# Petition — Verit Industries v. Ohashi

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1976
- **Citation:** 429 U.S. 1004

## Text

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-

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385004_0483%3A1. Public record. Not legal advice.