Petition — Verit Industries v. Ohashi

MICHAEL RODAK, JR. CLERK

anf

IN THE SUPREME COURT OF THE UNITED STATES

October Term, 1976

Verit Industries and Marvin Cobb,

Petitioners,

Ve

Joe Ohashi

Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Ninth Circuit

Fierstein & Sturman

Herbert D. Sturman

1€88 Century Park East

Los Angeles, CA 90067

Lederer & Levy

Thomas M. Norminton

433 North Camden Drive

Beverly Hills, CA 90210

Attorneys for Petitioner.

Opinions Below . . > * . . . . . . . . . 2

nr. « -« ole « #4 s & 6 * «2 =

Questions Presented .......... 2

Statutory and Rules Provisions

Involved . . . o . . * . . . *. . . 4

Statement of the Case ......e«.«.«-.

6

Be We PGs 2 © ce eo ee eee aS

B. The Rulings Below. ...... 7

Reasons for Granting the Writ .....1l

ee a ee a a ee

Appendix A - The Opinion of the

Court of Appeals for the

Mime GaeGeee« -- so ee eeeveeee

Appendix B - The Opinion of the

District Court of the Central

District of California ...... 38

INDEX TO CITATIONS

Cases: Page

Birnbaum v. Newport Steel Corp.,

139 Fi3d 461 (om nd Cir. 1952),

Cert. Denied 343 U.S. 959 (1952) .11

Blue Chip Stamps v. Manor Dru

Store, yal U.S. 723 C1578) >» « 46, 39

-i-

Davis v. Davis, 526 F.2d 1286

foe Gar. BOPO) « © 6 ec

Superintendent of Insurance v.

Banker's Life and Casualty

Company, 404 U.S. 6 (1

Statutes:

15 BeBe Ee § 785 (b). + . . « .

28 U.S.C. §1254(1) .....

‘Rules:

Rule 10b-5 of the Securities

and Exchange Commission

Miscellaneous:

l Bromberg, Securities Law:

Fraud S.E.C. Rule 10b-5

Section 4.7 (571) ...

1 Bromberg, Securities Law:

Fraud, S.E.C. Rule 10b-5

Section 4.7 (574)(3). .

alia

) .

>a)

IN THE ae COURT OF THE UNITED STATES

October Term 1976

No.

VERIT INDUSTRIES and MARVIN COBB,

Petitioners,

vs.

JOE OHASHI

PETITION FOR A WRIT OF CERTIORARI TO

THE COURT OF APPEALS FOR THE NINTH

CIRCUIT

To the Honorable, the Chief Justice, and

the Associate Justices of the Supreme Court

of the United States,

The petitioner, VERIT INDUSTRIES,

respectfully prays that a Writ of Certio-

rari issue to review the judgment and

opinion of the United States Court of

Appeals for the Ninth Circuit, entered

in this proceeding on May 25, 1976.

OPINIONS BELOW

The opinion of the Court of Appeals,

as yet unreported, appears at Appendix A,

infra, page 19. The opinion of the Dis-

trict Court of the Central District of

California is unreported, and appears at

Appendix B. infra, page 38. The Court of

Appeals affirmed part, and reversed part,

of the judgment of the District Court.

JURISDICTION

The order of judgment of the Court of

Appeals for the Ninth Circuit was entered

on May 25, 1976. See Apendix A, page 19,

infra. This petition for certiorari was

filed less than 90 days from the date

aforesaid. The jurisdiction of this Court

is invoked under 28 U.S.C. Section 1254(1).

QUESTIONS PRESENTED

This case presents the question of

o2eo

whether a covenant of good faith and fair

dealing, implied by state law, can keep an

otherwise completed exchange of stock con-

tract executory to provide a sufficient

"touching" between the exchange of stock

and petitioner's allegedly fraudulent acts

to satisfy the "in connection" requirement

of the Securities Exchange Act of 1934,

Section 10b, 15 U.S.C. Section 78)j(b) and

S.E.C. Rule 10b-5, 17 C.F.R., Section

240.10b-5. Thus, in 1968, petitioner

Verit Industries acquired Commerce-Pacific,

Inc., and, as part of the acquisition

agreement, respondent Ohashi exchanged his

Commerce-Pacific, Inc. common stock for

common stock of Verit Industries bearing a

restrictive legend. When Ohashi sought

removal of the restrictive legend on the

stock, more than two years after the

exchange of stock pursuant to the acqui-

sition agreement, he allegedly was met

with false assurances, misrepresentations,

= 3-2

and inaction on the part of petitioner.

