Mаy investors who purchased limited partnership interests in certain “tax shelters” recover as damages, in a federal securities fraud suit, back taxes and interest paid to the Internal Revenue Service?
I
This complex and seemingly interminable securities fraud action was initially filed in 1985
The plaintiffs’ complaint alleged that the defendants sold certain investment contracts to the partnerships in derogation of the registration and anti-fraud provisions of the Securities Act of 1933, 15 U.S.C. § 77a et seq., section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5. The complaint also alleged various violations of state law and of 18 U.S.C. § 1962(c), a section of the Racketeer Influеnced and Corrupt Organizations Act (“RICO”).
During the course of the litigation, the plaintiffs settled with two of the defendants (not including the present appellee, Dr. Jacob Y. Terner) for a total of $1,360,000. In addition, the district court also entered default judgments against a number of the other defendants (not including Terner) in the
According to the plaintiffs’ appellate brief, the defendants who sold the investment contracts to the partnerships also sold limited partnership interests in those partnerships to the individual partners. The defendants allegedly marketed these partnership interests as “tax shelters,” telling the partners that because the partnerships would be highly leveraged and would incur significant research and development (“R & D”) expenses, the partners would be entitled to substantial federal tax deductions from ordinary income under then-existing federal tax law. However, none of the R & D expenditures were made, and the Internal Revenue Service (“IRS”) subsequently disallowed the deductions. As a result, in July 1991, partners of two of the 1982 R & D Partnerships
While it is not entirely clear from the extremely limited factual sections of the parties’ briefs, it appears that during the course of the proceedings the plaintiff partnerships claimed that they were entitled to recover, as part of their damages, the taxes and interest paid by the individual partners to the IRS, as well as the funds paid to the CPA.
The plaintiffs timely appealed the court’s
II
In analyzing the appellants’ damages claims, we necessarily begin with Section 28(a) of the Exchange Act, 15 U.S.C. § 78bb(a). That provisiоn states in relevant part that:
The rights and remedies provided by this chapter shall be in addition to any and all other rights and remedies that may exist at law or in equity; but no person permitted to maintain a suit for damages under the provisions of this chapter shall recover, through satisfaction of judgment in one or more actions, a total amount in excess of his actual damages on account of the act complained of.
15 U.S.C. § 78bb(a) (emphasis added).
In Affiliated Ute Citizens of Utah v. United States,
In Affiliated Ute, the Supreme Court suggested that the proper measure of damages under section 28(a) is ordinarily
the difference between the fair value of all that the ... seller received and the fair value of what he would have received had there been no fraudulent conduct ... except for the situation where the defendant received more than the seller’s actual loss. In the latter case damages are the amount of the defendant’s profit.
Affiliated Ute,
Under the general rule, a plaintiff may recover the difference between the value of the consideration paid and the value of the securities received, plus consequential damages that can be proven with reasonable certainty to have resulted from the fraud.... The trial judge has the discretion to apply a rescissionary remedy which entitles a plaintiff to a return of his consideration less any value received on the investment. ... Thus, a plaintiff in an action under § 10(b) is gеnerally limited to recovery of out-of-pocket losses or actual damages.
Volk v. D.A. Davidson & Co.,
In this case, the plaintiffs argue that the back taxes and interest paid to the IRS, as well as the sums paid to the CPA, qualify either as out-of-pocket losses or consequential damages. In addition, they argue that the taxes paid qualify as benefit-of-the-bargain or expectancy damages, and they urge this court to hold that such damages are recoverable under sections 10(b) and 28(a). We address these claims in turn.
A
We first address the plaintiffs’ arguments concerning the back taxes paid to the IRS.
1
The plaintiffs first argue that thе back taxes are recoverable as out-of-pocket damages. The plaintiffs offer no authority in support of this argument, and we reject it.
