On Appeal from the United States District Court for the Eastern District of Pennsylvania (D.C. Civil No. 82-5051).
FACTS AND PROCEDURAL HISTORY
Plaintiffs Martin Eisenberg and Arthur Nissen were investors in two limited partnerships, Bar Associates (Bar) and Cay Associates (Cay), which were part of a series of limited partnerships designed as tax shelters. Their investment proved worthless and, moreover, the Internal Revenue Service eventually disallowed any deductions beyond their actual monetary loss. Plaintiffs' principal allegation has been that defendant David Wasserstrom, an attorney, together with Frederick Gagnon and Bernard Boyers, orchestrated a scheme to sell securities in worthless coal rights as purported tax shelters while concealing that they themselves would take the lion's share of the proceeds. As further developed in discovery and at trial, plaintiffs contended that Wasserstrom had, prior to the organization of the limited partnerships, negotiated the purchase of Cannon Coal Company (Cannon) by the Seah Corporation, of which Wasserstrom was president and a director, for $400,000 in late 1975. Cannon's principal asset was its leasehold on 3,200 acres of West Virginia coal property. Wasserstrom, Gagnon and Boyers then allegedly conspired in establishing six virtually identical limited partnerships that would each sublease 400 acre parcels of this property from Cannon for an "advanced royalty" from each of $2,225,000, of which $475,000 was payable in cash and $1,750,000 in non-recourse notes. Thus, the bulk of the property purchased for $400,000 was resold within a few months for a total of $2,850,000 in cash and $10,500,000 in non-recourse notes.
Wasserstrom, Gagnon and Boyers were alleged to have recruited as nominal general partners for three such limited partnerships, Ark Associates (Ark), Bar and Cay, defendants Charles Lieberman, Edward Hershenhorn and David Weinstein who distributed offering memoranda for the partnerships without revealing that those partnerships were in fact controlled by and benefitted Wasserstrom, Gagnon and Boyers. Plaintiffs claim that the offering memoranda, allegedly composed by Wasserstrom, Gagnon and Boyers, were false and misleading as to the coal reserves and feasibility of coal recovery.
The offering memoranda included a tax opinion written by Wasserstrom and issued under the name of Wasserstrom's law firm, Pelino, Wasserstrom, Chucas & Monteverde (PWC&M), that allegedly misrepresented that the IRS would allow the deduction of large advanced royalty payments by non-recourse notes. The memoranda also contained a statement by the defendant accounting firm of Clarence Rainess & Co. (Rainess) that the assumptions underlying the partnerships' projections were "not unreasonable." Plaintiffs claimed that Wasserstrom and the accountants knew there was no reasonable basis for these assumptions.
Wasserstrom, Gagnon and Boyers allegedly concealed from investors their own interests and those of general partners Lieberman, Hershenhorn and Weinstein in the sale of the partnerships and also concealed that Wasserstrom's law firm received what are claimed to be excessive legal fees for the preparation of the partnerships.
The complaint alleges that plaintiffs and those similarly situated were fraudulently induced to invest more than $1,400,000 in Ark, Bar and Cay, which money was in fact divided by some defendants, resulting in a complete loss on the investments and the disallowance of deductions by the IRS. Plaintiffs claimed these facts demonstrated intentional misrepresentations and omissions in connection with the sale of securities in violation of Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1985), and constituted a pattern of racketeering activity and a conspiracy to commit such activity in violation of the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1962(c) and 1962(d) (1982). Finally, plaintiffs alleged counts under state common law, including one for defendants' negligent misrepresentations in recommending and soliciting investments in enterprises in which they had an interest.
In the period before trial, the district court denied defendants' motions to dismiss the first amended complaint, see Eisenberg v. Gagnon, 564 F. Supp. 1347 (E.D. Pa. 1983), denied plaintiffs' motion for class certification, and gave plaintiffs leave to file a third amended complaint stating claims against Rainess and its alleged successor in interest, Seidman & Seidman (Seidman). At the trial, defendants were attorney Wasserstrom, his former law firm PWC&M, general partners Lieberman and Weinstein, and the Rainess and Seidman accounting firms. Defendants Gagnon and Boyers were not served and were therefore dismissed. A default judgment was entered against Edward Hershenhorn, general partner of Bar.
The jury was presented with a special verdict form asking it to decide the securities law, RICO, and negligence claims separately as to each plaintiff and defendant. The jury found for plaintiff Eisenberg and against defendants Wasserstrom and Weinstein on the state law negligence claim; for plaintiff Nissen and against defendant Wasserstrom on the same theory; but for defendants on all other claims. After a separate damages trial, the same jury awarded damages to Eisenberg of $12,200 against Wasserstrom and $6,100 against Weinstein, and to Nissen of $23,000 against Wasserstrom.
