Amicus Brief — Blue Chip Stamps v. Manor Drug Stores
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No. 74-124
K, JR. CLERK
Iu the Supreme Court of the United States
OCTOBER TERM, 1974
BLUE CHIP STAMPS, ET AL., PETITIONERS
Vv.
MANOR DRUG STORES, ETC.
ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE NINTH CIRCUIT
BRIEF FOR THE SECURITIES AND EXCHANGE
COMMISSION AS AMICUS CURIAE
ROBERT H. BORK,
Solicitor General,
FRANK H. EASTERBROOK,
Assistant to the Solicitor General,
Department of Justice,
Washington, D.C. 20530.
LAWRENCE E. NERHEIM,
General Counsel,
DAVID FERBER,
Solicitor,
RICHARD E. NATHAN,
Assistant General Counsel,
DAVID K. GINN,
Attorney,
Securities and Exchange Commission,
Washington, D.C. 20549.
INDEX
Page
Question presented 2
Interest of the Securities and Exchange Com-
i alae IF aa A A are SD 2
EEE LT rk Aree ae. Se ee 2
Summary of argument =§.5§. ©. 5
Arguments
The victim of deceptive activities in con-
nection with the purchase or sale of se-
curities should be able to recover his de-
monstrable damages whether or not he
has purchased or sold securities 8
A. Section 10(b) and Rule 10b-5 protect
“any person” against deceptive de-
vices material to an investment deci-
i a 10
B. There is an implied civil remedy on
behalf of all persons injured by vio-
lations of Rule 10b-5, including those
who have neither purchased nor sold
securities pean Se 17
C. This Court should not adopt the
Birnbaum rule as a method to limit
the class of potential plaintiffs _- 24
Conclusion __... nas indeed FOR Micky hen et = ohh 33
I Ul
fa CITATIONS . Cases—Continued Page
S:
age Fratt v. Robinson, 203 F.2d 627 —.-- 18, 20
A. T. Brod & Co. v. Perlow, 375 F.2d Goodman v. H. Hentz & Co., 265 F. Supp.
393 --------+-----40, 15, 32 “Seg: Pa EO a 10
Affiliated Ute Citizens v. United States, Greater Iowa Corp. \ v. McLendon, 378 F.
406 U. S. 128 7, 10, 18, 25, 26 2d 783 . PCy oe 12
Association of Data Processing Organi- Greenstein * v. , Paul, 400 F.2d “RR 31
zations, Inc. v. Camp, 397 U.S. 150_. 19 EK anly v. Securities and Exchange Com-
Berko v. Securities and Exchange Com- mission, 415 F.2d 589 _ 17
mission, 316 F.2d 137 16 Hardin v. Poveceeiteaed Utilities Co., 390
Birnbaum v. Newport Steel Corp., 193
F.2d 461, certiorari denied, 343 U.S.
956 _._4, 5, 6, 7, 8, 11
Britt v. Cyril Bath Co., 417 F.2d 433 __ 21
City National Bank v. Vandeboom, 422
F.2d 221, certiorari denied, 399 U.S.
905 Ds A EE i)
Commerce Reporting Co. v. Puretec, Inc.,
290 F. Supp. 715 __. Dae EN 10
Conley v. Gibson, 355 U.S. 41 Bates 2
Crane Co. v. Westinghouse Air Brake Co.,
419 F.2d 787, certiorari denied, 400
U.S. 822 Nae SEs ee 32
Drachman v. Harvey, 453 F.2d 722, re-
versed on rehearing en banc, 453 F. 2d
736 _ 81-32
Eason v. General Motors” Acceptance
Corp., 490 F.2d 654, certiorari denied,
416 U.S. 960 _9, 20, 24, 30
Ellis v. Carter, 291 F.2d 270, ‘dismissal
affirmed, 328 F.2d 573 _. 10
Fischman v. Raytheon Mfg. Co., 188 F. 2d
783 = _ 18, 20
Flast v. Cohen, 392 US. 83. eR 19
SRR SACRE een ee ee ee no 19
Hooper v. Mountain States Securities
Corp., 282 F.2d 195, certiorari denied,
BO WING (GUI oS dscecesdcaicinielanstomsscsababeriel ....-9, 18, 20
Hughes v. Securities and Exchange Com-
mission, 174 F.2d 969 16
International Controls Corp. v. Vesco,
490 F.2d 1334, certiorari denied, 417
eee ee ee ao a
Iroquois Industries, Ine. v. Syracuse
China Corp., 417 F.2d 963 _...... 9, 31
J. I. Case Co. v. Borak, 377 U.S. 426.2, 6, 7, 18,
21, 22, 23, 31
James v. Gerber Products Co., 483 F.2d
BD aids tiienn 9, 32
Kahan v. Rosenstiel, 424 F. 2d 161, ‘certio-
rari denied sub nom. Glen Alden Corp.
v. Kahan, 398 U.S. 950 - 21
Kardon v. National Gypsum Co., 69 F.
Supp. 512 ...... 19
Kerbs v. Fall River Industries, Ine., 502
F.2d 731 - 9
Kuehnert v. Texstar Corp., 412 F.2d 700. 16
Lanasa Fruit S.S. & I. Co. v. Universal
Insurance Co., 302 U.S. 556 12
Cases—Continued Page
Landy v. Federal Deposit Insurance
Corp., 486 F.2d 139, certiorari denied,
416 U.S. 960 a 9
M. L. Lee & Co. v. American Cardboard
& Packaging Corp., 36 F.R.D. 27 ___. 10
McClure v. Borne Chemical Co., 292 F.2d
824, certiorari denied, 368 U.S. 939. 11
Mills v. Electric Auto-Lite Co., 396 U.S.
eile Ridin 2, 6, 22
Mount Clemens Industries, Ine. v. _ Bell,
464 F.2d 339 ss 5
Mutual Shares Corp. v. Genesco, Inc., 384
F.2d 540 is
N. Sims Organ & Co., Ine. v. Securities
and Exchange Commission, 293 F.2d
78 16
Opper v. Hancock Securities Corp. he 367
F.2d 157, affirming, 250 F. Supp. 668 10
Petroleum Exploration, Inc. v. Public
Service Commission, 304 U.S. 209 | 24
Rekant v. Desser, 425 F.2d 872 ss‘ 10-1
Ruckle v. Roto American Corp., 339 F.2d
EES BT ee eo ee ED 32
Sargent v. Genesco, Inc., 492 F.2d 750 9
Securities and Exchange Commission v.
Capital Gains Research Bureau, Inc.,
375 U.S. 180 a
Securities and Exchange Commission 1 v.
National Securities, Inc., 393 U.S. 453 23
Securities and Exchange ‘Commission v.
Texas Gulf Sulphur Co., 401 F.2d 833,
certiorari denied sub nom. Coates v.
Securities and Exchange Commission,
394 U.S. 976
Cases—Continued Page
Schoenbaum v. Firstbrook, 268 F. Supp.
385, affirmed, 405 F.2d 200, reversed
in part on other grounds, 405 F.2d 215,
certiorari denied sub nom. Manley v.
Schoenbaum, 395 U.S. 906 - es 12
Shapiro v. Merrill Lynch, Pierce, Fenner
& Smith, Inc., 495 F.2d 228 - , 28
Sierra Club v. Morton, 405 US. 727 — 19
Simmons v. Wolfson, 428 F.2d 455, certio-
rari denied, 400 U.S. 999 9,12
Slavin v. Germantown Fire Ins. Co., 174
2, | Jaen ree 18
Smallwood v. Pearl Brewing Corp. “ 489
F.2d 579 __.... 9
Stockwell v. Reynolds & Co., 252 F. ‘Supp.
215 - 10
Superintendent 0 of Insurance v. - Bankers
Life & Casualty Co., 430 F.2d 355, re-
6-7, 8, 10, 13, 15,
versed, 404 U.S. 6 - oon oo
Tcherepnin v. Knight, 389 U.S. 332 18, 24
Travis v. Anthes Imperial Ltd., 473 F.2d ‘a
Sra
Tully v. Mott Supermarkets, Ine., 337
F. Supp. 834 . __ 9
United States v. Blue Chip Stamp Co., be
oe 0. Ga Ge. nn 3
United States v. Students Challenging
Regulatory Agency Procedures, 412
/ eee 19
Vine v. Beneficial Finance Co., 374 ‘F.2d
627, certiorari denied, 389 US. 970... 21, 32
Wyandotte Transportation Co. v. United
States, S59 UB. B66. 6, 19, 21
VI
Cases—Continued Page
Young v. Seaboard witha ., 360 F. Supp.
