
struction of the mote! would heg'n in May 1973 and be
completed seven months later in December 1973: that the
‘Plaintiffs each purchased one $35,000 unit excent for Dr. Neumann who
bought one and a half units for a total investment of $52,000.
*Loftsgaarden admits that Crawford made no representations “other than
those in the Offering Memorandum.” Brief for appellants at 16.
D-8
developer and the construction company (i.e., Loftsgaarden
and 2361) would receive $103,000 for “overhead and
profit”; that the $240,000 furniture and fixtures loan from
the Rochester bank would be at an interest rate of eight
percent; and that Alotel Associates had procured a firm
commitment for long term financing” from Larwin. Find-
ings of Fact, Conclusions of Law, and Order for J udgment,
Designated Record (D.R.) 445-59."
These representations were found to be false. In fact,
Loftsgaarden had not obtained either the interim construc-
tion loan or the furniture and fixtures loan at the stated
fixed interest rates, but rather at interest rates that floated
ing rate. The land lease was for fifteen years with a fif-
teen-year renewal option instead of forty years with re-
newal and purchase options. Loftsgaarden knowingly un-
derestimated the construction time by five months, thus the
memorandum’s estimate that construction loan interest
would amount to $130,000 was too low because it was
based on a lower interest rate and a shorter construction
time than actually expected. It was also not true that he
had a firm commitment from Larwin for tthe partnership's
permanent financing. The loan was contingent upon
Larwin receiving adequate assurance that it was not usur-
ious under Minnesota law.” Overall, the budgets and fore-
**At a nine and one-half percent interest rate.
“These findings and conclusions relate to the district court’s ruling on
plaintiffs’ §12(2) claim and are consistent with the special verdict
returned by the jury upon the §10(b), Rule 10b-5, Ch. 80A, and com-
mon law fraud claims. D.R. 266-74.
12At the time the offering memorandum was circulated, Minnesota law
limited interest rates on loans to noncorporations to eight percent.
Larwin finally agreed to make the loan through a corporate nominee,
PDRC, which borrowed the money at nine and one-half percent from
Larwin and then advanced it to the partnership at the legal rate of
eight percent. PDRC recovered its loss on the transaction by adjusting
the land rent it charged to the partnership. Supra note 7.
SUE
D-9
casts in the offering memorandum were found to be based
on unreasonable and misleading assumptions.
Additionally, it was found that Loftsgaarden had
omitted any explanation of the role his closely-held cor-
poration would assume in the development. He did not
reveal that PDRC expected to earn a profit on the various
land transactions required to set up the sale-leaseback
arrangement, that PDRC would receive a commitment fee
for having obtained financing for the partnership, and
that he owned a thirty percent interest in ARC-TEC—
the architectural firm with which he contracted to des'gn
the motel. Overall, it was clear that Loftsgaarden and the
corporate defendants expected compensation considerably
greater than the $103,000 stated in the offering memor-
andum, their expectation being more on the order of
$240,000.
Alotel Associates encountered financial difficulties from
the project’s inception. Construction costs exceeded those
budgeted, largely be-*"> of ever-increasing interests
rates.” When the motel finally opened in June 1974, oper-
ating expenses exceeded those that were forecast and oc-
cupancy rates fell short of expected levels. Exacerbating
matters was Larwin’s refusal to “take out” (supra note 5)
the interim construction loan upon completion of con-
struction because it had not received adequate assurances
that its loan to the partnership was legal under the Min-
nesota usury law. Loftsgaarden was not able to placate
Larwin and get the permanent financing in place until De-
‘*The district court’s findings indicate that the prime rate charged by the
construction lender, First National Bank of St. Paul, rose from six
percent in February 1973 to ten percent in February 1974. As has
already been noted, the partnership was obliged to pay interest on this
$2.31 million loan at a floating rate of four percent over the bank’s
prime lending rate.
D-10
cember 1974, resulting in an additional six months of
high interest charges to the partnership. Loftsgaarden sold
five additional units in Associates in October 1974 to raise
$175,000 for repayment of debts and additional operating
capital. In February 1975 Loftsgaarden asked the limited
partners to make $125,000 in loans to keep Associates
afloat. The limited partners hired an accountant, John
Essene, to investigate the partnership’s financial condition.
Essene reported in March that in fact $200,000 would
probably be required to continue business operations.
Plaintiffs and other limited partners did make loans to
Associates at this point,” but they also hired an attorney to
make further investigation of the partnership's financial
affairs. The district court found that by August or Septem-
ber 1975, plaintiffs knew or should have known of de-
fendants’ fraud. In September, Loftsgaarden agreed to re-
sign as general partner: thereafter pla‘ntiffs made addi-
tional loans to Associates, but the business continued to
flounder. Associates ultimately defaulted on its loans and
land rent payments and foreclosure by creditors ensued.
Plaintiffs filed their complaint on February 24, 1976.
On June 25, 1980, after a seven-day trial, the jury found
that Loftsgaarden knowingly had made material misrepre-
sentations and omissions in the offering memorandum
upon which plaintiffs relied and which caused plaintiffs’
damages. thus satisfying all the elements of the § 10 (b).
Rule 10b-5, Ch. 80A. and common law fraud cla‘ms.”
The district court also accepted the jury’s advisory ver-
dict that Loftsgaarden was liable under § 12(2) because
“The jury found that neither these nor any subsequent advances were
induced by any misrepresentations by Loftsgaarden and plaintiffs were
not entitled to recover any of the amounts advanced.
1The parties agree that the elements of these various claims are identical.
D-11
he knowingly made material misrepresentations or omis-
sions of which plaintiffs were unaware, and because there
was some causal connection between Loftsgaarden’s
wrongful conduct and plaintiffs’ purchases. See Alton
Box Board Co. v. Goldman, Sachs & Co., 560 F.2d 916
(8th Cir. 1977).
Il.
Loftsgaarden complains that there is insufficient evi-
dence of materiality, reliance or causation to sustain the
jury’s verdict upon piaintiffs’ § 10 (b), Rule 10b-5, Ch.
80A. and common law fraud claims. It is also claimed
that the district court’s findings of materiality and causa-
tion in support of its conclusion that liability existed under
§12 (2) are clearly erroneous.
A.
A statement or omitted fact is considered material if
it is substantially likely that a reasonable investor would
consider the matter important in making an investment
decision. TSC Industries, Inc. v. Northway, Inc., 426 U.S.
438, 449 (1976).” Whether or not the misrepresented
Or omitted fact is important turns On whether a reason-
able investor would regard it as significantly altering
the total mix of information made available. /d.
Leaving aside the relatively few misrepresented and
omitted matters which Loftsgaarden claims are unsup-
ported by the evidence, we focus upon what we regard as
**Reliance is not an element of an action under §12(2). Alton Box Board
Co. v. Goldman, Sachs & Co $60 F.2d 916, 924 (8th Cir. 1977).
“TSC Industries arose under §:4(a) of the Securities Exchange Act of
1934, but the test for materiality is the same under all of the securities
— See Alton Box Board Co. v. Goldman, Sachs & Co., supra at
919-20.
D-12
his primary challenge to the materiality finding Lofts-
gaarden in effect admits that the following facts were
either misrepresented in OF omitted from the offering
memc-andum, but he argues that these facts should be
deemed immaterial: Loftsgaarden held a 30% interest in
ARC-TEC; the partnership was to pay a $25,000 broker-
age fee in conjunction with the sale of land; the project
was a revision of a prior failed offering by Loftsgaarden;
Crawford was an unlicensed seller; the interest rate On
the interim construction loan floated at four percent over
the prime rate; the land lease was for a shorter term than
represented; the furniture and fixtures loan was to be se-
cured by a chattel mortgage; the permanent financing
from Larwin was contingent upon assurances that it would
not be usurious; the corporate general partner was an un-
funded shell corporation; Loftsgaarden stood to gain over
twice the profits stated; and the offering, while not required
to be registered with the state, would have failed to qual-
ify had registration been sought.
The jury applied the proper standard of materiality and
found that full disclosure of the above matters would be
regarded as important by a reasonable investor. The Su-
preme Court has recognized that the trier of fact is
uniquely competent to make the materiality determina-
tion, requiring as it does “delicate assessments of infer-
ences a [reasonable investor] would draw from a given set
of facts... .” Id. at 450. We cannot fault the jury’s as-
sessments in this case and we uphold the materiality f nd-
ing.
B.
