Randall v. Loftsgaarden

Brief Fact Summary. A district court judgment granted recovery based on rescissory damages to investors (Plaintiff) in a tax shelter that Loftsgaarden (Defendant) sold, Loftsgaardenappealed .

Synopsis of Rule of Law. The measure of damages obtainable by a defrauded tax shelter investor to void the falsified transaction or to recover rescissory damages is not lessened by whatever tax remunerations the investor may have gleaned from said investment under either § 12(2) of the Securities Act of 1933 or § 10(b) of the Securities Act of 1934.

Facts. Investors bought interests in Alotel Associates, a limited partnership created to build and supervise a hotel. Loftsgaarden sold the interests, who promoted their sale as a “tax shelter†that would provide limited partners with significant tax savings. Investors contributed between $35K and $52K each to the venture and when Associates started to experience financial difficulties, Loftsgaarden requested the investors contribute additional money. The investors gave the extra money but at the same time started an investigation into Associates. The motel was foreclosed due to Associates not meeting their requirements so the investors began suit alleging violations of § 12(2) of the Securities Act of 1933, § 10(b) of the Act of 1934 and securities fraud. The district court ruled in favor of investors and awarded rescission. The court of appeals reversed the award and remanded on the issue of damages. The district court, on remand, held the appropriate recovery for to consist of the price paid plus interest, less any tax benefits gleaned. Both parties appealed. The court of appeals held that granting rescissory damages to a tax shelter investor in an action for fraud should be lessened by the tax benefits the investor gleaned from said investment. The Supreme Court granted review. 

Issue. Is the measure of damages obtainable by a defrauded tax shelter investorto void the falsified transaction or to recover rescissory damages lessened by whatever tax remunerations the investor may have gleaned from said investment under either § 12(2) of the Securities Act of 1933 or § 10(b) of the Securities Act of 1934?

Held. (O’Conner, J.) No. The measure of damages obtainable by a defrauded tax shelter investor to void the falsified transaction or to recover rescissory damages is not lessened by whatever tax remunerations the investor may have gleaned from said investment under either § 12(2) of the Securities Act of 1933 or § 10(b) of the Securities Act of 1934.  § 12(2) produces a private right of action in the investor at law or equity for price paid for the security plus interest, minus any income received from that. If the security is no longer property of the investor, then he may be granted rescissory damages. This description of recovery excludes the deduction of tax benefits gleaned as an outcome of the deal due to such profits failing to meet the legislative description of revenue. Tax benefits are accumulated to counterbalance the investors other revenue, a tax deduction by itself fails to establish a taxable occurrence. Under the “direct product rule†in an action for rescission, at common law, the recovery was reduced only by benefits that were the “direct product†of the subject matter of the action. Tax benefits are only obtained if the investor has ample counterbalancing revenue. Such profits are not the “direct product†of the deal. The objective behind the passing of § 12(2) was not only to provide investors with a sufficient remedy, but to accomplish the more significant goal of deterring inaccuracies and inciting full disclosure linked to the selling of securities. Similarly, tax benefits do not establish a return of consideration as considered by the statute. In this framework, consideration refers to the price paid for the security.  § 28(a) fails to enforce a restriction on the measure of recovery accessible to the plaintiff equivalent to his entire economic injury. Instead, courts have acknowledged a choice on the part of the plaintiff to make a decision between rescission, when applicable, or recovery of “out-of-pocket damages.†Reversed and remanded.

Discussion. When looking at the Securities Act of 1933, § 11 only offers the recovery of damages, while § 12 offers different remedies of rescission, where the plaintiff still has control of the damages or security. Courts have not yet rectified the concern regarding what conditions the plaintiff would find to surrender his right to rescission.  Where rescission is not applicable, the court may award rescissory damages, with the measure of damages being based on the difference between the price the security was bought for and its resale price plus interest but less any income the plaintiff may have procured as an outcome of dividends and additional dispersals.