490 ine menses 9
Statutes and rules:
Securities Act of 1933, 48 Stat. 74, as
amended, 15 U.S.C. 77a, et seq.:
Section 17(a), 15 U.S.C. 77q(a) _ 12,29
Securities Exchange Act, 48 Stat. 881, as
amended, 15 U.S.C. 78a, et seq.:
Section 10(b), 15 U.S.C. 78j(b) _ passim
Section 14(a), 15 U.S.C. 78n(a) 22
Section 27, 15 U.S.C. 78aa iy 19
Rules under Securities Exchange Act of
1934:
Rule 10b-5, 17 C.F.R. 240.10b-5
. R. ' __ passim
Rule 10b-5(c), 17 C.F.R. 240.10b-5
(c) 10
Rule 14a-9(a), 17 C.F.R. 240. 14a-9
NE tedithcaettibibaniicntinini ners ialaiaidenaies 22
Miscellaneous:
2 Bromberg, Securities Law: Fraud—
SEC Rule 10b-5, Sec. 7.6(1), p. 190.21
(1973) 11
Comment, Jnroads on the Necessity for a a
Consummated Purchase or Sale under
Rule 10b-5, 1969 Duke LJ. 349
(1969) 23
Comment, The Decline of the Purchaser-
Seller Requirement of Rule 10b-5, 14
Vill. L. Rev. 499 (1969) - sailed 23
vil
Miscellaneous—Continued Page
Comment, The Purchaser-Selier Rule: An
Archaic Tool for Determining Stand-
ing under Rule 10b-5, 56 Geo. L.J. 1177
TESS A, a inetiialibideiniailinehes 23
78 Cong. Rec. | Pa 14
H. Rep. No. 1383, 73d Cong., 2d Sess. _. 11,13
H. Conf. Rep. No. 1838, 73d Cong., 2d
Sess. . 14,15
Hearings before the House ‘Committee 0 on
Interstate and Foreign Commerce on
H.R. 7852 and 8720, 73d Cong., 2d
Sess. u _ 14,15
Hearings before ‘the Senate Committee 0 on
Banking and Currency on S. Res. 84
(72d Cong.) and S. Res. 56 and 97
(73d Cong.), Part 15, 73d —_ 1st
Sess. 15
Investors Management Co., " Ine.; “ Securi-
ties Exchange Act Release No. 9267
(July 29, 1971) _.........-. 17
Jacobs, Birnbaum in Flue: " Significant
10b-5 en 2 Sec. Reg. L.J.
305 (1975) . on 23
Leech, Transactions in Corporate Control,
104 U. Pa. L. Rev. 725 (1956) — . 23
Lowenfels, The Demise of the Birnbaum
Doctrine: A New Era for Rule 10b-5,
54 Va. L. Kev. 268 (1968) - 23
Merrill Lynch, Pierce, Fenner & Smith,
Inc., Securities Exchange Act Release
No. 8459 (November 25, 1968) 17
Note, Civil Liability Under Rule X-10b-5,
42 Va. L. Rev. 537 (1956) —............ 24
VIII
Miscellaneous—Continued
Note, Fiduciary Suits Under Rule 10b-5,
1968 Duke L.J. 791 sae
Note, Limiting the Plaintiff Class: Rule
106-5 and the Federal Securities Code,
72 Mich. L. Rev. 1898 (1974)
Note, Rule 10b-5: Elements of a Private
Right of Action, 43 N.Y.U. L. Rev.
541 (1968) |
Note, Standing to Sue in 10b-5 Action:
Eason v. GMAC and Its Impact on the
Birnbaum Doctrine, 49 Notre Dame
Lawyer 1131 (1974) camel
Note, The Purchaser-Seller Limitation to
SEC Rule 10b-5, 53 Cornell L. Rev. 684
(1968)
2 Restatement of Torts, See. 286 |
Ruder, Current Developments in the Fed-
eral Law of Corporate Fiduciary Rela-
tions—Standing to Sue Under Rule
106-5, 26 Bus. Law 1289 (1971) .
S. 3420, 73d Cong., 2d Sess. ss
S. Rep. No. 1455, 73d Cong., 2d Sess.
27 Vand. L. Rev. 572 (1974)
23-24
23
23
20
24
15
18, 14
23
Iu the Supreme Count of the United States
OCTOBER TERM, 1974
No. 74-124
BLUE CHIP STAMPS, ET AL., PETITIONERS
Vv.
MANOR DRUG STORES, ETC.
ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE NINTH CIRCUIT
BRIEF FOR THE SECURITIES AND EXCHANGE
COMMISSION AS AMICUS CURIAE
QUESTION PRESENTED
The Commission will discuss the first question pre-
sented: Whether a party who neither purchased nor
sold securities has standing to seek damages for in-
juries caused it by a violation of the antifraud provi-
sions of Section 10(b) of the Securities Exchange Act
of 1934 and Rule 10b-5 thereunder.
(1)
2
INTEREST OF THE SECURITIES AND
EXCHANGE COMMISSION
The Commission is primarily responsible for the ad-
ministration and enforcement of the federal securities
laws, including the Securities Exchange Act of 1934.
Private actions by the victims of securities frauds,
however, are a “necessary supplement” to the Com-
mission’s enforcement activities. Mills v. Electric
Auto-Lite Co., 396 U.S. 375, 382; J. I. Case Co. v.
Borak, 377 U.S. 426, 432. The Commission opposes
restrictive constructions of the securities laws and of
the Commission’s rules that would weaken the protec-
tions they afford investors. Accordingly, the Commis-
sion as amicus curiae in private actions has argued
consistently that the right to recover damages for vio-
lations of the broad antifraud provisions of Rule 10b-
5, authorized by Section 10(b) of the Securities Ex-
change Act, should not be limited to actual purchasers
and sellers of securities but should extend to all in-
vestors and potential investors injured by violations
of the Rule.
STATEMENT
In December 1963 the United States filed a civil
antitrust action against Blue Chip Stamp Co. and nine
of its twelve stockholders.' The complaint charged
that the defendants had conspired to restrain and had
' This statement of facts is taken from the opinion of the
court of appeals and from the complaint filed by Manor Drug
Stores. Because the district court granted petitioners’ mo-
tion to dismiss the complaint, its factual allegations must be
accepted as correct. Conley Vv. Gibson, 355 U.S. 41.
3
monopolized the trading stamp business in California.
In addition to Blue Chip Stamp Co., the defendants
were major California retailers who used Blue Chip
stamps and who collectively owned 90 percent of Blue
Chip Stamp Co. stock. The suit was settled in 1967
by a consent judgment. See United States v. Blue
Chip Stamp Co., 272 F. Supp. 432 (C.D. Calif.).
Ths judgment provided that Blue Chip Stamp Co. ©
would be merged into a new corporation, Blue Chip
Stamps. Securities of the new corporation were to be
offered, at “bargain” prices, to retail firms—including
Manor Drug Stores, the plaintiff in this action—that
had used Blue Chip stamps but had not owned stock
in Blue Chip Stamp Co. Each of these retail firms
was entitled to purchase securities in proportion to the
amount of stamps it had used. The complaint of re-
spondent Manor Drug Stores alleges that the securi-
ties were offered at a bargain in order to allow the
users to share in the undistributed profits of Blue
Chip Stamp Co. (App. 10-11).
The complaint charges that the defendants (now
petitioners) devised a scheme to dissuade the offerees,
by means of misleading statements, from purchasing
the securities. The apparent motivation for the
scheme was that any securities not purchased in the
“bargain” offer could be sold later on the open mar-
ket by petitioners at a greater price, thereby increas-
ing the assets of Blue Chip Stamps and the value of
each share owned by the other petitioners. Alterna-
tively, the shares not sold in the offering could be
retained by Blue Chip Stamps and the shareholders of
4
Blue Chip Stamps could “retain” the undistributed
profits that would have been distributed by the “bar-
gain” sale.’
