Petition — Topsy's International, Inc. v. Seiffer

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| Supteme Court, U. S,

FILED

OCT 16 1975

“|

In the Supreme Court of the United States

OCTOBER TERM, 1975

eee eee ees cere ee ee. ce)

TOPSY’S INTERNATIONAL, INC., JERRY D. BERGER,

JAMES T. HOUSE and HARRY NUELL,

Petitioners,

vs.

ROBERT SEIFFER, et al.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

Harry P. THOMSON, JR.

RoBERT R. RAYMOND

Dennis D. PALMER

900 Commerce Bank Bldg.

Post Office Box 13007

Kansas City, Missouri 64199

Attorneys for Petitioners

E. L. Menpennatu, Inc., 926 Cherry Street, Kansas City, Mo. 64106, 421-3030

I a ara atl tiiedlenle 2

FES REESE A Re a ORIEN ASCE STC 3

SEITE ON HLS De AE PLT 3

Constitutional Provisions, Statutes and Rules Involved 4

I er Te GI ve ccectcertiectipsccieetnitindsctienintheandonitie 11

Reasons Relied On for the Allowance of the Writ ........ 13

I aca ticiiccaaiteanisiniseciitidecceacetesitiaipnindldintiltpiaaenestvmninsinetaiin 21

Appendix A—Opinion of the District Court .................... 23

Appendix B—Judgment of the District Court ................ 32

Appendix C—Order of the Court of Appeals ................ 34

_ Appendix D—Order of the Court of Appeals ...._............ 35

Appendix E—Opinion and Order of the Court of Ap-

ED ciccrscsinenrecapentplnepteciebioctivtiiabuinnebisnnialelatthianadbstanagininyes 36

Appendix F—Order of the Court of Appeals ................ 42

. Appendix G—Order of the Court of Appeals -................ 43

Appendix H—Opinion in Hickman, et al. v. Groesbeck,

OF Oe seichetsiticatnsetiscshdalbeiapditaiitiandtiaatidicmeniditcisnannialnibéenen 44

Case CITATIONS |

Cohen v. Beneficial Loan Corp., 337 U.S. 541, 69 S.Ct.

1221, 93 L.Ed. 1528 (1949) 3, 13, 16, 17

Eisen v. Carlisle and Jacquelin, 479 F.2d 1005 (1973)

ite x eI ax ee a NN Nd Rca NS 4,14, 17,19

Eisen v. Carlisle and Jacquelin, 417 U.S. 156 (1974) ....3, 15

General Motors Corp. v. City of New York, 501 F.2d

639 (2nd Cir. 1974) ...... sahinsithiaieiiiaiiiapaeamlinintnaiananiela 17, 19

Herbst v. International Telephone and Telegraph Corp.,

405 F.2d 1306 (2nd Cir. 1974) ................cc.eccscccceceees: 4,17,18

Korn v. Franchard Corp., 443 F.2d 1301 (2nd Cir.

EEUU. . cineenrsisbevccibcsinseidsuadmenipaapiietaliindeiitnsndianieaTaptiaea det AiR Rati 17

Parkinson v. April Industries, Inc., ........ ~~

(1975), 75 CCH Sec.L.Rep., para. 95,227 _...000000000.... 19

Sibbach v. Wilson & Co., 312 U.S. 1 (1941) 000... 13-14

Snyder v. Harris, 394 U.S. 332 (1969) 000 13

United States v. General Motors Corp., 323 U.S. 373,

65 S.Ct. 357, 89 L.Ed. 311 (1945) ................................... 18

CONSTITUTIONAL PROVISIONS,

STATUTES AND RULES

Be Geet Gs CI secttecteticnnenthiincctctincessnsemmentnsiniiannd 10, 11

Constitution of the United States—

Re MI cctinitdietiudesicolitivetnishesisitidedecicitnnianasalade 4

I I Siiitiscsiticsccinstiiiitliiatmtsalininaidiatliet 4

Rule 23, Federal Rules of Civil Procedure .......0..00.0......

sniidenisttiesenaanaiaasnadlanatiattiaiieiitiiaatitalettaiial 3, 7, 12, 14, 15, 16, 19, 21

Fp SETI sictienaicesitihapranrpnsiceninticaibipeeindsacetibiina eit tiaiae tensa 5,11

| ETT eT Te Le WERE NE 6, 11

Sy REIT TUTTI soisscchssrssceiotehehtaeiaceiineganbaciacehatiasiaaea 3, 6, 12, 13, 16, 17

28 U.S.C. 2072 ......:. soisntnielitieiiiaieiaalintstiit desma tices 6, 14, 15

MISCELLANEOUS

Advisory Committee Note, 39 F.R.D. 69 -.000000000000000... 19

In the Supreme Court of the United States

OCTOBER TERM, 1975

TOPSY’S INTERNATIONAL, INC., JERRY D. RERGER,

JAMES T. HOUSE and HARRY NUELL,

Petitioners,

vs.

ROBERT SEIFFER, et al.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

To: The Honorable, The Chief Justice and The Associate

Justices of the Supreme Court of the United States

The Petitioners, Topsy’s International, Inc., Jerry D.

Berger, James T. House and Harry Nuell pray that a Writ

of Certiorari issue to review the judgment of the United

States Court of Appeals for the Tenth Circuit filed in these

proceedings on July 28, 1975.

A timely filed Petition for Rehearing was overruled

by the Court of Appeals.

OPINIONS BELOW

The opinion of the United States District Court for

the District of Kansas granting a class action is reported

at 64 F.R.D. 713 (1974) and appears in the Appendix to

this Petition as Appendix A.

The judgment decreeing the action maintainable as

a class action appears in the Appendix as Appendix B.

The order of the United States Court of Appeals for

the Tenth Circuit denying an appeal pursuant to 28 U.S.C.

1292(b) appears in the Appendix to this Petition as Ap-

pendix C.

The order denying a Petition for a Rehearing En Banc

on the order denying appeal pursuant to 28 U.S.C. 1292(b)

appears in the Appendix to this Petition as Appendix D.

The opinion and order of the United States Court

of Appeals for the Tenth Circuit to be reviewed was en-

tered on July 28, 1975 and appears in the Appendix to

this Petition as Appendix E. The opinion is as yet unre-

ported.

The order of the United States Court of Appeals for

the Tenth Circuit denying the Petition for Rehearing and

the Petition for Rehearing En Banc was filed on August

26, 1975 and appears in the Appendix to this Petition

as Appendix F.

The order denying a Stay of Mandate was issued by

the United States Court of Appeals for the Tenth Circuit

on September 10, 1975 and appears in the Appendix to

this Petition as Appendix G.

JURISDICTION

The opinion and order of the United States Court

of Appeals for the Tenth Circuit dismissing Petitioners’

appeal from a judgment of the United States District Court

for the District of Kansas which granted a class action

pursuant to Rule 23, Fed.R.Civ.Proc., was entered on July

28, 1975. The Petition for Rehearing filed on August 11,

1975 and the Petition for Rehearing En Banc filed on

August 8, 1975 were denied on August 26, 1975. The

Court of Appeals denied a Motion for Stay of Mandate

on September 10, 1975. Jurisdiction of this Court is in-

voked pursuant to 28 U.S.C. 1254(1).

QUESTIONS PRESENTED

1. Should not a District Court’s order granting a class

action, which on its face modifies the substantive law

so as to eliminate the requirement of proof of certain

elements of the claims of prospective class members for

the sole purpose of conforming to the procedural require-

ments of Rule 23, Fed.R.Civ.Proc., be a final judgment

for purposes of appeal within the meaning of 28 U.S.C.

1291 under the Supreme Court’s opinions in Eisen v. Car-

lisle and Jacquelin, 417 U.S. 156 (1974) and Cohen v.

Beneficial Loan Corp., 337 U.S. 541 (1949) where such

order operates to deny Petitioners their right to trial by

jury in contravention of the Seventh Amendment to the

Constitution of the United States with respect to the sub-

stantive issues eliminated as elements of the claims?

2. Whether the opinion of the United States Court

of Appeals for the Tenth Circuit holding that orders of

the District Court granting class actions are not appealable

under the circumstances of this case directly conflicts with

the opinions of the United States Court of Appeals for

the Second Circuit in Herbst v. International Telephone

and Telegraph Corp., 495 F.2d 1308 (2nd Cir. 1974) and

Eisen v. Carlisle and Jacquelin, 479 F.2d 1005 (1973) so

that confusion exists with regard to the circumstances

under which a court of appeals should supervise and review

orders entered by the district courts granting class actions

pursuant to Rule 23, Fed.R.Civ.Proc.

CONSTITUTIONAL PROVISIONS, STATUTES AND

RULES INVOLVED

Fifth Amendment to the Constitution

of the United States

No person shall be held to answer for a capital, or

otherwise infamous crime, unless on a presentment or in-

dictment of a Grand Jury, except in cases arising in the

land or naval forces, or in the Militia, when in actual

service in time of War or public danger; nor shall any

person be subject for the same offence (sic) to be twice

put in jeopardy of life or limb, nor shall be compelled

in any criminal case to be a witness against himself, nor

be deprived of life, liberty, or property, without due process

of law; nor shall private property be taken for public

use without just compensation.

Seventh Amendment to the Constitution

of the United States

In Suits at common law, where the value in contro-

versy shall exceed twenty dollars, the right of trial by

jury shall be preserved, and no fact tried by a jury shall

be otherwise reexamined in any Court of the United States,

than according to the rules of the common law.

15 U.S.C. 77q

(a) It shall be unlawful for any person in the offer

or sale of any securities by the use of any means or

instruments of transportation or communication in inter-

state commerce or by the use of the mails, directly or

indirectly—

(1) to employ any device, scheme, or artifice to de-

fraud, or

(2) to obtain money or property by means of any

untrue statement of a material fact or any omission to

state a material fact necessary in order to make the state-

ments made, in the light of the circumstances under which

they were made, not misleading, or

(3) to engage in any transaction, practice, or course

of business which operates or would operate as a fraud

or deceit upon the purchaser.

(b) It shall be unlawful for any person, by the use

of any means or instruments or transportation or communi-

cation in interstate commerce or by the use of the mails,

to publish, give publicity to, or circulate any notice, circu-

lar, advertisement, newspaper, article, letter, investment

service, or communication which, though not purporting

to offer a security for sale, describes such security for

a consideration received or to be received, directly or

indirectly from an issuer, underwriter, or dealer, without

fully disclosing the receipt, whether past or prospective,

of such consideration and the amount thereof.

title shall not apply to the provisions of this section.

15 U.S.C. 78j

It shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality of

interstate commerce or of the mails, or of any facility

of any national securities exchange—

(a) To effect a short sale, or to use or employ any

stop-loss order in connection with the purchase or sale,

of any security registered on a national securities exchange,

in contravention of such rules and regulations as the Com-

mission may prescribe 25 necessary or appropriate in the

public interest or for the protection of investors

(b) To use or employ, in connection with the pur-

chase or sale of any security registered on a national

securities exchange or any security not so registered, any

manipulative or deceptive device or contrivance in contra-

vention of such rules and regulations as the Commission

may prescribe as necessary or appropriate in the public

interest or for the protection of investors.

28 U.S.C. 1291

The courts of appeals shall have jurisdiction of appeals

from all final decisions of the district courts of the United

States, the United States District Court for the District

of the Canal Zone, the District Court of Guam, and the

District Court of the Virgin Islands, except where a direct

review may be had in the Supreme Court.

28 U.S.C. 2072

The Supreme Court shall have the power to prescribe

by general rules, the forms of process, writs, pleadings,

and motions, and the practice and procedure of the dis-

trict courts and courts of appeals of the United States

in civil actions, including admiralty and maritime cases,

and appeals therein, and the practice and procedure in

proceedings for the review by the courts of appeals of

decisions of the Tax Court of the United States and for

the judicial review or enforcement of orders of ac‘ministra-

tive agencies, boards, commissions, and officers.

Such rules shall not abridge, enlarge or modify any

substantive right and shall preserve the right of trial by

jury as at common law and as declared by the Seventh

Amendment to the Constitution.