As noted above, under the out-of-pocket standard a defrauded purchaser is entitled to recover the difference between the price he or she paid for a security and the actual value of that security at the time of the purchase, plus interest on the difference. See, e.g., Affiliated Ute,
In arguing that the taxes paid by the partners to the IRS represent out-of-pocket “losses,” the plaintiffs fundamentally mis-characterize the nature of those payments. If the partners had not purchased limited partnership interests in the first instance, they would still have had to pay the taxes in question, based on their overall income situation. The fact that they ultimately did so does not suggest that they suffered an out-оf-pocket “loss” as a result of their investment; rather, it merely indicates that one anticipated benefit of their investment failed to materialize. The taxes paid can therefore properly be characterized only as benefit-of-the-bargain damages, not as out-of-pocket losses. See 2 T. Hazen, The Law of Securities Regulation § 13.7 at 115 (2d ed. 1990) (“Loss of expected tax benefits do not qualify as out-of-pocket loss and thus can be awarded only as expectation damages, which ... may not be appropriate in rule 10b-5 cases.”); Stone v. Kirk, 8 F.3d 1079, 1092 (6th Cir.1993) (“The Stones are not entitled to recover as damages the taxes they had to pаy on their 1981 and 1982 income. They did not expect to have to pay such taxes, to be sure, but expectancy damages — damages designed to give the plaintiff the benefit of his bargain — are simply not recoverable under the federal securities laws.”); Freschi v. Grand Coal Venture,
This is not to suggest, however, that the partners’ anticipated but unrealized tax benefits are irrelevant to the calculation of out-of-pocket losses. As explained by Justice Blackmun in his concurring opinion in Randall v. Loftsgaarden,
Justice Blackmun explained that:
To ascertain out-of-pocket loss requires taking into account all the elements that go into the price of a tax shelter. That price will reflect both the value of the underlying asset ... and the value of the tax write-offs that the construction and operation of the underlying asset will generate.... An investor will pay more for a share of an underlying asset when ownership will provide not only income and capital appreciation but also tax benefits.
Id. at 668,
An investor who receives the promised tax benefits, but not the promised income stream or appreciation, of course has been injured. But this injury — the difference between the value of what he received and the value of what he was promised — is represented, not by the entire purchase price, but rather by that portion of the purchase price which went toward a high quality underlying asset when what was received was a lower quality asset. In other words, the investor received the benefit of this bargain with resрect to that part of the purchase price which went toward buying the tax benefits. The proper measure of recovery in such a case is therefore the part of the purchase price attributable to payment for an asset that was never received.
Id. at 669,
Justice Blackmun’s reasoning makes it clear that taxes рaid to the IRS in settlement of liabilities stemming from the disallowance of tax deductions do not qualify as out-of-pocket damages. However, to the extent that a plaintiff can establish that a Rule 10b-5 violation occurred with respect to expected but unrealized tax benefits, any “premium” which the plaintiff paid in order to obtain those unrealized tax benefits would be relevant in calculating out-of-pocket damages. Cf. Randall,
However, in this case, the amount that the plaintiffs have already received in settlement from other defendants exceeds the total capital invested by the partners, plus interest on that capital. Accordingly, the partners have already necessarily recovered any “premium” which they may have paid for the unrealized tax benefits, and have thus completely recovered their out-of-pocket losses.
2
For similar reasons, we reject the plaintiffs’ assertion that the taxes paid may be recovered as consequential damages. As noted above, Rule 10b-5 plaintiffs may recover consequential damages which “can be proven with reasonable certainty to have resulted from the fraud." Volk,
3
Finally, the plaintiffs argue that the back taxes paid to the IRS may be recovered as benefit-of-the-bargain damages. Relying on a number of recent cases from other circuits, they urge this court to hold that benefit-of-the-bargain damages are available under Rule 10b-5, and that promised but unrealized tax benefits qualify as such damages.
The benefit-of-the-bargain measure of damages allows a plaintiff to recover “the difference between what the plaintiff expected he would receive, had the defendant’s representations been true, and the amount [the plaintiff] actually received .... ” Cunha v. Ward Foods, Inc.,
In any event, we conclude that we need not decide whether benefit-of-the-bar
We first review Randall. The plaintiffs in that case had purchased interests in a limited partnership which was organized by the defendant and marketed and sold as a tax shelter. The plaintiffs brought a securities fraud suit under both section 10(b) of the 1934 Act and section 12(2) of the 1933 Act.
The court of appeals reversed, holding that the “actual damages” principle of section 28(a) required that any award under section 12(2) be reduced by an amount equal to any tax benefits received.
