# Petitioners Brief — Randall v. Loftsgaarden > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0440%3A05 ## Record - **Collection:** Supreme Court brief - **Document type:** Petitioners Brief - **Published:** January 1, 1986 - **Citation:** 478 U.S. 647 ## Text Supreme Cou.t, U... | = FILED at No. 85-519 JAN 6 1986 NIOL, JR. In The CLERK Supreme Court of the United States October Term, 1985 sy Vv DR. WILLIAM C. RANDALL, DR. ROGER E. AUSTIN, DR. TOM W. ANDERSON and DR. MYREL A. NEUMANN, Petitioners, v. BEST AVAILABLE aa B. J. LOFTSGAARDEN; ALOTEL INCORPORATED, a Minnesota corporation; PROPERTY DEVELOPMENT AND RESEARCH COMPANY, a Minnesota corporation; and 2361 BUILDING CORPORATION, a Minnesota cor- poration, Respondents. ra’ Vv ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE EIGHTH CIRCUIT Vv BRIEF FOR THE PETITIONERS ray Vv * Robert Arthur Brunig Terence M. Fruth O'CONNOR & HANNAN FRUTH & ANTHONY, P.A. 3800 IDS Tower 1350 Internationa! Centre 80 South Eighth Street 900 Second Aven se South Minneapolis, Minnesota Minneapolis, Minnesota 55402 55402 Telephone: (612) 343-1200 Telephone: (612) 349-6969 Ted S. Meikle Wilbur F. Dorn, Jr. FREDRIKSON & BYRON, P.A. DORN LAW FIRM, LTD. 1100 International Centre 300 East Main Street 900 Second Avenue South Anoka, Minnesota 55303 Minneapolis, Minnesota Telephone: (612) 427-5903 55402 Telephone: (612) 347-7000 Counsel for Petitioners * Counsel of Record OCKLE LAW BRIEF PRINTING CO., (800) 835-7427 Ext. 333 QUESTIONS PRESENTED 1. Whether favorable tax consequences to defrauded investors in a limited partnership, together with imputed interest thereon, constitute ‘‘income received’’ which sec- tion 12(2) of the Securities Act of 1933 requires be de- ducted from the consideration paid when the investors’ purchase of the securities is rescinded. 2. Whether favorable tax consequences to defrauded investors in a limited partnership, together with imputed interest thereon, are to offset rescissionary damages awarded pursuant to section 10(b) of the Securities Ex- change Act of 1934 and Securities and Exchange Commis- sion Rule 10b-5 to insure that the investors do not recover more than ‘‘actual damages.”’ ii TABLE OF CONTENTS Page QUESTIONS PRESENTED i TABLE OF CONTENTS ..... ii TABLE OF AUTHORITIES iv OPINIONS BELOW 1 JURISDICTIONAL STATEMENT 1 STATUTES AND REGULATION .. 1 STATEMENT OF THE CASE 3 SUMMARY OF THE ARGUMENT 9 ARGUMENT — Il. The Interpretation Of Section 12(2) And The Caleulation Of Damages Under Section 10(b) And Rule 10b-5 Must Be Consistent With The Language Of The Statues And The Rule. wee eereee A. There Is No Statutory Basis For Differenti- ating Between ‘‘Tax Shelters’? And Other Securities The Language Of Section 12(2) Does Not Allow Deduction Of ‘‘Tax Benefits’? From A Defrauded Purchaser’s Recovery 1. **Tax Benefits’’ Are Not ‘‘Income,’?’ ........... 2. ‘‘Interest’’ Should Not Be Added To ‘*‘Tax Benefits’’ Even If ‘‘Tax Benefits’’ Were To Be Considered ‘‘Income Re- ceived.’’ a er Nothing In Section 28(a) Justifies Reducing Damages Under Section 10(b) And Rule 10b-5 By ‘*Tax Benefits.’’ Il. Permitting Defrauded Purchasers To Recover Their ‘‘Consideration Paid . .. With Interest’’ Without A Reduction For ‘‘Tax Benefits’’ Is Consistent With Precedent 12 13 16 16 21 22 25 ili TABLE OF CONTENTS—continued Page A. The Eighth Cireuit’s Decision Fails To Defer To This Court’s Precedent 25 B. The Eighth Cireuit’s Decision Fails To Defer To Othe. ?recedent 27 C. Deducting ‘‘Tax Benefits’? From Recoveries For Securities Fraud Disregards The Collat- eral Source Rule .............................. 29 Ill. Public Policy Considerations Require That ‘‘Tax Benefits” ot Be Subtracted From Securities IRR ST Ee ne I tc ST ON al a 32 A. Subtracting ‘‘Tax Benefits’’ From Securities Fraud Recoveries Undermines The Disclosure Requirements Of The Federal Securities Laws 32 B. Subtracting ‘‘Tax Benefits’? From Securities Fraud Recoveries Effectively Transfers Monies From The Public Treasury To The Defrauder 36 C. Subtracting ‘‘Tax Benefits’’ From Securities Fraud Recoveries Creates Anomalous Damage Awards 37 D. Subtracting ‘‘Tax Benefits’? From Securities Fraud Recoveries Does Not Fully viet saa Defrauded Investors 200. 38 EK. A Securities Fraud Action Is Not An Appro- priate Proceeding In Which To Litigate The Tax ape Of An Investment Induced By Fraud . PLDs a ee 41 FI casctetttcietecctvierstans sieielsatiidhdcinemesttiasal 43 iv TABLE OF AUTHORITIES CasEs: Page Affiliated Ute Citizens v. United States, 406 oF By ans rk 25 Alfred Bell & Co. v. Catalda Fine Arts, Inc., 191 je ae DB: Bs ek 24 Austin v. Loftsgaarden, 768 F.2d 949 (8th Cir. 1985), petition for cert. granted, 54 U.S.L.W. 3328 (U.S. Nov. 12, 1985) (No. 85-519) passim Austin v. Loftsgaarden, 675 F.2d 168 (8th Cir. | Re aee eae ee alien 1, 7, 8, 9, 14, 17, 28, 39, 48 Bayoud v. Ballard, 404 F.Supp. 417 (N.D. Tex. 1975) 28 Berg v. Xerxes-Southdale Office Bldg. Co., 290 PAF GB Eile Soka eh salen 28 Birdsall v. Coolidge, 93 U.S. 64 (1876) 23 Blue Chip Stamps v. Manor Drug Stores, 421 ee fs ee 9, 13, 32 Borovoy v. Bursar Realty Cory., 86 Mich. App. 732, 273 N.W.2d 545 (1979) a 28 Bridgen v. Scott, 456 F.Supp. 1048 ire Tex. RGD. iii senceieteainaeadecail. 28 Brown v. Producers Livestock Loan Co., 469 F, SS OE 2 eee oer ee 40 Burgess v. Premier siti 727 F.2d 826 “— Cir. 1984) ag Pe a ieee AC ne Oo nt ORR 29, 36 Carter Prod., Inc. v. Colgate-Palmolive Co., 214 F. Supp. 383 1S Rh nena cht ae ek Se 24 Cereal Byproducts Co. v. Hall, 16 Il. App.2d 79, 147 N.E.2d 383, aff'd, 15 Ill. 2d 313, 155 pe § 8 Bs pe ce ee 31 Vv TABLE OF AUTHORITIES—continued Page Chris-Craft Indus., Inc. v. Py r Aircraft Corp., 480 F.2d 341 (2d Cir.), ce. . denied, 414 U.S. Se I sechistchicincenc techeeesntlicticetatieasncahia tiphbaaniloriedlalidatabetas 27 Consumer Prod. Safety Comm’n v. GTE Syl- vamta, Toec., 447 U.S. 102 (1980) nena ne ccc ceececneceesnneeeeneee 13 Cooper v. Hallgarten & Co., 34 F.R.D. 482 ee a en 27 Danzig v. Jack Grynberg & Assoc., 161 Cal. App. 3d 1128, 208 Cal. Rptr. 336 (1984), cert. de- nied, 106 S. Ct. 67 (1985) .. eee a. ae Dupuy v. Dupuy, 551 F.2d 1005 (5th Cir.), cert. denied, 434 U.S. 911 (1977) ease. re 28 Eichel v. New York Cent. R.R., 375 U.S. 253 (1963) . A ET TEL a RT 31 wiheds | v. Gagnon, 766 F.2d 770 (3d Cir. 1985) 29 Eisner v. Macomber, 252 U.S. 189 (1920) 0 17 Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) . 9,13 Freschi v. Grand Coal Venture, 767 F.2d 1041 (2d Cir. 1985), petition for cert. filed, 54 U.S. L.W. 3154 (U.S. Sept. 6, 1985) (No. 85-377) 0. 29 Funston v. United States, 513 F.Supp. 1000 + te. Yh GRWRSROAR LURE ne sie 2.aiboror Sienna 31 G & R Corp. v. American Sec. & Trust Co., Be bs Bi they Ae.) ) ene 28 Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281 i a aignebaine 20 Goodyear Tire & Rubber Co. v. Overman Cush- ton Tire Co., 95 F.2d 978 (6th Cir. 1937)... 24 Hanover Shoe, Inc. v. United Shoe Mach. Corp., TR 11, 26, 27, 42 vi TABLE OF AUTHORITIES—continued / Page Harris v. Metropolitan Mall, 112 Wis. 2d 487, 334 N.W.2d 519 (1983) 29 Hayden v. McDonald, 742 F.2d 423 (8th Cir. 1984) . 37 Herman & MacLean v. Huddleston, 459 U.S. 375 (1983) Hickman v. Groesbeck, 389 F.Supp. 769 (D. Utah 1974) . Hokama v. E. F. Hutton ¢& Co., 566 F.Supp. 636 (C.D. Cal. 1983) 29 Houlihan v. Anderson-Stokes, Inc., 78 F.R.D. 232 (D.D.C. 1978) ................ 28 Iowa-Des Moines Nat’l Bank v. Schwerman Trucking Co., 288 N.W.2d 198 (Iowa 1980) _.. 31 Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert. Aemted, BB2 U.S. STD (19GB) naan eaceeecnnneenncerneeevneneevnernnee 20, 25 Johns Hopkins Unw. v. Hutton, 297 F. Supp. 1165 (D. Md. 1968), rev’d on other grounds, 422 F.2d 1124 (4th Cir. 1970), cert. denied, 416 U.S. 916 (1974) ... “a 10, 19, 20, 22, 27 Jones & Laughlin Steel iat v. si ani. 462 U.S. Ss NE ee le a ae Kauffman v. Sidereal Corp., 695 F.2d 343 (9th Cir. 1982) 31 Koehler v. Pulvers, [Current] Frp. Sec. L. Rep. (CCH) ¥ 92,232 (S.D. Cal. 1985) 29 Landreth Timber Co. v. Landreth, 105 S, Ct. 2297 (1985) 9, 13,17 L. P. Larson, Jr., Co. v. William Wrigley, Jr., ka ee Ue ND cette 23 Vii TABLE OF AUTHORITIES—continued Page Lumber Terminals, Inc. v. Nowakowski, 36 Md. App. 82, 373 A.2d 282 (1977) 31 Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970) 40 Mills Music, Inc. v. Snyder, 105 S. Ct. 638 (1985) 13, 16 Murphy v. Cady, 30 F. Supp. 466 (D. Me. 1939), aff’d, 113 F.2d 988 (1st Cir.), cert. denied, 311 U.S. 705 (1940) 21 Myzel v. Fields, 386 F.2d 718 (8th Cir. 1967), cert. denied, 390 U.S. 951 (1968) 20, 25 NLRB v. Gullett Gin Co., 340 U.S. 361 (1951). 31 Norfolk & W. Ry. v. Liepelt, 444 U.S. 490 (1980) 11, 26, 27 Osofsky v. Zipf, 645 F.2d 107 (2d Cir. 1981) 0. 11, 23 Red Bank Oil Co., 20 S.E.C. 863 (1945) 00. 33 Regional Properties, Inc. v. Financial & Real Estate Consulting Co., 678 F.2d 552 (5th Cir. 1982) 40 Rhode v. Hershberger Explorations, Inc., 349 F. Supp. 993 (D. Minn. 1972) ....... 27, 40 S & E Contractors, Inc. v. United States, 406 U.S. 1 (1972) 13 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963) 12 Salcer v. Envicon Equities Corp., 744 F.2d 935 (2d Cir. 1984), petition for cert. filed, 53 U.S.L.W. 3688 (U.S. Mar. 13, 1985) (No. 84-1447) ...... 22, 29, 30 Sharp v. Coopers & Lybrand, 83 F.R.D. 343 (E.D. Pa. 1979), rev’d on other grounds, 649 Vili TABLE OF AUTHORITIES—continued Page F.2d 169 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982) 28 Sheldon v. Wetro-Goldwyn Pictures Corp., 106 F.2d 45 (2d Cir. 1939), aff’d, 309 U.S. 390 (1940) 24 Smith v. Bader, 83 F.R.D. 437 (S.D.N.Y. 1979) 0. §=28 Spatz v. Borenstetm, 513 F. Supp. 571 (N.D. Tl. 1981) 28 Teamsters v. Daniels, 439 U.S. 551 (1979) 0 9,18 United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975) 10, 17, 18, 19 United States v. Gilliland, 312 U.S. 86 (1941) 0000. =«12 United States v. Naftalin, 441 U.S. 768 (1979)..11, 33, 36 United States v. Standard Brewery, Inc., 251 U.S. 210 (1920) 13 Western Fed. Corp, v. Erickson, 739 F.2d 1439 (9th Cir. 1984) Wiesenberger v. W. E. Hutton & Co., 35 F.R.D. 556 (S.D.N.Y. 1964) 29, 40 Wigand v. Flo-Tek, Inc., 609 F.2d 1028 (2d Cir. 1979) Wolf v. National Lead Co., 272 F.2d 867 (9th Cir. 1969) STATUTES: Section 1 of the Minnesota Uniform Securities Act, Minn. Stat. § 804.01 . ae Section 23 of the Minnesota Uniform Securities Se, NG CG SII seictotce a crcnapenieneneeocsntinenie 5, 6,7 ix TABLE OF AUTHORITIES—continued Page Section 2 of the Securities Act of 1933, 15 U.S.C. §$77b ... : 18, 19 Sections 3-4 of the Securities Act of 1933, 15 U.S.C, §§ 77¢-77d 34 Section 12 of the Securities Act of 1933, 15 U.S.C. § 771 passim Section 17 of the Securities Act of 1933, 15 U.S.C. § 77q 5 Section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78) _...... * ..passim Section 25 of the Copyright Act, 17 U.S.C. § 25 (1928) . 