In order to discourage the offerees from purchasing
the securities, petitioners unduly emphasized in the
prospectus (App. 55-90) certain “Items of Special
Interest” that might adversely affect the value of the
securities; the prospectus also contained inflated es-
timates of anticipated expenses. Because of these
misleading representations certain offerees did not
purchase the securities and, therefore, did not re-
ceive the intended “bargain.” *
The district court dismissed the complaint on the
basis of the “Birnbaum rule,” attributed to Brin-
baum v. Newport Steel Corp., 193 F.2d 461 (C.A. 2),
certiorari denied, 343 U.S. 956, which states that a
person who is neither a purchaser nor a seller of
securities may not bring an action under Section 10
(b) of the Securities Exchange Act of 1934 or Rule
10b-5 thereunder.
* As petitioners noted (Br. 7, n. 6), the plan of reorgani-
zation did not call specifically for public sale of the unsold
shares. The plan, however, forbade petitioners from owning
more than 43 percent of Blue Chip Stamps and, if some of the
users decided not to purchase the shares offered, petitioners
would have to sell either the unpurchased shares or their own
shares in order to reduce their holdings to this proportion. In
either event the asset value per share would be greater for
petitioners if the users failed to purchase their allotments.
* Although the offering price of the new securities was $101,
the market value was alleged to be $315 at that time (App.
11).
5
Respondents appealed, but before the appeal was
decided another panel of the Ninth Circuit, in Mount
Clemens Industries, Inc. v. Bell, 464 F. 2d 339,
adopted the Birnbaum rule. A divided panel in the
instant case accepted Birnbaum and Mount Clemens
as controlling, but reversed on the ground that those
cases did not involve a situation where the plaintiffs
had a right to buy securities “at a fixed price and in
a fixed amount” (App. 141). The court held that the
offering of securities in this case, in compliance with
the antitrust decree, “served the same function as”
a contract for the purchase or sale of securities and
therefore supported a damages remedy for the non-
buying plaintiff class (App. 141, 155).
SUMMARY OF ARGUMENT
Section 10(b) of the Securities Exchange Act of
1934, and Rule 10b-5, promulgated by the Securities
and Exchange Commission pursuant to Section 10
(b), provide that it is unlawful to use deceptive de-
vices or make misleading statements “in connection
with the purchase or sale of any security.” In Birn-
baum v. Newport Steel Corp., 193 F.2d 461 (C.A.
2), certiorari denied, 343 U.S. 956, the Second Cir-
cuit held that under the Act and Rule only individuals
who had purchased or sold securities could bring
actions to seek redress for a violation.
6
The proscriptions under Section 10(b) and Rule
10b-5 “are broad and, * * * are obviously meant to
be inclusive.” Affiliated Ute Citizens v. United States,
406 U.S. 128, 151. Accordingly, a violation of Sec-
tion 10(b) and Rule 10b-5 repeatedly has been held
not to depend upon proof of an actual purchase or
sale of a security, and includes deceptive activity
that affects an investment decision not to buy or sell
a security no less than a decision to do the contrary.
Even the dissenting opinion in the court below does
not question that a violation of Rule 10b-5 has been
alleged in this case.
The Birnbaum rule has nevertheless survived as an
essentially arbitrary principle of “standing’—that
a victim of a violation may bring an action for dam-
ages only if he is the purchaser or seller of securities
—although the courts applying the rule disagree as
to its precise scope and as to exceptions that may be
available. The Birnbaum limitation is inconsistent
with this Court’s repeated recognition that persons
within the class a statute is designed to protect, and
who have been injured by a violation of that statute,
have standing to seek relief for injuries they have
suffered. See, e.g., Wyandotte Transportation Co. v.
United States, 389 U.S. 191. This principle has been
applied generally under the Securities Exchange Act,
see J. I. Case Co. v. Borak, 377 U.S. 426, and Mills v.
Electric Auto-Lite Co., 396 U.S. 375, and specifically
under Rule 10b-5, Superintendent of Insurance v.
7
Bankers Life & Casualty Co., 404 U.S. 6, and Affi
liated Ute Citizens v. United States, 406 U.S. 128.
Consistent with this principle, courts of appeals
that have applied the Birnbaum doctrine to damage
actions have nevertheless permitted private suits for
equitable relief with respect to violations of Rule 10b-
5. But as this Court recognized in Borak, supra, and
Mills, supra, with respect to similar antifraud rules
relating to proxy solicitation, the remedial objectives
of the Securities Exchange Act require that a pri-
vate action for damages also be recognized.
To the extent the Birnbaum rule serves any pur-
pose, it acts as a device to limit the class of po-
tential plaintiffs, and thus, as petitioners point out,
may ameliorate the possibility of strike suits and
“calamitous” damage judgments. But the arbitrary
denial of standing to individuals who are not pur-
chasers or sellers of securities but have suffered
demonstrable loss because of a violation of the Act
is contrary to the purposes of the securities laws and
unjustified. The public policy of preventing unwar-
ranted damage awards could be achieved through
requirements (in appropriate cases) of stricter stand-
ards of proof or the limitation of vicarious liability.
8
ARGUMENT
THE VICTIM OF DECEPTIVE ACTIVITIES IN CON-
NECTION WITH THE PURCHASE OR SALE OF
SECURITIES SHOULD BE ABLE TO RECOVER HIS
DEMONSTRABLE DAMAGES WHETHER OR NOT
HE HAS PURCHASED OR SOLD SECURITIES
In Birnbaum v. Newport Steel Corp., 193 F.2d 461
(C.A. 2), certiorari denied, 343 U.S. 956, the Second
Circuit discussed the understanding it then had of
the purpose of Section 10(b) and Rule 10b-5. It
stated that the Rule is directed “only at ‘a fraud
perpetrated upon the purchaser or seller’ of securi-
ties,” id. at 463, and that, accordingly, the Rule
“extended protection only to the defrauded purchaser
or seller.” ‘ Jd. at 464. This narrow reading of Rule
* The plaintiff in Birnbawm was a shareholder in a corpora-
tion contemplating an advantageous merger with another
firm. The controlling shareholder in the corporation in which
plaintiff held securities elected to sell his shares, at a sub-
stantial control premium, to a third corporation. As a result
of this sale of control the possibilities for merger were fore-
gone, and plaintiff did not reap the advantages that merger
would have brought him. He sued the controlling share-
holder and the acquiring corporation; the court of appeals
affirmed a dismissal of the action, stating that the Rule was
not intended to protect the stockholders of a corporation
against a breach of fiduciary duties by corporate insiders.
Id. at 464. If no more were involved in Birnbaum, the case
would not be troublesome. This Court has subsequently
agreed that the statute does not regulate transactions that
constitute no more than internal corporate mismanagement.
Superinicident of Insurance V. Bankers Life & Casualty Co.,
404 U.S. 6, 12.
9
10b-5—principally based on the court’s narrow read-
ing of Section 10(b)—has not been followed.
The “Birnbaum rule” has become a principle of
“standing,” rather than an interpretation directed to
any limitation on the scope of the Act’s and Rule’s
prohibitions—that is, despite allegations of a clear
violation of Section 10(b) and Rule 10b-5 that have
resulted in injury, if the injured person did not
purchase or sell the securities he may not bring an
action to recover his damages.’
5 Most courts of appeals have accepted the Birnbawm rule,
although the courts disagree about the scope of the doctrine
and the exceptions available to avoid its application. See,
e.g., Iroquois Industries, Inc. v. Syracuse China Corp., 417 F.2d
963 (C.A. 2), certiorari denied, 399 U.S. 909; Landy v. Fed-
eral Deposit Insurance Corp., 486 F.2d 139 (C.A. 3), cer-
tiorari denied, 416 U.S. 960; Sargent v. Genesco, Inc., 492 F.2d
750 (C.A. 5); Smallwood v. Pearl Brewing Corp., 489 F.2d
579 (C.A. 5); City National Bank v. Vanderboom, 422 F.2d
221 (C.A. 8), certiorari denied, 399 U.S. 905; Simmons Vv.