Such rules shall not take effect until they have been

reported to Congress by the Chief Justice at or after the

beginning of a regular session thereof but not later than

the first day of May, and until the expiration of ninety

days after they have been thus reported.

All laws in conflict with such rules shall be of no

further force or effect after such rules have taken effect.

Nothing in this title, anything therein to the contrary

notwithstanding, shall in any way limit, supercede, or re-

peal any such rules heretofore prescribed by the Supreme

Court.

Rule 23, Federal Rules of Civil Procedure

(a) Prerequisites to a Class Action. One or more

members of a class may sue or be sued as representative

parties on behalf of all only if (1) the class is so numerous

that joinder of all members is impracticable, (2) there

are questions of law or fact common to the class, (3)

the claims or defenses of the representative parties are

typical of the claims or defenses of the class, and (4)

the representative parties will fairly and adequately pro-

tect the interests of the class.

(b) Class Actions Maintainable. An action may be

maintained as a class action if the prerequisites of sub-

division (a) are satisfied, and in addition:

(1) the prosecution of separate actions by or against

individual members of the class would create a risk of

(A) inconsistent or varying adjudications with re-

spect to individual members of the class whick would

establish incompatible standards of conduct for the party

opposing the class, or

(B) adjudications with respect to individual members

of the class which would as a practical matter be disposi-

tive of the interests of the other members not parties

to the adjudications or substantially impair or impede their

ability to protect their interests; or

(2) the party opposing the class has acted or refused

to act on grounds generally applicable to the class, there-

by making appropriate final injunctive relief or cor-

responding declaratory relief with respect to the class as

a whole; or

(3) the court finds that the questions of law or fact

common to the members of the class predominate over

any questions affecting only individual members, and that

a class action is superior to other available methods for

the fair and efficient adjudication of the controversy. The

matters pertinent to the findings include: (A) the interest

of members of the class in individually controlling the

prosecution or defense of separate actions; (B) the extent

and nature of any litigation concerning the controversy

already commenced by or against members of the class;

litigation of the claims in the particular forum; (D) the

difficulties likely to be encountered in the management

of a class action.

to be Maintained; Judgment; Actions Conducted Partially

as Class Actions.

(1) As soon as practicable after the commencement

of an action brought as a class action, the court shall

determine by order whether it is to be so maintained.

An order under this subdivision may be conditional, and

may be altered or amended before the decision on the

merits.

(2) In any class action maintained under subdivision

(b) (3), the court shall direct to the members of the

class the best notice practicable under the circumstances,

including individual notice to all members who can be

identified through reasonable effort. The notice shall ad-

vise each member that (A) the court will exclude him

from the class if he so requests by a specified date; (B)

the judgment, whether favorable or not, will include all

members who do not request exclusion; and (C) any mem-

ber who does not request exclusion may, if he desires,

enter an appearance through his counsel.

(3) The judgment in an action maintained as a class

action under subdivision (b) (1) or (b) (2), whether or

not favorable to the class, shall include and describe those

whom the court finds to be members of the class. The

judgment in an action maintained as a class action under

subdivision (b) (3), whether or not favorable to the class,

shall include and specify or describe those to whom the

notice provided in subdivision (c) (2) was directed, and

who have not requested exclusion, and whom the court

finds to be members of the class.

(4) When appropriate (A) an action may be brought

or maintained as a class action with respect to particular

issues, or (B) a class may be divided into subclasses and

each subclass treated as a class, and the provisions of

this rule shall then be construed and applied accordingly.

(d) Orders in Conduct of Actions. In the conduct

of actions to which this rule applies, the court may make

appropriate orders: (1) determining the course of pro-

ceedings or prescribing measures to prevent undue repeti-

tion or complication in the presentation of evidence or

argument; (2) requiring, for the protection of the members

of the class or otherwise for the fair conduct of the action,

that notice be given in such manner as the court may

direct to some or all of the members of any step in the

action, or of the proposed extent of the judgment, or of

the opportunity of members to signify whether they con-

sider the representation fair and adequate, to intervene

and present claims or defenses, or otherwise to come into

the action; (3) imposing conditions on the representative

parties or on intervenors; (4) requiring that the pleadings

be amended to eliminate therefrom allegations as to repre-

sentation of absent persons, and that the action proceed

accordingly; (5) dealing with similar procedural matters.

The orders may be combined with an order under Rule

16, and may be altered or amended as may be desirable

from time to time.

(e) Dismissal or Compromise. A class action shall

not be dismissed or compromised without the approval

of the court, and notice of the proposed dismissal or com-

promise shall be given to all members of the class in

such manner as the court directs.

17 C.F .R. Sec. 240.10(b-5)

It shall be unlawful for any person, directly or indi-

rectly, by the use of any means or instrumentality of

interstate commerce, or of the mails, or of any facility

of any national securities exchange,

(a) to employ any device, scheme, or artifice to de-

fraud,

(b) to make any untrue statement of a material fact

or to omit to state a material fact necessary in order

to make the statements made, in the light of the circum-

stances under which they were made, not misleading, or

ness which operates or would operate as a fraud or deceit

upon any person,

in connection with the purchase or sale of any security.

STATEMENT OF THE CASE

This action was brought by Respondents alleging vio-

lations of the Federal Securities Laws, 15 U.S.C. Sec.

77q (a), 78j(b) and 17 C.F.R. Sec. 240.10(b-5) against Peti-

tioners and others alleging that they made misstatements

of material facts or omitted to state material facts

in twenty-eight separate documents published over an eigh-

teen-month period including annual reports, letters to

shareholders, newspaper releases and a prospectus issued

in connection with a public offering on February 4, 1969

of securities of Topsy’s International, Inc. Respondents

seek to bring the action not only on their own behalf,

but also on behalf of all purchasers of Topsy’s debentures

during the period of February 4, 1969 to March 10, 1970

and all purchasers of Topsy’s common stock from Septem-

ber 28, 1968 to March 10, 1970. Although the last purchase

of a Topsy’s security by any Respondent was on August

1, 1969, the litigation was not commenced until November

11, 1971. The Kansas statute of limitations, K.S.A. 60-

513(3), with its two year limitation period measured from

the date of discovery of the alleged fraud, is applicable

to the Respondents’ claims under the Federal Security

Laws.

Pursuant to its opinion, the District Court of June

24, 1974 ordered the action to proceed as a class ac-

tion as provided by Rule 23, Fed.R.Civ.Proc. The District

Court in ordering that the action proceed as a class action

held that the issue of the due diligence of the plaintiffs

in bringing the action was “an issue for the trier of fact”

and that “if each of the members of the prospective class

were required to prove his or her due diligence in discov-

ering the alleged fraud, the individual questions would

indeed predominate over the common ones”. In order

to make the action suitable for class action treatment,

the Court modified the substantive law and fashioned an

“objective” test of due diligence holding that otherwise

the Court would be faced with examining the subject

intent of each class member and otherwise a class action

would never be feasible. (Appendix A)

At the time it ordered the action proceed as a class

action, the District Court certified its decision to the Tenth

Circuit Court of Appeals pursuant to the provisions of

28 U.S.C. 1292(b). (Appendix B) Petitioners’ timely No-

tice of Appeal pursuant to 1292(b) was denied by the

Tenth Circuit on September 19, 1974. (Appendix C) A

Petition for Rehearing En Banc was denied by the Court

of Appeals on October 18, 1974. (Appendix D)

Petitioners also filed an appeal with the Tenth Circuit

Court of Appeals under the provisions of 28 U.S.C. 1291.

On July 28, 1975, the Court of Appeals entered its order

holding that the District Court’s class action order was

not a final judgment appealable pursuant to Sec. 1291.

(Appendix E) A Motion for Rehearing and a Motion

for Rehearing En Banc of that decision were denied by

the Court on August 26, 1975. (Appendix F) The Court

of Appeals denied a Motion for Stay of Mandate on

September 10, 1975. (Appendix G)

REASONS RELIED ON FOR THE

ALLOWANCE OF THE WRIT

1. The District Court’s Order Granting a Class

Action Which on Its Face Modified the Substantive Law

So As to Eliminate the Requirement of Proof of Certain

Elements of the Claims of Prospective Class Members

for the Sole Purpose of Conforming to the Procedural

Requirements of Rule 23, Fed.R.Civ.Proc., Is a Final

Judgment for Purposes of Appeal Within the Meaning

of 28 U.S.C. 1291 Under the Supreme Court’s Opinions

in Eisen v. Carlisle and Jacquelin, 417 U.S. 156 (1974)

and Cohen v. Beneficial Loan Corp., 337 U.S. 541 (1949)

Where Such Order Operates to Deny Petitioners Their

Right to Trial by Jury in Contravention of the Seventh

Amendment to the Constitution of the United States

and Due Process in Contravention of the Fifth Amend-

ment to the Constitution of the United States With Re-

spect to the Substantive Issues Eliminated As Ele-

ments of the Claims.

The Order of the District Court, which the Tenth

Circuit refused to review as failing to be appeaiable pursu-

ant to 28 U.S.C. 1291, clearly falls within “that small

class (of orders) which finally determine claims of right

separable from, and collateral to, rights asserted in the

action, too important to be denied review and too indepen-

dent of the cause itself to require that appellate considera-

tion be deferred until the whole case is adjudicated”.

Cohen v. Beneficial Loan Corp., 337 U.S. 541, 69 S.Ct.

1221, 93 L.Ed. 1528 (1949).

Rule 23, Fed.R.Civ.Proc. is a procedural device

which cannot alter substantive rights. Snyder v. Harris,

394 U.S. 332 (1969); Sibbach v. Wilson & Co., 312 US.

1 (1941); Eisen v. Carlisle and Jacquelin, 479 F.2d 1005,

1014 (1973). When the District Court, in contravention

of the Rules Enabling Act, 28 U.S.C. 2072, modified the

substantive law of the claims solely to accommodate the

dictates of the procedural rule and in so doing impaired

Petitioners’ constitutional rights, the order became “too

important to be denied (immediate) review”. That the

District Court modified the substantive law to meet the

requirements of Rule 23 is conceded in the District Court’s

opinion. The District Court held, 64 F.R.D. 714, 719 that:

“If each of the members of the prospective class

were required to prove his or her due diligence in

discovering the alleged fraud, the individual questions

would indeed predominate over the common ones. But

we believe a more objective standard could and should

be applied; otherwise a class action would never be

feasible in a case such as this.”

The Rules Enabling Act, 28 U.S.C. 2072, is unequivocal

in its command that “Such rules (of civil procedure) shall

not abridge, enlarge or modify any substantive rights and

shall preserve the right to trial by jury ...”. The Dis-

trict Court by fashioning an “objective standard” whereby

proof of individual due diligence is eliminated, has denied

to Petitioners the right to trial by jury on the factual

issue of whether the particular circumstances pertaining

to each claimant bars his claim because of a lack of due

diligence. Petitioners séek to show that as to each, re-

gardless of the testimony of named plaintiffs, each knew

of facts claimed to have been omitted or did not rely

on alleged misrepresentations. The modification of the

substantive law affects a denial of defenses Petitioners

might otherwise raise denying them their constitutional

right of due process. The District Court’s order creates

a double standard as between named plaintiffs who would

be available to be cross-examined about their due diligence

as opposed to absent class members who could not be

confronted on the issue.

As noted by this Court, appellate review is restricted

to “final decisions” to avoid “piecemeal appellate disposi-

tion of what is, in practical consequence, but a single _

controversy”. Eisen v. Carlisle and Jacquelin, 417 US.

156, 170 (1974). The decision which the Tenth Circuit

declined to hear was not “merely a ‘step toward final

disposition of the merits of the case’”, but the clearly

collateral issue of whether the District Court was to be

allowed to proceed in violation of the Rules Enabling Act.

This question turns not one iota on the merit, or lack

thereof, inherent in the claims, but rather solely on the

question of law decidable without reference to the facts

in issue.