Respondent contends these actions violated

the federal securities law.

STATUTORY AND RULES PROVISIONS INVOLVED

Section 78j(b) of the Securities and

Exchange Act of 1934, 15 U.S.C. Section

783(b), provides in pertinent part:

"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 - ...

"(b) To use or employ, in

connection with the purchase 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-

o4e

|

vention of such rules and regula-

tions as the Commission may pre-

scribe as necessary or appropriate

in the public interest or for the

protection of investors."

Rule 10b-5 of the Securities and

Exchange Commission, dealing with employ-

ment of manipulative and deceptive devices,

provides as follows:

"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 a national secur-

ities exchange,

(1) To employ any device,

scheme or artifice to defraud,

(2) To make any untrue

statement of a material fact or

to omit to state a material fact

necessary in order to make the

oS<

statements made, in the light of

the circumstances under which

they were made, not misleading, or

(3) To engage in any act,

practice or course of business

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 is an action seeking damages

under Section 10(b) of the Securities and

Exchange Commission Act of 1934 (15 U.S.C.

Section 78j(b) and Securities and Exchange

Commission Rule 10b-5 and for common law

fraud, conversion, conspiracy, and dis-

paragement.

The allegations of respondent's com-

plaint may be briefly summarized: In

August of 1968, respondent became the

owner, individualiy and as custodian for

a6

certain of his children, of 7,784 shares

of Verit Industries stock. These shares

were subject to a legend restriction which

prohibited sale or transfer of these shares

unless they were registered with the S.E.C.,

Or exempt from registration.

In December, 1970, respondent conveyed

his intention to petitioner that he desired

to sell his shares of Verit stock, and he

requested petitioner to remove the trans-

fer restriction from his shares. Peti-

tioner then embarked upon a fraudulent

scheme to dissuade and prevent respondent

from taking any legal action or otherwise,

to have the transfer restrictions removed.

The Rulings Below

The District Court ruled (see Appen-

dix B, infra, page 38) that respondent's

cause of action based on Section 10b of

the Securities and Exchange Act of 1934

(15 U.S.C. Section 78j(b) and Rule 10b-5,

17 C.F.R. 240.10b-5) failed to state a

cause of action because respondent was

neither a purchaser or seller within the

meaning of the Act.

The Court in a Memorandum opinion

granting petitioner's motion to dismiss

the complaint held that although respon-

dent alleged that he would not have pur-

chased the Verit stock except for the

defendant's representation, the allega-

tions of fact indicated that the alleged

misrepresentations were first made long

after the original purchase. Furthermore,

the Court held that since the facts

alleged only show that respondent was

induced not to sell the stock because of

petitioner's representation, respondent

could not be a seller within the meaning

of the Act.

Since jurisdiction for respondent's

common law causes of action was based on

the doctrine of pendent jurisdiction, they

/

were dismissed once the federal cause of

action was held to fail to state a cause of

action.

The Court of Appeals in a yet unreported

decision (see Appendix A, infra, page 19),

agreed with the District Court that respon-

dent could not state a Section 10b or

Rule 10b-5 claim based on an inability to

sell or offer to sell Verit stock, even if

his inability was caused by petitioner's

fraudulent or deceptive acts. Nor could

respondent state a cause of action for the

diminished value of the stock that he

eventually sold to third persons, since

the complaint failed to make any showing

that connects any of the alleged fraudulent

activities to these sales.

However, the Court of Appeals found

that respondent's complaint stated a cause

of action for fraud in connection with the

original acquisition of Verit stock by

respondent. The Court reasoned that since

California law implies a covenant of good

faith and fair dealing in every contract,

whereby a party will do nothing to injure

the right of any other to receive the bene-

fit of the agreement, and each will do

everything that the contract presupposes

that he will do to bring the bargain to

fruition, respondent could not get the full

value of his bargain until he could sell his

Verit stock. Thus, under these circum-

stances, petitioner's implied covenant of

good faith continued and the exchange con-

tract remained executory, until the restric-

tions were removed, or until they could

have been removed, with the cooperation of

Verit. Since the contract was still execu-

tory, the alleged fraud was in connection

with the purchase or sale of securities

within the meaning of Section 10b and Rule

10b-5 and respondent pleaded enough facts

to withstand a motion to dismiss.

