Unpublished Disposition, 884 F.2d 1394 (9th Cir. 1981)

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U.S. Court of Appeals for the Ninth Circuit - 884 F.2d 1394 (9th Cir. 1981)

J.L. INTERNATIONAL, LTD., an Arizona corporation, Plaintiff-Appellant,v.SHEARSON, LEHMAN, HUTTON, INC., formerly doing business asE.F. Hutton & Co.; Carl R. Deppe; MargaretDeppe, Defendants-Appellees.

No. 88-15073.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 10, 1989.Decided Sept. 1, 1989.



Plaintiffs-appellants J.L. International, Ltd. ("JLI"), 2916-B Corporation ("B Corp."), and 2916-C Corporation ("C Corp.") (collectively "JLI" or "the plaintiff corporations") timely appeal from a summary judgment entered in favor of defendant-appellee Shearson, Lehman, Hutton, Inc. ("Hutton") as to all claims asserted against it, and in favor of defendant-appellee Carl Deppe ("Deppe") as to all but the state law RICO claim.

JLI contends that the district court misinterpreted and misapplied the "notice" provisions contained in Arizona statutes which shield a "holder in due course" of a negotiable instrument from liability to third parties for claims based on the instrument. JLI also contends that the district court erroneously dismissed its federal and state securities law claims. Finally, JLI argues that the district court erred in dismissing its state and federal civil RICO claims for, respectively, lack of a predicate Arizona criminal law or a federal securities law violation. We have jurisdiction, 28 U.S.C. § 1291, and we affirm.

* We review a district court's grant of summary judgment de novo. Ashton v. Cory, 780 F.2d 816, 818 (9th Cir. 1986). Viewing the evidence in the light most favorable to the plaintiffs-appellants, and drawing all inferences in their favor, we must determine whether there are any genuine issues of material fact and whether the district court correctly applied the relevant substantive law. Id. We also review de novo the district court's resolution of the questions of state law involved in this case. In re McLinn, 739 F.2d 1395 (9th Cir. 1984) (en banc).


Under the basic Uniform Commercial Code ("UCC") rules of negotiability, as adopted in Arizona, a holder in due course takes a negotiable instrument free from all claims of the drawer and, for that matter, of any person. Ariz.Rev.Stat.Ann. Sec. 47-3305. The purpose of this rule is clear: to encourage the free alienation of commercial paper. See Mecham v. United Bank of Arizona, 107 Ariz. 437, 441, 489 P.2d 247, 251 (1971). To qualify as a "holder in due course" under the Arizona version of the UCC, Hutton, as the payee in this case, must establish that it took the negotiable instruments (1) for value, (2) in good faith, and (3) without notice of any defense or claim to them on the part of any person. Ariz.Rev.Stat.Ann. Sec. 47-3302(A); see also Ariz.Rev.Stat.Ann. Secs. 47-3302(B) and 47-3307(C). JLI challenges the district court's conclusion that Hutton was a "holder in due course" only with respect to the "notice" element of section 47-3302(A) (3).

The general "notice" provision of the Arizona UCC is found in Ariz.Rev.Stat.Ann. Sec. 47-1201(25). Under that section, a person has notice of a fact if:

(a) He has actual knowledge of it; or

(b) He has received a notice or notification of it; or

(c) From all the facts and circumstances known to him at the time in question he has reason to know that it exists. A person "knows" or has "knowledge" of a fact when he has actual knowledge of it....

Id. (emphasis added).

The Arizona UCC contains another more specific definition of "notice" in a section entitled "Notice to purchaser." Ariz.Rev.Stat.Ann. Sec. 47-3304. Under that section, a purchaser has notice of a claim against an instrument, inter alia, when the purchaser has actual knowledge that a fiduciary has negotiated the instrument "in any transaction for his own benefit or otherwise in breach of duty." Ariz.Rev.Stat.Ann. Secs. 47-1201(25) (c), 47-3304(A) (1) and (B) (emphasis added). A purchaser is not, however, charged with notice of a defense or claim simply because he knows that the person negotiating the instrument is or was a fiduciary. Ariz.Rev.Stat.Ann. Sec. 47-3304(D) (5).

In Stewart v. Thornton, 116 Ariz. 107, 568 P.2d 414 (1977), the Arizona Supreme Court held that notice, in the context of a claim of "holder in due course" status, "contemplates actual knowledge of a defense or of such facts that would alert a person to a possible defense [,]" and that "notice under the UCC requires some inquiry if the purchaser has actual knowledge of facts which would apprise him of possible irregularities." Id. at 109, 568 P.2d at 416 (citing Eldon's Super Fresh Stores, Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 296 Minn. 130, 207 N.W.2d 282, 287-88 (1973)).1  The Stewart court explained, however, that " [t]he protection afforded a holder in due course cannot be used to shield one who simply refuses to investigate when the facts suggest an irregularity concerning the commercial paper he purchases." Stewart, 116 Ariz. at 110, 568 P.2d at 416.