Ordinarily, reliance requires proof that the misrepresen-
tations actually induced plaintiffs to act differently than
D-13
they otherwise would have in making their investment de-
cisions. St. Louis U. Trust Co. v. Merrill Lynch, Pierce,
Fenner & Smith, Inc., 562 F.2d 1040, 1048 (8th Cir.
1977), cert. denied, 435 U.S. 925 (1978). But in cases in-
volving primarily a failure to disclose, reliance will be pre-
sumed upon a showing that the withheld information was
material. Affiliated Ute Citizens v. United States, 406 U:S.
128, 153-54 (1972). Because there were both misrepre-
sentations and omissions in the offering memorandum,
Loftsgaarden requested and the jury given a dual in-
struction which stated that plaintiffs had the burden of
proving they relied on the misrepresentations, but that as
to the omissions, reliance was presumed upon a showing
of the materiality of the omitted facts.”
Loftsgaarden contends that there is no evidence to sup-
port a finding of reliance in this.case. On the contrary, the
record indicates that the only information received by
plaintiffs came from the offering memorandum. Austin
testified that he went over the offering memorandum with
Crawford, devoting particular attention to the forecast
**The court instructed:
In this case, the njaintiffs allege that the offering memorandum which
was supplied to thein by defendant Loftsgaarden contained representa-
tions which were false and misleading. They also alleged that defendant
Loftsgaarden made oral representations to them at the time that they
purchased their units in Alotel Associates, and at the time that further
contributions to the partnership were solicited, which were false and
misleading. As stated above, before the plaintiffs can prevail on these
claims, they must first prove that such false and misleading representa-
tions were made. In addition, the plaintiffs must prove that they in fact
relied upon these representations.
The plaintiffs also claim that the offering memorandum was false and
misleading in that it failed to disclose material facts. Where the claims
asserted under Section 10(b) or Rule 10b-5 relate to nondisclosure as
opposed to misrepresentations, then, if the nondisclosed facts are mate-
rial, there is a presumption that the plaintiffs relied upon that nondis-
closure. In that case, the plaintiffs need not prove that they would have
acted differently had the facts been disclosed.
T. 795-96.
D-14
of cash flow, and that the memorandum “was the principal
reason, I would say, that I invested in it.” T. 557. Like-
wise, Anderson testified that he read and made notes
on the offering memorandum and that it was “the extent
of the information I did have at the time I invested.” (T.
591. Randall relied on the advice of his accountant, John
Essene, who testified, “All I had to work with was the of-
fering circular. . . . It was really the only source of infor-
mation that was available.” T. 494. Neumann relied on
the advice of his accountant and business partner, Delroy
Blaske. who reviewed and analyzed the offer‘ng memor-
andum, particularly focusing on the forecasts, Blaske tes-
tified the offering memorandum was “all we had to go
on.” T. 568.”
Loftsgaarden argues that there is no evidence plaintiffs
actually were misled by eny of the specific aspects cf the
offering memorandum that were found to have been mis-
represented. But misrepresentations so permeated this
document that the trial court found the‘r cumulative effect
was to render the forecasts and projections unreasonable
and misleading.” Accordingly, .eliance could be found
1°] oftsgaarden argues that no “derivative reliance” theory (i.e., plaintiffs
relied on experts who in turn relied on the offering memorandum) may
be advanced because such a theory was neither pled nor raised at trial.
See Kiernan v. Homeland, Inc., 611 F.2d 785, 789-90 (9th Cir. 1980).
We reject this argument. The so-called derivative reliance theory was dis-
allowed in Keirnan because plaintiff raised it for the first time on appeal,
effectively denying defendants any opportunity for rebuttal. In addition,
plaintiff failed to introduce any evidence that the third parties upon
whom he purportedly relied did themselves rely on any misrepresenta-
tions. In the instant case, the third parties upon whom Neuman and
Randall relied. Blaske and Essene, gave direct testimony and were sub-
iect to cross-examination on the reliance issue.
2C#. Nye v. Blyth Eastman Dillon & Co.. $88 F.2d 1189. 1197 n.14 (8th
Cir. 1978) (“The appellants attempt to separate out each misrepresenta-
tion and show that each was insufficient to mislead the appellees. Such
a position has little merit. Considered in the acgrevate. we agree with
the trial court that the misrepresentations did induce reliance on the part
of the appellees.” ).
ee ~ PES
D-15
from evidence that plaintiffs’ only source of informa-
tion in making their investment decisions was the offering
memorandum.
It is next argued that the trial court erred in failing to
instruct that the presumption of reliance upon material
omitted facts is rebuttable. This point would be more
troublesome were we confronted with a situation where the
only reliance instruction given was a presumption instruc-
tion. In such a case, we think it is necessary that defend-
ant be allowed to rebut the presumption of reliance and
that the jury be instructed on the rebuttable nature of this
presumption. See Sharp v. Coopers & Lybrand, 649 F.2d
175, 189 (3d Cir. 1981); cert. denied, 50 U.S.L.W. 3668
(U.S. February 23, 1982) (No. 81-433); Shores v. Sklar,
647 F.2d 462, 476 (Sth Cir. 1981), petition for cert. filed,
50 U.S.L.W. 3377 (U.S. November 2, 1981) (No. 81-839);
St. Louis U. Trust Co., supra at 1049, But we hold that
Loftsgaarden suffered no prejudice in the instant case by
the omission of the rebuttability instruction because, in-
dependent of any presumption of reliance that may have
been made, the jury found that plaintiffs affirmatively
proved reliance.”
“It is not apparent from the findings on the §10(b) and Rule 10b-5
claims whether the jury found affirmative proof of reliance upon mis-
representations or presumed reliance based on material omissions or
both. The issue, however, is clarified by the jury’s alternative finding of
liability based upon common law fraud. In this regard, the trial court
instructed that plaintiffs had the burden of affirmatively proving reliance
in order to recover.
Overall, the instructions and special verdict questions fully and cor-
rectly presented the reliance issue to the jury. We are, however, inclined
to agree with the Third Circuit that a dual instruciton on reliance is not
the appropriate solution when confronted with a securities fraud case
where both misrepresentations and omissions are present. We endorse
that circuit’s conclusion that “the proper approach to the problem of
reliance is to analyze the plaintiff's allegations, in light of the likely
proof at trial, and determine the most reasonable placement of the bur-
den of proof of reliance.” Sharp v. Coopers & Lybrand, 649 F.2d 175,
188 (3d Cir. 1981). Such an approach is consistent with this circuit's
view that the presumption of reliance is limited to cases involving
primarily omissions. Vervaecke v. Chiles, Heider & Co., 578 F.2d 713,
716-17 (8th Cir. 1978).
D-16
C.
Causation requires a showing of “some causal nexus be-
tween the defendant’s wrongful conduct and [plaintiff's]
loss.” St. Louis U. Trust Co., supra at 1048. Loftsgaarden
contends that there is no connection between the mis-
representations and omissions in the offering memorandum
and the eventual foreclosure of the motel.” The the-
ory advanced appears to be something akin to a contribu-
tory negligence defense, in which Loftsgaarden claims
that it was acts by plaintiffs themselves that caused fore-
closure of the motel. Our answer to this is simply that any
direct contribution made by plaintiffs to the demise of the
project after they ousted Loftsgaarden as general partner
does not relieve him from liability for his own intentional
tortious acts. The evidence shows that the numerous mis-
representations and omissions—particularly those relating
to financing—unquestionably caused the project to be
launched on unsoutid financial footing. This in itself is
sufficient evidence to establish causation. Loftsgaarden is
not to be excused from liability because of plaintiffs’ in-
ability to extract themselves from a predicament for which
he was squarely to blame.
D.
Thus, we uphold the finding of liability on § 10 (b),
Rule 10b-5, Ch. 80A. and common law fraud. On the
22He further contends that the trial court erred in precluding introduction
of evidence surrounding the progress of the project and the decisions
which led to its ultimate foreclosure after Loftsgaarden resigned as
general partner. We have examined the record and we hold that the evi-
dentiary matters raised by Loftsgaarden had no bearing on the causation
issue and were properly excluded for the reasons stated by the lower
court at trial.
a | > ileal a
D-17
basis of the foregoing discussion, we also hold that no clear
error exists in the lower court’s findings of materiality and
causation in support of its conclusion that liability exists
under § 12 (2). As previously stated, the materiality stan-
dard is the same under all! the securities statutes. Alton
Box Board Co. v. Goldman, Sachs & Co., supra at 919-20.