The first part of the Court’s opinion addressed the plaintiffs’ contention that the definition of “income received” in section 12(2) did not include tax benefits received pursuant to a tax shelter investment. The Court agreed with this argument, explaining that the tax deductions “have no value in themselves; the economic benefit to the investor — the true ‘tax benеfit’ — arises because the investor may offset tax deductions against income received from other sources or use tax credits to reduce the taxes otherwise payable on account of such income.” Randall
In the second part of the Court’s opinion, the Court considered “whether § 28(a) requires such an offset when a rescissory measure of damages is applied to a plaintiff’s § 10(b) claim.” The Court concluded that no such offset was required, explaining as follows:
Respondents essentially ask us to treat tax benefits as a separate asset that is acquired when a limited partner purchases a share in a tax shelter partnership. But the legal form of the transaction does not reflect this treatment. Petitioners purchased securities, thereby acquiring freely alienable rights to any income that accrued to them by virtue of their ownership. They did not, however, also acquire a separate, freely transferable bundle of tax losses that would have value apart from petitioners’ status as partners. For obvious reasons, tax deductions and tax credits are not, in the absence of a statutory provision to the contrary, freely transferable from one person to another if wholly severed from the property or activity to which they relate.... Accordingly, we decline to treat these tax losses as so much •property created by the promoters of the partnership.
Id. at 665-66,
This court relied on Randall’s, rationales in Volk. In Volk, the district court had held that the appellants’ securities fraud claims were barred by the statute of limitations. In doing so, the district court rejected the appellants’ argument that their claims did not accrue, and that the statute of limitations was not triggered, until they sustained “out-
As is the case here, the appellants alleged on appeal that the appellees had marketed the limited partnership interests as tax shelters which would give rise to substantial tax deductions. Relying on this fact, the appellants argued that
[E]ven if their cause of action normally would accrue at the time of purchase, a tax shelter investment requires a different result. They contend that it was impossible for them to realize they had been injured until 1982 when their deductions were disallоwed by the IRS. Coupled with this argument is the proposition that appellants’ recoverable damages, had they prevailed, would include losses occasioned by adverse tax consequences sustained in 1982.
Volk,
This court, relying on Randall, rejected this argument:
An investment which leads to a suit for fraud does not vest a prevailing purchaser with a different measure of damages solely because the investment was marketed as a tax shelter. Appellants, like all investors in tax shelters, sought the benefit of sizea-ble tax deductions to offset other taxable income, but they did not acquire any alienable rights to tax losses having value apart from either the securities themselves or their status as limited partners.
Id. at 1414 (citing Randall, supra) (emphasis added). In addition, we stated that:
Contrary to appellants’ arguments, the nature of the investment as a tax shelter and the damages recoverable for fraud in connection with such investments have no bearing on the commencement of the limitations period. The actual monetary loss sustained by appellants in 1982 by virtue of the IRS disallowance is not the type of injury recognized by securities law. Investors must bring their lawsuits when they should discover that they paid an inflated price for securities as a result of misleading statements or omissions. Whatever action the IRS ultimately takes does not аffect defrauded investors’ rights to damages. Appellants’ damages were fully cognizable prior to the IRS decision.
Id. (emphasis added).
The plaintiffs here argue that this language is dictum, because Volk’s actual holding was that the plaintiffs’ claims were barred by the statute of limitations. It is true that Volk is distinguishable on that ground. However, as Terner correctly notes, Volk did necessarily consider whether a “loss” stemming from the disallowance of tax deductions constitutes an “injury recognized by securities law.” Id. Volk answered that question in the negative, and we are bound by our prior decision.
For the foregoing reasons, we reject the plaintiffs’ contentiоn that back taxes paid to the IRS as a result of disallowed deductions may be recovered as damages under section 10(b).
B
We also reject the plaintiffs’ argument that interest paid to the IRS may qualify as either out-of-pocket or consequential damages. The interest paid merely compensated the IRS for the partners’ use of money to which they were not entitled. As a result, to the extent that the IRS charged a market rate of interest, the interest payments merely prevented the partners from retaining a windfall. See Stone v. Kirk,
Similarly, the trial court noted that the interest and penalties IRS assessed against the senior Freschi were not a consequential damage; rather, they were simply compensation to IRS for the use of money IRS would have had if the senior Freschi had not wrongly withheld it. The interest and penalties were not, the trial court correctly observed, really a damage suffered by the senior Freschi at all, but a return by him of what would otherwise be a windfall resulting from his opportunity to use money to which he was not entitled.15
C
Finally, the plaintiffs argue that the $70,000 paid to the CPA may be recovered as either out-of-pocket or consequential damages. The plaintiffs’ argument that these sums constitute consequential damages may have merit. However, in light of our ruling that the back taxes and interest are not recoverable damages, we conclude that we need not decide this issue. The amount received in settlement by the plaintiffs ($1,360,-000) exceeds, by an amount greater than $70,000, the full rescissory recovery to which the plaintiffs would be entitled ($1,062,796, representing the capital invested by the partners plus interest). Accordingly, the plaintiffs have, in effect, already rеcovered the fees paid to the CPA, and we need not decide if those fees would otherwise qualify as consequential damages.