To determine whether Hutton qualifies as a "holder in due course" within the meaning of Ariz.Rev.Stat.Ann. Sec. 47-3302, we must decide whether Deppe, and therefore Hutton, had actual knowledge that Tollefson was negotiating the checks "for his own benefit or otherwise in breach of duty," see Ariz.Rev.Stat.Ann. Sec. 47-3304(B),2  or actual knowledge of facts that would have alerted them to a possible defense or apprised them of possible irregularities concerning the instruments.3 

Applying this standard, we agree with the district court's conclusion that the defendants were not on notice of JLI's claim to the negotiable instruments with which Tollefson conducted his securities trading activity. Deppe and Hutton knew that, on December 23, 1981, Tollefson sought to deposit corporate funds in an account he had previously opened in his own name. When Deppe inquired about Tollefson's authority and purpose in conducting his trading activities in this manner, Tollefson said he was authorized to act on behalf of the corporations "from an investment standpoint" and that he would be paid a commission "to the extent the investments were profitable."

JLI argues that these facts alone were sufficient to put Hutton on notice of its claims against the instruments Tollefson negotiated. We disagree. The mere act of purchasing stock through a personal account with a corporate check, without more, was not sufficient to apprise Deppe or Hutton of possible irregularities in the transaction. See Eldon's, 207 N.W.2d at 287-88.

Furthermore, there were many strong indicators of regularity from which we conclude that Deppe believed, as would have any reasonable person, that Tollefson's securities transactions were fully authorized by and known to JLI. From what he knew about Tollefson, as a social acquaintance of over three years with whom he shared mutual friends, Deppe reasonably believed that Tollefson was wealthy, trustworthy, and intelligent. Deppe knew as a fact that Tollefson was a licensed CPA, and it objectively appeared that Tollefson was an active, respectable member of his church and community. Tollefson also initially presented Hutton with cashier's checks which themselves bear special assurances of negotiability, see Wohlrabe v. Pownell, 307 N.W.2d 478, 485 (Minn.1981), to conduct what Tollefson assured Deppe was to be trading on behalf of an investment group of which he was known to be a corporate officer. Disregarding the factual dispute regarding Deppe's processing of the first three cashier's checks and accepting JLI's version of that event, we are persuaded that, because of his personal dealings with Tollefson and what he knew of his acquaintance's reputation, Deppe reasonably believed Tollefson's representations about his authority to trade through his personal account and undertook in good faith to accommodate an apparently respectable client's preferred means of transacting business.

In June of 1982, moreover, when Tollefson switched to ordinary checks--which bore his indisputably authorized signature and were drawn on the corporate account, but were not returned for insufficient funds or for any other defect during the nine-month period over which Tollefson used them--Deppe's and Hutton's belief that Tollefson's trading activities were authorized reasonably could have been reinforced. This belief also appears to have been justified given that, right from the start and throughout the trading period, Hutton sent to the same corporate offices detailed monthly statements and individual confirmations of each of Tollefson's numerous securities transactions, yet never received any reaction or objection from any third party.

Finally, after Tollefson sustained a large loss in late June of 1982 and, with the support of a corporate resolution, opened a corporate account into which he transferred all the funds from his personal account, Deppe and Hutton reasonably could have continued to believe that Tollefson was operating with the approval of the other corporate principals. Hutton, after all, undisputedly received no inquiry or complaint from any other JLI officers or their bank throughout the sixteen-month period in which Tollefson was trading.

Under the applicable Arizona UCC standard, we conclude that Hutton did not have notice of JLI's claims to the negotiable instruments used by Tollefson to conduct securities transactions through the brokerage, and that the district court did not err in its determination that Hutton was a "holder in due course" within the meaning of Ariz.Rev.Stat.Ann. Sec. 47-3302.