The question presented to the Court of Appeals was

simply whether the District Court in its desire to Utilize

Rule 23 had abridged Petitioners’ rights to enable the

theory of the action to fit the parameters of the procedural

tool. To decide this question, decides the totally inde-

pendent issue of whether a claim can be asserted on behalf

of absent class members. This the Tenth Circuit clearly

misapprehended. The Court of Appeals, in deciding the

question held that “. . . the ultimate issue sought to be

appealed is whether the class action authorized by the

order is appropriately manageable”. (Appendix E) This

is not at all the issue. The District Court conceded that

the action could not proceed as a class action without

the creation of an “objective standard” so that the Court

would be “freed from the overwhelming task of examining

the subjective intent of each class member”. 64 F.R.D.,

at 719. Thus, the issue which Petitioners seek reviewed

is whether, in light of 28 U.S.C. 2072, the District Court

can modify the substantive law to free itself from an

“overwhelming task” where the modification works to the

clear detriment of a party to the litigation. Petitioners

say it cannot and say that the matter was ripe for review

by the Court of Appeals.

The question presented to the Court of Appeals is

not part of the “single controversy”, but is the clearly

separable and collateral issue of the right of the District

Court to modify substantive rights to accommodate a pro-

cedural rule. This, like the District Court’s allocation of

the cost of notice in Eisen, is “but one aspect” of the

resolution of the Rule 23 question. 417 U.S., at 172. The

question was determined with finality by the District Court

and thereby became a final decision under Sec. 1291.

As in Cohen, where the District Court settled a ques-

tion of state law with regard to security for costs, the

District Court in this action has settled the law of the

case. By so doing, the District Court has settled a claim

of right under circumstances where substantive law may

not be modified, so that its order falls within “that small

class” of orders which become appealable pursuant to Sec.

1291.

2. The Opinion of the Tenth Circuit Holding That

Orders of the District Court Granting Class Actions Are

Not Appealable Under the Circumstances of This Case

Directly Conflicts With the Opinion of the Second Cir-

cuit in Herbst v. International Telephone and Tele-

graph Corp., 495 F.2d 1308 (1974) and Eisen v. Carlisle

and Jacquelin, 479 F.2d 1005 (1973) So That Confusion

Exists With Regard to the Circumstances Under Which

a Court of Appeals Should Supervise and Review Or-

ders Entered by the District Courts Granting Class Ac-

tions Pursuant to Rule 23, Fed.R.Civ.Proc.

The Tenth Circuit Court of Appeals, in its holding

that the District Court’s order was not appealable, applied

an interpretation of the “three-prong test for Sec. 1291

appealability” enunciated by the Second Circuit in General

Motors Corp. v. City of New York, 501 F.2d 639 (2nd

Cir. 1974). In doing so, the Tenth Circuit ignored and

held contrary to the clear guidelines given by the Second

Circuit in its two leading opinions which deal with the

appeal of the grant of a class action, Herbst v. International

Telephone and Telegraph Corp., 495 F.2d 1308 (1974) and

Eisen v. Carlisle and Jacquelin, 479 F.2d 1005 (1973). The

Second Circuit in that Eisen opinion, n.1, explaining its

rationale for retaining jurisdiction on remand of the action

to the District Court, adopted a philosophy of appealability

that “will afford equality of treatment as between plain-

tiffs and defendants”. See also Korn v. Franchard Corp.,

443 F.2d 1301 (2nd Cir. 1971). The Second Circuit, ac-

knowledging the pragmatic approach to the collateral order

doctrine suggested by the Supreme Court in Cohen, recog-

nized the irreparable harm engendered by the delay in

appellate review of an improvidently granted class action.

As noted by the Eisen Court, an order sustaining a class

action both “clearly involves issues ‘fundamental to the

further conduct of the case’” and is separate from the

issues on the merits. The Court realistically recognized

that the “irreparable harm to a defendant in terms of

time and money spent in defending a huge class action

when an appellate court may years later decide such action

does not conform to Rule 23, is evident”. 479 F.2d at

1007, n.1. In its subsequent decision in Herbst, the Second

Circuit further elaborated on the policy considerations that

speak for prompt appellate review of class action orders,

stating, 495 F.2d at 1313:

“We believe that in the exercise of our supervisory

powers over the administration of justice in the dis-

trict courts it is desirable for us to review orders

authorizing class actions before the parties and the

district courts expend large amounts of time and

money in managing them. Candor compels us to add

that a class action had been improper after the district

court and the parties had expended much time and re-

sources although we might have had serious doubts if

we had reviewed the question at the inception of the

action. Judicial efficiency requires that courts have

spent considerable time, effort, and money, on such

actions. Reviewing order allowing class actions to

proceed would determine issues ‘fundamental to the

further conduct of the case’, United States v. General

Motors Corp., 323 U.S. 373, 377, 65 S.Ct. 357, 89 L.Ed.

311 (1945), and would constitute a most effective way

of exercising our supervisory powers.”

The court goes on to hold that clearly, it has jurisdiction

of such an appeal. 495 F.2d, at 1313 and n.10.

The rationale of the Tenth Circuit in denying Peti-

tioners’ right of appeal not only is in direct conflict with

the decisions of the Second Circuit, but moreover takes

. oer eee ene eases ere cae

an unrealistic view of the impact of the class action order.’

The Tenth Circuit equates “fundamental to the conduct”

with the continued viability of the action finding that

named plaintiffs, having substantial claims, will continue

to press them whether or not the action proceeds as a

class action. This restrictive view ignores the effect of

the class action order. Creating a class action draws into

the proceedings thousands of persons who have otherwise

evidenced no interest in litigating with the defendants.

It creates immense administrative burdens on the District

Court. It forces a defendant to risk staggering liability

or settle regardless of the merit of the claims. No one

who has participated in a class action can truthfully say

it is not fundamental to the further conduct of the litiga-

tion.

The impact of the litigation in time, money and the

' intangible damage caused by the suit can never be recouped

so that irreparable harm is the inevitable outcome of an

erroneous class order.

The Tenth Circuit founds its decision in part on the

theory that the order remains subject to reappraisal and

modification by the District Court during the course of

the proceedings. (Appendix E) However, the mod-

ification of a class order contemplated by Rule 23(c) (1)

is that which would arise by virtue of reevaluation of

facts emerging from a fuller record, the order having been

granted as soon as practicable after commencement of

the action. Advisory Committee Note, 39 F.R.D. 69, 104.

1. Petitioners call to the Court’s attention that two Second

Circuit Opinions have held that orders granting class actions

were not appealable under the ps circumstances of each

case. General Motors Corp. v. y of New York, 501 F.2d 639

(2nd Cir. 1974); Parkinson v. April Industries, Inc., .... F.2d

pone (1975), 75 CCH Sec.L.Rep., para. 95,227. Neither decision

overrules the policy considerations of either Eisen or Herbst.

The District Court order which Petitioners seek reviewed

has two vitally different characteristics. First, the error

complained of turns solely on a question of law which

will not be affected by the facts developed by discovery.

Secondly, even if discovery were to aid the resolution,

the District Court’s decision came at a time two and one-

half years after the commencement of the action when

the Court had available to it hundreds of pages of testimony

and hundreds of documents in the form cf a record desig-

nated by the parties. If the Court of Appeals considered

the order a conditional order granted at the onset of the

litigation, it clearly misapprehended the circumstances.

While it might be unreasonable to argue that all class

action orders should be automatically appealable, it is with

equal force unreasonable to argue that the appellate courts

should take a limited part in the review of class action

decisions.? The conflict between the policy enunciated

by the Second Circuit and that of the Tenth Circuit is

highlighted by the circumstances of this case where the

error of the District Court is clearly apparent from the

face of its order and its holding on the substantive law

is in direct conflict with holdings of other district courts

2. The District Court in this action thought its decision

would be reviewed. The District Court not only certified the

ruling for appeal pursuant to 28 U.S.C. 1292(b) which was denied

by the Court of Appeals, but also commented in the record during

pretrial proceedings:

“I will tell you, now, if I grant it, I intended to frame it so

there is no question that it’s an appealable order. The Tenth

Circuit Court, though, has been liberal in taking these. Our

Wilcox case went up where we denied it, they took it on up,

interlocutory, and I wouldn’t anticipate any problem, but

I did think in view of the Eisen case that there would be no

problem in framing the order, if I permit it, that it could be—

go “P xy matter of course.” (R. Pretrial Transcript, Vol XX,

Pp. 95-

ee ee

in the circuit so that there now exists conflict among

the districts with the Tenth Circuit.*

The overwhelming impact of Rule 23 on both the

litigants and the District Court cannot be overlooked. The

decisions of the Second Circuit with regard to the degree

of responsibility of the appellate courts to participate in

the class action decision is clearly in conflict with that

of the Tenth Circuit as enunciated in this case.

CONCLUSION

The Petition should be granted for the reasons that

the opinion sought to be appealed was clearly a final

order in its particular circumstances and further because

there exists a clear conflict between the Courts of Appeals

as to the circumstances when orders granting class actions

should be reviewed.

Respectfully submitted,

Harry P. THOMSON, JR.

Rosert R. RAYMOND

Dennis D. PALMER

900 Commerce Bank Bldg.

Post Office Box 13007

Kansas City, Missouri 64199

Attorneys for Petitioners

3. Hickman, et al. v. Groesbeck, et al., No. C252-72, (D.C.

December 18, 1974), which appears in the Appendix as

p-—% -- H, holds that 2 a private right of action under Rule

10b-5, “In this Circuit it is clear that materiality, scienter, re-

liance and causation and damages in connection with a misrep-

resentation or omission must be shown.

APPENDIX

APPENDIX A

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF KANSAS

No. KC-3435

Robert Seiffer, et al.,

Plaintiffs,

vs.

Topsy’s International, Inc., et al.,

Defendants.

Memorandum and Order

Plaintiffs filed their original complaint alleging cer-

tain securities act violations, both federal and state, on

November 11, 1971. Since that time, plaintiffs have filed

several amended complaints, additional parties defendant

have been added, cross-claims and third-party complaints

have been filed, and extensive discovery has been con-

ducted. All of this is by way of prefacing the issue we

reach here: whether or not the plaintiffs should be al-

lowed to maintain this action as a class action pursuant

to Rule 23 of the Federal Rules of Civil Procedure.

The court has already denied a motion for an order

declaring this action not a class action. (Memorandum and

Order of October 2, 1972, p. 8.) Our ruling was condi-

tioned upon (1) a showing that plaintiffs’ discovery of

the alleged fraud is consistent with the requisite diligence;

and (2) assuming such a showing is made, that plaintiffs

amend their complaint to define clearly and with particu-

larity the class of plaintiffs they seek to represent. We

believe that the amendments to plaintiffs’ complaint have

satisfied the second condition; hence, we now turn to con-

sider the due diligence issue.

Plaintiffs essentially allege that defendants partici-

pated in a scheme to defraud the class they seek to repre-

sent in violation of §17(a) of the Securities Act of 1933

[15 U.S.C. §77q(a)] and of §10(b) of the Securities Ex-

change Act of 1934 [15 U.S.C. §78j(b)] and Rule 10b-5

promulgated thereunder (17 C.F.R. §240.10b-5). We have

already determined that the statute of limitations in this

private suit for damages under Rule 10b-5 is the Kansas

statute of limitations for fraud, K.S.A. 60-513(3), which

provides for a two-year period from the date of discovery

of the fraud. (Memorandum and Order of October 2,

1972, p. 7.) But the federal tolling doctrine applies in

the determination of when plaintiffs, in the exercise of

due diligence should have discovered the alleged fraud.

Esplin v. Hirschi, 402 F.2d 94 (10th Cir. 1968); deHaas v.

Empire Petroleum Company, 435 F.2d 1223 (10th Cir.

1970). Jt requires no restatement of the alleged facts of

this case and of the relationship of the parties for this

court to determine that this is an issue for the trier of

fact. Seldom is it possible for such an issue to be de-

termined summarily. Dzenitz v. Merrill Lynch, Pierce,

Fenner & Smith, Inc., 494 F.2d 168 (10th Cir. 1974). The

court is therefore satisfied that the conditions previously

imposed have been met insofar as is possible at this time.