Causation under § 12 (2) is shown by demonstrating “some
causal relationship” between the misrepresentations or
omissions and plaintiffs’ purchases. Jd. at 924. We are no-
where left with the “definite and firm conviction that a
mistake has been committed” regarding either of these
findings. United States v. United States Gypsum Co., 333
US. 364, 395 (1948).
In addition, we reject Loftsgaarden’s argument that re-
scission under § 12(2) was not an available remedy to
plaintiffs because no timely demand for rescission nor
timely tender of the limited partnership units was made.
We do not read § 12(2) as requiring any demand for re-
scission. All that is required is that the claim be made
within the applicable statute of limitations, § 13 of the
1933 Act, 15 U.S.C. § 77m Section 13 requires that ac-
tion brought under § 12(2) must be brought within one
year after the untrue statement or the omission is discovered
or should have been discovered and that in no event may
an action be brought more than three years after the sale.
But even an untimely claim raised under § 12(2) may sur-
vive if it is raised in accordance with the relation back rule.
Rule 15 (c), F.R.Civ.P.; see Gridley v. Cunningham, 550
F.2d 551, 553-54 (8th Cir. 1977): Gannett Co. v. Regis-
ter Pub. Co., 428 F.Supp. 818, 823 (D. Conn. 1977);
Wassel v. Eglowsky, 399 F.Supp. 1330, 1358-59 (D. Md.
1975), aff'd, 542 F.2d 1235 (4th Cir. 1976); cf. Straley v.
D-18
Universal Uranium and Milling Corp., 289 F.2d 370,
372-73 (9th Cir. 1961) (relation back of amendment
stating claim under § 12 (1) ).
It is undisputed that plaintiffs’ original complaint, filed
on February 26, 1976, was timely. The complaint al-
leged violations of § 10 (b). Rule 10b-5, and Minnesota
securities law. The § 12 (2) claim was raised in subsequent
amendments to the complaint filed on December 26,
1978, and May 18, 1979. It is also undisputed that the
§ 12 (2) claim “arose out of the conduct, transaction, or
occurrence set forth . . . in the original pleading.” Rule 15
(c), F.C.Civ.P. Accordingly, the § 12(2) claim -was timelv
raised because the amendments related back to the date
of the original pleading. Id. See generally C. Wright & A.
Miller, Federal Practice and Procedure § 1497 at 499-
500 (1971).
Nor are we persuaded that plaintiffs’ claim under §
1? (2) should be barred because no tender of the limited
partnership units was made until shortly before trial. No
time for tender is prescribed by § 12(2) and this circuit
has held that a tender prior to or during trial satisfies the
requirement. Gridley v. Cunningham, supra at 554; see
also Wigand v. Flo-Tek, Inc., 609 F.2d 1028, 1034-35
(2d Cir. 1979).
IT.
Before addressing damages. we briefly consid-r and re-
ject two tangential points raised by Loftsgaarden. One
noint concerns an allegedly preiudicial remark made by the
court to Loftsgaarden’s counsel. At the end of the first
dav of trial, the court limited counsel's cross-examination
of Crawford to an amount of time equal to that consumed
D-i9
by plaintiffs in their direct examination. When counsel for
Loftsgaarden balked, the court stated, “I don’t want to be
critical but you spent 15 minutes on minor historical
meetings.” T. 143. The following day, Loftsgaarden moved
for a mistrial alleging the court’s comment constituted ju-
dicial misconduct, irreparably prejudicing the rights of the
defendants. It is claimed the lower court erred in denying
the motion. We cannot say that such an incidental remark
in any way reflected any conscious or unconscious desire
on the part of the trial court to deprive Loftsgaarden of
a fair trial. Cf. Agee v. Lofton, 287 F.2d 709, 710 (8th
Cir. 1961) (“[{The trial judge’s] remarks making light of
the plaintiffs and their witnesses were, in our opinion, cal-
culated to prevent the plaintiffs from having the sort of
trial to which they were legally entitled.”). Furthermore,
any possible prejudice was cured by the court in its in-
structions to the jury.”
The second point raised is that the lower court abused
its discretion in permitting plaintiffs to introduce evidence
of a prior fraud cOmmitted by Loftsgaarden. After Lofts-
gaarden denied any intent to defraud plaintiffs, the court
permitted plaintiffs to rebut this testimony by introducing
evidence of a 1976 state court determination that Lofts-
gaarden had defrauded a party in a real estate transaction.
The lower court concluded that the evidence was proba-
tive of intent and that its value in this regard outweighed
any prejudice. See Fed.R.Evid. 403. A limiting instruction
**The jury was told:
It is the duty of the Court to admonish an attorney who, out of
zeal for his cause, does something which is not in keeping with the
rules of evidence or procedure. You are to draw no inference against
the side to whom an admonition of the Court may have been addressed
during the trial of the case.
T. 782.
D-20
was given in which it was made clear that the evidence
“was received only as it may relate to [Loftsgaarden’s]
intent and for no other purpose.” Once Loftsgaarden de-
nied any intent to defraud, it was within the trial court's
discretion to permit evidence of the prior fraud. See F ed.
R Evid. 404 (b). We hold that the court did not abuse
‘ts discretion in allowing this evidence to be placed before
the jury.
IV.
The most hotly contested issue !n this case concerns the
district court”s ruling that Loftsgaarden could not intro-
duce any evidence about the tax benefits accruing to plain-
tiffs as a result of their participation in Alotel Associates.
Loftsgaarden argues that the evidence was crucial to the
‘csue of whether plaintiffs. regardless of whether they had
been defrauded, suffered any actual damages.
A.
“[D]amages for securities fraud are determined in ac-
cordance with the extent to which false and misleading in-
formation actually harmed the complaining party... .”
Shapiro v. Midwest Rubber Reclaiming Co., 626 F.2d
63. 69 (8th Cir. 1980), cert. denied, 449 U.S. 1079
(1981): cf. 15 U.S.C. § 78bb (a) (limiting nlaintiff’s recov-
ery under the 1934 Act to “actual damages on account of
the act complained of”). Failure by the complaining
party to prove actual damages is fatal to the party’s cla'm.
Shapiro, supra at 70. Generally, the out-of-pocket measure
of damages is applied in securities fraud cases, usually
awarding plaintiff (in the case of a defrauded purchaser)
the difference between the purchase price of the security
D-21
and its actual value on the date of purchase.“ Harris v.
American Investment Co., 523 F.2d 220, 225 (Sth Cir.
1975), cert. denied, 423 U.S. 1054 (1976). This measure,
however, is “not a talisman”; the function of the court
“is to fashion the remedy best suited to the harm.” Gar-
natz v. Stifel, Nicolaus & Co., 559 F.2d 1357, 1360 (8th
Cir. 1977), cert. denied, 435 U.S. 951 (1978). According-
ly, a rescissional remedy, id., or some other measure of
damages in the nature of restitution may be applied. Cf.
Myzel v. Fields, 386 F.2d 718, 742-43 (8th Cir. 1967),
cert. denied, 390 U.S. 951 (1968) (“Rescission calls for
cancellation of the bargain, and the return of the parties
to the status quo ante; . . . [b]ut where there exists no
market value of the stock, the stock is no longer in exist-
ence, and there clearly has been a fluctuation in value. . .,
then what restitutional damages are to be awarded must
depend upon the facts of the particular case.”).
The actual damages principle requires that a rescission-
al or restitutional award be “reduced by any value re-
ceived as a result of the fraudulent transaction.” Garnatz
v. Stife’, Nicolaus & Co., supra at 1361. This principl-
applies in the instant case not only to the § 10 (b) and Rule
10b-5 claims, but also to the claims under * 12(2) and
Minnesota law. Under § 12(2), the defendant guilty of
prospectus fraud shall be liable to plaintiff,
who may sue either at law or in equity in any court
of competent jurisdiction, to recover the cousidera-
**Where fraud is found to have affected the open market price of the
security because others were influenced by the same misrepresentations
made to the person seeking recovery, the measure applied is the differ-
ence between the purchase price and the actual value on the date of
discovery of the fraud. Harris v. American Investment Co., 523 F.2d
220, 226 (8th Cir. 1975), cert. denied, 423 U.S. 1054 (1976).
D-22
tion 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] (emphasis added). Similarly, the Supreme
Court of Minnesota holds that the defrauded party is en-
titled to no recovery unless plaintiff is able to prove that
he suffered actual damages as a result. Berg v. Xerxes-
Southdale Office Bldg. Co., 290 N.W.2d 612, 615 (Minn.