JLI next argues that it was error to grant summary judgment in favor of Hutton and Deppe on its common law negligence and conversion claims. Under Ariz.Rev.Stat.Ann. Sec. 47-3305(1), a holder in due course takes a negotiable instrument free from " [a]ll claims to it on the part of any person...." Although there is no controlling Arizona authority on this point, we agree with the district court that section 47-3305 completely displaces those negligence and conversion claims that arose out of Tollefson's negotiable instruments transactions. See Eldon's, 207 N.W.2d at 289 (negligence); Richardson Co. v. First Nat'l Bank in Dallas, 504 S.W.2d 812, 816 (Tex.Civ.App.1974) (negligence and conversion); and Von Gohren v. Pacific Nat'l Bank of Washington, 8 Wash. App. 245, 505 P.2d 467, 471, 475 (1973) (negligence and conversion). As to its other potential common law tort claims, JLI has neither presented sufficient evidence nor cited Arizona authority to support a cause of action under any of the theories of recovery for which it argues.4 


To establish a direct cause of action against Hutton and Deppe for violation of section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 of the Securities Exchange Commission ("Rule 10b-5" or "10b-5"), or Arizona state securities laws,5  JLI must show, inter alia, that the defendants engaged in a fraud "in connection with the purchase or sale" of securities. 15 U.S.C. § 78j(b); 17 C.F.R. Sec. 240.10b-5. As this court recently observed, this requirement actually contains two elements. Roberts v. Peat, Marwick, Mitchell & Co., 857 F.2d 646, 650 (9th Cir. 1988). The "in connection with" component is a test for a causal relationship between the fraud and the resulting injury. Id. (citing Basic Inc. v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 989 (1988); and In re Financial Corp. of America Shareholder Litigation, 796 F.2d 1126, 1130 (9th Cir. 1986)). The second requirement, that of an actual "purchase or sale," see Roberts, 857 F.2d at 650, is a test for standing to bring a private action seeking damages resulting from a violation of the anti-fraud provisions of the federal securities laws. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 735 (1975).

We need not reach the "standing" issue for there are more serious defects in JLI's securities fraud claims. JLI has failed to establish both that Hutton breached any duty owed to the corporations, or that any fraud or deception which took place in this case was "in connection with" the purchase or sale of securities within the meaning of Rule 10b-5.

Hutton owed JLI only a duty to refrain from intentional misrepresentations of material fact. See White v. Abrams, 495 F.2d 724, 735-36 (9th Cir. 1974). As JLI essentially admitted below, Hutton made no misrepresentations whatsoever and cannot, therefore, be held liable for securities fraud.

The most closely analogous case cited by the parties, Miller v. Smith Barney, Harris Upham & Co., Fed.Sec.L.Rep. (CCH) p 92,498 (S.D.N.Y. 1986), is persuasive on the "in connection with" requirement. In Miller, a wife sued Smith Barney for her husband's (who was a Smith Barney account executive) alleged trading and transfers of funds deposited with the brokerage in a joint trading account. The court ruled that Miller had failed to satisfy the "purchases or sales" requirement and that there was no connection between Miller's claim based on conversion of monies earned through securities trading, and the actual purchase and sale of those securities. Miller, Fed.Sec.L.Rep. at 93,031. In dismissing Miller's securities fraud claims, the court held that "the fact that funds accrued through trades were allegedly converted or that allegedly converted funds were used to purchase securities does not create a cause of action under Sec. 10(b)" or Sec. 20(a). Id.

In the instant case, as in Miller, any fraud that occurred was, in the words of Judge Broomfield, "extrinsic to the purchase or sale of securities." Any misrepresentations or omissions involved in Tollefson's securities transactions were made by Tollefson, and did not pertain to the price or value of the securities themselves. Tollefson's trading, moreover, produced exactly what he was bargaining for; there is no evidence that he was in any way misled or deceived by Hutton or Deppe or any other person in his trading activity. Cf. Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir.), cert. denied, 469 U.S. 884 (1984).

JLI also posits two theories of secondary liability to support its securities fraud claims against Deppe and Hutton. First, the corporations assert that the defendants should be held liable as aiders and abettors of Tollefson's securities law violations. For Hutton and Deppe to be held liable as aiders and abettors, JLI would have to establish: (1) the existence of an independent primary wrong; (2) actual knowledge on the part of defendants of the primary wrong and of their role in furthering it; and (3) substantial assistance by the defendants in the primary wrongdoing. Harmsen v. Smith, 693 F.2d 932 (9th Cir. 1982), cert. denied, 464 U.S. 822 (1983).

JLI's aiding and abetting claims fail on at least one ground. Assuming that Tollefson's misrepresentations and affirmative concealment of his securities trading amounted to violations of the anti-fraud provisions of federal securities law, the evidence in the record simply fails to establish that Hutton and Deppe had actual knowledge of Tollefson's fraudulent activity or of their role in furthering it.

JLI further attempts to hold Hutton liable as a "controlling person" under section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a). For there to be liability under this section, the alleged "controlling person" must have acted in bad faith and directly or indirectly induced the conduct constituting a violation of the securities laws. Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1210 (9th Cir. 1970). JLI's arguments regarding this theory are meritless. There are simply no facts indicating that Hutton supervisory personnel acted in bad faith, or in any way induced Deppe or any other employee to engage in any kind of fraudulent misconduct.