Wolfson, 428 F.2d 455 (C.A. 6), certiorari denied, 400 U.S.
999;cf. Kerbs Vv. Fall River Industries, Inc., 502 F.2d 731, 738-
740 (C.A. 10); International Controls Corp. v. Vesco, 490 F.2d
1334 (C.A. 2), certiorari denied, 417 U.S. 932; Hooper v.
Mountain States Securities Corp., 282 F.2d 195 (C.A. 5),
certiorari denied, 365 U.S. 814; James v. Gerber Products Co.,
483 F.2d 944 (C.A. 6).
The Seventh Circuit has rejected Birnbaum. See Hason V.
General Motors Acceptance Corp., 490 F.2d 654, certiorari
denied, 416 U.S. 960. Several district courts recently have
disavowed the Birnbaum rule as inconsistent with the pre-
vailing interpretation of Rule 10b-5. See Young v. Seaboard
Corp., 360 F. Supp. 490 (D. Utah); Tully v. Mott Super-
markets, Inc., 337 F. Supp. 834 (D.N.J.). (Landy v. Federal
Deposit Insurance Corp., supra, 486 F.2d at 156, n. 10, ap-
parently limits Tully to requests for injunctive relief.) And
several district courts have held that there may be a private
10
A. Section 10(b) and Rule 10b-5 Protect “Any Person”
Against Deceptive Devices Materia! To An Investment
Decision
Section 10(b) of the Securities Exchange Act of
1934, 15 U.S.C. 78j(b), provides that it is unlawful
for any person to use, “in connection with the pur-
chase or sale of any security * * * any manipulative
‘or deceptive device or contrivance” in contravention of
the Commission’s rules. In Affiliated Ute Citizens v.
United States, 406 U.S. 128, 151, this Conrt stated
that Rule 10b-5(c) prohibits “any act, practice or
course of business which operates or would operate
as a fraud or deceit upon any person * * *,” and held
that the proscriptions under Section 10(b) and Rule
10b-5 “are broad and, by repeated use of the word
‘any,’ are obviously meant to be inclusive.” Similarly,
Superintendent of Insurance, supra, 404 U.S. at 11, n.
7, held that Section “10(b) and Rule 10b-5 prohibit
all fraudulent schemes in connection with the pur-
chase or sale of securities, * * *.’’* As the court be-
low recognized prior to the instant case: °
action by an investor who, in violation of the rule, has been
misled not to sell his securities. See, e.g., Commerce Report-
ing Co. V. Puretec, Inc., 290 F. Supp. 715, 718-719 (S.D.
N.Y.); Opper v. Hancock Securities Corp., 367 F.2d 157 (C.A.
2), affirming 250 F. Supp. 668 (S.D.N.Y.); Goodman v. H.
Hentz & Co., 265 F. Supp. 440, 443-445 (N.D. IIl.); Stockwell
v. Reynolds & Co., 252 F. Supp. 215, 213-219 (S.D.N.Y.);:
M. L. Lee & Co. V. American Cardboard & Packaging Corp.,
36 F.R.D. 27, 30-31 (E.D. Pa.).
* Emphasis in original. This Court was quoting from A. T.
Brod & Co. Vv. Perlow, 375 F.2d 393, 397 (C.A. 2).
* Ellis v. Carter, 291 F.2d 270, 274 (C.A. 9), dismissal
affirmed, 328 F.2d 573. Accord, Rekant v. Desser, 425 F.2d
11
It would have been difficult to frame the auth-
ority to prescribe regulations in broader terms.
* * * We see no reason to go beyond the plain
meaning of the word “any”, indicating that the
use of manipulative or deceptive devices or con-
trivances of whatever kind may be forbidden
* * *
Even the court of appeals that decided Birnbawm has
subsequently stated that the broad language of Rule
10b-5 “demonstrates that the SEC sought by the Rule
* * * fully to implement the Congressional purpose
and objectives underlying Section 10(b).”* And, as
one commentator wrote, the Section and Rule con-
tain what is “plainly and—one must assume—in-
tentionally the loosest linkage, in any of the federal
antifraud provisions, between a proscribed act and
a security transaction.” °
Petitioners assert (Pet. Br. 31) that the language
of Rule 10b-5 and Section 10(b), by “limiting” their
coverage to matters “in connection with the purchase
872, 880 n.15 (C.A. 5); see also McClure v. Borne Chemical
Co., 292 F.2d 824, 834 (C.A. 3), certiorari denied, 368 U.S.
939.
® Securities and Exchange Commission V. Texas Gulf Sul-
phur Co., 401 F.2d 833, 860 (C.A. 2) (en banc), certiorari
denied sub nom. Coates v. Securities and Exchange Commis-
sion, 394 U.S. 976.
The House Committee appraised the function of the Se-
curities Exchange Act as an undertaking to advance the law
by a “constant extension of the legal conception of a fiduciary
relationship—a guarantee of ‘straight shooting’ * * *.” H.
Rep. No. 1383, 73d Cong., 2d Sess. 5.
* Bromberg, Securities Law: Fraud—SEC Rule 10b-5, Sec.
7.6(1), p. 190.21 (1973).
12
or sale of any security,” “does not include an offer to
purchase or sell” (petitioners’ emphasis). They con-
clude: “Had Congress intended section 10(b) to reach
offers, it knew how to accomplish that purpose.” But
Section 17(a) of the Securities Act, upon which the
language of Rule 10b-5 is based, expressly and unam-
biguously proscribes fraud “in the offer” as well as
fraud “in the * * * sale of any securities * * *.” As
the petitioners themselves recognize (Pet. Br. 18-19),
Rule 10b-5 was adopted to extend to “all purchasers
of securities” the same “prohibitions on fraud” that
Section 17(a) imposed upon sellers." Although Sec-
tion 17(a) of the Securities Act relates only to
© Even if Rule 10b-5 were limited in application as the peti-
tioners suggest, the plaintiff’s only error in the district court
was in failing to allege a cause of action predicated upon
Section 17(a) of the Securities Act as well as one under Rule
10b-5.
The complaint must be read in the light most favorable
to the plaintiff, recognizing that any ambiguities or omissions
in the pleadings should be resolved in favor of the plaintiff,
since any such deficiencies in the complaint can be cured by
amendment, see Lanasa Fruit S. S. & 1. Co. v. Universal In-
surance Co., 302 U.S. 556, 559. For the same reasons that a
cause of action is recognized under Rule 10b-5, it must be
recognized under Section 17(a). This would cure the de-
ficiency that the petitioners perceive—although some courts,
disregarding even the unambiguous expression of congres-
sional purpose, have applied the Birnbaum doctrine to ac-
tions brought under Section 17(a) as well as under Rule
10b-5. See, e.g., Schoenbaum Vv. Firstbrook, 268 F. Supp. 385,
396 (S.D. N.Y.), affirmed, 405 F.2d 200 (C.A. 2), reversed in
part on other grounds, 405 F.2d 215 (en banc), certiorari
denied sub nom. Manley Vv. Schoenbaum, 395 U.S. 906; Greater
Iowa Corp. V. McLendon, 378 F.2d 783, 790-791 (C.A. 8);
Simmons V. Wolfson, supra, 428 F.2d 455.
13
fraudulent activity “in’’ the offer or sale of securities,
the broader statutory language “in connection with”
used in Section 10(b) and Rule 10b-5 (which re-
lates to all deceptive activities “touching” securities
transactions, Superintendent of Insurance, supra, 404
U.S. at 12) made it unnecessary to include the word
“offer” in those provisions. Cf. Securities and Ex-
change Commission v. Capital Gains Researcn Bureau,
Inc., 375 U.S. 180, 197-199.