-10-

REASONS FOR GRANTING THE WRIT

I

Certiorari Should Be Granted in Order

To Delimit The Scope Of The "In Connection"

Requirement Of Rule 10b-5.

Historically, when faced with the pro-

blem of deciding how closely related the

misconduct must be to the security transact-

ion in order to satisfy the "in connection"

requirement of Rule 10b-5, courts either

took a strict view and refused jurisdiction

when the connection was not direct (c.f.

Birnbaum v. Newport Steel Corp., 139 F.2d

461, 463 (2nd Circuit 1952), Cert. Denied

343 U.S. 959 (1952)), or a liberal inter-

pretation of the Rule thus permitting

a greater number of suits to be brought

under Rule 10b-5. 1 Bromberg, Securities

Law: Fraud S.E.C. Rule 10b-5 Section 4.7

(571). Whichever position a court took it

did so without guidance from this Court.

-ll-

Such was the state of the law until

this Court's decision in Supt. of Insurance

v. Banker's Life and Casualty Company, 404

U.S. 6 (1971). There, faced with the

mechanical mode of interpretation and

with the strict result it produced in the

District and Appellate Courts, this Court

reversed the lower courts and substituted

instead an open-ended concept of "touching"

at pages 12-13, when it said: "The crux

of the present case is that Manhattan

suffered an injury as a result of deceptive

practices touching its sale of securities

as an investor."

The consequences of the decision in

Banker's Life is still reverberating through-

out the lower courts. In the words of Pro-

fessor Bromberg:

"While the Court annihilated

the restrictions imposed on '‘'con-

nection’ by the lower courts, it

o) Re

avoided explicitly creating any of

its own. By using ‘touching’ as

a synonym, 404 U.S. 12-13, it

suggested that ‘'connection' can be

very tenuous indeed. Thus we are

left with a very open-ended concept

save for limits which might be

inferred from some of the phrase-

ology, particularly the references

to Manhattan ‘as an investor'.

Given the statutory base for this

phrase, it is probably the critical

element in delimiting ‘connection’.

Even with this clue, trying to

devise a test of ‘connection’ is

risky, both because the Court refused

to do so and because the situa-

tions to which it must apply are so

various." 1 Bromberg, Securities

Law: Fraud S.E.C. Rule 10b-5 Section

4.7(574) (3).

o}) 3a

_

Since Banker's Life, lower courts have

had to deal with the "connection" issue

on case by case basis without any guidelines

from this Court. This willingness to allow

for case by case analysis in this area,

is in direct contrast with this Court's

unwillingness to allow such development

of the law in the purchaser and seller area.

In Blue Chip Stamps v. Manor Drug Store,

421 U.S. 723, 44 L.Ed 539, 95 S.Ct. 1917,

(1975) after noting that there has been

widespread recognition that litigation

under Rule 10b-5 presents a danger of

vexatiousness different in degree and

in kind from litigation in general, and

after discussing the legislative history

of Sections 10b and Rule 10b-5, this Court

finally concluded:

"Were we to agree with the

Court of Appeals in this case, we

would leave the Birnbaum rule open

to endless case-by-case erosion

=Y=

depending on whether a particular

group of plaintiffs were thought

by the court in which the issue

was being litigated to be suffi-

ciently more discreet than the

world of potential purchasers at

large to justify an exception. We

do not believe that such a shift-

ing and highly fact-oriented dis-

position of the issue of who may

bring a damages claim for viola-

tion of Rule 10b-5 is a satisfac-

tory basis for a rule of liability

imposed on the conduct of business

transactions. Nor is it as con-

sistent as a straightforward ap-

plication of the Birnbaum rule

with the other factors which sup-

port the retention of that rule."

Blue Chip Stamps v. Manor Drug

Store, Supra, page 755.