The parties, following the court's instruction, had filed post-trial motions prior to the damages trial which it ruled on thereafter. The district court granted Wasserstrom's and Weinstein's motion for judgment n.o.v. on liability, concluding that there was insufficient evidence upon which a jury could find reliance by plaintiffs on the offering materials.
Plaintiffs appeal from the district court's orders entering judgment for all defendants on jury verdicts under federal securities laws, entering judgment on the jury verdict for defendant PWC&M under Pennsylvania common law of negligent misrepresentation, and entering judgment n.o.v. for Wasserstrom and Weinstein on the common law claim of negligent misrepresentation. Appellants also seek reversal of the district court's orders denying class certification and denying their motion to compel production of certain documents. Wasserstrom, as a protective matter, cross-appeals from the court's denial of his motion for a new trial.*fn1
FEDERAL SECURITIES CLAIMS
We consider first the plaintiffs' claim that defendants violated § 10(b) of the Securities and Exchange Act of 1933, 15 U.S.C. § 78j(1982), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1985), promulgated thereunder, which prohibit misrepresentations and misleading omissions in connection with the sale of securities. The jury found for defendants on these claims. Appellants argue that the district court erroneously refused to instruct the jury that fraudulent projections were actionable and that the district court gave misleading instructions on the requisite state of mind.
A. Fraudulent Projections
Plaintiffs requested that the district court instruct the jury that fraudulent financial projections used in the sale of securities are actionable under Section 10(b). The proposed instruction, derived from 3 E. Devitt & C. Blackmar, Federal Jury Practice and Instructions § 98.11 (3d ed. 1977), was as follows:
Projections and financial forecasts made with a reasonable basis are not made misleading merely because they may ultimately be proven incorrect.
A projection or a forecast may constitute a basis for plaintiffs' verdict if, but only if, it be proved by a preponderance of the evidence that at the time the forecast or projection was made, the defendants either
(1) did not believe that the forecast or projection was reliable, or
(2) had reason to believe that the forecast or projections were not reliable.
If you find defendants had reason to believe that the projection was not reliable, you should find that they issued a misleading statement.
Appellees agree that fraudulent projections are actionable under § 10(b) and Rule 10b-5. There is considerable authority that projections, forecasts and opinions are actionable as misleading in a variety of circumstances. See First Virginia Bankshares v. Benson, 559 F.2d 1307, 1314 (5th Cir. 1977), cert. denied, 435 U.S. 952, 55 L. Ed. 2d 802, 98 S. Ct. 1580 (1978); Gottreich v. San Francisco Investment Corp., 552 F.2d 866, 867 (9th Cir. 1977); Marx v. Computer Sciences Corp., 507 F.2d 485, 489-90 (9th Cir. 1974); SEC v. Okin, 137 F.2d 862, 864 (2d Cir. 1943); R. Jennings & H. Marsh, Securities Regulation 880-85 (5th ed. 1982); Jacobs, What is a Misleading Statement or Omission under Rule 10b-5 ?, 42 Fordham L. Rev. 243, 279-87 (1973). See also Sharp v. Coopers & Lybrand, 649 F.2d 175, 184-85 (3d Cir. 1981), cert. denied, 455 U.S. 938, 71 L. Ed. 2d 648, 102 S. Ct. 1427 (1982). As presented to the jury, the offering memoranda contained allegedly fraudulent projections in the tax opinion letter supporting the view that the IRS would consider the investments as valid tax shelters, and in the projections of coal reserves and likely ability to mine them.
The district court refused to give any instruction pertaining to projections or forecasts, but instead emphasized that plaintiffs must establish that representations of "existing fact" are untrue. In relevant part, the court's instruction was that:
A "fraudulent misrepresentation" . . . means a representation that an existing fact is true, it being known to the person making said representation that the facts represented to exist do not in fact exist and that said representation is false. A fraudulent misrepresentation may be said to be the intentional misstatement of a person as to the truth of an existing fact, it being then known to the person making said statements that the facts represented to be true are false.
Plaintiff must prove by preponderance of the evidence that the defendant stated material facts which he knew to be false, or knew of the existence of material facts which were not disclosed and should have realized their significance in the making of an investment decision . . . .