23 Section 28 of the Securities Exchange Act of ane passim Section 29 of the Securities Exchange Act of Se eee ae 40 Sections 16-19 of the Trademark Act, 15 U.S.C. §§ 96-99 (1928) 0... CBleh Cie ae OSs a . B Section 1 of the Internal Revenue Code, 26 ES ys I ne 10 Section 11 of the Internal Revenue Code, 26 U.S.C. $11 - e 10 Section 61 of the Internal Revenue Code, 26 ae Oe ee PS OR oe Ae eee 10, 17, 18, 19 Section 165 of the Internal Revenue Code, 26 8 RS Aa Ee ae ee 15 Section 219 of the Internal Revenue Code, 26 hs Se lc iciaietantineins eae Section 305 of the Internal Revenue Code, 26 8 NE ST eA Ay ns On 15 Section 401 of the Internal Revenue Code, 26 Ra RE SR aE ee coy Section 403 of the Internal Revenue Code, 26 aes I hcaliataletiaseseeibtiisnetesirciisieesntttnlinibabiaiiectnietate TABLE OF AUTHORITIES—continued Page Section 6111 of the Internal Revenue Code, 26 ° U.S.C. § 6111 | : ae 14 Section 6501 of the Internal Revenue Code, 26 U.S.C. § 6501 ete ao - 39 Sections 1311-14 of the Internal Revenue Code, 26 U.S.C. §§ 1311-14 va . .....09, 40, 41 Sections 346-47 of the Judicial Code of 1911, 28 U.S.C. § 1254 m nS ee 5 ae a Section 59 of the Patent Law, 35 U.S.C. § 67 (1928) . 23 REGULATION : Rule 10b-5 of the Securities and Exchange Com- mission, 17 C.F.R. § 240.10b-5 passim Oruer AUTHORITIES: S. Banoff, To What Extent Will Benefits from Tax Shelters be Permitted to Offset Rescis- sion Damages, 57 J. Taxation 154 (1982) 38 A Blankenheimer, Tax Consequences of Rescis- sion: The Interplay Between Private & Pub- lic Law, 42 U. Cun. L. Rev. 562 (1975) 22241, 42 Bureau of Nat’!] Affairs, Ine., Daily Report for Executwes (Feb. 21, 1984) . 34 77 Cong. Rec. 937 (1933) ........................ 32,37 77 Cong. Ree. 2913 (1933) .......... | 21 F. Easterbrook & D. Fischel, Optimal Damages in Securities Cases, 52 U. Cur. L. Rev. 611 (1985) 12, 34 [1976] 5 Fep. Sec. L. Rep. (CCH) ? . 34 Xl TABLE OF AUTHORITIES—Continued Page [1985] 6 Fep. Sec. L. Rep. (CCH) ...... Bee Sateen . 34 H. R. Rep. No. 85, 73d Cong., Ist Sess. (1933), reprinted in 9 J. Ellenberger & E. Mahar, LEGISLATIVE History OF THE SEcurRItTIES ACT OF a 3 3 & THE SecurITIES ExcHaNnGeE Act oF 1934 R. Haft & P. Fass, Tax SHeuterep INVESTMENTS (3a ed. 1960) se EP a ee (a Oey T. Hazen, Administrative Enforcement: An Evaluation of the SEC’s Use of Injunctions & Other Enforcement Methods, 31 Hastines we: £0) — RET Me eae AOD ER 33 T. Hazen, Tue Law or Securities ReauLaTIon a ec araaheaiioan 32,33 O. Holmes, The Theory of Legal Interpretation, 12 Harv. L. Rev. 417 (1898) Se, A. Jacobs, Litigation & Practice Unper Rue 10b-5 (2d ed. 1985) .... 19, 40 M. Kaminsky, An Analysis of Securities Litiga- tion Under Section 12(2), 13 Hovs. L. Rev. 231 (1976) 19, 43 D. Korn, A Taxing Quandry: Should Investors Deprived of Shelter Sue, Barron’s, Jun. a inlin 43 L. Loss, Securities Reauxiation (2d ed. 1961) ....... 33 J. Mertens, Law or Feperat Income TAXATION Sr aa 41 Note, Austin v. Loftsgaarden: Securities Fraud in Real Estate Limited Partnership Invest- ments, 16 Cretonton L. Rev. 1140 (1982) .........17, 28, 35 xii TABLE OF AUTHORITIES—-Continued Note, Insiders Liability under Rule 10b-5 for the Purchase of Actively Traded Securities, be 6p OS OS ee eee ea 23 Note, Real Estate Limited Partnerships & Al- locational Efficiency: The Incentive to Sue for Securities Fraud, 63 Va. L. Rev. 669 (3977) ...... in nani esldgiiels lca Ldleeidilicabieideoaiadedianines 12, 34, 35 RESTATEMENT (SECOND) OF TORTS (1979) oecceccocceccccosose 29, 31 S. Rep. No. 47, 73d Cong., Ist Sess. (1933), reprinted in 2 J. Ellenberger & E. Mahar, LEGISLATIVE History OF THE Securities ACT OF 1933 & THe Securitres Excuance Act or 1934 0 ERE ENES 5) SIT 11, 21, 33 sf & 2 -eee a OEP Tor AP Avo 32 R. Thompson, The Measure of Recovery under Rule 10b-5, 37 Vann. L. Rev. 349 (1984) ................ 31, 36 Tre, Nov. 26, 198¢4 ............... Pd SA ee ee 34 ~ Washimagtonm Post, Sram. 4, 1984 nnnceecceccecececnesoesnseeneenneenneenens 34 OPINIONS BELOW The en banc opinion ot the Eighth Circuit and the accompanying panel opinion (hereinafter ‘‘ Austin II1’’) are reported at 768 F.2d 949 and are set forth in Petition Appendix A. The unreported Amended Judgment and the unreported Order of the district court on a remand by the Kighth Cireuit on a prior occasion are set forth in Petition Appendices B and C. The earlier opinion of an- other panel of the Kighth Cireuit (hereinafter “ Austin I’’) is reported at 675 F.2d 168 and is set forth in Peti- tion Appendix D. The unreported Findings of Fact, Con- clusions of Law and Order for Judgment and the Memo- randum Order of the district court at the conclusion of the first trial are set forth in Petition Appendices FE and F. ra’ Vv JURISDICTIONAL STATEMENT The judgment of the Court of Appeals for the Kighth Cireuit was entered on July 16, 1985. The Petition for a Writ of Certiorari was filed on September 24, 1985, and was granted on November 12, 1985. (J.A.3). This Court’s jurisdiction is invoked pursuant to 28 U.S.C. § 1254(1). STATUTES AND REGULATION Section 12(2) of the Securities Act of 1933, 15 U.S.C. § 771(2): Any person who— (2) offers or sells a security ... by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral com- 1 2 munication, 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 omis- sion, 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 there- on, upon the tender of such security, or for damages if he no longer owns the security. Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78)(b) : 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 fa- cility of any national security exchange— * m7 * (b) To use or employ, in connection with the purchase or sale of any security . . . any ma- nipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the pub- lic interest or for the protection of investors. Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5: 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 security exchange, (a) To employ any device, scheme, or arti- fice to defraud, 3 (b) To make any untrue statement of a ma- terial fact or to omit to state a material fact nec- essary 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. Section 28(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78bb(a) : The rights and remedies provided by [the Se- eurities Exchange Act of 1934] shall be in addition to any and all other rights and remedies that may exist at law or in equity; but no person permitted to maintain a suit for damages under the provisions of [the Securities Exchange Act of 1934] shall re- cover, through satisfaction of judgment in one or more actions, a total amount in excess of the actual dam- ages on account of the act complained of. ra’ — STATEMENT OF THE CASE Petitioners are four investors who purchased one or more units! in Alotel Associates, a limited partnership formed to operate a Ramada Inn in Rochester, Minne- sota. (Pet.App.D1). Respondents are the individual and corporate general partners of Alotel Associates and their affiliates. (Pet.App.D3-D4). Respondents distributed an Offering Memorandum to potential investors, including Petitioners. (Pet.App. D7). The Offering Memorandum purported to describe the limited partnership, the Ramada Inn project, the terms available for financing the partnership’s activities and the timetable for constructing the Ramada Inn. (Pet.App.D7; ! The price of each unit was $35,000. (Pet.App.D7). + PLEx.2: Tr.42). The Offering Memorandum contained a pro forma projection of cash flow, of resale price and anticipated profit at the time of resale and of the tax consequences of a limited partner’s investment. (PLEx.2 at 27; Tr.42). The Offering Memorandum misrepresented the rate and amount of interest to be paid for construction finane- ing, the length of a ground lease, the completion date and the terms of financing available for furnishings and equip- ment. (Pet.App.D7-D8). The Offering Memorandum de- seribed a non-existent commitment for long-term financ- ing. (Pet.App.D8). The Offering Memorandum omitted in- formation about the control which Respondent B. J. Lofts- eaarden (hereinafter “Loftsgaarden”) exercised over Re- spondents Alotel Incorporated, Property Development and Research Company (hereinafter “PDRC”) and 2361 Build- ing Corporation (hereinafter ‘‘2361’’), about PDRC’s an- ticipated profits on a sale of land, about a commitment fee to be paid to PDRC, about Loftsgaarden’s interest in are-TECH. ine. a firm which was to design the Ramada Inn and to supervise its construction and about Lofts- caarden, PDRC, 2361 and are-TECH, ine.’s anticipated profits. (Pet.App.D9, E11). PDRC_ received $23,100 as a commitment fee and $57,390 for undisclosed purposes. (Pet.App.E11; PLEX 50: Def.Ex.41A; Tr.371,662). PDRC also earned a profit of between $37,388 and $54,078 on land transactions. (Pet. App.D9,E7; P1.Ex.51,55,56 ; Tr.372,398,403-07). 2361 re- ceived $35,000 as ‘‘contractor’s overhead,’’ $23,524 for ‘‘re- imbursement,’’ $449 for ‘‘general contracting services,”’ 3.972 for “eontracting work” and $2,349, $63,724 and 5 $38,041 for undisclosed purposes.” (Def. Fx.41B,41C,41E, 41F,41G6,41H,41J,41K ; Tr.662). Are-TECH, inc., received $90,000 for its services. (Pet.App.E7,E11). The limited partners’ investments and the available loans proved insufficient to construct and furnish the Ramada Inn. (Pet.App.D10). Alotel Associates had no initial operating capital. Alotel Associates was forced to obtain additional investors. (Pet.App.D10; P1.Ex.79; Tr. 672-73,693-94). The additional investments proved insuf- ficient, and the business continued to flounder. The in- vestors then made several loans to Alotel Associates.’ (Pet.App.F12). Alotel Associates ultimately defaulted on its loans and its rental payments, and its creditors foreclosed. (Pet.App.D10; P1.Ex.46; Tr.348,350,577). On February 24, 1976, Petitioners and others com- menced this action to recover their investments. (J.A.1; D.R.1-10). Their amended complaints alleged that Re- spondents had violated sections 12(2) and 17(a)* of the Securities Act of 1933, 15 U.S.C. §4§771(2) and 77q(a); section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5; and section 1 of the Minnesota Uniform Securities Act, Minn, Siat. § 80A.01 (1978), had committed a fraud under the common law of Minnesota, had been negligent and had breached fiduciary duties to Petitioners.’ (D.R.219-46,266-74). Petitioners alleged misrepresentations and omissions of material in- 2 Respondents had anticipated that 2361 would receive $316,572 as “overhead” and “contingency and profit.” (Pet. App.£5; PI.Ex.27 at 2; Tr.305). 3 The total loans “assessed” against each unit was $8,500. (PI.Ex.34-45; Tr.337,345,497). The district court dismissed Petitioners’ section 17(a) claim. Petitioners discontinued their negligence and breach of fiduciary duty claims at trial. (Tr.730). 