Our ruling in this regard is applicable to defendant Touche,

Ross & Company even though it was not joined as a de-

fendant until October 17, 1973, when plaintiffs’ third

amended complaint was filed.

In addition to the conditions imposed by the court,

Rule 23 establishes several prerequisites for the mainte-

nance of a class action. Firstly, the alleged class of de-

frauded purchasers must be so numerous that joinder of

all members is impracticable. Here the number of per-

sons who purchased Topsy’s securities, both common stock

and debentures, in the February 4, 1969, offering alone,

while difficult to determine with any degree of certainty,

may well exceed 1,000. Thus the court believes that this

first prerequisite has been satisfied.

Secondly, there must be questions of law or fact com-

mon to the class. Inasmuch as the alleged scheme to de-

fraud was designed to inflate the price of Topsy’s securi-

ties, all of the class members who purchased those securi-

ties during the relevant period of time would presumably

have been affected, albeit in varying degrees. We will

consider later in this memorandum whether the common is-

sues relating to the alleged fraud predominate over indi-

vidual ones. For now, we conclude that there are com-

mon questions of law and fact.

Thirdly, the claims or defenses of the representative

parties must be typical of the claims or defenses of the

class. This requirement appears to duplicate other pro-

visions of the rule, i.e., the common questions and repre-

sentative party provisions. 3B Moore’s Federal Practice

123,06-2. In view of our rulings on these other provisions,

we hold that the claims of the plaintiffs are typical of

those of the class of purchasers who have allegedly been

defrauded by defendants’ scheme.

Finally, the representative parties must fairly and ade-

quately protect the interests of the class. Plaintiffs seek

to represent a class of purchasers of the common stock of

defendant Topsy’s International from September 28, 1968,

to March 10, 1970, and purchasers of the debentures of

Topsy’s from February 4, 1969 (when they were first of-

fered), to March 10, 1970. These dates roughly coincide

with when Topsy’s shareholders would have received let-

ters from the company’s management announcing the ac-

quisition of SaxonS Sandwich Shoppes, Inc., in September

1968, and announcing the losses from the repurchase of

SaxonS units in March 1970. It was during this period of

time that defendants are alleged to have maintained an in-

flated price for Topsy’s securities through a fraudulent

scheme whereby defendants’ public statements painted an

overly optimistic picture of the SaxonS operation, when in

truth there was no reasonable basis for making such state-

ments. Since the named plaintiffs purchased stock and

debentures during this period, we see no reason why they

cannot fairly and adequately protect the interests of all

those who purchased in that span of time. Even though de-

fendants contend these plaintiffs’ purchases were not ex-

actly coextensive with the proposed class, we aie of the

opinion that there is no inconsistency with the interests

of other members of the class who purchased at other

times during the relevant period which would prevent the

named plaintiffs from representing the whole class. De-

fendants also specifically challenge the willingness and

ability of certain of the named plaintiffs to represent the

class, and, further, the ability of the plaintiffs’ attorneys

to represent the class because of an alleged conflict of in-

terest with a third party defendant. We do not believe

these matters of sufficient import to deny certification of

the class. We hold that plaintiffs have met all the prereq-

uisites of Rule 23(a).

In addition to the prerequisites of subdivision (a) of

Rule 23, plaintiffs must satisfy one of the sections of sub-

division (b). Plaintiffs contend that this action falls with-

in (b) (3):

“the court finds that the questions of law or fact

common to the members of the class predominate

over any questions affecting only individual members,

and that a class action is superior to other available

methods for the fair and efficient adjudication of the

controversy. The matters pertinent to the findings

include: (A) the interest of members of the class in

individually controlling the prosecution or defense of

separate actions; (B) the extent and nature of any

litigation concerning the controversy already com-

menced by or against members of the class; (C) the

desirability or undesirability of concentrating the liti-

gation of the claims in the particular forum; (D) the

difficulties likely to be encountered in the management

of a class action.”

Defendants voice strenuous objections to certification

of a (b)(3) type class. Because the list of matters per-

tinent to the court’s findings under (b)(3) is non-ex-

haustive (Notes of the Advisory Committee Regarding the

1966 Amendment to Rule 23), defendants raise issues

which, for the most part, are unique to this kind of 10b-5

action.

Defendants first contend that reliance is a necessary

element in a 10b-5 action and that this issue is primarily

an individual one, citing in particular Financial Industrial

Fund, Inc. v. McDonnell Douglas Corp., 474 F.2d 514 (10th

Cir. 1973). The element of reliance in 10b-5 cases is

usually considered part of the larger issue of causation.

Thus, in a case very similar to this, the United States Su-

preme Court held:

“Under the circumstances of this case, involving

primarily a failure to disclose, positive proof of reliance

is not a prerequisite to recovery. All that is necessary

is that the facts withheld be material in the sense that

a reasonable investor might have considered them im-

portant in the making of this decision. (Citations

omitted.) This obligation to disclose and this with-

holding of a material fact establish the requisite ele-

ment of causation in fact. (Citation omitted.)” Af-

filiated Ute Citizens v. United States, 406 U.S. 128, 153-

54, 31 L.Ed.2d 741, 92 S.C. 1456 (1972).

We regard the Affiliated Ute case as controlling here.

See Rochez Bros., Inc. v. Rhoades, 491 F.2d 402 (3rd Cir.

1974); Shapiro v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 42 L.W. 2544, April 23, 1974 (2nd Cir.); Dorfman v.

First Boston Corp., 42 L.W. 2552, April 30, 1974 (E.D.Pa.);

Werfel v. Kramarsky, 61 F.R.D. 674 (S.D.N.Y. 1974). De-

fendants err in thinking that the Tenth Circuit in the

Financial Industrial Fund case implied any different stan-

dard than that set forth in Affiliated Ute, where the Su-

preme Court overruled the Tenth Circuit’s restrictive in-

terpretation of the reliance issue in a 10b-5 case. We

therefore conclude that reliance is not a bar to plaintiffs’

maintenance of a class action.

Defendants next contend that there are material dif-

ferences in the alleged misrepresentations which preclude

class action treatment of this suit. On the other hand, it

has been suggested that a fraud perpetrated on numerous

persons by the use of similar misrepresentations is an

appealing situation for a class action. (Notes of the Ad-

visory Committee Regarding the 1966 Amendment to Rule

23.) Despite the fact that the alleged misrepresentations

regarding the SaxonS operation appeared in different pub-

lications at different times, they all emanated from the de-

feRdants as part of the alleged fraudulent scheme to main-

tain an inflated price for Topsy’s securities, and in the

opinion of the court they are interrelated and cumulative.

Moreover, plaintiffs are primarily alleging a complete fail-

ure to disclose material facts—which default was neces-

sarily common to all members of the proposed class. Esplin

v. Hirschi, supra. Thus we believe the common issues pre-

dominate over individual ones insofar as the alleged mis-

representations and omissions are concerned. Parentheti-

cally, we would observe that cases which the defendants

have cited such as Simon v. Merrill Lynch, Pierce, Fenner

& Smith, Inc., 482 F.2d 880 (5th Cir. 1973), are inapposite

because they involve oral misrepresentations.

Defendants further contend that the limitations issue

makes this case unsuitable for class action designation.

The court has previously expressed some misgivings about

the propriety of maintaining a class action because of this

very issue. Though plaintiffs have convinced the court

that their due diligence in discovering the alleged fraud

is an issue for the trier of fact (supra, p. 2), we must now

inquire whether there must be an individual determina-

tion of the due diligence issue which would predominate

over questions common to the class. If each of the mem-

bers of the prospective class were required to prove his

or her due diligence in discovering the alleged fraud, the

individual questions would indeed predominate over the

common ones. But we believe a more objective standard

could and should be applied; otherwise a class action would

never be feasible in a case such as this. The s‘andard

should be whether a reasonable investor, in light of the

facts existing at the time of the nondisclosure and in the

exercise of due care, would have been entitled to receive

full disclosure from the party charged and would have

acted differently had the alleged nondisclosure not oc-

curred. City National Bank of Fort Smith, Ark. v. Vander-

boom, 422 F.2d 221 (8th Cir. 1970). Thus the due dili-

gence issue, which in a case such as this is really an ex-

tension of the issue of causation in fact, can be deter-

mined by resorting to the same “reasonable investor” test

employed by the Supreme Court in the Affiliated Ute case,

supra. It is only by using such an approach that the court

is freed from the overwhelming task of examining the sub-

jective intent of each class member. Grad v. Memorex

Corporation, CCH Fed. Sec. L. Rep. 94,029 (N.D.Cal.

1973). We conclude that plaintiffs have satisfied the re-

quirement that the common issues predominate over in-

dividual ones.

Finally, we must decide whether a class action is su-

perior to other available methods for the fair and efficient

adjudication of the controversy. It has been our view that

the class action appears particularly suitable for this kind

of shareholder suit. (Memorandum and Order of October

2, 1972, p. 8.) While we are well aware of the potential

burden upon the court and jury posed by the maintenance

of a class action, our primary task is to see that the se-

curities laws are enforced to protect investors from fraud

of whatever magnitude as intended by Congress. Securi-

ties and Exchange Commission v. International Chemical

Development Corp., 469 F.2d 20 (10th Cir. 1972). Further-

more, it has been said that, “the ultimate effectiveness of

[the security anti-fraud laws] may depend on the ap-

plicability of the class action device.” Loss, Securities

Regulation, 2d Ed. 1961, p. 1819. Following Judge Hill’s

directive in Esplin v. Hirschi, supra, that if there is to be

any error it should be committed in favor of allowing the

class action, we hold that the class action is superior to

other available methods for the fair and efficient adjudica-

tion of this controversy.

The plaintiffs’ motion to strike defendants’ supple-

mental brief has been rendered moot by the court’s order

herein. The issue of the possible liability of defendant

Touche, Ross is not, in our view, properly raised in con-

nection with the class action issue and will not be treated

here.

CONCLUSION

The court finds that the requirements of Rule 23 have

been met and that this action should proceed as a class

action. The court hereby certifies a class of purchasers

who bought Topsy’s common stock from September 28,

1968, to March 10, 1970, and who bought Topsy’s debentures

from February 4, 1969, to March 10, 1970, and who suffered

a loss as a result of the defendants’ alleged misrepresenta-

tions and omissions. Notice shall be given to the class

pursuant to Rule 23(c)(2), with costs to be borne by

plaintiffs. Eisen v. Carlisle & Jacquelin, ........ oe ;

42 L.W. 4804 (May 28, 1974). Our ruling applies only to

Count I of plaintiffs’ third amended complaint; Count II,

the Kansas claims which have not been discussed in this

memorandum, shall proceed individually. Plaintiffs’ coun-

sel are directed to prepare and submit a journal entry of

judgment reflecting the conclusion reached here.

IT IS SO ORDERED.

Dated this 27th day of June, 1974, at Kansas City,

Kansas.

/s/ Earl E. O’Connor

United States District Judge

APPENDIX B

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF KANSAS

No. KC-3435

Robert Seiffer, et al.,

Plaintiffs,

vs.

Topsy’s International, Inc., et al.,

Defendants.

JUDGMENT DECREEING THE ACTION MAINTAIN-

ABLE AS A CLASS ACTION

This matter having been fully briefed by the parties

including designations of deposition testimony and docu-

ments, on plaintiffs’ motion for an order declaring the in-

stant action maintainable as a class action pursuant to Rule

23(c)(1) of the Federal Rules of Civil Procedure, with

oral argument being held on June 13, 1974; and,

The court having entered a Memorandum and Order

on June 27, 1974, determining that all requirements of

Rule 23 have been met by plaintiffs and that Count I of

plaintiffs’ Third Amended Complaint is to be maintained

as a class action under Rule 23(b)(3) for and on behalf

of plaintiffs and all purchasers of the common stock of

Topsy’s International, Inc. from September 28, 1968, to

March 10, 1970, and all purchasers of Topsy’s Convertible

Subordinated Debentures due 1984, from February 4, 1969,

to March 10, 1970, who suffered a loss as a result of defen-

dants’ alleged misrepresentations and omissions, against all

of the defendants; it is hereby

-——

ORDERED that Count I of plaintiffs’ Third Amended

Complaint is to be maintained as a class action under Rule

23(b) (3) of the Federal Rules of Civil Procedure on be-

half of a class comprised of plaintiffs and all other pur-

chasers of (1) Topsy’s common stock from September 28,

1968, to March 10, 1970, and (2) Topsy’s debentures from

February 4, 1969, to March 10, 1970, who suffered a loss

as a result of defendants’ alleged misrepresentations and

omissions.