There can be no doubt under the Act, Rule, and
controlling decisions of this Court, that, if the allega-
tions of respondent’s complaint are true, prohibited
deceptive statements have been made. This conclu-
sion is supported by the legislative history of the
statute. The Securities Exchange Act of 1934 was
enacted in response to “the speculative orgy of 1928
and 1929” and a presidental call ior securities
“legislation [that] has teeth in it.” Congress,
recognized that “[s]peculation, manipulation, * * *
investors’ ignorance, and disregard of trust relation-
ships by those whom the law should regard as fiduci-
aries” were “all a single seamless w_b,” * and that an
act designed to purge all avenues of abuse would re-
quire broad remedial provisions. Thus, the Act was
intended to cover “a wide field.” *
Congress understood, however, that it could not, by
specifying or cataloguing particular forms of unlaw-
1S, Rep. No. 1455, 73d Cong., 2d Sess. 81.
12 H, Rep. No. 1383, 73d Cong., 2d Sess. 2.
13 H. Rep. No. 1383, 73d Cong., 2d Sess. 6.
14 Tbid.
14
ful conduct, itself effectively prohibit all forms of
practices that “for some purposes may be turned to
illegitimate and fraudulent means.” '* Accordingly, it
vested “broad discretionary powers in the [Securities
and Exchange Commission].” ** See generally Super-
intendent of Insurance, supra.
Section 10(b) creates such discretionary power by
authorizing the Commission by rule and regulation to
proscribe manipulative or deceptive practices in con-
nection with the purchase or sale of any security. As
one of the draftmen described an earlier version (then
Section 9(c)) before the House Committee, the section
provided, in effect:
“Thou shalt not devise any other cunning de-
vices.” * * * [S]ubsection (c) is a catch-all
clause to prevent manipulative devices. * * * The
Commission should have the authority to deal
with new manipulative devices.”
The Senate bill, from which most of Section 10(b)
was taken verbatim," went further; it gave the Com-
mission broad rulemaking authority with respect to
deceptive as well as manipulative practices. Although
© Id. at 7.
'* [bid.; see also 78 Cong. Rec. 7696 (remarks of Rep. Ray-
burn). The Senate Committee viewed the Securities Act of
1933 and the Securities Exchange Act of 1934 as vesting “in
the Securities e-d Exchange Commission jurisdiction over the
source of and traffic in securities.” S. Rep. No. 1455, 73d
Cong., 2d Sess. 393.
* Hearings Before the House Committee on Interstate and
Foreign Commerce on H.R. 7852 and 8720, 73d Cong., 2d
Sess. 115.
* H. Conf. Rep. No. 1838, 73d Cong., 2d Sess. 32-33.
!
15
representatives of the securities industry had com-
plained that these provisions would give the Commis-
sion power to prohibit virtually anything,” the Con-
ference Committee broadened the language of the sec-
tion still further.
The Senate bill would have authorized rulemaking
with respect to practices “detrimental to the interests
of the investor,” but the Committee expanded the au-
thority to cover rulemaking “necessary or appropriate
in the public interest” as well as “for the protection
of investors.” * After considering these alternatives,
Congress agreed upon the present language, which
gives the Commission broad rulemaking power to pro-
hibit “any manipulative or deceptive device or contri-
vance,” and omitted language that would have con-
fined the section solely to securities traded or listed
on a national securities exchange.”
” Hearings on H .. 7852 and 8720, supra, n. 17, at 178,
208-209, 251, 258, 297, 305, 486; Hearings Before the Senate
Committee on Banking and Currency on S. Res. 84 (72d
Cong.) and S. Res. 56 and 97 (73d Cong.), Part 15, 73d Cong.,
lst Sess. 6624-6625, 6634, 6899, 6910, 6936-6938, 6988.
* H. Conf. Rep. No. 1838, supra, at 32-33. Cf. A.T. Brod &
Co. V. Perlow, supra, 375 F.2d at 396:
These rules and regulations [under Section 10(b)] were
to be promulgated by the Commission “in the public in-
terest or for the protection of investors.” * * * Rule
10b-5 * * * was designed to protect both investors and
‘the public interest.’ [Emphasis in original.]
* See S. 3420, Section 10(b), 73d Cong., 2d Sess. (April 17,
1934). In enacting Section 10(b), Congress intended to en-
sure fairness in securities transactions generally, whether
conducted in the organized securities markets or face-to-face.
Superintendent of Insurance, supra, 404 U.S. at 10.
16
In order to fulfill these Congressional objectives, the
courts have repeatedly rejected restrictive readings of
Rule 10b-5. For example, proof of a substantive
violation of Section 10(b) and Rule 10b-5 does not
depend upon proof of an actual purchase or sale of a
security. In Securities and Exchange Commission v.
Texas Gulf Sulphur Co., 401 F.2d 833, 854-855 (C.A.
2), certiorari denied sub nom. Coates v. Securities
and Exchange Commission, 394 U.S. 976, the court
held that deceptive public statements, negligently
made, that might generally affect securities transac-
tions, violate Rule 10b-5. Nor must the Commission,
in its own actions, demonstrate that any persons have
suffered injury because of a purchase or sale; it need
show only that the forbidden deceptive practices have
been committed. Hughes v. Securities and Exchange
Commission, 174 F.2d 969, 974 (C.A.D.C.). See also
Berko v. Securities and Exchange Commission, 316
F.2d 137, 143 (C.A. 2); N. Sims Organ & Co., Ine.
v. Securities and Exchange Commission, 293 F.2d 78,
80, n: 3 (C.A. 2). Cf. Kwehnert v. Texstar Corp.,
412 F.2d 700, 704 (C.A. 5), in which the court stated
that it was not convinced that there was any difler-
ence in substance between a successful fraud and an
attempt, since the statutory phrase “ ‘any manipula-
tive or deceptive device’ * * * seem[ed] broad enough
to encompass conduct irrespective of its outcome.”
The Court of Appeals for the Second Circuit has
aptly noted that material facts that must be fully dis-
closed if the standard of Rule 10b-5 is to be met in-
clude those “which may affect the desire of investors
to buy, sell, or hold the company’s securities.” Securi-
17
ties and Exchange Commission v. Texas Gulf Sulphur
Co., supra, 401 F.2d at 849. Consistent with this view
is Hanly v. Securities and Exchange Commission, 415
F.2d 589, 594-595 (C.A. 2), which applied Rule 10b-5
to misleading statements and omissions that had in-
duced a broker’s customer to hold his stock rather
then to sell it in the face of a declining market. In
administrative proceedings the Commission has re-
peatedly taken the position that a person violates the
Rule by misleading an investor not to sell.”
Because—if the assertions in respondent’s com-
plaint are correct—there has been a violation by peti-
tioners of the Act and Rule, the question open for de-
cision is whether that violation can be redressed by a
private plaintiff.
B. There Is an Implied Civil Remedy on Behalf of All
Persons Injured by Violations of Rule 10b-5, Includ-
ing Those Who Have Neither Purchased Nor Sold
Securities
The limitation on standing imposed by the Birn-
baum rule is inconsistent with the decisions of this
and other courts that have implied causes of action
for violations of the securities acts’ prohibitions in
_ order to provide redress to persons for whose protec-
tion those prohibitions were adopted.
Although Section 10(b) and Rule 10b-5 do not ex-
pressly provide a civil remedy to the victims of pro-
scribed behavior, this Court has recognized an implied
2 See, e.g., Investors Management Co., Inc., Securities Ex-
change Act Release No. 9267 (July 29, 1971), pp. 9-10; Merrill
Lynch, Pierce, Fenner & Smith, Inc., Securities Exchange
Act Release No. 8459 (November 25, 1968), p. 5.
18
right of action under vheir provisions. Superintendent
of Insurance vy. Bankers Life & Casualty Co., supra,
404 U.S. at 13 n.9; Affiliated Ute Citizens v. United
States, supra, 406 U.S. at 151.” These two decisions
reflect this Court’s repeated admonition that the fed-
eral securities laws, ‘enacted for the purpose of avoid-
ing frauds,” must be construed “not technically and
respectively, but flexibly to effectuate [their] re-
medial purposes.” Securities and Exchange Com-
mission v. Capital Gains Research Bureau, Inc., 375
U.S. 180, 195 (Investment Advisers Act). In Tchere-
pnin v. Knight, 389 U.S. 332, 336, this principle was
applied to the Securities Exchange Act generally; and
in Superintendent, supra, 404 U.S. at 12, and Affili-
ated Ute Citizens, supra, 406 U.S. at 151, this Court
recognized that damages could be sought for viola-
tions of Section 10(b) and Rule 10b-5.
