United States Court of Appeals,
Eleventh Circuit.
No. 94-6908.
Robert L. BROWN, and all those similarly situated, Plaintiff-
Appellant,
v.
The ENSTAR GROUP, INC., Richard J. Grassgreen, Perry Mendel,
Defendants-Appellees.
May 31, 1996.
Appeal from the United States District Court for the Middle
District of Alabama. (No. CV 90-A-1268-N), W. Harold Albritton,
III, Judge.
Before TJOFLAT, Chief Judge, and CARNES, Circuit Judge.*
TJOFLAT, Chief Judge:
This appeal presents the issue of what must be proven to
establish "controlling person" liability under section 20(a) of the
Securities Exchange Act of 1934 (the "Act"), ch. 404, 48 Stat. 881,
899, 15 U.S.C. § 78t(a) (1994). We adopt the district court's
test, and affirm its grant of summary judgment in favor of
appellee.
I.
In the late 1960s, appellee Perry Mendel founded what became
Kinder-Care, Inc. ("KCI"), a publicly held corporation. He served
as president of the child-care company until 1985, when he became
chairman of the board of directors. In 1987, KCI established
Kinder-Care Learning Centers, Inc. ("KCLC") as a wholly owned
subsidiary and Mendel undertook the responsibilities of chairman of
*
Senior Circuit Judge Frank M. Johnson heard argument in
this case but did not participate in this decision. This
decision is rendered by quorum. 28 U.S.C. § 46(d).
KCLC's board of directors in addition to his responsibilities as
chair of KCI's board. Not long after KCLC was formed, the
management of KCI began to plan a spin-off of the subsidiary, and
in 1988, KCI caused KCLC to conduct a public offering of its common
stock, reducing KCI's holdings to 87 percent of KCLC's common
stock. On May 29, 1989, KCI announced plans for a corporate
restructuring which would completely separate KCLC from KCI.
Part of this restructuring called for separate boards of
directors for the two companies; to that end, Mendel resigned as
chairman of KCI's board effective May 29, 1989. He remained
chairman of KCLC's board, however. The uncontroverted evidence is
that Mendel had very little contact with KCI's board after his
resignation, and retained only a 2.6 percent interest in KCI.
Richard Grassgreen, who had been president of KCI since 1985,
became KCI's chairman, and continued to plan for the spin-off of
KCLC.
Problems with the proposed restructuring developed, and in
September of 1989, KCI's board met to discuss alternative plans.
Mendel was invited to and did attend this meeting, but no new plan
was adopted. At a subsequent meeting, which Mendel did not attend,
KCI's board adopted a new plan, which it announced on September 22,
1989. The new plan called for the issuance to KCI shareholders of
rights to purchase KCI's shares of KCLC stock.
In connection with the new restructuring plan, KCI issued a
Prospectus to its shareholders on October 4, 1989. The Prospectus
was prepared primarily by KCI's attorney. There is no evidence
that Mendel personally participated in the preparation of the
Prospectus. On October 5, Mendel sent a letter to KCLC's
shareholders, advising them of the restructuring and enclosing a
copy of the Prospectus for their information. In the letter,
Mendel stated that the Prospectus had been "jointly prepared" by
KCI and KCLC. Shortly after the restructuring was completed, KCI
changed its name to The Enstar Group, Inc. ("Enstar").
Appellants are shareholders of KCI/Enstar who bought KCLC
stock from KCI as part of the restructuring.1 They brought a
three-count complaint against Enstar, Grassgreen, and Mendel,2
alleging material omissions and fraud in the dissemination of the
Prospectus. Enstar and Grassgreen subsequently filed for
bankruptcy, and appellants dismissed all claims against those
defendants, proceeding against Mendel alone.
Count one of appellants' complaint alleged that, in failing to
disclose material facts in the Prospectus, Mendel violated section
10(b) of the Act, 48 Stat. at 891, 15 U.S.C. § 78j(b) (1994), and
rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1995),
which together provide an implied private right of action for
misrepresentations in the purchase or sale of securities. In
addition, appellants alleged that Mendel was secondarily liable for
any violations of the Act by KCI because he was a "controlling
person" of KCI within the meaning of section 20(a) of the Act.
1
The district court certified a plaintiff class with respect
to appellants' federal securities law claims (count one). The
court denied appellants' motion to certify a class with respect
to appellants' state law claims (count three).