Let me discuss what a material fact is . . . . [It] is one that a reasonable man would deem important in determining whether or not to purchase a limited partnership interest. An omitted fact is material if there is a substantial likelihood that a reasonable person would consider it important in deciding whether or not to purchase the limited partnership interest.
There is a possibility that taking the charge as a whole the jurors would have assumed that the term "existing facts" does not include projections or opinions. This would have been a serious error of law. An opinion or projection, like any other representation, will be untrue if it has no valid basis; see Marx v. Computer Sciences Corp., 507 F.2d at 490, but "reasoned and justified statement of opinion, one with a sound factual or historical basis, is not actionable." Id. (quoting G & M, Inc. v. Newbern, 488 F.2d 742, 745-46 (9th Cir. 1973)). Since the district court's error in failing to instruct the jurors that projections and opinions come within the ambit of actionable misrepresentations may have affected the jurors' verdicts as to all of the defendants, we must overturn the jury verdict in favor of defendants on the securities claim.*fn2
Appellees Lieberman and Weinstein justify the district court's failure to instruct the jurors on projections and opinions on the ground that plaintiffs' proposed instruction incorrectly stated the requisite standard of culpability. They argue that the requested charge would have permitted the jury to hold the defendants liable if it found that defendants had any reason to believe the projections were not reliable, whereas under the proper standard plaintiffs must show that defendants did not have an "informed and reasonable belief" that they were reliable. While the formbook instruction proffered by plaintiffs may not have adequately conveyed all the subtleties involved when the alleged misrepresentation stems from a projection or opinion, it was not so seriously erroneous as to justify the district court's failure to give an instruction that predictions and opinions are actionable, which went to the heart of plaintiffs' federal claims.
In establinshing scienter with respect to projections and opinions, it is insufficient to show mere negligent conduct, Ernst & Ernst v. Hochfelder, 425 U.S. 185, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976), or that a forecast turned out to be inaccurate. However, as this court has previously stated, an opinion must not be made "with reckless disregard for its truth or falsity", or with a lack of a "genuine belief that the information disclosed was accurate and complete in all material respects." McLean v. Alexander, 599 F.2d 1190, 1198 (3rd Cir. 1979) (quoting Ultramares v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931) (Cardozo, J.)). Therefore, an oppinion that has been issued without a genuine belief or reasonable basis is an "untrue" statement which, if made knowingly or recklessly, is culpable conduct actionable under § 10(b) and Rule 10b-5. See Marx v. Computer Sciences Corp., 507 F.2d at 490. Chris-Craft Industries v. Piper Aircraft Corp., 480 F.2d 341, 363-66 (2d Cir.), cert. denied, 414 U.S. 910, 94 S. Ct. 231, 38 L. Ed. 2d 148 (1973); Jacobs, What is a Misleading Statement or Omission under Rule 10b-5 ?, 42 Fordham L. Rev. at 280-84. See also Gottreich v. San Fransisco Investment Corp., 552 F.2d at 867.
When a representation is made by professionals or "those with greater access to information or having a special relationship to investors making use of the information," there is an obligation to disclose data indicating that the opinion or forecast may be doubtful. See Chris-Craft Industries v. Piper Aircraft Corp., 480 F.2d at 363-66; Jacobs, What is a Misleading Statement or Omission under Rule 10b-5 ?, 42 Fordham L. Rev. at 280-81, 283-84. When the opinion or forecast is based on underlying materials which on their face or under the circumstances suggest that they cannot be relied on without further inquiry, then the failure to investigate further may "support an inference that when [the defendant] expressed the opinion it had no genuine belief that it had the information on which it could predicate that opinion." McLean v. Alexander, 599 f.2d at 1198.
Rainess mounts a vigorous challenge to the sufficiency of the evidence presented against it, and contends that the instructions, even if erroneous, were harmless as to it since it should have been awarded a directed verdict on the securities claims. The particular assertion by Rainess on which plaintiffs sought to predicate liability was the statement in its opinion that "the assumptions [of management on which the projections of future operations were based] are not unreasonable." One crucial management assumption was that the coal tracts contained 1,250,000 tons each of recoverable coal reserves that could be mined at the rate of 72,000 tons a year. Plaintiffs presented testimony at trial that the offering memoranda overstated reserves by 50% and did not provide sufficient data to support any conclusion as to whether 72,000 tons of coal could be mined a year. Although Rainess claims to have relied on a coal reserve report by J. D. Brackenrich, an engineer with significant coal experience, and Lieberman and Weinstein also contend that this report gave all defendants a reasonable basis doe the projections, a jury ...