6 formation. (DR.219-46,266-74). They sought rescission® or damages. (D.R.245-46,273-74). Respondents denied liability. (D.R.196-218). Respon- dents argued that reductions in Petitioners’ federal and state income tax liabilities which resulted from deductions Petitioners took as a result of operating losses sustained by and depreciation and investment credits attributable to Alotel Associates constituted “income received” and that section 12(2) mandated that “income received” be deducted from any recovery. (Pet.App.F5-F9). They also argued that the tax consequences reduced the “actual damages” to which Petitioners might be entitled under section 10(b) and Rule 10b-5. (Pet.App.F5-F9). The district court refused Respondents’ request to instruct the jury that it might reduce damages by “income tax benefits which [Petitioners had] obtained.” (D.R.365; Tr.740-42). Instead, the district court found that “the limited partnership units in Alotel Associates . . . were valueless” at the time Petitioners discovered the fraud. (Pet.App.£13). The district court therefore instructed the jury that Petitioners’ damages under section 10(b), Rule 10b-5, Minn. Stat. §¢80A.23 and common law fraud would “be equal to the amounts of monies which [Peti- tioners had] paid out in reliance upon the false representa- tions.” (Tr.805). The district court concluded that Peti- tioners were “entitled to recover the consideration [they had] paid for the limited partnership units” under section 12(2) and held that the ‘‘ out-of-pocket fand] rescissionary measures fof damages] would yield the same results.’ (Pet.App.F7). Based upon the jury’s verdict and its own findings, the district court awarded Petitioners Judgment 6 Petitioners had tendered their limited partnership units to Respondents. (Pet.App.D18,E14; Ct.Ex.2,3; Tr.626,629). 7 in amounts equal to the amounts of their investments plus interest’? on the amounts of their investments.’ (Pet.App. £16,F15-F 16). Respondents appealed, (J.A.2). An EKighth Circuit panel affirmed the jury’s and the district court’s findings of liability, but vacated and remanded to the district court for a new trial on the issue of damages. The panel held that in a private securities fraud action involving an in- vestment structured and marketed as a tax shelter, where a rescissory measure of damages is applied, evidence of any benefit derived by the plaintiff/ investor via tax savings must be permitted. Austin I at 183-84. The panel aslo held that ‘‘the dam- age award must be reduced by any value shown to have heen received by plaintiffs.’’ Austin I at 181. On remand, the district court stated: [T]he starting point for assessing damages will be the amount each plaintiff paid Loftsgaarden for his investment (in other words, the plaintiff’s consideration). To this, the court will add 8 per- cent 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 ccusideration and interest. (Pet.App.C5\. The district court then made the follow- ing calculations and awards: Plaintiff Anderson Consideration paid June 2, 1983: $35,000.00 Plus interest at 8 percent to February 22, 1984: $64, (87.00 Minus tax benefits: $29,615.00 Total Damages: $35,172.00 _ Interest was awarded pursuant to the statutory mandates in section 12(2) and in Minn. Stat. § 80A.23, subd 2. 8 The district court denied Petitioners a return of their “loans” to Alotel Associates. (Pet.App.A3,D10,E12,F12-F13). Plaintiff Austin Consideration paid June 6, 1983: $35,000.00 Plus interest at 8 per cent to February 22, 1984: $64,610.00 Minus tax benefits: $33,333.00 Total Damages: $31,277.00 Plaintiff Ne[u]mann Consideration paid August 21, 1973: $35,000.00 Plus consideration paid October 19, 1973: $17,500.00 Plus interest at 8 percent to February 2, 1984: $96,385.00 Minus tax benefits: $57,014.00 Total Damages: $39,371.00 Plaintiff Randall Consideration paid November 13, 1973: $35,000.00 Plus interest at 8 percent to February 22, 1984: $63,770.00 Plus consideration paid 1975: $ 2,512.00 Plus interest at 8 percent to February 22, 1984: $ 4,203.00 Subtotal: $67,973.00 Minus tax benefits: $36,404.00 Total Damages: $31,569.00 (Pet.App.B1-B2). Respondents again appealed. (J.A.3). The Eighth Circuit sua sponte granted en banc consideration as to whether Austin I should be reconsidered and as to whether damages had een caleulated properly if Austin I had been decided properly. Austin IJ at 951. The Eighth Cir- cuit then held that Austin I had been decided correctly. To compute the recovery the Eighth Cireuit adopted a formula: add interest to the consideration paid for the se- curity, subtract ‘‘tax benefits” received and imputed in- terest thereon, then multiply the difference by two. The Eighth Circuit therefore reduced the awards as follows: 9 Austin ($7,666), Anderson ($18,790), Neumann ($1,984) and Randall ($506). Austin I at 961. On September 24, 1985, Petitioners filed their Peti- tion for Writ of Certiorari. (J.A.3). On November 12, 1985, this Court granted the Petition. (J.A.3). SUMMARY OF THE ARGUMENT I. In interpreting the federal securities laws, this Court has always started with the statutory language. See Landreth Timber Co. v. Landreth, 105 8. Ct. 2297, 2301 (1985): Teamsters v. Daniels, 439 U.S. 551, 558 (1979) ; Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976) ; Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 756 (1975) (econeurring opinion). The language of section 12(2) of the Securities Act of 1933 [hereinafter ‘‘section 12(2)’’] does not provide that the recovery of ‘‘considera- tion paid’’ be reduced by ‘‘tax benefits.’? The ‘‘actual damages’’ limitation of section 28(a) of the Securities Ex- change Act ef 1934 [hereinafter “section 28(a)’’] does not require that ‘‘tax benefits’? be subtracted from damages awarded under section 10(b) of the Securities Exchange Act of 1934 [hereinafter ‘‘section 10(b)’’] and Securities and Exchange Commission Rule 10b-5 [hereinafter ‘‘Rule 10b-5’’]. The Eighth Cireuit strayed from the approp- riate starting point when it deducted ‘‘tax benefits’? from recoveries under such statutes. The Eighth Circuit first strayed from the statutory language by distinguishing between ‘‘tax shelters’’ and other securities and by adopting a rule which applies only to “tax shelters.’? Section 12(2), section 10(b), Rule 10b-5 and section 28(a) apply to all securities. There is no sta- 10 tutory language on which a special rule applicable only to ‘‘tax shelters’’ might be based. The Eighth Circuit next strayed from the statutory language by defining ‘‘income received’’ to include ‘‘tax benefits.’’ In United Housing Foundation, Inc. v. For- man, 421 U.S. 837, 855 (1975), this Court held that ‘‘pay ment of interest, with its consequent deductibility for tax purposes,’’ did not constitute income within the context of the federal securities laws. In fact, ‘‘income’’ is compensation for services, . . . gross income derived from business, gains derived from dealings in prop- erty, interest, rents, royalties, dividends, . . . income from discharge of indebtedness [and] distributive share of partuership gross income. 26 U.S.C. 461. “Tax benefits’? are not included in the plain language of the statutory definition of ‘‘income.’’ ‘‘Income”’ is taxable. See 26 U.S.C. §§ 1 & 11. ‘“Tax bene- fits’? are not. Because ‘‘tax benefits’’ are not ‘‘income,’’ they should not be deducted from ‘‘consideration paid’’ when caleulating the recovery available to a defrauded investor under section 12(2). The Eighth Cirenit also strayed from the statutory language by awarding interest on the “tax benefits.’’ Such an award rewrites ‘‘the remedial language of the statute.’’ Johns Hopkins Univ. v. Hutton, 297 F. Supp. 1165, 1231 (D. Md. 1968), rev’d on other grounds, 422 I" 2d 1124 (4th Cir. 1970), cert. denied, 416 U.S. 916 (1974). Section 12(2) provides only for adding ‘‘interest’’ to the ‘consideration paid.’’? The courts are not free to substi tute their wisdom for the statutory language. /d. The Kighth Cireuit again straved from the statutory language in interpreting the ‘‘actual damages”’ provision of section 28(a). The term ‘‘actual damages’’ appears only in the context of authorizing parallel state and fed 11 eral remedies. It was designed only to prevent duplica- tive recoveries based on state and federal law. F.9., Osof- sky v. Zipf, 645 F.2d 107, 111 (2d Cir. 1981). Il. The rule of Hanover Shoe, Inc., v. United Shoe Mach. Corp., 392 U.S. 481, 503 (1968) and of Norfolk & W. Ry. v. Liepelt, 444 U.S. 490, 493-94 (1980) that taxes are to be taken into account in calculating the amount of recov- ery only when the recovery is tax-free remains sound. An ” investor in a ‘‘tax shelter” defers the payment of taxes. When the ‘‘tax shelter’’ is concluded, the investor must pay the taxes which he deferred. Because of changes in the investor’s other income, changes in the Internal Rev- enue Code and variations in applicable marginal rates, the amount of taxes the investor actually pays in a later year may be greater or less than the amount would have been at the time the taxes would have been due but for the ‘‘tax shelter.’’ The ‘‘rough result of not taking account of taxes for the year of injury but then taxing recovery’’ is ‘‘the most satisfactory outeome.’’ Hanover Shoe, Inc. v. United Shoe Mach. Corp., 392 U.S. at 503. III. The purpose of the Securities Act of 1933 is to protect the investing public and honest business. The aim is to prevent further exploitation of the public by the sale of unsound, fraudulent, and worth- less securities through misrepresentation; to place adequate and true information before the investor; to protect honest enterprise, seeking capital by honest presentation, against the competition afforded by dis- honest securities offered to the public through crooked promotion .... S. Rep. No. 47, 73d Cong., Ist Sess. 1 (1933), reprinted in 2 J. Ellenberger & E. Mahar, Lecistatrve History oF THE Securities Act or 1933 & tHe Securttres ExcHANGE Act or 1934 (1973); see also United States v. Naftalin, 441 U.S. 768, 775 (1979); SEC v. Capital Gains Research Bur- 12 eau, Inc., 375 U.S. 180, 186-87 (1963). There is ‘‘no war- rant for narrowing’’ the safeguards created by Congress. See United States v. Gilliland, 312 U.S. 86, 93 (1941). The Eighth Cireuit saw the function of section 12(2), section 10(b) and Rule 10b-5 only as one of compensating defrauded investors “for any actual monetary loss.”’ Even if it were true that an award of $506 as of December 15, 1983, fully compensated an investor’s actual monetary loss which had resulted from investing $35,000 in a worth less security on November 13, 1973, the award would not accomplish the statute’s purpose in deterring fraud. Fraud can be deterred only if investors have sufficient incentives to seek a recovery and thus to compel promoters to pay damages in amounts large enough to induce full dis- closure. F. Easterbrook & D. Fischel, Optimal Damages im Securities Cases, 52 U. Cur L. Rev. 611, 620 (1985). The threat of civil liability is an important mechanism for coercing adewuate disclosure. Only if the sanction of civil liability is sufficiently serious (and the damages suf ficiently high) will fraud be deterred and accurate and complete information be provided to prospective invest ors. Note, Real Estate Limited Partnerships & Alloca- tional Efficiency: The Incentiwe to Sue for Securities Fraud, 63 Va. L. Rev. 669, 685 (1977). ARGUMENT I. THE INTERPRETATION OF SECTION 12(2) AND THE CALCULATION OF DAMAGES UN- DER SECTION 10(b) AND RULE 10b-5 MUST BE CONSISTENT WITH THE LANGUAGE OF THE STATUTES AND THE RULE. ‘‘The starting point’’ for the imterpretation of the federal securities laws ‘‘is the language [of the statute | 13 itself.’ Blue Chip Stamps v. Manor Drug Stores, 421 U.S. at 756 (concurring opimon); accord, Landreth Tim- ber Co. v. Landreth, 105 S. Ct. at 2301; Teamsters v. Dan- tels, 429 U.S. at 558; Ernst € Ernst v. Hochfelder, 425 U.S. at 197. In attempting to interpret section 12(2) and to define the damages which section 28(a) permits to be re- covered under section 10(b) and Rule 10b-5, the Eighth Cireuit started at the wrong point. It disregarded the clear language and effectively rewrote the statutes un- der the guise of interpreting them. When a court sets out to interpret a statute, it is to determine ‘‘only what the statute means.’’ O. Holmes, The Theory of Legal Interpretation, 12 Harv. L. Rev. 417, 419 (1898); see also S & E Contractors, Inc. v. United States, 406 U.S. 1, 14 n.9 (1972). If the language of a statute is plain, it is the duty of a court to enforce the statute as written. United States v. Standard Brewery, Inc., 251 U.S. 210, 217 (1920). Absent a clearly expressed legislative intent to the contrary, the language of a statute must ordinarily be regarded as conclusive. Consumer Prod. Safety Comm’n v. GTE Sylvania, Inc., 447 U.S. 102, 108 (1980). ‘‘In construing a federal statute it is approp- riate to assume that the ordinary meaning of the language that Congress employed ‘accurately expresses the legis- lative purpose.’ ’’ Mills Music, Inc. v. Snyder, 105 8. Ct. 638, 645 (1985). A. There Is No Statutory Basis For Differentiat- ing Between “Tax Shelters’ And Other Se- curities. Section 12(2) applies to all fraudulent sales of “a security” and provides the same remedy to all defrauded purchasers. Section 10(b) and Rule 10b-5 apply to “the purchase or sale of any security.” Section 28(a) applies 14 to all suits for damages under section 10(b) and Rule 10b-5. Section 12(2), sections 10(b) and 28(a) and Rule LOb-5 say nothing about a special rule for suits seeking recovery on account of frauds related to “tax shelters.” The Eighth Cireuit held 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 via tax savings must be per- mitted. Austin I at 183-84. The Eighth Cireuit expressly re- stricted its holding “to cases involving investments that are expressly marketed and sold as tax shelters.”? Austin I at 183; accord, Austwm II at 954 (holding applies only to “special case of tax shelter investments”). Alotel Associates does not meet the definition of a “tax shelter” established by the Internal Revenue Code. See 26 U.S.C. § 6111(c)(1) (“tax shelter’’ means an investment represented as providing a ‘tax shelter ratio’ for an investor “sreater than 2 to 1” during any of first 5 years). The Of- fering Memorandum projected investment, deductions and credits as follows: Year Investment Deductions Credits 1973 $35,000 $20,395 $2,432 1974 14,695 1975 2,960 1976 476 1977 ( 1,929) (PI.Ex.2 at 27; Tr.42). Thus, the “tax shelter ratio” during the first 5 years was to be Year Ratio 1973 72/1 1974 1.14/17 1975 1.23/1 1976 1.24/1 1977 1.18/1 See 26 U.S.C. § 6111(c)(2). Because the ratio was never rep- resented as reaching 2 to 1, an investment in Alotel Asso- ciates could not be characterized as a ‘tax shelter.” 15 That holding creates a distinction with no statutory basis. If there were to be a rule that “income” under section 12(2) ineludes “tax benefits” and that damages under section 10(b) and Rule 10b-5 must be reduced by ‘‘tax benefits,’’ the rule should apply to all cases. There is no basis for distinguishing a fraudulent sale of a se- curity “structured and marketed as a tax shelter” from a fraudulent sale of a security not so structured and mar- keted. Common stock, if it becomes worthless, generates a “tax benefit” for the investor. Yet, if the investor had purchased the stock in reliance on a misrepresentation and if the stock had become worthless, the Eighth Circuit would not reduce his recovery on account of the “tax benefits” he had obtained.” The Eighth Circuit justified its distinction on the ground that the “tax benefits” were “bargained for.” Aus- tin IIT at 955. That justification ignores the obvious: every purchase of a security includes a “bargain” con- cerning the tax consequences. Every purchaser knows of and accepts the holding period for capital gains treatment, the deduction available if the security becomes worthless 10 An investor receives “tax benefits” in a variety of circum- stances involving purchases of securities. He is permitted to take a loss when a security, i.e., stock, bond, debenture or note, becomes worthless. See 26 U.S.C. § 165(g). He is permitted to reduce his taxable income on account of con- tributions to an individual retirement account, see 26 U.S.C. § 219, on account of a qualified reinvested stock dividend, see 26 U.S.C. § 305(b), on account of a contribution by a self-employed person to a pension or profit-sharing plan, see 26 U.S.C. $401(c), and on account of a qualified cash arrangement by which he directed an employer to con- tribute to a qualified trust. See 26 U.S.C. § 401(k). He is permitted to elect to have a tax-exempt organization which employs him reduce his income and use the monies to purchase an annuity for him. See 26 U.S.C. § 403(b). Such deductions defer taxes in the same manner as does a “tax shelter” and thus create “tax benefits.” 16 or is sold at a loss, ete. The purchase of a “tax shelter” differs only in the specifies of the “tax benefits” that were bargained for. B. The Language Of Section 12(2) Does Not Al- low Deduction Of “Tax Benefits’ From A De- frauded Purchaser’s Recovery. Section 12(2)’s language is straightforward. The statute allows a defrauded purchaser to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security. The measure of recovery for a defrauded purchaser who still owns the security has three elements: (1) the con- sideration paid, (2) interest on the consideration and *) a ° . io} LNnecomMe Tecely ed. 1. “Tax Benefits” Are Not “Income.” The district court attempted to use “the ordinary meaning” of the term “income” in interpreting section 12(2). Cf. Mills Music, Inc. v. Snyder, 105 S. Ct. at 645. The district court found that there had been a timely tender of the limited partnership units, concluded that rescission was appropriate and refused to reduce the re- covery under section 12(2) on account of “tax benefits.” (Pet.App.D10,D17,F15-E16). The Fighth Cireuit rejected the district court’s literal reading of section 12(2). Although it acknowledged that tax benefits received were not a form of income in a strict accounting sense, Austin II at 955, the Eighth Cireuit nev- ertheless held that section 12(2)’s language “income recewed thereon” may properly be construed as including tax benefits bargained for and received . . . Austin II at 958 (emphasis in original). 17 The Eighth Cireuit disregarded “the ordinary mean- ing” of the word “income.” “Income” normally means “gain derived from capital, from labor, or from both com- bined.” Eisner v. Macomber, 252 U.S. 189, 207 (1920). “Tax benefits” are not gain derived from capital or labor. In interpreting a term, courts are to use a “well- settled meaning” if one exists. See Landreth Timber Co. v. Landreth, 105 S. Ct. at 2302. ‘‘Income” carries a ‘‘well- settled meaning.” 26 U.S.C. 461 establishes the meaning of “income”: compensation for services, . .. gross income derived from business, gains derived from dealings in prop- erty, interest, rents, royalties, dividends, . . . income from discharge of indebtedness [and] distributive share of partnership gross income. “Tax benefits” are not included within that “well-settled meaning’’ of ‘‘income.’’” Courts also look to “significant characteristics typi- cally associated with” terms in attempting to interpret them. See Landreth Timber Co. v. Landreth, 105 S. Ct. at 2302; United Housing Foundation, Inc. v. Forman, 421 U.S. at 851. “Income” has “significant characteristics.” One of those characteristics is taxability. “Tax benefits,” of course, are not taxable. If deductions were “income,” every taxpayer who took a deduction in one year would be required to include it within “gross income” on the fol- 11 One commentator noted that “Austin /1/ is without prece- dent in classifying tax benefits received by the plaintiff as ‘income’ within the meaning of section 12(2).” Note, Aus- tin v. Loftsgaarden: Securities Fraud in Real Estate Limited Partnership Investments, 16 CREIGHTON L. REV. 1140, 1151 (1982). Although “income” expressly includes a “distributive share of partnership gross income,” 26 U.S.C. § 61(a)(1), it does not include “tax benefits’ attributable to a distributive share of partnership losses. 12 18 lowing year’s tax return. Austin IJ at 963 n.1 (dissenting opinion). No reported case or revenue ruling construes a deduction or credit as “income.” See 26 U.S.C. § 61. In United Housing Foundation, Inc. v. Forman, 421 U.S. 837, this Court considered whether non-interest bear- “ ing shares in a non-profit housing cooperative were “in- vestment contracts” and therefore “securities.” as that term is used in section 2(1) of the Securities Act of 1933. ** An “investment contract” requires an “expectation of profits.” The sellers therefore argued that the purchasers had bought the shares to obtain housing, not to obtain income or profits. The court of appeals disagreed, hold- ing that profit might “be derived from the income yielded by an investment,” id. at 855, and that one source of such income was “tax deductions for the portion of the monthly rental charges allocable to interest payments on the mort- gage.” Id. at 846. This Court reversed, stating that the conclusion that ‘ tax deductions are a “supposed source of income or profits may .e disposed of summarily.” /d. at 855. It held that income or profits means “either capital appreciation re- sulting from development of the initial investment or a participation in earnings resulting from the use of the investors’ funds,” td. at 852, and concluded: We know of no basis in law for the view that the pay- ment of interest, with its consequent deductibility for tax purposes, constitutes income or profits. Respondents themselves did not argue that tax benefits constituted income. Austin II at 958 (“Loftsgaarden argues that . . . tax benefits are a return of ‘consideration paid’ ”’). Respondents’ own expert also testified that “tax benefits’ were not “income.” (R.178). The district court took “ju- dicial notice that [Randall] didn’t receive any income.” (R.179). 