2
Appellants' original complaint referred to Mendel as the
chairman of the board of KCI. The district court allowed them to
amend their complaint to remedy this error. We refer to the
amended complaint as the "complaint."
That count further contended that if Mendel was not liable as a
controlling person under section 20(a), then he aided and abetted
KCI in connection with the 10b-5 violation. Count two alleged a
violation of the Racketeer Influenced and Corrupt Organizations
Act, 18 U.S.C. §§ 1961-1964 (1994); this count was dismissed by
the district court and is not at issue here. Count three alleged
that Mendel committed fraud in violation of Alabama law. No aider
and abettor liability was asserted in this last count.
The district court granted summary judgment to Mendel, holding
that "the facts cannot legally support a finding that Mendel was a
"controlling person' of KCI" at the time of the issuance of the
Prospectus. Brown v. Mendel, 864 F.Supp. 1138, 1140
(M.D.Ala.1994). The court also found that Mendel was not
personally involved in the alleged fraud, that he owed no duty to
disclose any information to appellants in the Prospectus, and that
therefore he could not be liable for fraud under Alabama law. Id.
at 1147.
II.
We review the district court's grant of summary judgment de
novo, applying the same legal standards that bound the district
court. See Reserve, Ltd. v. Town of Longboat Key, 17 F.3d 1374,
1377 (11th Cir.1994), cert. denied, --- U.S. ----, 115 S.Ct. 729,
130 L.Ed.2d 633 (1995). In making this determination, we view all
evidence in the light most favorable to the non-moving party. See
Sammons v. Taylor, 967 F.2d 1533, 1538 (11th Cir.1992). Summary
judgment is appropriate in cases in which there is no genuine issue
of material fact. Fed.R.Civ.P. 56(c). For the reasons that
follow, we affirm the district court's grant of summary judgment in
favor of Mendel.
With respect to the first count of their complaint, appellants
effectively concede that Mendel is liable for violations of the Act
only if he is a "controlling person" within the meaning the Act. 3
Section 20(a) provides:
Every person who, directly or indirectly, controls any person
liable under any provision of this chapter or of any rule or
regulation thereunder shall also be liable jointly and
severally with and to the same extent as such controlled
person to any person to whom such controlled person is
liable....
15 U.S.C. § 78t(a). The regulations promulgated under the Act
define control as "the possession, direct or indirect, of the power
to direct or cause the direction of the management and policies of
a person." 17 C.F.R. § 230.405 (1995). The burden is on the
plaintiff to show that a defendant is a controlling person. The
courts of appeals, however, do not agree on exactly how a plaintiff
is to meet this burden.
The Eighth Circuit has developed what has become the most
widely used test for determining whether a defendant is liable as
3
Appellants also assert that, if Mendel is not liable for
the 10b-5 violations as a "controlling person" of KCI, then he is
liable as an aider and abettor. It is clear from the record,
however, that appellants abandoned all aider and abettor claims
well before trial. In their response to Mendel's
interrogatories, appellants stated unequivocally, "Plaintiff[s]
no longer contend[ ] that Mendel is liable as an "aider and
abettor.' " Appellants maintained at oral argument that the
aiding and abetting allegation was dropped only with respect to
the 10b-5 claim. It was only with respect to the 10b-5 claim,
however, that appellants raised aiding and abetting allegations.
There was no mention in the complaint of aider or abettor
liability with respect to the state law claims. We find that
appellants abandoned any claim that defendant Mendel was an aider
and abettor.
a controlling person. That court's two-prong test requires a
plaintiff to establish that "the defendant ... actually
participated in (i.e., exercised control over) the operations of
the corporation in general ... [and] that the defendant possessed
the power to control the specific transaction or activity upon
which the primary violation is predicated." Metge v. Baehler, 762
F.2d 621, 631 (8th Cir.1985) (internal quotation marks and citation
omitted), cert. denied, 474 U.S. 1057, 106 S.Ct. 798, 88 L.Ed.2d
774 (1986). Metge 's test has been cited approvingly by a number
of courts of appeals. See, e.g., Harrison v. Dean Witter Reynolds,
Inc., 974 F.2d 873, 887, 881 (7th Cir.1992), cert. denied, 509 U.S.
904, 113 S.Ct. 2994, 125 L.Ed.2d 688 (1993); Abbott v. Equity
Group, Inc., 2 F.3d 613, 619-20 (5th Cir.1993), cert. denied, ---
U.S. ----, 114 S.Ct. 1219, 127 L.Ed.2d 565 (1994); Sanders
Confectionery Prods., Inc. v. Heller Fin., Inc., 973 F.2d 474, 486
(6th Cir.1992); cert. denied, 506 U.S. 1079, 113 S.Ct. 1046, 122
L.Ed.2d 355 (1993); First Interstate Bank of Denver, N.A. v.