- Aad

Despite this Court's refusal to set

-15-

et

guidelines for "connection" in Banker's

Life, nonetheless, the “connection” require-

ment must have some boundaries. Without

adequate boundaries lower courts will

always be able to search the complex fact-

ual situations usually involved in Rule

10b-5 actions and find some "connection"

between the alleged misconduct and the pur-

chase and sale of securities, no matter

how tenuous it may be. A prime example of

the type of abuse possible is the instant

case. There the Court of Appeals for the

Ninth Circuit found that an implied cove-

nant of good faith and fair dealing kept

an otherwise completed stock exchange con-

tract executory and that executory contract

provided sufficient "touching" between the

alleged misconduct and the securities trans-

action to satisfy the "connection" require-

ment. While at least one other court has

held that an executory contract satisfies

the "connection" requirement, Davis v.

Sy =

Davis, 526 F.2d 1286, 1290 (5th Cir. 19765),

Davis is clearly distinguishable from the

case at bar. In Davis, the contract had

been entered into but payment had not yet

been made pursuant to the contract. The

purpose of the alleged scheme was to reduce

the amount of the payment due. Thus, the

misconduct was more directly related to

the transaction than in the instant case.

Furthermore, the plaintiff in Davis was

only seeking injunctive relief. Histori-

cally, the standards for bringing a suit

under 10b-5 for injunctive relief have

always been more lenient than where money

damages are sought.

Thus, the Court of Appeals in the

instant case has stretched the “in connec-

tion" requirement to an unprecedented

length. By its decision, it allows vexa-

tious litigation in the back door after

this court in Blue Chip Stamps shut the

front door on such suits. The only way

ole

that these types of cases can be stopped,

and the case by case erosion of the "in

connection” requirement be stopped, is for

this Court to provide guidelines for deter-

mining the scope of the "in connection"

requirement.

CONCLUSION

For these reasons, a Writ of Certio-

rari should issue to review the judgment

and opinion of the Court of Appeals for

the Ninth Circuit.

Respectfully submitted,

By

Herbert D. Sturman

Fierstein & Sturman

1888 Century Park East

Los Angeles, CA 90067

Lederer & Levy

Thomas M. Norminton

433 North Camden Drive

Beverly Hills, CA 90210

o19<

APPENDIX A

Opinion of the United States Court

Of Appeals for the Ninth Circuit

Entered May 25, 1976

UNITED STATES :‘QOURT OF APPEALS

FOR THE NINTH CIRCUIT

JOE OHASHI, )

)

Plaintiff and Appellant, )No. 74-2027

)

vs. OPINION

tion, BERJ HAGOPIAN, EDWARD

L. CLABAUGH, MARVIN COBB,

ROBERT O. MARSHALL, and UNITED)

STATES STOCK TRANSFER CORPORA-)

TION, a corporation, )

)

Defendants and Appellees.)

)

)

)

VERIT INDUSTRIES, a corpora- )

)

)

Appeal from the United States District

Court for the Central District of

California

Before: BARNES and HUFSTEDLER, Circuit

Judges, and SKOPIL,* District

Judge

“Honorable Otto Skopil, Jr., District

of Oregon, sitting by designation.

-19-

HUFSTEDLER, Circuit Judge:

Ohashi appeals from the dismissal of

his damages claims for failure to state a

claim for relief under the federal secur-

ities laws (Securities Exchange Act of

1934, §10b, 15 U.S.C. §78j(b), and SEC

Rule 10b-5, 17 C.F.R. §240.10b-5) and for

want of jurisdiction of the common law

tort claims. The defendants are Verit

Industries, a corporation ("Verit"); three

of its directors and officers, Hagopian,

Clabaugh, and Cobb; United States Stock

Transfer Corporation ( Stock Transfer")

and its president, Marshall.

The district court held that the

Birnbaum rule (Birnbaum v. Newport Steel

Corp. (2d Cir. 1952) 193 F.2d 461) barred

relief under Section 10b and Rule 10b-5;

with the demise of the federal claim, the

pendent state claims were also dismissed.

We agree with the district court's

disposition of all theories of federal

-20-

* securities relief, save one: Verit's fraud

was alleged to have impaired the consider-

ation for the exchange of securities after

the securities had been transferred to

Ohashi, but while the contract was still

executory. That alleged fraud was "in con-

nection with the purchase or sale of any

securities” within the meaning of Section

10b and Rule 10b-5. The complaint ade-

quately pleaded enough facts to withstand

the motion to dismiss filed by Verit,

Hagopian, Clabaugh, and Cobb on this

theory.