Because JLI has failed to establish its securities fraud claims as a matter of law, the federal RICO claims and one of the state RICO claims against both Hutton and Deppe must fall for failure of the requisite predicate securities fraud claim. See 18 U.S.C. § 1961(1) (D); Ariz.Rev.Stat.Ann. Sec. 13-2301(D) (4) (r).

The other two state RICO claims against Hutton are similarly meritless because of JLI's total failure to establish the predicate "racketeering acts" alleged: trafficking in stolen property, or participating in a scheme or artifice to defraud. See Ariz.Rev.Stat.Ann. Sec. 13-2301(D) (4) (1) and (t).

The judgment of the district court is AFFIRMED.


This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by 9th Cir.R. 36-3


We reject Hutton's argument that by citing to Eldon's with approval, the Stewart court adopted that case in its entirety as the law of Arizona. We do believe, however, that the Arizona courts would view Eldon's as persuasive authority in deciding this appeal. We are duty-bound to apply the Arizona UCC law of notice in this case and, because the Arizona courts have not decided a case that is on all fours with the instant case, we must do our best to predict how they would resolve the mixed question whether Hutton had sufficient notice as to preclude it from claiming "holder in due course" status. See Dimidowich v. Bell & Howell, 803 F.2d 1473, 1482 (9th Cir. 1986), modified on other grounds, 810 F.2d 1517 (1987). We invoke Eldon's only for the persuasive value we believe the Arizona courts would see in it


Our review of the record reveals no evidence that Deppe or Hutton actually knew that Tollefson was embezzling corporate funds or that Tollefson was otherwise acting in breach of his fiduciary duties as a corporate officer. Accordingly, we focus our inquiry on the latter part of the Arizona UCC "notice" test


We decline the parties' invitation to definitively characterize the Arizona "notice" requirement as either a "subjective" or "objective" test, or a test of "inferable knowledge." We rely only on the text of the Arizona statutes, Ariz.Rev.Stat.Ann. Secs. 47-1201(25) (c) and 47-3304, and the elaboration by the Arizona Supreme Court in Stewart, 116 Ariz. at 109-10, 568 P.2d at 416-17, to ascertain the Arizona "notice" standard applicable to Hutton's "holder in due course" defense

We do, however, reject JLI's argument that the Arizona courts have adopted the "duty to inquire" test, the minority rule of UCC notice as stated in the California case, Sun 'n Sand, Inc. v. United California Bank, 21 Cal. 3d 671, 582 P.2d 920, 148 Cal. Rptr. 329 (1978). JLI supports this argument primarily by citing a recent decision of the Arizona Court of Appeals, Valley Bank of Nevada v. JER Management Corp., 149 Ariz. 415, 719 P.2d 301 (Ct.App.1986). As Hutton correctly notes, the Valley Bank court did refer to, but then distinguished Sun 'n Sand. Valley Bank, 149 Ariz. at 421, 719 P.2d at 307.


JLI appears to argue that Hutton negligently failed to follow appropriate account-opening procedures in accordance with the Branch Office Procedures Manual ("BOPM"). JLI also argues that Hutton's failure to prevent Tollefson's speculative stock trading constitutes actionable negligence or conversion

JLI seems to rely on Ickes v. Bache Halsey Stuart Shields, Inc., 133 Ariz. 300, 650 P.2d 1282 (Ct.App.1982), for its argument that the Hutton BOPM establishes the applicable standard of care for negligence claims based on violation of internal regulations. We reject this argument. First, Hutton correctly observes that liability in Ickes was premised on the UCC provision governing forged endorsements, Ariz.Rev.Stat.Ann. Sec. 47-3419 (formerly Ariz.Rev.Stat.Ann. Sec. 44-244613). Ickes, 133 Ariz. at 302-03, 650 P.2d at 1284-85. There is nothing in the Ickes opinion to suggest that an internal corporate rule establishes or can supplant state law.

As to its claim that Hutton negligently failed to control Tollefson's trading, JLI cites no authority for the proposition that Hutton had a duty to control the actions of a third party for its benefit.


As Hutton notes, the Arizona statute governing securities fraud, Ariz.Rev.Stat.Ann. Sec. 44-1991, is virtually identical to Rule 10b-5 and is construed in conformity with federal law. State v. Gunnison, 127 Ariz. 110, 112-13, 618 P.2d 604, 606-07 (1980). Accordingly, all references to Rule 10b-5 in this memorandum are intended to be references to the Arizona securities fraud statute as well