1980): cf. Minn. Stat. § 80A.23 (limiting recovery to ac-
tual damages sustained for violation of state securities
laws).
At trial Loftsgaarden attempted to show that in spite
of any fraud he may have perpetrated, plaintiffs suffered
no actual damages because of the tangible economic ben-
efit they derived from the limited partnership units in the
form of large tax write-offs which they used to offset
their sizeable professional incomes. Loftsgaarden’s offer of
proof indicates that he was prepared to introduce evidence
that three of the four plaintiffs suffered no actual damages
on account of the tax savings they experienced from th
‘nvestment. The district court stated that it was “not
going to get into a lot of complicated tax testimony” ur
23). and disallowed the evidence, dismissing the argument
as “sophistic malarky.” D.R. 438. The court concluded
that the limited partnership units were worthless and in-
structed the jury that if they found liability. the measure
of camages would be the amount “which the plaint'ffs
paid cut in reliance upon the fa'sc representations cf
[the] defendant .. .” T. 805. We take no issue with the
court’s decision to apply what was essentially a resc'ssOrv
wr
Le A ee i lL cl
D-23
measure of damages in this case,” but we hold that the
court committed reversible error in refusing to allow proof
of any economic benefits received by plaintiffs on account
of the investment and in failing to instruct the jury that
the damage award must be reduced by any value shown
to have been received by plaintiffs.
V.
We have already explained the basic principles of
real estate tax shelter investment in Part I of this opinion.
The aim is to generate large amounts of artificial losses
in the early years of the investment which may be passed
on to the limited partners for use in offsetting their out-
side income. The ultimate goal, of course, is to establish a
positive cash flow and become an income-producing en-
terprise, which income—just as the early losses—is dis-
tributed proportionately to the limited partners. Thus the
benefits from a profitable real estate tax shelter invest-
ment are two-fold, offering tax savings to the lim‘ted part-
ner in its early years and generating income in later
years. But unlike a corporate shareholder, for example,
even if the enterprise fails to become profitable, the limited
partner clearly may have something of value because of the
investment’s unique tax treatment:
A limited partner who has been misled into investing
in an unprofitable real estate venture may be in a
better position than a shareholder in an unprofitable
**Accordingly, there is no merit to Loftsgaarden’s contention that the lower
court erred in failing to submit to the jury the issue of when plaintiffs
discovered the fraud. Loftsgaarden contends that jury determination of
the question was “crucial to the issue of damages.” Brief at 38. But in
the context of damages, the time of discovery of the fraud is crucial
only where the out-of-pocket measure is to be applied and the trier of
fact is obliged to value the security as of this date.
D-24
corporation. By use of depreciation, real estate limited
partnerships can generate a substantial tax loss
while actually taking in sufficient cash to cover part-
nership expenses. This tax loss can be passed through
to the partners as a shelter for other taxable income.
In the extreme case where the partnership’s gross rents
are exactly equal to its expenditures, the tax loss con-
tinues to make the partnership an attractive invest-
ment. On the other hand, the stock of a corporation
having no profit or pt! gspects of profit would be
worthless. and a shareholder in that corporation
would value any recovery in a civil suit more than
his investment.
Note, Real Estate Limited Partnerships and Allocational
Efficiency: The Incentive to Sue for Securities Fraud, 63
Va.L.Rev. 669, 672-73 (1977) (footnotes omitted). We
note that the above excerpt discusses the value of the
limited partnership interest in a break-even investment.
Whether or not the costs exceeded the benefits in the in-
stant case where the enterprise never even reached the
break-even point cannot be determined absent evidence on
the matter.
The few recent cases addressing the issue hold that in
private securities fraud actions brought by limited part-
ners in real estate tax shelter investments, consideration
of tax benefits rece'ved by the limited partners is relevant
to the question of whether plaintiffs suffered any actual
damage. In Br‘dgen v. Sctt, 456 F.Supp. 1048 (S.D. Tex.
1978), limited partners sued the ceneral partner under
§ 10 (b) and Rule 10b-5 after they received tax benefits.
but no profit upon a speculative real estate investment.
D-25
The court permitted defendant to introduce evidence of
the tax aspects of the investment:
Requiring the jury or this Court to try this case with-
out reference to the tax consequences of the transac-
tion would be requiring the jury and the Court to live
in an artificial “never-never land.” The plaintiffs’
position that the tax consequences of this transaction
should be ignored is simply not realistic and is tan-
tamount to requesting this Court and the jury to try
this case blindfolded.
Id. at 1061. The court held that application of a rescissory
damage measure would require reduction of the price paid
by the specific value received by plaintiffs in the form of
tax write-offs. Jd. at 1060. In Smith v. Bader, 83 F.R.D.
437 (S.D.N.Y. 1979), the court permitted discovery of
plaintiffs’ tax returns, holding that “knowledge of plain-
tiffs’ income tax rate and the net value of their investment,
along with other information. may be needed to calculate
any tax benefits which may mitigate damages” Id. at
439. Similarly, in Berg v. Xerxes-Southdale Office Bldg. Co
supra, at 615, the court held that in valuing the interest in
a real estate limited partnership, income tax considera-
tions are relevant. Cf. Dupuy v. Dupuy, 551 F.2d 1005,
1925 (Sth Cir.), cert. denied, 434 U.S. 911 (1977): Bay-
oud v. Ballard, 404 F.Supp. 417, 426 (N.D. Tex. 1975);
Hickman v. Groesbeck, 389 F.Supp. 769, 779-80 (D. Utah
1974). Indeed, the tax aspects of a real estate limited
partnership investment are of such tangible economic ben-
efit to the investor that damages are recoverable under the
securities laws where, on account of fraud by the offeror,
tax write-offs taken by the investor are disallowed by the
D-26
Internal Revenue Service. Sharp v. Coopers & Lybrand,
supra. Thus, we acknowledge the value of the tax deduc-
tions generated by such an investment and hold that the
strictly compensatory nature of damages awardable in
private securities fraud actions requires that such value
be taken into account ir determining whether and to what
extent damages were inflicted upon plaintiffs.
The lower court’s allusion to the complexity of evidence
relating to plaintiffs’ tax savings is not a viable reason for
precluding such evidence in light of Norfolk & Western R.
Co. v. Liepelt, 444 U.S. 490 (1980). In the context of a
wrongful death action under the Federal Employer’s Lia-
bility Act (FELA),” the Court held that it was error to
preclude evidence of the income tax payable on the de-
cedent’s past and estimated future earnings and to refuse
to instruct the jury that the award of damages would not
be subject to income taxation. While admitting that
many variables affect the amount of a wage earner’s future
‘ncome tax liability, the Court observed that the calcu-
lation was no more uncertain or complex than that al-
ready made by juries in determining future earnings. The
Court concluded. “We therefore reject the notion that the
‘ntroduction of evidence describing a decedent's estimated
after-tax earnings is too speculative or complex for a
jury.” Id. at 494.
In the case before us, it is likely that the jury will not
even be faced with the vagaries of calculating future in-
come tax liability. Loftsgaarden’s offer of proof indicated
that he was prepared to show, based on an analysis of
plaintiffs’ income tax returns for the years 1973 to 1978,
that three out of the four plaint'ffs were net dollars ahead
45 U.S.C. $51 ef seq.
-
.
D-27
after foreclosure of the investment. All plaintiffs except
Dr. Randall reported the proceeds from the foreclosure in
their 1978 tax returns.” Thus, the net affect of the invest-
ment is subject to proof without the need for the jury to
speculate about the impact of any future recoupment of the
losses deducted. This is not to say that the present damage
calculation is entirely devoid of speculation. Plaintiffs did
indicate that their returns for the years 1973 to 1978 were
undergoing audits by the Internal Revenue Service. Evi-
dence of the audit and expert opinions as to its likely re-
sults are admissible at the retrial on damages. Certainly
the possibility that past tax deductions will be disallowed
is relevant to the determination of the extent of any bene-
fit actually received by plaintiffs from those deductions.
The jury is entitled to determine whether and to what ex-
tent there would be a disallowance of deductions.
We wish to clarify that the impact of our holding is not
nearly so far-reaching as plaintiffs predict. They argue that
because there are tax consequences to any investment
one makes, evidence of those consequences will not figure
in every securities fraud case. But our holding applies
only to cases involving investments that are expressly
marketed and sold as tax shelters. That is, investments
which allow the investor
to offset certain “artificial losses” (that is, nonecono-
mic losses but losses which are available as deduc-
tions under the present tax laws) not only against
the income from those investments but also against
*It is safe to assume that by this time, Dr. Randall has also reported the
extent of his proportional share of the proceeds from the foreclosure.