In substance, the pleadings recited

the following facts, the truth of which is

presently assumed. Ohashi was the majority

stockholder of Commerce-Pacific, Inc.

("Commerce") when Tanger Industries (now

Verit) undertook to acquire Commerce in

1968. Ohashi's Commerce stock was then

worth about $300,000. As a part of the

acquisition agreement of May 13, 1968,

@2ie

Ohashi exchanged his Commerce stock for

shares of Verit's one dollar par common

stock. Although Verit's common stock was

being publicly traded, the shares issued

to Ohashi were not registered with the SEC;

that block of stock was issued pursuant to

the private offering exemption of Section

4(2) of the Securities Act of 1933. (15

U.S.C. §77d(2).) An integral part of the

exchange agreement was the provision

requiring Ohashi to execute an "Investment

Letter" wherein he agreed not to transfer

his Verit shares until (1) he had given a

detailed statement of facts surrounding

the proposed transfer to Verit, and had

received a written opinion from Verit's

counsel stating that the proposed trans-

action would not violate federal securities

regulations, or (2) he had received a "no

action" letter from the SEC. The follow-

ing legend and transfer restriction was

placed on his shares:

o22e

"No sale, offer to sell or trans-

fer of the shares represented by

this certificate shall be made

unless a registration statement

under the Federal Securities Act

of 1933, as amended with respect

to such shares is then in effect

Or an exemption from the regis-

tration requirements of such Act

is then in fact applicable to

such shares."

Verit instructed its transfer agent,

Stock Transfer, that none of Ohashi's stock

could be sold, offered for sale, or trans-

ferred without Verit's express authoriza-

tion.

From December, 1970, until January,

1972, Ohashi repeatedly inquired about

removal of the restrictions and was falsely

assued by the Verit defendants that removal

was imminent or that they were taking

appropriate steps in that direction. In

November, 1971, Ohashi sent Verit a "no

action" letter from the SEC. The Verit

defendants continued their inaction and

false assurances of their intent to per-

form. When relief was still not forth-

@23<

coming, Ohashi was coercively induced to

enter an escrow agreement in January, 1972,

whereby he agreed to removal of the restric-

tions on a piecemeal basis. Ohashi avers

that all of these misrepresentations were

made to further a conspiracy among the

defendants to keep Ohashi's stock off the

market and thereby to limit the "public

float" of Verit's stock for the purpose

of artificially raising the price of the

publicly traded stock. The restrictions

were removed on January 12, 1972, but, by

that time, the defendants’ manipulations

of publicly traded Verit stock were under

investigation which culminated in the SEC's

suspending trading in Verit on May 18, 1972.

During the period from August l, 1972

to October 31, 1973, Ohashi sold about one-

third of his Verit stock to third persons.

At the time he acquired his stock, Verit

common stock was trading at $14 per share,

but when he sold it, the price had fallen

@24-

to $1.50 per share.

For claimed fraud in connection with

the purchase and sale of securities, he

sought compensatory and punitive damages

and attorney's fees.

The district court correctly held

that Ohashi could not state a Section 10b

Or Rule 10b-5 claim based on his inability

to sell or offer to sell his Verit stock

to third persons, even if his inability

was caused by defendants' fraudulent or

deceptive acts. As to these nonsales,

Ohashi was neither a buyer nor a seller

of securities, and the Birnbaum fule fore-

closed his claim. (Blue Chip Stamps v.

Manor Drug Stores (1975) 421 U.S. 723.)

Likewise correct was the dismissal of

his Section 10(b) and Rule 10b-5 claim

based on the diminished value of the stock

that he sold to third persons. He was a

seller of that stock, but the complaint

fails to make any showing that connects

@25-

any of the alleged fraudulent activities

to these sales. The deceptive conduct

involving his shares occurred between June

1, 1971, when the restrictions were supposed

to be removed and January 12, 1972, when

the restrictions were removed. His sales

did not occur until August l, 1972, and

thereafter. He did not claim that he sold

his shares for less than their market value

at the time of the sales. Rather, his

theory is that the market value of the

stock would have been much higher if the

value of all of the Verit stock, including

his own, had not been impaired by the

wrongful conduct that had occurred before

January 12, 1972. Recovery on this theory

is also foreclosed by the Birnbaum rule.