It is further

ORDERED that notice shall be given to the class

members pursuant to Rule 23(c) (2) with costs to be borne

by plaintiffs.

It is further

ORDERED that the Memorandum and Order of June

27, 1974 involves controlling questions of law as to which

there is substantial ground for difference of opinion and

that an immediate appeal from the order may materially

advance the ultimate termination of the litigation.

IT IS SO ORDERED.

Ear] E. O’Connor

United States District Judge

July 26, 1974

APPENDIX C

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

No. 74-8091

No. 74-8094

September Term, 1974

Robert Seiffer, et a!

Respondents,

vs.

Topsy’s International, Inc., et al.,

Petitioners,

and

Touche Ross & Co.,

Petitioner,

vs.

Robert Seiffer, et al.,

Respondent.

Appeal from the United States District Court

for the District of Kansas

Before Honorable Oliver Seth, Honorable William J. Hol-

loway, Jr., and Honorable William E. Doyle, Circuit

Judges

This matter comes on for consideration of petitions for

leave to appeal under §1292(b) of Title 28, U.S.C.

Upon consideration whereof, it is ordered that the pe-

titions for leave to appeal are denied.

September 19, 1974

APPENDIX D

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

Misc. No. 74-8091

September Term, 1974

Robert Seiffer, et al.,

Plaintiffs-Respondents,

vs.

Topsy’s International, Inc., et al.,

Defendants-Petitioners.

Appeal from the United States District Court

for the District of Kansas

This matter comes on for consideration of the petition

for rehearing and suggestion for rehearing en banc filed

by the petitioners in the captioned case.

Upon consideration whereof, the petition for rehear-

ing is denied by Circuit Judges Seth, Holloway and Doyle,

to whom the cases were argued and submitted.

The petition for rehearing having been denied by the

original panel to whom the cases were argued and sub-

mitted and no member of the panel nor judge in regular

active service on the Court having requested that the

Court be polled on rehearing en banc, Rule 35, Federal

Rules of Appellate Procedure, the suggestion for rehearing

en banc is denied.

October 18, 1974

APPENDIX E

UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

No. 74-1711

No. 74-1712

No. 74-1713

Robert Seiffer, et al.,

Plaintiffs-Appellees,

vs.

Topsy’s International, Inc.,

Defendants-Appellants.

Appeal from the United States District Court

for the District of Kansas

Before Murrah, Barrett and Doyle, Circuit Judges.

Murrah, Circuit Judge.

OPINION

Topsy’s International, Inc., and its accountants Touche

Ross & Co. bring this §1291 appeal from a judgment cer-

tifying a class action in a federal’ securities fraud suit

against them and two other defendants not parties to this

appeal.? The trial court held and all the parties appar-

1. Only federal claims under 15 U.S.C. §§ 77q(a), 78j(»)

and 17 C.F.R. § 240.10b-5 were certified to be maintainable in

the class action. The complaint also contained allegations under

Kansas state securities laws, which are to proceed individually

and are not components of the case being reviewed here.

2. Topsy’s underwriters and lawyers are also named as de-

fendants, but they do not join this appeal of the certification of

the class.

A 6 te ne ane

ently acknowledge that the Kansas two-year statute of

limitations is applicable as a defense to the action, unless

it can be shown under the federal tolling doctrine® that

the action was brought within two years of the time when

plaintiffs by due diligence would discover or should have

discovered the alleged fraud. In holding that the plain-

tiffs and the defined class meet all the requirements of

Fed. R. Civ. P. 23(b) (3), the trial judge concluded that

neither the federal securities laws nor the federal tolling

doctrine require each class member to prove individual

due diligence in discovering the fraud; that, instead, the

applicable test is the “objective standard” of whether and

when a “reasonable investor” would have discovered the

fraud; and that common questions of law and fact thus

predominate. Appellants contend that such an objective

standard is not the law; that due diligence must be proved

individually, making a class action unmanageable; and

that we should therefore reverse the order certifying the

class. We have previously held that the same order was

not appealable under §1292(b). (Order of September 19,

1974; petition for rehearing en banc denied by Order of

October 18, 1974.) We now hold that the order is not

appealable under §1291. This means that, as the record

presently stands, the case will be tried as structured by

the order certifying the class and that the error in that

order, if any, must await review until final decision on

the merits.

According to the plaintiffs’ allegations, the defendants

maintained an artificially inflated price for Topsy’s se-

curities by means of misleading annual reports, letters to

3. “[W]here the party injured by the fraud remains in

ignorance of it without any fault or want of diligence or care on

his part, the bar of the statute does not begin to run until the

fraud is discovered ... .” Bailey v. Glover, 88 U.S. 342 (1874),

quoted in deHaas v. Empire Petroleum Co., 435 F.2d 1223, 1226

(10th Cir. 1970).

shareholders, newspaper releases, and purportedly inde-

pendent research reports, regarding Topsy’s financial

status and prospects, particularly as to its acquisition of

Saxons Sandwich Shoppes, Inc. These reports of Saxons

actual and potential profitability were allegedly dissemi-

nated, even though Saxons was declining and was ulti-

mately closed by Topsy’s at a great loss. The trial court’s

order gave the named plaintiffs the right to represent a

class defined as all the damaged purchasers of Topsy’s

common stock from September 28, 1968, when each share-

holder received the same letter from Topsy’s favorably

announcing its acquisition of Saxons, and all damaged pur-

chasers of Topsy’s debentures from February 4, 1969, un-

til March 10, 1970, when the losses from the Saxons op-

eration were revealed in a letter to all shareholders.

Generally, appealability under §1291 is limited to final

judgments reached after trial on the merits. An order

allowing or disallowing a class action may be assigned as

error at that time. Esplin v. Hirschi, 402 F.2d 94 (10th

Cir. 1968). We have expressed reluctance to grant im-

mediate review of orders granting or denying class status,

in view of the fact that such an order is subject to amend-

ment as the trial proceeds. Fed. R. Civ. P. 23(c)(1) and

the Notes thereto. In Gerstle v. Continental Airlines, Inc.,

466 F.2d 1374, 1377 (10th Cir. 1972), we held that an order

disallowing the class status previously granted was non-

appealable under §1291, since the trial court had expressed

its openness to further consideration and modification of

the order. See also Gold Strike Stamp Co. v. Christensen,

436 F.2d 791, 792 n.2 (1@th Cir. 1970). Cf., Wilcox v.

Commerce Bank of Kansas City, 474 F.2d 336 (10th Cir.

1973) (granting §1292 appealability of an order denying

class status).

These cases preceded Eisen v. Carlisle & Jacquelin,

417 U.S. 156, 171 (1973). In that case, the Supreme Court,

= —— . . ee -

giving §1291 “a practical rather than a technical construc-

tion,” granted appeal from “collateral orders” in a class

action before final judgment on the merits. See also

Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541,

546 (1949). In doing so, the Court observed that the

determination of finality for purposes of §1291 may pose

a close question and should be guided by balancing “the

inconvenience and costs of piecemeal review on the one

hand and the danger of denying justice by delay on the

other.” It affirmed the Court of Appeals’ jurisdiction to

review the district court’s order allowing a class action

with the condition that the defendants bear 90% of the

cost of notice to the class. Expressly declining to decide

jurisdiction over the issues of manageability and fluid-

class recovery, the Court held that the order was appeal-

able because the allocation of notice costs was a “final

disposition of a claimed right which is not an ingredient

of the cause of action and does not require consideration

with it.” See generally, Manual for Complex Litigation,

pp. 17-51 (1973). In our case, no claim is made as to the

propriety of the allocation of notice costs to the plaintiffs.

Rather, the ultimate issue sought to be appealed is whether

the class action authorized by the order is appropriately

manageable,

Following Eisen III, the Courts of Appeals have under-

taken to articulate the guidelines governing the §1291 ap-

pealability of a class action order. In denying the appeal-

ability of an order granting class standing, in General

Motors Corp. v. City of New York, 501 F.2d 639, 644

(2d Cir. 1974), Chief Judge Kaufman reviewed and reaf-

firmed the Second Circuit’s pre-Eisen three-prong test for

§1291 appealability: (1) whether the class action deter-

mination is fundamental to the further conduct of the

case; (2) whether review of that order is separable from

the merits; and (3) whether that order will cause irrep-

arable harm to the defendant in terms of time and money

spent in defending a huge class action. The General Motors

case distinguished Herbst v. International Telephone and

Telegraph Corp., 495 F.2d 1308 (2d Cir. 1974), where §1291

appeal from an order certifying a class action was allowed

because the practical viability of the action as well as

the defense costs were vastly altered by the order. In

that case, the order granting class standing converted the

plaintiff from a single individual holding 100 shares to

a class of 16,000 shareholders. Cf., Green v. Wolf Corp.,

406 F.2d 291 (2d Cir. 1968), cert. denied, 395 U.S. 977

(1969) (granting §1291 appealability of an order denying

class status on “death knell” principle).

In Rodgers v. United States Steel Corp., 508 F.2d

152, 159 (3rd Cir. 1975) (opinion by Judge Gibbons), the

court disallowed §1291 appeal from an order postponing

class action determination and restricting communications

with potential class members by plaintiffs or their attor-

neys. In this case, the Third Circuit formulated a similar

three-prong appealability test: (1) the order must be a

final rather than a provisional disposition of an issue;

(2) it must not merely be a step toward final disposi-

tion of the merits; and (3) the rights asserted would be

irreparably lost if review is postponed until final judgment.

See also In re Cessna Aircraft Distributorship Antitrust

Litigation, White Industries, Inc., v. The Cessna Aircraft

Co., No. 74-1563 (8th Cir. June 23, 1975) (denying §1291

appealability of an order granting class status); Williams

v. Mumford, 511 F.2d 363 (D.C. Cir. 1975) (denying §1291

appealability of an order denying class status).

In our case, the “fundamental conduct” or viability

of the suit does not turn on the class certification. The

inclusion of the estimated 4,700 potential class members

will indeed enlarge the stakes in the litigation, but it

is not a sine qua non for the further conduct of the suit

by the plaintiffs. There is probative evidence on the record

that the nine named plaintiffs have substantial personal

assets and a total potential recovery of $200,000, and they

have manifest an intent to pursue the suit even if denied

class status. The order thus does no “irreparable harm”

to the defendants. They will be faced with a large and

persistent lawsuit whether the class action is allowed or

not. Cf. Herbst v. International Telephone and Telegraph,

supra, and Eisen III, supra.

Furthermore, the determination of class here is not

collateral to the final adjudication of the issues; rather

it is an essential “ingredient of the cause of action” and

“require[s] consideration with it.” The objective standard

for proving plaintiff’s due diligence was necessarily estab-

lished by the order; and proof of due diligence is an

integral part of the cause of action whether brought indi-

vidually or as a class because it involves both the right

to bring the suit under the statute of limitations and the

ultimate right to recover under the securities laws. See

note 1, supra; Affiliated Ute Citizens v. United States,

406 U.S. 128, 153-154 (1972).

Both quantitative and qualitative analysis convince

us that it would be improper to review this order until

the case has proceeded to a final disposition on the merits.

Of course, the order remains subject to reappraisal and

modification by the trial court during the course of its

proceedings, and nothing herein expressed is intended to

hinder or limit that process. We hold that at this juncture

review of the order certifying the class is jurisdictionally

inappropriate.

The appeal is dismissed.

