62 F. Supp.2d 533 (1999) | Cited 0 times | D. Rhode Island | August 24, 1999

Memorandum and Order

The plaintiffs are former shareholders in Nyman Manufacturing Co.,Inc. ("Nyman Mfg." or the "corporation"). They brought this actionagainst the corporation and several of its officers and directorsalleging violations of § 10(b) of the Securities Exchange Act of1934, 15 U.S.C. § 78j(b) (the"1934 SEA"), violations of Securities and Exchange Commission Rule10b-5, 17 C.F.R. § 240.10b-5, breach of fiduciary duties, fraud,negligent misrepresentation, and unjust enrichment in connection with theredemption of their stock. The corporation has moved to dismiss, pursuantto Fed.R.Civ.P. 12(b)(6).

The issue presented is whether, under § 10(b), a corporation may beheld liable for false or misleading statements made by persons havingapparent authority to speak on its behalf. Because I answer that questionin the affirmative, the motion to dismiss is denied.


The allegations set forth in the complaint may be summarized asfollows. The plaintiffs owned 952 shares of Class A common stock in NymanMfg. On May 8, 1996, Keith Johnson, a corporate officer and director,sent letters to the plaintiffs stating that the corporation was willingto purchase their shares for $200 per share.1 Shortly thereafter,Judith Lawton's brother, Robert Nyman, another corporate officer anddirector, telephoned Lawton and told her that the corporation was losingmoney, the losses were likely to continue and the value of the stock waslikely to decline. Based on those representations, on May 22, 1996, theplaintiffs accepted the offer and sold all of their stock to thecorporation for $200 per share.

One month later, Robert Nyman, Keith Johnson, and Kenneth Nyman, acorporate officer and director and another brother of Judith Lawton,bought 4,115 shares of Class A stock and 750 shares of Class B stock fromthe corporation. The Class A shares were purchased for $200 per share,the same price for which the plaintiffs' shares were redeemed.Approximately 15 months later, in September 1997, Van Leer Industriespurchased all of Nyman Mfg.'s stock for $1,800 per share.

The gist of the plaintiffs' claims is that the defendants

knew and failed to disclose [to the plaintiffs] that (a) Nyman Mfg. would be purchased or was likely to be purchased, (b) Nyman Mfg. was being prepared for purchase, (c) the shares of Class A common stock in Nyman Mfg. were grossly undervalued at two hundred ($200.00) dollars per share, and (d) defendants intended to repurchase plaintiffs' shares.

(Am.Compl. ¶ 15.) The plaintiffs allege that, in deciding to selltheir stock, they relied on the defendants' misrepresentations. (See id.¶ 19.)


The corporation has presented several reasons why some or all of theplaintiffs' claims should be dismissed. After hearing oral argument, theCourt rendered a bench decision granting the motion to dismiss withrespect to some claims; denying it with respect to others and reservingdecision as to whether, under § 10(b) of the 1934 SEA, thecorporation can be held vicariously liable for the acts of its officersand directors.

The corporation's motion to dismiss the breach of fiduciary duty claimcontained in Count II was granted on the ground that the claim could beasserted only against the individual defendants. The motion to dismissthe unjust enrichment claim against the corporation contained in Count Valso was dismissed because it was the individual defendants and not thecorporation who benefitted from the redemption and resale of theplaintiffs' stock. See Anthony Corrado, Inc. v. Menard & Co. Bldg.Contractors, 589 A.2d 1201, 1201-02 (R.I. 1991) (in order to recover on aclaim of unjust enrichment, a plaintiff must prove that a benefit wasconferred upon the defendant).

On the other hand, the motion to dismiss the § 10(b) claim and thestate law claims for fraud and misrepresentation on the ground that thoseclaims were not pled with the particularity required by Fed. R.Civ.P.9(b) was denied. This Court determined that the complaint adequatelyspecified "'the time, place, and content of [the] alleged falserepresentation.'" Dowling v. Narragansett Capital Corp., 735 F. Supp. 1105,1111 (D.R.I. 1990) (quoting Hayduk v. Lanna 775 F.2d 441, 444 (1st Cir.1985)), and that the specific facts alleged "make it reasonable tobelieve that [the] defendant[s] knew that [their] statement wasmaterially false or misleading." Greenstone v. Cambex Corp., 975 F.2d 22,25 (1st Cir. 1992).