(Birnbaum v. Newport Steel Corporation,

supra.)

As the Supreme Court explained in Blue

Chip Stamps, supra:

-26-

"Three principal classes of poten-

tial plaintiffs are presently

barred by the Birnbaum rule...

Third are shareholders, creditors,

and perhaps others related to an

issuer who suffered loss in the

value of their investment due to

corporate or insider activities in

connection with the purchase or

sale of securities which violate

Rule 10b-5. It has been held that

shareholder members of the...

third of these classes may fre-

quently be able to circumvent the

Birnbaum limitation through bring-

ing a derivative action on behalf

of the corporate issuer if the latter

is itself a purchaser or seller of

securities." (Blue Chip Stamps v.

Manor Drug Stores, supra, 421 U.S.

at 738-39.)

Ohashi is within the "third class" in

respect to his own sales, and he cannot

circumvent Birnbaum in this action. It

does not purport to be a derivative suit.

One theory remains: Was there fraud

"in connection with" the Verit stock that

he acquired in exchange for his Commerce

stock?

If the exchange had been fully exe-

cuted upon Verit's issuance of its stock

to him and his transfer to Verit of his

o2Ja

Commerce stock, the answer would be "No."

Ohashi does not contend that the defendants

fraudulently incuded the exchange or that

any fraud tainted the initial restrictions

placed upon his Verit stock. The fraud of

which he complains occurred after the ex-

change; the subsequent illegal conduct was

not in connection with the inducement nor

concurrently with the exchange.

However, if the contract by which

Ohashi acquired Verit stock was still exe-

cutory when the fraudulent activities

occurred and if those acts affected the

unperformed part of the bargain, the fraud

may be "in connection with the sale or

exchange of any securities." If the con-

tract was still executory, a sufficient

contractual relationship existed. It is

clear by our prior decision in Mount Cle-

mens Industries, Inc. v. Bell, 464 F.2d

339 (9th Cir. 1972), that “the existence

of a contractual relationship between the

-28-

parties [is an essential element to ele-

vate] the plaintiffs to the status of

statutory purchasers or sellers." (id. at

345.) We turn to the law of California,

where the contract was made, to decide

whether the contract was executory and then

to federal law to ascertain whether the

alleged fraud was in connection with the

exchange of securities.

Under California law, every contract

contains an implied covenant of good faith

and fair dealing whereby no party will do

anything to injure the right of any other

to receive the benefits of the agreement,

and each will do everything that the con-

tract presupposes that he will do to bring

the bargain to fruition. (Crail v. Blakely

(1973) 8 Cal. 3d 744, 749-50, 106 Cal.

Rptr. 187, 191; Berkeley Lawn Bowling

Club v. City of Berkeley (lst Dist. 1974)

42 Cal. App. 3d 280, 286-87, 116 Cal.

Rptr. 762,766.) The exchange contract

-29-

presupposed that Ohashi could not receive

the full benefit of his bargain until the

transfer restrictions were lifted. But,

Verit could not permit removal until a

transfer of Ohashi's Verit stock would not

place it in danger of violating the Secur-

ities Act of 1933. Under the private

offering exemption, the stock issued to

Ohashi was not registered, and if the terms

of the exemption were not met, Verit would

have been in violation of the Act. The

removal of the restrictions could not

legally have occurred for a substantial

period of time; it was anticipated that

the condition would not be met until 1971.

Although Verit did not have any express

contractual duty to remove the restrictions,

its cooperation was necessary to permit

removal as soon as feasible. Under these

circumstances, Verit's implied covenant of

good faith continued and the exchange con-

tract remained executory (see 1 B. Witkin,

-30-

Summary of California Law, §6 (8th ed.

1973), but see 1 Williston on Contracts,

§14 (3d ed. 1957)) until the restrictions

were removed, or until they could have been

removed with the cooperation of Verit.

(Cf. Riess v. Murchison (9th Cir. 1974) 503

F2d 999, 1011-1012.) Thus, the exchange

contract will still executory at least

until sometime in 1971, and, perhaps,

later.