July 28, 1975

APPENDIX F

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

No. 74-1711

No. 74-1712

No. 74-1713

July Term, 1975

Robert Seiffer, et al.,

Plaintiffs-Appellees,

vs.

Topsy’s International, Inc.,

Defendants-Appellants.

Appeal from the United States District Court

for the District of Kansas

Before The Honorable David T. Lewis, Chief Judge, The

Honorable Alfred P. Murrah, The Honorable Delmas

C. Hill, The Honorable Oliver Seth, The Honorable

William J. Holloway, Jr., The Honorable Robert H.

McWilliams, The Honorable James E. Barrett and The

Honorable William E. Doyle, Circuit Judges

This matter comes on for consideration of the appel-

lants’ petitions for rehearing, and suggestions for rehearing

en banc filed with the Court on August 8, 1975 and Au-

gust 11, 1975.

Upon consideration whereof, the petitions for rehear-

ing are denied by Circuit Judges Murrah, Barrett and

Doyle to whom the cases were argued and submitted.

The petitions for rehearing having been denied by

the original panel to whom the cases were argued and

submitted and no member of the panel nor judge in reg-

ular active service on the Court having requested that

the Court be polled on rehearing en banc, Rule 35, Federal

Rules of Appellate procedure, the suggestions for rehearing

en banc are denied.

August 26, 1975

APPENDIX G

UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

No. 74-1711

No. 74-1712

Robert Seiffer, et al.,

Plaintiffs-Appellees,

vs.

Topsy’s International, Inc.,

Defendants-Appellants.

Appeal from the United States District Court

for the District of Kansas

Before The Honorable Alfred P. Murrah, Senior Judge,

The Honorable James E. Barrett and The Honorable

William E. Doyle, Circuit Judges

This matter comes on for consideration of the motion

of Appellants for stay of mandate in the captioned cases,

and of the various responses thereto.

Upon consideration whereof, it is the order of the

Court that the motion for stay of mandate is denied.

September 10, 1975

APPENDIX H

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF UTAH

CENTRAL DIVISION

No. C 252-72

GRANT A. HICKMAN, STANFORD E. POULSON, BEN

M. FISHLER and NEWELL E. WARR,

Plaintiffs,

ARTHUR J. GROESBECK, III, ARTHUR J. GROESBECK

ASSOCIATES, INC., a California corporation, GRIFFIN

SERVICES CORPORATION, a California corporation,

GRIFFIN PROPERTIES CORPORATION, a California

corporation, GRIFFIN SECURITIES CORPORATION, a

California corporation, GRIFFIN BUSINESS SERVICES

CORPORATION, a California corporation, COMPU-MAN-

AGEMENT COMPANY, a California corporation, A. J.

GROESBECK FINANCIAL ADVISORS, INC., a Cali-

fornia corporation, A. J. GROESBECK ASSOCIATES OF

UTAH, INC., a Utah corporation, PETER A. REID, CAR-

LIN, LEVY AND COMPANY, Certified Public Accoun-

tants, a partnership, and COMMERCIAL SECURITY

BANK, a national banking corporation,

Defendants.

MEMORANDUM OPINION IN LIEU OF FINDINGS OF

FACT AND CONCLUSIONS OF LAW

Adam M. Duncan, Esq., Salt Lake City, Utah, for plain-

tiffs.

William R. Dickerson of Lafollette, Johnson, Horgan

& Robinson, Los Angeles, California, and Reed L. Mar-

tineau of Worsley, Snow & Christensen, Salt Lake City,

Utah, for defendant Carlin, Levy & Company.

Robert M. Anderson and Jean L. Weaver of VanCott,

Bagley, Cornwall & McCarthy, Salt Lake City, Utah, for

defendant Commercial Security Bank.

Kenneth W. Yeates of Prince, Yeates, Ward, Miller

& Geldzahler, Salt Lake City, Utah, for all other defen-

dants.

The plaintiffs at Salt Lake City, Utah, purchased

certain interests in a limited partnership known as Cinco

Villa Company, which they allege are securities within the

meaning of 15 U.S.C. 78c(a) (1), and contend that the sale

of these interests by certain of the named defendants vio-

lated Section 10 of the Securities Exchange Act of 1934

and Rule 10b-5, promulgated thereunder. Plaintiffs fur-

ther allege that defendants Carlin, Levy and Company,

Certified Public Accountants, and Commercial Security

Bank, were aiders and abetters in the alleged securities

fraud, and that certain of the defendant Groesbeck cor-

porations are liable as alter egos of defendant Groesbeck,

or as control persons under Section 20 of the Exchange

Act of 1933. Plaintiffs also claim damages under common

law fraud principles and exemplary damages against cer-

tain of the named defendants. Jurisdiction exists under

the Securities Exchange Act of 1934, 15 U.S.C. § 78aa, and

the pendent jurisdiction of this court.

The matter came before the court, sitting without a

jury, for hearing commencing on August 26, 1974. The

parties appeared in person and were represented by their

respective counsel. Plaintiffs presented their case by docu-

mentary evidence and sworn testimony. At the close of

the plaintiffs’ case, defendant Commercial Security Bank

moved to dismiss the action as against it pursuant to Fed.

R. Civ. P. 41(b). The court granted the bank’s motion

and it was dismissed from the case.’ A similar motion

was made by defendant Carlin, Levy and Company, and

this motion was taken under advisement. The cause was

submitted to the court for its determination and decision

as to the other defendants. This opinion, together with

the admitted facts contained in the pretrial order, shall

constitute this court’s Findings of Fact and Conclusions of

Law, as required by Fed. R. Civ. P. 52(a).

FACTS AND BACKGROUNL

During 1968 and prior thereto, defendant Arthur J.

Groesbeck, III, was employed by Financial Concept, Inc.,

at Los Angeles, California, as an advisor to professional

people in the areas of financial planning and investments.

His activities involved generally the organization of lim-

ited partnerships in real estate and the sale of interests in

those limited partnerships to professional people as an in-

vestment and tax shelter. In order to engage in this same

type of business activity on his own, Groesbeck organized

and/or acquired an interest in a number of business enti-

ties in 1968 and 1969.”

Jordan M. Carlin and Harvey H. Levy are licensed

and practicing Certified Public Accountants and are part-

ners in the Los Angeles accounting firm of Carlin, Levy

and Company, one of the defendants herein (hereinafter

Carlin-Levy). Commencing in 1967, Carlin-Levy prepared

the personal tax returns for Groesbeck, and following the

1. Findings of Fact and Conclusions of Law were filed by

the court respecting Commercial Security Bank’s dismissal from

the case on October 10, 1974.

2. These business entities which are named defendants in

this case include Arthur J. Goesbeck Associates, Inc., Griffin _

vice Corporation, Griffin Properties Co ration, Griffin

curities Corporation, Griffin Business —— _

nay ement Company, A. J. Groesbeck Financial Advisors,

. Groesbeck Associates of Utah, Inc.

organization or acquisition by Groesbeck of the other busi-

ness entities referred to above, Carlin-Levy also prepared

tax returns and did other general accounting work for

those entities.

Sometime prior to November 11, 1969, Groesbeck, or the

Groesbeck organization, conceived of a limited partnership

to be known as “Cinco Villa.” On November 11, 1969,

Harvey H. Levy received a phone call from an agent or

employee of Groesbeck, in which he was requested to ren-

der a tax impact opinion letter regarding the deductibility

of prepaid interest and losses of the proposed Cinco Villa.

It was requested that the opinion letter be prepared on the

basis of facts which were related to Levy over the tele-

phone. Based upon the information and assumptions re-

lated to him,* Levy prepared a tax impact opinion letter,

as requested, dated November 13, 1969. The format of

this letter was the same as similar letters prepared for the

Groesbeck organization for similar ventures, and, although

addressed to Groesbeck, the letter was subsequently used

by the Groesbeck organization in the marketing and sales

of the limited partnership interests. The possibility that

the letter would be used in the marketing of limited partner-

ship interests through salesmen was known by Carlin-

Levy.

To sell the limited partnership interests in Cinco Villa,

the Groesbeck organization’s marketing program consisted

of postcards, seminars, and personal visits to prospective

buyers. Defendant Peter Reid was employed as Director of

> Be peers & De Sp Sees alee See, Levy

make independent verification of the information given

4. This letter was plaintiff's Exhibit 4 at trial

Marketing by the Groesbeck organization during the fall of

1969 and was the organization’s primary contact with each

of the plaintiffs in the case.5 Reid conducted seminars and

discussions in December, 1969, and in connection therewith

printed informational materials were distributed to prospec-

tive investors in person and through the mails. Plaintiffs

Warr, Hickman, and Poulson each attended one or more

of these seminars and each received the written informa-

tional materials. Plaintiffs Hickman, Poulson, and Warr

received two sales brochures, one dated November 11, 1969

(Trial Exh. P-2), and one dated December 12, 1969 (Trial

Exh. P-3). These plaintiffs also received the tax impact

opinion letter under the letterhead of Carlin-Levy dated

November 13, 1969 (Trial Exh. P-4). Plaintiff Fishler did

not attend the seminars or receive any written material

prior to signing the partnership agreement on December

5. Each of the plaintiffs is, and at all times material to this

action was, a resident and citizen of the State of Utah. Plaintiffs

Hickman and Poulson are licensed physicians. Plaintiff Warr is

a licensed dentist. Plaintiff Fishler has been engaged in the

pharmaceutical and medical supply business. Each of the plain-

tiffs is well educated and has had some investment experience.

It is unnecessary for the court to outline in detail the exact steps

which lead up to the investment decision of each plaintiff. Suf-

fice it to say, defendant Peter Reid made three visits to Salt Lake

City on December 2, December 16, and approximately December

29, 1969. During such visits Reid met with Warr, Poulson and

Hickman and on the last visit with Fishler. Groesbeck made one

trip to Utah in October, 1969, and conducted a seminar. In con-

nection with the seminars and the discussions, printed informa-

tional materials were distributed to the prospective investors in

person and through the mails. Defendants Groesbeck and Reid

— talked by telephone during that period with prospective Utah

vestors.

Plaintiffs Hickman, Warr and Poulson also submitted financial

information to A. J. Groesbeck Associates, Inc., for the purpose

of obtaining a financial analysis, including the recommendation

of suitable investment programs. Plaintiff Fishler did not have

any such financial ysis performed. There was no evidence

at trial in any way indicating that such financial evaluations were

in any way conducted for any purpose other than to make proper

and suitable financial and investment recommendations to clients

of A. J. Groesbeck Associates, Inc., or that the recommendations

were in any way misleading or used for any ulterior purpose.

29, 1969. Fishler did, however, have telephone and per-

sonal discussions with Reid on December 29, 1969, in re-

gard to the Cinco Villa venture.* The two sales brochures,

the tax impact opinion letter, the partnership agreement,

and correspondence prepared and distributed by the Groes-

beck organization were reviewed by plaintiffs Warr,

Poulson and Hickman with their respective accountant (Mr.

Osman for Warr and Poulson) and tax attorney (Mr.

Jardine for Hickman) prior to making the investment.

CINCO VILLA

The Cinco Villa limited partnership was formed for the

purpose of purchasing two apartment complexes located

at 11130-32-34 Freeman Avenue and 4846-48 116th Street

in Hawthorne, California. These two apartment house

complexes are approximately a mile to a mile and a quarter

apart from each other and consist of five four-unit build-

ings with three located at one location and two at the

other.? On December 29, 1969, all of the plaintiffs herein

executed copies of a limited partnership agreement and

invested the following amounts:

Grant A. Hickman $40,000

Stanford E. Poulson 10,000

Newell E. Warr 5,000

Ben M. Fishler 15,000

6. Except for the partnership agreement signed December

29, 1969, Fishler neither saw nor received any other documents

or written information on the Cinco Villa venture until the spring

of 1970, after he had made his investment.

7. Reid originally viewed and examined the property some-

time in November, 1969. Robert Tromblay, an employee of A. J.

Groesbeck Associates, Inc., had managed and supervised the

roperty while employed previously by Hawthorne Savings and

lean Company.