Even if he has not so reported, the extent of his share certainly is either
known or discoverable.
D-28
the [investor’s] other income, usually from his regu-
lar business or professional activity.
Staff of Joint Comm. on Internal Revenue Taxation, 94th
Cong., Ist Sess.. Overview of Tax Shelters 1 (Comm.
Print 1975).
In conclusion we hold that in a private securities fraud
action involving an investment structured and marketed
as a tax shelter, where a rescissory measure of damages
is applied, evidence of any benefit derived by the plain-
tiff /investor via tax savings Must be permitted.
V.
For the foregoing reasons, we vacate the award of dam-
ages and remand to the district court for a new trial on
that issue.” In all other respects, the judgment of the dis-
trict court is affirmed.
A true copy.
Attest:
CLERK, U. S. COURT OF APPEALS, EIGHTH CIR-
CUIT.
** Accordingly, it is unnecessary for us now to address issues ra‘sed regard-
ing the awards of prejudgment inierest and attorneys’ fees.
ee ee
a Ye
E-1
APPENDIX E
Dr. Roger E, Austin, Dr. Thomas W. Anderson, Dr. Myrel
A. Neumann and Dr. William C. Randall,
Plaintiffs,
vs.
B. J. Loftsgaarden, M. S. Noah, Lyman H. Coult, Alotel
Inc., a Minnesota corporation, Property Development &
Research Co., a Minnesota corporation, and 2361
Building Corp., a Minnesota corporation,
Defendants.
FINDINGS OF FACT, CONCLUSIONS OF LAW AND
ORDER FOR JUDGMENT
No. 4-76- Civ. 82
INTRODUCTION
This securities fraud case proceeded to trial and the
jury found for the plaintiffs on the 10b-5, Minn. Stat. §
80A.23 and common law fraud claims. The § 12(2) count
was to be decided by the Court and was submitted to the
jury for an advisory verdict. The jury also found for the
plaintiffs on this count. The Court accepts the jury’s ver-
dict and adopts the propposed findings of fact and con-
clusions of law submitted by plaintiffs, as modified below.
FINDINGS OF FACT
1. Defendants B. J. Loftsgaarden (“Loftsgaarden”)
and Alote] Incorporated offered to sell and did sell limited
partnership units in Alotel Associates, a Minnesota limited
E-2
partnership, to plaintiffs Dr. Roger E. Austin (“Austin”),
Dr. Thomas W. Anderson (“Anderson”), Dr. Myrel A. Neu-
mann (“Neumann”), and Dr. William C. Randall (“Ran-
dall”). The offers were made and the sales were accom-
plished by means of a document which was denominated
“Offering Memorandum.”
2. The Offering Memorandum included the following
statements.
(a) The Offering Memorandum stated that it was
then presently contemplated that interim construction
financing would be obtained from the First National
Bank of St. Paul at an interest rate of 9-1/2% per
annum.
(b) The Offering Memorandum stated that pro-
jected construction loan interest would be $130,000.
(c) The Offering Memorandum stated that the
land on which the motel project was to be built had been
leased for an initial term of 40 years with renewal op-
tions extending thereafter.
(d) The Offering Memorandum stated that it was
anticipated that construction of the project would begin
in May of 1973, that construction would be completed
by December of 1973 and that the motel might be
opened for occupancy in December of 1973.
(e) The Offering Memorandum stated that it was
then contemplated that Alotel Associates would enter
into a construction contract for the construction and
furnishing of the motel for a total expenditure of $3,150.,-
000 (including certain expenditures which were to be
treated as partnership expenses for tax purposes).
(f) The Offering Memorandum stated that it was
————
SSS
en SS
ee
E-3
then projected that the developer and the construction
company would receive a total of $103,900 for “over-
head and profit.”
(g) The Offering Memorandum stated that it as-
sumed that a $240,000 five-year 8% loan would be ob-
tained in January of 1974.
(h) The Offering Memorandum stated that Alotel
Associates had procured a firm commitment for long-
term financing of the project from Larwin Realty &
Mortgage Trust (“Larwin”).
(i) The Offering Memorandum included various
budgets and forecasts.
ee tc ky Me
3. The following facts were known to Loftsgaarden
and Alotel Incorporated:
(a) On February 15, 1973, Loftsgaarden filed an
application with First National Bank of St. Paul for in-
terim construction financing for Defendant Property De-
velopment & Research Company (“PDRC”). The rate
of interest to be charged pursuant to that commitment
was one which would float at 4% per annum over the
prime rate charged by First National Bank of St. Paul.
Subsequently First National Bank of St. Paul issued a
commitment on the terms stated. Between December
27, 1972. and February 25. 1973. the prime rate
charged by First Nationa] Bank of St. Paul was 6%.
Between Februarv 26. 1973. and March 18, 1973. the
prime rate was 6-1/4%. Between March 19. 1973, and
May 6. 1973, the prime rate was 6-3/4% .Between
May 7. 1973 and May 24. 1973, the prime rate was 78.
Between May 25, 1973, and June 6, 1973. the prime
rate was 7-1/4%. Between June 7, 1973, and June
meal
E-4
20, 1973, the prime rate was 7-1/2%. Between June
21, 1973, and July 1, 1973, the prime rate was 7-3/4%.
Between July 2, 1973, and July 5, 1973, the prime rate
was 8%. Between July 6, 1973, and July 17, 1973, the
prime rate was 8-1/4%. Between July 18, 1973, and
July 26, 1973, the prime rate was 8-1/2%. Between
July 27, 1973, and August 5. 1973, the prime rate was
8.3/4%. Between August 6, 1973, and August 12,
1973, the prime rate was 9%. Between August 13, 1973,
and August 19, 1973, the prime rate was 9-1/4%. Be-
tween August 20, 1973 and August 26, 1973, the
prime rate was 9-1/2%. Between August 27, 1973 and
September 13, 1973 the prime rate was 9-3/4%. Be-
tween September 14, 1973, and February 6, 1974, the
prime rate was 10%.
(b) The projected construction loan interest de-
pended upon the prime rate’s remaining at 9-1/2%
per year and completion of the construction of the motel
on December 31, 1973. Construction of the motel began
in June of 1973. Loftsgaarden and Alotel Incorporated
anticipated that it would require at least one (1) year to
complete construction of the motel.
(c) Alotel Associates was never a party to a
lease for an initial term of forty (40) years with renewa!
options. On October 24, 1973, Alotel Associates became
a party to a lease with an initial term of fifteen (15)
years with a fifteen-year renewal option. That lease
contained no option to purchase.
(d) Loftsgaarden and Alotel Incorporated never
caused Alotel Associates to execute a contract for the
construction and furnishing of the motel for a total ex-
penditure of $3.150,000 (including certain expendi-
pep EO UI EAL EID EGS ese
and were statements of material fact.
E-5
tures which were to be treated as partnership expenses
for tax purposes) and did not contemplate that they
would cause Alotel Associates to enter into such a con-
struction contract.
(e) Loftsgaarden submitted construction estimates
to First National Bank of St.Paul and Larwin Realty
and Mortgage Trust (“Larwin”) in which he stated that
he, PDRC or Defendant 2361 Building Corporation
(“2361”) expected that “overhead” would total $61,668
and that “contingency and profit” would total $254,900.
(f) On July 31, 1973, Loftsgaarden had obtained
a commitment for a five-year $240,000 loan. The com-
mitment provided that the interest rate would float at
up to 3% over the prime rate.
(g) Alotel Associates would not be able to make
use of the commitment from Larwin because of condi-
tions contained in the commitment.
4. The statements set forth in Paragraph 2 were untrue
5. The Offering Memorandum omitted to state the fol-
lowing facts:
(a) It was contemplated that interim construction
financing would be obtained from First National Bank
of St. Paul at an interest rate which would float at 4%
over the prime rate charged by First National Bank of
St. Paul and that the prime rate would continue to ex-
ceed 5-1/2% per annum.
(b) Projected construction loan interest was de-
pendent upon the prime rates remaining at 5-1/2%
per annum and the completion of construction of the
motel project on December 31, 1973.
E-6
(c) Construction of the motel project had begun
in June of 1973.
(d) Projected construction loan interest was de-
pendent upon the completion of construction of the motel
in seven (7) months. Loftsgaarden, Alotel Incorporated,
PDRC and 2361 expected that construction of the mo-
tel would require at least one year.