The alleged false representations by

Verit, acting through Hagopian, Clabaugh

and Cobb relating to the acts done by Verit

to remove the restrictions and with respect

to Verit's intentions in acting to remove

them were made between December, 1970,

and January 12, 1972. At this stage of

the pleading, we cannot ascertain whether

all of the misrepresentations were made

while the contract was alive, but some of

them were made before the restrictions

were or could have been removed.

@3le

Not every failure to perform a con-

tractual covenant in a contract to sell or

exchange securities can become a basis for

a claim that a defaulting party has em-

ployed a "device, scheme, or artifice to

defraud" within the meaning of Rule 10b-5,

let alone a claim for common law fraud .2/

"(W]hether there is actionable fraud or a

mere breach of contract depends on the

facts and circumstances developed at the

trial or on motion for summary judgment."

(A.T. Brod & Co. v. Perlow (2d Cir. 1967)

375 F.2d 393, 398.) Especially is this

observation true in a situation like this

one in which it is alleged that active mis-

representations were made to Ohashi and

marked manipulations were wrongfully under-

taken as an accompaniment to nonperformance

of the implied covenant. (Cf. Allico

+/a.L.I. Restatement (Second) Torts

§§ 525-45A (Tentative Drafts 10, 1964 &ll,

1965).

@32-

National Corp. v. Amalgamated Meat Cutters

and Butcher Workmen of North America (7th

Cir. 1968) 397 F.2d 727, 1 A. Bromberg,

Securities Law: Fraud, §4.6(230) at 82.1

(1975) .)

The alleged misrepresentations of

Verit and Verit's named officers and direc-

tors were made in connection with the still

executory covenant of good faith and fair

dealing in the 1968 exchange agreement.

These averments together with the asserted

detriment to Ohashi were enough to with-

stand Verit's and its directors' and

officers' motion to dismiss Ohashi's Sec-

tion 10(b) and Rule 10b-5 claim.

However, the defendants' attack upon

the complaint for deficiencies in the

damage averments is well taken. As pre-

sently drafted, the complaint does not

specifically relate the alleged fraud in

connection with the 1968 exchange to iden-

tified out of-pocket loss suffered by him

-33-

as a consequence of the fraud. (Estate

Counseling Service Inc. v. Merrill Lynch,

Pierce, Fenner & Smith, Inc. (10th Cir.

1962) 303 F.2d 527. See Sackett v. Beaman

(9th Cir. 1968) 399 F.2d 884, 891.) We

have no reason to believe at this time that

these defects cannot be cured by amendment

on remand.

Nothing we have said saves any federal

claim against United States Stock Transfer

Corporation or its president, Robert O.

Marshall. These defendants were not par-

ties to the exchange agreement, and no

act of theirs is alleged that tied them

into any deception or unfair dealing in

connection with that exchange. The federal

claim and the pendent state claims were

correctly dismissed against them.

The order dismissing the complaint

against United States Stock Transfer Cor-

poration and Robert O. Marshal is affirmed,

and they shall have their costs on appeal.

o3go

The order dismissing the appeal

against Verit, and the individually named

officers and directors of Verit is affirmed

in part, reversed in part, and remanded to

the district court for further proceed-

ings consistent with the views herein

expressed .2/ These parties and Ohashi shall

each bear their own costs on appeal.

2/Because we find the securities law

Claim does not fail to state a claim, the

district court retains its pendent juris-

diction over the state law claims against

Verit and its officers and directors.

= 3S-

Ohashi v. Verit Industries, Inc. -

No. 74-2027

SKOPIL, District Judge, Dissenting:

I must respectfully dissent.

The existence of a contractual rela-

tionship is crucial to plaintiff's federal

cause of action. As the majority recog-

nizes, its decision is correct only if

the 1968 exchange contract was still

executory when the alleged fraud occurred.

Clearly, as express agreement by Verit to

remove the stock transfer restrictions

would have rendered the contract executory.

But the contract contained no such agree-

ment. The express terms of the contract

had already been fully performed when the

alleged fraud occurred. Even acknowledg-

ing that every contract contains an implied

covenant of good faith and fair dealing,

I do not believe that any implied duty

sufficient to make the contract executory

exists under the facts of this case.