A private right of action under Rule 10b-5 reflects
this Court’s recognition that “[p]rivate enforcement
* * * provides a necessary supplement to Commission
action.” J.J. Case Co. v. Borak, supra, 377 U.S. at
432. Accordingly, this Court in Borak directed “the
federal courts ‘to adjust their remedies so as to grant
the necessary relief’ where federally secured rights
are invaded.” /d. at 433. It continued:
** The Courts of Appeals have long recognized an implied
right of action under Rule 10b-5. See, e.g., Fischman Vv.
Raytheon Mfg. Co., 188 F.2d 783 (C.A. 2); Fratt v. Robinson,
203 F.2d 627 (C.A. 9); Hooper v. Mountain States Securities
Corp., 282 F.2d 195; cf. Slavin v. Germantown Fire Insurance
Co., 174 F.2d 799, 805-806 (C.A. 3) (dictum).
19
And it is also well settled that where legal rights
have been invaded, and a federal statute provides
for a general right to sue for such invasion,
federal courts may use any available remedy to
make good the wrong done.
It then held that Section 27 of the Securities Ex-
change Act provided such a “general right to sue” be-
cause it “grants the District Courts jurisdiction ‘of all
suits in equity and actions at law brought to enforce
any liability or duty created by this title.’” /bid.
Borak and this Court’s more recent cases apply to
the Securities Exchange Act the principle, applied in
other areas of the law, that the touchstone for deter-
mining whether particular persons may maintain a
civil action to redress a violation of a statutory pro-
hibition or obligation is whether their interest “fell
within the class that the statute was intended to pro-
tect” and whether “the harm that had occurred was
of the type that the statute was intended to forestall.”
Wyandotte Transportation Co. v. United States, 389
U.S. 191, 202.”
This was the principle recognized and applied in
Kardon v. National Gypsum Co., 69 F. Supp. 512, 514
(E.D. Pa.), the first judicial decision holding that
there is an implied right of action under Rule 10b-5.
There the plaintiff’s standing to seek relief was upheld
because the plaintiff was within the class of persons
* See also United States v. Students Challenging Regula-
tory Agency Procedures, 412 U.S. 669, 686; Sierra Club Vv.
Morton, 405 U.S. 727, 733; Association of Data Processing
Organizations, Inc. v. Camp, 397 U.S. 150, 152-153. Cf. Flast
v. Cohen, 392 U.S. 83; Hardin v. Kentucky Utilities Co., 390
US. 1.
20
“for whose special benefit the statute was enacted.” *
More recently, the Court of Appeals for the Seventh
Circuit in Eason v. General Motors Acceptance Corp.,
490 F.2d 654, certiorari denied, 416 U.S. 960, cor-
rectly perceived that the opinions of this Court “fairly
imply that the rule [10b-5] was intended to protect
a broader class of persons” than only purchasers and
sellers of securities. 490 F.2d at 659. Because the
plaintiffs in that case “were members of the class for
whose special benefit Rule 10b-5 was adopted,” id.
at 658, they were held to have standing to seek dam-
ages for their alleged injuries, although they were
neither purchasers nor sellers of securities.
A primary purpose of Rule 10b-5 is to protect all
persons, not merely persons who may have purchased
or sold securities, against making investment decisions
on the basis of misleading or inaccurate informa-
tion. In prohibiting misleading or deceptive prac-
tices that operate as a fraud upon “any person,” it
prohibits such practices where their tendency is im-
properly to discourage action no less than when their
** Kardon based its decision on 2 Restatement of Torts, Sec.
286, which provided:
The violation of a legislative enactment by doing a pro-
hibited act, or by failing to do a required act, makes
the actor liable for an invasion of an interest of another
if: (a) the intent of the enactment is exclusively or in
part to protect an interest of the other as an individual;
and (b) the interest invaded is one which the enactment
is intended to protect * * * [emphasis added].
See also Fratt v. Robinson, supra, 203 F.2d at 631; Fischman
v. Raytheon Mfg. Co., supra, 188 F.2d at 787, n. 4; Hooper v.
Mountain States Securities Corp., supra, 282 F.2d at 201.
21
tendency is to encourage unwarranted action. Indeed,
in Superintendent of Insurance, supra, 404 U.S. at
12, the Court observed that among those Congress
sought to protect from the impact of fraud were per-
sons who were the creditors of corporations that
may have been misled into buying or selling securi-
ties.” A fortiori, persons making investment deci-
sions, including the decision not to purchase or sell,
are within the scope of the Act, and should (under
the Borak and Wyandotte principle) be able to re-
cover damages.
Consistently with the principles supporting a pri-
vate cause of action, the courts generally have recog-
nized that a person who has neither purchased nor
sold securities nevertheless is entitled te the protec-
tion of Rule 10b-5, and therefore can obtain equitable
relief with respect to an alleged Rule 10b-5 violation.
Kahan v. Rosenstiel, 424 F. 2d 161 (C.A. 3), cer-
tiorari denied sub nom. Glen Alden Corp. v. Kahan,
398 U.S. 950; Mutual Shares Corp. v. Genesco, Inc.,
384 F. 2d 540, 546-547 (C.A. 2); Britt v. Cyril
Bath Co., 417 F. 2d 483 (C.A. 6). In light of these
decisions, some of which have been rendered by the
same courts that adhere to the Birnbaum rule, it is
26 Situations where individuals are injured by the invest-
ment decisions of others include that involved in Vine v.
Beneficial Finance Co., 374 F.2d 627 (C.A. 2), certiorari
denied, 389 U.S. 970, in which so many of plaintiff’s fel-
low shareholders accepted a tender offer (which was mis-
leading, in violation of Rule 10b-5) that the acquiring corpo-
ration was able to effect a merger, causing plaintiff injury.
The Vine court permitted recovery, and reconciled its hold-
ing with the Birnbaum doctrine by deeming the merger to
be a “forced sale” of the plaintiff’s securities.
22
significant that in Borak this Court expressly re-
jected a contention that the private right of action
for violation of the antifraud provisions of proxy
Rule 14a-9(a)* should be “limited to prospective re-
lief,” and held that the remedial objectives of the
Securities Exchange Act required that a private right
of action for damages also be recognized.”
The Court observed in Borak that to limit “victims
of deceptive proxy statements” to prospective relief
under the federal statute would relegate them to state
court monetary remedies, and if these proved inade-
quate, “the whole purpose of the section [14(a) ] might
be frustrated.” 877 U.S. at 434-435. Moreover,
building upon these principles, Mills v. Electric Auto-
Lite Co., 396 U.S. 375, rejected an interpretation that
would have “[insulated] from private redress an en-
tire category of proxy violations * * *,” holding that
“such a result would subvert the congressional pur-
pose of ensuring full and fair disclosure to sharehold-
ers.” 396 U.S. at 382.
The same reasoning applies to the scope of Rule
10b-5 and the remedies available under it. “[T]here
** The language of Rule 14a-9(a) is substantially similar to
the language of Rule 10b-5(b).
** Based upon the “purpose of §14(a) * * * to prevent
management or others from obtaining authorization for cor-
porate action by means of deceptive or inadequate disclosure
in proxy solicitation,” 377 U.S. at 431, and the language of
Section 14(a), which, like Section 10(b), authorizes the
adoption of rules “in the public interest or for the protection
of investors,” 377 U.S. at 432 (emphasis by the Court), the
Court recognized “the availability of judicial relief where
necessary to achieve that result.” 377 U.S. at 482.
23
is no reason to emasculate the securities laws by for-
bidding remedies which might prove to be essential.
Cf. J. I. Case Co. v. Borak, 377 U.S. 426 (1964).”
