Unpublished Disposition, 940 F.2d 1533 (9th Cir. 1991)

MEMORANDUM^* 

Beloit Corporation appeals the grant of summary judgment for all defendants.

* Sometime in 1981, Beloit Corporation ("Beloit") decided to expand its interest in the reinsurance business. Beloit already owned a reinsurance company, Paperchine Insurance, Ltd. ("Paperchine"), but determined that purchasing an existing, licensed reinsurance company was less expensive and risky than expanding Paperchine. In a letter dated May 8, 1981, Beloit's broker, Theodore J. Newton, Jr., informed Beloit that Pinehurst Corporation ("Pinehurst") had decided to sell its reinsurance outlet, Presidio Insurance Company ("Presidio").

Time was of the essence, Newton noted, as Pinehurst was courting two other potential purchasers. Negotiations between Beloit and Pinehurst ensued almost immediately. On June 9, 1981, Newton, Dennis Hays (Beloit's Assistant Secretary and Assistant General Counsel), Charles Smith (the president of Pinehurst), and others met to discuss the proposed purchase. There, Beloit was given a preliminary report on Presidio's reserves prepared in December 1980 by an independent insurance actuary firm for a prior prospective purchaser. This report stated that " [t]he Presidio Insurance Company's method of computing IBNR reserve is sophisticated and within the state of the art from an actuarial viewpoint." However, the report further noted: "IBNR reserves were basically properly established from Presidio's standpoint but could be as much as $1,000,000 to $3,000,000 inadequate under different comparative assumptions." At this meeting, Smith told Hays that Pinehurst would not warranty the adequacy of the IBNR reserves, but apparently stated that the reserves were "adequate."

On June 18, 1981, Beloit offered Pinehurst $6.8 million for Presidio, conditioned upon further review of Presidio's treaties and loss reserves. Thereafter, Beloit retained two consultants from Mead Reinsurance Company ("Mead Re") (Fred Wootan and Scott Rodeghiero) and one from the accounting firm of Arthur Andersen (Robert Griswold) to conduct pre-purchase reviews of Presidio. Wootan concluded that Presidio's IBNR reserves should be increased by at least $1 million; use of current industry loss ratios, Wootan figured, would increase Presidio's IBNR by $2.3 million. Rodeghiero was critical of Presidio's claims procedures: " [Presidio's] passive philosophy, unfortunately, produces the individual risks of 'sudden' shock losses, 'surprises' at all levels, slow development, and victim to capricious accountabilities of others." Similarly, he noted: "Given [Presidio's] diverse and long-tail developing book, setting an adequate IBNR/case base reserve will be a most difficult and demanding task. Unfortunately, there is no Rosetta Stone here!" Rodeghiero recommended that " 'at least' a $1,000,000 IBNR/Case Base Reserve deficiency should be factored into the ultimate offer." Rodeghiero's "Armageddon" scenario was that IBNR reserves might be understated by up to $3 million. Nonetheless, he did recommend that Beloit proceed with the acquisition of Presidio.

The Arthur Andersen consultant, Robert Griswold, issued a seven-page report on July 15, 1981, in which he concluded that " [t]he IBNR reserve is probably understated. The probable range of understatement is large enough so that a study should be performed to quantify the amount." Griswold recommended that an audit be performed.

After receiving the Mead Re Report, Dennis Hays called Charles Smith of Pinehurst and told him that Beloit was concerned with the adequacy of Presidio's reserves. Hays sent a copy of the Mead Re report to Smith. Thereafter, on July 16, 1981, Smith flew to Beloit's headquarters in Beloit, Wisconsin, and met with Hays and Beloit's President, John Franz. There, Smith conceded that Presidio's IBNR reserves could be as much as $1 million light, but that they were generally "very adequate." Smith agreed to lowering Presidio's purchase price by $500,000, to $6.3 million.

To assuage Beloit's board of directors, Franz and others thought it might be helpful to obtain additional information from Pinehurst's auditors, Peat, Marwick, Mitchell & Co. ("Peat Marwick"). Richard Cebrowski, Beloit's Internal Auditor, flew to Los Angeles to meet with Jerry Miller, the Peat Marwick partner in charge of the 1980 audit of Pinehurst. Miller told Cebrowski--"off the record"--that Presidio's IBNR reserves were probably understated by close to $2 million.