19 Id. at 855. If “tax benefits” do not constitute income or profits under section 2(1), then “tax benefits” should not be considered income under section 12(2)." “Tneome,” as used in section 12(2), does not include every favorable economic consequence. In Johns Hop- kins Univ. v. Hutton, 297 F. Supp. at 1232, payments made by the seller to defrauded purchasers intended to be ap- plied to taxes were held not to be “income” under section 12(2). See also M. Kaminsky, An Analysis of Securities Intigation under Section 12(2), 13 Hous. L. Rev. 231, 281 (1976); 5C A. Jacobs, Litigation & Practice Unprer Rute 10b-5 § 260.03[e] [vi] at 11-56 n.3 (2d ed. 1985) ; 26 U.S.C. § 61. The Eighth Circuit rationalized that its expansive in- terpretation of “income” reflected “economic reality” and that to ignore “tax benefits actually realized . . . would be unrealistic.” Austin IT at 955 & n.9. That rationaliza- tion flies in the face of a cardinal principle of rescission: “(tlhe goal of rescission under section 12(2) is to return the parties to the status quo ante.’’ Austin II at 954. The Kighth Circuit purports to return Petitioners to the status quo ante, but it never purports to return Respondents to the status quo ante or to require them to disgorge their unlawfully obtained profits. As the dissent noted: There was evidence at trial showing Loftsgaarden received over $100,000 profit from the investment scheme. Under the majority’s approach, Loftsgaarden 4 ~The Eighth Circuit tried to distinguish United Housing Foundation by characterizing the tax benefits at issue there as “marginal” and those now at issue as “the primary mo- tivation behind the investment.” Austin // at 955. Such a distinction should be of no consequence. Nothing in sec- tion 12(2) contemplates substracting substantial ‘tax bene- fits” from damages but ignoring marginal ones. 20 gains both his own profit from the scheme and the advantage of plaintiffs’ speculative tax benefits.” Austin II at 963 (dissenting opinion). The Eighth Cireuit’s rationalization also assumes that “tax benefits” would provide a “windfall” to defrauded purchasers unless those ‘‘tax benefits’? were deducted from their recoveries. The Eighth Cirenit therefore chose to award the ‘‘windfall’’ to defrauding sellers. Even if a de- frauded purchaser were to obtain a windfall, it would be ‘‘more appropriate to give the defrauded party the benefit even of windfalls than to let the fraudulent party keep them.’ Myzel v. Fields, 386 F.2d 718, 747 (8th Cir. 1967), cert. denied, 390 U.S. 951 (1968) ; Janigan v. Taylor, 344 F. 29d 781, 786 (1st Cir.), cert. denied, 382 U.S. 879 (1965) ; see also Gerstle v. Gamble-Skoqmo, Inc., 478 F.2d 1281, 1305 (2d Cir. 1973); Johns Hopkins Univ. v. Hutton, 297 F. Supp. at 1226. The Fighth Cireuit’s rationalization also ignores the legislative history. That history demonstrates that a de- frauded purchaser is to obtain his recovery from the seller. H.R. Rep. No. 85, 73d Cong., 1st Sess. 9 (1933), reprinted in 2 J. Ellenberger & E. Mahar, Leerstative History or rue Securities Act or 1933 & THE Securitres ExcHANGE Acr or 1934 (1973) (defrauded purchaser can ‘‘sue for re- covery of his purchase price’’); S. Rep. No, 47, 73d Cong. Ist Sess. 15 The evidence showed that PDRC received no less than $80,490, that 2361 received no less than $213,334 and that arc-TECH, inc., received $90,000. 16 = Petitioners will get no windfall. Any recoveries will be subject to tax. Furthermore, it would be reasonable to assume that if plaintiffs had not invested in Loftsgaarden’s fraudulent scheme, they would have invested in another legitimate project which would have returned similar tax benefits as well as principal and interest over the life of the investment. .. . Austin II at 964 n.2 (dissenting opinion). 21 6 (1933), reprented m 2 J. Ellenberger & E. Mahar, Lects- LATIVE History or THE Securities Act or 1933 & THE Securities Exonance Acr or 1934 (1973) (defrauded pur- chaser can “sue for a return of his money’) ; 77 Cong. Ree. 2913 (1933) (defrauded purchaser can get his ‘‘money back” from seller). 2. ‘‘Interest’’ Should Not Be Added To ‘‘Tax Benefits” Even If “Tax Benefits” Were To Be Considered ‘‘Income Received.’’ The Eighth Cireuit compounded its error by subtract- ing interest on the ‘‘tax benefits” from the ‘‘consideration paid.” Austin II at 959. That further reduces a de- frauded purchaser’s recovery under section 12(2). After remand, the district court had stated: The clear language of [section] 12(2) presents the order in which to consider these items: “considera- tion paid . . . with interest thereon, less the amount of any income received... .” These words present an express directive to this court, and [the] defend- ant[s] cite no eases directly on point which hold to the contrary. (Pet.App.C7). The Eighth Cireuit reversed. It con- ceded that the result of its holding as to section 12(2) was to permit a defrauded purchaser “to recover the amount paid for [the security] with interest, less the amount received with interest.” Austin IT at 959, quoting Murphy v. Cady, 30 F. Supp. 466, 470 (D. Me. 1939), aff'd 113 F.2d 988 (1st Cir.), cert. dented, 311 U.S. 705 (1940). Section 12(2) mandates recovery of “the considera- tion paid for the security with interest thereon, less the amount of any income received thereon.” The Eighth Cir- euit effectively rewrote the latter portion of the statute to read “less the amount of any income received thereon 22 with interest thereon.” The words “interest thereon” mod- iiy only “consideration paid.” The word “thereon” has no other antecedent. Interest is to be added only to the ‘‘consideration paid,’’ and ‘‘income received’’ is then to be subtracted from the sum. See Johns Hopkins Univ. »v. Hutton, 297 F. Supp. at 1231 [adding interest to ‘‘in- come received” under section 12(2) would be proper only if court had ‘‘power, to in effect, rewrite the remedial lan- cnace of the statute’). C. Nothing In Section 28(a) Justifies Reducing Dam- ages Under Section 10(b) And Rule 10b-5 By “Tax Benefits.’’ Damages under section 10(b) and Rule 10b-5 are lim- ited by section 28(a). Section 28(a) provides: The rights and remedies provided by [the Securi- ties Exchange Act of 1934} shall be in addition to any and all other rights and remedies that may exist at law or in equity; but no person permitted to maintain a suit for damages under the provisions of [the Securi- ties Exchange Act of 1934] shall recover, through sat- isfaction of judgment in one or more actions, a total amount in excess of his actual damages on account of the act complained of . . The Eighth Cireuit concluded that ‘‘a plaintiff can recover no more than his ‘net economic loss’ ’’ and held that ‘‘net economic loss’’ was to be equated with ‘‘actual damages.”’ Austin IT at 954; accord, Salcer v. Envicon Equities Corp., 744 F.2d 935, 940 (2d Cir. 1984), petition for cert. filed, 53 U.S.L.W. 3688 (U.S. Mar. 13, 1985) (No. 84-1447). That interpretation begs the question of what is in- tended by the term ‘‘actual damages.’’ A careful examin- ation of section 28(a) and of other statutes that use the term and a review of judicial construction of the term demonstrate that ‘‘actual damages” does not require a reduction of damages on account of ‘‘tax benefits.’’ 23 First, the sentence structure of section 28(a) suggests that Congress meant only to prevent duplicative recoveries when a plaintiff asserted a state law claim as well as a federal securities law claim. The first clause of section 28(a) provides that federal remedies do not preempt state remedies. The phrase ‘‘actual damages’’ prevents a plaintiff from recovering more than once if he pursues both federal and state causes of action.” F.g., Osofsky v. Zipf, 645 F.2d at 111. Second, although Congress did not define the term ‘‘actual damages’’ when it enacted section 28(a), the term already had an accepted meaning. The term was used in statutes governing patent, copyright and trademark in- fringement. See 35 U.S.C. § 67 (1928); 17 U.S.C. § 25 (1928); 15 U.S.C. §§ 16-19 (1928). This Court had defined the term ‘‘actual damages,’’ as used in the patent statutes, to require damages to be ‘‘viven as a compensation, recompense, or satisfaction to the plaintiff, for an injury actually received.’ Birdsall v. Coolidge. 92 U.S. 64 (1876). The copyright and trademark statutes allowed a plaintiff to recover both his ‘‘injury”’ and the infringer’s ‘‘profits’’ and equated ‘‘injury” and ‘‘profits’’? with ‘‘actual damages.’’ See 17 U.S.C. § 25 (1928); 15 U.S.C. § 19 (1928). In L. P. Larson, Jr., Co. v. William Wrigley, Jr., Co., 277 U.S. 97 (1928), this Court refused to deduct income taxes from a recovery for trademark infringement. This Court held: To review one of these questions a writ of certiorari was granted by this court. That question is whether 17 A strict construction of section 28(a), which refers only to “a suit for damages,” may preclude any limitation on the equitable remedy of rescission. See Note, Insiders Liability under Rule 10b-5 for the Purchase of Actively Traded Se- curities, 78 YALE L.J. 864, 874 n.51 (1969). 24 . . the Wrigley Company should be allowed to deduct the Federal income and excess profits taxes from the profits with which it is to be charged. Even if the only relief that the Wrigley Company can get is a deduction from gross income when the amount of its hability is finally determined, the Larson Com- pany will have to pay a tax on the Wrigley profits when it receives them, and in a case of what has been found to have been one of conscious and deliberate wrongdoing, we think it just that the further deduc- tion should not te allowed. Id. at 99-100. Thus, when the Securities Exchange Act of 1934 became law, the term ‘‘actual damages’’ did not re- quire damages to be reduced because of tax consequences.'* The reasoning behind the judicial refusal to credit an infringer with the taxes paid on the profits being recovered in patent, copyright and trademark cases applies equally to securities fraud cases. Recovery for patent, copyright or trademark infringement is not reduced by income taxes .. . since plaintiffs will be required to pay income taxes on any amount recovered and should not have that amount diminished... . Carter Prod., Inc. v. Colgate-Palmolive Co., 214 F. Supp. 383, 406 (D. Md. 1963). Recoveries in securities fraud cases are also taxable and also should not.be diminished. 18 Subsequent patent, copyright and trademark cases contin- ued to apply the rule and refused to consider tax conse- quences when computing damages. See, e.g., Wolf v. Nat- ional Lead Co., 272 F.2d 867, 873 (9th Cir. 1969) (income taxes paid by infringer are not a proper deduction when accounting for a trademark infringer’s profit); Alfred Bell & Co. v. Catalda Fine Arts, Inc., 191 F.2d 99, 106 (2d Cir. 1951) (error to allow deduction when accounting for a copy- right infringer’s profits); Sheldon v. Metro-Goldwyn Pic- tures Corp., 106 F.2d°45, 53 (2d Cir. 1939), aff'd, 309 U.S. 390 (1940); Goodyear Tire & Rubber Co. v. Overman Cush- ion Tire Co., 95 F.2d 978, 985 (6th Cir. 1937) (no deduction from profits for income taxes paid by patent infringer). 