More specifically, the Court noted that the defendants purchased theshares surrendered by the plaintiffs one month after they had beenredeemed and for the same price at which the plaintiffs sold them ($200per share). In addition, 15 months later, all of the stock in thecorporation was sold for $1,800 per share. It is certainly reasonable toinfer that the defendants would not have purchased the plaintiffs' stockfor $200 per share if they believed that the corporation would continueto lose money and if they did not know that a sale of the corporation wasimminent.

The remaining issue to be decided is whether the corporation can beheld liable, under § 10(b), for the alleged misrepresentations of itsofficers and directors. The corporation argues that it cannot be heldliable because § 10(b) does not impose vicarious liability.Alternatively, it argues that even if § 10(b) imposes vicariousliability, the plaintiffs' allegations are insufficient to establish suchliability.

I. Standard of Review

In ruling on a Rule 12(b)(6) motion, a court must accept all factualallegations in the complaint as true and construe them in the light mostfavorable to the plaintiff. See Gooley v. Mobil Oil Corp., 851 F.2d 513,514 (1st Cir. 1988). The motion should be granted "only if, when viewedin this manner, the pleading shows no set of facts which could entitle[the] plaintiff to relief." Id.

II. Indirect Liability under § 10(b)

Section 10(b) of the Securities Exchange Act of 1934 provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . .

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C. § 78j(b).

Securities and Exchange Commission Rule 10b-5 provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5.

A party may violate § 10(b) even though that party, itself, did notdirectly commit the manipulative or deceptive act, in question. Thestatute and the regulation expressly prohibit committing such acts eitherdirectly or indirectly. Thus, a party that causes or is responsible forthe commission of manipulative or deceptive acts may not escape liabilityon the ground that those acts were performed through a proxy rather thanby the party, itself.

The difficulty lies in determining the circumstances under which aparty is responsible for; and, therefore, can be said to have indirectlyengaged in conduct proscribed by § 10(b). The specific issuepresented in this case is whether a corporation may be viewed asindirectly committing deceptive acts because of misrepresentations madeby individuals cloaked with apparent authority to speak for thecorporation.

In In re Atlantic Financial Management, Inc., 784 F.2d 29 (1st Cir.1986), the First Circuit held that this determination should be basedupon traditional common law rules regarding a principal's vicariousliability for the acts of its agents. Id. at 31-32. The Court furtherheld that the provisions of § 20(a) imposing liability for violationsof the 1934 SEA on "controlling persons" did not preclude "this kind ofvicarious liability." Id. at 32-34. Accordingly, the court affirmed adecision holding a corporation vicariously liable, under § 10(b); formisrepresentations made by its chairman who had had apparent authority toact on behalf of the corporation.

Nyman Mfg. argues that Atlantic Financial Management has beensuperseded by the Supreme Court's subsequent decision in Central Bank ofDenver, N.A. v. First Interstate Bank of Denver N.A., 511 U.S. 164, 114S.Ct. 1439, 128 L.Ed.2d 119 (1994), which Nyman Mfg. reads as eliminatingvicarious liability under § 10(b). However, this Court rejects thatargument.

Central Bank holds that, under § 10(b), liability extends only tothose who engage in deceptive conduct and not to those who simply aid andabet the violation. Id. at 177, 114 S.Ct. 1439 ("[W]e again conclude thatthe statute prohibits only the making of a material misstatement (oromission) or the commission of a manipulative act. . . . The proscriptiondoes not include giving aid to a person who commits a manipulative ordeceptive act.").

The decision in Central Bank rests primarily on the fact that the textof the statute contains no reference to "aiding and abetting." Id. at176-177, 114 S.Ct. 1439. However, the Court also rejected the argumentthat "aiding and abetting" was encompassed by the phrase "directly orindirectly" because it found that "aiding and abetting liability reachespersons who do not engage in the proscribed activities at all, but whogive a degree of aid to those who do." Id. at 176, 114 S.Ct. 1439. Inthat connection, the Central Bank Court noted that § 20 of the 1934SEA imposes liability on persons who "control" those who violate the Actbut not those who aid and abet violators and it concluded that theimposition of "some forms of secondary liability, but not others,indicates a deliberate congressional choice with which the courts shouldnot interfere." Id. at 184, 114 S.Ct. 1439.