On December 31, 1969, the Cinco Villa limited partnership

was formed and on that day purchased the Cinco Villa

apartment house complexes and paid the sum of $280,000,

including broker’s commission. Based upon an appraisal

in which the market value could be reasonably estimated

near the time of the sale, the fair market value of the Cinco

Villa complexes closely approximated $280,000. The gen-

eral partner for the Cinco Villa limited partnership was

A. J. Groesbeck Associates of Utah, Inc., organized in De-

cember, 1969, but prior to the formation of the limited

partnership.*®

ELEMENTS OF 10b-5

The private right of action under Rule 10b-5 is pred-

icated on a statutory tort theory—a general principle of

tort law that violation of a provision of a criminal statute

designed to prevent a particular type of harm can give rise

to a civil remedy. Mitchell v. Texas Gulf Sulphur Com-

pany, 446 F.2d 90, 97 (10th Cir. 1971). To recover under

8. Subsequent to the formation of the limited partnership,

plaintiffs received a picture of one of the apartment complexes

and periodic letters under the letterhead of A. J. Groesbeck Finan-

cial Advisors for A. J. Groesbeck Associates, Inc. Such letters

were signed A. J. Groesbeck, general partner, or A. J. Groesbeck

Associates, Inc. of Utah, general partner.

Plaintiffs also received periodic reports from Compumanage-

ment Company indicating the cash position and financial condi-

tion of the Cinco Villa limited partnership. For the years 1969,

1970, 1971 and 1972, plaintiffs received partnership income tax

returns. Each of the plaintiffs deducted the specified amount of

partnership loss attributable to each plaintiff on his own personal

income tax returns for each of the indicated years. Defendant’s

Exhibit D-G-40 at trial indicated that over the four-year period,

1969-1972, each of the plaintiffs received the following total tax

savings from his claimed deductions arising from his limited part-

nership interests in Cinco Villa:

Grant A. Hickman $21,636.93

Stanford E. Poulson 2,272.99

Newell E. Warr 1,422.32

Ben M. Fishler 6,134.12

the rule it has been repeatedly held that a successful plain-

tiff must prove (1) the use of the mails or instrumentalities

of interstate commerce, (2) the purchase or sale of a secu-

rity; and (3) the use of a manipulative or deceptive device.

Kerbs v. Fall River Industries, Inc., 502 F.2d 731, 737 (10th

Cir. 1974); Stevens v. Vowell, 343 F.2d 374, 378 (10th Cir.

1965). The literal fulfillment of these three elements does

not, however, guarantee recovery. Although it is not neces-

sary to allege or prove common law fraud to make out a

case under Rule 10b-5, the “common law fraud elements—

misrepresentation or nondisclosure, materiality, scienter,

intent to defraud, reliance and causation—have crept in and

played varying roles of significance.” Mitchell v. Texas

Gulf Sulphur Company, 446 F.2d, at 97. It is undoubtedly

true that

“({s]ome form of reliance-causation test for damages

must remain in the rules . . . in order to prevent the

rule from turning defendants into public guarantors

of losses wherever a violation of the rule has oc-

curred.’”

In this Circuit it is clear that materiality,’® scienter," re-

liance and causation” and damages in connection with a

misrepresentation or omission must be shown,

9. Cobine, Elements of Liability and Actual Damages in Rule

10b-5 Actions, 1972 LAW FORUM, 651, 684 (1972).

10. See, Mitchell v. Texas Gulf Sulphur Co., 446 F.2d 90, 97

(10th Cir. 1971).

11. See Clegg v. Conk, -..... = (10th Cir. November

1974) in which the court, after reviewing the relevant Tenth Cir-

cuit decisions in the area, stated:

“From their common principles and applications may be

deduced the propositions that there is required something

additional by way of scienter or conscious fault than mere

negligence, and something more by way of reliance or causa-

tion in fact than some abstract wrong expending its force

entirely upon itself.”

12. Id.

THE MATERIALITY OF THE ALLEGED MISREPRE-

SENTATIONS

At trial, plaintiffs claimed misrepresentations or omis-

sions of fact arising from the two sales brochures, dated

November 11, 1969 (Exh. P-2) and December 12, 1969

(Exh. P-3), prepared for and used in the sale of the lim-

ited partnership, from the tax impact opinion letter (Exh.

P-4) prepared by Carlin-Levy, and from the sales semi-

nars and personal discussions held in Salt Lake City by

Groesbeck and Reid. Plaintiffs compiled in their post-

trial brief a long list of alleged misrepresentations and

omissions;** however, only two were stressed at trial and

only two could reasonably be argued to be material.

13. The court finds that the following alleged misrepresenta-

tions or omissions are not material for the following reasons:

1. In the November 11 and December 12, 1969, sales

brochures the representations (a) that employees of A. J.

Groesbeck Associates of Utah, Inc., were investing in the

property as limited partners, and (b) that Carlin-Lev, had

been retained as auditors and tax counsel of the venture

were not material because reasonable investors would not

likely make an investment decision merely on the basis of

what employees or functionaries of a corporation do or fail

to do, nor would reasonable investors mistakenly assume

that the success of an investment is dependent on who serves

as auditors or tax counsel.

2. In the November 11 and December 12, 1969, sales bro-

chures the alleged omissions to state (a) that Groesbeck owed

(sic) 90% of both Griffin Properties Corporation and A. J.

Groesbeck Associates, Inc., (b) that the “Table of Benefits”

did not state that all of the numbers would change if any

of the claimed deductible items were thereafter disallowed

by the IRS, (c) that Groesbeck had never seen Cinco Villa,

(d) that each limited partner would be subject to further

cash calls should the limited partnership require additional

funds, (e) that the amount of payments, whether inclusive

or noninclusive of interest accrued, and whether payments

were to be monthly, quarterly, annual or otherwise, on the

first trust deed of $225,000, (f) that the identity of the

owner of the second trust deed of $20,000 and consideration

therefor was unknown, (g) that there were risks of short-

time foreclosures upon late payment or other default, and

that there might be possible problems of obtaining refinancing

or additional financing where the property was subject to

(Continued on following page)

First, in both the November 11, 1969, sales brochure

and the tax impact opinion letter it is represented that

Groesbeck would invest personally and be the general

Footnote Continued—

two trust deeds, and (h) that there was a prior and contin-

uing relationship between Carlin-Levy and the Groesbeck

organization, were not material because (a) common owner-

ship of related corporations is no indication of foul play,

(b) it is only common sense that claimed deductible items

will change if disallowed by the IRS (however, the evidence

shows that all the claimed deductible items were allowed by

the IRS in this case), (c) the law does not require that a

corporate president personally inspect every detail concerned

with his corporation (in this case, Groesbeck’s agent and em-

ployee inspected the property in question), (d) the subject

of further cash calls need not be discussed in promotional

material (this was clearly treated in paragraph 13 of the

Limited Partnership Agreement, Exh. P-8), (e) this is not

material that needs to be specified in promotional or sales

material, (f) this is not material that needs to be specified

in promotional or sales material, (g) contingent risks (which

the evidence fails to show ever occurred) need not be men-

tioned in promotional or sales material, (h) a relationship

between a corporation and its accountants is of little probative

value in evaluating an investment possibility, especially in

the absence of any evidence of illegal participation.

In the November 13, 1969 Tax Impact Opinion Letter pre-

pared by Carlin-Levy the following are claimed omissions: (a)

that the letter was based solely on two telephone conversations

and a memo from the Groesbeck organizations, (b) that Carlin-

Levy had made no investigation as to the property involved in

the letter, (c) that Carlin-Levy had written at least six other

similar letters, (d) that Carlin-Levy did not consider themselves

qualified tax advisers or tax experts, (e) that Carlin-Levy had

never written a tax impact letter for anyone other than the

Groesbeck organization, and (f) that Carlin-Levy had performed

internal accounting services for all of the Groesbeck corporations.

The court finds that these alleged omissions were not material

because it is not customary in the accounting profession, when pre-

paring a tax impact letter, to include this type of information

because the tax opinion letter was prepared only for a “proposed”

limited partnership venture. It was a representation of the tax

consequences of prepaid interest and losses and not a warranty

on the location or condition of the property. The information in

the letter was shown by the evidence to be accurate and the de-

ductions represented were allowed by the IRS.

Plaintiffs have failed to establish by a preponderance of the

evidence that the alleged misrepresentations or omissions in this

footnote would be material to the investment decision of a man

of ordinary prudence and intelligence under the circumstances

in this case.

partner of Cinco Villa limited partnership when, in re-

ality, A. J. Groesbeck Association of Utah, Inc., subse-

quently became the general partner. Alth ugh this rep-

resentation was corrected in the December 12, 1969, sales

brochure and in voluminous correspondence subsequent

to plaintiffs’ investment, this court finds that this repre-

sentation could have been material to plaintiffs in making

their investment decision. That is, as objectively mea-

sured against reasonable investors,’ the plaintiffs’ invest-

ment judgment was likely influenced by the representation

that Groesbeck, a man represented to plaintiffs as being

an experienced and successful financial adviser to large

numbers of professional people, was personally investing

funds in Cinco Villa as the general partner.’® Second, the

tax impact opinion letter used by the Groesbeck organiza-

tion’s sales promotion represented that the property con-

sisted of ‘a 20-unit apartment building” rather than rep-

resenting the property as located in two different loca-

tions."* The Court is unable to say that this misrepre-

sentation was material. Reasonable investors, without the

hindsight that plaintiffs now have that two separate lo-

14. SEC v. Texas Gulf Sulphur Co., 446 F.2d 90, 97 (10th

Cir. 1971).

15. The court does not reach this conclusion without consid-

erable hesitation, especially in light of plaintiffs’ subsequent in-

action upon discovering for certain that Groesbeck was not the

general partner. ;

It seems that if the representation that Groesbeck was going

to personally invest in Cinco Villa as general partner was of

primary significance in the plaintiffs’ investment decision, (as

they testified it was) it is almost inconceivable that they did not

protest upon their discovery of the truth, which at the latest

would have been April, 1970, when each of the plaintiffs received

from Cinco Villa the necessary information to file his 1969 income

tax return. However, the court does not feel that this fact alone

justifies a conclusion that this representation was not material

at the time the investment decision was made in December, 1969.

16. Despite the language “a 20-unit apartment building” the

je impact letter listed both addresses of the two separate com-

plexes.

cations might cause additional management and super-

visorial problems, would not likely be influenced in their

investment decision by the fact that the twenty apartment

units were at two different, although proximate, locations.

SCIENTER

Scienter or “conscious fault’’” is easily found in this

case. Groesbeck indisputably distributed sales material

and reports on the Cinco Villa venture representing him-

self as becoming the general partner when the limited

partnership was organized. Before the execution of the

partnership agreement, as well as after the investments

were made, Groesbeck corresponded with plaintiffs, sign-

ing his name as Cinco Villa’s general partner. Without

doubt Groesbeck knew that he was misrepresenting this

fact.

RELIANCE AND CAUSATION”

The Circuit Court of Appeals has repeatedly expressed

the requirement that “the plaintiff must .. . exercise good

17. See Footnote 11, supra.

18. Undoubtedly the area of federal securities litigation is

better off for not analyzing cases in terms of proximate cause.

However, with the White v. Abrams, 495 F.2d 724 (9th Cir. 1974)

duty analysis in the Ninth Circuit and the brief discussion of

“cause in fact” in the recent Tenth Circuit decision of Clegg v.