Beloit rejected Peat Marwick's suggestion that a full-scope audit, which would include IBNR reserves, be conducted. There were, it appears, two reasons for the rejection. First, a full-scope audit would apparently have been too time-consuming. Second, Beloit wanted the tax advantages of any reserve shortfall; if the exact amount of the shortfall was determined prior to the purchase, the tax benefits would have accrued to the seller, Pinehurst, rather than to the purchaser, Beloit.

Shortly after receiving Peat Marwick's report, Franz recommended to Beloit's board that the purchase of Presidio proceed. The transaction closed on September 1, 1981.

In September 1982, Beloit retained Peat Marwick to audit Presidio. During the audit, Peat Marwick advised Beloit that Presidio's reserves should be increased to $12-17 million. When pressed for an explanation, Jerry Miller of Peat Marwick told Glynn Rossa, Beloit's Treasurer, that he knew when he spoke to Cebrowski in 1981 that the IBNR reserve shortfall could have been $3 to $5 million. Beloit investigated further, finding in files at Presidio's offices computer printouts and other calculations which, according to Beloit, contained data that Pinehurst expressly denied it had. This data, Beloit contends, shows that Pinehurst knew that Presidio's $4.9 million IBNR reserve was woefully inadequate.

Following Pinehurst's liquidation in 1986, Beloit brought this action against Pinehurst, Pinehurst's president (Charles Smith), and Peat Marwick, asserting a host of claims. The district court granted summary judgment for all defendants on all counts on November 2, 1989. On appeal, Beloit challenges summary judgment for Pinehurst as to its fraud, rescission, breach of contract, section 10(b) and Rule 10b-5, section 12(2), and state securities laws causes of action. As to Peat Marwick, Beloit challenges the dismissal of its fraud, breach of fiduciary duty, and section 10(b) causes of action.

II

We begin with Beloit's claims against Pinehurst.

* The elements of a section 12(2) cause of action were recently summarized by the Third Circuit:

[S]ection 12(2) provides a remedy and rescissionary damages, only to a purchaser of securities against an offeror or seller of securities in the event that

1. Defendants offered or sold a security;

2. By the use of any means of communication in interstate commerce;

3. Through a prospectus or oral communication;

4. By making a false or misleading statement of a material fact or by omitting to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading;

5. Plaintiff did not know of the untruth or omission; and

6. Defendants knew, or in the exercise of reasonable care, could have known of the untruth or omission.

Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 687-88 (3d Cir. 1991), pet'n for cert. filed, No. 90-1924 (June 19, 1991). Summary judgment is, of course, appropriate where the non-moving party fails to make a sufficient showing on any essential element of its case. See Pau v. Yosemite Park & Curry Co., 928 F.2d 880, 886 (9th Cir. 1991). Accordingly, we shall consider each of the disputed elements in turn.

* Beloit alleges three key misrepresentations or omissions by Pinehurst. First, Beloit contends that Pinehurst represented that it had performed only one calculation of Presidio's reserves, when, in fact, it had performed numerous such IBNR calculations. Second, Beloit urges as material misrepresentations Smith's statements that Presidio's reserves were "very adequate." Finally, Beloit asserts that Pinehurst's statement that it could not segregate Presidio's loss data by type was also a material misrepresentation. In response, Pinehurst contends that it did not make any misrepresentations of omissions, or, assuming it did, that such misrepresentations were not material, or, finally, any such misrepresentations or omissions were merely unactionable "opinions" rather than fact.