Central Bank is readily distinguishable from both Atlantic FinancialManagement and this case. In Central Bank, the issue was whether aidingand abetting a misrepresentation that violates § 10(b) also is aviolation of that section. Here, as in Atlantic Financial Management, theconduct on which the claimed liability rests is the misrepresentationitself, and not merely "giv[ing] a degree of aid to those who [made it]."Id. at 176, 114 S.Ct. 1439. Here, it is clear that the allegedmisrepresentations regarding the value of the plaintiffs' stock clearlyviolate the statute and the plaintiffs seek to hold the corporationvicariously liable for that conduct rather than for aiding and abettingthose who committed the alleged violation. Thus, "[u]nlike the issues inCentral Bank . . . the issue in this case-whether respondeat superior isa legitimate basis of liability under § 10(b)-is not a question ofdefining the scope of affirmative conduct proscribed by the statute.Instead, the issue is 'deciding on whose shoulders to placeresponsibility for conduct indisputably proscribed' by the statute."Seolas v. Bilzerian, 951 F. Supp. 978, 983 (D.Utah 1997) (quotingAmerican Telephone and Telegraph Co. v. Winback and Conserve Program,Inc., 42 F.3d 1421, 1430-31 (3d Cir. 1994) ("AT & T")).

On that question, the holding in Atlantic Financial Management that acorporation may be vicariously liable for § 10(b) violations basedupon common law agency principles remains controlling. See also Hollingerv. Titan Capital Corp., 914 F.2d 1564, 1576-77 & n. 27 (9th Cir. 1990),and cases cited therein. To put it another way, misrepresentations madeby agents vested with apparent authority to speak for a corporation maybe described as made "indirectly" by the corporation.

Indeed, if the term "indirect" did not embrace common law agencyprinciples, § 10(b) would be rendered virtually inapplicable tocorporations because a corporation acts only through its agents. See AT &T, 42 F.3d at 1431. Such a result would conflict with Congress' manifestintent to subject corporations to liability by including them in thedefinition of "person" contained in 15 U.S.C. § 77b(2). See AtlanticFin. Management, 784 F.2d at 33-34.

In short, applying agency principles of vicarious liability todetermine whether a corporation may be held accountable for § 10(b)violations does not enlarge the scope of the conduct that the statuteproscribes. Rather, it permits the determination to be made in accordancewith the same well established rules that govern corporate liability inother contexts. As the Third Circuit has said: "The principal is heldliable not because it committed some wrongdoing outside the purview ofthe statute which assisted the wrongdoing prohibited by the statute, butbecause its status merits responsibility for the tortious actions of itsagent." AT & T, 42 F.3d at 1431 (emphasis in the original).

III. Sufficiency of the Plaintiffs' Allegations

Nyman Mfg. argues that, even if vicarious liability may be imposedunder § 10(b), the amended complaint is insufficient to state such aclaim. First, it points out that the § 10(b) claim refers only toconduct by the individual defendants. However, it is clear from thecomplaint that the plaintiffs are asserting a claim against thecorporation on the theory that the corporation is vicariously liable forthe alleged misrepresentations of its directors and officers. Moreover,the complaint specifically describes those misrepresentations. Nothingmore is required. "A complaint need not specify in detail the precisetheory giving rise to recovery. All that is required is that thedefendant be on notice as to the claim being asserted against him and thegrounds on which it rests." Sams v. United Food & Commercial WorkersInt'l Union, 866 F.2d 1380, 1384 (11th Cir. 1989); accord ConnecticutGen. Life Ins. Co. v. Universal Ins. Co., 838 F.2d 612, 622 (1st Cir.1988); 2 James Wm. Moore et al., Moore's Federal Practice § 8.04[3](3d ed. 1999).

Nyman Mfg. also argues that the amended complaint is deficient becauseit fails to allege that the plaintiffs relied on the individualdefendants' apparent authority to act for the corporation. It is truethat reliance upon the appearance of authority is a necessary element inestablishing apparent authority. See J. Christopher York, VicariousLiability of Controlling Persons: Respondeat Superior and the SecuritiesActs-A Reversible Consensus in the Circuits, 42 Emory L.J. 313, 326-28(1993). It is also true that the complaint does not expressly allegerelianceon the individual defendants' appearane of authority. However, it doesallege that the plaintiffs relied on the individual defendants'representations and that those defendants were "at all times . . .officer[s], director[s], shareholder[s] and employee[s] of defendantNyman Mfg." (Am. Compl.¶¶ 4-6, 12). In addition, it alleges that theplaintiffs sold their stock to the corporation in response to a formaloffer contained in a letter signed by Keith Johnson as President of thecorporation. (See Am.Compl. Ex. A.) Thus, although the complaint couldhave been drafted more artfully, it is sufficient to put the corporationon notice that the plaintiffs' claim against it rests on the appearanceof authority vested in the individual defendants.