SS 3 _- (10th Cir. November, 1974), it seems ap-

propriate to conceptually relate the two approaches with the

following observations:

Causation is an essential element of any tort action. Prop-

erly considered, it has two elements: cause in fact and proxi-

mate cause. Cause in fact embraces both positive acts and

passive conditions which have so contributed to the result that

without them it would not have occurred. Cause in fact is often

expressed as the “but for” test, and courts have felt a need to

limit the “but for” test in its application. Materiality has often

been a limiting factor in this test, and, as such, the test can be

stated in broader terms as: “The defendant’s conduct is a cause

(Continued on following page)

faith in its purchase, due diligence, and demonstrate re-

liance on the acts or inaction of the defendant” to re-

cover in Rule 10b-5 actions. Reliance and causation are

very closely related in some cases. In Mitchell v. Texas

Gulf Sulphur Co., 446 F.2d, at 101-02, the court stated that

“the cases have deemed the ‘connection’ requirement ful-

filled” if the defendant has uttered false or misleading

statements concerning the securities in question, upon

which the plaintiff has relied. This use of the concept of

reliance as a means of finding a connection introduces the

factor of causation. Thus, a plaintiff could rely on a mate-

rial misrepresentation or omission which would cause him

to purchase or sell a security. If the misrepresentation

concerned the value of the security, then the damage could

be said to occur when the purchase or sale was made. In

this example, materiality, reliance and causation would be

closely related sequentially. The materiality and reliance

Footnote Continued—

of the event if it was a material element and a substantial factor

in bringing it about.” W. Prosser, Law of Torts 240 (4th ed.

1971). “Under Rule 10b-5, the materiality and reliance require-

ments are best classified as cause in fact elements.” Cobine,

supra Note 9, at 656.

Proximate cause is a far more complex question because it

involves questions of legal policy. “It has been suggested that

the question of proximate cause is not really a question of causa-

tion at all, but rather a question of whether the defendant was

under a duty to the plaintiff, or whether defendant’s duty re-

quired him to protect plaintiff from the event which did in fact

occur.” Cobine, supra, Note 9 at 653. The proximate cause or

duty question is answered in 10b-5 litigation by the rule itself:

the defendant should not commit any of the acts proscribed in

the rule in connection with the purchase or sale of any security.

Cause in fact and proximate cause (duty) are not new con-

cepts in tort analysis. Both cause in fact and duty must be de-

termined in each case. A tort analysis approach which stresses

either one cannot properly decide a case at the total exclusion

of the other.

19. Financial Indus. Fund, Inc. v. McDonnell Douglas Corp.,

474 F.2d 514, 517 (10th Cir. 1973), citing Mitchell v. Texas Gulf

Sulphur Co., 446 F.2d 90 (10th Cir. 1971) and Gilbert v. Nixon,

429 F.2d 348 (10th Cir. 1970).

could be said to have (1) caused both the decision to buy

or sell and the damages, because (2) the value of the secu-

rity was misrepresented and the (3) damages resulted

merely from either the purchase or the sale. Unlike this

hypothetical case, however, in the instant case it is neces-

sary to make a distinction between reliance on the misrep-

resentations as they caused the investment decision and

the misrepresentations as the cause of the damages sus-

tained. The court finds that plaintiffs, in making their

decision to invest, relied on the misrepresentation that

Groesbeck would be Cinco Villa’s general partner and that

he would be personally investing in the venture.” The

court is unable to conclude, however, that this misrepre-

sentation was in any way connected to the damages

claimed by plaintiffs. Although the misrepresentation was

material and although it was relied upon by plaintiffs in

making their decision to invest, the securities that were

purchased were equal in value to the amount paid for

them. It has not been shown that Groesbeck’s misrepre-

sentation in any way caused plaintiffs’ alleged damages.

That is, Groesbeck was under no duty which required him

to protect plaintiffs from the events which did in fact cause

20. The court concludes that although three of the plaintiffs

had their own advisers review the information concerning the

proposed venture that reliance can still be found since the advisers

could have also relied on the alleged misrepresentations. The

court, however, is unable to say, in view of the evidence pre-

sented, that plaintiffs’ reliance was justified under the facts of

this case. The location of the buildings and the identity of the

general partner were inconsistently represented in the promotional

material. If the contradictions and inconsistencies in the promo-

tional material were so insignificant as not to be noted by the

plaintiffs, then it is likely that plaintiffs relied on something other

than the written materials. Of course, they could have relied

totally on oral representations. The evidence showed that on

December 29, 1969, and prior thereto, plaintiffs were so anxious

to complete negotiations for income tax shelters that they reck-

lessly ignored and disregarded much pertinent information supplied

to them concerning Cinco Villa. At trial, each of the plaintiffs

was, as to certain material facts testified to by him, uncertain,

vague and contradictory.

the alleged damages." This distinction is explained in ap-

plying the “out-of-pocket” theory of damages.

DAMAGES

Although there exists no rigid law of damages under

Rule 10b-5,” actual damages based on the Securities Ex-

change Act of 1934 are measured by the “out-of-pocket

rule.” In Estate Counseling Service v. Merrill Lynch,

Pierce, Etc., 303 F.2d 527, 533 (10th Cir. 1962) the court

stated:

The failure to show actual damages is also a fatal de-

fect in the cause of action based on the Securities Ex-

change Act of 1934, 15 U.S.C. § 78a et seq. That Act

permits recovery of “his actual damages on account

of the act complained of.” “Actual damages,” under

the Federal rule of damages for fraud is the “out of

pocket rule.” In the Federal courts the measure of

damages recoverable by one who through fraud or

misrepresentation has been induced to purchase bonds

or corporate stock, is the difference between the con-

tract price, or the price paid, and the real or actual

value at the date of the sale, together with such out-

lays as are attributable to the defendant’s conduct. Or

in other words, the difference between the amount

parted with and the value of the thing received.

[Citations omitted. ]

According to this theory, the question is not what the

plaintiff might have gained, but what he has lost by

21. See Note 24 infra.

22. In Mitchell v. Texas Gulf Sulphur, 446 F.2d 90, 105

(10th Cir. 1971) the court stated:

[B]ecause of the uniqueness of the litigation, it would be

unwise to set forth a uniform rule [of damage awards] with

broad applications to all securities cases.

being deceived into the purchase; the defendant is

liable to respond in such damages as naturally and

proximately result from the fraud; he is bound to

make good the loss sustained—such moneys as the

plaintiff has paid out, with interest, and any other

outlay legitimately attributable to the defendant’s

fraudulent conduct—but this liability does not include

the expectant fruits of an unrealized speculation.

The sales materials (Exhibits 2, 3 and 4) represented

the purchase price of the Cinco Villa apartment complexes

to be $280,000—the price the limited partnership ultimately

paid for them. The apartment complexes had a market

value equal to the $280,000 purchase price paid for them

in late December, 1969, and they substantially retained

such value thereafter as evidenced by plaintiffs’ own ap-

praiser’s report obtained in December, 1971. Plaintiffs

presented no evidence to show that there was any dis-

crepancy between the price paid and the actual value at

the date of the sale. This failure to show actual damages

based upon the out-of-pocket rule as set forth above is a

fatal defect in plaintiffs’ case.

Plaintiffs’ complaint invalidly seeks a _ rescission

remedy by claiming, contrary to the evidence, that the

investment was totally worthless. When rescission is

sought in actions of this nature, there is a promptness

rule which requires the plaintiff to seek rescission as soon

as fraud or misrepresentation is discovered. In Estate

Counseling Service v. Merrill Lynch, Pierce, Etc., supra

at 532, the court stated:

In view of the speculative nature of the transaction

and with a fluctuating market, the law required the

appellant to act promptly or waive its right to rescind.

Where parties have the right to rescind, they cannot

delay the exercise of that right to determine whether

avoidance or affirmance will be more profitable to

them. This is particularly true where the transaction

is one of a speculative nature. [Citations omitted. ]

So also where a party desires to rescind upon the

grounds of misrepresentation or fraud he must, upon

discovery of the fraud, announce his purpose and ad-

here to it.

Construing the evidence most favorably to plaintiffs’ posi-

tion, all plaintiffs had notice of the alleged misrepresenta-

tions by March or April of 1970 when they received from

Cinco Villa the necessary information to file their 1969

income tax returns. In general, courts have been wary of

claims for rescission, restitution, and equivalent damages

in 10b-5 litigation. To award such a remedy in this case,

in which plaintiffs have delayed action for over two years

after learning of the alleged misrepresentations, would

allow plaintiffs to reap significant tax benefits while spec-

lating on the future of their venture and then return to

them the value of their initial investment when the ven-

ture failed. The securities laws contemplate no such in-

vestment guarantee. The basis of the requirement of

immediacy of action by one who seeks rescission is the

prevention of speculation. The radical relief sought by

plaintiffs in this action is denied.»

23. Cobine, supra Note 9, at 670.

24. Counsel for defendants argued that the Cinco Villa

venture failed because of possible mismanagement, rent and price

controls, and the state of economy which influenced tenancy, etc.

Although these arguments were poorly documented with evidence,

plaintiffs did not offer evidence in opposition. Whatever the

reason for the failure of the Cinco Villa venture, plaintiffs offered

no evidence connecting the failure (which is the real measure of

plaintiffs’ damages, if any) with any of the alleged misrepresenta-

COMMON LAW FRAUD

The law of Utah is well settled as to the necessary

elements of a common law action for fraud and deceit.

Those elements are: (1) a representation; (2) its

falsity; (3) its materiality; (4) the speaker’s knowl-

edge of its falsity or ignorance of its truth; (5) his

intent that it should be acted upon by the person and

in the manner reasonably contemplated; (6) the

hearer’s ignorance of its falsity; (7) his reliance upon

its truth; (8) his right to rely thereon; (9) his conse-

quent and proximate injury. ([Citation]. Estate

Counseling Service v. Merrill Lynch, Pierce, Etc., 303

F.2d 527, 532 (10th Cir. 1962).

Plaintiffs failed to prove these necessary elements by

a preponderance of the evidence. Not unlike an action

based on the Securities Exchange Act of 1934, “[a]ctions

for fraud have failed because of lack of proof of damages.”

Id.

CARLIN-LEVY

Carlin, Levy and Company, Certified Public Accoun-

tants, are charged by plaintiffs as aiders and abetters in

the alleged securities fraud primarily due to the tax im-

pact opinion letter that was used in the sales of the limited

partnership interests. The alleged misrepresentations in

the tax impact letter concerned the location of the apart-

ment complexes and represented Groesbeck as the general

partner. At the close of the plaintiffs’ case, Carlin-Levy

moved to dismiss the action as against it pursuant to Fed.

R. Civ. P. 41(b). This motion was taken under advise-

ment at that time.

The court is well aware that Kerbs v. Fall River

Industries, Inc., 502 F.2d 731 (10th Cir. 1974) states that

under Rule 10b-5, “knowing assistance of or participation

in a fraudulent scheme gives rise to liability equal to

that of the perpetrators themselves” and that “one who

aids and abets a fraudulent scheme may be held account-

able even though his assistance consists of mere silence

or inaction.” Id. at 740. However, plaintiffs have failed

to prove by a preponderance of the evidence that Carlin-

Levy either knew of the alleged fraudulent scheme or

knew of the alleged misstatements in the tax opinion letter

when issued. Rather, the evidence shows that the mis-

representation given to Mr. Levy by the Groesbeck orga-

nization on November 11, 1974, that Groesbeck was to be

the general partner of Cinco Villa, accurately reflected

the expectations of the Groesbeck organization as of that

date. The subsequent change in the proposed general part-

ner which resulted when A. J. Groesbeck Associates of

Utah, Inc., was organized in December, 1969, could not

have been reflected in the November 13, 1969, opinion

letter. Plaintiffs have failed to present convincing evi-

dence showing that Carlin-Levy could reasonably have

been expected to know of the alleged fraudulent scheme.

Therefore, Carlin-Levy’s motion to dismiss is now granted

and it is dismissed from the case.

No evidence was adduced at trial that would enable

the court to make a separate finding concerning the liability

of Peter Reid, the Groesbeck agent in Utah. Reid’s liabil-

ity is therefore determined in conjunction with Groesbeck

and the Groesbeck organizations. The record is not clear

whether some of the defendants are presently named as

parties in bankruptcy proceedings in California. Judgment

in this case, therefore, should be entered subject to mod-

ification if it is subsequently shown that all actions against

any of the defendants have been stayed.

Based upon the foregoing, judgment should be ren-

dered for defendants, no cause of action on plaintiffs’ com-

plaint. :

DATED this 18th day of December, 1974.

/s/ Aldon J. Anderson

Aldon J. Anderson

United States District Judge

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.