(e) The $240,000 five-year loan was to be se-
cured by a chattel mortgage of the furniture, fixtures,
and some of the equipment of the motel.
(f) The $240,000 five-year loan was to be ob-
tained at a rate of interest which would float at up to
3% per annum over the prime rate charged by the First
National Bank of Rochester.
(g) Larwin’s commitment for long-term financing
of the project was dependent upon Larwin’s obtaining
of a satisfactory opinion from a Minnesota attorney of
‘ts choice that the loan to Alotel Associates would not be
usurious.
(h) The risk that the loan from Larwin to Alotel
Associations would be found to be usurious was so sub-
stantial that Larwin would be able either to refuse to
honor its commitment or to insist upon certain condi-
tions which would impose substantial additional costs
and risks upon Alotel Associates.
(i) Loftsgaarden had not and would not fund
Alotel Incorporated and did not intend that Alotel In-
corporated would ever become either an active or a fi-
nancially responsible general partner of Alotel As-
sociates.
(j) Loftsgaarden did not state that certain of the
persons whom the Offering Memorandum had identified
ss
eT -
E-7
as directors and officers of Alotel Incorporated had not
agreed to become active directors and officers.
(k) Loftsgaarden was the sole shareholder of
PDRC.
(1) PDRC held options to purchase or the fee in-
terest in most of the tracts of land upon which the mo-
tel was to be constructed.
(m) Loftsgaarden, Alotel Incorporated and PDRC
intended and expected that PDRC would earn a sub-
stantial profit through PDRC’s acquisition and sale of
the land upon which the motel was to be constructed.
(n) Loftsgaarden owned 30% of the outstand'ng
shares of stock of arc-TECH, inc., the corporation
which was to act as the architect in connection with the
design and construction of the motel project and which
was to earn a fee of $90,000.
(o) Loftsgaarden, Alotel Incorporated, PDRC
and 2361 intended and expected that they would receive
compensation which would be considerably in excess of
the “overhead and profit” which was projected in the
Offering Memorandum.
(p) Loftsgaarden, Alotel Incorporated and PDRC
intended and expected that PDRC would be paid a com-
mitment fee by Alotel Associates for obtaining financ-
ing for the motel project.
(q) Paul D. Crawford (“Crawford”), a person
who was purporting to act as an investment advisor to
Austin, Anderson and Neumann in connection with
Loftsgaarden’s and Alotel Incorporated’s offers to sell
and sales of limited partnership units in Alotel Asso-
ciates, was not licensed to act as an investment advisor.
Crawford, whom Loftsgaarden had caused 2361 to
E-8
hire and whom Loftsgaarden had caused to offer to sell
and to sell a limited partnership in Alotel Associates to
Randall, had had his license to sell securities suspended
by the Commissioner of Securities of the State of Min-
nesota.
(r) The budgets and forecasts contained in the
Offering Memorandum were based upon assumptions
and a rational that were not reasonable and were mis-
leading in light of the facts known to Loftsgaarden,
Alotel Incorporated, PURC and 2361.
6. The omitted facis set forth in Paragraph 5 were
material facts.
7. The omitted facts set forth in Paragraph 5 were
material facts.
8. Loftsgaarden’s and Alotel Incorporated’s offers and
sales of limited partnership units in Alotel Associates to
Anderson, Austin, Neumann and Randall were made and
accomplished by the use of means and instruments of
transportation and communication in interstate commerce
and of the mails.
9. At the time that Anderson purchased his limited
partnership unit in Alotel Associates, he did not know of
the omitted facts set forth in Paragraph 5 and did not
know that any of the untrue statements set forth in Para-
graph 2 were false.
10. At the time that Austin purchased his limited
partnership unit in Alotel Associates, he did not know of
the omitted facts set forth in Paragraph 5 and did not know
that any of the untrue statements set forth in Paragraph 2
were false.
11. At the time that Neumann purchased his limited
partnership units in Alotel Associates, he did not know of
E-9
the omitted facts set forth in Paragraph 5 and did not
Know that any of the untrue statements set forth in Para-
graph 2 were false.
12. At the time that Randall purchased his limited
partnership unit in Alotel Associates, he did not know of
the omitted facts set forth in Paragraph 5 and did not know
that any of the untrue statements set forth in Paragraph 2
were false.
13. Loftsgaarden and Alotel Incorporated have not
sustained the burden of proof that they did not know and
in the exercise of reasonable care could not have known of
the untrue statements and omissions set forth in Paragraph
2 and 5 because of the following:
(a) At the time that the Offering Memorandum
was prepared and at the time of the sales to Anderson,
Austin, Neumann and Randall, Loftsgaarden knew
that the interim construction financing would be ob-
tained only at a rate which would float at 4% per an-
num over the prime rate charged by First National Bank
of St. Paul.
(b) At the time that the Offering Memorandum
was prepared and at the times of the sales to Anderson,
Austin, Neumann and Randall, Loftsgaarden knew that
the total projected const: uction loan interest of $130,000
depended upon the prime rates remaining at 5-1/2%
per year and the completion of construction of the motel
on December 31, 1973, that the prime rate had risen
above 5-1/2% per annum and that construction of the
motel would require at Jeast one year and would not be
completed until long after December 31, 1973.
(c) At the time that the Offering Memorandum was
prepared and at the times of the sales to Anderson,
AS
E-10
Austin, Neumann and Randall, Loftsgaarden knew
that Alotel Associates had not executed a 40-year lease
with renewal options extending thereafter with respect
to the land on which the motel was to be constructed.
(d) On October 24, 1973, Loftsgaarden knew that
Alotel Associates had executed a 15-year lease with a
15-year renewal option.
(e) At the time that the Offering Memorandum
was prepared and at the times of the sales to Anderson,
Austin, Neumann and Randall, Loftsgaarden knew that
construction of the motel was expected to take at tzast
one year.
(f) In June 1973 and thereafter, Loftsgaarden
knew that the $240,000 five-year loan would be ob-
tained at an interest rate which would float above the
prime rate, that the interest rate might be as much
3% per annum above the prime rate and that the loan
would be secured by a chattel mortgage of the furni-
ture, fixtures and certain of the equipment at the motel.
(g) In June 1973 and thereafter. Loftsgaarden
knew that Larwin would not make long term financing
available directly to Alotel Associates because charging
Alotel Associates interest at 9-1/ 2% per annum would
be usurious under Minnesota law and that Larwin
would make such a loan only through a nominee.
(h) At the time that the Offering Memorandum
was prepared and at the times of the sales to Ander-
son. Austin, Neumann and Randa’, Loftsgaarden knew
that he would not cause 2361, the general contractor,
to enter into a contract with Alotel Associates for the
construction and furnishing of the motel for total expend-
‘ture of $3.150,000 (including certain expenditures
&
E-11
which would be treated as partnership expenses for tax
purposes).
(i) At the time that the Offering Memorandum
was prepared and at the times of the sales to Anderson,
Austin, Neumann and Randall, Loftsgaarden knew
that he had not caused and did not intend to cause
Alotel Incorporated to be funded and that he did not
intend Alotel Incorporated ever to become an active
or financially responsible general partner of Alotel As-
sociates.
(j) At the time that the Offering Memorandum
was prepared and at the times of the sales to Anderson,
Austin, Neumann and Randall, Loftsgaarden knew that
he expected that he and/or PDRC expected to earn a
profit through the acquisition and sale of the land
upon which the motel was to be constructed.
(k) At the time the Offering Memorandum was
prepared and at the time of the sales to Anderson,
Austin, Neumann and Randall, Loftsgaarden knew
that he owned 30% of the outstanding stock of arc-
PECH, inc., that arc-TECH, inc., was to be the ar-
chitect involved in designing and supervising construc-
tion of the motel and that arc-Tech, inc., would earn a
fee of $90.000.
(1) At the time that the Offering Memorandum
was prepared, Loftsgaarden knew that he intended that
either he or his companies expected to receive compen-
sation and profits in excesss of $240,000 as a result of
the development of the motel for Alotel Associates.
(m) Loftsgaarden knew that Alotel Associates
would pay PDRC a commmitment fee for obtaining
long-term financing for the motel project.
E-12
(n) At the time that the Offering Memorandum
was prepared and at the times of the sales to Ander-
son, Austin, Neumann and Randall, Loftsgaarden knew
that Crawford was not licensed to act as an investment
advisor. In October 1973, Loftsgaarden knew that the
Commissioner of Securities of the State of Minnesota
had suspended Crawford’s license to sell securities.