Finally, Nyman Mfg. makes a novel argument that the claim against itshould be dismissed because the plaintiffs have an adequate remedyagainst the individual defendants, and, therefore, there is no need tobind the company to any judgment. In support of that argument, NymanMfg. cites language in Calenda v. Allstate Insurance Co., 518 A.2d 624(R.I. 1986), where the court stated that, in order to establish apparentauthority under Rhode Island law

facts must be shown that the principal has manifestly consented to the exercise of such authority or has knowingly permitted the agent to assume the exercise of such authority; that a third person knew of the fact and, acting in good faith had reason to believe and did actually believe that the agent possessed such authority; and that the third person, relying on such appearance of authority, has changed his position and will be injured or suffer loss if the act done or transaction executed by the agent does not bind the principal.

Id. at 628 (quoting Soar v. National Football League Players Ass'n438 F. Supp. 337, 342 (D.R.I. 1975), aff'd, 550 F.2d 1287 (1st Cir.1977)) (emphasis added).

Nyman's reliance on Calenda is misplaced. Like most apparent authoritycases, Calenda involved a suit for breach of contract in which it wasincumbent upon the plaintiff to show that he would suffer a loss (i.e.,loss of the benefit of his bargain) unless the principal was bound by thecontract made with the principal's apparently authorized agent. Theunderscored language in Calenda merely confirms the requirement that theloss would result from a failure to bind the principal. It does not meanthat the principal is relieved of liability for the acts of its agentsimply because a claimant also may have a cause of action against theagent.

By contrast, the applicability of the doctrine of apparent authority ismuch more limited in tort cases. Ordinarily, a plaintiff who is injuredby the negligence of a putative agent would be hard-pressed todemonstrate that the injury resulted from reliance upon the agent'sapparent authority. For example, it is unlikely that a pedestrian who isstruck by a truck could establish that he was injured because he believedthat the driver had the owner's authorization to operate the truck.2

However, the doctrine of apparent authority frequently applies in tortcases involving misrepresentation. Thus, a principal may be liable formisrepresentations made by an agent having apparent authority to speakfor the principal when a claimant suffers a loss resulting from itsreliance on the agent's appearance of authority. See Atlantic Fin.Management, 784 F.2d at 32.

That is precisely the situation presented in this case. The plaintiffsallege that Nyman Mfg. is liable for the losses theysustained upon the redemption of their stock because they acted inreliance upon representations that they believed to have been authorizedby the corporation. The fact that the plaintiffs also may have a claimagainst the individuals making the representations is immaterial.

IV. Direct Liability Under § 10(b)

Even if "indirect liability" under § 10(b) did not includevicarious liability based upon the doctrine of apparent authority, thecomplaint is sufficient to state a claim against the corporation. Theletter appended to the complaint that offers to redeem the plaintiffs'shares is signed by Johnson on behalf of Nyman Mfg. (See Am.Compl. Ex.A.) Thus, it appears to be an act in furtherance of the alleged scheme todefraud that was performed by the corporation, itself, that would providea basis for imposing "direct" liability under § 10(b).


For all of the foregoing reasons, defendant Nyman Mfg.'s motion todismiss is granted with respect to the claims for breach of fiduciaryduty and unjust enrichment contained in Counts II and V, and it is deniedwith respect to all other claims.


1. A copy of the letter that was sent to Judith A. Lawton is attachedto the amended complaint as Exhibit A.

2. On the other hand, it may make sense to say that a hospital isliable for the consequences of malpractice by an unqualified staffphysician when the patient submits to treatment only because the patientbelieves that the physician is an agent of the hospital and, therefore,relies upon the hospital's judgment with respect to the physician'squalifications. See Rodrigues v. Miriam Hosp., 623 A.2d 456, 462 (R.I.1993).

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