25 Third, deducting tax benefits from damages gives a defrauder the benefit of provisions of the Internal Rev- enue Code that were structured to benefit investors. The Eighth Cireuit expressed concern that, if Respondents were to retain the ‘‘tax benefits,’’ Respondents would reap a windfall, t.e., something in excess of their ‘‘actual dam- ages.’’ This Court has not seen fit to interpret ‘‘actual damages’’ to restrict recoveries in any such way. In 4ffili- ated Ute Citizens v. United States, 406 U.S. 128 (1972), defrauded sellers sought to recover profits earned by the defrauder. The defrauder objected that such a recovery was precluded by the ‘‘actual damages’’ limitation of sec- tion 28(a). This Court held that the ‘‘actual damages’’ limitation does not prevent recoveries constituting ‘‘more than the [defrauded] seller’s actual loss’’ in actions under section 10(b). Jd. at 155. Thus the ‘‘actual damages’’ limitation does not pre- vent a plaintiff from recovering a ‘‘windfall,’”’ Myzel v. Fields, 386 F.2d at 747; Janigan v. Tayior, 344 F.2d at 786, nor does it prevent a plaintiff from recovering more than his ‘factual loss.’’ Affiliated Ute Citizens v. United States, 406 U.S. at 155. Neither should the limitation pre- vent a plaintiff from recovering damages in reduction by ‘*tax benefits.’’ II. PERMITTING DEFRAUDED PURCHASERS TO RECOVER THEIR ‘‘CONSIDERATION PAID . . . WITH INTEREST” WITHOUT A REDUC- TION FOR “TAX BENEFITS” IS CONSISTENT WITH PRECEDENT. A. The Eighth Circuit’s Decision Fails To Defer To This Court’s Precedent. The Eighth Cireuit’s decision that recoveries for se- , curities fraud must be reduced by ‘‘tax benefits’? canuoi he reconciled with this Court’s decisions. The impact of 26 taxes on recovery is the subject of a number of significant opinions. In Hanover Shoe, Inc. v. Umted Shoe Mach. Corp., 392 U.S. 481, this Court first addressed a party’s argument part; gi that an adversary’s damages must be reduced to the “aft- er-tax profits that [the adversary] failed to receive.’’ Jd. at 503. This Court held that to diminish the actual damages by the amount of taxes that [a plaintiff] would have paid had it received greater profits in the years it was damaged would be to apply a double deduction for taxation, leaving [the plaintiff] with less income than it would have had if [the defendant] had not injured it. Id. This Court, recognizing the changing rates of tax- ation, expired statutes of limitation and difficulties in re- computing taxes that would have accrued over a period of years, stated that the rough result of not taking account of taxes for the year of injury but then taxing recovery when received seems the most satisfactory outcome, id., and held that damages should equal pre-tax profits and that the IRS should be permitted to tax the recovery. Id. In Norfolk € W. Ry. v. Lrepelt, 44 U.S. 490, this Court held that it was necessary to instruct a jury that a dam- age award would not be taxable. Jd. at 4°1. This Court recognized that an injured individual’s after-tax income, not his gross income before taxes, was the relevant factor in calculating the damages sustained by his dependents when he died. Jd. at 493-94. This Court again recognized the complexities in predicting the many variables; never theless, it held that the danger of overcompensation based on an erroneons assumption concerning taxability required the admission of expert testimony concerning income tax 27 liability for future wages and the giving of an instruction that a judgment would not be taxable. Jd. at 497-98. In Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523 (1983), this Court offered guidance to those seeking to reconcile Hanover Shoe with Liepelt. This Court stated that, when the damages award itself is to be tax-free, the evidence to be considered is that concerning ‘‘after-tax’’ amounts. It implied that, when the damage award itself is taxable, evidence of taxes paid or to be paid should be excluded. fd. at 547-51. The Eighth Cireuit applied Litepelt to Petitioners’ claims for damages even though it recognized that each would ‘‘have to pay taxes on his award.’’ The Eighth Cireuit failed to consider Hanover Shoe or Pfeiffer. In doing so, the Eighth Cireuit glossed over Liepelt’s predi- cate that its holding applied only when an award of dam- ages is not taxable. B. The Eighth Circuit’s Decision Fails To Defer To Other Precedent. Jourts interpreted the federal securities laws and provided remedies to defrauded purchasers for over thirty years before the deductibility of tax benefits surfaced as an issue in a reported decision. See Cooper v. Hallgarten € Co., 34 F.R.D. 482 (S.D.N.Y. 1964). When defendants first argued that a plaintiff’s recovery should be reduced by an amount equal to the tax benefits flowing from an investment, court uniformly rejected those arguments. See, e.g., Rhode v. Hershberger Explorations, Inc., 349 F. Supp. 993, 994 (D. Minn. 1972); Johns Hopkins Univ. v. Hutton, 297 F. Supp. at 1232; Wiesenberger v. W. E. Hut- ton & Co., 35 F.R.D. 556, 557 (S.D.N.Y. 1964); Cooper v. Hallgarten & Co., 34 FR.D. at 484; see also Chris-Craft Indus., Inc., v. Piper Aircraft Corp., 480 F.2d 341, 391 28 (2d Cir.), cert. denied, 414 U.S. 910 (1973) (‘‘party seek- ing rescission must return any proceeds... received from the transaction being rescinded [but] the proceeds that must be returned are [only] those received from the other party’’). Some courts eventually permitted discovery concern- ing ‘‘tax benefits’’ because information discovered might be relevant to issues other than damages. Courts which permitted such discovery considered it relevant to valua- tion of the investment, see Dupuy v. Dupuy, 551 F.2d 1005, 1025 (5th Cir.), cert. dented, 434 U.S. 911 (1977); Smith v. Lader, 83 F.R.D. 4387, 439 (S.D.N.Y. 1979); cf. Berg v. Xerxes-Southdale Office Bldg. Co., 290 N.W.2d 612, 615 (Minn. 1980), to misrepresentation of tax benefits, Bridgen v. Scott, 456 F. Supp. 1048, 1062 (S.D. Tex. 1978) ; Bayoud v. Ballard, 404 F. Supp. 417, 426 (N.D. Tex. 1975), to causation, see Houlihan v. Anderson-Stokes, Inc., 78 F.R.D, 232, 234 (D.D.C. 1978), to reliance, see Smith v. Bader, 83 F.R.D. at 439; Sharp v. Coopers & Lybrand, 83 I’. R.D. 343, 352 (E.D. Pa. 1979), rev’d on other grounds, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982), and to laches. See Hickman v. Groesbeck, 389 F. Supp. 769, 780 (D. Utah 1974). Other courts continued to consider tax benefits wholly irrelevant. E.9., Spatz v. Borenstein, 513 F. Supp. 571, 576-86 (N.D. Ill. 1981); see also Borovoy v. Bursar Realty Corp., 86 Mich. App. 732, 738, 273 N.W.2d 545, 548 (1979) (tax consequences ‘‘do not enter into the computation of damages’’ under Michi gan’s securties laws); G & R Corp. v. American Sec. Trust Co., 523 F.2d 1164, 1173-74 (D.C. Cir. 1975) (con tract damages not to be offset by tax benefits). The Eighth Cireuit was the first to require that a recovery be reduced by tax benefits. Austin I at 183; Note, Austin v. Loftsgaarden: Securities Fraud in Real Estate ee ee ee Cet ee —— ee ee en ee —_— 29 Iimited Partnership Investments, 16 Creicuton L. Rev. at 1151. Most other courts rejected the Highth Cir- euit’s approach. E.g., Western Fed. Corp. v. Erickson, 739 F.2d 1489, 1444 (9th Cir. 1984); Burgess v. Premier Corp., 727 F.2d 826, 837-38 (9th Cir. 1984); Koehler v. Pulvers, [Current] Ferp. Sec. L. Rep. (CCH) { 92,232 at 91,671 (S.D. Cal. 1985); Hokama v. EF. F. Hutton & Co., 566 F. Supp. 636, 847-48 (C.D. Cal. 1983); see also Eisen- berg v. Gagnon, 766 F.2d 770, 782 (3d Cir. 1985) (deduct- ibility of losses net to be considered in assessing damages) ; Danzig v. Jack Grunberg & Assoc., 161 Cal. App. 3d 1128, 1139-40, 208 Cal. Rptr. 336, 343-44 (1984), cert. denied, 106 S. Ct. 67 (1985) (limited partners’ tax consequences ir- relevant to their rescissionary recovery based upon mis- representation); Harris v. Metropolitan Mall, 112 Wis. 2d 487, 501-02, 334 N.W.2d 519, 526 & n.21 (1983) (tax consequences of ‘‘tax shelter’’ do not reduce restitutionary recovery). The Second Circuit, however, adopted the Eighth Cirevit’s approach. See Freschi v. Grand Coal Venture, 767 F.2d 1041, 1050-51 (2d Cir. 1985), petition for cert. filed, 54 U.S.L.W. 3154 (U.S. Sent. 6, 1985) (No. 85- 377); Salcer v. Envicon Equities Corz., 744 F.2d at 940-44. C. Deducting “Tax Benefits” From Recoveries For Securities Fraud Disregards The Collat- eral Source Rule. The Eighth Cireuit’s decision vitiates the ‘‘collateral source’’ rule. The rule is set forth in RestaTeEMENT (SEc- onpD) or Torts § 920A(2) (1979): Payments made to or benefits conferred on [an] in- jured party from other sources are not credited against the tortfeasor’s liability, although they cover all or a part of the harm for which the tortfeasor is liable. 30 The rule means that a benefit that is directed to the injured party should not be shifted so as to become a windfall for the tort- feasor. If the plaintiff was himself responsible for the benefit, as by maintaining his own insurance or by making advantageous employment arrangements, the law allows him to keep it for himself. If the bene- fit was a gift to the plaintiff from a third party or established for him by law, he should not be deprived of the advantage that it confers. The law does not differentiate between the nature of the benefits, so long as they did not come from the defendant or a person acting for him. Td. comment b. The Eighth Cireuit held that the tax benefits of plaintiffs’ investments are not a collateral source because ‘‘although paid by the gov- ernment, [they] emanate directly from the tax shelter sought by the plaintiffs and provided by defendants, without which plaintiffs could not have realized any tax benefits. Benefits resulting directly from a trans- action under attack must be credited toward the dam- age award. Austin II at 956, quoting Salcer v. Envicon Equities Corp., 744 F.2d at 941-42. That analysis misconstrues the nature of a ‘‘collateral source.’’” Every collateral source results ‘‘directly’’ from the tort or transaction at issue: otherwise, no defendant could claim to reduce his obligation based on a payment from ’ the ‘‘collateral sourece.’’ Health and disability insurance ’ payments come from a ‘‘collateral source’’ and do not re- 19 The analysis fails to acknowledge that there would be no “tax benefits” but for a defrauded purchaser’s income from other sources. 