@36<

I would affirm the decision of the APPENDIX B

district court. Opinion of the United States District

Court for the Central District of

California

UNITED STATES DISTRICT COURT

CENTRAL DISTRICT OF CALIFORNIA

JOE OHASHI,

Plaintiff, No. 73-2701-JWC

vs. MEMORANDUM GRANT-

ING DEFENDANTS '

MOTION TO DISMISS

THE COMPLAINT.

‘ VERIT INDUSTRIES, Inc.,

et al.,

‘ Defendants.

ROBERT O. MARSHALL,

Cross Claimant,

vs.

VERIT INDUSTRIES, etc.,

et al.,

Cross Defendants.

me ee ee ee ee ee ee ee ee”

This is a security fraud case brought

by a stockholder against the issuing cor-

poration and its officers. The complaint

-37]- -38-

consists of 13 counts. The first through

the third and sixth through the eighth

counts allege common law fraud under Cali-

fornia law. The fourth, fifth and ninth

counts appear to allege common law conver-

sion. The tenth and twelfth counts purport

to accrue under common law rules with res-

pect to civil conspiracy, while the thir-

teenth count alleges common law disparage-

ment (i.e., slander of title close). Only

one, the eleventh claim attempts to state

a federal claim for relief.

Since there is no diversity alleged,

plaintiff is apparently relying upon the

doctrine of pendent jurisdiction to main-

tain his twelve state claims in this court.

Turning our attention, then, the

plaintiff's eleventh claim, plaintiff

seeks relief for an alleged violation of

§l10(b) of the Securities Exchange Act of

1934 [15 U.S.C. §78j(b) and Rule 10b-5, 17

C.F.R. 240.10b-5].

-39-

In general, the complaint alleges that

in August of 1968 the plaintiff, Ohashi,

became the owner, individually and as cus-

todian for certain of his unidentified

children, of 7,784 shares of Verit stock.

These shares were subject to a legend res-

triction, which prohibited sale or transfer

until they were registered with the S.E.C.

Or exempted from registration. Plaintiff

further alleges that between February 1969

and October 1971 he acquired an additional

16,141 shares as a result of a stock split

and two stock dividends. In December 1970,

the plaintiff decided to sell a portion of

his shares, but he alleges he was prevented

from doing so because of the restrictions

on the stock.

The alleged misconduct of defendants

is stated in a variety of ways throughout

the complaint. However, the thrust of the

argument is that although the defendants

represented that they would obtain a

-~40-

release of the restrictions on the stock,

and although they had a reasonable time

within which to do so, they have failed to

take the necessary steps to bring it about.

The plaintiff's eleventh claim fails

to state a cause of action, for it fails

to allege facts from it would appear that

the plaintiff is either a purchaser or a

seller within the meaning of the Act.

Although plaintiff asserts that he

would not have purchased the stock except

for the defendants' representations, the

allegations of fact indicate that the

alleged misrepresentations were first made

to the plaintiff in December 1970, long

after his original purchase of the stock.

He therefore is not a purchaser.

The plaintiff also alleges that he is

a defrauded seller of securities in that

he was induced not to sell the stock

because of the representations. The plain-

tiff relies on Mount Clemens Industries,

ogle

Inc. v. Bell, 464 F.2d 399 (9th Cir. 1972).

This case holds that while ordinarily a

stockholder who is persuaded not to sell

his stock is not a seller within the mean-

ing of the Act, if he has been induced to

enter into an agreement to either purchase

or sell securities, then he is either a pur-

chaser of a seller within the statutory

definition. But here there is no such

agreement. Plaintiff refers vaguely to

some contractual right which he has to sell

the stock on the open market, but this is

a far cry from an agreement to buy and sell

stock as would make the plaintiff a buyer

or seller within themeaning of Rule 10b-5.

Actually, the conduct of which the

plaintiff complains is in the nature of a

breach of contract in that the defendants

have failed to do that which they were

obligated to do, either by express or im-

plied agreement, to clear up the restric-

tion endorsed on the stock.

~43e

The facts alleged simply do not fit

the statutory concept of a Rule 10b-5

violation. Defendants' motion to dismiss

is therefore granted.

DATED: April 4, 1974.

JESSE W. CURTIS

United States District

Judge

-43-