Securities and Exchange Commission v. National Se-
curities, Inc., 393 U.S. 453, 463. If the rule is to be
effective in accomplishing its objective of preventing
fraud relating to securities transactions, the right of
the victims of such fraud to maintain a private suit
based upon their negative actions must encompass
damages as well as injunctive relief. As the Court
2° Commentators have concluded that the Birnbaum decision
was not dictated by the express language of Section 10(b)
or Rule 10b-5. They also note that Birnbaum has encouraged
mechanical application of a purchaser-seller requirement,
producing results contrary to the purposes for which that
legislation was enacted—to protect the public from the
effects of fraudulent representations about securities. See,
e.g., Note, Limiting the Plaintiff Class: Rule 10b-5 and the
Federal Securities Code, 72 Mich. L. Rev. 1398, 1412 (1974);
Note, Standing to Sue in 10b-5 Actions: Eason v. GMAC and
Its Impact on the Birnbaum Doctrine, 49 Notre Dame Lawyer
1131, 1146-1147 (1974); Comment, Jnroads on the Necessity
for a Consummated Purchase or Sale under Rule 10b-5, 1969
Duke L.J. 349 (1969) ; Comment, The Purchaser-Seller Rule:
An Archaic Tool for Determining Standing under Rule 10b-5,
56 Geo. L.J. 1177, 1178 (1968); Note, The Purchaser-Seller
Limitation to SEC Rule 10b-5, 53 Cornell L. Rev. 684, 698
(1968); Lowenfels, The Demise of the Birnbaum Doctrine:
A New Era for Rule 10b-5, 54 Va. L. Rev. 268, 275-276
(1968) ; see also, Jacobs, Birnbaum in Flux: Significant 10b-5
Developments, 2 Sec. Reg. L.J. 305 (1975); 27 Vand. L.
Rev. 572 (1974); Leech, Transactions in Corporate Control,
104 U. Pa. L. Rev. 725, 774 (1956) ; Comment, The Decline of
the Purchaser-Seller Requirement of Rule 10b-5, 14 Vill. L.
Rev. 499, 501-502 (1969); Note, Fiduciary Suits Under Rule
10b-5, 1968 Duke L.J. 791, 807-808; Note, Rule 10b-5: Ele-
ments of a Private Right of Action, 43 N.Y.U. L. Rev. 541,
24
of Appeals for the Seventh Circuit observed in Eason,
supra, 490 F.2d at 659, the purchaser-seller limita-
tion
is not consistent with the overriding requirement
that, in construing the 1934 Act, “form should be
disregarded for substance and the emphasis
should be on economic reality.” Tcherepnin v.
Knight, 389 U.S. 332, 336.
C. This Court Should Not Adopt the Birnbaum Rule as a
Method to Limit the Class of Potential Plaintiffs
Petitioners express concern (Pet. Br. 34) that
the decision of the court of appeals would allow
anyone who had not purchased securities which were
offered to him to bring an action simply by claiming
that he would have purchased the securities, if the
offeror had disclosed additional facts from which he
might have inferred that the securities were worth
more than the offering price.” We agree with pe-
titioners that the effect, if any, of a deceptive prac-
545 (1968); Note, Civil Liability Under Rule X-10b-5, 42
Va. L. Rev. 537, 570-571 (1956); Ruder, Current Develop-
ments In The Federal Law of Corporate Fiduciary Relations
—Standing to Sue Under Rule 10b-5, 26 Bus. Law. 1289
(1971).
* Of course, frivolous suits can be brought whatever the
rules of standing; it is necessary only for a determined plain-
tiff to plead words consistent with applicable standing re-
quirements, even though he knows that he cannot succeed on
the merits. Opportunities for vexatious litigation will abound
whether or not the Birnbaum rule is adopted. As this Court
has recognized in a different context, “the expense and annoy-
ance of litigation is ‘part of the social burden of living under
government’.” Petroleum Exploration, Inc. v. Public Service
Commission, 304 U.S. 209, 222.
25
tice on someone who has neither purchased nor sold
securities may be more difficult to demonstrate than
is the effect on a purchaser or seller. In either case
the plaintiff must demonstrate some relationship be-
tween the alleged deceptive practice and his injury.
If, as here, that injury resulted from his own “non-
action,” he also must demonstrate that his failure to
act was caused by the defendant’s activities. But
this additional problem of proof can be ameliorated
by devices more consistent with the purposes of the
securities laws.
In Affiliated Ute Citizens, supra, Indians sought
relief under Rule 10b-5 against bankers who sought
their shares in the course of encouraging a market
for shares among non-Indians. This Court held that
if there was a direct relationship between the In-
dians and the bankers, and the bankers omitted to
state facts that a reasonable investor might have con-
sidered important in the making of his investment
decision, a causal connection between the wrong-
ful omission and the plaintiffs’ injuries would be
presumed. This presumption might apply in many
eases involving potential investors. In other cases,
however, it might be unreasonable for the courts to
make such a presumption and, indeed, where only a
tenuous relationship exists, it might be appropriate
(in order to prevent abuses) to impose upon the
plaintiffs a heavier burden of proof than would nor-
mally be applicable. It might be necessary, for ex-
ample, for a plaintiff who has neither purchased nor
26
sold securities to offer corroborative evidence which,
independent of his own testimony, tends to show that
the plaintiff’s investment decision was directly af-
fected by the deceptive device (or that the violation
caused him injury in some other way) and that he
was within the class of persons for whose benefit the
rule was adopted.”
Thus, contrary to petitioners’ argument, a decision
by this Court not to adopt the Birnbaum rule would
not require submitting to the finders of fact every
suit in which someone claimed that “but for” a public
statement by the defendant the plaintiff would have
acquired or would have sold securities. In fact, there
would be few situations where plaintiffs could dem-
onstrate a nexus between a wrongful act and an
alleged injury sufficient to permit submission of the
case to the jury, if that plaintiff were not the owner
of securities or a person to whom an offer to buy or
sell had been directed.
* Tn the instant case, the direct relationship that is alleged
to have existed between the plaintiff and the defendants seems
sufficient to warrant the presumption permitted by Affiliated
Ute Citizens. In any event, respondent’s reliance upon the
defendants’ alleged deceptive practices is corroborated by
the consent judgment in the antitrust action and by respond-
ent’s receipt of the misleading prospectus. It is reasonable
to believe that respondent was actively considering a purchase
of Blue Chip Stamps’ securities, and that the representations
in the prospectus were material to this decision. That should
be sufficient objective indicia, particularly if a plaintiff can
show, as respondent alleged here, that th re was a plausible
reason why the issuer of the shares would be motivated to
make representations that would deter the plaintiff from
acing.
27
Moreover, even where a proper nexus has been
established, the fact that liability may be imposed
upon individual wrongdoers does not require that a
damage remedy must necessarily be recognized to the
same extent against the corporations for which they
work, if broad vicarious liability would conflict with
the objectives of the federal securities laws. Although
there are strong public policies that militate in favor
of imposing liability upon a corporation for the acts
of its officers and authorized agents, a court may
well be concerned that the wrongful acts of officers
in violations of Rule 10b-5 not expose the shareholders
of a publicly-owned corporation to undue liability.
Of course no reason exists, either in equity or in the
objectives of the federal securities laws, to permit
a corporation to retain profits or any other forms
of benefits it may have derived from the wrongful
acts of its officers or agents.** But where the cor-
poration has not benefited, the courts may find it
equitable, and consistent with the basis upon which
82 Since the Birnbaum rule may, in some situations, protect
corporations from liability even to the extent of profits that
can be traced to violations of the law, its rejection may impose
additional costs on some companies. Judge Hufstedler’s analy-
sis in dissent below seems implicitly to assume that there is or
may be widespread non-compliance with Rule 10b-5. If this
is so, any increased costs that would result from allowing
suit are the costs of compliance with the Rule, and long
since should have been paid. The securities laws as a whole
reflect a congressional judgment that the benefits to be de-
rived from full disclosure of material facts outweigh the
economic costs that disclosure entails.
28
a right of action has been implied under Rule 10b-
5, to limit an award of damages against it.”
Nor is the arbitrary rule of “standing” advanced
by petitioners essential to protect the “common
method of distributing new securities * * *” (Pet.
Br. 28). The case at bar is not the “typical se-
curities transaction” described by petitioners (Pet.
Br. 28-30) ; typically the issuer and underwriter seek
to sell the securities as promptly as possible, and
rarely if ever would make them appear unattractive
through inadvertence or otherwise.