Pring, 969 F.2d 891, 898 (10th Cir.1992), rev'd on other grounds
sub nom. Central Bank v. First Interstate Bank, --- U.S. ----, 114
S.Ct. 1439, 128 L.Ed.2d 119 (1994).
As the district court noted, our court has not formulated its
own test for controlling person liability, nor have we adopted all
or part of the Eighth Circuit's test. Two decisions of the former
Fifth Circuit provide us with guidance in formulating a test,
however.4 In 1980, we found that a defendant who did not have the
4
In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th
Cir.1981) (en banc), this court adopted as binding precedent all
decisions of the former Fifth Circuit handed down prior to
power to control the management of a company or the company itself
could not be liable as a controlling person under section 20(a).
Pharo v. Smith, 621 F.2d 656, 670 (5th Cir.1980). A year later, we
found a defendant liable as a controlling person because the
evidence established that he "had the requisite power to directly
or indirectly control or influence corporate policy." G.A.
Thompson & Co. v. Partridge, 636 F.2d 945, 958 (5th Cir.1981).
The district court devised a test that is a combination of
the requirements outlined in Pharo and Thompson. We find the
reasoning of the district court persuasive, and so adopt the test
set forth in its dispositive order.5 In this circuit, a defendant
is liable as a controlling person under section 20(a) if he or she
"had the power to control the general affairs of the entity
primarily liable at the time the entity violated the securities
laws ... [and] had the requisite power to directly or indirectly
control or influence the specific corporate policy which resulted
in the primary liability." 6 Brown v. Mendel, 864 F.Supp. 1138,
October 1, 1981.
5
We do not find footnote 7 of Rosen v. Cascade Int'l, Inc.,
21 F.3d 1520, 1525 n. 7 (11th Cir.1994), to be contrary to our
holding in the instant case. The Rosen footnote is not only
dictum, it is also contrary to G.A. Thompson & Co., 636 F.2d at
958 ("Neither [the regulation] nor the statute appears to require
participation in the wrongful transaction."), which is binding
authority on this court. See also Abbott v. Equity Group, Inc.,
2 F.3d 613, 620 n. 18 (5th Cir.1993) (noting that Thompson
rejected a "culpable participation" requirement).
6
There is an important distinction between the test we adopt
today and the Eighth Circuit's test discussed above. The Eighth
Circuit's test requires a plaintiff to prove that a defendant
actually exercised power over the entity primarily liable.
Because we hold infra that Mendel neither possessed nor exercised
power over KCI at the time the Prospectus was issued, we do not
need to decide here whether "power to control the general affairs
1145 (M.D.Ala.1994). Of course, the plaintiff must also establish
that the controlled person violated the securities laws.
There is no evidence in the record that Mendel had any power
over KCI at the time of the issuance of the Prospectus. Appellants
insist that because Mendel was chairman of KCI's board of directors
at the time KCI decided to restructure, he was a controlling person
of KCI. The only fraud alleged, however, is fraud in the
preparation and dissemination of the Prospectus. Appellants allege
no violation of the Act in connection with the restructuring
itself. Thus, for Mendel to be liable as a controlling person in
this case, he must have had the power to control KCI at the time
the Prospectus was issued. The district court correctly held that
Mendel was not a controlling person of KCI, and thus cannot be
secondarily liable for KCI's alleged securities law violations.
We likewise affirm the district court's grant of summary
judgment in favor of Mendel on appellants' count three state-law
claims. Under Alabama law, fraud is the "[s]uppression of a
material fact which the party is under an obligation to
communicate." Ala.Code § 6-5-102 (1995). There is no evidence in
the record that Mendel was under any obligation to communicate
anything to the appellants that would support appellants' state law
claims. Appellants were shareholders of KCI, not KCLC. As
previously discussed, Mendel had no role in the management of KCI
at the time the Prospectus was issued, and thus he did not stand in
a fiduciary relationship to KCI's shareholders with respect to the
of the entity primarily liable" means simply abstract power to
control, or actual exercise of the power to control.
issuance or the contents of the Prospectus.
AFFIRMED.
Brown v. Enstar Group, Inc.
Combined Opinion