We conclude that there is a genuine issue of material fact as to whether Pinehurst misrepresented material information or otherwise withheld information that it was obligated to disclose. Pinehurst did not disclose the existence of its computer program, Underwriting Report No. 7, which supposedly segregated loss data by type and projected necessary IBNR reserves. Whether Pinehurst should have disclosed this information is a question for the finder of fact. We cannot say that the information was immaterial as a matter of law; the information was prepared by Presidio officials with the express purpose of determining the IBNR reserves. The adequacy of IBNR reserves was perhaps the most important consideration in Beloit's decision to purchase a reinsurance company.¹ 

Smith's statement that IBNR reserves were "very adequate" is, standing alone, of questionable import. However, when considered in conjunction with Pinehurst's other alleged misrepresentations and omissions, the statement takes on a new light. In Casella v. Webb, 883 F.2d 805 (9th Cir. 1989), we held that a seller's claim that an investment was a "sure thing" was actionable under section 12(2). Id. at 807. We reasoned: "What might be innocuous 'puffery' or mere statement of opinion standing alone may be actionable as an integral part of a representation of material fact when used to emphasize and induce reliance upon such a representation." Id. Here, whether Smith's statement was mere "puffery" or a material misrepresentation is, again, an issue for the finder of fact.

2

A misrepresentation or omission is not actionable under section 12(2) if the plaintiffs had knowledge of the untruth or omission. See Casella, 883 F.2d at 809 ("All that is required [under section 12(2) ] is ignorance of the untruth or omission.") (quoting Sanders v. John Nuveen & Co., 619 F.2d 1222, 1229 (7th Cir. 1980), cert. denied, 450 U.S. 1005 (1981)); see also MidAmerica Federal Savings & Loan Ass'n v. Shearson/American Express, Inc., 886 F.2d 1249, 1256 (10th Cir. 1989). Here, Pinehurst points to the various studies and reports--by Arthur Anderson, Mead Re, and Tillinghast--as evidence that Beloit "knew" that Presidio's IBNR was understated. However, one reasonable reading of the record is that Beloit only knew that the IBNR might be understated by up to $3 million. Thus, there is a material issue of fact as to whether Beloit knew that the IBNR shortfall could exceed $3 million.

3

Reliance is not an element of a section 12(2) claim. Smolen v. Deloitte, Haskins & Sells, 921 F.2d 959, 965 (9th Cir. 1990). Similarly, a section 12(2) plaintiff does not have to prove "loss causation." See Casella, 883 F.2d at 808 ("The buyer need not show any causal connection between the misrepresentation and his damage; indeed, he need not even show that he has been damaged.") (quoting L. Loss, Fundamentals of Securities Regulation 873 (1988)). However, "transaction causation" is required, namely, that the misrepresentation somehow caused the buyer to enter into the transaction, even if such causation does not rise to the level of reliance. See Barnes v. Resource Royalties, Inc., 795 F.2d 1359, 1366 n. 9 (8th Cir. 1986) (cited with approval in Smolen, 921 F.2d at 965). Such causation is presumed in cases involving primarily a failure to disclose material facts. See Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972).

Pinehurst argues that Beloit's failure to audit Presidio's books, including the IBNR figures, is an "intervening cause" defeating the necessary causal link. We disagree. In this regard, Pinehurst has mistaken "transaction causation" for contributory negligence. Section 12(2) does not impose any affirmative duties on the plaintiff. See Casella, 883 F.2d at 809 ("Constructive knowledge, which plaintiff might have acquired by exercising ordinary care, will not preclude him from recovery [under section 12(2) ].... Contributory negligence has been rejected as a defense under Sec. 12(2).") (quoting 3 A. Bromberg & L. Lowenfels, Securities Fraud and Commodities Fraud Sec. 8.4 (317, at 204.14-204.15 (1986)); see also MidAmerica Federal Savings & Loan, 886 F.2d at 1256 ("A purchaser has no duty to investigate a seller's possible fraud and need not verify a statement's accuracy.").

Beloit has sustained its burden of showing that genuine issues of fact regarding its section 12(2) cause of action remain. Accordingly, we reverse the grant of summary judgment for Pinehurst on this claim.