The Birnbaum rule does not produce a conflict be-
tween the registration requirements of the Securities
Act and the antifraud provisions of the Securities
Exchange Act, as petitioners suggest (Pet. Br. 36-
42). To be sure, comptiance with the registration
requirements of the Securities Act assumes that
proper emphasis be given to risk factors by persons
who seek to sell securities to the public. In this con-
text there may be a tendency to overstate risks, be-
cause it is doubtful that any court would find it ap-
propriate to impose liability upon an offerer who
tends somewhat to understate the merits of the se-
curities he is honestly trying to sell, so long as no
truly material falsehood or omission is involved.*
3° Cf. Shapiro Vv. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 495 F.2d 228, 241 (C.A. 2).
* The concept of materiality (see, e.g., Securities and Ex-
change Commission V. Texas —ulf Sulphur Co., 401 F.2d 833,
849 (C.A. 2) (en banc), certiorari denied, 394 U.S. 976) elim-
inates the possibility that the most minute mistake will lead
to liability. Thus, offerers are not required to be “micro-
29
But where, as is alleged here, tiie sal2 of stock was
contrary to the petitioners’ self-interest, any over-
statement of the risks should not be viewed char-
itably. Fraud in the offer of securities is a violation
of Section 17(a) of the Securities Act, as well as a
violation of Rule 10b-5 under the Securities Exchange
Act, and, as we have seen (pp. 8-17, supra), the Birn-
baum rule adds nothing to a registrant’s substantive
legal duty. It relates only to a plaintiff’s ability to
recover for injuries.”
Petitioners also argue (Pet. Br. 34-35) that the
availability of the class-action procedure, a device
designed to permit vindication of just claims that
might be too small to pursue individually, and this
Court’s recognition that a causal relationship between
wrongful acts and resultant injury may be inferred
from the materiality of undisclosed facts, are reasons
to deny standing. But this really is a complaint that
remedies for violation of the Rule will work too well.
Throughout their brief (particularly at pp. 32-33)
petitioners also stress that respondent was not an
metrically accurate,” as Judge Hufstedler seems to fear (App.
151, n. 8.).
%° Thus, the alleged conflict is irrelevant to the question of
standing, since petitioners’ argument goes to the merits of
plaintiff’s claim that Rule 10b-5 hax been violated, rather than
to the threshhold question of who may bring suit to test those
merits. If the petitioners can show that their discouraging
statements concerning Blue Chips Stamps’ prospects were
justified, consistent with the conservative philosophy of the
Securities Act registration requirements, they may prevail
on the merits. But the possibility that they may have a good
defense is no reason to deny a plaintiff its day in court.
30
“investor.” * We submit that this is irrelevant. The
essence of respondent’s complaint is that petitioners
fraudulently induced the offerees to refrain from
investing; it would be most anomalous if the defend-
ants’ success in preventing an investment—the very
fraud that gives rise to the claim for relief—should
be viewed as a reason why the alleged victims should
not even be heard on the merits of their claim.
Finally, petitioners suggest that it would be un-
fair to those who have invested in particular se-
curities were a court to permit “those who have
never invested in, or made a legal commitment to the
offered securities,” to “seek the profit they allegedly
could have made had they accepted the offer, en-
tered into the transaction and put their funds at risk”
and then be “paid out of the pocket of the company
with which those who bought risked their funds.”
(Pet. Br. 32-33). But this analysis, whatever its
merits, does not support the Birnbaum rule.
Comparable situations exist even where the Birn-
baum rule permits suit. For example, a similar no-
risk-therefore-no-suit argument can be made where
a person has been fraudulently induced to sell (thus
ending his “risk’”) while other non-selling investors
continued to risk their capital. The Birnbaum rule
would not preclude these sellers, in effect, from hav-
ing a call on stock without having been subjected to
% On this basis petitioners (Pet. Br. 20) purport to dis-
tinguish Eason v. General Motors Acceptance Corp., supra,
which expressly rejected the purchaser-seller requirement.
See pp. 9 n.5, 24, supra.
31
the risk borne by those who had not been deceived
into selling.“ At the same time the Birnbaum rule
bars suit iy an investor who has put his funds at
risk but who is fraudulently dissuaded from selling
shares he aiready owns.
The Birnbaum purchaser-seller requirement simply
is not a doctrine placing “reasonable limits on the
broad exposure to damage liability that has developed
under the section and rule” (Pet. Br. 23). The
“limits” imposed by the Birnbaum rule are artificial
and arbitrary; it denies standing—without regard to
defendants’ culpability or plaintiffs’ ability to prove
their claims—to a class of persons for whose pro-
tection the statute was enacted.
The Birnbaum rule itself has provoked substantial
litigation concerning its scope and exceptions. At
least in recent years courts that have concluded from
the pleadings that a plaintiff might have a meritorious
claim have been willing to devise interpretations and
exceptions to the Birnbaum rule that emphasize the
artificial nature of that rule. Compare Jroquois In-
dustries, Inc. v. Syracuse China Corp., 417 F.2d 963
(C.A. 2); Greenstein v. Paul, 400 F.2d 580 (C.A.
2); Superintendent of Insurance v. Bankers Life &
Casualty Co., 430 F.2d 355 (C.A. 2), reversed, 404
U.S. 6, and Drachman v. Harvey, 453 F.2d 722
7 Any inequity in both these situations can be adjusted
through judicious allocations of damages appropriate to the
particular case. Cf. J. I. Case Co. Vv. Borak, supra, 377 U.S.
at 433-435.
32
(C.A. 2), reversed on rehearing en banc, 453 F.2d
736, with /nternational Controls Corp. v. Vesco, 490
F.2d 1334 (C.A. 2), certiorari denied, 417 U.S. 932;
James v. Gerber Products Co., 483 F.2d 944 (C.A.
6); Travis v. Anthes Imperial Ltd., 473 F.2d 515
(C.A. 8); Crane Co. v. Westinghouse Air Brake Co.,
419 F.2d 787 (C.A. 2), certiorari denied, 400 U.S.
822; Vine v. Beneficial ’ wince Co., 374 F.2d 627
(C.A. 2), certiorari denied, 389 U.S. 970; A. T.
Bred & Co. v. Perlow, 375 F.2d 393 (C.A. 2); Mutual
Shares Corp. v. Genesco, Inc., 384 F.2d 540 (C.A.
2), and Ruckle v. Roto American Corp., 339 F.2d 24
(C.A. 2).
The existing exceptions to the Birnbaum rule al-
low some individuals who neither purchased nor sold
securities to bring suit, and so already permit the
vexatious litigation petitioners fear. Others may
sue in the hope of creating additional exceptions to
the rule. Litigation over these exceptions can be
protracted and costly, as the instant case demon-
strates. Indeed, the combined social costs of strike
suits falling within the current exceptions and the
costs of litigation determining the existence and
scope of these exceptions may exceed whatever costs
might be incurred from allowing standing to all per-
sons within the class protected by Rule 10b-5 who
allege they have been injured by a defendant’s viola-
tion of it.
We submit that the equitable limitation on vicar-
ious liability for damages we have suggested above,
together with appropriate burden-of-proof require-
33
ments, will sufficiently protect all of the legitimate
interests of petitioners and other offerors of securities.
This Court should not go further and adopt a rule of
standing that places an arbitrary obstacle to recovery
in the path of innocent victims and serves primarily
to protect violators of the rule.
CONCLUSION
For the foregoing reasons, the judgment of the
court of appeals should be affirmed on the ground that
no “purchaser-seller limitation” is applicable to a
private cause of action pursuant to Section 10(b)
of the Securities Exchange Act and Rule 10b-5.
Respectfully submitted.
ROBERT H. BORK,
Solicitor General.
FRANK H. EASTERBROOK,
Assistant to the Solicitor General.
LAWRENCE E. NERHEIM,
General Counsel,
DAVID FERBER,
Solicitor,
RICHARD E. NATHAN,
Assistant General Counsel,
DAVID K. GINN,
Attorney,
Securities and Exchange Commission.
FEBRUARY 1975.
WY =v. &. GOVERNMENT PRINTING OFrics; 1975 s69602 113
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