31 duce the damage for which the tortfeasor is liable even though the injury and hence the insurance payments result ‘‘directly’’ from the tort. The rule applies even if the tortfeasor contributes to a fund which provides the bene- fits. E.g., Eichel v. New York Cent. R.R., 375 U.S. 253, 254-55 (1963); NLRB v. Gullett Gin Co., 340 U.S. 361, 364 (1951); Kauffman v. Sidereal Corp., 695 F.2d 343, 346-47 (9th Cir. 1982). The proper question is whether the benefit is conferred on an injured party from a source other than the defen- dant. Kestatement (Seconp) or Torts 4 920A(2). Pe- titioners’ ‘‘tax benefits’? come from a third party, 1.e., the government, and are calculated based on Petitioners’ other income. R. Thompson, The Measure of Recovery under Rule 10b-5, 37 Vanp. L. Rev. 349, 390 (1984) (‘‘plaintiff who receives a tax benefit obtains his advantage from the gov- ernment, not from the defendant’’). Petitioners’ ‘‘tax bene- fits’? do not come from Respondents. Because the ‘‘tax ben- efits’’ were established for [them] by law,’’ Petitioners ‘‘should not be deprived of the advantage’’ created. See RestaTEMENT (Seconp) or Torts § 920A(2) comment b; Funston v. Umited States, 513 F. Supp. 1000, 1010 (M.D. Pa. 1981) (‘‘tax benefit conferred by [the state] is from a collateral source’); Jowa-Des Moines Nat’l Bank v. Schwerman Trucking Co., 288 N.W.2d 198, 205 (lowa 1980) (‘‘tax saving [is to be] treated as a collateral source’’); Cereal Byproducts Co. v. Hall, 16 Ill. App. 2d 79, 81, 147 N.E.2d 383, 384, aff’d, 15 Til. 2d 313, 155 N.E.2d 14 (1958) (tax consequences of theft loss treated as being from collateral source); Lumber Terminals, Inc. v. Nowa- kowski, 36 Md. App. 82, 97, 373 A.2d 2 *, 291-92 (1977) (‘*[t]axes are strictly between plaintiff as taxpayer and Ww bo the government as collector, and are of no legitimate con- cern of the defendants’’). III. PUBLIC POLICY CONSIDERATIONS REQUIRE THAT ‘‘TAX BENEFITS’ NOT BE SUB- TRACTED FROM SECURITIES FRAUD RE- COVERIE&. This Court often considers practical factors and con- siderations of policy in explicating congressional intent. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. at 749. All practical and policy considerations require courts to disregard ‘‘tax benefits’’ in calculating recoveries under the federal securities laws. A. Subtracting ‘‘Tax Benefits’’ From Securities Fraud Recoveries Undermines The Disclosure Requirements Of The Federal Securities Laws. In 1933 President Roosevelt ay pealed to Congress in seeking passage of the Securities Act of 1933: This proposal adds to the ancient rule of caveat emptor, the further doctrine, “Let the seiler also be- ware.” It puts the burden of telling the whole truth on the seller. Jt should also give impetus to honest dealing in securtties . . (7 Cong. Rec. 937 (1933) (emphasis added). The preamble to the Securities Act states that its purpose is to provide full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sale thereof .... 47 Stat. 74 (1933) (emphasis added). When it became law, the Securities Act of 1933 created “a system of full disclosure.’’ T. Hazen, Taz Law or Securities REGULATION 33 § 1.2 at 7 (1985) ; see also 1 L. Loss, Securrrizs Reeutarion 184 (2d ed. 1961). The Securities Exchange Act of 1934 is intended to regulate all aspects of the public trading of securities, bars material misstatements and omissions and requires full disclosure. T. Hazen, Tae Law or Securities REGULATION § 1.2 at 7; see also 1 L. Loss, Securities Recu- LATION 184. The Securities Act of 1933 and the Securities Exchange Act of 1934 implement the requirement of full disclosure by five primary means: (1) SEC examination of registra- tion documents to determine compliance with the laws’ disclosure requirements, (2) SEC initiation of injunction proceedings, (3) SEC administrative hearings and sanc- tion procedures, (4) criminal prosecutions and (5) private litigants’ suits for restitution and damages. T. Hazen, Tae Law or Securirms Recuiation §1.3 at 10-11; 1 L. Loss, Securitres Reeuratrion 302-03; 2 L. Loss, Securities Reeuxation 845-57 (2d ed. 1961); T. Hazen Administrative Enforcement: An Evaluation of the SEC’s Use of Injunc- tions & Other Enforcement Methods, 31 Hasttnas L..J. 427 (1979); S. Rep. No. 47, 73d Cong., Ist Sess. 6 (1933), re- printed im 2 J. Ellenberger & E. )‘ahar, Lecistative His- TORY OF THE Securities Act oF 1933 & THE SECURITIES Excuance Act or 1934 (1973); see also United States v. Naftalin, 441 U.S. at 778; Red Bank Oil Co., 20 S.E.C. 863, 866 (1945). The Securities Act of 1933 exempts certain securities from its registration requirements because of the “small amount involved” or because of the limited character of 34 the public offering, 15 U.S.C. §77c, and exempts certain transactions because of the nature of the transactions or the participants. 15 U.S.C. § 77d. Most limited partner- ship offerings” fall within one or more exemptions.”! Therefore, the SEC has no opportunity to examine cocu- ments prior to sale. Because neither the SEC nor the Department of Justice has the resources to police all of the fraudulent activity by organizers of limited partner- ships,” the primary tool in enforcing the disclosure re- quirements is the private civil action. Note, Real Estate Limited Partnerships & Allocational Efficiency: The In- centive to Sue for Securities Fraud, 63 Va. L. Rev. at 670- 71. The incentive to make full disclosure thus is in direct relation to the likelihood and risk of a suecessful suit. Id. at 671; see also F. Easterbrook & D. Fischel, Optimal Damages in Securities Cases, 52 U. Cur. L. Rev. at 614 30. The Eighth Cireuit’s decision makes it unlikely that 20 ~The total invested in limited partnerships in 1983 was es- timated to be $8.4 billion. TIME, Nov. 26, 1984 at 26. The total invested in 1984 was estimated to be $19 billion. 4 R. Haft & P. Fass, TAX SHELTERED INVESTMENTS vii (3d ed. 1985). In 1980 there were approximately 211,000 real estate limited partnerships in existence. Bureau of Nat'l Affairs, Inc., Daily Report for Executives (Feb. 21, 1984). 21 In a 12 month period during 1975-1976 only 10 limited partnerships were registered with the SEC. [1976] 5 FED. SEC. L. REP. (CCH) at 64,214. In a similar period during 1984-1985 less than 60 real estate limited partnerships were registered. [1985] 6 FED. SEC. L. REP. (CCH) Br. 5 & 6 at 64,264-77. tN N Fraud continues to grow despite the efforts of federal and state enforcement agencies. Washington Post, Jun. 4, 1984, at A-11. 35 defrauded investors will sue and minimizes the risk to the fraudulent promoter in the unlikely event that they do sue. Note, Real Estate Limited Partnerships & Alloca- tional Efficiency: The Incentive to Sue For Securities Fraud, 63 Va. L. Rev. at 671-72. One commentator de- scribed the Eighth Circuit’s message to potential pro- moters: Relax. Should a violation of the securities law occur, promoters in the Eighth Circuit apparently need only assure themselves that the investors get a large enough tax deduction. Note, Austin v. Loftsgaarden: Securities Fraud in Real Estate Limited Partnership Investments, 16 CreicHTon L. Rev. at 1152. Allowing the Eighth Cireuit’s decision to stand en- courages promoters to omit or to misrepresent information material to potential investors. Like Loftsgaarden, those promoters will hope to pocket in excess of $100,000, see Austm IT at 963 (dissenting opinion), to keep all of the money for twelve years and then to return less than $30,000. The decision will discourage investors who look at Randall and see only a man who invested $35,000 as a result of a fraud, who spent $7,500 in loans and other thousands of dol- lars trying to salvage his investment and who was left with nothing but an expenditure of more than ten years and additional thousands of dollars in attorney’s fees in pur- suit of his recovery of $506. This Court must insist on the disclosure required by statute. To do so, it must insure the continued viability of the express and implied remedies for violations of the 36 securities laws’ disclosure requirements. To do otherwise is to undercut the protective purpose of the securities laws. See R. Thompson, The Measure of Recovery under Rule 10b-5, 37 Vanp. L. Rev. at 390 (‘‘[fjocusing ‘on the de- fendant and resolving doubts against the party committing the frand is consistent .. . with the dual deterrent/com- pensatory purposes of the federal securities laws’’ and requires that there be no deduction for tax benefits) ; United States v. Naftali, 441 U.S. at 774-77. B. Subtracting ‘‘Tax Benefits’’ From Securities Fraud Recoveries Effectively Transfers Mon- ies From The Treasury To The Defrauder. By crediting a promoter who defrauded investors with ‘‘tax benefits’’ conferred by the government, the Eighth Circuit makes the ‘‘government...the banker for fraudu- lent tax shelter activity.’’ Burgess v. Premier Corp., 727 F. 2d at 838. Because a defrauded purchaser’s recovery is tax- able, he will not retain all of it. Taxation will transfer a part of the recovery to the public treasuries from which the ‘‘tax benefits’’ first came. [T]o simply subtract the tax benefits from damages would place an unfair burden on taxpayers generally . Such a result leaves the government bearing the costs of [a seller’s] fraud. A better result is to set damages equal to [the defrauded purchaser’s] losses exclusive of tax benefit. Id. In calling for enactment of the Securities Act of 1933, President Roosevelt cautioned that the Federal Government cannot and should not take any action which might be construed as. . . guaran- teeing that newly issued securities are sound in the sense that their value will be maintained. — TCs AMOI iy te ee ee ee I Ee te a 37 77 Cong. Rec. 937 (1933). The securities laws still do not guarantee the ‘‘value”’ of securities. However, the Eighth Circuit’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 fraud- ulent transaction. To the extent a defendant can, by his ngful act, create a tax loss for the innocent victim, the defendant will be allowed to escape liabil- ity, shifting the burden of the loss onto the govern- ment. Austin IT at 964 (dissenting opinion). That is something neither President Roosevelt nor the Congress would ever have imagined: the government now provides a guarantee, not for the investor, but for the fraudulent promoter. C. Subtracting ‘‘Tax Benefits’ From Securities Fraud Recoveries Creates Anomalous Damage Awards. The Eighth Circuit decision creates anomalous dam- age awards. Investors in different tax brackets, but iden- tically situated in every other way, would receive awards which vary widely. The differences are based upon fac- tors which have nothing to do with the investments or with the frauds which occasioned the awards. Even though Randall, Austin and Anderson each invested $35,000 in Alotel Associates and even though none received any cash or cash equivalent as a return on his investment, Randall is to recover $506, Austin $7,666 and Anderson $18,790. Id, at 961; compare Hayden v. McDonald, 742 F.2d 423, 425, 439 (8th Cir. 1984) (56 plaintiffs and presumably 56 dif- ferent results). Disparate treatment of investors based upon differences in their taxable income undermines the 38 purposes of the federal securities laws. See Herman & Mac- Lean v. Huddleston, 459 U.S. 375, 390 (1983) (defrauded investors are persons securities laws seek to protect). Furthermore, the Eighth Cireuit decivion enables plaintiffs and defendants to manipulate the amount of damages. Because ‘‘tax benefits’? depend upon an in- vestor’s ordinary income and marginal tax bracket, a plaintiff may control the timing of his receipt of ordinary income and thereby increase his damages. A defendant may also control the amount of ‘‘tax benefits’’ (and of damages) by his own ability to make elections. S. Banoff, To What Extent Will Benefits from Tax Shelters be Per- mitted to Offset Rescission Damages, 57 J. TAXATION 154, 155-56 (1982). D. Subtracting ‘Tax Benefits’ From Securities Fraud Recoveries Does Not Fully Compensate Defrauded Investors. The Eighth Circuit held that the words ‘‘income re- ceived’”’ in section 12(2) include all economic benefits bar- gained for and received, including ‘‘tax benefits.’’