(o) At the time the Offering Memorandum was
prepared and at the times of the sales to Anderson, Aus-
tin, Neumann and Randall, Loftsgaarden knew that the
budgets and forecasts contained in the Offering Memor-
andum were based upon assumptions and a rationale that
were not reasonable and which were misleading in light
of the facts known to him.
14. At all relevant times, Loftsgaarden was the pres-
‘dent. a director, the sole shareholder and a controlling
person of Alotel Incorporated, PDRC and 2361.
15. Anderson, Austin, Neumann and Randall relied
upon the Offering Memorandum, including the untrue state-
ments contained therein, in making their purchases of
limited partnership units in Alotel Associates. Such re-
liance was either direct, indirect through an advisor who
directly relied upon the Offering Memorandum or a com-
bination of both.
16. There was a causal relationship between the Of-
ferine Memorandum’s inclusion of the untrue statements
set forth in Paraeravh 2 and omission of the facts set forth
in Paragraph 5 and Anderson’s, Austin’s, Neumann’s and
Randall’s purchases of limited partnership units in A’otel
Associates.
17. There was no causal connection between the de-
fendants’ fraud and plaintiffs’ loans to the partnership.
E-13
18. Dr. Anderson purchased one limited partnership
unit of Alotel Associates on June 2, 1973, for $35,000.
Dr. Austin purchased one unit on June 26, 1973, for
$35,000. Dr. Neumann purchased one unit on August 21,
1973, for $35,000. He purchased one-half unit on Octo-
ber 19, 1973, for $17,500. Dr. Randall purchased one
unit on November 23, 1973 for $35,000.
19. In March 1975, Anderson, Austin, Neumann, Ran-
dall and the other investors in Alotel Associates retained
John Essene, a certified public accountant, in an effort to
obtain accurate financial information concerning Alotel
Associates.
20. In July 1975, Anderson, Austin, Neumann, Ran-
dall and the other investors in Alotel Associates retained
Gene Happe, an attorney, to investigate the financial af-
fairs of Alotel Associates.
21. Retention of John Essene and Gene Happe fol-
lowed Anderson’s, Austin’s, Neumann’s and Randall's
first suspicions that there was something amiss concerning
the financial affairs of Alotel Associates and constituted
the exercise of reasonable diligence to discover the untrue
statements set forth in Paragraph 2 and the omissions set
forth in Paragraph 5.
22. Plaintiffs discovered or should have discovered de-
fendants’ fraud some time in August-September 1975. The
original complaint in this action was filed on Februarv
24, 1976.
23. At the time that Anderson. Austin, Neumann and
Randall discovered that the Offering Memorandum con-
tained untrue statements of material fact and omitted to
state mater‘al facts, the limited partnership units in Alotel
Associates which they had purchased were valueless.
E-14
24. Anderson, Austin, Neumann and Randall have
tendered the limited partnership units in Alotel Associates
which they had purchased to Loftsgaarden and Alotel In-
corporated.
CONCLUSIONS OF LAW
1. The Court has subject matter jurisdiction over this
action.
2. The limited partnership units of Alotel Associates
purchased by the plaintiffs were securities.
3. B. J. Loftsgaarden and Alotel Incorporated of-
fered or sold a security by the use of means or instruments
of transportation or communication in interstate commerce
or of the mails; by means of a prospectus or oral commun-
ication. which included an untrue statement of a material
fact and omitted to state a material fact necessary in order
to make the statements not misleading. This conduct is a
violation of 15 U.S.C. § 77] (2).
4. None of the plaintiffs knew at the time of such of-
fer or such sale of the untruths or omissions.
5. B. J. Loftsgaarden and Alotel Incorporated knew
or in the exercise of reasonable care should have known of
such untruths or omissions.
6. Although reliance is not a necessary element of a
§ 12(2) action, plaintiffs did rely on the defendants’ untrue
statements.
7. Although reliance is not an element of the § 12(2)
action, there must be a showing of some causal connection
between the defendants’ wrongful conduct and the plain-
tiffs’ purchases. Sanders v. John Nuveen & Co., 619 F.2d
1222, 1225 (7th Cir. 1980); Alten Box Board Co. v. Gold-
man, Sachs & Co., 560 F.2d 916, 924 (8th Cir. 1977);
E-15
Eriksson v. Galvin, 484 F.Supp. 1108, 1121 (S.D .N.Y.
1980). Plaintiffs have established this connection in regard
to their purchases of the limited partnership units, but did
not establish the Yermuisite connection in regard to their
loans to the partnership.
8. Plaintiffs brought this action within one year after
the discovery of the untrue statements or the omissions or
within one year after such discovery should have been
made by the exercise of reasonable diligence. The plaintiffs
also commenced this action within three years after the
date of the sale of the limited partnership units to them.
The Court was persuaded by the evidence produced at trial
that the plaintiffs could have discovered the fraud in Au-
gust-September of 1975. Even if some of defendants’ argu-
ments were accepted, the earliest discovery date would be
about March of 1975. This action would still have been
timely since the complaint was filed in February 1976.
9. It is generally an equitable requirement of rescission
that a tender of the security be made to the defendants.
Plaintiffs here did not make such a tender until shortly
before trial. Such a tender could be appropriate under any
circumstances. See Gridley v. Cunningham, 550 F.2d
551, 554 (8th Cir. 1977). By the time the plaintiffs here
had learned of the fraud, their securities were worthless and
a tender was essentially futile. There was no showing that
defendants would have repurchased the units at that time.
Under these circumstances it is impossible to restore the
status quo by tender, and plaintiffs are not barred from
recovery merely because they did rot tender until shortly
before trial. See Wigand v. Flo-Tek, 609 F.2d 1028, 1035
(2d Cir. 1979).
10. Pursuant to section 12(2) of the Securities Act of
E-16
1933, plaintiffs are entitled to recover the consideration
paid for the limited partnership units.
11. Plaintiffs are also entitled to prejudgment interest
in the amounts set forth in the Court’s post-trial Order on
the other counts.
ORDER FOR JUDGMENT
IT IS ORDERED THAT:
1. Judgment is entered for the same plaintiffs and
against the same defendants on the § 12 (2) count in ac-
cordance with the Judgment entered on June 25, 1980, and
the Memorandum Order entered August 15, 1980.
2. The Court has found defendants liable to plaintiffs
on the § 12(2) claim. The jury found defendants liable on
the 10b-5, Minnesota Statutes § 80A.23 and common law
fraud claims. Any of these counts independently supports
defendants’ liability; but each plaintiff is entitled only to a
single recovery. In addition, as further explained in to-
day’s post-trial Order on the jury verdict, only the § 12 (2)
and Minnesota Statutes § 80A.23 count supports the award
of prejudgment interest; and only the Minnesota Statutes
§ 80A.23 count supports the award of attorneys’ fees.
August 15, 1980.
/s/ Earl R. Larson
United States Senior District Judge
F-1
APPENDIX F
(Title of Cause.)
MEMORANDUM ORDER
No. 4-76-riv. 82
The plaintiffs here were investors in a limited partner-
ship. They sued the seller of the partnership units for se-
curities and common law fraud. After trial, the jury re-
turned verdicts in favor of plaintiffs on the 10b-5, Minn.
Stat. § 80A.23 and common law fraud claims. Both plain-
tiffs and defendants have made a number of post-trial mo-
tions.
DEFENDANTS’ MOTION FOR A NEW TRIAL OR
JUDGMENT NOTWITHSTANDING THE VERDICT
Defendants contend that there was insufficient evidence
to support the jury’s findings of materiality, reliance or
causation. Although defendants’ brief refers only to the
10b-5 claim, the argument is apparently also addressed to
the State securities law and common law fraud claims.
The materiality requirement serves two functions. It
protects sellers and buyers of securities from having to dis-
close every picayune fact which might be related to the
transaction. It also has an important role in the determina-
tion of causation, particularly in nondisclosure or omission
cases. A misrepresentation or omitted fact is material if
there is a substantial likelihood that a reasonable purchaser
would consider it important or would give it actual signifi-
cance in making his investment decision. TSC Industries,
Inc. v. Northway, Inc., 426 US. 438. 449 (1976). The
reliance requirement encompasses whether the particular
F-2
plaintiff did consider the misrepresentation or omission im-
portant or significant, or whether he would have made the
same decision even if he had known the full truth. The only
purpose of this element is to aid in ensuring the presence of
causation. Causation involves a determination that the mis-
representation or nondisclosure by the defendant led to
the plaintiff's loss.