Ill
Because the partnerships have already recovered all the “actual damages” to which the partners may be entitled under section 28(a), they are not entitled to any additional recovery. Accordingly, we affirm the district court’s order that the plaintiffs “take nothing” from Terner.
AFFIRMED.
Notes
.The case has already spawned a number of interlocutory rulings by this court. See DCD Programs, Ltd. v. Leighton,
. Technimatics Five, Ltd.; DCD Programs, Ltd.; Integrated Commodity Systems; and JKB Alpha Programs.
. Lord Hill Investors; Pack Programmers; and Uxbridge Management.
. The parties have not discussed this default judgment in their damage calculations, presumably because the plaintiffs have little or no chance of satisfying this judgment.
. DCD Programs and Integrated Commodity Systems.
. In light of the fact that the named plaintiffs in this case are thе partnerships, not the individual partners, and in light of the fact that only the partners (as opposed to the partnerships) actually pay taxes and might arguably have been "damaged” as a result of the disallowance of the tax deductions, we have some doubt regarding whether the partnerships are the proper parties to seek recovery of the taxes and interest paid by the partners.
However, Temer has not directly challenged the partnerships' standing to seek recovery of these alleged damages on behalf of the partners. This court was faced with an arguably similar situation in Sycuan Band of Mission Indians v. Roache,
In this case, as in Sycuan Band, we believe that the constitutional standing requirements outlined in Lujan v. Defenders of Wildlife,
. The plaintiffs initially appealed the order as to both Dougherty and Temer. However, they subsequently dropped their claims against Dougherty after the Supreme Court ruled in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,
. We note that the district court’s order is ambiguous, and that it does not explicitly mention § 28(a). However, Terner apparently agrees with the plaintiffs' assertion that the district court's order was based on an interpretation of § 28(a). Because this is a plausible reading of the order, we accept the parties' interpretation and address the statutory issue on the merits.
. Freschi was vacated by the Supreme Court and remandеd for reconsideration in light of Randall; however, Randall did not affect this portion of Freschi, and we find the Second Circuit's reasoning on the point persuasive.
. Although Salcer was subsequently vacated by the Supreme Court for reconsideration in light of Randall, the majority opinion in Randall did not affect this portion of Salcer's analysis. This fact was implicitly recognized by Justice Blackmun, whose concurring opinion in Randall cited and relied on Salcer.
. Although the plaintiffs do not argue that they are entitled to recovery of additional damages based on a rescissionaiy measure of damages, we note that the amounts already received by the plaintiffs also exceed a complete rescissionary recovery.
. Cf. 79A C.J.S. Securities Regulation § 282 at 313 (1995) ("It has been said that a buyer defrauded in violation of the securities laws is entitled to recover only the excess of what he paid over the value of what he got, not the difference between the value of what he got and what it was represented he would be getting.”) (footnote, citation omitted); 2 T. Hazen, The Law of Securities Regulation 115 (2d ed. 1990) ("the better argument [appears to be that] rule 10b-5 is couched in fraud, and as such the remedy should be limited to the traditional fraud [out-of-pocket] remedy with state law still being available for expectation losses on appropriate facts”).
. Section 12(2) states that aggrieved plaintiffs may sue "to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he no longer owns the security.” 15 U.S.C. § 771(a) (emphasis added).
. The Court of Appeals applied § 28(a)'s “actual damages” limit to both the § 10(b) claims and the § 12(2) claims, even though § 28(a) is part of the 1934 Act and does not expressly apply to actions brought under § 12(2) of the 1933 Act.
. As noted above, Freschi was vacated by the Supreme Court and remanded for reconsideration in light of Randall; however, Randall did not affect this portion of Freschi, and we find the
. In light of our disposition of this case, we need not address the other issues raised by the parties.