* Aus- tin II at 955. The holding misapprehended the nature and effect of a ‘‘tax shelter.’’ The ‘‘tax benefits’’ which an investor obtains through a ‘‘tax shelter” are no more than a deferral of taxes. Aus- 2. «~The Eighth Circuit never considered Respondents’ tax con- sequences. Payment of rescissionary damages will result in a business expense which can be deducted from ordinary income; actual rescission will result in a short-term capital loss. Both will result in “tax benefits” to Respondents. If the Eighth Circuit’s reasoning is to be followed, Petitioners, as the ones who bestowed the “tax benefits” on Respond- ents, should be able to recover them from Respondents. 39 tin II at 963 (dissenting opinion). The district court found that Petitioners ‘‘were not actually going to make any money because of tax losses’’ and were getting only a tax deferral. (Pet.App.F6). Indeed. the Eighth Circuit panel recognized that Petitioners’ investments in Alotel Asso- ciates served ‘‘only to defer taxation until the investment is liquidated and each partner receive[d] his . . . propor- tional share of the proceeds of the sale.” Austin I at 174. The Eighth Circuit treated ‘‘tax benefits’’ as ‘‘perm- anent’’ because the relevant tax years were ‘‘closed.” Austin IT at 955. The Internal Revenue Code does contain a three-year statute of limitation, 26 U.S.C. § 6501(a), and more than three years have passed, (Def.Ex.1A,1B,1C; R. 42-43,62), but the final tax consequences of the original investment and the subsequent recovery are not yet deter- mined. The Eighth Cireuit itself acknowledges that a de- frauded purchaser who recovers will be taxed on his re- covery. Austin II at 960. At the time of recovery taxes may be imposed as a result of a purchaser’s amendment of his earlier tax returns. Taxes may be imposed under the mitigation provisions of the Internal Revenue Code, which permit correction of the effect of an error even if the statute of limitation woul! otherwise prevent correc- tion. 26 U.S.C. §§ 1311-14. Taxes may be imposed under the tax benefit rule’s requirement that a recovery be taxed as ordinary income. The Ninth Cireuit correctly understood the conse- quences of a ‘‘tax shelter’’; it held: While we agree that consideration of tax consequences is relevant for certain purposes, we decline to make the government the banker for fraudulent tax shelter 40 activity. Judge Hardy’s analysis in Western Federal Corp. v. Davis, 553 F. Supp. 818, 820 (D. Ariz. 1982) is correct in discerning that the economic benefit by way of tax deductions is ates because amended returns will have to be filed . Id.; accord, Western Fed. Corp. v. Brickoon, 739 F.2d at 1444; Rhode v. Hershberger Explorations, Inc., 349 F. Supp. at 994 (‘‘[t]o the extent recovery is had, amended income tax returns will have to be filed’’). Rescission may invoke the mitigation provisions. Section 12(2) allows a defrauded purchaser to rescind. Wigand ». Flo-Tek, Inc., 609 F.2d 1028, 1035 (2d Cir. 1979). Section 29(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78ee(b), declares contracts ‘‘made in violation of’’ section 10(b) or Rule 10b-5 to be ‘‘void.’’ Thus, a defrauded purchaser who can demonstrate a violation of section 10(b) or Rule 10b-5 can sue for and obtain recis- sion. E.g., Mills v. Electric Auto-Lite Co., 396 U.S. 375, 387-88 (1970); Regional Properties, Inc., v. Financial & Real Estate Consulting Co., 678 F.2d 552, 558 (5th Cir. 1982). Recission voids the underlying transactions from the inception and returns the parties to the sittus quo ante. Brown v. Producers Livestock Loan Co., 469 F. Supp. 27, 31 (D. Utah 1978); 5C A. Jacobs, Lirication & , 7, Paacrice Unver Rute 10b-5 § 260.03 [e][vi] at 11-56. ex. When a ‘‘court of competent jurisdiction’’ enters a ‘final “ judgment, decree, or other order’’ which “deter- mines the basis of property’’ or ‘‘of any transaction on ‘ “which [the]basis [for valuing an asset] depends’’ and the ~ basis is different from the basis claimed by a taxpayer, see 26 U.S.C. §§ 1312-13, the ‘‘effect of the error shall be corrected’’ despite the restriction otherwise imposed by the statute of limitation. See 26 U.S.C. §1311(a). A 41 judgment rescinding a purchase of a ‘‘tax shelter’’ and declaring it void ‘‘from the inception’’ would be a deter. mination of a transaction on which the purchaser’s basis depended and requires correction of “the effect of the er- ror... by an adjustment.’’ See 26 U.S.C. §1311(a). The IRS may invoke the tax benefit rule. See 1 J. Mertens, Law or Freperat Income Taxation § 7.34 at 7-115 & § 7.37 at 7-129 to -130 (1985) (taxpayer who claims de- duction resulting in tax benefit one year and who obtains recovery or repayment in later year must include recovery or repayment as ordinary income in the year of recovery). Invocation of the tax benefit rule ‘‘ ‘eliminates’ [a defraud- ed] purchaser’s tax benefits.’’ A. Blankenheimer, Tax Consequences of Rescission: The Interplay Between Pri- vate & Public Law, 42 U. Cut. L. Rev. 562, 588 (1975). If the rule is invoked, ‘‘a court ordering recission has no grounds for awarding the seller an offset.’’ Id. E. A Securities Fraud Action Is Not An Appro- priate Proceeding In Which To Litigate The Tax Consequences Of An Investment Induced By Fraud. It is undisputed that Petitioners’ investments in Alotel Associates and their recoveries, if any, did and will create tax consequences for them. It is also undis- puted that Respondents’ sales of limited partnership units and payments of judgments, if any, did and will create tax consequences for them. It is also undisputed that those tax consequences will be determined. However, a securities fraud action is not an appropriate proceeding in which to determine those consequences. A number of factors indicate that a securities fraud trial is not the time to determine tax consequences. First, 42 the language of section 12(2), of section 10(b) and of Rule 10b-5 does not contemplate making tax adjustments. Sec- ond, this Court has indicated that, where a recovery will be subject to taxes, any adjustments should be deferred to the appropriate taxing authorities. Hanover Shoe, Inc. ~®. United Shoe Mach. Corp., 392 U.S. at 503. ‘Third, the collateral source rule requires that ‘‘tax benefits’’ not be subtracted from recoveries. Finally, the facts necessary to make a proper determination of all tax consequences of the transaction and the resulting recovery can never be known at the time of trial. It is impossible for a trier of fact to make an accurate allocation beeause all necessary facts can never be known. The year in which the judgment will finally be collected is unknown. A plaintiff’s income and his tax bracket in that year are unknown. A defendant’s income and tax bracket in that year are unknown. The tax laws and tax rates in that year are unknown. In the face of all the un- certainty, it is impossible at the time of trial to accurately predict the tax consequences of the fraudulent sale and resulting recovery. A speculative approximation is, of course, possible. However, it is unnecessary, and it is redundant. Congress intended the IRS and the courts to make the determina- tions after all the relevant facts were known. When the IRS and the courts do make those determinations, they will make them with precision and in accordance with ap- plicable law.% Foisting that responsibility on triers of fact who can never have the necessary facts will yield only spec- ulation. 4 No taxing authority can be bound by the result of a securities fraud action to which it is not a party. See A. Blankenheimer, Tax Consequences of Rescission: The Interplay Between Public & Private Law, 42 U. CHI. L. REV. 562. 43 The approach that yields mere speculation also adds substantial complexity to already complex securities law eases. The Eighth Circuit held: Evidence of [an IRS] audit and expert opinions as to its likely results are admissible at the retrial on damages. Certainly the possibility that past tax de- ductions will be disallowed is relevant to the determi- nation of the extent of any benefit actually received by plaintiffs from those deductions. The jury is en- titled to determine whether and to what extent there would be a disallowance of deductions. Austin I at 183. Presumably, the jury will also be required to consider and determine the probability and likely out- come of IRS appeals, Tax Court or district court litigation and further judicial review. Such a procedure creates a dilemma for the defrauded investor. Proving the weakness of his ‘‘tax shelter bene- fits’? creates a road map for an IRS audit, but failing to offer proof reduces the damages available. D. Korn, A Taxing Quandry: Should Investors Deprived of Shelter Sue, Barron’s, Jun. 17, 1985, at 39. Section 12(2) was designed ‘‘to provide relatively easy civil relief to [defrauded] purchasers.’’ M. Kamin- sky, An Analysis of Securities Litigation under Section 12(2), 13 Houston L. Rev. at 280. The Eighth Circuit has converted it into a labyrinth. ty. — CONCLUSION The judgment of the Highth Circuit should be re- versed insofar as it requires ‘‘tax benefits’’ to be con- 44 strued as ‘‘income,’’ which reduces recovery of a de- frauded purchaser who rescinds pursuant to section 12(2). The judgment also should be reversed insofar as it re- quires ‘‘tax benefits’’ to offset damages under section 10(b) and Rule 10b-5. This Court should remand for the entry of judgment awarding Petitioners the consideration paid, interest on the purchase prices from the dates of purchase through the date of judgment and a reasonable attorney’s fee. Respectfully submitted, Rosert ArtHUuR Brunia O’Connor & Hannan 3800 IDS Tower 80 South Eighth Street Minneapolis, Minnesota 55402 Telephone: (612) 343-1200 Tep S. Mere Freprikson & Byron, P.A. 1100 International Centre 900 Second Avenue South Minneapolis, Minnesota 55402 Telephone: (612) 347-7000 Terence M. FrutH Fruta & AnruHony, P.A. 1350 International Centre 900 Second Avenue South Minneapolis, Minnesota 55402 Telephone: (612) 349-6969 Wusur F. Dorn, Jr. Dorn Law Fem, Lop. 300 East Main Street Anoka, Minnesota 55303 Telephone: (612) 427-5903 January 6, 1986. --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0440%3A05. Public record. Not legal advice.