When a misrepresentation is the basis for a plaintiff's
claim, he must show reliance. The Eighth Circuit has held
that this rule applies to misstatements and half-truths,
which have the same essential nature as misrepresenta-
tions.’ Vervaecke v. Chiles, Heider & Co., 578 F.2d 713,
717 (8th Cir. 1978). A different rule, however, has long
been followed when the defendant’s wrongful conduct
consists of a failure to disclose a material fact. In this cir-
cumstance, because plaintiffs can hardly be expected to
prove actual reliance on what does not exist; a presump-
tion of reliance arises.” Affiliated Ute Citizens v. United
‘Defendants argue that there are not true omissions in this case. and
therefore the Vervaeccke rule applies. Defendants have mischaracterized
the nature of this case and the Vervaecke holding. There were om:
sions here aside from any misstatements or half-truths. Vervaecke is
not a model of cli: city, but if its holding were as defendants claim, it
would conflict with Affiliated Ute, and well-reasoned decisions in
other circuits. The whole question of omissions is largely irrelevant
because the jury found reliance on the affirmative misrepresentations
and that. coupled with the finding of causation, is sufficient to justify
the defendants’ liability.
*The presumption of reliance has also heen found in circumstances where
the defendants’ fraud depresses secondary market value. See Shores v.
Sklar, 610 F.2d 235, 239 (Sth Cir. 1980). In addition, Shores v. Sklar
eliminated the need for reliance where the fraud was a major cause
for the security being sold at all. 610 F.2d at 24M. That reasoning
could properly be extended to this case. A first attempted offering
failed miserably. The second offering, reworked and replete with mis-
representations and omissiors, succeeded in attracting investors. Un-
less it did attract a certain number of purchasers. >v its own terms
the offering wou'd not result in formation of a limited partnership.
Therefore, the reliance of the various investors could be viewed as
interwoven. Case law seems to recognize that where causation is
clearly established, reliance becomes largely irrelevant. That situation
may be present here.
F-3
States, 406 U.S. 128, 153 (1972); Continental Grain, Ltd.
v. Pacific Oilseeds, Inc., 582 F.2d 409, 412 n.i (8th Cir.
1979). The fairness of this rule stems from the fact that
the defendant has created the problem by failing to dis-
close the material fact." Of course, defendants may intro-
duce evidence to rebut this presumption. Shores v. Sklar,
610 F.2d 235, 239 (Sth Cir. 1980); St. Louis Union Trust
Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 562
F.2d 1040, 1049 (8th Cir. 1977), cert. denied, 435 US.
925 (1978).
When an affirmative misrepresentation is alleged, causa-
tion is proved by showing that the plaintiff relied on the
misrepresentation and that the misrepresentation is related
to plaintiff's loss. In the case of a nondisclosure, causation
may be established merely by proving the materiality of
the omitted fact, which creates the presumption of re-
liance.* Affiliated Ute Citizens v. United States, 406 U.S.
at 154; Stromfield v. Great Atlantic & Pacific Tea Co., 484
F.Supp. 1264, 1270 (S.D. N.Y. 1980): Eriksson v. Galvin,
484 F.Supp. 1108, 1126 (S.D.N.Y. 1080). These rules
should not be applied rigidly, but must always be used
to analyze a particular set of facts with an awareness of
the linkage between these concepts.
Some courts attempt to split causation into “loss causa-
tion” and “transaction causation.” This distinction ap-
*The linkage between materiality and reliance also supports this rule.
Reliance on an itnmaterial fact is highly unlikely. The odds are, how-
ever, that an investor will rely on any material facts in making his
investment decision.
‘It is unclear why courts do not mention the need for some further
proof of causation in omission cases. Perhaps it is believed that once
materialitty is shown and reliance presumed. it is highly likely that
causation is also present. In any event, defendants can alwavs introduce
evidence designed to undercut the causal connection between the
fraud and loss.
F-4
pears to be based on confusion over whether a plaintiff
should have to show that the alleged fraud ~ as directly re-
lated to the security’s drop in value (loss causation) or
whether it is enough to show that the fraud induced pur-
chase of the security (transaction causation). It might be
argued that even when a defendant’s fraud causes purchase
of a security, it is unfair to find him liable when the loss
is caused by factors unrelated to the fraud. The opposing
argument is that any time fraud induces purchase, causa-
tion-in-fact or but-for causation of a resulting loss has been
established.
It appears to the Court that the appropriate focus is on
loss causation. See Vervaecke v. Chiles, Heider & Co., 578
F.2d at 715. The essence of securities fraud damage actions
is whether plaintiff suffered a loss because of the defend-
ant’s conduct, not whether he purchased a security because
of it.’ It also seems reasonable, however, to presume that a
drop in value is caused by the fraud. See Seiffer v. Topsy’s
International, Inc., 487 F.Supp. 643, 665-66 (D. Kan.
1980). Therefore, generally even if only transaction causa-
tion were established, plaintiff would have met his burden
of proof on the causation issue: and any time loss causation
‘< shown. even if transaction causation is not, that burden
is met. See Garnatz v. Stifel, Nicolaus & Co., 559 F.2d
1357. 1361 (8th Cir. 1977), cert. denied, 435 U.S 951
(1978). In this case there was sufficient evidence to sustain
findings of both transaction and loss causation, and there
is no basis for overturning the jury’s conclusion that de-
fendants’ fraud led to plaintiffs’ damages.
‘Of course, the fraud must be “in connection with” a sale or purchase
for plaintiff to have standing. This is analyticat!y different. however,
from the determination whether the fraud induced the sale or pur-
chase.
F-5
The law in the fraud area is not always crystal clear.
The important thing is that the jury get an adequate state-
ment of the law. The Court believes that its instructions
were correct and fulfilled their purpose. Counsel were
given wide latitude in arguing their theories of the case. The
jury was attentive and apparently had a good grasp of the
law and facts. Materiality, reliance and causation involve
factual and objective determinations and are properly given
to the jury for decision. No adequate reason has been pre-
sented to the Court for overturning th. jury’s findings. Not
only was there ample affirmative evidence offered by plain-
tiffs to support the verdict, but defendant Loftsgaarden’s
evasive and resistive testimony could have seriously under-
mined the credibility of his version of the facts in the jury’s
eyes. Certainly the Court has no feeling that an injustice
has been done to the defendants.
Defendants next raise a lav .e group of interconnected
arguments centering around the measure of damages and
the tax benefits plaintiffs received on their investments
They claim that plaintiffs suffered no damage because of
these tax benefits, that the Court used the wrong measure of
damages, that the Court should have allowed the jury to
decide when the fraud was discovered for damages purposes,
that reference to tax benefits should not have been ex-
cised from some exhibits and that the Court should have
received more evidence on subseauert events for the pur-
pose of showing that plaintiffs’ damages were their own
fault. The Court finds no merit in any of these alleged er-
rors.
initially, the Court would note that defendants overstress
the tax aspect of these investments. The offering memor-
andum contained projections which estimated large tax
losses only in the first two years of the hotel’s operation.
F-6
After two more years of small losses, the limited partners
would have received significant yearly income on which tax
would have to be paid. Each limited partner would have
ended up with a large amount of tax owing, not including
any tax on money received if and when the hotel was sold.
In addition, the offering memorandum warned of impend-
ing changes in the tax laws which would limit the tax
losses. Furthermore, plaintiffs were not actually going to
make any money because of tax losses; what they were get-
ting was a tax deferral. The limited partners clearly were
interested in making money. The projections displayed a
business which would provide them with good yearly in-
come as well as ga:a at time of disposal. They were upset
when they discovered that the project was becoming insol-
vent, and they took several steps to try to put the partner-
ship on a profitable track. inciuding loaning money and re-
placing the general partner. This suit is further evidence
that plaintiffs do not feel they got their money’s worth from
some incidental tax benefits.
The Court did allow defendants to introduce evidence of
the tax benefits to show that any misrepresentation on
another subject was not material to the investors. The
jury apparently rejected this argument and adopted the
common sense view that people do not make an invest-
ment for losses, tax or otherwise, but t scause they antici-
pate a profit.
The Court totally rejects defendants’ suggestion thai be-
cause plaintiffs received some tax benefits they have not
been damaged. Plaintiffs expended at least $35,000 each
for a security which became worthless. The causes of the
failure of the partnership bus‘ness were linked to defend-
ants’ fraud. Plaintiffs have shown damage.
F-7
The subsequent events evidence which defendants sought
to introduce, and the Court rejected, supposedly went to the
merits
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