B

To prevail on a section 10(b) and Rule 10b-5 cause of action, Beloit must show that the defendants intentionally or recklessly misrepresented or failed to disclose a material fact in connection with the sale or purchase of securities, that the plaintiff relied upon the misrepresentation or omission, and that the misleading information proximately caused plaintiff's loss. See Caravan Mobile Home Sales v. Lehman Bros. Kuhn Loeb, Inc. 769 F.2d 561, 564 (9th Cir. 1985); Hollinger v. Titan Capital Co., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc) (acknowledging recklessness as sufficient scienter for 10(b) and 10b-5 claims), cert. denied, 111 S. Ct. 1621 (1991). The first provision--misrepresentation or omission of a material fact--is identical to that of the section 12(2) cause of action and thus, our analysis there controls here. We thus consider only those disputed elements that differ from the section 12(2) cause of action.

* Scienter is a necessary element of a section 10(b) and Rule 10b-5 cause of action. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976). Recklessness may satisfy this scienter element. Hollinger, 914 F.2d at 1568-69. Recklessness, in turn, has been defined in the context of omissions, as "a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Id. at 1569 (quoting Sundstand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir.), cert. denied, 434 U.S. 875 (1977)).

Here, Beloit contends that Pinehurst's misrepresentations and omissions were intentional or, at the very least, reckless. Basically, Beloit infers scienter from Pinehurst's knowledge of the information and its failure to share that knowledge. Pinehurst raises a two-fold defense. First, it contends that the omitted calculations were unreliable and, second, that the IBNR estimates it provided to Beloit were made in good faith. However, there is evidence from which a reasonable fact-finder could conclude that Pinehurst intentionally or recklessly withheld the higher IBNR reserve estimates from Beloit. For example, Presidio's underwriter, Andy Akermanis, asked insurance broker Tim Delaney to keep computer program information "confidential" because he did not want it to interfere with Beloit's pending purchase offer. We thus conclude that a genuine issue of fact regarding scienter remains.

2

Reliance, transaction causation, and loss causation are all elements of a 10(b)/10b-5 cause of action. See Hatrock v. Edward D. Jones & Co., 750 F.2d 767, 773 (9th Cir. 1984). Section 10(b) imposes a significantly greater standard of care upon the plaintiff than does section 12(2). Cf. MidAmerica Federal Savings & Loan, 886 F.2d at 1256 ("The case law makes clear that plaintiffs under section 12(2) are not held to the same standard of care as are plaintiffs under section 10b-5." [sic]. Even so, we cannot say that Beloit transgressed this standard of care as a matter of law. The record indicates that Beloit knew only that the IBNR shortfall could be as high as $3 million; it is the role of the finder of fact to determine, under all of the facts and circumstances of this case, whether Beloit's failure to investigate further was unreasonable.

C

The elements of a cause of action for fraud under California law are misrepresentation, knowledge of its falsity, intent to defraud (i.e., to induce reliance), justifiable reliance, and resulting damage. Home Budget Loans, Inc. v. Jacoby & Meyers Law Offices, 207 Cal. App. 3d 1277, 1285, 255 Cal. Rptr. 483, 487 (1989). The elements of an action for negligent misrepresentation are a false representation made by the defendant as to a past or existing material fact, made without any reasonable ground for believing it to be true, made with the intent that the plaintiff rely upon it, and that the plaintiff was not aware of the representation's falsity and justifiably relied upon it. See Continental Airlines, Inc. v. McDonnell Douglas Corp., 216 Cal. App. 3d 388, 402, 264 Cal. Rptr. 779, 784 (1989). These elements mirror the elements of either a section 12(2) claim or a section 10(b) claim, or both. Thus, for the reasons expressed in our analysis of the statutory claims, we reverse the grant of summary judgment on the state law fraud counts.

D

Beloit's state securities laws claims parallel the federal section 12(2) claim in all important respects. See In re Rexplore, Inc. Securities Litigation, 685 F. Supp. 1132, 1142 (N.D. Cal. 1988) (noting that California Corporations Code sections 25401, 25501 and 25504 are the "California analog to Section 12(2)"); Rousseff v. Dean Witter & Co., Inc., 453 F. Supp. 774, 779 (N.D. Ind. 1978) (Indiana securities law provision is "drawn nearly verbatim from Section 12(2) of the Federal Securities Act of 1933"). We reverse the grant of summary judgment for Pinehurst on these counts as well.

E

Beloit contends that the defendants violated the Purchase Agreement between Pinehurst and Beloit by omitting material information regarding Presidio's IBNR reserves. While the Agreement specifically denies any warranty by Pinehurst with respect to the adequacy of the IBNR reserve, sections 4.5 and 4.19 of the Agreement required Pinehurst to disclose material information related to the transaction. There is a genuine issue of fact whether Pinehurst fulfilled its obligations under sections 4.5 and 4.19. We reverse the grant of summary judgment for Pinehurst on Beloit's breach of contract claim.

III

Beloit also appeals the grant of summary judgment for Charles Smith. Smith's liability turns on the underlying liability of Pinehurst. If Pinehurst is liable, then Smith may also be vicariously liable as a "control person." See, e.g., Cal.Corp.Code Sec. 25504 ("Every person who directly or indirectly controls a person liable under Section 25501 or 25503, ..., every principal executive officer or director of a corporation so liable, ..., are also liable jointly and severally with and to the same extent as such person...."); 15 U.S.C. § 77o ("Every person who ... controls any person liable under section ... 12 shall also be liable jointly and severally with and to the same extent as such controlled person...."). Accordingly, since we reverse the grant of summary judgment for Pinehurst, we must also reverse the grant of summary judgment for Smith.

IV

Finally, Beloit appeals the district court's grant of summary judgment for Peat Marwick.

* Although purportedly appealing summary judgment on the breach of fiduciary duty claim, Beloit neither posits this issue in its statement of issues nor discusses it either its opening or reply briefs. Claims not addressed in the appellant's brief are deemed abandoned. Collins v. City of San Diego, 841 F.2d 337, 339 (9th Cir. 1988).

B

To prevail on its 10(b)/10b-5 claim against Peat Marwick, Beloit must show that Peat Marwick's conduct was either intentional or reckless. Beloit contends that Jerry Miller's representation that Presidio's IBNR reserve estimate was understated by about $2 million was made recklessly, asserting that Miller and Peat Marwick lacked a factual foundation for such a statement. We disagree.

The record indicates that Miller had workpapers indicating an IBNR shortfall of approximately $1.75 million. Other than the subsequent statement that Miller thought the shortfall might be $3 to $5 million, there is no evidence indicating that Peat Marwick thought its workpapers were incorrect. As to the $3 to $5 million statement, the undisputed context of this statement--made after Miller repeatedly indicated that he could not remember the shortfall amount, and Beloit's Treasurer pushed for some type of response--suggests that this statement cannot be given serious consideration in establishing Peat Marwick's knowledge.

Accordingly, we find that Beloit has not demonstrated a triable issue of fact regarding Peat Marwick's scienter.

C

The elements of a cause of action for 'aider and abettor' liability under federal securities laws are (1) the existence of an independent primary wrong; (2) actual knowledge by the alleged aider and abettor of the wrong and of his or her role in furthering it; and (3) substantial assistance in the wrong. Jett v. Sunderman, 840 F.2d 1487, 1495 (9th Cir. 1988). Beloit has not fulfilled its burden with respect to either of the final two elements. Beloit contends that Peat Marwick must have known of Pinehurst's violation, since Charles Smith sent a copy of the Mead Re report to Peat Marwick and Peat Marwick examined the financial statement prepared by Pinehurst for Beloit, and that Peat Marwick's understatement of Presidio's IBNR ($2 million) when it knew the IBNR shortfall was much higher ($3-$5 million) constitutes "substantive assistance." However, the context of these occurrences does not support Beloit's allegations. As previously noted, Miller's "$3 to $5 million" statement is of questionable relevance. Moreover, Miller's off the record "closer to $2 million" statement is not tantamount to "substantial assistance" as a matter of law, since it was Beloit who pressed Miller for the statement.

D

For the reasons expressed above, we also affirm the grant of summary judgment for Peat Marwick on Beloit's fraud claims.

V

For the foregoing reasons, we reverse the grant of summary judgment for Pinehurst and Charles Smith and remand for proceedings not inconsistent with this disposition. We affirm the grant of summary judgment for Peat Marwick.

AFFIRMED in part, REVERSED in part, and REMANDED.